SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the Transition period from____________to______________
Commission File Number 33-94884
COATES INTERNATIONAL LTD.
(Exact name of small business issuer as specified in its charter)
Delaware 22-2925432
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
Highway 34 & Ridgewood Road, Wall Township, New Jersey 07719
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code (908) 449-7717
Securities registered pursuant to Section 12(b) of the Act:
Title of Class
None
Securities registered pursuant to Section 12(g) of the Act:
Title of Class
None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes No X
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of the issuer's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or in any amendment to
this Form 10-KSB. [ ]
For the year ended December 31, 1996, the issuer's revenues were $37,375.
During the year ended December 31, 1996, there was no established public trading
market for the issuer's Series A Preferred Stock. On December 31, 1996, there
were 5,963,600 shares of Series A Preferred Stock of the Issuer issued and
outstanding.
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COATES INTERNATIONAL LTD.
PART I
Item 1. Description of Business
Background
Coates International Ltd. ("CIL") has completed the basic development of a
spherical rotary valve system (the "Coates System") for use in piston driven
internal combustion engines of all types. Development of the Coates System was
initiated by CIL's founder, George J. Coates, in Ireland in the late 1970's. In
1982, Mr. Coates obtained a patent from the Republic of Ireland for the Mark I
version of the Coates spherical rotary valve system for use in piston driven
engines. In 1986, George J. Coates emigrated to the United States where he
commenced development of the Mark II version and subsequently, the Mark III
version of his spherical rotary valve system. Between 1990 and 1994, George J.
Coates was issued seven United States patents (the "Coates Patents") with
respect to various aspects of the Coates System including the Mark II and the
Mark III version. Mr Coates has also been issued a number of foreign patents
with respect to various aspects of the Coates System and has patent applications
pending in several foreign jurisdictions. See "Patents and Licenses."
CIL holds a non-exclusive license from George J. Coates and his son
Gregory Coates, to manufacture, sell and grant sublicenses with respect to
products based on the Coates Patents, within the United States, its territories
and possessions (the "Licensed Areas"). George J. Coates and Gregory Coates have
also agreed, as long as CIL remains independent and viable, not to compete with
CIL in the manufacture, assembly, use or sale of internal combustion engines
utilizing the technology falling within the scope of the Coates Patents in the
Licensed Areas, or to grant any other exclusive or non-exclusive license in the
Licensed Areas except through CIL. In addition, George J. Coates and Gregory
Coates have executed an agreement granting CIL the right to retain any monies
including royalties received from Nicholson McLaren or from Noble Motor Sport
(manufacturer of Ascari racing cars) for manufacture, sale, use or assembly of
internal combustion engines anywhere in the world using the technology falling
within the scope of the Coates Patents. See "Patents and Licenses."
CIL and its Predecessor Entity have realized insignificant revenues from
the inception of the Predecessor Entity in August 1988 through the present date
and is a company in the development stage. In July 1991, CIL signed a prototype
manufacturing agreement with Harley-Davidson, Inc. ("Harley Davidson") as a
prelude to an anticipated license agreement. Pursuant to the prototype
manufacturing agreement, CIL commenced to attempt to retrofit a Harley Davidson
motorcycle engine using the Coates technology. An initial $150,000 engineering
and development fee was paid to CIL by Harley Davidson. CIL has not, to date,
developed a retrofitted Harley Davidson motorcycle engine using the Coates
technology that is acceptable to Harley Davidson and no assurances can be given
that an acceptable engine will be developed or that a license agreement will be
concluded with Harley Davidson. Under the terms of a February 1994 license
agreement, CIL received a $500,000 initial payment made by Millwest Corporation
("Millwest") for a license of the Coates System technology. Millwest
subsequently defaulted in making the next payment required under the license
agreement. In 1996, CIL recognized $37,375 in revenues paid by Nicholson McLaren
in partial payment for two high performance racing car engines modified with the
Coates System shipped to Nicholson McLaren by CIL. In April and July 1996, CIL
executed a License
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Agreement and a Sales Representative Agreement with Nicholson McLaren. See
"Patents and Licenses."
Since its inception, the bulk of the development costs and related
operational costs of CIL have been funded primarily through cash generated from
the sale of stock, through capital contributions made by Gregory Coates and the
above described payments from Harley Davidson and Millwest. As a development
stage company, CIL has incurred losses from the inception of the Predecessor
Entity in August 1988 through December 31, 1996 of $13,376,892 and at December
31, 1996, had a negative net worth of ($488,642) and negative working capital of
($2,114,271).
Business Plan
CIL's ability to generate revenues and achieve profitable operations is
principally dependent upon the execution and funding of sub-license agreements
with engine manufacturers or retrofitters, and upon the manufacture and sale, by
CIL, of high performance automotive, motorcycle and marine racing engines. CIL
is actively attempting to market its technology and is in communication with
various persons and entities who may be interested in acquiring sub-licenses to
use the technology.
CIL is currently manufacturing high performance automotive engines
modified with the Coates System on a limited basis at its Wall Township, New
Jersey manufacturing facility. Except as set forth herein, none of the engines
has been sold. CIL has received numerous oral and written inquiries from
potential customers, expressing an interest in acquiring high performance
automotive racing engines modified with the Coates System. After it completes
manufacture of a sufficient backlog of such engines, CIL intends to attempt to
convert these inquiries into binding sales orders, to fill such orders from its
limited inventory of engines and to continue to manufacture on a limited basis
and market high performance automotive, motorcycle and marine racing engines
using the Coates System technology. Assuming CIL obtains sufficient financing
and a sufficient number of orders, CIL management believes that it will be able
to produce racing engines using the Coates System technology at its Wall
Township facility on a limited basis at the rate of approximately 30 engines per
month. CIL expects that the bulk of its initial sales of engines, to the extent
it is able to effectuate same, will be at a base sales price in the range of
$25,000 to $30,000 per engine although depending on type and size, some of the
engines may be priced as high as $75,000. To achieve such production levels, CIL
will be required to expand its production work force to approximately 15-20
production workers.
Assuming its sales develop to a sufficiently increased level, CIL intends
to establish a full scale production facility (presumably in central New
Jersey), significantly larger than its present facility, at which it will
manufacture high performance racing engines modified with the Coates System on
an assembly line basis. Management estimates that CIL will require approximately
$7,500,000 of additional funding to establish and operate such a facility. Such
funding would be required to acquire the larger facility and production
machinery, to prepare assembly lines, castings and molds for manufacturing, to
acquire inventory including engine blocks and heads, crank shafts and bearings
and to employ additional production workers, mechanics, machine tool operators
and assembly personnel as well as marketing personnel.
It is the intention of CIL to fund its business plan by borrowings and the
sale of equity and/or debt instruments, and through the sale of sub-licenses.
All of these financing vehicles will be pursued simultaneously. It is not
presently known which, if any, of these alternatives will be utilized, whether
they are available to CIL, and if available, in what mixture or in what amounts.
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In view of its minimal revenues and recurring losses from operations since
inception, its deficit accumulated during its development stage and its limited
liquid assets, no assurances can be given that CIL will be able to pursue its
business plan. If it does not obtain sufficient liquid assets to fund such plan,
CIL may be forced to sell its assets or to seek protection from creditors
through a bankruptcy or similar filing.
The Coates System
The Coates System differs from the conventional poppet valve currently
used in almost all piston driven automotive, motorcycle and marine engines, by
changing the method by which the air and fuel mixture is delivered to the engine
cylinder as well as the method of expelling the exhaust gases after the mixture
is ignited. Unlike the poppet valve which protrudes into the engine cylinder,
the Coates System utilizes spherical valves which do not protrude into the
cylinder but rotate in a cavity formed between a two piece cylinder head. As a
result of employing fewer moving parts as compared to the poppet valve and not
protruding into the engine cylinder, management believes that the Coates System
will promote less engine wear and will require less lubrication over the life of
the engine. In addition, because the Coates System does not employ parts which
protrude into the engine cylinder, it is designed with larger openings into the
cylinder than conventional poppet valves so that more fuel and air mixture can
be inducted into and expelled from the engine cylinder in a shorter period of
time using the Coates System, leading to an ability to operate the engine faster
and an ability to utilize higher compression ratios with lower combustion
chamber temperatures. Management believes that as a result, engines modified
with the Coates System will produce more power than similar engines utilizing
the poppet valve system.
Third Party Evaluations. In May 1993, a team of Chrysler Corporation
("Chrysler") engineers made a trip to the CIL facility in Wall Township, New
Jersey to observe and evaluate the "Coates Spherical Rotary Valve Train System"
for a possible investment by Chrysler. The Chrysler team recommended that "...no
further activity should be undertaken by Chrysler at this time..." because of a
lack of documented proof to substantiate that the System functions as claimed.
Among other factors, the Chrysler team concluded that CIL required an
"exorbitant" up-front licensing fee and vehicle royalty, that documented proof
of component durability, system performance and emissions characteristics were
non-existent and that demonstrated components were not acceptable. The Chrysler
team also concluded that the Coates System's kinematics were extremely
efficient, would yield a lower package height than a comparable poppet valve
system and had good emission development potential. In listing potential
benefits of the Coates System, the Chrysler team indicated that in comparison to
a poppet valve train system, the Coates System will consist of fewer components,
will reduce the vertical height of the cylinder head and will permit a higher
rotating speed. Other cited potential benefits of the Coates System included
improved power output and idle quality, reduced hydrocarbon emissions and
potential emissions and fuel economy benefits. The Chrysler team also cited
certain Coates System components as potential problems for meeting 100,000 mile
durability goals including the combustion chamber seals, the spherical rotary
valves "especially the exhaust", and the rotating valve shaft bearings. Other
cited potential problems included a statement that the overall weight may be
greater than a comparable poppet valve train system and that initial
manufacturing costs will be greater than a comparable poppet valve train system.
Pursuant to a July 1991 prototype manufacturing agreement signed by CIL
with Harley Davidson as a prelude to an anticipated license agreement, Harley
Davidson engineers (according to Harley Davidson) conducted dynamometer tests of
two prototype motorcycle engines modified to incorporate the Coates System. In
the fall of 1991, Harley Davidson advised CIL that relatively early in the test
process, each prototype engine experienced mechanical durability problems. CIL
has not,
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to date, developed a retrofitted Harley Davidson motorcycle engine using the
Coates technology that is acceptable to Harley Davidson. No assurances can be
given that an acceptable engine will be developed or that a license agreement
will be concluded with Harley Davidson.
Test Results. An automobile engine modified with the Coates System was
tested in February and August 1990 and February 1991 at the facilities of
Compliance and Research Services, Inc. ("CRS") an independent motor vehicle
testing contract laboratory recognized by the United States Environmental
Protection Agency ("EPA"), in tests set up to measure power and fuel economy.
The test results indicated emission levels of pollutants which were
substantially higher than maximum emission levels permitted pursuant to
regulations adopted by the EPA. However, the tests conducted were not emissions
tests and the engine of the vehicle being tested had been operated for more than
100,000 miles prior to testing. Furthermore, the engine tested was not equipped
with an EGR system or an air pump, two standard pollution control devices
required to be installed in most automobiles operating on U.S. roads today.
