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, 1997

                                       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 X No

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. [ ]

Issuer did not generate any revenues for the year ended December 31, 1997.

During the year ended December 31, 1997, there was no established public trading
market for the issuer's Series A Preferred  Stock.  On December 31, 1997,  there
were  6,564,424  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 an  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 all of the countries,  their territories and
possessions,  comprising  North America,  Central America and South America (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

                                        1

<PAGE>



     Nicholson  McLaren by CIL. In April and July 1996,  CIL  executed a License
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, 1997 of $24,809,078  and at December
31, 1997, had a negative net worth of ($547,976) and negative working capital of
($1,036,578).

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 several 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.





                                        2

<PAGE>



      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.

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

                                        3

<PAGE>



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.
Subsequently,  CIL has reassembled the Harley Davidson  motorcycle  engine,  the
same engine  previously  tested by Harley Davidson,  again utilizing the Coates'
technology.  CIL is in the process of testing this reassembled motorcycle engine
which has now been  running for over two years.  Notwithstanding  the facts that
the Harley Davidson  motorcycle engine has been reassembled and has been running
for over two years,  it has not been  delivered  nor tested by Harley  Davidson.
Accordingly,  there can be no assurances given that Harley Davidson will accept,
test and/or agree to license this reassembled Harley Davidson motorcycle engine.

      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 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
any vehicles  containing engines can be sold to the public 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



                                        4

<PAGE>



      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 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


                                        5

<PAGE>



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:

                            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.  On December 22, 1997, George J.
Coates and his son Gregory  Coates  amended the existing  license  agreement and
previous amendments thereto,  modifying them from a non-exclusive  license to an
exclusive  one.  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

                                        6

<PAGE>



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.

      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,

                                        7

<PAGE>



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.

      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, 1997,  CIL employed 5 full-time  employees and 1 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  and a 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.




                                        8

<PAGE>



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 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

                                        9

<PAGE>



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:

      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

                                       10

<PAGE>



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.

         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.


                                       11

<PAGE>



      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.

                                       12

<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, 1997, 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 top own approximately  nine % 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 Unites States patents (the "Coates Patents")
have been issued to George J. Coates. CIL holds an exclusive license from George
J.  Coates  and  his  son  Gregory  Coates,  to  manufacture,   sell  and  grant
sub-licenses with respect to products based on the Coates Patents, within all of
the countries,  their  territories and  possessions,  comprising  North America,
South America and Central  America (the "License  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 moneys 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 Licensees."


                                       13

<PAGE>



CIL has 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 much time attempting 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. CIL intends to aggressively
pursue all inquiries  with the goal of obtaining  firm orders.  CIL's ability to
generate  revenues and achieve  profitable  operations is principally  dependent
upon the  execution of  sub-license  agreements  with engine  manufacturers  and
retrofitters  and upon the  Company's  successful  marketing  and  sales of high
performance  automotive,  motorcycle and marine racing engines.  Despite limited
success  to-date  Coates will  continue  manufacturing  a limited  inventory  of
automotive engines,  and pursue the marketing of Coates System technology.  Such
efforts will especially be directed towards sub-licensing of the technology.

Results of Operations from Inception August 31, 1988, through December 31, 1997

Virtually no revenues were  realized  from the  inception of operations  through
December 31, 1997, 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. See
"The Coates System".

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".  The
funds were  subsequently  transferred over to CIL.  Pursuant to the terms of the
license agreement,  Millwest was obligated to make another payment of $9,500,000
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
its intention to activate the license  agreement and advised that  financing has
been arranged, however, to date no additional payments have been received by CIL
from Millwest.  No assurances can be given that any additional  payments will be
made.

No revenues were recognized during the quarter and year ended December 31, 1997.
During 1996, CIL recognized $37,375 in revenues,  representing a partial payment
from Nicholson  McLaren Engines Ltd. (U.K.)  ("Nicholson  McLaren") for two high
performance  racing car  engines  modified  with the Coates  System,  shipped to
Nicholson McLaren.

Operating  expenses incurred during the last quarter and the year ended December
31, 1997, amounted to $363,730 and $1,427,798 respectively, compared to $507,425
and $1,564,447 for the same periods in 1996. In addition, the Company during the
last  quarter  in 1997  recognized  a charge of  $10,000,000  in the  research &
development  category of operating  expenses,  representing the value of 500,000
shares of the  Company's  Series A  Preferred  Stock  issued to George J. Coates
pursuant to an exclusive  license agreement between CIL an George J. Coates (see
"Related  Party  Transactions"  in Notes to Financial  Statements).  General and
administrative  expenses net of R&D declined from $1,356,197 in 1996 to $762,121
in 1997, due to, principally, lay-offs of CIL's production staff because of lack
of funding as well as the result of ongoing efforts to streamline operations and
reduce overhead.

Including the above mentioned  $10,000,000,  total aggregate  operating expenses
incurred since August 31, 1988,  amounted to  $25,382,323,  of which the largest
portion pertained to research and development expenses which total $18,118,583 .


                                       14

<PAGE>



After recognizing $4,388 interest expenses,  the Company's operations show a net
loss of  $11,432,186  or $1.74 per share for the year ended  December  31, 1997,
compared to a net loss of $1,600,110 or $0.27 per share for the preceding  year.
As mentioned above,  the 1997 figure includes a non-recurring  special charge of
$10,000,000 . Total losses since  inception in August 1988 through  December 31,
1997 amount to $24,746,109 .

Liquidity and Capital Resources

Since its inception,  all of the development costs and operating expenses of CIL
have  primarily  been financed  through the cash  generated  through the sale of
stock,  through  capital  contributions  made by George J. Coates' son,  Gregory
Coates, and the $500,000 license payment made by Millwest. Capital contributions
advanced to CIL by Gregory Coates in 1996 and during the year ended December 31,
1997, aggregated $1,132,523 and $953,834, 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.

