SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                 --------------

                                   FORM 10-KSB

|X|   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
      SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]

      For the fiscal year ended December 31, 1996

                                       OR

|_|   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
      SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

      For the Transition period from____________to______________

                         Commission File Number 33-94884

                            COATES INTERNATIONAL LTD.
        (Exact name of small business issuer as specified in its charter)

    Delaware                                         22-2925432
(State or other jurisdiction of                 (IRS Employer
 incorporation or organization)                  Identification No.)

Highway 34 & Ridgewood Road, Wall Township, New Jersey       07719
  (Address of principal executive offices)                    (Zip Code)

Issuer's telephone number, including area code (908) 449-7717

Securities registered pursuant to Section 12(b) of the Act:

                                 Title of Class
                                      None

Securities registered pursuant to Section 12(g) of the Act:

                                 Title of Class
                                      None

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes No X

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-B is not contained  herein,  and will not 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 in any amendment to
this Form 10-KSB. [ ]

For the year ended December 31, 1996, the issuer's revenues were $37,375.

During the year ended December 31, 1996, there was no established public trading
market for the issuer's Series A Preferred  Stock.  On December 31, 1996,  there
were  5,963,600  shares of Series A  Preferred  Stock of the  Issuer  issued and
outstanding.





<PAGE>



                           COATES INTERNATIONAL LTD.

                                    PART I




Item 1.     Description of Business

Background

      Coates International Ltd. ("CIL") has completed the basic development of a
spherical  rotary valve system (the  "Coates  System") for use in piston  driven
internal  combustion engines of all types.  Development of the Coates System was
initiated by CIL's founder,  George J. Coates, in Ireland in the late 1970's. In
1982,  Mr. Coates  obtained a patent from the Republic of Ireland for the Mark I
version of the Coates  spherical  rotary valve  system for use in piston  driven
engines.  In 1986,  George J. Coates  emigrated  to the United  States  where he
commenced  development  of the Mark II version  and  subsequently,  the Mark III
version of his spherical rotary valve system.  Between 1990 and 1994,  George J.
Coates was issued  seven United  States  patents  (the  "Coates  Patents")  with
respect to various  aspects of the Coates  System  including the Mark II and the
Mark III  version.  Mr Coates has also been  issued a number of foreign  patents
with respect to various aspects of the Coates System and has patent applications
pending in several foreign jurisdictions. See "Patents and Licenses."

      CIL  holds a  non-exclusive  license  from  George J.  Coates  and his son
Gregory  Coates,  to  manufacture,  sell and grant  sublicenses  with respect to
products based on the Coates Patents,  within the United States, its territories
and possessions (the "Licensed Areas"). George J. Coates and Gregory Coates have
also agreed, as long as CIL remains  independent and viable, not to compete with
CIL in the manufacture,  assembly,  use or sale of internal  combustion  engines
utilizing the  technology  falling within the scope of the Coates Patents in the
Licensed Areas, or to grant any other exclusive or non-exclusive  license in the
Licensed  Areas except  through  CIL. In addition,  George J. Coates and Gregory
Coates have  executed an  agreement  granting CIL the right to retain any monies
including  royalties  received from Nicholson  McLaren or from Noble Motor Sport
(manufacturer of Ascari racing cars) for  manufacture,  sale, use or assembly of
internal  combustion  engines anywhere in the world using the technology falling
within the scope of the Coates Patents. See "Patents and Licenses."

      CIL and its Predecessor Entity have realized  insignificant  revenues from
the inception of the Predecessor  Entity in August 1988 through the present date
and is a company in the development  stage. In July 1991, CIL signed a prototype
manufacturing  agreement with  Harley-Davidson,  Inc.  ("Harley  Davidson") as a
prelude  to  an  anticipated  license  agreement.   Pursuant  to  the  prototype
manufacturing  agreement, CIL commenced to attempt to retrofit a Harley Davidson
motorcycle engine using the Coates technology.  An initial $150,000  engineering
and  development fee was paid to CIL by Harley  Davidson.  CIL has not, to date,
developed a  retrofitted  Harley  Davidson  motorcycle  engine  using the Coates
technology  that is acceptable to Harley Davidson and no assurances can be given
that an acceptable  engine will be developed or that a license agreement will be
concluded  with  Harley  Davidson.  Under the terms of a February  1994  license
agreement,  CIL received a $500,000 initial payment made by Millwest Corporation
("Millwest")   for  a  license  of  the  Coates  System   technology.   Millwest
subsequently  defaulted  in making the next payment  required  under the license
agreement. In 1996, CIL recognized $37,375 in revenues paid by Nicholson McLaren
in partial payment for two high performance racing car engines modified with the
Coates System  shipped to Nicholson  McLaren by CIL. In April and July 1996, CIL
executed a License

                                      1

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Agreement and a Sales Representative Agreement with Nicholson McLaren.  See 
"Patents and Licenses."

      Since  its  inception,  the  bulk of the  development  costs  and  related
operational  costs of CIL have been funded primarily through cash generated from
the sale of stock, through capital  contributions made by Gregory Coates and the
above  described  payments from Harley  Davidson and Millwest.  As a development
stage  company,  CIL has incurred  losses from the inception of the  Predecessor
Entity in August 1988 through  December 31, 1996 of $13,376,892  and at December
31, 1996, had a negative net worth of ($488,642) and negative working capital of
($2,114,271).


Business Plan

      CIL's ability to generate  revenues and achieve  profitable  operations is
principally  dependent upon the execution and funding of sub-license  agreements
with engine manufacturers or retrofitters, and upon the manufacture and sale, by
CIL, of high performance  automotive,  motorcycle and marine racing engines. CIL
is actively  attempting to market its  technology and is in  communication  with
various persons and entities who may be interested in acquiring  sub-licenses to
use the technology.


      CIL  is  currently   manufacturing  high  performance  automotive  engines
modified  with the Coates System on a limited  basis at its Wall  Township,  New
Jersey manufacturing  facility.  Except as set forth herein, none of the engines
has been  sold.  CIL has  received  numerous  oral and  written  inquiries  from
potential  customers,  expressing  an interest  in  acquiring  high  performance
automotive  racing engines  modified with the Coates System.  After it completes
manufacture of a sufficient  backlog of such engines,  CIL intends to attempt to
convert these inquiries into binding sales orders,  to fill such orders from its
limited  inventory of engines and to continue to  manufacture on a limited basis
and market high  performance  automotive,  motorcycle  and marine racing engines
using the Coates System technology.  Assuming CIL obtains  sufficient  financing
and a sufficient number of orders, CIL management  believes that it will be able
to  produce  racing  engines  using the  Coates  System  technology  at its Wall
Township facility on a limited basis at the rate of approximately 30 engines per
month. CIL expects that the bulk of its initial sales of engines,  to the extent
it is able to  effectuate  same,  will be at a base sales  price in the range of
$25,000 to $30,000 per engine  although  depending on type and size, some of the
engines may be priced as high as $75,000. To achieve such production levels, CIL
will be  required to expand its  production  work force to  approximately  15-20
production workers.

      Assuming its sales develop to a sufficiently  increased level, CIL intends
to  establish  a full scale  production  facility  (presumably  in  central  New
Jersey),  significantly  larger  than  its  present  facility,  at which it will
manufacture high  performance  racing engines modified with the Coates System on
an assembly line basis. Management estimates that CIL will require approximately
$7,500,000 of additional funding to establish and operate such a facility.  Such
funding  would be  required  to  acquire  the  larger  facility  and  production
machinery,  to prepare assembly lines, castings and molds for manufacturing,  to
acquire inventory  including engine blocks and heads,  crank shafts and bearings
and to employ additional production workers,  mechanics,  machine tool operators
and assembly personnel as well as marketing personnel.

      It is the intention of CIL to fund its business plan by borrowings and the
sale of equity and/or debt  instruments,  and through the sale of  sub-licenses.
All of  these  financing  vehicles  will be  pursued  simultaneously.  It is not
presently known which, if any, of these  alternatives will be utilized,  whether
they are available to CIL, and if available, in what mixture or in what amounts.

                                      2

<PAGE>



      In view of its minimal revenues and recurring losses from operations since
inception,  its deficit accumulated during its development stage and its limited
liquid  assets,  no assurances  can be given that CIL will be able to pursue its
business plan. If it does not obtain sufficient liquid assets to fund such plan,
CIL may be  forced  to sell its  assets  or to seek  protection  from  creditors
through a bankruptcy or similar filing.

The Coates System

      The Coates System  differs from the  conventional  poppet valve  currently
used in almost all piston driven automotive,  motorcycle and marine engines,  by
changing the method by which the air and fuel mixture is delivered to the engine
cylinder as well as the method of expelling  the exhaust gases after the mixture
is ignited.  Unlike the poppet valve which  protrudes into the engine  cylinder,
the Coates  System  utilizes  spherical  valves which do not  protrude  into the
cylinder but rotate in a cavity formed  between a two piece  cylinder head. As a
result of  employing  fewer moving parts as compared to the poppet valve and not
protruding into the engine cylinder,  management believes that the Coates System
will promote less engine wear and will require less lubrication over the life of
the engine.  In addition,  because the Coates System does not employ parts which
protrude into the engine cylinder,  it is designed with larger openings into the
cylinder than  conventional  poppet valves so that more fuel and air mixture can
be inducted  into and expelled from the engine  cylinder in a shorter  period of
time using the Coates System, leading to an ability to operate the engine faster
and an  ability to  utilize  higher  compression  ratios  with lower  combustion
chamber  temperatures.  Management  believes that as a result,  engines modified
with the Coates  System will produce more power than similar  engines  utilizing
the poppet valve system.

      Third  Party  Evaluations.  In May 1993,  a team of  Chrysler  Corporation
("Chrysler")  engineers  made a trip to the CIL facility in Wall  Township,  New
Jersey to observe and evaluate the "Coates  Spherical Rotary Valve Train System"
for a possible investment by Chrysler. The Chrysler team recommended that "...no
further  activity should be undertaken by Chrysler at this time..." because of a
lack of documented  proof to substantiate  that the System functions as claimed.
Among  other  factors,   the  Chrysler  team  concluded  that  CIL  required  an
"exorbitant"  up-front licensing fee and vehicle royalty,  that documented proof
of component durability,  system performance and emissions  characteristics were
non-existent and that demonstrated components were not acceptable.  The Chrysler
team  also  concluded  that  the  Coates  System's   kinematics  were  extremely
efficient,  would yield a lower  package  height than a comparable  poppet valve
system  and had  good  emission  development  potential.  In  listing  potential
benefits of the Coates System, the Chrysler team indicated that in comparison to
a poppet valve train system, the Coates System will consist of fewer components,
will reduce the vertical  height of the  cylinder  head and will permit a higher
rotating  speed.  Other cited  potential  benefits of the Coates System included
improved  power  output and idle  quality,  reduced  hydrocarbon  emissions  and
potential  emissions  and fuel economy  benefits.  The Chrysler  team also cited
certain Coates System components as potential  problems for meeting 100,000 mile
durability  goals including the combustion  chamber seals,  the spherical rotary
valves  "especially the exhaust",  and the rotating valve shaft bearings.  Other
cited  potential  problems  included a statement  that the overall weight may be
greater  than  a   comparable   poppet  valve  train  system  and  that  initial
manufacturing costs will be greater than a comparable poppet valve train system.

      Pursuant to a July 1991 prototype  manufacturing  agreement  signed by CIL
with Harley Davidson as a prelude to an anticipated  license  agreement,  Harley
Davidson engineers (according to Harley Davidson) conducted dynamometer tests of
two prototype  motorcycle  engines modified to incorporate the Coates System. In
the fall of 1991,  Harley Davidson advised CIL that relatively early in the test
process, each prototype engine experienced  mechanical durability problems.  CIL
has not,

                                      3

<PAGE>



to date,  developed a retrofitted  Harley Davidson  motorcycle  engine using the
Coates  technology that is acceptable to Harley  Davidson.  No assurances can be
given that an  acceptable  engine will be developed or that a license  agreement
will be concluded with Harley Davidson.

      Test  Results.  An automobile  engine  modified with the Coates System was
tested in  February  and August  1990 and  February  1991 at the  facilities  of
Compliance and Research  Services,  Inc.  ("CRS") an  independent  motor vehicle
testing  contract  laboratory  recognized  by the  United  States  Environmental
Protection  Agency  ("EPA"),  in tests set up to measure power and fuel economy.
The  test  results   indicated   emission   levels  of  pollutants   which  were
substantially   higher  than  maximum  emission  levels  permitted  pursuant  to
regulations adopted by the EPA. However,  the tests conducted were not emissions
tests and the engine of the vehicle being tested had been operated for more than
100,000 miles prior to testing.  Furthermore, the engine tested was not equipped
with an EGR  system or an air  pump,  two  standard  pollution  control  devices
required to be installed  in most  automobiles  operating  on U.S.  roads today.
Subsequently, CRS conducted an emission test in February 1995 on a 1985 Mercedes
engine  modified to utilize the improved  Coates System as compared to a similar
1985 Mercedes engine not so modified.  The test,  conducted on a dynamometer and
characterized  as a "hot start" test,  comprised  only one of the three required
Federal Testing Procedure or "FTP" tests required by the EPA to be passed before
an engine can be manufactured for commercial use in the United States.  The test
results were as follows:

                              Pollutants Emitted
                              (in Grams per Mile)

                        Total             Total CarbonOxides of
                        Hydrocarbons       Monoxide   Nitrogen

Mercedes Engine
with Coates System          .642          1.752       3.069

Mercedes Engine
without Coates System       .978          4.237       3.032

Maximum allowable
EPA emission standards       .41          3.4         1.0

      Although the  Mercedes  engine  modified  with the Coates  System  emitted
substantially  less pollutants than the  non-modified  Mercedes engine in two of
the three  categories and emitted only slightly more oxides of nitrogen than the
non-modified  Mercedes;  in two of the three  pollutant  categories,  the Coates
System  modified  engine  emissions  exceeded  maximum  permitted  EPA  emission
standards. It should be noted that in these preliminary tests conducted in 1995,
neither engine was equipped with an EGR system or an air pump. No assurances can
be given that equipping the Coates System modified engine with an EGR system and
an air pump would have reduced  pollutant  emissions to EPA acceptable levels or
that  continued  developmental  efforts on the Coates  System will reduce  total
hydrocarbon and oxides of nitrogen emissions to EPA acceptable levels.

      A vehicle engine runs  approximately  50% of its life at idle, or close to
idle. Most pollution occurs when vehicles are bumper to bumper, in a stop and go
situation.  This  happens  mainly in cities  where the  majority  of people  and
vehicles  are  concentrated.  The  EPA  has  standards  for  vehicles  in  these
situations.  Every vehicle in the United  States must pass a tailpipe  emissions
test on a regular basis.  On February 26, 1991, a Mercedes 280 equipped with the
Coates System was tested at Glendinning Ultra Service Center, Wall Township, New
Jersey 07719 (a local service station which

                                      4

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is not an independent  motor vehicle testing contract  laboratory  recognized by
the EPA), with results as follows:

                  HC    134 PPM
                  CO    0.22%
                  CO2   14.66%
                  O2    0.0%
                  RPM   1,000

At such time, the maximum EPA limits were:

                  HC    220 PPM
                  CO    1.2%
                  NOx   was not required.

On March 30, 1993  another  tailpipe  test was  carried out with a Mercedes  280
fitted  with the  Coates  System at a local  State of New Jersey  Motor  Vehicle
Inspection  Station  (which is also not an  independent  motor  vehicle  testing
contract laboratory recognized by the EPA), in order to register the vehicle and
the emission levels were as follows:

                  HC    0 PPM
                  CO    .00%
                  RPM   825

Another  test  carried out on the same day at the same  facility  indicated  the
following emission levels:

                  HC    0 PPM
                  CO    .01%
                  RPM   1,264

The  tests  conducted  at the local  service  station  and at the Motor  Vehicle
Inspection  Station  were not  dynamometer  tests and were  conducted  merely to
indicate  how  much  emissions  the  engine  puts  out at idle  or in a  traffic
situation.