Subsequently, CRS conducted an emission test in February 1995 on a 1985 Mercedes
engine modified to utilize the improved Coates System as compared to a similar
1985 Mercedes engine not so modified. The test, conducted on a dynamometer and
characterized as a "hot start" test, comprised only one of the three required
Federal Testing Procedure or "FTP" tests required by the EPA to be passed before
an engine can be manufactured for commercial use in the United States. The test
results were as follows:
Pollutants Emitted
(in Grams per Mile)
Total Total CarbonOxides of
Hydrocarbons Monoxide Nitrogen
Mercedes Engine
with Coates System .642 1.752 3.069
Mercedes Engine
without Coates System .978 4.237 3.032
Maximum allowable
EPA emission standards .41 3.4 1.0
Although the Mercedes engine modified with the Coates System emitted
substantially less pollutants than the non-modified Mercedes engine in two of
the three categories and emitted only slightly more oxides of nitrogen than the
non-modified Mercedes; in two of the three pollutant categories, the Coates
System modified engine emissions exceeded maximum permitted EPA emission
standards. It should be noted that in these preliminary tests conducted in 1995,
neither engine was equipped with an EGR system or an air pump. No assurances can
be given that equipping the Coates System modified engine with an EGR system and
an air pump would have reduced pollutant emissions to EPA acceptable levels or
that continued developmental efforts on the Coates System will reduce total
hydrocarbon and oxides of nitrogen emissions to EPA acceptable levels.
A vehicle engine runs approximately 50% of its life at idle, or close to
idle. Most pollution occurs when vehicles are bumper to bumper, in a stop and go
situation. This happens mainly in cities where the majority of people and
vehicles are concentrated. The EPA has standards for vehicles in these
situations. Every vehicle in the United States must pass a tailpipe emissions
test on a regular basis. On February 26, 1991, a Mercedes 280 equipped with the
Coates System was tested at Glendinning Ultra Service Center, Wall Township, New
Jersey 07719 (a local service station which
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is not an independent motor vehicle testing contract laboratory recognized by
the EPA), with results as follows:
HC 134 PPM
CO 0.22%
CO2 14.66%
O2 0.0%
RPM 1,000
At such time, the maximum EPA limits were:
HC 220 PPM
CO 1.2%
NOx was not required.
On March 30, 1993 another tailpipe test was carried out with a Mercedes 280
fitted with the Coates System at a local State of New Jersey Motor Vehicle
Inspection Station (which is also not an independent motor vehicle testing
contract laboratory recognized by the EPA), in order to register the vehicle and
the emission levels were as follows:
HC 0 PPM
CO .00%
RPM 825
Another test carried out on the same day at the same facility indicated the
following emission levels:
HC 0 PPM
CO .01%
RPM 1,264
The tests conducted at the local service station and at the Motor Vehicle
Inspection Station were not dynamometer tests and were conducted merely to
indicate how much emissions the engine puts out at idle or in a traffic
situation.
Patents and Licenses
In 1982, George J. Coates obtained a patent from the Republic of Ireland
for the Mark I version of the Coates spherical rotary valve system for use in
piston driven internal combustion engines. In 1986, George J. Coates emigrated
to the United States where he commenced development of the Mark II version and
subsequently the Mark III version of his spherical rotary valve system. Between
1990 and 1994, George J. Coates was issued seven United States patents (the
"Coates Patents") with respect to various aspects of the Coates System including
the Mark II and Mark III version. The Coates Patents are as follows:
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Date Date
U.S. Patent No. Application Filed of Patent
4,989,576 (Mark I) July 26, 1982 February 5, 1991
4,953,527 (Mark II) November 14, 1988 September 4, 1990
4,989,558 September 14, 1989 February 5, 1991
4,944,261 (Mark IIB) October 16, 1989 July 31, 1990
4,976,232 December 6, 1989 December 11, 1990
5,109,814 May 10, 1991 May 5, 1992
5,361,739 (Mark III) May 12, 1993 November 8, 1994
The Mark I, Mark II, Mark IIB and Mark III patents were also the subject
of foreign filings by Mr. Coates who has been issued foreign patents with
respect to some of these filings by Austria, Belgium, Denmark, France, Germany,
Great Britain, Greece, Italy, Luxembourg, The Netherlands, Spain, Sweden and
Switzerland as well as by Australia, Brazil, Canada, Hong Kong, Japan, Korea,
Mexico, Singapore, South Africa and Taiwan. Mr. Coates continues to have patent
applications pending in some of these as well as other foreign jurisdictions.
In connection with the settlement of the SEC complaint described in Item 3
herein, the final consent judgment executed by George J. Coates permitted him to
retain title to the Coates Patents as well as all other patents pending or
issued with respect to his Spherical Rotary Valve technology and future patent
applications with respect to such technology (collectively, the "Patents")
provided that he reimburse CIL for all monies expended in the preparation,
application and/or prosecution of the Patents. Such sums in the aggregate amount
of $434,639 were credited to or paid to CIL in 1995 so that George J. Coates
retained title to the Patents.
Subsequent thereto, in February 1995, George J. Coates and his son Gregory
Coates each granted CIL a non-exclusive license to manufacture, sell and grant
sublicenses with respect to products based on the Coates Patents within the
United States, its territories and possessions. The licenses expire in the event
of bankruptcy or similar insolvency of CIL. George J. Coates and Gregory Coates
have also agreed, as long as CIL remains independent and viable, not to compete
with CIL in the manufacture, assembly, use or sale of internal combustion
engines utilizing the technology falling within the scope of the Coates Patents
in the Licensed Areas, or to grant any other exclusive or non-exclusive license
in the Licensed Areas except through CIL. In addition, George J. Coates and
Gregory Coates have executed an agreement granting CIL the right to retain any
monies including royalties received from Nicholson McLaren or from Noble Motor
Sport (manufacturer of Ascari racing cars) for manufacture, sale, use or
assembly of internal combustion engines anywhere in the world using the
technology falling within the scope of the Coates Patents. CIL agreed to pay a
$5,500,000 license fee to George J. Coates in consideration for his grant to CIL
of the non-exclusive license payable at management's discretion but in no event
later than February 17, 1998. In September 1995, this arrangement was modified.
CIL and George J. Coates agreed that instead of the $5,500,000 payment, CIL
would issue 275,000 shares of Series A Stock to Mr. Coates as the license fee.
The shares were issued to Mr. Coates in November 1995.
See "Item 1 - Business-The Coates System-Third Party Evaluations" as to a
July 1991 prototype manufacturing agreement executed by CIL with Harley Davidson
as a prelude to an anticipated license agreement. As CIL has been unable, to
date, to develop a retrofitted Harley Davidson motorcycle engine using the
Coates technology that is acceptable to Harley Davidson, no assurances can be
given that a license agreement will be concluded with Harley Davidson.
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In February 1994, CIL executed a license agreement with Millwest
Corporation of Dumas, Texas ("Millwest") granting Millwest a five year exclusive
license to retrofit pre-existing internal combustion engine blocks (excluding
air-cooled engines and engines used for racing competition) by replacing the
pre-existing valve system with the Coates Spherical Rotary Valve System in the
United States, its territories and possessions, Canada and Mexico, the five year
term to commence after payment to CIL by Millwest on or before May 4, 1994 of a
$10,000,000 licensing fee. The agreement also provided Millwest with a
non-exclusive license to manufacture the Coates Spherical Rotary Valve System
subject to the payment of royalties. Additional payments of $1,666,666 were
required to be paid to CIL on the third, fourth and fifth anniversary of the
effectiveness of the license. An additional $15,000,000 payment is due on
February 5, 1999. Millwest made an initial $500,000 payment pursuant to the
agreement in February 1994 but has failed to pay the additional $9,500,000 to
activate the license. CIL has placed Millwest on notice that it is in default.
In June 1995, Millwest informed CIL of an intention to activate the license
agreement claiming that financing had been arranged to do so but to date, no
additional payments have been received by CIL from Millwest and no assurances
can be given that any additional payments will be made.
His appearance at the Birmingham (U.K.) Autosport Show in January 1996
resulted in George J. Coates receiving a letter of intent from Nicholson McLaren
to acquire a license to distribute the racing engines modified with the Coates
System within the European Patent Community upon a commission or royalty basis
to be negotiated. Also, as a result of George J. Coates' appearance at the same
show, CIL received a $1,000 check from Noble Motorsport U.S.A., a subsidiary of
Ascari Cars Ltd. (U.K.) (formerly Noble Motor Sport Ltd.) and a $28,000 order to
install a high performance racing car engine modified with the Coates System in
an Ascari racing car. The car was delivered in March 1996 to the CIL plant in
Wall Township, New Jersey, but to date, an engine modified with the Coates
System has not been installed in the car.
In April 1996, CIL executed a license agreement with Nicholson McLaren
granting Nicholson McLaren a non-exclusive license to assemble, sell, use and
lease internal combustion engines incorporating the Coates Spherical Rotary
Valve System within the European Patent Community, which includes but is not
limited to Austria, Belgium, Denmark, France, Germany, Greece, Ireland, Italy,
Portugal, Spain, Sweden, Switzerland, and the United Kingdom. In consideration
of the rights granted under the license agreement, Nicholson McLaren agreed to
pay CIL a licensing fee of $5 million payable $37,375 upon receipt of the first
demonstration model by Nicholson McLaren from CIL; another $37,375 upon receipt
of the second; with the balance to be paid out of sales (if any) of internal
combustion engines modified with the Coates Spherical Rotary Valve System
assembled by Nicholson McLaren with components purchased from CIL. The balance
is payable pursuant to a payment schedule to be mutually agreed between both
parties. The license agreement also gives Nicholson McLaren the right to obtain
a manufacturing license from CIL against payment of royalties on the manufacture
of components at a rate to be established. The Company recognized revenue of
$37,375 in 1996 upon receipt of cash from Nicholson McLaren after delivery of
the first demonstration model in April 1996. CIL has waived payment for the
second demonstration model which was delivered in July 1996. CIL has retained
ownership to this second model which is being demonstrated by Nicholson McLaren
for potential customers on behalf of CIL. The payment schedule with respect to
the balance of the licensing fee has not yet been finalized by the parties. No
assurances can be given that CIL will be paid a substantial portion of the
balance of the licensing fee by Nicholson McLaren as such balance is contingent
upon future sales by Nicholson McLaren of internal combustion engines modified
with the Coates Spherical Rotary Valve System. During 1996, John Nicholson, the
president of Nicholson McLaren purchased 4,000 shares of CIL Series A Stock at
$20 per share.
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In June 1996, CIL executed a Sales Representative Agreement retaining an
affiliate of Nicholson McLaren as its exclusive sales representative in the
United Kingdom and Europe for the sale of the Coates Technology for a four-year
term. The agreement provides for a sliding scale commission varying from 5% of
the first $1 million in Net Product Billings to 1% of the fifth $1 million in
Net Product Billings and all amounts in excess thereof. No assurances can be
given that the sales representative will produce significant billings for CIL
products pursuant to the agreement.