At December 31, 1997, CIL had a net worth of $547,976 compared to a negative net
worth or capital  deficiency of  $(488,642)  at the  beginning of the year.  The
working capital  deficiency  which showed a negative  balance of $(2,114,271) at
December 31, 1996,  relatively  improved to a negative  $(1,036,578) at December
31, 1997. These improvements were a result of capital raising efforts throughout
the last year which  included  capital  contributions  from  Gregory  Coates and
certain  private  placements  of the Company's  preferred  stock as well as debt
restructuring, which altogether contributed an aggregate $2,468,804 to equity, a
figure which does not include an amount of $9,999,500 additional paid-in capital
and $500 preferred  equity  realized in connection  with the issuance of 500,000
shares  Series A  Preferred  Stock  issued to George J.  Coates  pursuant  to an
exclusive license agreement between CIL and George J. Coates (see "Related Party
Transactions"  in Notes to Financial  Statements).  The latter amounts have been
offset by a $10,000,000 charge to earnings, as described above.

The 1997 capital  transactions  furthermore  included (i) the issuance of 48,000
Series A preferred shares in private placement transactions which raised a total
of $960,000  equity;  (ii) the issuance of 24,325  Series A preferred  shares to
investors  who had  previously  subscribed  and  paid  for  such  shares,  for a
cumulative $496,970 in equity  contributions,  and; (iii) issuance of a total of
8,000 Series A preferred  shares pursuant to the conversion of certain loans and
mortgage liabilities,  with such transactions contributing altogether $58,000 to
capital.

In order to further improve the Company's  financial situation and provide funds
to meet  current  obligations  and  finance  the  ongoing  efforts to market the
Company's  products,  management  plans to raise  additional  capital  through a
combination  of  private  placements  and  debt  issues.  While  the  successful
realization  of such plans cannot be assured,  management is confident  that the
Company's  unique patented  technology will attract further  investments,  which
provide the means for  continued  efforts to obtain firm orders and  sub-license
agreements with engine manufacturers and refitters,  which ultimately will yield
positive cash flows.

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.




                                       15

<PAGE>



Item 7.           Financial Statements

      Attached.

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."



                                       16

<PAGE>






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

         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.

         During 1996, CIL engaged the accounting  firm of Moore  Stephens,  P.C.
("MSPC") to serve as its principal independent  accounting firm and to audit its
finaicial statements for the year ended December 31, 1995 and December 31, 1996.
On March 27, 1998,  CIL's Board of Directors  dismissed MSPC as its  independent
auditors.

         MSCP's report issued in connection with CIL's financial  statements for
the years ended December 31, 1995 and 1996 did not contain an adverse opinion or
disclaimer of opinion.  However,  such report did include a modification  of the
auditor's standard report, stating that:

         ...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  $13,000,000.  The Company also has minimal
         liquid  assets,  and has over $2.2 million in current  liabilities.  In
         addition  to a recorded  liability  of  $496,970  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 regards 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.

         CIL's Board of Directors  approved the dismissal of MSPC and retained a
new  principal  accounting  firm,  Rosenberg  Rich  Baker  Berman &  Company  of
Bridgewater,  New Jersey to audit the financial  statements  for the fiscal year
ended December 31, 1997.

         During the fiscal year ended  December 31,  1996,  CIL and MSPC did not
have any  disagreements  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 MSPC, would have caused it
to make a reference to the subject matter of the disagreement in connection with
its report.

         With the exception of the disagreement  referred to above in connection
with Warner,  Berman & Lott's  treatment of the "CIL Transfer  Account",  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.

                                       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, 1997, the executive  officers and directors of CIL were
as follows:

    Name                     Age                  Position

George J. Coates             57           President, Treasurer, Chief Executive
                                          Officer, Chief Financial Officer and
                                          Director

Richard W. Evans             66           Secretary and Director

Michael J. Suchar D.D.S.     42           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.

Item 10. Executive Compensation

                                       18

<PAGE>



         None of CIL's executive  officers has an employment  contract with CIL.
With respect to each of calendar years 1995, 1996 and 1997, 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,                         1997               $183,550
Chief Executive Officer                   1996               $184,908
                                          1995               $183,549*

* 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, 1997 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
officers as a Group
 (four persons)            4,800,500 shs     80%

        * 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.

         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 the first half of calendar 1997, 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,
1996 and 1997 were $187,889, $181,500 and $212,626, 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.






                                       20

<PAGE>
         In the second half of calendar 1995, and during calendar years 1996 and
1997,  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,
1996 and 1997, aggregated $404,549, $1,132,523 and $953,834,  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.

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.
     
 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 December 22, 1997 between George
                    J. Coates, Gregory Coates and CIL.

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

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

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

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

__________
*Incorporated by reference to the Exhibits filed with CIL's Registration
  Statement on Form S-1, filed with the Securities and Exchange Commission on
  November 1, 1995 under File No. 33-94884.


                                       21

<PAGE>

Exhibit No.                        Description of Exhibit


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

 10.8*         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.

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

 10.10*        Final Consent Judgment of George J. Coates in the above action
                                     initiated by the Commission (94 Civ. 5361).

 (23)          Independent Auditors' Consent - attached to Exhibit A

 (27)          Financial Data Schedule - attached to Exhibit A

_________
* Incorporated by reference to the exhibits filed with CIL's
         Registration Statement on Form S-1 filed with the Securities and
         Exchange Commission on November 1, 1995 under File No.33-94884.

         (b)   Reports on Form 8-K

               CIL did not file any reports on Form 8-K during the quarter ended
                December 31, 1997.

                                       22

<PAGE>




                                   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.

June 16, 1998                                   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
George J. Coates  Director (Principal Executive                June 16, 1998
                  Principal Financial Officer, Principal
                  Accounting Officer

s/Richard W. Evans
Richard W. Evans           Director                            June 16, 1998 


s/Michael J. Suchar
Michael J. Suchar          Director                            June 16, 1998







coat10k.97






                                       23

<PAGE>






                           Coates International, Ltd.
                         (A Development Stage Company)

                              Financial Statements

                           December 31, 1997 and 1996



<PAGE>



                           Coates International, Ltd.
                          (A Development Stage Company)
                        Index to the Financial Statements
                           December 31, 1997 and 1996




                                                                         Page

Independent Auditors' Report  ...................................         1

Financial Statements

     Balance Sheet...............................................         2

     Statements of Operations....................................         3

     Statement of Stockholders' Equity...........................         4

     Statements of Cash Flows....................................        5-6

     Notes to the Financial Statements...........................       7-10




<PAGE>

To the Board of Directors and Shareholders of
Coates International, Ltd.