Patents and Licenses

      In 1982,  George J. Coates  obtained a patent from the Republic of Ireland
for the Mark I version of the Coates  spherical  rotary  valve system for use in
piston driven internal  combustion  engines. In 1986, George J. Coates emigrated
to the United States where he commenced  development  of the Mark II version and
subsequently the Mark III version of his spherical rotary valve system.  Between
1990 and 1994,  George J. Coates was issued  seven  United  States  patents (the
"Coates Patents") with respect to various aspects of the Coates System including
the Mark II and Mark III version. The Coates Patents are as follows:


                                      5

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                            Date                Date
U.S. Patent No.         Application Filed       of Patent

4,989,576   (Mark I)    July 26, 1982           February 5, 1991
4,953,527   (Mark II)   November 14, 1988       September 4, 1990
4,989,558               September 14, 1989      February 5, 1991
4,944,261   (Mark IIB)  October 16, 1989        July 31, 1990
4,976,232               December 6, 1989        December 11, 1990
5,109,814               May 10, 1991            May 5, 1992
5,361,739   (Mark III)  May 12, 1993            November 8, 1994

      The Mark I, Mark II, Mark IIB and Mark III  patents  were also the subject
of  foreign  filings by Mr.  Coates who has been  issued  foreign  patents  with
respect to some of these filings by Austria,  Belgium, Denmark, France, Germany,
Great Britain,  Greece, Italy,  Luxembourg,  The Netherlands,  Spain, Sweden and
Switzerland as well as by Australia,  Brazil,  Canada,  Hong Kong, Japan, Korea,
Mexico, Singapore,  South Africa and Taiwan. Mr. Coates continues to have patent
applications pending in some of these as well as other foreign jurisdictions.

      In connection with the settlement of the SEC complaint described in Item 3
herein, the final consent judgment executed by George J. Coates permitted him to
retain  title to the  Coates  Patents  as well as all other  patents  pending or
issued with respect to his Spherical  Rotary Valve  technology and future patent
applications  with  respect to such  technology  (collectively,  the  "Patents")
provided  that he  reimburse  CIL for all monies  expended  in the  preparation,
application and/or prosecution of the Patents. Such sums in the aggregate amount
of  $434,639  were  credited  to or paid to CIL in 1995 so that George J. Coates
retained title to the Patents.

      Subsequent thereto, in February 1995, George J. Coates and his son Gregory
Coates each granted CIL a non-exclusive  license to manufacture,  sell and grant
sublicenses  with  respect to products  based on the Coates  Patents  within the
United States, its territories and possessions. The licenses expire in the event
of bankruptcy or similar  insolvency of CIL. George J. Coates and Gregory Coates
have also agreed, as long as CIL remains  independent and viable, not to compete
with  CIL in the  manufacture,  assembly,  use or  sale of  internal  combustion
engines utilizing the technology  falling within the scope of the Coates Patents
in the Licensed Areas, or to grant any other exclusive or non-exclusive  license
in the  Licensed  Areas except  through  CIL. In addition,  George J. Coates and
Gregory  Coates have executed an agreement  granting CIL the right to retain any
monies including  royalties  received from Nicholson McLaren or from Noble Motor
Sport  (manufacturer  of Ascari  racing  cars)  for  manufacture,  sale,  use or
assembly  of  internal  combustion  engines  anywhere  in the  world  using  the
technology  falling within the scope of the Coates Patents.  CIL agreed to pay a
$5,500,000 license fee to George J. Coates in consideration for his grant to CIL
of the non-exclusive license payable at management's  discretion but in no event
later than February 17, 1998. In September 1995, this  arrangement was modified.
CIL and George J. Coates  agreed that  instead of the  $5,500,000  payment,  CIL
would issue  275,000  shares of Series A Stock to Mr. Coates as the license fee.
The shares were issued to Mr. Coates in November 1995.

      See "Item 1 - Business-The  Coates System-Third Party Evaluations" as to a
July 1991 prototype manufacturing agreement executed by CIL with Harley Davidson
as a prelude to an anticipated  license  agreement.  As CIL has been unable,  to
date,  to develop a  retrofitted  Harley  Davidson  motorcycle  engine using the
Coates  technology that is acceptable to Harley  Davidson,  no assurances can be
given that a license agreement will be concluded with Harley Davidson.


                                      6

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      In  February  1994,  CIL  executed  a  license   agreement  with  Millwest
Corporation of Dumas, Texas ("Millwest") granting Millwest a five year exclusive
license to retrofit  pre-existing  internal  combustion engine blocks (excluding
air-cooled  engines and engines used for racing  competition)  by replacing  the
pre-existing  valve system with the Coates  Spherical Rotary Valve System in the
United States, its territories and possessions, Canada and Mexico, the five year
term to commence  after payment to CIL by Millwest on or before May 4, 1994 of a
$10,000,000   licensing  fee.  The  agreement  also  provided  Millwest  with  a
non-exclusive  license to manufacture the Coates  Spherical  Rotary Valve System
subject to the payment of  royalties.  Additional  payments of  $1,666,666  were
required  to be paid to CIL on the third,  fourth and fifth  anniversary  of the
effectiveness  of the  license.  An  additional  $15,000,000  payment  is due on
February 5, 1999.  Millwest  made an initial  $500,000  payment  pursuant to the
agreement in February  1994 but has failed to pay the  additional  $9,500,000 to
activate the license.  CIL has placed  Millwest on notice that it is in default.
In June 1995,  Millwest  informed  CIL of an  intention  to activate the license
agreement  claiming  that  financing  had been arranged to do so but to date, no
additional  payments  have been  received by CIL from Millwest and no assurances
can be given that any additional payments will be made.

      His  appearance at the  Birmingham  (U.K.)  Autosport Show in January 1996
resulted in George J. Coates receiving a letter of intent from Nicholson McLaren
to acquire a license to distribute the racing  engines  modified with the Coates
System within the European  Patent  Community upon a commission or royalty basis
to be negotiated.  Also, as a result of George J. Coates' appearance at the same
show, CIL received a $1,000 check from Noble Motorsport  U.S.A., a subsidiary of
Ascari Cars Ltd. (U.K.) (formerly Noble Motor Sport Ltd.) and a $28,000 order to
install a high performance  racing car engine modified with the Coates System in
an Ascari  racing car.  The car was  delivered in March 1996 to the CIL plant in
Wall  Township,  New Jersey,  but to date,  an engine  modified  with the Coates
System has not been installed in the car.

      In April 1996, CIL executed a license  agreement  with  Nicholson  McLaren
granting  Nicholson McLaren a non-exclusive  license to assemble,  sell, use and
lease internal  combustion  engines  incorporating  the Coates  Spherical Rotary
Valve System within the European  Patent  Community,  which  includes but is not
limited to Austria,  Belgium,  Denmark, France, Germany, Greece, Ireland, Italy,
Portugal, Spain, Sweden,  Switzerland,  and the United Kingdom. In consideration
of the rights granted under the license  agreement,  Nicholson McLaren agreed to
pay CIL a licensing fee of $5 million  payable $37,375 upon receipt of the first
demonstration  model by Nicholson McLaren from CIL; another $37,375 upon receipt
of the  second;  with the  balance to be paid out of sales (if any) of  internal
combustion  engines  modified  with the Coates  Spherical  Rotary  Valve  System
assembled by Nicholson  McLaren with components  purchased from CIL. The balance
is payable  pursuant to a payment  schedule to be mutually  agreed  between both
parties.  The license agreement also gives Nicholson McLaren the right to obtain
a manufacturing license from CIL against payment of royalties on the manufacture
of components at a rate to be  established.  The Company  recognized  revenue of
$37,375 in 1996 upon receipt of cash from  Nicholson  McLaren after  delivery of
the first  demonstration  model in April  1996.  CIL has waived  payment for the
second  demonstration  model which was delivered in July 1996.  CIL has retained
ownership to this second model which is being  demonstrated by Nicholson McLaren
for potential  customers on behalf of CIL. The payment  schedule with respect to
the balance of the licensing fee has not yet been  finalized by the parties.  No
assurances  can be  given  that CIL will be paid a  substantial  portion  of the
balance of the licensing fee by Nicholson  McLaren as such balance is contingent
upon future sales by Nicholson McLaren of internal  combustion  engines modified
with the Coates Spherical Rotary Valve System. During 1996, John Nicholson,  the
president of Nicholson  McLaren  purchased 4,000 shares of CIL Series A Stock at
$20 per share.


                                      7

<PAGE>



      In June 1996, CIL executed a Sales  Representative  Agreement retaining an
affiliate of Nicholson  McLaren as its  exclusive  sales  representative  in the
United Kingdom and Europe for the sale of the Coates  Technology for a four-year
term. The agreement  provides for a sliding scale commission  varying from 5% of
the first $1 million in Net  Product  Billings  to 1% of the fifth $1 million in
Net Product  Billings and all amounts in excess  thereof.  No assurances  can be
given that the sales  representative will produce  significant  billings for CIL
products pursuant to the agreement.

Employees

      At  December  31,  1996,  CIL  employed  12  full-time  employees  and one
part-time  employee  including  George J. Coates and his son Gregory who perform
both  management,  assembly and research and  development  functions;  George J.
Coates' wife Bernadette who is involved in administration  functions, two people
in  marketing  and  communications,   one  shop  foreman,  one  draftsman,   one
programmer,  three tool and lathe operators,  one person performing  secretarial
and inventory control functions and one part-time bookkeeper.


Item 2.     Description of Property

      CIL's   executive   offices  and  testing   facility  are  located  in  an
approximately 25,000 square foot one and one-half story building of concrete and
steel  construction  on a 6 1/2 acre  site in Wall  Township,  New  Jersey.  CIL
acquired this property from The George J. Coates 1991 Family  Partnership,  L.P.
in 1995. See "Item 12" herein.

      In its development  operations,  CIL owns and utilizes  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, reasonable wear and tear excepted.


Item 3.     Legal Proceedings

SEC Complaint

      In July 1994,  the SEC filed a  complaint  in the United  States  District
Court for the Southern  District of New York (94 Civ.  5361)  against  George J.
Coates,  CIL and  certain  affiliated  companies  seeking  injunctive  and other
relief.  In its complaint,  the SEC alleged that CIL and George J. Coates raised
"...almost $6.5 million from almost 400 investors..." through offers,  purchases
and sales of CIL  securities  which the SEC  alleged  were  fraudulent.  The SEC
alleged that CIL and George J. Coates  misrepresented  the  capabilities  of the
Coates engine;  omitted to disclose negative results of independent tests on the
engine; falsely claimed that CIL had sold licenses and received orders and other
commercial opportunities;  and misrepresented that George J. Coates had assigned
all patents  related to the Coates  engine to CIL. The SEC also alleged that CIL
and George J. Coates had failed to disclose to shareholders  that certain of the
shares sold by Mr.  Coates  were not  authorized  by CIL;  that George J. Coates
misappropriated  or misused  approximately  $2 million of investor funds for his
personal benefit; and that CIL had engaged in several related party transactions
with other entities controlled by George J. Coates.

      At the time of the filing of the SEC complaint, the Court issued an order 
freezing the assets of CIL and George J. Coates (although George J. Coates was
permitted to use future income for living expenses).  The Court appointed Donald
H. Steckroth, Esq., a New Jersey attorney, as

                                      8

<PAGE>



Temporary  Receiver,  to  take  possession  and  control  of  CIL's  assets  and
properties, to preserve the status quo and to prevent any misuse, encumbrance or
disposal of CIL's corporate property and assets.

Arrest of George J. Coates

      At the same time as the SEC complaint was filed in July 1994, an inspector
for the United States Postal Inspection  Service swore out a criminal  complaint
against  George J. Coates in the United States  District  Court for the Southern
District of New York, based on allegations similar to those contained in the SEC
complaint.  As a result,  Mr. Coates was arrested but he was released after four
days of incarceration.  On May 30, 1995, a United States Magistrate Judge of the
United  States  District  Court for the Southern  District of New York signed an
order in response to a request by the office of the United  States  Attorney for
the Southern  District of New York dismissing  without  prejudice,  the criminal
complaint against George J. Coates.

Settlement of the SEC Complaint

      On  February  6, 1995,  CIL and George J.  Coates,  without  admitting  or
denying the allegations  contained in the SEC complaint,  consented to the entry
of final consent  judgments  enjoining them from effecting sales of any security
unless  a  registration  statement  is in  effect  as  to  such  security  or an
applicable  exemption  from  registration  is  available  and from  engaging  in
fraudulent activities in connection with the offer or sale of any security.  CIL
was also ordered to provide an  accounting  of its assets and  liabilities;  its
financial  statements and a list of all purchasers of CIL stock from CIL, George
J. Coates or any other source during the period commencing April 24, 1990 to the
date of the consent  judgment  including the number of shares  purchased and the
purchase price.  George J. Coates was ordered to provide an accounting as to his
assets and  liabilities;  as to any  money,  property,  assets or other  revenue
received  by him or for his  benefit  from  January  1,  1990 to the date of the
accounting; and as to all assets, funds, securities or real or personal property
of investors in CIL which were  transferred to or for George J. Coates'  benefit
during such period.

      George J. Coates was also  ordered to cause the  transfer by The George J.
Coates 1991 Family  Partnership,  L.P. to CIL of the real  property and building
used by CIL as its principal  facility  located at Highway 34 and Ridgewood Road
in Wall Township,  New Jersey.  This transfer was effected on February 21, 1995.
George J. Coates has guaranteed  repayment of the mortgage loan on this property
and CIL is obligated to indemnify  George J. Coates from any liability  based on
the mortgage  loan on the property.  The consent  judgment  permitted  George J.
Coates to retain title to the Coates Patents provided that he reimbursed CIL for
all of the monies it expended in the preparation, application and prosecution of
the Patents.  Such sums in the aggregate  amount of $335,805 were paid to CIL by
February 15, 1995 so that George J. Coates  retained  title to the Patents.  Mr.
Coates was also ordered to cause the transfer to CIL of all  licensing  fees and
other funds paid to persons or entities  other than CIL in  connection  with the
acquisition  by the payor of an  interest  in the  Patents or in the  technology
embodied in the Patents,  including the $500,000  licensing fee paid by Millwest
Corporation  and  held  in  a  bank  account  entitled   "Coates   International
Licensing."  On  February  24,  1995,  the  $500,000  license fee and $12,144 of
interest thereon was paid to CIL.

Rescission and Exchange Offer

      The consent  judgment also required CIL to file a  registration  statement
with the SEC to effect a Rescission and Exchange Offer, as follows:


                                      9

<PAGE>



      Purchasers of Series A Stock who  purchased  such stock from CIL or George
J. Coates during the period  commencing April 24, 1990 through November 13, 1995
and who  continued to own their shares at such date were  afforded the option to
choose one of the  following two forms of  consideration  in exchange for his or
her shares of Series A Stock.

      Option One - Subject  to the  availability  of same,  the right to receive
cash or assets equal in amount to the consideration  such Purchaser paid for his
or her shares of Series A Stock,  in exchange  therefore,  plus simple  interest
calculated  at an annual rate of five (5%)  percent from the date of payment for
the Series A Preferred Stock; or

      Option Two - the right to receive one share of newly issued Series A Stock
identical to the previously  purchased Series A Stock in exchange for each share
of Series A Stock held by such Purchaser.

      Pursuant to the consent  judgment,  CIL filed a registration  statement on
Form S-1 with the SEC (File No.  33-94884) to effect the Rescission and Exchange
Offer. The registration  statement was declared effective by the SEC on November
13, 1995.

      Pursuant to the consent judgment, Donald H. Steckroth, Esq., the Temporary
Receiver, was appointed Special Master, to continue in possession and control of
any and all  assets  of CIL  until  a  distribution  was  made  pursuant  to the
Rescission and Exchange Order and until he was discharged by order of the Court.
The  consent  judgment  required  CIL to mail a copy of the  November  13,  1995
Prospectus  together with a cover letter prepared by the Special Master advising
the Purchasers of the allegations  contained in the SEC complaint,  the terms of
the final CIL consent judgment,  the fact that the Prospectus contained detailed
information  concerning  the status of CIL's business and efforts to develop and
commercially exploit the Coates engine technology,  and explaining the above two
options,  and an Election Form, by certified mail return receipt  requested,  to
each Purchaser.