Employees
At December 31, 1996, CIL employed 12 full-time employees and one
part-time employee including George J. Coates and his son Gregory who perform
both management, assembly and research and development functions; George J.
Coates' wife Bernadette who is involved in administration functions, two people
in marketing and communications, one shop foreman, one draftsman, one
programmer, three tool and lathe operators, one person performing secretarial
and inventory control functions and one part-time bookkeeper.
Item 2. Description of Property
CIL's executive offices and testing facility are located in an
approximately 25,000 square foot one and one-half story building of concrete and
steel construction on a 6 1/2 acre site in Wall Township, New Jersey. CIL
acquired this property from The George J. Coates 1991 Family Partnership, L.P.
in 1995. See "Item 12" herein.
In its development operations, CIL owns and utilizes milling machines,
lathes, grinders, hydraulic lifts and presses, tooling, dynamometers and
emission testing machines and computerized drafting and printing equipment. All
of such equipment is in good condition, reasonable wear and tear excepted.
Item 3. Legal Proceedings
SEC Complaint
In July 1994, the SEC filed a complaint in the United States District
Court for the Southern District of New York (94 Civ. 5361) against George J.
Coates, CIL and certain affiliated companies seeking injunctive and other
relief. In its complaint, the SEC alleged that CIL and George J. Coates raised
"...almost $6.5 million from almost 400 investors..." through offers, purchases
and sales of CIL securities which the SEC alleged were fraudulent. The SEC
alleged that CIL and George J. Coates misrepresented the capabilities of the
Coates engine; omitted to disclose negative results of independent tests on the
engine; falsely claimed that CIL had sold licenses and received orders and other
commercial opportunities; and misrepresented that George J. Coates had assigned
all patents related to the Coates engine to CIL. The SEC also alleged that CIL
and George J. Coates had failed to disclose to shareholders that certain of the
shares sold by Mr. Coates were not authorized by CIL; that George J. Coates
misappropriated or misused approximately $2 million of investor funds for his
personal benefit; and that CIL had engaged in several related party transactions
with other entities controlled by George J. Coates.
At the time of the filing of the SEC complaint, the Court issued an order
freezing the assets of CIL and George J. Coates (although George J. Coates was
permitted to use future income for living expenses). The Court appointed Donald
H. Steckroth, Esq., a New Jersey attorney, as
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Temporary Receiver, to take possession and control of CIL's assets and
properties, to preserve the status quo and to prevent any misuse, encumbrance or
disposal of CIL's corporate property and assets.
Arrest of George J. Coates
At the same time as the SEC complaint was filed in July 1994, an inspector
for the United States Postal Inspection Service swore out a criminal complaint
against George J. Coates in the United States District Court for the Southern
District of New York, based on allegations similar to those contained in the SEC
complaint. As a result, Mr. Coates was arrested but he was released after four
days of incarceration. On May 30, 1995, a United States Magistrate Judge of the
United States District Court for the Southern District of New York signed an
order in response to a request by the office of the United States Attorney for
the Southern District of New York dismissing without prejudice, the criminal
complaint against George J. Coates.
Settlement of the SEC Complaint
On February 6, 1995, CIL and George J. Coates, without admitting or
denying the allegations contained in the SEC complaint, consented to the entry
of final consent judgments enjoining them from effecting sales of any security
unless a registration statement is in effect as to such security or an
applicable exemption from registration is available and from engaging in
fraudulent activities in connection with the offer or sale of any security. CIL
was also ordered to provide an accounting of its assets and liabilities; its
financial statements and a list of all purchasers of CIL stock from CIL, George
J. Coates or any other source during the period commencing April 24, 1990 to the
date of the consent judgment including the number of shares purchased and the
purchase price. George J. Coates was ordered to provide an accounting as to his
assets and liabilities; as to any money, property, assets or other revenue
received by him or for his benefit from January 1, 1990 to the date of the
accounting; and as to all assets, funds, securities or real or personal property
of investors in CIL which were transferred to or for George J. Coates' benefit
during such period.
George J. Coates was also ordered to cause the transfer by The George J.
Coates 1991 Family Partnership, L.P. to CIL of the real property and building
used by CIL as its principal facility located at Highway 34 and Ridgewood Road
in Wall Township, New Jersey. This transfer was effected on February 21, 1995.
George J. Coates has guaranteed repayment of the mortgage loan on this property
and CIL is obligated to indemnify George J. Coates from any liability based on
the mortgage loan on the property. The consent judgment permitted George J.
Coates to retain title to the Coates Patents provided that he reimbursed CIL for
all of the monies it expended in the preparation, application and prosecution of
the Patents. Such sums in the aggregate amount of $335,805 were paid to CIL by
February 15, 1995 so that George J. Coates retained title to the Patents. Mr.
Coates was also ordered to cause the transfer to CIL of all licensing fees and
other funds paid to persons or entities other than CIL in connection with the
acquisition by the payor of an interest in the Patents or in the technology
embodied in the Patents, including the $500,000 licensing fee paid by Millwest
Corporation and held in a bank account entitled "Coates International
Licensing." On February 24, 1995, the $500,000 license fee and $12,144 of
interest thereon was paid to CIL.
Rescission and Exchange Offer
The consent judgment also required CIL to file a registration statement
with the SEC to effect a Rescission and Exchange Offer, as follows:
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Purchasers of Series A Stock who purchased such stock from CIL or George
J. Coates during the period commencing April 24, 1990 through November 13, 1995
and who continued to own their shares at such date were afforded the option to
choose one of the following two forms of consideration in exchange for his or
her shares of Series A Stock.
Option One - Subject to the availability of same, the right to receive
cash or assets equal in amount to the consideration such Purchaser paid for his
or her shares of Series A Stock, in exchange therefore, plus simple interest
calculated at an annual rate of five (5%) percent from the date of payment for
the Series A Preferred Stock; or
Option Two - the right to receive one share of newly issued Series A Stock
identical to the previously purchased Series A Stock in exchange for each share
of Series A Stock held by such Purchaser.
Pursuant to the consent judgment, CIL filed a registration statement on
Form S-1 with the SEC (File No. 33-94884) to effect the Rescission and Exchange
Offer. The registration statement was declared effective by the SEC on November
13, 1995.
Pursuant to the consent judgment, Donald H. Steckroth, Esq., the Temporary
Receiver, was appointed Special Master, to continue in possession and control of
any and all assets of CIL until a distribution was made pursuant to the
Rescission and Exchange Order and until he was discharged by order of the Court.
The consent judgment required CIL to mail a copy of the November 13, 1995
Prospectus together with a cover letter prepared by the Special Master advising
the Purchasers of the allegations contained in the SEC complaint, the terms of
the final CIL consent judgment, the fact that the Prospectus contained detailed
information concerning the status of CIL's business and efforts to develop and
commercially exploit the Coates engine technology, and explaining the above two
options, and an Election Form, by certified mail return receipt requested, to
each Purchaser.
After the November 13, 1995 effectiveness of the above registration
statement, the Prospectus and the required cover letter and Election Form were
mailed to each of the Purchasers. Of the 328 persons to whom the Rescission and
Exchange Offer was directed (who had invested approximately $6,500,000 in CIL),
an aggregate 32 Purchasers elected to rescind their prior purchases of an
aggregate 48,500 shares of Series A Preferred Stock entitling them to be paid an
aggregate $1,270,000 plus interest. Two of the 32 Purchasers invested $900,000
of the $1,270,000 in CIL with respect to which rescission was elected. In the
second quarter of calendar year 1996, a group of investors advanced funds in
order to purchase Series A Preferred Stock. These funds were used by CIL to
repurchase Series A Preferred Stock owned by the persons who accepted the 1995
Rescission and Exchange Offer. An aggregate $1,260,000 of the funds and $65,000
of interest was paid to 31 of the 32 Purchasers who elected to accept Option One
of the Rescission and Exchange Offer and their 48,000 shares of Series A
Preferred Stock were canceled. No shares were issued to the investors who
advanced said funds at such time.
By letter dated July 31, 1996, the Special Master filed a report with the
United States District Court recommending that CIL be permitted to undertake a
private offering. A successful private offering would generate sufficient funds
to permit reimbursement of those investors (the "Potential Investors") who
advanced funds in the second quarter of calendar 1996 in order to purchase
Series A Preferred Stock, which funds were used by CIL to repurchase Series A
Preferred Stock owned by persons who elected pursuant to the Rescission and
Exchange Offer to rescind their prior purchases of Series A Preferred Stock. On
August 19, 1996, United States District Court Judge Kimba Wood signed an order
permitting a Private Offering to proceed and ordered CIL and George J. Coates to
reimburse the Potential Investors for the amounts advanced by them.
10
<PAGE>
George J. Coates had consented to pay up to the first $773,500 of the
amounts payable pursuant to the Rescission and Exchange Offer to those
Purchasers who elected Option One using all of his personal assets other than
his personal residence. To the extent that he was unable to pay any such
amounts, CIL was required to pay same and would retain its rights to assert
claims against George J. Coates personally to recover its payment of any such
shortages. CIL also consented to pay any additional amounts required to fund the
Rescission and Exchange Offer.
The Private Offering permitted by Judge Wood's August 1996 order was
completed in July 1997. Pursuant to the terms of the Private Offering, each of
the Potential Investors was offered the right to elect to receive shares of
Series A Preferred Stock at a value of $20 per share for the amounts he advanced
in the second quarter of calendar year 1996 or to have the amount of his advance
refunded. Of the $1,270,000 advanced, one Potential Investor elected to have his
advance of $10,000 refunded and the remaining Potential Investors elected to
receive Series A Preferred Stock. George J. Coates made the $10,000 cash payment
to the Potential Investor who elected the refund and transferred 38,175 shares
of his Series A Preferred Stock to the remaining Potential Investors. CIL issued
the balance of 24,825 shares of Series A Preferred Stock to the Potential
Investors. CIL also received $960,000 in cash proceeds from the Private Offering
(paid to purchase shares of Series A Preferred Stock at $20 per share) which it
applied to the payment of outstanding payables including the final bill of the
Special Master who was then discharged by Judge Wood.
CIL is a defendant in various lawsuits. In the opinion of management, none
of these lawsuits will have a material adverse effect on CIL, its business or
its financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
CIL did not submit any matter to a vote of its stockholders during the
fourth quarter of calendar year 1996.
11
<PAGE>
COATES INTERNATIONAL LTD.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
There is no established public trading market for CIL's only outstanding
class of capital stock, its Series A Preferred Stock. At December 31, 1996, the
approximate number of holders of record of the Series A Preferred Stock was 510.
CIL has not paid any dividends with respect to its Series A Preferred Stock and
anticipated capital requirements make it highly unlikely that any dividends will
be paid by CIL in the foreseeable future.
Pursuant to the SEC Complaint described in "Item 3" herein, the SEC
alleged that since April 24, 1994, CIL (including its predecessor) and George J.