We have audited the balance sheet of Coates  International,  Ltd. (A Development
Stage Company) as of December 31, 1997 and the related statements of operations,
stockholders'  equity and cash flows for the years ended  December  31, 1997 and
1996.  These  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audits.

We  conducted  our  audits  in  accordance  with  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,  1997,  and the results of their
operations,  and cash flows for the years  ended  December  31, 1997 and 1996 in
conformity with generally accepted accounting principles.  We express no opinion
on the cumulative  period from inception  (August 31, 1988) through December 31,
1997 as  shown  in the  cumulative  columns  on the  statements  of  operations,
stockholders' equity and cash flows.

The accompanying  financial  statements have been prepared  assuming the Company
will  continue as a going  concern.  As discussed in the notes to the  financial
statements,  the Company has insignificant revenues to date, has incurred losses
and has  accumulated a deficit since its inception to December 31, 1997, of over
$24 million in research and development activities. The Company also has minimal
liquid assets,  while  reporting over $1,000,000 in current  liabilities.  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 the  notes to the  financial  statements.  The  financial  statements  do not
include  any   adjustments   that  might   result  from  the  outcome  of  these
uncertainties.


Bridgewater, New Jersey
May 14, 1998

                                       1

<PAGE>


                           Coates International, Ltd.
                          (A Development Stage Company)
                                  Balance Sheet
                                December 31, 1997




      Assets
Current Assets
   Cash                                             $         35,249
   Restricted cash                                           112,000
                                                      --------------

      Total Current Assets                                   147,249
                                                      --------------

Property, Plant and Equipment - Net                        1,582,054
                                                      --------------

Other Assets
   Deposit                                                     2,500
                                                      --------------

      Total Assets                                         1,731,803
                                                      ==============

      Liabilities and Stockholders' Equity

Current Liabilities
   Mortgage payable                                          160,000
   Accounts payable and accrued expenses                     904,706
   Accrued interest payable                                  106,559
   Due to stockholder                                         12,562
                                                      --------------

        Total Current Liabilities                          1,183,827
                                                      --------------

Stockholders' Equity
   Preferred stock,  Series A, $.001 par value,  14,000,000  shares authorized -
   voting, non-cumulative convertible, 6,564,424 shares
   issued and outstanding 6,564 Common stock, $.001 par value, 20,000,000 shares
   authorized - no shares issued - Additional paid-in capital 25,350,490 Deficit
   accumulated during the development stage (24,809,078)
                                                       --------------

        Total Stockholders' Equity                            547,976
                                                       --------------
                                                       $    1,731,803
        Total Liabilities and Stockholders' Equity     ==============





See notes to the financial statements.

                                        2

<PAGE>



                           Coates International, Ltd.
                          (A Development Stage Company)
                            Statements of Operations


<TABLE>
<CAPTION>


                                                                                                      Period From
                                                                                                        August 31,
                                                                                                     1988 (Date of
                                                                                                        Inception)
                                                                                                         Through
                                                                                                      December 31,
                                                                                                           1997
                                                                   Years Ended December 31,
                                                              ---------------------------------     ----------------
                                                                   1997              1996
                                                              ---------------   ---------------     ----------------

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

                                                              ---------------   ---------------     ----------------

Operating Expenses:
   Research and development costs                                     453,051            64,125          2,224,457
   Research and development costs - related party                  10,212,626           181,500         15,894,126
   General and administrative expenses                                721,829         1,315,282          6,945,380
   Depreciation expense                                                40,292            40,915            319,670
                                                              ---------------   ---------------   ----------------

      Total Operating Expenses                                     11,427,798         1,601,822         25,383,633
                                                              ---------------   ---------------   ----------------

   Loss From Operations                                          (11,427,798)       (1,564,447)       (24,696,258)
                                                              ---------------   ---------------   ----------------

Other Income (Expense):
   Interest income                                                     11,262             1,121            124,866
                                                                                          =====
   Interest expense                                                  (15,650)          (36,784)          (238,996)
                                                              ---------------   ---------------   ----------------

      Total Other Income (Expense)                                    (4,388)          (35,663)          (114,130)
                                                              ---------------   ---------------   ----------------

   Net Loss                                                  $   (11,432,186) $     (1,600,110) $     (24,810,388)
                                                              ===============   ===============   ================

   Net Loss Per Share                                        $         (1.89) $          (0.27)
                                                              ===============   ===============
                                                                    6,033,669         5,963,600
   Weighted Average Number of Shares

                                                              ===============   ===============

</TABLE>






See notes to the financial statements.

                                        3

<PAGE>




                           Coates International, Ltd.
                          (A Development Stage Company)
                        Statement of Stockholders' Equity
                Inception (August 31, 1988) to December 31, 1997

<TABLE>
<CAPTION>






                                                  Common Stock           Common Stock      Series A Preferred
                                                     Class A                Class C               Stock            Preferred Stock
                                             ----------------------- -------------------- --------------------- -------------------
                                                Shares      Amount     Shares    Amount     Shares     Amount     Shares     Amount
                                             ------------- --------- ---------- --------- ----------- --------- --------- ---------
<S>                                                       <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)          -         -           -         - 2,055,000     2,050
Exchange of Preferred Stock for Common
   Stock Class C                                         -         -  (450,000)     (450)           -         -   450,000       450
Cancellation of Common Stock Class C                     -         -          -         -           -         - (225,000)     (220)
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(2,280,000)  (2,280)
Issuance of Stock                                        -         -          -         -     102,000       102         -         -
Purchase of Treasury Stock                               -         -          -         -           -         -         -         -
Stock Split 2:1                                          -         -          -         -   2,382,000     2,382         -         -
New Loss for Year Ended December 31, 1991                -         -          -         -           -         -         -         -
                                             ------------- --------- ---------- --------- ----------- --------- ----------- --------
     Balance -December 31, 1991                          -         -          -         -   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         -         -

</TABLE>

                                        4

<PAGE>
<TABLE>
<CAPTION>



                                                   Additional                 Deficit
                                                    Paid-In                Accumulated           Total
                                                    Capital                   During the     Stockholders'
                                                               Treasury      Development         Equity
                                                                 Stock         Stage          (Deficit)