      After the  November  13,  1995  effectiveness  of the  above  registration
statement,  the  Prospectus and the required cover letter and Election Form were
mailed to each of the Purchasers.  Of the 328 persons to whom the Rescission and
Exchange Offer was directed (who had invested approximately  $6,500,000 in CIL),
an  aggregate  32  Purchasers  elected to rescind  their prior  purchases  of an
aggregate 48,500 shares of Series A Preferred Stock entitling them to be paid an
aggregate  $1,270,000 plus interest.  Two of the 32 Purchasers invested $900,000
of the $1,270,000 in CIL with respect to which  rescission  was elected.  In the
second  quarter of calendar  year 1996, a group of investors  advanced  funds in
order to  purchase  Series A  Preferred  Stock.  These funds were used by CIL to
repurchase  Series A Preferred  Stock owned by the persons who accepted the 1995
Rescission and Exchange Offer. An aggregate  $1,260,000 of the funds and $65,000
of interest was paid to 31 of the 32 Purchasers who elected to accept Option One
of the  Rescission  and  Exchange  Offer  and  their  48,000  shares of Series A
Preferred  Stock were  canceled.  No shares  were  issued to the  investors  who
advanced said funds at such time.

      By letter dated July 31, 1996,  the Special Master filed a report with the
United States District Court  recommending  that CIL be permitted to undertake a
private offering.  A successful private offering would generate sufficient funds
to permit  reimbursement  of those  investors (the  "Potential  Investors")  who
advanced  funds in the second  quarter  of  calendar  1996 in order to  purchase
Series A Preferred  Stock,  which funds were used by CIL to repurchase  Series A
Preferred  Stock  owned by persons who elected  pursuant to the  Rescission  and
Exchange Offer to rescind their prior purchases of Series A Preferred  Stock. On
August 19, 1996,  United States  District Court Judge Kimba Wood signed an order
permitting a Private Offering to proceed and ordered CIL and George J. Coates to
reimburse the Potential Investors for the amounts advanced by them.

                                      10

<PAGE>



      George J.  Coates had  consented  to pay up to the first  $773,500  of the
amounts  payable  pursuant  to  the  Rescission  and  Exchange  Offer  to  those
Purchasers  who elected  Option One using all of his personal  assets other than
his  personal  residence.  To the  extent  that he was  unable  to pay any  such
amounts,  CIL was  required  to pay same and would  retain  its rights to assert
claims  against  George J. Coates  personally to recover its payment of any such
shortages. CIL also consented to pay any additional amounts required to fund the
Rescission and Exchange Offer.

      The  Private  Offering  permitted  by Judge  Wood's  August 1996 order was
completed in July 1997.  Pursuant to the terms of the Private Offering,  each of
the  Potential  Investors  was offered  the right to elect to receive  shares of
Series A Preferred Stock at a value of $20 per share for the amounts he advanced
in the second quarter of calendar year 1996 or to have the amount of his advance
refunded. Of the $1,270,000 advanced, one Potential Investor elected to have his
advance of $10,000  refunded and the remaining  Potential  Investors  elected to
receive Series A Preferred Stock. George J. Coates made the $10,000 cash payment
to the Potential  Investor who elected the refund and transferred  38,175 shares
of his Series A Preferred Stock to the remaining Potential Investors. CIL issued
the  balance  of  24,825  shares of Series A  Preferred  Stock to the  Potential
Investors. CIL also received $960,000 in cash proceeds from the Private Offering
(paid to purchase  shares of Series A Preferred Stock at $20 per share) which it
applied to the payment of outstanding  payables  including the final bill of the
Special Master who was then discharged by Judge Wood.

      CIL is a defendant in various lawsuits. In the opinion of management, none
of these  lawsuits will have a material  adverse  effect on CIL, its business or
its financial condition.


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

      CIL did not  submit any  matter to a vote of its  stockholders  during the
fourth quarter of calendar year 1996.




                                      11

<PAGE>



                           COATES INTERNATIONAL LTD.

                                    PART II


Item 5.     Market for Common Equity and Related Stockholder Matters

      There is no established  public trading market for CIL's only  outstanding
class of capital stock,  its Series A Preferred Stock. At December 31, 1996, the
approximate number of holders of record of the Series A Preferred Stock was 510.
CIL has not paid any dividends with respect to its Series A Preferred  Stock and
anticipated capital requirements make it highly unlikely that any dividends will
be paid by CIL in the foreseeable future.

      Pursuant  to the SEC  Complaint  described  in  "Item 3"  herein,  the SEC
alleged that since April 24, 1994, CIL (including its predecessor) and George J.
Coates  raised  "...almost  $6.5 million from almost 400  investors..."  through
offers,  purchases  and sales of CIL's  securities  which the SEC  alleged  were
fraudulent.  The SEC also  alleged that such  offers,  purchases  and sales were
effected without registration under the Securities Act of 1933 or pursuant to an
applicable  exemption  thereunder.  The shares of Series A Preferred  Stock were
sold at effective prices of $5, $10, $20 and $30 by CIL, its predecessor and its
controlling  stockholder  for $6,578,000 in gross  proceeds.  As a result of the
settlement  of  the  SEC  Action  described  in  "Item  3,"  no  exemption  from
registration  under the  Securities  Act of 1933 is being claimed by CIL and the
"Rescission and Exchange Offer" therein described has been effectuated.


Item 6.     Management's Discussion and Analysis or Plan of Operation

      Coates   International  Ltd.  ("CIL"  or  the  "Company")  is  a  Delaware
corporation  organized in October  1991 by George J. Coates as the  successor in
interest to a Delaware  corporation of the same name incorporated in August 1988
(the  "Predecessor  Entity").  As a result  of a  dispute  with  certain  former
employee-directors  who claimed to own  approximately  nine (9%)  percent of the
Predecessor  Entity's  outstanding  capital stock,  the  Predecessor  Entity was
reorganized  in  November,  1991.  Pursuant  to the  reorganization,  all of the
Predecessor  Entity's assets subject to liabilities were distributed to CIL, the
non-litigating stockholders of the Predecessor Entity became the stockholders of
CIL and the Predecessor Entity was dissolved.

      CIL has completed the basic development of a spherical rotary valve system
(the "Coates  System"),  the  development of which was initiated by its founder,
George J.  Coates,  for use in internal  combustion  engines of all types.  With
respect to the Coates  System,  seven  applicable  United  States  patents  (the
"Coates   Patents")  have  been  issued  to  George  J.  Coates.   CIL  holds  a
non-exclusive  license  from  George J. Coates and his son  Gregory  Coates,  to
manufacture,  sell and grant  sublicenses  with respect to products based on the
Coates Patents,  within the United States,  its territories and possessions (the
"Licensed Areas"). George J. Coates and Gregory Coates have also agreed, as long
as  CIL  remains  independent  and  viable,  not  to  compete  with  CIL  in the
manufacture,  assembly, use or sale of internal combustion engines utilizing the
technology falling within the scope of the Coates Patents in the Licensed Areas,
or to grant any other exclusive or  non-exclusive  license in the Licensed Areas
except  through  CIL. In  addition,  George J.  Coates and  Gregory  Coates have
executed  an  agreement  granting  CIL the right to retain any monies  including
royalties   received   from   Nicholson   McLaren  or  from  Noble  Motor  Sport
(manufacturer of Ascari racing cars) for  manufacture,  sale, use or assembly of
internal  combustion  engines anywhere in the world using the technology falling
within the scope of the Coates Patents. See "Item 1 - Patents and Licenses."

                                      12

<PAGE>



      CIL  has had a short  operating  history  during  which  it has  primarily
devoted its attention to developing  the technology  associated  with the Coates
System.  During such time CIL has also  arranged  for certain  tests in order to
evaluate the effectiveness of the technology.  CIL has also devoted such time in
an attempt to interest various persons and entities in acquiring sub-licenses to
use the technology.

      CIL  is  currently   manufacturing  high  performance  automotive  engines
modified  with the Coates System on a limited  basis at its Wall  Township,  New
Jersey manufacturing  facility.  Except as set forth herein, none of the engines
has been  sold.  CIL has  received  numerous  oral and  written  inquiries  from
potential  customers,  expressing  an interest  in  acquiring  high  performance
automotive  racing engines modified with the Coates System. No assurances can be
given  that  these  inquiries  will  result in binding  sales  orders.  After it
completes  manufacture of a sufficient  backlog of such engines,  CIL intends to
attempt to convert  these  inquiries  into binding  sales  orders,  to fill such
orders from its limited inventory of engines and to continue to manufacture on a
limited  basis and market high  performance  automotive,  motorcycle  and marine
racing engines using the Coates System technology.
CIL also intends to attempt to sublicense such technology.

Results of Operations from Inception August 31, 1988 through December 31, 1996

      Virtually no revenues  were  realized  from the  inception  of  operations
through  December  31,  1996,  as  the  principal  operations  were  those  of a
development  stage company.  In July 1991, CIL signed a prototype  manufacturing
agreement  with  Harley-Davidson,  Inc.  ("Harley  Davidson")  and  commenced to
attempt  to  retrofit  a Harley  Davidson  motorcycle  engine  using the  Coates
technology.  An initial $150,000 engineering and development fee was paid to CIL
by Harley Davidson. CIL has not, as yet, developed a retrofitted Harley Davidson
motorcycle  engine  using the Coates  technology  that is  acceptable  to Harley
Davidson.

      Under the terms of a February 1994 license  agreement,  a $500,000 initial
payment  was made by  Millwest  Corporation  ("Millwest")  for a license  of the
technology  and  was  held  in a bank  account  entitled  "Coates  International
Licensing." This sum was subsequently paid over to CIL. Pursuant to the terms of
the license  agreement,  Millwest was obligated to make another  payment of $9.5
Million to CIL on or before May 4, 1994. Millwest did not make such payment. CIL
placed  Millwest  on  notice  that it was in  default.  In June  1995,  Millwest
informed CIL of an intention to activate the license  agreement and claimed that
financing has been  arranged to do so but to date,  no additional  payments have
been  received  by CIL from  Millwest  and no  assurances  can be given that any
additional payments will be made.

      CIL did not recognize any revenues in calendar year 1995. In calendar year
1996, CIL recognized  $37,375 in revenues paid by Nicholson McLaren Engines Ltd.
(U.K.) ("Nicholson  McLaren") in partial payment for two high performance racing
car engines modified with the Coates System shipped to Nicholson McLaren by CIL.
See "Item 1 - Patents and Licenses" as to the execution by CIL in April and July
1996 of a License Agreement and a Sales Representative  Agreement with Nicholson
McLaren.

      Operating  expenses incurred during CIL's  development  stage, from August
31, 1988, to December 31, 1996 were  $13,954,525.  Of this amount,  salaries and
related  benefits  aggregated  $1,868,188 (or 13%).  Other  expenses  aggregated
$12,086,337 (or 87%).

      Included  in  this  total  were  research  and  development   expenses  of
$7,452,906  (including  a  $5,500,000  license  fee  payable to George J. Coates
converted  into  275,000  shares  of  Series A  Stock)  and  officers'  salaries
aggregating $1,330,561. Occupancy expense of $468,736 primarily reflects total

                                      13

<PAGE>



rent through February 1995 associated with CIL's lease of  approximately  25,000
square  feet of  research,  machine  shop and  office  space,  at Highway 34 and
Ridgewood Road, Wall Township, New Jersey, from The George J. Coates 1991 Family
Partnership,  L.P.  Pursuant to the consent  judgment in connection with the SEC
complaint as previously described,  in February,  1995, the lease was terminated
as title to the  premises was  conveyed,  to CIL, by the  Partnership.  Thus the
rental  payments  have been  terminated.  See "Item 3 - Rescission  and Exchange
Offer" as to CIL's  obligation to indemnify George J. Coates with respect to the
$300,000  mortgage  obligation  assumed by CIL on the premises.  The balance has
since been reduced to $210,000 and the mortgagees  have agreed to further reduce
the mortgage balance by an additional  $50,000 to $160,000 upon issuance to them
of an aggregate 2,500 shares of Series A Stock but to date, said shares have not
been issued.  CIL is currently  paying interest only on the mortgage at the rate
of $1,200 per month.

Liquidity and Capital Resources

      Since its inception,  all of the development costs and related operational
costs of CIL have  primarily  been paid through the cash  generated  through the
sale of stock,  through  capital  contributions  made by George J.  Coates' son,
Gregory  Coates and the  $500,000  initial  license  payment  made by  Millwest.
Capital  contributions  advanced  to CIL by  Gregory  Coates  in 1995  and  1996
aggregated  $404,549  and  $1,132,523  respectively.  Harley  Davidson  paid CIL
$150,000 as an initial deposit towards a license agreement;  that money has also
been expended by CIL.  Certain of the aforesaid funds generated income from bank
accounts in a depository institution;  that interest income was also expended by
CIL. CIL has incurred  losses as a  development  stage  company from  inception,
August 31, 1988, to December 31, 1996, of  $13,376,892  and at December 31, 1996
had a  negative  net  worth  of  ($488,642)  and  negative  working  capital  of
($2,114,271).

      CIL had  agreed to pay a  $5,500,000  license  fee to George J.  Coates in
consideration  for a  non-exclusive  license  granted by him to CIL in  February
1995. In September 1995, this arrangement was modified. CIL and George J. Coates
agreed that instead of the $5,500,000 payment, CIL would issue 275,000 shares of
Series A Stock to George J. Coates as the license fee.  These shares were issued
to George J. Coates in November 1995. See "Item 1 - Patents and Licenses."

      See "Item 1 - Business Plan" as to CIL's current  business plan. It is the
intention of CIL to fund its business plan by borrowings  and the sale of equity
and/or debt  instruments,  and through  the sale of  sub-licenses.  All of these
financing  vehicles will be pursued  simultaneously.  It is not presently  known
which,  if any,  of  these  alternatives  will be  utilized,  whether  they  are
available to CIL, and if available, in what mixture or in what amounts.

      In view of its minimal revenues and recurring losses from operations since
inception,  its deficit accumulated during its development stage and its limited
liquid  assets,  no assurances  can be given that CIL will be able to pursue its
business plan. If it does not obtain sufficient liquid assets to fund such plan,
CIL may be  forced  to sell its  assets  or to seek  protection  from  creditors
through a bankruptcy or similar filing.

Note Regarding Forward-Looking Statements

      This  Annual   Report   contains   historical   information   as  well  as
forward-looking  statements.  Statements looking forward in time are included in
this Annual  Report  pursuant  to the "safe  harbor"  provisions  of the Private
Securities  Litigation  Reform Act of 1995.  Such  statements  involve known and
unknown risks and  uncertainties  that may cause the Company's actual results in
future periods to be materially different from any future performance  suggested
herein.


                                      14

<PAGE>



Item 7.     Financial Statements

      Attached.


                                      15

<PAGE>



                         REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders
  Coates International Ltd.
  Wall Township, New Jersey

        We have audited the accompanying  balance sheets of Coates International
Ltd. [a  development  stage  company] as of December 31, 1996 and 1995,  and the
related statements of operations, stockholders' equity [deficit], and cash flows
for the years then ended.  These financial  statements are the responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
financial  statements  based on our audits.  The financial  statements of Coates
International  Ltd. as of and for the year ended December 31, 1995, were audited
by other auditors whose report dated March 11, 1996, on those statements [except
for one  Note to the  financial  statements  for  which  the  date  for  various
information included therein was March 15 and 23, 1996], included an explanatory
paragraph  describing the uncertainty about Coates  International Ltd.'s ability
to continue as a going concern,  which was more fully described in a Note to the
1995 financial statements. As more fully discussed in Note 4 to the accompanying
financial statements, Coates International Ltd. has made various restatements to
its 1995 financial  statements during 1996. The principal  restatements  reflect
decisions by the United States  District Court for the Southern  District of New
York regarding the legal rights to a certain cash bank account and the amount of
the  Company's  obligation  to  Rescinding  Shareholders  at December  31, 1995.
Another  principal   restatement  relates  to  cash  infusions  by  a  principal
stockholder  that were  restated  from loans to  additional  paid-in  capital at
December 31, 1995.