Coates raised "...almost $6.5 million from almost 400 investors..." through
offers, purchases and sales of CIL's securities which the SEC alleged were
fraudulent. The SEC also alleged that such offers, purchases and sales were
effected without registration under the Securities Act of 1933 or pursuant to an
applicable exemption thereunder. The shares of Series A Preferred Stock were
sold at effective prices of $5, $10, $20 and $30 by CIL, its predecessor and its
controlling stockholder for $6,578,000 in gross proceeds. As a result of the
settlement of the SEC Action described in "Item 3," no exemption from
registration under the Securities Act of 1933 is being claimed by CIL and the
"Rescission and Exchange Offer" therein described has been effectuated.
Item 6. Management's Discussion and Analysis or Plan of Operation
Coates International Ltd. ("CIL" or the "Company") is a Delaware
corporation organized in October 1991 by George J. Coates as the successor in
interest to a Delaware corporation of the same name incorporated in August 1988
(the "Predecessor Entity"). As a result of a dispute with certain former
employee-directors who claimed to own approximately nine (9%) percent of the
Predecessor Entity's outstanding capital stock, the Predecessor Entity was
reorganized in November, 1991. Pursuant to the reorganization, all of the
Predecessor Entity's assets subject to liabilities were distributed to CIL, the
non-litigating stockholders of the Predecessor Entity became the stockholders of
CIL and the Predecessor Entity was dissolved.
CIL has completed the basic development of a spherical rotary valve system
(the "Coates System"), the development of which was initiated by its founder,
George J. Coates, for use in internal combustion engines of all types. With
respect to the Coates System, seven applicable United States patents (the
"Coates Patents") have been issued to George J. Coates. CIL holds a
non-exclusive license from George J. Coates and his son Gregory Coates, to
manufacture, sell and grant sublicenses with respect to products based on the
Coates Patents, within the United States, its territories and possessions (the
"Licensed Areas"). George J. Coates and Gregory Coates have also agreed, as long
as CIL remains independent and viable, not to compete with CIL in the
manufacture, assembly, use or sale of internal combustion engines utilizing the
technology falling within the scope of the Coates Patents in the Licensed Areas,
or to grant any other exclusive or non-exclusive license in the Licensed Areas
except through CIL. In addition, George J. Coates and Gregory Coates have
executed an agreement granting CIL the right to retain any monies including
royalties received from Nicholson McLaren or from Noble Motor Sport
(manufacturer of Ascari racing cars) for manufacture, sale, use or assembly of
internal combustion engines anywhere in the world using the technology falling
within the scope of the Coates Patents. See "Item 1 - Patents and Licenses."
12
<PAGE>
CIL has had a short operating history during which it has primarily
devoted its attention to developing the technology associated with the Coates
System. During such time CIL has also arranged for certain tests in order to
evaluate the effectiveness of the technology. CIL has also devoted such time in
an attempt to interest various persons and entities in acquiring sub-licenses to
use the technology.
CIL is currently manufacturing high performance automotive engines
modified with the Coates System on a limited basis at its Wall Township, New
Jersey manufacturing facility. Except as set forth herein, none of the engines
has been sold. CIL has received numerous oral and written inquiries from
potential customers, expressing an interest in acquiring high performance
automotive racing engines modified with the Coates System. No assurances can be
given that these inquiries will result in binding sales orders. After it
completes manufacture of a sufficient backlog of such engines, CIL intends to
attempt to convert these inquiries into binding sales orders, to fill such
orders from its limited inventory of engines and to continue to manufacture on a
limited basis and market high performance automotive, motorcycle and marine
racing engines using the Coates System technology.
CIL also intends to attempt to sublicense such technology.
Results of Operations from Inception August 31, 1988 through December 31, 1996
Virtually no revenues were realized from the inception of operations
through December 31, 1996, as the principal operations were those of a
development stage company. In July 1991, CIL signed a prototype manufacturing
agreement with Harley-Davidson, Inc. ("Harley Davidson") and commenced to
attempt to retrofit a Harley Davidson motorcycle engine using the Coates
technology. An initial $150,000 engineering and development fee was paid to CIL
by Harley Davidson. CIL has not, as yet, developed a retrofitted Harley Davidson
motorcycle engine using the Coates technology that is acceptable to Harley
Davidson.
Under the terms of a February 1994 license agreement, a $500,000 initial
payment was made by Millwest Corporation ("Millwest") for a license of the
technology and was held in a bank account entitled "Coates International
Licensing." This sum was subsequently paid over to CIL. Pursuant to the terms of
the license agreement, Millwest was obligated to make another payment of $9.5
Million to CIL on or before May 4, 1994. Millwest did not make such payment. CIL
placed Millwest on notice that it was in default. In June 1995, Millwest
informed CIL of an intention to activate the license agreement and claimed that
financing has been arranged to do so but to date, no additional payments have
been received by CIL from Millwest and no assurances can be given that any
additional payments will be made.
CIL did not recognize any revenues in calendar year 1995. In calendar year
1996, CIL recognized $37,375 in revenues paid by Nicholson McLaren Engines Ltd.
(U.K.) ("Nicholson McLaren") in partial payment for two high performance racing
car engines modified with the Coates System shipped to Nicholson McLaren by CIL.
See "Item 1 - Patents and Licenses" as to the execution by CIL in April and July
1996 of a License Agreement and a Sales Representative Agreement with Nicholson
McLaren.
Operating expenses incurred during CIL's development stage, from August
31, 1988, to December 31, 1996 were $13,954,525. Of this amount, salaries and
related benefits aggregated $1,868,188 (or 13%). Other expenses aggregated
$12,086,337 (or 87%).
Included in this total were research and development expenses of
$7,452,906 (including a $5,500,000 license fee payable to George J. Coates
converted into 275,000 shares of Series A Stock) and officers' salaries
aggregating $1,330,561. Occupancy expense of $468,736 primarily reflects total
13
<PAGE>
rent through February 1995 associated with CIL's lease of approximately 25,000
square feet of research, machine shop and office space, at Highway 34 and
Ridgewood Road, Wall Township, New Jersey, from The George J. Coates 1991 Family
Partnership, L.P. Pursuant to the consent judgment in connection with the SEC
complaint as previously described, in February, 1995, the lease was terminated
as title to the premises was conveyed, to CIL, by the Partnership. Thus the
rental payments have been terminated. See "Item 3 - Rescission and Exchange
Offer" as to CIL's obligation to indemnify George J. Coates with respect to the
$300,000 mortgage obligation assumed by CIL on the premises. The balance has
since been reduced to $210,000 and the mortgagees have agreed to further reduce
the mortgage balance by an additional $50,000 to $160,000 upon issuance to them
of an aggregate 2,500 shares of Series A Stock but to date, said shares have not
been issued. CIL is currently paying interest only on the mortgage at the rate
of $1,200 per month.
Liquidity and Capital Resources
Since its inception, all of the development costs and related operational
costs of CIL have primarily been paid through the cash generated through the
sale of stock, through capital contributions made by George J. Coates' son,
Gregory Coates and the $500,000 initial license payment made by Millwest.
Capital contributions advanced to CIL by Gregory Coates in 1995 and 1996
aggregated $404,549 and $1,132,523 respectively. Harley Davidson paid CIL
$150,000 as an initial deposit towards a license agreement; that money has also
been expended by CIL. Certain of the aforesaid funds generated income from bank
accounts in a depository institution; that interest income was also expended by
CIL. CIL has incurred losses as a development stage company from inception,
August 31, 1988, to December 31, 1996, of $13,376,892 and at December 31, 1996
had a negative net worth of ($488,642) and negative working capital of
($2,114,271).
CIL had agreed to pay a $5,500,000 license fee to George J. Coates in
consideration for a non-exclusive license granted by him to CIL in February
1995. In September 1995, this arrangement was modified. CIL and George J. Coates
agreed that instead of the $5,500,000 payment, CIL would issue 275,000 shares of
Series A Stock to George J. Coates as the license fee. These shares were issued
to George J. Coates in November 1995. See "Item 1 - Patents and Licenses."
See "Item 1 - Business Plan" as to CIL's current business plan. It is the
intention of CIL to fund its business plan by borrowings and the sale of equity
and/or debt instruments, and through the sale of sub-licenses. All of these
financing vehicles will be pursued simultaneously. It is not presently known
which, if any, of these alternatives will be utilized, whether they are
available to CIL, and if available, in what mixture or in what amounts.
In view of its minimal revenues and recurring losses from operations since
inception, its deficit accumulated during its development stage and its limited
liquid assets, no assurances can be given that CIL will be able to pursue its
business plan. If it does not obtain sufficient liquid assets to fund such plan,
CIL may be forced to sell its assets or to seek protection from creditors
through a bankruptcy or similar filing.
Note Regarding Forward-Looking Statements
This Annual Report contains historical information as well as
forward-looking statements. Statements looking forward in time are included in
this Annual Report pursuant to the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995. Such statements involve known and
unknown risks and uncertainties that may cause the Company's actual results in
future periods to be materially different from any future performance suggested
herein.
14
<PAGE>
Item 7. Financial Statements
Attached.
15
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
Coates International Ltd.
Wall Township, New Jersey
We have audited the accompanying balance sheets of Coates International
Ltd. [a development stage company] as of December 31, 1996 and 1995, and the
related statements of operations, stockholders' equity [deficit], and cash flows
for the years then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. The financial statements of Coates
International Ltd. as of and for the year ended December 31, 1995, were audited
by other auditors whose report dated March 11, 1996, on those statements [except
for one Note to the financial statements for which the date for various
information included therein was March 15 and 23, 1996], included an explanatory
paragraph describing the uncertainty about Coates International Ltd.'s ability
to continue as a going concern, which was more fully described in a Note to the
1995 financial statements. As more fully discussed in Note 4 to the accompanying
financial statements, Coates International Ltd. has made various restatements to
its 1995 financial statements during 1996. The principal restatements reflect
decisions by the United States District Court for the Southern District of New
York regarding the legal rights to a certain cash bank account and the amount of
the Company's obligation to Rescinding Shareholders at December 31, 1995.
Another principal restatement relates to cash infusions by a principal
stockholder that were restated from loans to additional paid-in capital at
December 31, 1995.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Coates International
Ltd. [a development stage company] as of December 31, 1996 and 1995, and the
results of its operations and its cash flows for the years then ended in
conformity with generally accepted accounting principles. We express no opinion
on the cumulative period from inception [August 31, 1988] through December 31,
1996 as shown in the cumulative columns on the statement of operations and the
statement of cash flows, nor on the statement of stockholders' equity [deficit]
for the period from inception [August 31, 1988] through December 31, 1994.
The accompanying financial statements have been prepared assuming that
Coates International Ltd. will continue as a going concern. As discussed in Note
5 to the financial statements, the Company has had insignificant revenues to
date, has suffered recurring losses and has accumulated a deficit since its
inception to December 31, 1996, of over $13 million. The Company also has
minimal liquid assets, and has over $2.2 million in current liabilities. In
addition to a recorded liability of $486,970 to certain potential investors, the
Company has a contingent liability of $773,500 related to these potential
investors. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also discussed in Note 5. The financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
MOORE STEPHENS, P.C.
Certified Public Accountants.