<S>                                               <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                                             -           -              -               -
Exchange of Preferred Stock for Common
   Stock Class C                                             -           -              -               -
Cancellation of Common Stock Class C                         -           -              -           (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                                      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)           -              -               -
New Loss for Year Ended December 31, 1991                    -           -      (739,096)       (739,096)
                                                   ----------- ----------- --------------  --------------
     Balance -December 31, 1991                      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)


</TABLE>

                                        4A

<PAGE>

<TABLE>
<CAPTION>


                                                  Common Stock           Common Stock      Series A Preferred
                                                     Class A                Class C               Stock            Preferred Stock
                                             ----------------------- -------------------- --------------------- -------------------
                                                Shares      Amount     Shares    Amount     Shares     Amount     Shares     Amount
                                             ------------- --------- ---------- --------- ----------- --------- --------- ---------


<S>                                                      <C>       <C>        <C>      <C>      <C>       <C>          <C>      <C>
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                         -         -          -         -   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                           -         -          -         -           -         -        -        -
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                           -         -          -         -           -         -        -        -
Net Loss for Year Ended December 31, 1996                -         -          -         -           -         -        -        -
                                             ------------- --------- ---------- --------- ----------- --------- -------- ---------
     Balance - December 31, 1996                         -         -          -         -   5,963,600     5,963        -        -
Issuance of Stock                                        -         -          -         -      48,000        48        -        -
Restoration of Shares Not Redeemed by
   Stockholders                                          -         -          -         -      24,325        24        -        -
Issuance of Stock in Exchange for Mortgage
   Paydown                                               -         -          -         -       2,500         3        -        -
Issuance of Stock in Exchange for Exclusive
   License                                               -         -          -         -     500,000       500        -        -
Issuance of Stock for Loans Reclassification             -         -          -         -       5,500         6        -        -
Completion of 1990 Stock Split 2:1                       -         -          -         -      20,499        20        -        -
Additional Contributions of Capital From a
   Shareholder                                           -         -          -         -           -         -        -        -
Net Loss for Year Ended December 31, 1997                -         -          -         -           -         -        -        -
                                             ------------- --------- ---------- --------- ----------- --------- -------- ---------
     Balance - December 31, 1997                         -$        -          -$        -   6,564,424$    6,564        -$       -
                                             ============= ========= ========== ========= =========== ========= ======== =========
</TABLE>






                                       4B

<PAGE>

<TABLE>
<CAPTION>


                                             Additional                  Deficit
                                              Paid-In                  Accumulated          Total
                                             Additional                During the        Stockholders'
                                              Paid-In      Treasury    Development          Equity
                                              Capital       Stock       Stage              (Deficit)

<S>                                               <C>        <C>         <C>             <C>
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                  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)    11,749,764           -    (11,776,782)        (21,055)
Adjustments to Paid-in Capital                  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)
Issuance of Stock                                 959,952           -              -         960,000
Restoration of Shares Not Redeemed by
   Stockholders                                   496,946           -              -         496,970
Issuance of Stock in Exchange for Mortgage
   Paydown                                         49,997           -              -          50,000
Issuance of Stock in Exchange for Exclusive
   License                                      9,999,500           -              -      10,000,000
Issuance of Stock for Loans Reclassification        7,994           -              -           8,000
Completion of 1990 Stock Split 2:1                    (20)          -              -               -
Additional Contributions of Capital From a
   Shareholder                                    953,834           -              -         953,834
Net Loss for Year Ended December 31, 1997               -           -    (11,432,186)    (11,432,186)
                                              ----------- ----------- --------------  --------------
     Balance - December 31, 1997             $ 25,350,490$          -$   (24,809,078$        547,976
                                              =========== =========== ==============  ==============
</TABLE>





                                       4C

See notes to the financial statements.


<PAGE>
<TABLE>
<CAPTION>

                                                                                                                Period From
                                                                                                                 August 31,
                                                                                                                1988 (Date of
                                                                                                                 Inception)
                                                                                                                   Through
                                                                                                                December 31,
                                                                                                                    1997
                                                                                                              -----------------
                                                                               Years Ended December 31,
                                                                           ---------------------------------  -----------------
                                                                                1997              1996
                                                                           ---------------   ---------------  -----------------
Cash Flows From Operating Activities
<S>                                                                       <C>              <C>               <C>
    Net Loss                                                              $    (11,432,186)$      (1,600,110)$      (24,809,078)

                                                                           ---------------   ---------------  -----------------
    Adjustments to Reconcile Net Loss to Net Cash Used in Operating
        Activities
          Depreciation                                                              40,292            40,915            319,670
          Noncash research and development costs                                10,000,000            31,131         15,531,131
    Changes in Assets and Liabilities
        (Increase) Decrease in
          Inventory                                                                144,033          (144,033)                 -
          Due to/from affiliated companies                                           4,485            (2,312)                57
        Increase (Decrease) in
          Accounts payable and accrued expenses                                   (542,861)          629,407            904,706
          Accrued interest payable                                                (114,849)           18,371             62,340
                                                                           ---------------   ---------------  -----------------

        Total Adjustments                                                        9,531,100           573,479         16,817,904
                                                                           ---------------   ---------------  -----------------
    Net Cash Used in Operating Activities                                       (1,901,086)       (1,026,631)        (7,991,174)
                                                                           ---------------   ---------------  -----------------

Cash Flows from Investing Activities
    Payments for property and equipment                                                  -            (5,252)          (413,032)
    Loans to stockholders                                                                -            (7,487)        (1,208,678)
                                                                           ---------------   ---------------  -----------------
    Net Cash Used in Investing Activities                                                -           (12,739)        (1,621,710)
                                                                           ---------------   ---------------  -----------------

Cash Flows From Financing Activities
    Proceeds of additional paid-in capital                                         938,147         1,017,242          2,307,438
    Proceeds from issuance of stock                                                960,000                 -          7,338,148
    Payment for treasury stock                                                           -                 -            (30,000)
    Loans from stockholder                                                          24,547             8,000             32,547
                                                                           ---------------   ---------------  -----------------
    Net Cash Provided by Financing Activities                                    1,922,694         1,025,242          9,648,133
                                                                           ---------------   ---------------  -----------------

    Net Increase (Decrease) in Cash                                                 21,608           (14,128)            35,249
    Cash - Beginning of Periods                                                     13,641            27,769                  -
                                                                           ---------------   ---------------  -----------------
    Cash - End of Periods                                                 $         35,249 $          13,641 $           35,249
                                                                           ===============   ===============  =================
</TABLE>




See notes to the financial statements.