        We conducted our audits in accordance with generally  accepted  auditing
standards.  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 audits provide a reasonable basis for our opinion.

        In our  opinion,  the  financial  statements  referred to above  present
fairly, in all material respects, the financial position of Coates International
Ltd. [a  development  stage  company] as of December 31, 1996 and 1995,  and the
results  of its  operations  and its cash  flows  for the  years  then  ended in
conformity with generally accepted accounting principles.  We express no opinion
on the cumulative  period from inception  [August 31, 1988] through December 31,
1996 as shown in the  cumulative  columns on the statement of operations and the
statement of cash flows, nor on the statement of stockholders'  equity [deficit]
for the period from inception [August 31, 1988] through December 31, 1994.

        The accompanying  financial  statements have been prepared assuming that
Coates International Ltd. will continue as a going concern. As discussed in Note
5 to the financial  statements,  the Company has had  insignificant  revenues to
date,  has suffered  recurring  losses and has  accumulated  a deficit since its
inception  to December  31,  1996,  of over $13  million.  The Company  also has
minimal  liquid  assets,  and has over $2.2 million in current  liabilities.  In
addition to a recorded liability of $486,970 to certain potential investors, the
Company  has a  contingent  liability  of  $773,500  related to these  potential
investors.  These conditions raise substantial doubt about the Company's ability
to continue as a going  concern.  Management's  plans in regard to these matters
are also  discussed  in Note 5. The  financial  statements  do not  include  any
adjustments that might result from the outcome of these uncertainties.




                                          MOORE STEPHENS, P.C.
                                          Certified Public Accountants.

Cranford, New Jersey
January 24, 1997

                                       F-1

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
------------------------------------------------------------------------------


BALANCE SHEETS
------------------------------------------------------------------------------
<TABLE>


                                                                                December 31,
                                                                           1 9 9 6       1 9 9 5
                                                                                        [Restated]
Assets:
Current Assets:
<S>                                                                     <C>          <C>        
  Cash and Cash Equivalents                                             $   13,641   $    27,769
  Inventory                                                                144,033            --
                                                                        ----------   -----------

  Total Current Assets                                                     157,674        27,769
                                                                        ----------   -----------

Property, Plant and Equipment - Net                                      1,606,659     1,634,822
                                                                        ----------   -----------

Other Assets:
  Due from Stockholder                                                      12,042        35,686
  Deposit                                                                    2,500         2,500
  Due from Affiliated Companies                                              4,428         2,116
                                                                        ----------   -----------

  Total Other Assets                                                        18,970        40,302
                                                                        ----------   -----------

  Total Assets                                                          $1,783,303   $ 1,702,893
                                                                        ==========   ===========

Liabilities and Stockholders' Equity [Deficit]:
Current Liabilities:
  Amounts Due to Potential Investors                                    $  486,970   $        --
  Redeemable Series A Preferred Stock                                       10,000       496,970
  Mortgage Payable                                                         210,000       250,000
  Accrued Legal Fees                                                     1,198,273       665,475
  Accounts Payable                                                          45,081        44,659
  Accrued Interest                                                         109,408       158,818
  Other Accrued Expenses                                                   204,213       108,026
  Due to Stockholder                                                         8,000            --
                                                                        ----------   -----------

  Total Current Liabilities                                              2,271,945     1,723,948
                                                                        ----------   -----------

Commitments and Contingencies [10]                                              --            --
                                                                        ----------   -----------

Stockholders' Equity [Deficit]:
  Common Stock, $.001 Par Value, 20,000,000 Shares Authorized -
   No Shares Issued                                                             --            --

  Preferred Stock, Series A, $.001 Par Value, 14,000,000 Shares
   Authorized - Voting, Non-Cumulative Convertible, 5,963,600 Shares
   Issued and Outstanding at December 31, 1996 and 1995                      5,963         5,963

  Additional Paid-in Capital                                            12,882,287    11,749,764

  Deficit Accumulated During the Development Stage                     (13,376,892) (11,776,782)

  Total Stockholders' Equity [Deficit]                                    (488,642)      (21,055)
                                                                        ----------   -----------
  
  Total Liabilities and Stockholders' Equity [Deficit]                  $1,783,303   $ 1,702,893
                                                                        ==========   ===========

See Notes to Financial Statements.
</TABLE>

                                        F-2

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
------------------------------------------------------------------------------


STATEMENTS OF OPERATIONS
------------------------------------------------------------------------------
<TABLE>


                                                                           For the
                                                                         Period from
                                                                         August 31,
                                                                        1988 [Date of
                                                                         Inception]
                                                    Years ended            Through
                                                   December 31,         December 31,
                                                1 9 9 6      1 9 9 5       1 9 9 6
                                                -------      -------       -------
                                                           [Restated]

<S>                                          <C>           <C>          <C>        
Revenue                                      $    37,375   $       --   $   687,375
                                             -----------   ----------   -----------

Operating Expenses:
  Research and Development Costs                 245,625    5,860,244     7,452,906
  General and Administrative Expenses          1,315,282    1,055,160     6,222,241
  Depreciation Expense                            40,915       66,386       279,378
                                             -----------   ----------   -----------

  Total Operating Expenses                     1,601,822    6,981,790    13,954,525
                                             -----------   ----------   -----------

  Loss From Operations                        (1,564,447)  (6,981,790)  (13,267,150)
                                             -----------   ----------   -----------

Other Income [Expense]:
  Interest Income                                  1,121        9,514       113,604
  Interest Expense                               (36,784)     (90,530)     (223,346)
                                             -----------   ----------   -----------

  Net Other [Expense]                            (35,663)     (81,016)     (109,742)
                                             -----------   ----------   -----------

  Net Loss                                   $(1,600,110)  $(7,062,806) $(13,376,892)
                                             ===========   ===========  ============

  Net Loss Per Share                         $      (.27)  $    (1.23)
                                             ===========   ==========

  Weighted Average Number of Shares            5,963,600    5,764,000
                                             ===========   ==========



See Notes to Financial Statements.

</TABLE>
 
                                        F-3

<PAGE>
<TABLE>

COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
-------------------------------------------------------------------------------------------------------------------


STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
-------------------------------------------------------------------------------------------------------------------

                                                     Common Stock                Common Stock              Series A
                                                        Class A                     Class C             Preferred Stock
                                                 Shares       Amount       Shares        Amount       Shares       Amount
<S>                                               <C>         <C>          <C>       <C>     <C>          <C>   <C>

August 31, 1988 [Date of Inception]                      --  $       --          --  $        --           --  $        --

Issuance of Shares                                  854,500         854          --           --           --           --

Issuance of Stock Pursuant to Private
   Placement Offering                               100,000          96          --           --           --           --

Net Loss for the Period from
   August 31, 1988 [Date of Inception]
   Through December 31, 1988                             --          --          --           --           --           --
                                             --------------  ----------  ----------  -----------  -----------  -----------

   Balance - December 31, 1988                      954,500         950          --           --           --           --

Stock Dividend                                       50,000          50     450,000          450           --           --

Issuance of Stock for Services Rendered              12,000          12          --           --           --           --

Net Loss for Year Ended
   December 31, 1989                                     --          --          --           --           --           --
                                             --------------  ----------  ----------  -----------  -----------  -----------

   Balance - December 31, 1989                    1,016,500       1,012     450,000          450           --           --

Issuance of Stock Pursuant to Private
   Placement Offering                                76,000          76          --           --           --           --

Issuance of Stock                                   962,500         962          --           --           --           --

Net Loss for Year Ended
   December 31, 1990                                     --          --          --           --           --           --
                                             --------------  ----------  ----------  -----------  -----------  -----------

   Balance - December 31, 1990                    2,055,000       2,050     450,000          450           --           --

Exchange of Preferred Stock for
   Common Stock Class A                          (2,055,000)     (2,050)         --           --           --           --

Exchange of Preferred Stock for
   Common Stock Class C                                  --          --    (450,000)        (450)          --           --

Cancellation of Common Stock Class C                     --          --          --           --           --           --

Issuance of Stock in Connection with
   Reorganization                                       100          --          --           --           --           --

Dissolution of Coates International Ltd.               (100)         --          --           --           --           --

Exchange of Series A Preferred Stock for
   Preferred Stock                                       --          --          --           --    2,280,000        2,280

Issuance of Stock                                        --          --          --           --      102,000          102

Purchase of Treasury Stock                               --          --          --           --           --           --

Stock Split 2:1                                          --          --          --           --    2,382,000        2,382

Net Loss for Year Ended
   December 31, 1991                                     --          --          --           --           --           --
                                             --------------  ----------  ----------  -----------  -----------  -----------

   Balance - December 31, 1991 - Forward                 --  $       --          --  $        --    4,764,000  $     4,764
See Notes to Financial Statements.

</TABLE>

<PAGE>

<TABLE>


COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
-------------------------------------------------------------------------------------------------------------------


STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
-------------------------------------------------------------------------------------------------------------------



                                                     Common Stock                Common Stock              Series A
                                                        Class A                     Class C             Preferred Stock
                                                 Shares       Amount       Shares        Amount       Shares       Amount
<S>                                                <C>         <C>         <C>        <C>         <C>          <C>

   Balance - December 31, 1991 -
     Forwarded                                           --  $       --          --  $        --    4,764,000  $     4,764

To Correct Balance at
   December 31, 1991                                     --          --          --           --      772,500          772

Issuance of Stock for Service                            --          --          --           --          500           --

Issuance of Stock                                        --          --          --           --      115,850          116

Private Placement Costs                                  --          --          --           --           --           --

Net Loss for Year Ended
   December 31, 1992                                     --          --          --           --           --           --
                                             --------------  ----------  ----------  -----------  -----------  -----------

   Balance - December 31, 1992                           --          --          --           --    5,652,850        5,652

Issuance of Stock                                        --          --          --           --       82,250           83

Purchase of Treasury Stock                               --          --          --           --           --           --

Prior Period Adjustment                                  --          --          --           --           --           --

Adjustment for Redeemable
   Preferred Stock                                       --          --          --           --     (479,950)        (480)

Net Loss for Year Ended
   December 31, 1993                                     --          --          --           --           --           --
                                             --------------  ----------  ----------  -----------  -----------  -----------

   Balance - December 31, 1993                           --          --          --           --    5,255,150        5,255

Issuance of Stock                                        --          --          --           --        2,000            2

Purchase of Treasury Stock                               --          --          --           --           --           --

Adjust Treasury Stock for Redeemable
   Preferred Stock                                       --          --          --           --       (1,000)          (1)

Adjust Remaining Redeemable Preferred
   Stock Issued in 1994                                  --          --          --           --       (1,000)          (1)

Restoration of Shares Not Redeemed by
   Stockholders                                          --          --          --           --      415,200          415

Net Loss for Year Ended
   December 31, 1994                                     --          --          --           --           --           --
                                             --------------  ----------  ----------  -----------  -----------  -----------

   Balance - December 31, 1994 -
     Forward                                             --  $       --          --  $        --    5,670,350  $     5,670


See Notes to Financial Statements.

</TABLE>

<PAGE>


<TABLE>

COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
-------------------------------------------------------------------------------------------------------------------


STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
-------------------------------------------------------------------------------------------------------------------

                                                     Common Stock                Common Stock              Series A
                                                        Class A                     Class C             Preferred Stock
                                                 Shares       Amount       Shares        Amount       Shares       Amount
<S>                                                <C>       <C>             <C>        <C>         <C>        <C>

   Balance - December 31, 1994 -
     Forwarded                                           --  $       --          --  $        --    5,670,350  $     5,670

Restoration of Shares Not Redeemed
   by Stockholders                                       --          --          --           --       18,250           18

Issuance of Stock in Exchange for
   U.S. Patent Rights                                    --          --          --           --      275,000          275

Adjustments to Paid-in Capital [4]                       --          --          --           --           --           --

Treasury Stock Adjustment                                --          --          --           --           --           --

Net Loss for Year Ended
   December 31, 1995                                     --          --          --           --           --           --
                                             --------------  ----------  ----------  -----------  -----------  -----------

   Balance - December 31, 1995
     [Restated]                                          --          --          --           --    5,963,600        5,963

Adjustments to Paid-in Capital [4]                       --          --          --           --           --           --

Net Loss for Year Ended
   December 31, 1996                                     --          --          --           --           --           --
                                             --------------  ----------  ----------  -----------  -----------  -----------

   Balance - December 31, 1996                           --  $       --          --  $        --    5,963,600  $     5,963
                                             ==============  ==========  ==========  ===========  ===========  ===========

See Notes to Financial Statements.

</TABLE>

<PAGE>


<TABLE>


COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
-------------------------------------------------------------------------------------------------------------------


STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
-------------------------------------------------------------------------------------------------------------------

                                                                                                 Deficit
                                                                                               Accumulated        Total
                                                                     Additional                During the     Stockholders'
                                                Preferred Stock        Paid-in    Treasury     Development       Equity
                                             Shares       Amount       Capital      Stock         Stage         [Deficit]
<S>                                             <C>    <C>          <C>          <C>          <C>             <C>

August 31, 1988 [Date of Inception]                --  $       --  $          --  $       --  $           --  $         --

Issuance of Shares                                 --          --             --          --              --           854

Issuance of Stock Pursuant to Private
   Placement Offering                              --          --        499,900          --              --       499,996

Net Loss for the Period from August 31, 1988
   [Date of Inception] Through
   December 31, 1988                               --          --             --          --         (52,708)      (52,708)
                                         ------------  ----------  -------------  ----------  --------------  ------------

    Balance - December 31, 1988                    --          --        499,900          --         (52,708)      448,142

Stock Dividend                                     --          --           (500)         --              --            --

Issuance of Stock for Services Rendered            --          --            (12)         --              --            --

Net Loss for Year Ended
   December 31, 1989                               --          --             --          --        (252,288)     (252,288)
                                         ------------  ----------  -------------  ----------  --------------  ------------

   Balance - December 31, 1989                     --          --        499,388          --        (304,996)      195,854

Issuance of Stock Pursuant to Private
   Placement Offering                              --          --        701,165          --              --       701,241

Issuance of Stock                                  --          --             --          --              --           962

Net Loss for Year Ended
   December 31, 1990                               --          --             --          --        (392,564)     (392,564)
                                         ------------  ----------  -------------  ----------  --------------  ------------

   Balance - December 31, 1990                     --          --      1,200,553          --        (697,560)      505,493

Exchange of Preferred Stock for
   Common Stock Class A                     2,055,000       2,050             --          --              --            --

Exchange of Preferred Stock for
   Common Stock Class C                       450,000         450             --          --              --            --

Cancellation of Common Stock
   Class C                                   (225,000)       (220)            --          --              --          (220)

Issuance of Stock in Connection with
   Reorganization                                  --          --          1,000          --              --         1,000

Dissolution of Coates International Ltd.           --          --         (1,000)         --              --        (1,000)

Exchange of Series A Preferred Stock
   for Preferred Stock                     (2,280,000)     (2,280)        18,990          --              --        18,990

Issuance of Stock                                  --          --      1,019,898          --              --     1,020,000

Purchase of Treasury Stock                         --          --             --     (25,000)            - -       (25,000)

Stock Split 2:1                                    --          --         (2,382)         --              --            --

Net Loss for Year Ended
   December 31, 1991                               --          --             --          --        (739,096)     (739,096)
                                         ------------  ----------  -------------  ----------  --------------  ------------

   Balance - December 31, 1991 -
     Forward                                       --  $       --  $   2,237,059  $  (25,000) $   (1,436,656) $    780,167

See Notes to Financial Statements.