Cranford, New Jersey
January 24, 1997
F-1
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- ------------------------------------------------------------------------------
BALANCE SHEETS
- ------------------------------------------------------------------------------
<TABLE>
December 31,
1 9 9 6 1 9 9 5
[Restated]
Assets:
Current Assets:
<S> <C> <C>
Cash and Cash Equivalents $ 13,641 $ 27,769
Inventory 144,033 --
---------- -----------
Total Current Assets 157,674 27,769
---------- -----------
Property, Plant and Equipment - Net 1,606,659 1,634,822
---------- -----------
Other Assets:
Due from Stockholder 12,042 35,686
Deposit 2,500 2,500
Due from Affiliated Companies 4,428 2,116
---------- -----------
Total Other Assets 18,970 40,302
---------- -----------
Total Assets $1,783,303 $ 1,702,893
========== ===========
Liabilities and Stockholders' Equity [Deficit]:
Current Liabilities:
Amounts Due to Potential Investors $ 486,970 $ --
Redeemable Series A Preferred Stock 10,000 496,970
Mortgage Payable 210,000 250,000
Accrued Legal Fees 1,198,273 665,475
Accounts Payable 45,081 44,659
Accrued Interest 109,408 158,818
Other Accrued Expenses 204,213 108,026
Due to Stockholder 8,000 --
---------- -----------
Total Current Liabilities 2,271,945 1,723,948
---------- -----------
Commitments and Contingencies [10] -- --
---------- -----------
Stockholders' Equity [Deficit]:
Common Stock, $.001 Par Value, 20,000,000 Shares Authorized -
No Shares Issued -- --
Preferred Stock, Series A, $.001 Par Value, 14,000,000 Shares
Authorized - Voting, Non-Cumulative Convertible, 5,963,600 Shares
Issued and Outstanding at December 31, 1996 and 1995 5,963 5,963
Additional Paid-in Capital 12,882,287 11,749,764
Deficit Accumulated During the Development Stage (13,376,892) (11,776,782)
Total Stockholders' Equity [Deficit] (488,642) (21,055)
---------- -----------
Total Liabilities and Stockholders' Equity [Deficit] $1,783,303 $ 1,702,893
========== ===========
See Notes to Financial Statements.
</TABLE>
F-2
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- ------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
- ------------------------------------------------------------------------------
<TABLE>
For the
Period from
August 31,
1988 [Date of
Inception]
Years ended Through
December 31, December 31,
1 9 9 6 1 9 9 5 1 9 9 6
------- ------- -------
[Restated]
<S> <C> <C> <C>
Revenue $ 37,375 $ -- $ 687,375
----------- ---------- -----------
Operating Expenses:
Research and Development Costs 245,625 5,860,244 7,452,906
General and Administrative Expenses 1,315,282 1,055,160 6,222,241
Depreciation Expense 40,915 66,386 279,378
----------- ---------- -----------
Total Operating Expenses 1,601,822 6,981,790 13,954,525
----------- ---------- -----------
Loss From Operations (1,564,447) (6,981,790) (13,267,150)
----------- ---------- -----------
Other Income [Expense]:
Interest Income 1,121 9,514 113,604
Interest Expense (36,784) (90,530) (223,346)
----------- ---------- -----------
Net Other [Expense] (35,663) (81,016) (109,742)
----------- ---------- -----------
Net Loss $(1,600,110) $(7,062,806) $(13,376,892)
=========== =========== ============
Net Loss Per Share $ (.27) $ (1.23)
=========== ==========
Weighted Average Number of Shares 5,963,600 5,764,000
=========== ==========
See Notes to Financial Statements.
</TABLE>
F-3
<PAGE>
<TABLE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- -------------------------------------------------------------------------------------------------------------------
STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
- -------------------------------------------------------------------------------------------------------------------
Common Stock Common Stock Series A
Class A Class C Preferred Stock
Shares Amount Shares Amount Shares Amount
<S> <C> <C> <C> <C> <C> <C> <C>
August 31, 1988 [Date of Inception] -- $ -- -- $ -- -- $ --
Issuance of Shares 854,500 854 -- -- -- --
Issuance of Stock Pursuant to Private
Placement Offering 100,000 96 -- -- -- --
Net Loss for the Period from
August 31, 1988 [Date of Inception]
Through December 31, 1988 -- -- -- -- -- --
-------------- ---------- ---------- ----------- ----------- -----------
Balance - December 31, 1988 954,500 950 -- -- -- --
Stock Dividend 50,000 50 450,000 450 -- --
Issuance of Stock for Services Rendered 12,000 12 -- -- -- --
Net Loss for Year Ended
December 31, 1989 -- -- -- -- -- --
-------------- ---------- ---------- ----------- ----------- -----------
Balance - December 31, 1989 1,016,500 1,012 450,000 450 -- --
Issuance of Stock Pursuant to Private
Placement Offering 76,000 76 -- -- -- --
Issuance of Stock 962,500 962 -- -- -- --
Net Loss for Year Ended
December 31, 1990 -- -- -- -- -- --
-------------- ---------- ---------- ----------- ----------- -----------
Balance - December 31, 1990 2,055,000 2,050 450,000 450 -- --
Exchange of Preferred Stock for
Common Stock Class A (2,055,000) (2,050) -- -- -- --
Exchange of Preferred Stock for
Common Stock Class C -- -- (450,000) (450) -- --
Cancellation of Common Stock Class C -- -- -- -- -- --
Issuance of Stock in Connection with
Reorganization 100 -- -- -- -- --
Dissolution of Coates International Ltd. (100) -- -- -- -- --
Exchange of Series A Preferred Stock for
Preferred Stock -- -- -- -- 2,280,000 2,280
Issuance of Stock -- -- -- -- 102,000 102
Purchase of Treasury Stock -- -- -- -- -- --
Stock Split 2:1 -- -- -- -- 2,382,000 2,382
Net Loss for Year Ended
December 31, 1991 -- -- -- -- -- --
-------------- ---------- ---------- ----------- ----------- -----------
Balance - December 31, 1991 - Forward -- $ -- -- $ -- 4,764,000 $ 4,764
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- -------------------------------------------------------------------------------------------------------------------
STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
- -------------------------------------------------------------------------------------------------------------------
Common Stock Common Stock Series A
Class A Class C Preferred Stock
Shares Amount Shares Amount Shares Amount
<S> <C> <C> <C> <C> <C> <C>
Balance - December 31, 1991 -
Forwarded -- $ -- -- $ -- 4,764,000 $ 4,764
To Correct Balance at
December 31, 1991 -- -- -- -- 772,500 772
Issuance of Stock for Service -- -- -- -- 500 --
Issuance of Stock -- -- -- -- 115,850 116
Private Placement Costs -- -- -- -- -- --
Net Loss for Year Ended
December 31, 1992 -- -- -- -- -- --
-------------- ---------- ---------- ----------- ----------- -----------
Balance - December 31, 1992 -- -- -- -- 5,652,850 5,652
Issuance of Stock -- -- -- -- 82,250 83
Purchase of Treasury Stock -- -- -- -- -- --
Prior Period Adjustment -- -- -- -- -- --
Adjustment for Redeemable
Preferred Stock -- -- -- -- (479,950) (480)
Net Loss for Year Ended
December 31, 1993 -- -- -- -- -- --
-------------- ---------- ---------- ----------- ----------- -----------
Balance - December 31, 1993 -- -- -- -- 5,255,150 5,255
Issuance of Stock -- -- -- -- 2,000 2
Purchase of Treasury Stock -- -- -- -- -- --
Adjust Treasury Stock for Redeemable
Preferred Stock -- -- -- -- (1,000) (1)
Adjust Remaining Redeemable Preferred
Stock Issued in 1994 -- -- -- -- (1,000) (1)
Restoration of Shares Not Redeemed by
Stockholders -- -- -- -- 415,200 415
Net Loss for Year Ended
December 31, 1994 -- -- -- -- -- --
-------------- ---------- ---------- ----------- ----------- -----------
Balance - December 31, 1994 -
Forward -- $ -- -- $ -- 5,670,350 $ 5,670
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- -------------------------------------------------------------------------------------------------------------------
STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
- -------------------------------------------------------------------------------------------------------------------
Common Stock Common Stock Series A
Class A Class C Preferred Stock
Shares Amount Shares Amount Shares Amount
<S> <C> <C> <C> <C> <C> <C>
Balance - December 31, 1994 -
Forwarded -- $ -- -- $ -- 5,670,350 $ 5,670
Restoration of Shares Not Redeemed
by Stockholders -- -- -- -- 18,250 18
Issuance of Stock in Exchange for
U.S. Patent Rights -- -- -- -- 275,000 275
Adjustments to Paid-in Capital [4] -- -- -- -- -- --
Treasury Stock Adjustment -- -- -- -- -- --
Net Loss for Year Ended
December 31, 1995 -- -- -- -- -- --
-------------- ---------- ---------- ----------- ----------- -----------
Balance - December 31, 1995
[Restated] -- -- -- -- 5,963,600 5,963
Adjustments to Paid-in Capital [4] -- -- -- -- -- --
Net Loss for Year Ended
December 31, 1996 -- -- -- -- -- --
-------------- ---------- ---------- ----------- ----------- -----------
Balance - December 31, 1996 -- $ -- -- $ -- 5,963,600 $ 5,963
============== ========== ========== =========== =========== ===========
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- -------------------------------------------------------------------------------------------------------------------
STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
- -------------------------------------------------------------------------------------------------------------------
Deficit
Accumulated Total
Additional During the Stockholders'
Preferred Stock Paid-in Treasury Development Equity
Shares Amount Capital Stock Stage [Deficit]
<S> <C> <C> <C> <C> <C> <C>
August 31, 1988 [Date of Inception] -- $ -- $ -- $ -- $ -- $ --
Issuance of Shares -- -- -- -- -- 854
Issuance of Stock Pursuant to Private
Placement Offering -- -- 499,900 -- -- 499,996
Net Loss for the Period from August 31, 1988
[Date of Inception] Through
December 31, 1988 -- -- -- -- (52,708) (52,708)
------------ ---------- ------------- ---------- -------------- ------------
Balance - December 31, 1988 -- -- 499,900 -- (52,708) 448,142
Stock Dividend -- -- (500) -- -- --
Issuance of Stock for Services Rendered -- -- (12) -- -- --
Net Loss for Year Ended
December 31, 1989 -- -- -- -- (252,288) (252,288)
------------ ---------- ------------- ---------- -------------- ------------
Balance - December 31, 1989 -- -- 499,388 -- (304,996) 195,854
Issuance of Stock Pursuant to Private
Placement Offering -- -- 701,165 -- -- 701,241
Issuance of Stock -- -- -- -- -- 962
Net Loss for Year Ended
December 31, 1990 -- -- -- -- (392,564) (392,564)
------------ ---------- ------------- ---------- -------------- ------------
Balance - December 31, 1990 -- -- 1,200,553 -- (697,560) 505,493
Exchange of Preferred Stock for
Common Stock Class A 2,055,000 2,050 -- -- -- --
Exchange of Preferred Stock for
Common Stock Class C 450,000 450 -- -- -- --
Cancellation of Common Stock
Class C (225,000) (220) -- -- -- (220)
Issuance of Stock in Connection with
Reorganization -- -- 1,000 -- -- 1,000
Dissolution of Coates International Ltd. -- -- (1,000) -- -- (1,000)
Exchange of Series A Preferred Stock
for Preferred Stock (2,280,000) (2,280) 18,990 -- -- 18,990
Issuance of Stock -- -- 1,019,898 -- -- 1,020,000
Purchase of Treasury Stock -- -- -- (25,000) - - (25,000)
Stock Split 2:1 -- -- (2,382) -- -- --
Net Loss for Year Ended
December 31, 1991 -- -- -- -- (739,096) (739,096)
------------ ---------- ------------- ---------- -------------- ------------
Balance - December 31, 1991 -
Forward -- $ -- $ 2,237,059 $ (25,000) $ (1,436,656) $ 780,167
See Notes to Financial Statements.