                                       5


                           Coates International, Ltd.
                          (A Development Stage Company)
                            Statements of Cash Flows

<TABLE>
<CAPTION>

                                                                                                         Period From
                                                                                                          August 31,
                                                                                                         1988 (Date of
                                                                                                          Inception)
                                                                                                            Through
                                                                                                         December 31,
                                                                                                             1997
                                                                                                       -----------------
                                                                        Years Ended December 31,
                                                                    ---------------------------------  -----------------
                                                                         1997              1996
                                                                    ---------------   ---------------  -----------------
Supplemental  Disclosures of Cash Flow  Information Cash paid during the periods
for:
<S>                                                                <C>              <C>               <C>
        Interest paid                                              $         18,499 $          18,413 $           64,656
                                                                    ===============   ===============  =================
        Taxes paid                                                 $              - $               - $                -
                                                                    ===============   ===============  =================
</TABLE>

Supplemental Schedule of Non-Cash Investing and Financing Activities:

    The financial  statements at December 31, 1996,  include  noncash  financing
    transactions  of  $40,000  as  a  result  of  mortgage  payments  made  by a
    shareholder which were treated as additional paid-in capital.

    The financial  statements  at December 31, 1997 and 1996,  include a noncash
    financing   transaction  of  $486,970  for  the   respective   exchange  and
    reclassification  of  redeemable  preferred  stock to amounts due to certain
    stockholders.

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

    The  financial  statements  at December 31, 1997 and 1996,  include  noncash
    investing  and  financing   transactions  of  $15,688  and  $7,500  for  the
    acquisition  of equipment by a shareholder  which were treated as additional
    paid-in capital.

    The financial  statements at December 31, 1997,  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 an exclusive license agreement from 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.

    The financial  statements  at December 31, 1997 include a noncash  investing
    and financing transaction of an $8,000 loan from a stockholder,  made in the
    prior year was  exchanged  for 500 shares of Series A  preferred  stock.  In
    addition,  2,500  shares of Series A  preferred  stock was  exchanged  for a
    $50,000 decrease in the mortgage payable.





                                       6




See notes to the financial statements.

<PAGE>


                           Coates International, Ltd.
                          (A Development Stage Company)
                        Notes to the Financial Statements


SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Organization

Coates  International,  Ltd. ("CIL" or the "Company") is a Delaware  corporation
organized in October 1991 by its  President and majority  stockholder  George J.
Coates  ("GJC') 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. CIL also has
    an exclusive  license to sell and grant sublicenses with respect to products
    using the Coates System based on the Coates Patents. Since there has been no
    significant  revenue  generated from the 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.

Going Concern Uncertainty
    The  accompanying  financial  statements  have been  prepared  assuming  the
    Company will continue as a going concern. CIL's ability to generate revenues
    and  achieve  profitable   operations  is  principally  dependent  upon  the
    execution   and   funding  of   sub-license   agreements   with  the  engine
    manufacturers of retrofitters, and upon the manufacture and sale, by CIL, of
    high performance  engines.  The Company has suffered recurring losses during
    its  development  stage and has accumulated a deficit since its inception to
    December 31, 1997, of over $24,000,000.  The Company also has minimal liquid
    assets,  while  reporting  over  $1,000,000  in  current  liabilities.   The
    aforementioned  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.

    Management's  plans are to raise  additional  capital through a common stock
    offering,  sell sub-licenses to use its technology to interested  purchasers
    as well as to obtain firm orders on its engines for  delivery to  interested
    customers.  On this accord,  the Company plans to construct a  manufacturing
    facility as well as to acquire the  necessary  machinery and equipment for a
    full scale assembly line.

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

Earnings (Loss) Per Share
    The Company has not issued any common  stock,  but the  preferred  stock has
    voting  privileges.  (Loss) per share,  in accordance with the provisions of
    Financial  Accounting  Standards  Board No.  128,  "Earnings  Per Share," is
    computed by dividing the net (loss) by the weighted average number of
    preferred shares outstanding during the periods.

Research and Development
    Research and development  (R&D) costs are charged to operations as incurred.
    R&D expense for the year ended  December  31, 1997  includes a non-cash  $10
    million charge related to the signing of an exclusive  agreement with GJC to
    license the Coates System  technology owned by GJC for 500,000 shares of CIL
    Series A Preferred Stock. (see "RELATED PARTY TRANSACTIONS")


                                        7

<PAGE>



                           Coates International, Ltd.
                          (A Development Stage Company)
                        Notes to the Financial Statements


SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued

Income Taxes
    In accordance with the provisions of Financial Accounting Standards No. 109,
    "Accounting  for  Income  Taxes"  ("SFAS  No.  109"),   deferred  taxes  are
    recognized for operating  losses that are available to offset future taxable
    income.  Valuation  allowances  are  established  when  necessary  to reduce
    deferred tax assets to the amount expected to realized. The Company incurred
    net operating losses for  financial-reporting  and  tax-reporting  purposes.
    Accordingly,  the benefit  from income  taxes has been offset  entirely by a
    valuation  allowance  against  the related  deferred  tax asset for the year
    ended December 31, 1997.

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  expenses  during the
    reporting period. Actual results could differ from those estimates.

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

CONCENTRATIONS OF CREDIT AND BUSINESS RISK

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

    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  (U.S.),  the Company will be required to obtain a
    Certificate  of  Conformity  from  the  Office  of  Mobile  Services  of the
    Environmental  Protection  Agency  (EPA) to the effect  that its  engines as
    modified with the Coates System comply with applicable emission standards.