<PAGE>

</TABLE>

<TABLE>

COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
-------------------------------------------------------------------------------------------------------------------


STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
-------------------------------------------------------------------------------------------------------------------

                                                                                                 Deficit
                                                                                               Accumulated        Total
                                                                     Additional                During the     Stockholders'
                                                Preferred Stock        Paid-in    Treasury     Development       Equity
                                             Shares       Amount       Capital      Stock         Stage         [Deficit]
<S>                                             <C>      <C>        <C>           <C>         <C>             <C>

   Balance - December 31, 1991 -
     Forwarded                                     --  $       --  $   2,237,059  $  (25,000) $   (1,436,656) $    780,167

To Correct Balance at December 31, 1991            --          --           (772)         --              --            --

Issuance of Stock for Service                      --          --         10,000          --              --        10,000

Issuance of Stock                                  --          --      2,306,884          --              --     2,307,000

Private Placement Costs                            --          --        (80,675)         --              --       (80,675)

Net Loss for Year Ended
   December 31, 1992                               --          --             --          --        (996,055)     (996,055)
                                         ------------  ----------  -------------  ----------  --------------  ------------

   Balance - December 31, 1992                     --          --      4,472,496     (25,000)     (2,432,711)    2,020,437

Issuance of Stock                                  --          --      1,944,917          --              --     1,945,000

Purchase of Treasury Stock                         --         - -             --     (55,000)             --       (55,000)

Prior Period Adjustment                            --          --             --          --         219,224       219,224

Adjustment for Redeemable Preferred Stock          --          --     (5,921,818)     65,000              --    (5,857,298)

Net Loss for Year Ended
   December 31, 1993                               --          --             --          --      (1,270,966)   (1,270,966)
                                         ------------  ----------  -------------  ----------  --------------  ------------

   Balance - December 31, 1993                     --          --        495,595     (15,000)     (3,484,453)   (2,998,603)

Issuance of Stock                                  --          --         39,998          --              --        40,000

Purchase of Treasury Stock                         --          --             --     (35,000)             --       (35,000)

Adjust Treasury Stock for Redeemable
   Preferred Stock                                 --          --        (19,999)     20,000              --            --

Adjust Remaining Redeemable Preferred Stock
   Issued in 1994                                  --          --        (19,999)         --              --       (20,000)

Restoration of Shares Not Redeemed by
   Stockholders                                    --          --      4,586,883          --              --     4,587,298

Net Loss for Year Ended
   December 31, 1994                               --          --             --          --      (1,229,523)   (1,229,523)
                                         ------------  ----------  -------------  ----------  --------------  ------------

   Balance - December 31, 1994                     --          --      5,082,478     (30,000)     (4,713,976)      344,172

Restoration of Shares Not Redeemed by
   Stockholders                                    --          --         19,982          --              --        20,000

Issuance of Stock in Exchange for
   U.S. Patent Rights                              --          --      5,499,725          --              --     5,500,000

Adjustments to Paid-in Capital [4]                 --          --      1,177,579          --              --     1,177,579

Treasury Stock Adjustment                          --          --        (30,000)     30,000              --            --

Net Loss for Year Ended
   December 31, 1995                               --          --             --          --      (7,062,806)   (7,062,806)
                                         ------------  ----------  -------------  ----------  --------------  ------------

   Balance - December 31, 1995
     [Restated] - Forward                          --  $       --  $11,749,764    $       --  $  (11,776,782) $    (21,055)

See Notes to Financial Statements.

</TABLE>

<PAGE>

<TABLE>

COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
-------------------------------------------------------------------------------------------------------------------


STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
-------------------------------------------------------------------------------------------------------------------

                                                                                                 Deficit
                                                                                               Accumulated        Total
                                                                     Additional                During the     Stockholders'
                                                Preferred Stock        Paid-in    Treasury     Development       Equity
                                             Shares       Amount       Capital      Stock         Stage         [Deficit]
<S>                                            <C>      <C>        <C>              <C>        <C>            <C>

   Balance - December 31, 1995
     [Restated] - Forwarded                        --  $       --  $11,749,764    $       --  $  (11,776,782) $    (21,055)

Adjustments to Paid-in Capital [4]                 --          --      1,132,523          --              --     1,132,523

Net Loss for Year Ended
   December 31, 1996                               --          --             --          --      (1,600,110)   (1,600,110)
                                         ------------  ----------  -------------  ----------  --------------  ------------

   Balance - December 31, 1996                     --  $       --  $  12,882,287  $       --  $  (13,376,892) $   (488,642)
                                         ============  ==========  =============  ==========  ==============  ============

See Notes to Financial Statements.


                                            F-4          
</TABLE>                                                                       




                                           F-5

<PAGE>


<TABLE>

COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
------------------------------------------------------------------------------


STATEMENTS OF CASH FLOWS
------------------------------------------------------------------------------

                                                                          For the
                                                                        Period from
                                                                        August 31,
                                                                       1988 [Date of
                                                                        Inception]
                                                    Years ended           Through
                                                   December 31,        December 31,
                                                1 9 9 6      1 9 9 5      1 9 9 6
                                                -------      -------      -------
                                   [Restated]
<S>                                          <C>           <C>          <C> 

Operating Activities:
  Net Loss                                   $(1,600,110)  $(7,062,806) $(13,376,892)
                                             -----------   -----------  ------------
  Adjustments to Reconcile Net Loss to
   Net Cash  Used in Operating Activities:
   Depreciation                                   40,915       66,386       279,378
   Noncash Research and Development Costs         31,131    5,500,000     5,531,131

  Changes in Assets and Liabilities:
   [Increase] Decrease in:
     Inventory                                  (144,033)          --      (144,033)
     Due from Affiliated Companies                (2,312)     511,544        (4,428)

   Increase [Decrease] in:
     Accounts Payable                                422       21,243        45,081
     Accrued Interest                             18,371       63,500       177,189
     Other Accrued Expenses                      628,985      145,353     1,402,486
                                             -----------   ----------   -----------

   Total Adjustments                             573,479    6,308,026     7,286,804
                                             -----------   ----------   -----------

  Net Cash - Operating Activities             (1,026,631)    (754,780)   (6,090,088)
                                             -----------   ----------   -----------

Investing Activities:
  Payments for Property and Equipment             (5,252)          --      (413,032)
  Payments on Loans to Stockholders                   --      335,805            --
  Loans to Stockholders                           (7,487)     (35,686)   (1,208,678)
                                             -----------   ----------   -----------

  Net Cash - Investing Activities                (12,739)     300,119    (1,621,710)
                                             -----------   ----------   -----------

Financing Activities:
  Proceeds of Additional Paid-in Capital       1,017,242      352,049     1,369,291
  Proceeds from Issuance of Stock                     --           --     6,378,148
  Payment for Treasury Stock                          --           --       (30,000)
  Payment on Stockholders Loans                       --       (4,538)           --
  Loans from Stockholder                           8,000           --         8,000
                                             -----------   ----------   -----------

  Net Cash - Financing Activities              1,025,242      347,511     7,725,439
                                             -----------   ----------   -----------

  Net [Decrease] Increase in Cash and
   Cash Equivalents                              (14,128)    (107,150)       13,641

Cash and Cash Equivalents - Beginning
 of Periods                                       27,769      134,919            --
                                                --------   ----------   -----------

  Cash and Cash Equivalents - End of Periods $    13,641   $   27,769   $    13,641
                                              ===========   ==========   ===========

See Notes to Financial Statements.

                                        F-6
</TABLE>

<PAGE>


<TABLE>

COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
------------------------------------------------------------------------------


                                                                          For the
                                                                        Period from
                                                                        August 31,
                                                                       1988 [Date of
                                                                        Inception]
                                                    Years ended           Through
                                                   December 31,        December 31,
                                                1 9 9 6      1 9 9 5      1 9 9 6
                                                -------      -------      -------
                                   [Restated]
<S>                                          <C>           <C>         <C>

Supplemental Disclosures of Cash Flow 
Information:
  Cash paid during the periods for:
   Interest Paid                             $    18,413   $   27,030   $    46,157
   Taxes Paid                                $        --   $       --   $        --
</TABLE>

Supplemental Schedule of Non-Cash Investing and Financing Activities:
  The  financial  statements  at  December  31, 1996 and 1995,  include  noncash
financing  transactions  of $40,000 and  $50,000,  respectively,  as a result of
mortgage  payments  made by  Gregory  Coates  which were  treated as  additional
paid-in capital.

  The  financial  statements at December 31, 1996,  include a noncash  financing
transaction of $486,970 for the  reclassification of redeemable  preferred stock
to amounts due to certain stockholders [See Note 4].

  The financial  statements at December 31, 1996,  included a noncash  operating
and financing  transaction  of $67,781 for the payment of interest to rescission
stockholders by Gregory Coates which was treated as additional paid-in capital.

  The  financial  statements  at  December  31, 1996 and 1995,  include  noncash
investing and financing transactions of $7,500 and $2,500 for the acquisition of
equipment and a downpayment on a building, respectively, by Gregory Coates which
were treated as additional paid-in capital.

  The financial statements at December 31, 1995, include a noncash financing and
operating transaction of $5,500,000 for the issuance of 275,000 shares of Series
A Stock in exchange  for a non  exclusive  agreement to license  certain  patent
rights owed by George J. Coates.

  The financial statements at December 31, 1996, include a noncash operating and
investing  transaction  of $31,131 for patent  costs that were paid on behalf of
CIL's  principal  stockholder  in 1995,  which  costs were  expensed in 1996 [as
research and  development] in  consideration  of a granting of certain rights to
the Company as more fully described in Note 13 to the financial statements.




See Notes to Financial Statements.


                                        F-7

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS
------------------------------------------------------------------------------



[1] Nature of Operations and Business Risk Factors

Coates International Ltd. ["CIL" or the "Company"] is a Delaware corporation 
organized in October 1991 by George J. Coates as the successor in interest to a 
Delaware corporation of the same name incorporated in August 1988.

CIL has developed a spherical  rotary valve system [the "Coates System"] for use
in piston driven internal  combustion  engines of all types and is manufacturing
automotive  engines  modified with the Coates System on a limited scale basis at
its Wall Township,  New Jersey  facility.  Also, as more fully discussed in Note
13, CIL has a non-exclusive  license to sell and grant  sublicenses with respect
to products  using the Coates System [based on the "Coates  Patents"].  However,
since  there has been no  significant  revenue  generated  from sales of engines
modified  with the Coates  System,  or from the  granting of  sub-licenses,  the
Company is considered to be a Development Stage Company for financial  reporting
purposes.

Initially,  the Company  intends to market its engines  modified with the Coates
System to the automotive  racing  market.  To  successfully  develop and sell an
automobile,  truck or motorcycle  engine for road use [as opposed to racing use]
in the United  States,  the Company will be required to obtain a Certificate  of
Conformity  from the Office of Mobile Services of the  Environmental  Protection
Agency to the effect that its engines as modified  with the Coates System comply
with  applicable  emission  standards.   The  Company  has  not  applied  for  a
Certificate  of  Conformity  from the EPA.  Companies  already exist that modify
automotive, motorcycle and marine racing engines on a customized order basis and
if CIL competed with major manufacturers, CIL would be an insignificant factor.

Development  of the Coates System  technology was initiated by George J. Coates,
CIL's  founder,  principal  and  controlling  stockholder  and  chief  executive
officer,  in the  late  1970's  and  development  efforts  have  been  conducted
continuously  since such time.  From July 1982  through May 1993,  seven  United
States patents [the "Coates  Patents"][as  well as a number of foreign patents],
were issued to George J. Coates with respect to the Coates System [See Note 13].
Since the inception of the Predecessor  Entity [See Note 3] in 1988, all aspects
of the business of CIL have been  completely  dependent  upon the  activities of
George J. Coates.  Mr.  Coates,  who is a resident alien and not a United States
citizen,  does  not  have an  employment  contract  with CIL and the loss of Mr.
Coates'  availability  or  services,  whether  due to his death,  incapacity  or
otherwise,   would  have  a  material  adverse  effect  on  CIL's  business  and
operations.

[2] Summary of Significant Accounting Policies

Use of Estimates - The  preparation of financial  statements in conformity  with
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 costs and expenses  during
the reporting period. Actual results could differ from those estimates.

Cash and Cash  Equivalents - Cash  equivalents  are comprised of certain  highly
liquid investments with a maturity of three months or less when purchased.

Credit Risk - The Company places it cash and cash  equivalents  with high credit
quality  financial  institutions.  The amount on deposit in any one  institution
that exceed  federally  insured limits is subject to credit risk.  There were no
such  amounts  existing at December  31, 1996 or 1995.  The Company  believes no
significant  concentration  of credit  risk  exists  with  respect to these cash
investments.

Inventory - Inventory,  consisting of engine parts and components,  is stated at
the lower of average cost or market.


                                       F-8

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #2
------------------------------------------------------------------------------



[2] Summary of Significant Accounting Policies [Continued]

Property,  Plant and Equipment, and Depreciation - Property, plant and equipment
are  recorded  at  cost.   Depreciation  is  computed   principally   using  the
straight-line method over the estimated useful life of the assets.  Expenditures
for  maintenance  and repairs are charged to expense as incurred,  whereas major
betterments are capitalized.

Research  and  Development  -  Research  and  development  costs are  charged to
operations  as  incurred.  Research and  development  expense for the year ended
December  31,  1995,  includes a non-cash  $5.5  million  charge  related to the
signing of a non-exclusive  agreement with the Company's  principal  stockholder
and executive,  George J. Coates,  to license certain patent rights owned by Mr.
Coates for 275,000 shares of CIL Series A Stock [See Note 13].

Earnings  [Loss] Per Share - As more fully  discussed in Note 3 to the financial
statements, the Company has not issued any common stock, but its preferred stock
has voting  privileges.  Loss per share has been  calculated by dividing the net
loss by the average number of preferred shares outstanding during the period(s).

[3] Capital Stock

CIL is a Delaware  corporation  organized in October 1991 by George J. Coates as
the  successor  in  interest  to  a  Delaware   corporation  of  the  same  name
incorporated in August 1988 [the "Predecessor Entity"]. As a result of a dispute
with certain former  employee-directors  who claimed to own  approximately  nine
[9%]  percent  of  the  Predecessor  Entity's  outstanding  capital  stock,  the
Predecessor   Entity  was   reorganized  in  November  1991.   Pursuant  to  the
reorganization,  all of the  Predecessor  Entity's assets subject to liabilities
were  distributed to CIL; the  non-litigating  stockholders  of the  Predecessor
Entity became the stockholders of CIL; and the Predecessor Entity was dissolved.
The lawsuits instituted against CIL by the former  employee-directors  have been
dismissed with prejudice.

CIL is  authorized by its  Certificate  of  Incorporation  to issue an aggregate
34,000,000 shares of capital stock including  20,000,000 shares of Common Stock,
$.001 par value and  14,000,000  shares of Series A  Non-Cumulative  Convertible
Preferred Stock [the "Series A Stock"],  $.001 par value. There are no shares of
common stock issued as of December 31, 1996.

The  holders  of shares of CIL's  Series A Stock are  entitled  to ten votes per
share held on all matters submitted to a vote of its shareholders.  In addition,
such  holders  are  entitled to receive  ratably  such  dividends,  if any, on a
non-cumulative  basis,  as may be  declared  from  time to time by the  Board of
Directors  out  of  funds  legally  available  therefor.  In  the  event  of the
dissolution, liquidation or winding up of CIL, the holders of CIL Series A Stock
are entitled to share  ratably in all assets  remaining  after payment of all of
CIL's  liabilities  to the extent of the par value of such shares  together with
all unpaid dividends on such shares,  prior to any payment being made to holders
of  Common  Stock;  provided  that the  holders  of  Series A Stock  will not be
entitled to  participate  any further in a  distribution  of CIL's assets in the
event of a dissolution or liquidation.

The  holders of CIL Series A Stock do not have any  subscription  or  redemption
rights,  nor do they have any preemptive or other rights to acquire or subscribe
for additional, unissued or treasury shares.



                                       F-9

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #3
------------------------------------------------------------------------------



[3] Capital Stock [Continued]

The Series A Stock is  convertible  on a  share-for-share  basis into  shares of
Common  Stock at the option of the holder.  Holders of Common Stock are entitled
to one vote per share on all matters submitted to a vote of shareholders, but do
not have  subscription,  redemption  or conversion  rights,  and do not have any
preemptive  or other rights to acquire or subscribe for  additional  unissued or
treasury shares.