<PAGE>
</TABLE>
<TABLE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- -------------------------------------------------------------------------------------------------------------------
STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
- -------------------------------------------------------------------------------------------------------------------
Deficit
Accumulated Total
Additional During the Stockholders'
Preferred Stock Paid-in Treasury Development Equity
Shares Amount Capital Stock Stage [Deficit]
<S> <C> <C> <C> <C> <C> <C>
Balance - December 31, 1991 -
Forwarded -- $ -- $ 2,237,059 $ (25,000) $ (1,436,656) $ 780,167
To Correct Balance at December 31, 1991 -- -- (772) -- -- --
Issuance of Stock for Service -- -- 10,000 -- -- 10,000
Issuance of Stock -- -- 2,306,884 -- -- 2,307,000
Private Placement Costs -- -- (80,675) -- -- (80,675)
Net Loss for Year Ended
December 31, 1992 -- -- -- -- (996,055) (996,055)
------------ ---------- ------------- ---------- -------------- ------------
Balance - December 31, 1992 -- -- 4,472,496 (25,000) (2,432,711) 2,020,437
Issuance of Stock -- -- 1,944,917 -- -- 1,945,000
Purchase of Treasury Stock -- - - -- (55,000) -- (55,000)
Prior Period Adjustment -- -- -- -- 219,224 219,224
Adjustment for Redeemable Preferred Stock -- -- (5,921,818) 65,000 -- (5,857,298)
Net Loss for Year Ended
December 31, 1993 -- -- -- -- (1,270,966) (1,270,966)
------------ ---------- ------------- ---------- -------------- ------------
Balance - December 31, 1993 -- -- 495,595 (15,000) (3,484,453) (2,998,603)
Issuance of Stock -- -- 39,998 -- -- 40,000
Purchase of Treasury Stock -- -- -- (35,000) -- (35,000)
Adjust Treasury Stock for Redeemable
Preferred Stock -- -- (19,999) 20,000 -- --
Adjust Remaining Redeemable Preferred Stock
Issued in 1994 -- -- (19,999) -- -- (20,000)
Restoration of Shares Not Redeemed by
Stockholders -- -- 4,586,883 -- -- 4,587,298
Net Loss for Year Ended
December 31, 1994 -- -- -- -- (1,229,523) (1,229,523)
------------ ---------- ------------- ---------- -------------- ------------
Balance - December 31, 1994 -- -- 5,082,478 (30,000) (4,713,976) 344,172
Restoration of Shares Not Redeemed by
Stockholders -- -- 19,982 -- -- 20,000
Issuance of Stock in Exchange for
U.S. Patent Rights -- -- 5,499,725 -- -- 5,500,000
Adjustments to Paid-in Capital [4] -- -- 1,177,579 -- -- 1,177,579
Treasury Stock Adjustment -- -- (30,000) 30,000 -- --
Net Loss for Year Ended
December 31, 1995 -- -- -- -- (7,062,806) (7,062,806)
------------ ---------- ------------- ---------- -------------- ------------
Balance - December 31, 1995
[Restated] - Forward -- $ -- $11,749,764 $ -- $ (11,776,782) $ (21,055)
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- -------------------------------------------------------------------------------------------------------------------
STATEMENT OF STOCKHOLDERS' EQUITY [DEFICIT]
- -------------------------------------------------------------------------------------------------------------------
Deficit
Accumulated Total
Additional During the Stockholders'
Preferred Stock Paid-in Treasury Development Equity
Shares Amount Capital Stock Stage [Deficit]
<S> <C> <C> <C> <C> <C> <C>
Balance - December 31, 1995
[Restated] - Forwarded -- $ -- $11,749,764 $ -- $ (11,776,782) $ (21,055)
Adjustments to Paid-in Capital [4] -- -- 1,132,523 -- -- 1,132,523
Net Loss for Year Ended
December 31, 1996 -- -- -- -- (1,600,110) (1,600,110)
------------ ---------- ------------- ---------- -------------- ------------
Balance - December 31, 1996 -- $ -- $ 12,882,287 $ -- $ (13,376,892) $ (488,642)
============ ========== ============= ========== ============== ============
See Notes to Financial Statements.
F-4
</TABLE>
F-5
<PAGE>
<TABLE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- ------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------
For the
Period from
August 31,
1988 [Date of
Inception]
Years ended Through
December 31, December 31,
1 9 9 6 1 9 9 5 1 9 9 6
------- ------- -------
[Restated]
<S> <C> <C> <C>
Operating Activities:
Net Loss $(1,600,110) $(7,062,806) $(13,376,892)
----------- ----------- ------------
Adjustments to Reconcile Net Loss to
Net Cash Used in Operating Activities:
Depreciation 40,915 66,386 279,378
Noncash Research and Development Costs 31,131 5,500,000 5,531,131
Changes in Assets and Liabilities:
[Increase] Decrease in:
Inventory (144,033) -- (144,033)
Due from Affiliated Companies (2,312) 511,544 (4,428)
Increase [Decrease] in:
Accounts Payable 422 21,243 45,081
Accrued Interest 18,371 63,500 177,189
Other Accrued Expenses 628,985 145,353 1,402,486
----------- ---------- -----------
Total Adjustments 573,479 6,308,026 7,286,804
----------- ---------- -----------
Net Cash - Operating Activities (1,026,631) (754,780) (6,090,088)
----------- ---------- -----------
Investing Activities:
Payments for Property and Equipment (5,252) -- (413,032)
Payments on Loans to Stockholders -- 335,805 --
Loans to Stockholders (7,487) (35,686) (1,208,678)
----------- ---------- -----------
Net Cash - Investing Activities (12,739) 300,119 (1,621,710)
----------- ---------- -----------
Financing Activities:
Proceeds of Additional Paid-in Capital 1,017,242 352,049 1,369,291
Proceeds from Issuance of Stock -- -- 6,378,148
Payment for Treasury Stock -- -- (30,000)
Payment on Stockholders Loans -- (4,538) --
Loans from Stockholder 8,000 -- 8,000
----------- ---------- -----------
Net Cash - Financing Activities 1,025,242 347,511 7,725,439
----------- ---------- -----------
Net [Decrease] Increase in Cash and
Cash Equivalents (14,128) (107,150) 13,641
Cash and Cash Equivalents - Beginning
of Periods 27,769 134,919 --
-------- ---------- -----------
Cash and Cash Equivalents - End of Periods $ 13,641 $ 27,769 $ 13,641
=========== ========== ===========
See Notes to Financial Statements.
F-6
</TABLE>
<PAGE>
<TABLE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
- ------------------------------------------------------------------------------
For the
Period from
August 31,
1988 [Date of
Inception]
Years ended Through
December 31, December 31,
1 9 9 6 1 9 9 5 1 9 9 6
------- ------- -------
[Restated]
<S> <C> <C> <C>
Supplemental Disclosures of Cash Flow
Information:
Cash paid during the periods for:
Interest Paid $ 18,413 $ 27,030 $ 46,157
Taxes Paid $ -- $ -- $ --
</TABLE>
Supplemental Schedule of Non-Cash Investing and Financing Activities:
The financial statements at December 31, 1996 and 1995, include noncash
financing transactions of $40,000 and $50,000, respectively, as a result of
mortgage payments made by Gregory Coates which were treated as additional
paid-in capital.
The financial statements at December 31, 1996, include a noncash financing
transaction of $486,970 for the reclassification of redeemable preferred stock
to amounts due to certain stockholders [See Note 4].
The financial statements at December 31, 1996, included a noncash operating
and financing transaction of $67,781 for the payment of interest to rescission
stockholders by Gregory Coates which was treated as additional paid-in capital.
The financial statements at December 31, 1996 and 1995, include noncash
investing and financing transactions of $7,500 and $2,500 for the acquisition of
equipment and a downpayment on a building, respectively, by Gregory Coates which
were treated as additional paid-in capital.
The financial statements at December 31, 1995, include a noncash financing and
operating transaction of $5,500,000 for the issuance of 275,000 shares of Series
A Stock in exchange for a non exclusive agreement to license certain patent
rights owed by George J. Coates.
The financial statements at December 31, 1996, include a noncash operating and
investing transaction of $31,131 for patent costs that were paid on behalf of
CIL's principal stockholder in 1995, which costs were expensed in 1996 [as
research and development] in consideration of a granting of certain rights to
the Company as more fully described in Note 13 to the financial statements.
See Notes to Financial Statements.
F-7
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
[1] Nature of Operations and Business Risk Factors
Coates International Ltd. ["CIL" or the "Company"] is a Delaware corporation
organized in October 1991 by George J. Coates as the successor in interest to a
Delaware corporation of the same name incorporated in August 1988.
CIL has developed a spherical rotary valve system [the "Coates System"] for use
in piston driven internal combustion engines of all types and is manufacturing
automotive engines modified with the Coates System on a limited scale basis at
its Wall Township, New Jersey facility. Also, as more fully discussed in Note
13, CIL has a non-exclusive license to sell and grant sublicenses with respect
to products using the Coates System [based on the "Coates Patents"]. However,
since there has been no significant revenue generated from sales of engines
modified with the Coates System, or from the granting of sub-licenses, the
Company is considered to be a Development Stage Company for financial reporting
purposes.
Initially, the Company intends to market its engines modified with the Coates
System to the automotive racing market. To successfully develop and sell an
automobile, truck or motorcycle engine for road use [as opposed to racing use]
in the United States, the Company will be required to obtain a Certificate of
Conformity from the Office of Mobile Services of the Environmental Protection
Agency to the effect that its engines as modified with the Coates System comply
with applicable emission standards. The Company has not applied for a
Certificate of Conformity from the EPA. Companies already exist that modify
automotive, motorcycle and marine racing engines on a customized order basis and
if CIL competed with major manufacturers, CIL would be an insignificant factor.
Development of the Coates System technology was initiated by George J. Coates,
CIL's founder, principal and controlling stockholder and chief executive
officer, in the late 1970's and development efforts have been conducted
continuously since such time. From July 1982 through May 1993, seven United
States patents [the "Coates Patents"][as well as a number of foreign patents],
were issued to George J. Coates with respect to the Coates System [See Note 13].
Since the inception of the Predecessor Entity [See Note 3] in 1988, all aspects
of the business of CIL have been completely dependent upon the activities of
George J. Coates. Mr. Coates, who is a resident alien and not a United States
citizen, does not have an employment contract with CIL and the loss of Mr.