    Development  of the Coates System  technology  was  initiated by GJC,  CIL's
    founder,  President  and  controlling  stockholder  in the late  1970's  and
    development  efforts have been conducted  continuously since such time. From
    July  1982  through  May 1993,  seven  U.S.  patents  as well as a number of
    foreign patents were issued to GJC with respect to the Coates System.  Since
    the  inception  of CIL in  1988,  all  aspects  of the  business  have  been
    completely dependent upon the activities of GJC (who is a resident alien and
    not a U.S.  citizen and who does not have an employment  contract with CIL).
    The loss of GJC's  availability  or  services  due to death,  incapacity  or
    otherwise would have a material adverse effect on the Company's business and
    operations.

RESTRICTED CASH

    The Company placed $112,000 in an escrow account (pursuant to a court order)
    of net proceeds  raised from a 48,000 CIL Series A Preferred  Stock  private
    placement  offering in July 1997. The funds were escrowed for the payment of
    interest due to two former stockholders.



                                        8

<PAGE>



                           Coates International, Ltd.
                          (A Development Stage Company)
                        Notes to the Financial Statements


 PROPERTY, PLANT AND EQUIPMENT

    Property,  plant  and  equipment  at cost,  less  accumulated  depreciation,
consists of the following at December 31, 1997:


             Land                                           $         920,550
             Building                                                 579,450
             Building improvements                                    145,871
             Machinery and equipment                                  251,054
             Furniture and fixtures                                    39,295
                                                              ---------------
                                                                    1,936,220
             Less:  Accumulated depreciation                         (354,166)
                                                              ---------------

                  Total                                     $       1,582,054
                                                              ===============

    Depreciation  expense  amounted  to $40,292  and $40,915 for the years ended
December 31, 1997 and 1996, respectively.

MORTGAGE PAYABLE

    The 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  4, 1994.  The  Company is
    making interest only payments on the mortgage which has not been demanded in
    full  by the  mortgagor.  The  balance  has  been  classified  as a  current
    liability and has been guaranteed by GJC.

INCOME TAXES

    The Company has available net operating loss  carryforwards  at December 31,
    1997, which may be used to reduce Federal taxable income and tax liabilities
    in future years, approximating $8,500,000 which begin to expire December 31,
    2003 through 2012.

    The Company's  total deferred tax asset and valuation  allowance at December
31, 1997 is as follows:


             Total deferred tax asset                     $       3,000,000
             Less valuation allowance                            (3,000,000)
                                                            ---------------
                                                          $               -
             Net deferred tax asset
                                                            ===============


LICENSES

    The Company has incurred legal and related costs  associated  with licenses.
    Such costs amounted to $10,073,111  and $75,305 for the years ended December
    31, 1997 and 1996. As the probable future economic  benefit of such costs is
    uncertain, they have been expensed.



                                       9

<PAGE>



                           Coates International, Ltd.
                          (A Development Stage Company)
                        Notes to the Financial Statements


RELATED PARTY TRANSACTIONS

    Due to  Stockholder  represent net  advances/repayments  made to the Company
    which   amounts  to  $12,562  at  December  31,  1997  and  are   unsecured,
    non-interest bearing and payable on demand.

    The Company subcontracts its project expense from any entity of which GJC is
    the sole shareholder. During the years ended December 31, 1997 and 1996, the
    Company paid $212,626 and $181,500, respectively, for these services.

    The  Company  has  signed  a  licensing  agreement  with a  company  and its
    affiliates of which the President is a less than 1% stockholder of CIL.

    During 1997, the Company  incurred a $10,000,000  non-cash charge related to
    the signing of an exclusive agreement with GJC, the majority  shareholder of
    CIL, to license the Coates System  technology in exchange for 500,000 shares
    of CIL Series A Preferred Stock at $20 per share.

COMMITMENTS AND CONTINGENCIES

    The  Company is a defendant  in various  lawsuits  incident to the  ordinary
    course of business which are 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.

FAIR VALUE OF FINANCIAL INSTRUMENTS

    Cash, accounts payable and accrued expenses:
        The  carrying  amount  approximates  fair  value  because  of the  short
maturity of these instruments.

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

NEW AUTHORITATIVE ACCOUNTING PROFESSION PRONOUNCEMENT
     The Financial  Accounting  Standards Board ("FASB") has issued Statement of
Financial Accounting  Standards ("SFAS") No. 130, "Other Comprehensive  Income".
SFAS No. 130 is effective for periods  beginning  after  December 15, 1997.  The
provisions  of SFAS No. 130 may be early  applied in which the Company chose not
to do so. It is unlikely  that the  provisions  for SFAS No. 130 will even apply
nor have a material impact on the Company.









                                       10

<PAGE>


                                  EXHIBIT 10.3

                                LICENSE AGREEMENT

         THIS  AGREEMENT,  dated this 22 day of December,  1997,  by and between
GEORGE J. COATES,  individually,  residing at 1811 Murray Drive,  Wall Township,
New Jersey 07719  (hereinafter  referred to as "LICENSOR I") and GREGORY COATES,
residing at 1811  Murray  Drive Wall  Township,  New Jersey  07719  (hereinafter
referred  to as  "LICENSOR  II"),  and  COATES  INTERNATIONAL,  LTD.  having its
principle place of business at Route 34 and Ridgewood  Road, Wall Township,  New
Jersey 07719, (hereinafter referred to as "LICENSEE").

                              B A C K G R O U N D:

         WHEREAS,  LICENSOR  I is the  patentee  and owns  and has the  right to
license  certain PATENT RIGHTS (as  hereinafter  defined) used in the design and
construction of internal  combustion  engines employing  spherical rotary valves
(the "COATES SPHERICAL ROTARY VALVE SYSTEM"); and

         WHEREAS, LICENSOR II has loaned LICENSOR I funds to reimburse
Coates International, ltd. for patent expenses; and

         WHEREAS,  LICENSOR  I has  granted  to  LICENSOR  II and  LICENSOR  has
accepted an exclusive, revocable license with the right to sublicense; and

         WHEREAS,  LICENSOR I and  LICENSOR  II have each  granted to  LICENSEE,
previously,  an exclusive  revocable license for the United States of America to
make, use, sell and have made,  LICENSED PRODUCT falling within the scope of the
PATENT RIGHTS; and




<PAGE>



         WHEREAS,  it is the desire of LICENSOR I and  LICENSOR II to modify and
expand  upon the  previously  granted  license for the  consideration  set forth
herein and to render the previously granted licenses  superseded by this license
and hence null and void.