The  holders of the Series A Stock and the Common  Stock do not have  cumulative
voting rights.  Accordingly,  the holders of more than half of the votes of such
shares on an aggregated  basis [with each share of Series A Stock being entitled
to ten votes per share and each share of Common Stock being entitled to one vote
per share] can elect all of the Directors to be elected in any election. In such
event,  the  holders  of the  remaining  shares  would  not be able to elect any
Directors.  The Board is empowered to fill any vacancies on the Board created by
the resignation, death or removal of Directors.

[4] SEC Complaint, Court Order, Redeemable Preferred Stock, Restatement of 1995
 Financial Statements

In July 1994, the Securities and Exchange  Commission  ["SEC"] filed a complaint
in the United States  District Court for the Southern  District of New York [the
"Court"] against George J. Coates, principal stockholder and executive of Coates
International Ltd., CIL and certain affiliated  companies seeking injunctive and
other relief. In its complaint, the SEC made a number of allegations,  including
allegations that sales of CIL Series A Stock were fraudulently  effected through
misrepresentations  and omissions of material facts concerning CIL's product and
business and without registration of such stock under the Securities Act of 1933
or pursuant to an applicable exemption thereunder.  At the time of the filing of
the SEC  complaint,  the Court  issued an order  freezing  the assets of CIL and
George J.  Coates and  appointed a Temporary  Receiver  to take  possession  and
control of CIL's assets and properties.

In February  1995,  CIL and George J. Coates,  without  admitting or denying the
allegations  contained  in the SEC  complaint,  consented  to the entry of final
consent  judgments  enjoining them from effecting sales of any security unless a
registration  statement  is in effect  as to such  securities  or an  applicable
exemption  from  registration  is  available  and from  engaging  in  fraudulent
activities  in connection  with the offer or sale of any security.  CIL was also
ordered to provide a list of all purchasers of CIL stock from CIL, George Coates
or any other source during the period  commencing April 24, 1990, to the date of
the consent  judgment  including the number of shares purchased and the purchase
price.

The consent judgment also required CIL to file a registration statement with the
SEC to effect a Rescission and Exchange Offer to the  aforementioned  purchasers
of CIL Series A Stock.  Such purchasers would be given the option to (a) receive
cash or assets equal in amount to the  consideration  such  purchasers  paid for
their currently held CIL Series A Stock,  plus simple interest  calculated at an
annual rate of five [5%] percent; or (b) the right to receive one share of newly
issued CIL Series A NonCumulative  Convertible  Preferred Stock identical to the
Series A Stock. The consent order further discharged the Temporary Receiver and,
instead,  named him as Special  Master of CIL,  with  specific  responsibilities
including assisting in CIL's compliance with the consent judgment.

CIL succeeded in registering the Rescission and Exchange Offer.  Thirty-two [32]
Rescinding Shareholders elected to receive cash in exchange for their stock. The
total amount due to these Rescinding Shareholders was $1,270,000, plus interest.



                                      F-10

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #4
------------------------------------------------------------------------------


[4] SEC Complaint, Court Order, Redeemable Preferred Stock, Restatement of 1995
 Financial Statements [Continued]

CIL does not contract with a stock  transfer agent to maintain a record of stock
transactions or stockholders.  In an attempt to maintain accurate stock transfer
records for  shareholders of CIL, other than George J. Coates,  who were selling
stock  privately,  CIL opened  the "CIL  Transfer  Account"  in March  1995.  In
February 1996, the Special Master  reported to the Court that,  without  waiting
for the Court's  approval,  CIL had collected  funds from persons  interested in
purchasing CIL stock [the "Purchasing Shareholders"], and segregated such funds,
$1,565,000 through December 31, 1995, in the CIL Transfer Account.  It should be
noted that during 1995,  and prior to the  Rescission  and Exchange  Offer being
made, certain  shareholders  requested refunds for CIL Series A Stock previously
purchased by them [the "Refunding  Shareholders"].  These Refunding Shareholders
were not part of the Rescission  Offer. The Purchasing  Shareholders did receive
an aggregate 78,250 shares of CIL Series A Stock in 1995 primarily from sales of
the personal  shares of CIL Series A Stock of Gregory  Coates,  son of George J.
Coates,  and a then Vice  President  and Director of CIL, and from the Refunding
Shareholders,  with the CIL Transfer Account facilitating the monetary transfers
in  connection  with  the  purchase  and  sale of  such  shares.  The  Refunding
Shareholders  were paid $527,000 from the CIL Transfer  Account as part of these
transfers  of  shares  through  December  31,  1995.   Gregory  Coates  withdrew
approximately $280,000 from the CIL Transfer Account during 1995, representing a
distribution of a portion of his profits on the sales of his personal stock, and
certain bills of CIL were paid from the CIL Transfer Account,  leaving a balance
in the CIL Transfer Account of $508,428 at December 31, 1995.

The Special Master reported to the Court that CIL's then independent  accounting
firm informed him that  although the funds in the CIL Transfer  Account were the
proceeds of the private sales of stock by existing CIL  shareholders  [primarily
Gregory  Coates],  the independent  accounting firm was taking the position that
because the CIL Transfer  Account was in CIL's name,  it would be  considered an
asset of CIL unless the name on the CIL Transfer  Account was changed.  The name
of the CIL Transfer  Account was not changed and the balance in the CIL Transfer
Account at December 31, 1995, $508,428,  was included in the cash balance of CIL
in its December 31, 1995 balance sheet before  restatement.  CIL took issue with
that  characterization  of the CIL  Transfer  Account,  and as a result  of this
disagreement, CIL's Board of Directors decided to dismiss the accounting firm as
its independent  accountants,  and filed a Form 8-K describing this disagreement
and dismissal in August of 1996.

The Special  Master also reported to the Court that an  additional  $540,000 had
been disbursed from the CIL Transfer Account to Gregory Coates in February 1996.
If the legal  rights to the funds in the CIL Transfer  Account  belonged to CIL,
and  not to  Gregory  Coates,  then  payments  to  Gregory  Coates,  represented
repayments of loans from Gregory Coates,  and not simply a withdrawal of his own
funds.  That being the case,  such payment would have  constituted  repayment of
loans,  and the money  repaid  would have to be returned to CIL because the loan
payments  would  have been made in  violation  of the terms of the asset  freeze
provision  contained  in the consent  judgment as  discussed  in the first three
paragraphs of this note.

Also,  during  1996,  certain  individuals  deposited  $2,604,970  into  the CIL
Transfer Account seeking to acquire an aggregate  130,249 shares of CIL Series A
Stock.  Some of these  individuals  were sold an aggregate  66,725 shares of CIL
Series A Stock by Gregory Coates for proceeds totaling $1,334,500,  with the CIL
Transfer  Account  facilitating  the monetary  transfers in connection  with the
purchase and sale of such shares.  The funds of the remaining  individuals  [the
"Potential Investors"],  $1,270,470,  who did not receive any CIL Series A Stock
from Gregory  Coates or other sources,  was used to pay  thirty-one  [31] of the
aforementioned thirty-two [32] Rescinding Shareholders. In addition, pursuant to
the Court order, approximately $65,000 was paid to these Rescinding Shareholders
from the CIL Transfer Account  representing  interest on their funds. Two [2] of
the 31 Rescinding  Shareholders informed CIL that as long as they received their
funds,  they would not insist that CIL pay interest on such returned  funds.  As
the Court requires that such interest be paid, approximately $105,000 remains as
accrued interest payable to such Rescinding Shareholders at December 31, 1996.

                                      F-11

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #5
------------------------------------------------------------------------------


[4] SEC Complaint, Court Order, Redeemable Preferred Stock, Restatement of 1995 
Financial Statements [Continued]

The Court heard  arguments from the Special Master,  CIL legal counsel,  and the
SEC regarding the aforementioned exchanges of CIL stock, and the legal rights to
funds in the CIL Transfer  Account.  The Court  decided  that such  exchanges of
stock were not  permitted  by the Consent  Orders and ordered  George J. Coates,
personally,  and CIL to  return  funds to the  Potential  Investors  who had not
received any CIL Series A Stock.  The Court also concluded that the CIL Transfer
Account was not a corporate  asset of CIL,  and that  disbursements  of funds to
Gregory Coates from the CIL Transfer  Account were a release of his own funds to
him rather  than the  improper  repayment  by CIL of a loan.  Based on the above
decision of the Court  determining the legal rights to the CIL Transfer Account,
CIL's 1995 balance sheet has been restated to eliminate the CIL Transfer Account
from CIL's cash balance at December 31, 1995.

Per the original Consent Order, George J. Coates was ordered by the Court to pay
up to the first $773,500 of the amounts due to the Rescinding Shareholders using
all of his personal  assets other than his personal  residence.  [Per the August
19, 1996, Court Order,  the  aforementioned  Potential  Investors have taken the
place of the Rescinding  Shareholders who have received refunds].  To the extent
that he is unable to pay any such amounts,  CIL is required to pay same and will
retain  its rights to assert  claims  against  George J.  Coates  personally  to
recover its payment of any such  shortages.  CIL also has  consented  to pay any
additional  amounts  required.  CIL's  December  31, 1995  balance  sheet before
restatement  reflected  the  entire  amount due to the  Rescinding  Shareholders
totaling  $1,448,818,  including  accrued  interest  of  $158,818,  as a  direct
obligation  of CIL.  Whereas  the court  order  required  George J. Coates to be
personally  liable for up to the first $773,500 of amounts due to the Rescinding
Shareholders,  CIL's  1995  balance  sheet has been  restated  to  reduce  CIL's
recorded  liability  to the  Rescinding  Shareholders  accordingly.  CIL's  1995
restated financial  statements now disclose a contingent liability [See Note 10]
on the part of CIL of $773,500,  in the event of  nonpayment by George J. Coates
to the  Rescinding  Shareholders  [as replaced by the  aforementioned  Potential
Investors at December 31, 1996].

Because 31 of the 32 Rescinding  Shareholders have been paid out of funds in the
CIL Transfer  Account during 1996, that liability has been reduced to $10,000 at
December 31, 1996, and the amount due to the aforementioned Potential Investors,
$1,270,470 [as described in the eighth  paragraph of this Note],  less $773,500,
[which latter amount represents that portion of the liability owed personally by
George J. Coates as  discussed  in the  preceding  paragraph]  is reflected as a
liability of $486,970, plus $10,000 due to the remaining Rescinding Shareholder,
and  approximately  $105,000 of accrued interest  related to certain  Rescinding
Shareholders [as described in the eighth paragraph of this Note] at December 31,
1996.

In addition to the  restatements  discussed in the ninth and tenth paragraphs of
this Note, other principal 1995 restatements include:

o  The Company has been receiving cash infusions from Gregory  Coates,  a former
   Vice President and Director of CIL, and son of George J. Coates. Such amounts
   had been  classified  as loans from  Gregory  Coates on the December 31, 1995
   balance  sheet before  restatement.  Such amounts were not loans,  but rather
   additional capital  contributions by Gregory Coates. CIL's 1995 balance sheet
   has  been  restated   accordingly,   and  related  accrued  interest  expense
   [approximately $32,000] has been eliminated.

o  The  Company  incurs  legal and related  costs  associated  with  registering
   patents.  On the  December 31, 1995 balance  sheet before  restatement,  such
   costs amounted to $51,397 and were  capitalized as Patent Right Costs. As the
   probable future economic benefit of such costs is uncertain,  such costs have
   been expensed for the year ended December 31, 1995.

                                      F-12

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #6
------------------------------------------------------------------------------


[4] SEC Complaint, Court Order, Redeemable Preferred Stock, Restatement of 1995 
Financial Statements [Continued]

o  The Company  expended  $12,000 to a broker during the year ended December 31,
   1995, in  anticipation of using said broker for an offering of Company stock.
   Prior to December 31, 1995,  management  decided that any offering of Company
   stock would be best served by using  another  broker and such amount has been
   expensed for the year ended December 31, 1995.

o  The Notes to the 1995 financial statements before restatement stated that "on
   March 15, 1996 the Board of  Directors  authorized  a two for one stock split
   after  converting all Preferred Series A Stock to Common Stock." No corporate
   action had been taken to legally  effectuate  such conversion or stock split.
   As a result,  the 1995 financial  statements  have been restated to eliminate
   all  references  to "issued  shares of Common  Stock," and to  reinstate  the
   Series A Stock as such stock has not been converted to Common Stock.

The net  effect of the  above  restatements  on  operations  for the year  ended
December  31,  1995,  was an  increase in the net loss for the period of $31,442
[$.01  per  share],  reflecting  retroactive  application  of the  prior  period
adjustments to the following components of operations:

                                                             Effect on Net Loss
                                                             Increase/[Decrease]
                                                                   To Amounts
                                                            Previously Reported
esearch and Development Costs                                    $    51,396
General and Administrative Expenses                                    12,000
Interest Expense                                                      (31,954)
                                                                  -----------

  Increase to Net Loss for the Year Ended December 31, 1995            31,442

Deficit Accumulated During the Develop.  Stage as Previously Reported11,745,340

  Deficit Accumulated During the Development Stage as Restated      $11,776,782

[5] Going Concern

The  accompanying  financial  statements  have been prepared in conformity  with
generally accepted accounting principles, which contemplates continuation of the
Company  as a  going  concern  and  realization  of  assets  and  settlement  of
liabilities  and  commitments in the normal course of business.  The Company has
met its obligations in 1995 and 1996 primarily  through  capital  infusions from
one of its principal stockholders, Gregory Coates.

CIL's  ability  to  generate  revenues  and  achieve  profitable  operations  is
principally  dependent upon the execution and funding of sub-license  agreements
with engine manufacturers or retrofitters, and upon the manufacture and sale, by
CIL, of high performance  automotive,  motorcycle and marine racing engines. CIL
is actively  attempting to market its  technology and is in  communication  with
various persons and entities who may be interested in acquiring  licenses to use
the technology [Also See Note 13].





                                      F-13

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #7
------------------------------------------------------------------------------




[5] Going Concern [Continued]

CIL's short term  operational  business plan is to attempt to obtain firm orders
for  racing  engines  modified  with the  Coates  System  from oral and  written
inquiries  it has  received  and to  construct  those  engines,  initially  from
inventory at its limited production  facility in Wall Township,  New Jersey, for
delivery  to  interested  purchasers,  and to  sell  sub-  licenses  to use  its
technology.  With  sufficient  short term  financing and a sufficient  number of
orders,  CIL management  believes that it will be able to produce racing engines
using the Coates System  technology  at its Wall Township  facility on a limited
basis at the rate of  approximately  30 engines per month.  CIL expects that the
bulk of its initial  sales of engines will be at a base sales price in the range
of $25,000 to $30,000 per engine  although  depending on type and size,  some of
the engines may be priced as high as $75,000. To achieve such production levels,
CIL will be required to expand its production work force to approximately  15-20
production workers.

CIL's short term business  funding plan is to complete a private offering of its
Series A Stock which is  expected to  generate,  at a minimum,  after  expenses,
approximately  $660,000;  and  at  a  maximum,  after  expenses,   approximately
$7,060,000.  As more fully  described in Note 4,  approximately  $600,000 of the
proceeds of the private  offering will have to be used to satisfy  certain Court
ordered  obligations,  which would leave the  Company  approximately  $60,000 of
working capital  assuming the minimum target of the private  offering is met and
it does not have to satisfy any of its contingent  liabilities  related  thereto
[also  see Note 10].  The  proceeds  of any  sales of  Series A Stock  above the
minimum will be applied to pay outstanding  payables and to the extent there are
sufficient  additional  proceeds,  such funds will be applied to purchase engine
blocks,  molds, dyes,  castings and components;  to marketing and promotion;  to
salaries and  associated  benefits for production  line workers,  and for patent
maintenance  costs.  Gregory  Coates has also  agreed to  continue to fund CIL's
operations, up to $1,000,000, as needed, for the next twelve months.

CIL's long range operational business plan is to acquire a larger plant facility
and acquire  production  machinery and equipment for a full scale assembly line,
and continue its research and development efforts. CIL would fund this plan with
a public offering of its stock wherein it would seek a minimum of $7,500,000.