Coates' availability or services, whether due to his death, incapacity or
otherwise, would have a material adverse effect on CIL's business and
operations.
[2] Summary of Significant Accounting Policies
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and costs and expenses during
the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents - Cash equivalents are comprised of certain highly
liquid investments with a maturity of three months or less when purchased.
Credit Risk - The Company places it cash and cash equivalents with high credit
quality financial institutions. The amount on deposit in any one institution
that exceed federally insured limits is subject to credit risk. There were no
such amounts existing at December 31, 1996 or 1995. The Company believes no
significant concentration of credit risk exists with respect to these cash
investments.
Inventory - Inventory, consisting of engine parts and components, is stated at
the lower of average cost or market.
F-8
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #2
- ------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies [Continued]
Property, Plant and Equipment, and Depreciation - Property, plant and equipment
are recorded at cost. Depreciation is computed principally using the
straight-line method over the estimated useful life of the assets. Expenditures
for maintenance and repairs are charged to expense as incurred, whereas major
betterments are capitalized.
Research and Development - Research and development costs are charged to
operations as incurred. Research and development expense for the year ended
December 31, 1995, includes a non-cash $5.5 million charge related to the
signing of a non-exclusive agreement with the Company's principal stockholder
and executive, George J. Coates, to license certain patent rights owned by Mr.
Coates for 275,000 shares of CIL Series A Stock [See Note 13].
Earnings [Loss] Per Share - As more fully discussed in Note 3 to the financial
statements, the Company has not issued any common stock, but its preferred stock
has voting privileges. Loss per share has been calculated by dividing the net
loss by the average number of preferred shares outstanding during the period(s).
[3] Capital Stock
CIL is a Delaware corporation organized in October 1991 by George J. Coates as
the successor in interest to a Delaware corporation of the same name
incorporated in August 1988 [the "Predecessor Entity"]. As a result of a dispute
with certain former employee-directors who claimed to own approximately nine
[9%] percent of the Predecessor Entity's outstanding capital stock, the
Predecessor Entity was reorganized in November 1991. Pursuant to the
reorganization, all of the Predecessor Entity's assets subject to liabilities
were distributed to CIL; the non-litigating stockholders of the Predecessor
Entity became the stockholders of CIL; and the Predecessor Entity was dissolved.
The lawsuits instituted against CIL by the former employee-directors have been
dismissed with prejudice.
CIL is authorized by its Certificate of Incorporation to issue an aggregate
34,000,000 shares of capital stock including 20,000,000 shares of Common Stock,
$.001 par value and 14,000,000 shares of Series A Non-Cumulative Convertible
Preferred Stock [the "Series A Stock"], $.001 par value. There are no shares of
common stock issued as of December 31, 1996.
The holders of shares of CIL's Series A Stock are entitled to ten votes per
share held on all matters submitted to a vote of its shareholders. In addition,
such holders are entitled to receive ratably such dividends, if any, on a
non-cumulative basis, as may be declared from time to time by the Board of
Directors out of funds legally available therefor. In the event of the
dissolution, liquidation or winding up of CIL, the holders of CIL Series A Stock
are entitled to share ratably in all assets remaining after payment of all of
CIL's liabilities to the extent of the par value of such shares together with
all unpaid dividends on such shares, prior to any payment being made to holders
of Common Stock; provided that the holders of Series A Stock will not be
entitled to participate any further in a distribution of CIL's assets in the
event of a dissolution or liquidation.
The holders of CIL Series A Stock do not have any subscription or redemption
rights, nor do they have any preemptive or other rights to acquire or subscribe
for additional, unissued or treasury shares.
F-9
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #3
- ------------------------------------------------------------------------------
[3] Capital Stock [Continued]
The Series A Stock is convertible on a share-for-share basis into shares of
Common Stock at the option of the holder. Holders of Common Stock are entitled
to one vote per share on all matters submitted to a vote of shareholders, but do
not have subscription, redemption or conversion rights, and do not have any
preemptive or other rights to acquire or subscribe for additional unissued or
treasury shares.
The holders of the Series A Stock and the Common Stock do not have cumulative
voting rights. Accordingly, the holders of more than half of the votes of such
shares on an aggregated basis [with each share of Series A Stock being entitled
to ten votes per share and each share of Common Stock being entitled to one vote
per share] can elect all of the Directors to be elected in any election. In such
event, the holders of the remaining shares would not be able to elect any
Directors. The Board is empowered to fill any vacancies on the Board created by
the resignation, death or removal of Directors.
[4] SEC Complaint, Court Order, Redeemable Preferred Stock, Restatement of 1995
Financial Statements
In July 1994, the Securities and Exchange Commission ["SEC"] filed a complaint
in the United States District Court for the Southern District of New York [the
"Court"] against George J. Coates, principal stockholder and executive of Coates
International Ltd., CIL and certain affiliated companies seeking injunctive and
other relief. In its complaint, the SEC made a number of allegations, including
allegations that sales of CIL Series A Stock were fraudulently effected through
misrepresentations and omissions of material facts concerning CIL's product and
business and without registration of such stock under the Securities Act of 1933
or pursuant to an applicable exemption thereunder. At the time of the filing of
the SEC complaint, the Court issued an order freezing the assets of CIL and
George J. Coates and appointed a Temporary Receiver to take possession and
control of CIL's assets and properties.
In February 1995, CIL and George J. Coates, without admitting or denying the
allegations contained in the SEC complaint, consented to the entry of final
consent judgments enjoining them from effecting sales of any security unless a
registration statement is in effect as to such securities or an applicable
exemption from registration is available and from engaging in fraudulent
activities in connection with the offer or sale of any security. CIL was also
ordered to provide a list of all purchasers of CIL stock from CIL, George Coates
or any other source during the period commencing April 24, 1990, to the date of
the consent judgment including the number of shares purchased and the purchase
price.
The consent judgment also required CIL to file a registration statement with the
SEC to effect a Rescission and Exchange Offer to the aforementioned purchasers
of CIL Series A Stock. Such purchasers would be given the option to (a) receive
cash or assets equal in amount to the consideration such purchasers paid for
their currently held CIL Series A Stock, plus simple interest calculated at an
annual rate of five [5%] percent; or (b) the right to receive one share of newly
issued CIL Series A NonCumulative Convertible Preferred Stock identical to the
Series A Stock. The consent order further discharged the Temporary Receiver and,
instead, named him as Special Master of CIL, with specific responsibilities
including assisting in CIL's compliance with the consent judgment.
CIL succeeded in registering the Rescission and Exchange Offer. Thirty-two [32]
Rescinding Shareholders elected to receive cash in exchange for their stock. The
total amount due to these Rescinding Shareholders was $1,270,000, plus interest.
F-10
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #4
- ------------------------------------------------------------------------------
[4] SEC Complaint, Court Order, Redeemable Preferred Stock, Restatement of 1995
Financial Statements [Continued]
CIL does not contract with a stock transfer agent to maintain a record of stock
transactions or stockholders. In an attempt to maintain accurate stock transfer
records for shareholders of CIL, other than George J. Coates, who were selling
stock privately, CIL opened the "CIL Transfer Account" in March 1995. In
February 1996, the Special Master reported to the Court that, without waiting
for the Court's approval, CIL had collected funds from persons interested in
purchasing CIL stock [the "Purchasing Shareholders"], and segregated such funds,
$1,565,000 through December 31, 1995, in the CIL Transfer Account. It should be
noted that during 1995, and prior to the Rescission and Exchange Offer being
made, certain shareholders requested refunds for CIL Series A Stock previously
purchased by them [the "Refunding Shareholders"]. These Refunding Shareholders
were not part of the Rescission Offer. The Purchasing Shareholders did receive
an aggregate 78,250 shares of CIL Series A Stock in 1995 primarily from sales of
the personal shares of CIL Series A Stock of Gregory Coates, son of George J.
Coates, and a then Vice President and Director of CIL, and from the Refunding
Shareholders, with the CIL Transfer Account facilitating the monetary transfers
in connection with the purchase and sale of such shares. The Refunding
Shareholders were paid $527,000 from the CIL Transfer Account as part of these
transfers of shares through December 31, 1995. Gregory Coates withdrew
approximately $280,000 from the CIL Transfer Account during 1995, representing a
distribution of a portion of his profits on the sales of his personal stock, and
certain bills of CIL were paid from the CIL Transfer Account, leaving a balance
in the CIL Transfer Account of $508,428 at December 31, 1995.
The Special Master reported to the Court that CIL's then independent accounting
firm informed him that although the funds in the CIL Transfer Account were the
proceeds of the private sales of stock by existing CIL shareholders [primarily
Gregory Coates], the independent accounting firm was taking the position that
because the CIL Transfer Account was in CIL's name, it would be considered an
asset of CIL unless the name on the CIL Transfer Account was changed. The name
of the CIL Transfer Account was not changed and the balance in the CIL Transfer
Account at December 31, 1995, $508,428, was included in the cash balance of CIL
in its December 31, 1995 balance sheet before restatement. CIL took issue with
that characterization of the CIL Transfer Account, and as a result of this
disagreement, CIL's Board of Directors decided to dismiss the accounting firm as
its independent accountants, and filed a Form 8-K describing this disagreement
and dismissal in August of 1996.
The Special Master also reported to the Court that an additional $540,000 had
been disbursed from the CIL Transfer Account to Gregory Coates in February 1996.
If the legal rights to the funds in the CIL Transfer Account belonged to CIL,
and not to Gregory Coates, then payments to Gregory Coates, represented
repayments of loans from Gregory Coates, and not simply a withdrawal of his own
funds. That being the case, such payment would have constituted repayment of
loans, and the money repaid would have to be returned to CIL because the loan
payments would have been made in violation of the terms of the asset freeze
provision contained in the consent judgment as discussed in the first three
paragraphs of this note.
Also, during 1996, certain individuals deposited $2,604,970 into the CIL
Transfer Account seeking to acquire an aggregate 130,249 shares of CIL Series A
Stock. Some of these individuals were sold an aggregate 66,725 shares of CIL
Series A Stock by Gregory Coates for proceeds totaling $1,334,500, with the CIL
Transfer Account facilitating the monetary transfers in connection with the
purchase and sale of such shares. The funds of the remaining individuals [the
"Potential Investors"], $1,270,470, who did not receive any CIL Series A Stock
from Gregory Coates or other sources, was used to pay thirty-one [31] of the
aforementioned thirty-two [32] Rescinding Shareholders. In addition, pursuant to
the Court order, approximately $65,000 was paid to these Rescinding Shareholders
from the CIL Transfer Account representing interest on their funds. Two [2] of
the 31 Rescinding Shareholders informed CIL that as long as they received their
funds, they would not insist that CIL pay interest on such returned funds. As
the Court requires that such interest be paid, approximately $105,000 remains as
accrued interest payable to such Rescinding Shareholders at December 31, 1996.