         NOW THEREFORE, in consideration of the premises and covenants and other
good and valuable  consideration  and the mutual  promises of the performance of
the  undertakings  herein,  it is agreed by and between  the  parties  hereto as
follows:
                             ARTICLE I - DEFINITIONS

 head or heads for an
         1.1 - "CSRV VALVE  SYSTEM"  shall mean a cylinder  head or heads for an
internal combustion engine manufactured in accordance with the PATENT RIGHTS (as
hereinafter defined)
 .
         1.2  -   "IMPROVEMENTS"   shall  mean  any  improvement,   change,   or
modification  to the CSRV  VALVE  SYSTEM  which may be  developed,  created,  or
acquired by either party to this Agreement, but only to the extent that the same
comes  within the scope of one or more of the  claims of the  patent  rights (as
hereinafter defined).

         1.3 - "PATENT  RIGHTS"  shall mean the patents as listed in  Attachment
1.3.

         1.4 - "PROTOTYPES" shall mean LICENSED PRODUCT manufactured for testing
and evaluation purposes only.

         1.5 - "TERRITORY"  shall mean all of the countries,  their  territories
and possessions, comprising North America, Central America and South America.



                                        2

<PAGE>



                          ARTICLE II - LICENSES GRANTED

         2.1 - LICENSES GRANTED TO LICENSEE

                  (1)  LICENSOR  I and  LICENSOR  II  (hereinafter  referred  to
jointly as  "LICENSOR")  hereby  grants to LICENSEE an exclusive  license in the
TERRITORY,  to make, use, sell, and have made,  product falling within the scope
of the PATENT  RIGHTS,  and to prevent  others from  making,  using,  selling or
having made product falling within the scope of the PATENT RIGHTS;

                  (2) LICENSOR hereby grants to LICENSEE the non-exclusive right
to manufacture and sell PROTOTYPES falling within the scope of the PATENT RIGHTS
anywhere in the world.

         2.2 - IMPROVEMENTS

         If LICENSORS have heretofore  brought about or shall  hereafter  during
the term of this  Agreement  bring about any  IMPROVEMENTS  to the PATENT RIGHTS
LICENSORS  shall  promptly  disclose  such  IMPROVEMENTS  TO LICENSEE.  Any such
IMPROVEMENTS shall become subject to this Agreement.

         2.3 - PATENT MARKINGS

         LICENSEE shall mark on an exposed  surface of all products made through
use of the PATENT RIGHTS  hereunder,  appropriate  patent  markings  identifying
LICENSOR I as the owner of the  pertinent  PATENT  RIGHTS.  The content,  formal
language  used in such  markings  shall  be in  accordance  with  the  laws  and
practices of the countries  where such products  bearing such markings are made,
sold, or used and shall be approved by LICENSOR I.


                                        3

<PAGE>



         2.4      ACKNOWLEDGMENT OF LICENSE

         On all CSRV VALVE SYSTEMS, LICENSEE and Sublicensee shall
acknowledge that the same are manufactured under license from
LICENSOR I.  Unless otherwise agreed to by the parties, the
following notice shall be used by LICENSEE and sublicensees on an
exposed surface of all products:  "Manufactured under License from
George J. Coates".  Sublicensees shall use the notice:
"Manufactured under License from Coates International, Ltd. and
George J. Coates."  Such notices shall be used in all descriptive
materials, instruction and service manuals relating to the CSRV
VALVE SYSTEM.
                             ARTICLE III - PAYMENTS

         3.1 - In  consideration  for the grant of this  license,  the  LICENSEE
shall grant to LICENSORS, shares of stock in LICENSEE.

     The shares shall be granted as follows:  500,000 Series A Preferred  shares
to LICENSOR I $4,000.00  to LICENSOR II 3.2 - In further  consideration  of this
License,  LICENSEE  shall  pay all  costs  associated  with  the  PATENT  RIGHTS
identified herein both in the TERRITORY and world wide.

            ARTICLE IV - REPRESENTATIONS, OBLIGATIONS, WARRANTIES AND
                                   DISCLAIMERS

         4.1 -  LICENSOR  I  represents  and  warrants  that  LICENSOR  I is the
rightful  owner of the PATENT RIGHTS and has the exclusive  right to license all
of the PATENT  RIGHTS and that all such  PATENT  RIGHTS  pertaining  to the CSRV
VALVE SYSTEM under  LICENSOR'S  control and  possession in the TERRITORY are set
forth in Attachment 1.4.

                                        4

<PAGE>



Further,  LICENSOR I and  LICENSOR II have the power and  authority  to execute,
deliver and perform its obligations under this Agreement, nor the performance of
its obligations hereunder will constitute a breach of the terms or provisions of
any contract or agreement to which LICENSOR is a party.

         4.2 - LICENSEE  will use its best  efforts to execute all such tasks as
may be necessary to bring about the speedy manufacture,  sale or use of products
manufactured  with the use of the PATENT  RIGHTS  consistent  with good business
practice;  and ensure that all steps  within its power are  undertaken  with all
reasonable  speed to ensure  that such  products  made by  LICENSEE  comply with
relevant  government  regulations  and to ensure that all steps within its power
are  undertaken  with  all  reasonable  speed to  ensure  that  sublicenses  are
negotiated and executed with respect to the PATENT RIGHTS.

                      ARTICLE V - DURATION AND TERMINATION
         
         5.1 - Subject to the  provisions of Section 5.1 hereof,  all rights and
obligations under this Agreement shall expire upon the last to expire patents of
the PATENT RIGHTS.  