In view of its substantial recorded  [approximately $600,000 including interest]
and contingent  [$773,500]  obligations to the Potential Investors and remaining
Rescinding  Shareholders as more fully discussed in Note 4, no assurances can be
given that CIL will be able to pursue its business plan as it presently does not
possess  sufficient liquid assets to fund such obligations.  Also,  depending on
the results of the proposed private  placement  discussed above, the Court could
direct the Special Master to file a bankruptcy petition for CIL.

The Company has suffered  recurring losses during its development  stage and has
accumulated  a deficit  since its  inception to December  31, 1996,  of over $13
million.  The Company also has minimal liquid assets,  while reporting over $2.2
million in current liabilities.

The  aforementioned  conditions  discussed in this Note raise  substantial doubt
about the Company's ability to continue as a going concern.

The financial  statements do not include any adjustments that might be necessary
in the event the Company cannot continue as a going concern.




                                      F-14

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #8
------------------------------------------------------------------------------




[6] Income Taxes

Pursuant to  Statement  of  Financial  Accounting  Standards  ["SFAS"]  No. 109,
"Accounting  for Income  Taxes," income tax expense [or benefit] for the year is
the sum of deferred tax expense [or benefit] and income taxes currently  payable
[or refundable]. Deferred tax expense [or benefit] is the change during the year
in a company's deferred tax liabilities and assets. Deferred tax liabilities and
assets are determined based on differences  between financial  reporting and tax
basis of assets and  liabilities,  and are measured  using the enacted tax rates
and laws that will be in effect when the difference are expected to reverse. The
Company files its tax return on a cash basis. Other temporary difference consist
of depreciation.

The Company has a deferred tax asset of  approximately  $2,000,000  based on net
operating  loss  carryforwards  of  approximately  $6,000,000.  If not used, the
carryforwards  will expire from 2003  through  2011.  SFAS No. 109  requires the
establishment  of a deferred tax asset for all deductible  temporary  difference
and operating loss  carryforwards.  Because of the uncertainty  that the Company
will  generate  income in the future  sufficient  to fully or partially  utilize
these  carryforwards,  a valuation  allowance of $2,000,000 has been established
pursuant to SFAS No. 109.  Accordingly,  no deferred  tax asset is  reflected in
these financial statements.

[7] Fair Value of Financial Instruments

Statement of Financial  Accounting  Standards  No. 107,  "Disclosure  about Fair
Value of Financial  Instruments"  requires  disclosing  fair value to the extent
practicable  for financial  instruments  which are recognized or unrecognized in
the balance sheet.

For certain instruments,  including cash and cash equivalents and trade payables
and accrued liabilities,  it was estimated that the carrying amount approximates
fair value for these instruments because of their short maturities. The mortgage
payable   approximates   fair  value  since  the  interest  rate  being  charged
approximates  a current  market rate of interest  for  similar  debt.  Remaining
amounts due to certain  existing and potential  shareholders  approximates  fair
value as such amounts are due within one year.

As more  fully  discussed  in Notes 4 and 10,  pursuant  to the Court  Order the
Company is contingently  liable to certain  existing and potential  shareholders
for up to  $773,500  [plus  additional  amounts as  required]  if the  Company's
principal  stockholder  and  executive  does not fulfill his  obligation to such
existing and  potential  shareholders  pursuant to the Court order.  The Company
does not believe it is practicable to estimate the fair value of this contingent
liability and does not believe the risk of payment is likely.




                                      F-15

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #9
------------------------------------------------------------------------------


[8] Property, Plant and Equipment

Property,  plant and equipment at December 31, 1996 and 1995,  and their related
estimated useful lives are as summarized below:

                                      Estimated
                                     Useful Life        December 31,
Assets                                 [Years]       1 9 9 6     1 9 9 5
------                                  -----        -------     -------

Land                                              $  920,550  $  920,550
Building                                   40        579,450     579,450
Building Improvements                      40        145,871     145,871
Machinery and Equipment                   5-7        235,366     222,614
Furniture and Fixtures                   5-10         39,295      39,295
                                                  ----------  ----------

Totals - At Cost                                   1,920,532   1,907,780
Less: Accumulated Depreciation                       313,873     272,958
                                                  ----------  ----------

  Totals                                          $1,606,659  $1,634,822
  ------                                          ==========  ==========

The Company's land and building was acquired from a related party [See Note 9].

As more fully  described in Note 2, CIL's policy is to depreciate  its property,
plant and  equipment,  which has a net book value of $$1,606,659 at December 31,
1996, over its remaining useful life principally using the straight-line method.
It is reasonably  possible that the Company's  estimate that the carrying amount
of its property,  plant and equipment will be recoverable from future operations
will change in the near term given the uncertainty  about the Company's  ability
to continue as a going concern as more fully discussed in Note 5.

[9] Related Party Transactions

Due from  Stockholder - Due from stockholder  represents  payments by CIL of the
automobile  insurance  of George J.  Coates in the  amounts of $3,430 and $6,986
during the years ended December 31, 1996 and 1995, respectively.  The balance at
December 31, 1995, also includes foreign patent costs incurred by the Company on
behalf of George Coates, which costs were expensed in 1996 in consideration of a
granting of certain  rights to the Company as more fully  described  in Note 13.
Amounts  due  bear  interest  at the  rate of 7% and  have no  stated  terms  of
repayment.

Due to Stockholder - Due to stockholder represents working capital loans made to
the Company in the amount of $8,000 during the year ended December 31, 1996. The
loans are non-interest bearing and have no stated terms of repayment.

Due from Affiliated Companies - Due from affiliated companies represents working
capital  loans  made  to  companies  of  which  George  J.  Coates  is the  sole
stockholder.  During 1996, the Company loaned these affiliated companies $2,312.
During  1995,  the Company  received  $513,660 in  repayment of amounts due from
affiliated  companies  relating to the Millwest License Agreement [which is more
fully  described  in Note 13].  The loans are  non-interest  bearing and have no
stated terms of repayment.

Subcontract  Labor - The  Company  subcontracts  its project  expense  [payroll,
insurance  and  supplies]  from an entity  which  George  J.  Coates is the sole
stockholder.  During the years ended  December  31, 1996 and 1995,  $181,500 and
$187,889, respectively, were paid for these services.



                                      F-16

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #10
------------------------------------------------------------------------------



[9] Related Party Transactions [Continued]

Purchase of Land and  Building - From August 1990  through  February  1993,  CIL
subleased the Company's Wall  Township,  New Jersey,  facility [the  "Facility"]
from  George  J.  Coates,  and then  from  the  George  J.  Coates  1991  Family
Partnership  [the   "Partnership"   eventually   purchasing  the  Facility  from
unaffiliated  third parties for  $1,500,000 in February  1993].  Pursuant to the
February  6, 1995  consent  judgment,  George J. Coates was ordered to cause the
Partnership  to transfer  the  Facility to CIL with CIL  obtaining  title to the
Facility and assuming a $300,000 mortgage loan obligation [See Note 14].

Patents  and  Licenses - As more fully  described  in Note 13, CIL has  executed
agreements with Nicholson McLaren Engines ["Nicholson  McLaren"] Ltd. of London,
United  Kingdom and its  affiliates.  John  Nicholson,  President  of  Nicholson
McLaren, is a less than 1% stockholder of CIL.

[10] Commitments and Contingencies

The Company is a defendant in various  lawsuits  incident to the ordinary course
of business.  It is not possible to determine the probable outcome or the amount
of  liability,  if  any,  under  these  lawsuits;  however,  in the  opinion  of
management,  the disposition of these lawsuits will not have a material  adverse
effect on the  Company's  financial  position,  results of  operations,  or cash
flows.

As more fully discussed in Note 4 to the financial statements, George J. Coates,
principal and controlling  shareholder  and chief executive  officer of CIL, per
the  original  consent  order of the Court,  was  ordered to pay up to the first
$773,500 of amounts due to  Rescinding  Shareholders.  Per the August 19,  1996,
court order,  new  Potential  Investors  have taken the place of the  Rescinding
Shareholders. To the extent that Mr. Coates is unable to pay any such amounts to
the Potential  Investors,  CIL is required to pay same and is thus  contingently
liable for such amounts as it may have to pay should Mr.  Coates not fulfill all
or part of his primary commitment on amounts due to Potential  Investors.  It is
at least  reasonably  possible that the above  circumstances  will change in the
near term due to future  confirming  events  and the  effect of any such  change
would be material to the financial statements.

[11] Reclassification

Certain  items  pertaining to the prior year have been  reclassified  to conform
with the current year's presentation.

[12] New Authoritative Accounting Pronouncement

The Financial Accounting Standards Board ["FASB"] has issued Statement of 
Financial Accounting Standards ["SFAS"] No. 125, "Accounting for Transfers
 and Servicing of Financial Assets and Extinguishment of Liabilities.
"  SFAS No. 125 is effective for transfers and servicing of financial assets
and extinguishment of liabilities occurring after December 31, 1996. 
The provisions of SFAS No. 125 must be applied prospectively; retroactive
 application is prohibited, and early application is not allowed. 
SFAS No. 125 is not expected to have a material impact on the Company.  
Some provisions of SFAS No. 125, which are unlikely to apply to the Company
 have been deferred by the FASB.



                                      F-17

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #11
------------------------------------------------------------------------------



[13] Patents and Licenses

Development  of the Coates System  technology was initiated by George J. Coates,
CIL's  founder,  principal  and  controlling  stockholder  and  chief  executive
officer,  in the  late  1970's  and  development  efforts  have  been  conducted
continuously  since such time.  From July 1982  through May 1993,  seven  United
States patents [the "Coates  Patents"][as  well as a number of foreign patents],
were issued to George J. Coates with respect to the Coates  System.  The consent
order allowed  George J. Coates the  alternative to elect to retain title to his
patents on the  condition  that he  either:  (a) grant to CIL an  exclusive  and
irrevocable license to utilize and exploit the patents, or (b) reimburse CIL for
all monies expended in the preparation,  application  and/or  prosecution of the
patents,  including  but not limit to, legal fees paid by CIL.  George J. Coates
elected to reimburse CIL and retain  possession of the patents and did so during
1995. In February 1995, George J. Coates and his son Gregory Coates each granted
CIL a non-exclusive  license to  manufacture,  sell and grant  sublicenses  with
respect to products based on the Coates  Patents  within the United States,  its
territories  and  possessions   [the  "Licensed   Areas"].   The  licenses  were
non-exclusive  so  that  neither  George  J.  Coates  nor  Gregory  Coates  were
prohibited from granting  similar  licenses to other parties within the Licenses
Areas or to otherwise  compete  directly  with CIL.  The licenses  expire in the
event of bankruptcy or similar insolvency of CIL. CIL agreed to pay a $5,500,000
license  fee to George J.  Coates in  consideration  for his grant to CIL of the
non-exclusive  license payable at management's  discretion but in no event later
than February 17, 1998. In September  1995, this  arrangement was modified.  CIL
and George J. Coates agreed that instead of the  $5,500,000  payment,  CIL would
issue  275,000  shares of Series A Stock to Mr.  Coates,  which cost the Company
charged to  research  and  development  for the year ended  December  31,  1995.
Because  the  license  granted to CIL was  non-exclusive,  the  Coates'  are not
prohibited from granting  similar licenses to other parties outside the Licensed
Areas.   In  addition,   George  J.  Coates  holds  patents  issued  by  foreign
jurisdictions  with respect to the Coates System, the rights to which he has not
licensed to CIL.

In February 1996, George J. Coates and Gregory Coates executed a non-competition
agreement agreeing not to compete with CIL in the manufacture,  assembly, use or
sale of internal  combustion engines utilizing the technology falling within the
scope of the Coates Patents in the Licensed Areas and not to grant any exclusive
or  non-exclusive  license in the Licensed  Areas except  through CIL, while CIL
remains an  independent,  viable company and is in compliance with the terms and
conditions of the above described licenses.

In February 1994, a license agreement was executed with Millwest  Corporation of
Dumas,  Texas  ["Millwest"]  granting  Millwest a five year exclusive license to
retrofit  pre-existing  internal combustion engine blocks [excluding  air-cooled
engines and engines used for racing  competition] by replacing the  pre-existing
valve system with the Coates Spherical Rotary Valve System in the United States,
its  territories  and  possessions,  Canada  and  Mexico,  the five year term to
commence  after  payment  to CIL by  Millwest  on or  before  May 4,  1994  of a
$10,000,000   licensing  fee.  The  agreement  also  provided  Millwest  with  a
non-exclusive  license to manufacture the Coates  Spherical  Rotary Valve System
subject to the payment of  royalties.  Additional  payments of  $1,666,666  were
required  to be paid to CIL on the third,  fourth and fifth  anniversary  of the
effectiveness  of the  license.  An  additional  $15,000,000  payment  is due on
February 5, 1999.  Pursuant to the agreement,  Millwest made an initial $500,000
payment in February 1994 to a company owned by George J. Coates. Pursuant to the
consent  judgments [as also discussed in the second paragraph of Note 4], George
J. Coates was ordered to cause the  transfer  to CIL of all  licensing  fees and
other funds paid to persons or entities other than CIL related to an interest in
the Coates Patents or in the technology  embodied in the Coates Patents. In this
regard,  in 1995 CIL received  approximately  $513,000 from the company owned by
George J. Coates that  originally  received  the $500,000  initial  payment from
Millwest;  such payment  representing  the $500,000  amount from  Millwest  plus
accrued interest related thereto.



                                      F-18

<PAGE>



COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #12
------------------------------------------------------------------------------


[13] Patents and Licenses [Continued]

While  Millwest made an initial  $500,000  payment  pursuant to the agreement in
February  1994, it has failed to pay the  additional  $9,500,000 to activate the
license.  CIL has placed Millwest on notice that it is in default. In June 1995,
Millwest informed CIL of an intention to activate the license agreement claiming
that  financing had been  arranged to do so but to date, no additional  payments
have been received by CIL from Millwest and no assurances  can be given that any
additional  payments will be made;  accordingly  no additional  revenue has been
recognized  beyond the  aforementioned  $500,000  received during the year ended
December 31, 1994.

In February  1996,  George J. Coates and Gregory Coates granted CIL the right to
retain any monies,  including  royalties received from Nicholson McLaren Engines
Ltd. ["Nicholson  McLaren"] of London,  United Kingdom,  and its affiliates,  or
from Noble Motor Sport of London,  United Kingdom [manufacturer of Ascari racing
cars] and its  affiliates,  for  manufacture,  sale, use or assembly of internal
combustion engines anywhere in the world using the technology falling within the
scope of the Coates Patents [U.S. and foreign]. The grant is effective while CIL
remains an  independent,  viable company and is in compliance with the terms and
conditions of the above described  licenses.  In consideration for these grants,
CIL agreed to pay all outstanding  Coates Patent fees [U.S. and foreign] as well
as all such fees incurred subsequently.

In April 1996, CIL executed a license  agreement with Nicholson McLaren granting
Nicholson  McLaren a  non-exclusive  license to assemble,  use,  sell, and lease
internal  combustion  engines  incorporating  the Coates  Spherical Rotary Valve
System within the "European Patent Community," which includes but is not limited
to Austria, Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Portugal,
Spain,  Sweden,  Switzerland,  and the United Kingdom.  In  consideration of the
rights granted under the license agreement,  Nicholson McLaren agrees to pay CIL
a total  licensing fee of $5 million  payable  $37,375 upon receipt of the first
demonstration  model by Nicholson McLaren from CIL; another $37,375 upon receipt
of the  second;  with the  balance to be paid out of sales,  if any, of internal
combustion  engines  modified  with the Coates  Spherical  Rotary  Valve  System
assembled by Nicholson  McLaren with components  purchased from CIL. The license
agreement  also  gives  Nicholson  McLaren  the right to obtain a  manufacturing
license from CIL against  payment of royalties on the  manufacture of components
at a rate to be established.  The Company recognized revenue of $37,375 in April
1996 upon receipt of cash from  Nicholson  McLaren  after  delivery of the first
demonstration  model. CIL has waived payment of the second  demonstration  model
which was  delivered  in July 1996.  CIL has  retained  ownership of this second
model which is being  demonstrated by Nicholson McLaren for potential  customers
on behalf of CIL.  The  payment  schedule  with  respect  to the  balance of the
licensing  fee,  which is based on sales,  if any, has not yet been finalized by
the  parties.  As discussed  in Note 9, John  Nicholson,  President of Nicholson
McLaren, purchased shares of CIL Series A Stock in 1996.