         5.2 - This Agreement shall terminate effective immediately
upon: 
                  (a) The  filing by  LICENSEE  of an  involuntary  petition  in
         bankruptcy,  the  entry of a decree  or order by a court or  agency  or
         supervisory  authority  having  jurisdiction  in the  premises  for the
         appointment  of a  conservator,  receiver,  trustee  in  bankruptcy  or
         liquidator for LICENSEE in any

                                        5

<PAGE>



         insolvency, readjustment of debt, marshaling of assets and liabilities,
         bankruptcy or similar proceedings,  or the winding up or liquidation of
         its affairs, and the continuance of any such petition,  decree or order
         undismissed  or  unstayed  and in  effect  for a period  of sixty  (60)
         consecutive days; or

                  (b)  The  consent  by  LICENSEE  to  the   appointment   of  a
         conservator,  receiver,  trustee in  bankruptcy  or  liquidator  in any
         insolvency, readjustment of debt, marshaling of assets and liabilities,
         bankruptcy  or similar  proceedings  of or  relating  to  LICENSEE,  or
         relating to  substantially  all of its property,  or if LICENSEE  shall
         admit in  writing  its  inability  to pay its debts  generally  as they
         become due,  file a petition to pay its debts  generally as they become
         due, file a petition to take  advantage of any  applicable  insolvency,
         reorganization  or  bankruptcy  statute,  make  an  assignment  for the
         benefit  of  its  creditors  or  voluntarily  suspend  payment  of  its
         obligations.  

                ARTICLE VI - LIMITATION OF ASSIGNMENT BY LICENSEE

         6.1 - This  Licensee  is  non-assignable  and the  rights,  duties  and
privileges of LICENSEE hereunder shall not be sold,  transferred,  hypothecated,
or  assigned  by  LICENSEE,  either in whole or in part  without  the consent of
LICENSORS.

                           ARTICLE VII - GOVERNING LAW

         7.1 - This Agreement shall be governed by and construed and enforced in
accordance  with  the Laws of the  State of New  Jersey  and each  party  hereby
submits to the  jurisdiction  of any state or federal  court in the State of New
Jersey in the event of any claims 

                                        6

<PAGE>



arising under this Agreement.

                         ARTICLE VIII - ENTIRE AGREEMENT

         8.1 - This Agreement sets forth the entire Agreement and  understanding
by and between  LICENSOR  and LICENSEE as to the subject  matter  hereof and has
priority over all documents,  verbal consents and understandings made before the
execution of this  Agreement  and none of the terms of this  Agreement  shall be
amended  or  modified  except in a written  document  signed  by  LICENSORS  and
LICENSEE hereto.

         8.2 - Should any portion of this Agreement be declared null and void by
operation of law, or otherwise,  the remainder of this Agreement shall remain in
full force and effect.

         8.3  -  This   Agreement  is  understood  by  the  parties   hereto  to
specifically supersede the February 17, 1997 License from LICENSOR I to LICENSEE
and any subsequent  amendments  thereto as well s the Agreement from LICENSOR II
to LICENSEE dated February 22, 1997 and any subsequent amendments thereto.

                              ARTICLE IX - NOTICES

         9.1 - Any notice,  consent or approval  required  under this  Agreement
shall be in English  and in writing,  and shall be  delivered  to the  following
addresses (a)  personally by hand, (b) by Certified Air Mail,  postage  prepaid,
with return receipt  requested,  or (c) by telefax,  confirmed by such Certified
Air Mail:




                                        7

<PAGE>



         If to the LICENSORS:

                  Mr. George J. Coates
                  c/o COATES INTERNATIONAL, LTD.
                  Route 34 & Ridgewood Road
                  Wall Township, NJ 07719-9738
                  Telephone:  (732) 449-7717
                  Telefax:            (732) 449-7736

                  Mr. Gregory Coates
                  c/o COATES INTERNATIONAL, LTD.
                  Route 34 & Ridgewood Road
                  Wall Township, NJ 07719-9738
                  Telephone:  (732) 449-7717
                  Telefax:            (732) 449-7736

         If to LICENSEE:

                  COATES INTERNATIONAL, LTD.
                  Route 34 & Ridgewood Road
                  Wall Township, NJ 07719-9738

         All notices shall be deemed  effective  upon the date delivered by hand
or sent.  If either party  desires to change the address to which notice is sent
to such party,  it shall so notify the other party in writing in accordance with
the foregoing.
                            ARTICLE X - MISCELLANEOUS

         10.1 -  Headings  and  References  -  Headings  in this  Agreement  are
included  herein for ease of reference only and have no legal effect.  Reference
herein to  Sections  or  Attachments  are to Sections  and  Attachments  to this
Agreement, unless expressly stated otherwise.

         10.2              - Reference on Disclosure of Terms and Provisions (a)
                           This Agreement shall be distributed solely to:
(i) those  personnel of LICENSORS  and LICENSEE who shall have a need to know of
its contents; (ii) those persons whose knowledge of its contents will facilitate
performance of the obligations of the

                                        8

<PAGE>


parties under this  agreement;  (iii) those persons,  if any, whose knowledge of
its  contents is  essential  in order to permit  LICENSEE or LICENSORS to place,
maintain or secure benefits as required by law, regulation or judicial order.
         IN  WITNESS  WHEREOF,  the  parties  have cause  this  Agreement  to be
executed as of the date first above written by their authorized representatives.

ATTEST:


s/Shirley Naidel                            s/George J. Coates
Notary Public of New Jersey               GEORGE J. COATES - INDIVIDUALLY
My Commission Expires
Dec. 27, 2000


s/Shirley Naidel                           s/Gregory Coates
Notary Public of New Jersey               GREGORY COATES - INDIVIDUALLY
My Commission Expires
Dec. 27, 2000


s/Shirley Naidel                           s/George J. Coates
Notary Public of New Jersey               COATES INTERNATIONAL, LTD.
My Commission Expires                     BY:  GEORGE J. COATES
Dec. 27, 2000
















coat-lic.agr

                                                         9

<PAGE>






                                    EXHIBIT 23


                      Rosenberg Rich Baker Berman & Company
                                380 Foothill Road
                          Bridgewater, New Jersey 08807




                          Independent Auditors' Consent





We consent to the  incorporation by reference in the Annual Report filed on Form
10-KSB of Coates International,  Ltd. and Subsidiaries for the fiscal year ended
December 31, 1997, of our report dated May 14, 1998.

                                ROSENBERG RICH BAKER BERMAN & COMPANY
                                s/Rosenberg Rich Baker Berman & Company



Bridgewater, New Jersey
June 15, 1998







aud-cons.coa

<PAGE>