In June  1996,  CIL  executed  a Sales  Representative  Agreement  retaining  an
affiliate of Nicholson  McLaren as its  exclusive  sales  representative  in the
United Kingdom and Europe for the sale of the Coates  technology for a four-year
term. The agreement  provides for a sliding scale commission  varying from 5% of
the first $1 million in Net Product  Billings [as defined] to 1% of the fifth $1
million in Net Product Billings and all amounts in excess thereof.

[14] Mortgage Payable

The $210,000  mortgage  payable is  collateralized  by the land and the building
that the Company uses as its  principal  place of business.  The mortgage  bears
interest at the rate of 9% per annum and was due  February 3, 1994.  The Company
is making  interest  only  payments on the  mortgage  and the  mortgagor  is not
demanding  full payment until  December 31, 1997.  The entire  mortgage  payable
balance has been classified as a current  liability.  The mortgage is guaranteed
by George J. Coates [See Note 9].


                    .  .  .  .  .  .  .  .  .  .  .  .  .  .

                                      F-19

<PAGE>



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

         On August 7, 1996,  CIL  dismissed  the firm of Warner,  Berman & Lott,
Certified  Public  Accountants,  P.A.  ("WB&L")  which  firm  was its  principal
independent   accounting  firm  previously  engaged  to  audit  CIL's  financial
statements.

         WB&L's report with respect to CIL's financial  statements for the years
ended  December  31,  1994 and 1995 did not  contain  an  adverse  opinion  or a
disclaimer of opinion.  However,  such report did include a modification  of the
auditors'  standard report,  stating that "...the company has suffered recurring
losses from  operations  since  inception and has a net capital  deficiency that
raise substantial doubt about its ability to continue as a going  concern....The
financial  statements do not include any adjustments  that might result from the
outcome of this uncertainty."

         The decision to dismiss WB&L and to retain a new principal  independent
accounting firm was approved by CIL's board of directors.

         During the two fiscal  years ended  December  31,  1995,  there were no
disagreements  between CIL and WB&L on any matter of  accounting  principles  or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreement,  if not resolved to the satisfaction of WB&L, would have caused it
to make a reference to the subject matter of the disagreement in connection with
its report.

         However  during the interim  period  subsequent to December 31, 1995, a
disagreement  arose between WB&L and CIL  concerning  the fiscal 1995  financial
statements.  The issue is  whether  a bank  account  known as the "CIL  Transfer
Account" maintained at NatWest Bank in Wall, New Jersey was an asset of CIL's at
December  31,  1995.  The  balance in said  account  at  December  29,  1995 was
$508,428.44. CIL's balance sheet at December 31, 1995 with respect to which WB&L
issued its report, included this account as an asset of CIL. In July 1996, CIL's
management  and its  attorneys,  with the  approval  of its board of  directors,
discussed  this issue with WB&L and advised WB&L that as such account was not an
asset of CIL's at December 31, 1995,  that CIL's  financial  statements  for the
year ended  December  31, 1995 were in error and should be revised and  reissued
with a new auditor's report.  WB&L refused to accede to management's  request to
issue a new report with respect to financial  statements revised in such manner.
WB&L stated in part;

         "...When we issued our opinion we were attesting to the presentation of
         the company's financial position as represented to us by management and
         based on the  evidence  collected  during the  course of our audit.  If
         management  now  determines  that this  account  does not belong to the
         company we cannot  present our opinion  that the  financial  statements
         present fairly in all material respects,  the financial position of the
         company.  Accordingly,  we would  have no choice  but to  withdraw  our
         opinion concerning these financial statements."

As a result of this  disagreement,  CIL's board of directors  decided to dismiss
WB&L as CIL's principal independent accountants.

         With the  exception  of the  disagreement  referred  to  above,  CIL is
unaware  of  the  occurrence  of  any  of  the  kinds  of  events  described  in
subparagraphs  (A)  through  (D)  of  Item  304(a)(1)(v)  of  Regulation  S-B as
promulgated by the SEC.



                                       16

<PAGE>



         On August 7, 1996, CIL engaged the certified public  accounting firm of
Moore Stephens,  P.C. ("MSPC") to serve as its principal independent  accounting
firm and to reaudit its  financial  statements  for the year ended  December 31,
1995 and, if necessary, 1994. Prior to the engagement,  CIL's management and its
attorneys  consulted  with a  principal  of MSPC and  apprised  him of the facts
underlying the above described disagreement with WB&L. The MSPC principal stated
that he could not advise as to the type of report his firm would  issue until it
had completed an independent  review of the facts and had completed its audit of
the year (or years) in  question.  WB&L's  views with  respect to this issue are
stated above.

         By order dated  December 30, 1996,  United States  District Judge Kimba
Wood  determined  that the transfer  account was not a CIL asset at December 31,
1995 and CIL's revised  financial  statements at December 31, 1995 as audited by
MSPC do not include the balance in such account as a CIL asset.


                                       17

<PAGE>



                            COATES INTERNATIONAL LTD.

                                    PART III


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

         At December 31, 1996, the executive  officers and directors of CIL were
as follows:

         Name              Age               Position

George J. Coates            56         President, Treasurer, Chief Executive
                                         Officer, Chief
                                       Financial Officer and Director

Richard W. Evans            65         Secretary and Director

Michael J. Suchar D.D.S.    41         Director

         George J. Coates has been employed by CIL since its inception as 
president and chief executive officer.  Mr. Coates is an Irish citizen but has
been granted resident alien status in the United States.  See"Item 3" herein
as to the final consent judgment executed by George J. Coates in connection with
an SEC complaint and as to his arrest and release after a four day
 incarceration based on allegations similar to those contained in the
 SEC complaint.  On May 30, 1995, a United States Magistrate Judge of the
United States District Court for the Southern District of New York signed
 an order in response to a request by the office of the United States 
Attorney for the Southern District of New York dismissing without prejudice,
 the criminal complaint against George J. Coates.

         Richard W. Evans became a director of CIL in May 1996.  Dr. Evans, who
 holds an Ed.D. degree from Rutgers University, was a Supervisor a
 Highland Park High School in Highland Park, New Jersey, a post he held for
 more than the preceding five years until his retirement in June 1996. Dr. Evans
will not devote a substantial portion of his working time to the business of CIL


         Michael J. Suchar became a director of CIL in May 1996.  Dr. Suchar, 
who holds a Doctor of Dental Surgery degree from the Temple University Dental 
School, has been a practicing pediatric dentist for more than the
 preceding five years.  Dr. Suchar will not devote a substantial portion of his
working time to the business of CIL.




Compliance with Section 16(a) of the Exchange Act

         CIL's only class of outstanding  capital stock,  its Series A Preferred
Stock,  is not registered  pursuant to Section 16(a) of the Exchange Act so that
filings of Forms 3, 4 and 5 in compliance with such Section are not required.



                                       18

<PAGE>




Item 10. Executive Compensation

         None of CIL's executive  officers has an employment  contract with CIL.
With respect to each of calendar years 1994, 1995 and 1996, no executive officer
had compensation  paid or accrued in excess of $100,000 for any such year except
for George J. Coates,  CIL's chief executive officer,  whose compensation was as
follows:

                           SUMMARY COMPENSATION TABLE
                                        Annual Compensation
                                       Year Ended
         Name                          December 31             Salary

George J. Coates,                      1996                    $184,908
Chief Executive Officer          1995                    $183,549*
                                       1994                    $175,553
------------
* CIL had  agreed  to pay a  $5,500,000  license  fee to  George  J.  Coates  in
consideration  for  his  grant  to CIL of a  non-exclusive  license.  See  "Item
1-Business-Patents and Licenses." The fee was payable at management's discretion
but  in no  event  later  than  February  17,  1998.  In  September  1995,  this
arrangement  was  modified.  CIL and George J. Coates agreed that instead of the
$5,500,000  payment,  CIL would issue 275,000 shares of Series A Preferred Stock
to Mr.  Coates as the  license  fee.  The shares  were  issued to Mr.  Coates in
November 1995.

         To date, no employee stock options have been granted by CIL.


Item 11. Security Ownership of Certain Beneficial Owners and Management

         The following table sets forth as of December 31, 1996 the ownership of
CIL  Series  A  Preferred  Stock  by  (i)  each  person  known  by CIL to be the
beneficial  owner of more than 5% of the outstanding  Series A Preferred  Stock,
(ii) each director and executive officer of CIL who owned shares,  and (iii) all
directors and executive officers as a group.





                                                Shares of Series A
Name of                             Stock Beneficially Owned
Beneficial Owner                       Number            Percent

George J. Coates*                      4,769,000 shs       80%
Gregory Coates*                          318,150 shs        5%
Richard W. Evans                            26,000 shs       -%
Michael J. Suchar                             5,500 shs      -%
All directors and executive            4,800,500 shs       80%
officers as a Group (three persons)
---------
        * c/o CIL, Highway 34 & Ridgewood Road, Wall Township, New Jersey 07719.



                                       19

<PAGE>



Item 12. Certain Relationships and Related Transactions

         After  its  February   1993   purchase  of  CIL's  office  and  product
development  facility  in  Wall  Township,  New  Jersey  (the  "Facility")  from
unaffiliated third parties,  The George J. Coates 1991 Family Partnership,  L.P.
(the "Partnership")  continued the lease of the Facility to CIL. Pursuant to the
February 6, 1995 final consent judgment described in "Item 3" herein,  George J.
Coates was ordered to cause the  Partnership to transfer the Facility to CIL and
the transfer was effected on February 21, 1995 with CIL  obtaining  title to the
Facility and assuming the $300,000 mortgage loan obligation,  the residue of the
$400,000  mortgage note issued by the Partnership at the time of its purchase of
the Facility.  At the time of such transfer,  all accrued rents in the aggregate
amount of $287,100 owed by CIL to the  Partnership  were  forgiven.  CIL's "Loan
Receivable Officer" account on its financial statement was adjusted accordingly.
CIL is obligated to indemnify  George J. Coates from any liability he may suffer
based on the remaining mortgage loan on the Facility. In December 1995, CIL made
an  additional  $50,000  principal  payment  against this  mortgage loan thereby
reducing the principal balance to $250,000. An additional aggregate $40,000 paid
by CIL in May and July 1996 reduced the balance to $210,000. The mortgagees have
agreed to reduce the mortgage balance by an additional  $50,000 to $160,000 upon
issuance to them of an aggregate  2,500  shares of CIL Series A Preferred  Stock
but to date, said shares have not been issued.

         In January 1992,  CIL,  which had  previously  been assigned  George J.
Coates' ownership rights in the Coates Patents,  transferred such rights back to
George J. Coates in return for an  exclusive  right to  negotiate  licenses  and
transfers of technology  associated with the Coates  Patents.  The final consent
judgment  permitted  George  J.  Coates to retain  title to the  Coates  Patents
provided  that  he  reimbursed  CIL  for  all  the  monies  it  expended  in the
preparation,  application  and  prosecution  of the Patents.  The amount due was
determined  by  management  to total  $434,639 of which  $98,834 was offset from
other  amounts due to George J. Coates prior to December 31, 1994.  The $335,805
balance was paid to CIL in 1995. See "Item 1 - Business-Patents and Licenses" as
to a non-exclusive  license with respect to the Coates Patents granted to CIL by
George J. Coates and Gregory Coates.

         Pursuant to the final consent judgment, George J. Coates was ordered to
cause the transfer to CIL of all licensing  fees and other funds paid to persons
or entities other than CIL in connection with the acquisition by the payor of an
interest  in the  Patents  or in the  technology  embodied  in the  Patents.  On
February 24, 1995,  the $500,000  licensing fee paid by Millwest  Corporation in
1994  and  held in a bank  account  entitled  "Coates  International  Licensing"
together  with  $12,144 of interest  thereon was paid over to CIL. See "Item 1 -
Business-Patents and Licenses" and "Item 3" herein.

         Through  1996,  CIL  subcontracted  for its project  labor expense with
Coates Precision  Engineering,  Inc., an entity  controlled by George J. Coates.
The  amounts  paid to such  subcontractor  with  respect  to 1995 and 1996  were
$187,889  and $181,500  respectively.  These  payments  constitute a direct pass
through  to  the   subcontractor   of   payroll,   workers'   compensation   and
hospitalization insurance expense and management believes the arrangement was in
CIL's best interests.

         In the second half of calendar 1995 and during  calendar  1996, CIL was
primarily  dependent for its working  capital on capital  contributions  made by
Gregory  Coates,  the son of George  J.  Coates,  a  principal  (5% or  greater)
stockholder and until January 1996, an executive  officer and a director of CIL.
Such  capital  contributions  advanced  by  Gregory  Coates  in  1995  and  1996
aggregated  $404,549 and  $1,132,523  respectively.  The funds for such advances
were  obtained  from sales of Gregory  Coates'  shares of CIL Series A Preferred
Stock at a price of $20 per share.




                                       20

<PAGE>



Item 13. Exhibits and Reports on Form 8-K

         (a)   Exhibits

Exhibit No.*   Description of Exhibit

 3.1           CIL's Restated Certificate of Incorporation.

 3.2           CIL's By-Laws.

 4.1           Form of Certificate for CIL's Series A Non-Cumulative 
                        Convertible Preferred Stock.




Exhibit No.    Description of Exhibit

 10.1          Deed dated February 21, 1995 transferring title to CIL's
                  Principal Facility at Route 34
               and Ridgewood Road, Wall Township, N.J. from The George J. 
               Coates 1991 Family
               Partnership, L.P. (the "Partnership") to CIL.

 10.2          Assumption and Indemnification Agreement dated February 21,
                   1995 between the partnership and CIL.

 10.3          License Agreement dated February 17, 1995 between George J. 
                 Coates and CIL and
               First and Second Amendments thereto dated July 17, 1995.

 10.3(a)     Third  Amendment  dated  September 21, 1995 to License 
             Agreement dated February 17, 1995 between George J. Coates and CIL.

10.4           License Agreement dated February 22, 1993 between Gregory Coates
                 and CIL and   First Amendment thereto dated July 17, 1995.

 10.5          Prototype Manufacturing Agreement dated July 16, 1991 between
                 CIL, George  J. Coates and Harley-Davidson, Inc.

 10.6*         License  Agreement  dated  February 4, 1994 by and  between  CIL,
               Coates  International  Licensing  Partnership,  L.P.,  George  J.
               Coates and Millwest Corporation.

 10.7*         Securities and Exchange  Commission  Complaint  filed on July 22,
               1994  in the  United  States  District  Court  for  the  Southern
               District of New York (94 Civ. 5361) against George J. Coates, CIL
               and related entities.

 10.8*         Final Consent Judgment of CIL in the above action initiated by
                       the Commission (94 Civ. 5361).

 10.9*         Final Consent Judgment of George J. Coates in the above action
                 initiated by the   Commission (94 Civ. 5361).
------------
         * Incorporated by reference to the exhibit filed with CIL's 
   Registration Statement on Form S-1
(File No. 33-94884).

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         (b)   Reports on Form 8-K

               CIL did not file any reports on Form 8-K during the quarter ended
December 31, 1996.

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                                   Signatures

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
and  Exchange  Act of 1934,  the  Registrant  has duly  caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.

         Date                          COATES INTERNATIONAL LTD.


October   , 1997                 By:   /s/ George J. Coates
                                    -----------------------
                           George J. Coates, President

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
Registrant and in the capacities and on the date indicated.

      Signature                              Title                    Date

/s/ George J. Coates             Director (Principal Executive October , 1997
George J. Coates                 Principal Financial Officer, Principal
                                 Accounting Officer


/s/ Richard W. Evans             Director                        October  , 1997
------------------------------
Richard W. Evans



/s/ Michael J. Suchar            Director                        October  , 1997
------------------------------
Michael J. Suchar

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