F-11
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #5
- ------------------------------------------------------------------------------
[4] SEC Complaint, Court Order, Redeemable Preferred Stock, Restatement of 1995
Financial Statements [Continued]
The Court heard arguments from the Special Master, CIL legal counsel, and the
SEC regarding the aforementioned exchanges of CIL stock, and the legal rights to
funds in the CIL Transfer Account. The Court decided that such exchanges of
stock were not permitted by the Consent Orders and ordered George J. Coates,
personally, and CIL to return funds to the Potential Investors who had not
received any CIL Series A Stock. The Court also concluded that the CIL Transfer
Account was not a corporate asset of CIL, and that disbursements of funds to
Gregory Coates from the CIL Transfer Account were a release of his own funds to
him rather than the improper repayment by CIL of a loan. Based on the above
decision of the Court determining the legal rights to the CIL Transfer Account,
CIL's 1995 balance sheet has been restated to eliminate the CIL Transfer Account
from CIL's cash balance at December 31, 1995.
Per the original Consent Order, George J. Coates was ordered by the Court to pay
up to the first $773,500 of the amounts due to the Rescinding Shareholders using
all of his personal assets other than his personal residence. [Per the August
19, 1996, Court Order, the aforementioned Potential Investors have taken the
place of the Rescinding Shareholders who have received refunds]. To the extent
that he is unable to pay any such amounts, CIL is required to pay same and will
retain its rights to assert claims against George J. Coates personally to
recover its payment of any such shortages. CIL also has consented to pay any
additional amounts required. CIL's December 31, 1995 balance sheet before
restatement reflected the entire amount due to the Rescinding Shareholders
totaling $1,448,818, including accrued interest of $158,818, as a direct
obligation of CIL. Whereas the court order required George J. Coates to be
personally liable for up to the first $773,500 of amounts due to the Rescinding
Shareholders, CIL's 1995 balance sheet has been restated to reduce CIL's
recorded liability to the Rescinding Shareholders accordingly. CIL's 1995
restated financial statements now disclose a contingent liability [See Note 10]
on the part of CIL of $773,500, in the event of nonpayment by George J. Coates
to the Rescinding Shareholders [as replaced by the aforementioned Potential
Investors at December 31, 1996].
Because 31 of the 32 Rescinding Shareholders have been paid out of funds in the
CIL Transfer Account during 1996, that liability has been reduced to $10,000 at
December 31, 1996, and the amount due to the aforementioned Potential Investors,
$1,270,470 [as described in the eighth paragraph of this Note], less $773,500,
[which latter amount represents that portion of the liability owed personally by
George J. Coates as discussed in the preceding paragraph] is reflected as a
liability of $486,970, plus $10,000 due to the remaining Rescinding Shareholder,
and approximately $105,000 of accrued interest related to certain Rescinding
Shareholders [as described in the eighth paragraph of this Note] at December 31,
1996.
In addition to the restatements discussed in the ninth and tenth paragraphs of
this Note, other principal 1995 restatements include:
o The Company has been receiving cash infusions from Gregory Coates, a former
Vice President and Director of CIL, and son of George J. Coates. Such amounts
had been classified as loans from Gregory Coates on the December 31, 1995
balance sheet before restatement. Such amounts were not loans, but rather
additional capital contributions by Gregory Coates. CIL's 1995 balance sheet
has been restated accordingly, and related accrued interest expense
[approximately $32,000] has been eliminated.
o The Company incurs legal and related costs associated with registering
patents. On the December 31, 1995 balance sheet before restatement, such
costs amounted to $51,397 and were capitalized as Patent Right Costs. As the
probable future economic benefit of such costs is uncertain, such costs have
been expensed for the year ended December 31, 1995.
F-12
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #6
- ------------------------------------------------------------------------------
[4] SEC Complaint, Court Order, Redeemable Preferred Stock, Restatement of 1995
Financial Statements [Continued]
o The Company expended $12,000 to a broker during the year ended December 31,
1995, in anticipation of using said broker for an offering of Company stock.
Prior to December 31, 1995, management decided that any offering of Company
stock would be best served by using another broker and such amount has been
expensed for the year ended December 31, 1995.
o The Notes to the 1995 financial statements before restatement stated that "on
March 15, 1996 the Board of Directors authorized a two for one stock split
after converting all Preferred Series A Stock to Common Stock." No corporate
action had been taken to legally effectuate such conversion or stock split.
As a result, the 1995 financial statements have been restated to eliminate
all references to "issued shares of Common Stock," and to reinstate the
Series A Stock as such stock has not been converted to Common Stock.
The net effect of the above restatements on operations for the year ended
December 31, 1995, was an increase in the net loss for the period of $31,442
[$.01 per share], reflecting retroactive application of the prior period
adjustments to the following components of operations:
Effect on Net Loss
Increase/[Decrease]
To Amounts
Previously Reported
esearch and Development Costs $ 51,396
General and Administrative Expenses 12,000
Interest Expense (31,954)
-----------
Increase to Net Loss for the Year Ended December 31, 1995 31,442
Deficit Accumulated During the Develop. Stage as Previously Reported11,745,340
Deficit Accumulated During the Development Stage as Restated $11,776,782
[5] Going Concern
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplates continuation of the
Company as a going concern and realization of assets and settlement of
liabilities and commitments in the normal course of business. The Company has
met its obligations in 1995 and 1996 primarily through capital infusions from
one of its principal stockholders, Gregory Coates.
CIL's ability to generate revenues and achieve profitable operations is
principally dependent upon the execution and funding of sub-license agreements
with engine manufacturers or retrofitters, and upon the manufacture and sale, by
CIL, of high performance automotive, motorcycle and marine racing engines. CIL
is actively attempting to market its technology and is in communication with
various persons and entities who may be interested in acquiring licenses to use
the technology [Also See Note 13].
F-13
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #7
- ------------------------------------------------------------------------------
[5] Going Concern [Continued]
CIL's short term operational business plan is to attempt to obtain firm orders
for racing engines modified with the Coates System from oral and written
inquiries it has received and to construct those engines, initially from
inventory at its limited production facility in Wall Township, New Jersey, for
delivery to interested purchasers, and to sell sub- licenses to use its
technology. With sufficient short term financing and a sufficient number of
orders, CIL management believes that it will be able to produce racing engines
using the Coates System technology at its Wall Township facility on a limited
basis at the rate of approximately 30 engines per month. CIL expects that the
bulk of its initial sales of engines will be at a base sales price in the range
of $25,000 to $30,000 per engine although depending on type and size, some of
the engines may be priced as high as $75,000. To achieve such production levels,
CIL will be required to expand its production work force to approximately 15-20
production workers.
CIL's short term business funding plan is to complete a private offering of its
Series A Stock which is expected to generate, at a minimum, after expenses,
approximately $660,000; and at a maximum, after expenses, approximately
$7,060,000. As more fully described in Note 4, approximately $600,000 of the
proceeds of the private offering will have to be used to satisfy certain Court
ordered obligations, which would leave the Company approximately $60,000 of
working capital assuming the minimum target of the private offering is met and
it does not have to satisfy any of its contingent liabilities related thereto
[also see Note 10]. The proceeds of any sales of Series A Stock above the
minimum will be applied to pay outstanding payables and to the extent there are
sufficient additional proceeds, such funds will be applied to purchase engine
blocks, molds, dyes, castings and components; to marketing and promotion; to
salaries and associated benefits for production line workers, and for patent
maintenance costs. Gregory Coates has also agreed to continue to fund CIL's
operations, up to $1,000,000, as needed, for the next twelve months.
CIL's long range operational business plan is to acquire a larger plant facility
and acquire production machinery and equipment for a full scale assembly line,
and continue its research and development efforts. CIL would fund this plan with
a public offering of its stock wherein it would seek a minimum of $7,500,000.
In view of its substantial recorded [approximately $600,000 including interest]
and contingent [$773,500] obligations to the Potential Investors and remaining
Rescinding Shareholders as more fully discussed in Note 4, no assurances can be
given that CIL will be able to pursue its business plan as it presently does not
possess sufficient liquid assets to fund such obligations. Also, depending on
the results of the proposed private placement discussed above, the Court could
direct the Special Master to file a bankruptcy petition for CIL.
The Company has suffered recurring losses during its development stage and has
accumulated a deficit since its inception to December 31, 1996, of over $13
million. The Company also has minimal liquid assets, while reporting over $2.2
million in current liabilities.
The aforementioned conditions discussed in this Note raise substantial doubt
about the Company's ability to continue as a going concern.
The financial statements do not include any adjustments that might be necessary
in the event the Company cannot continue as a going concern.
F-14
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #8
- ------------------------------------------------------------------------------
[6] Income Taxes
Pursuant to Statement of Financial Accounting Standards ["SFAS"] No. 109,
"Accounting for Income Taxes," income tax expense [or benefit] for the year is
the sum of deferred tax expense [or benefit] and income taxes currently payable
[or refundable]. Deferred tax expense [or benefit] is the change during the year
in a company's deferred tax liabilities and assets. Deferred tax liabilities and
assets are determined based on differences between financial reporting and tax
basis of assets and liabilities, and are measured using the enacted tax rates
and laws that will be in effect when the difference are expected to reverse. The
Company files its tax return on a cash basis. Other temporary difference consist
of depreciation.
The Company has a deferred tax asset of approximately $2,000,000 based on net
operating loss carryforwards of approximately $6,000,000. If not used, the
carryforwards will expire from 2003 through 2011. SFAS No. 109 requires the
establishment of a deferred tax asset for all deductible temporary difference
and operating loss carryforwards. Because of the uncertainty that the Company
will generate income in the future sufficient to fully or partially utilize
these carryforwards, a valuation allowance of $2,000,000 has been established
pursuant to SFAS No. 109. Accordingly, no deferred tax asset is reflected in
these financial statements.
[7] Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosure about Fair
Value of Financial Instruments" requires disclosing fair value to the extent
practicable for financial instruments which are recognized or unrecognized in
the balance sheet.
For certain instruments, including cash and cash equivalents and trade payables
and accrued liabilities, it was estimated that the carrying amount approximates
fair value for these instruments because of their short maturities. The mortgage
payable approximates fair value since the interest rate being charged
approximates a current market rate of interest for similar debt. Remaining
amounts due to certain existing and potential shareholders approximates fair
value as such amounts are due within one year.
As more fully discussed in Notes 4 and 10, pursuant to the Court Order the
Company is contingently liable to certain existing and potential shareholders
for up to $773,500 [plus additional amounts as required] if the Company's
principal stockholder and executive does not fulfill his obligation to such
existing and potential shareholders pursuant to the Court order. The Company
does not believe it is practicable to estimate the fair value of this contingent
liability and does not believe the risk of payment is likely.
F-15
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #9
- ------------------------------------------------------------------------------
[8] Property, Plant and Equipment
Property, plant and equipment at December 31, 1996 and 1995, and their related
estimated useful lives are as summarized below:
Estimated
Useful Life December 31,
Assets [Years] 1 9 9 6 1 9 9 5
- ------ ----- ------- -------
Land $ 920,550 $ 920,550
Building 40 579,450 579,450
Building Improvements 40 145,871 145,871
Machinery and Equipment 5-7 235,366 222,614
Furniture and Fixtures 5-10 39,295 39,295
---------- ----------
Totals - At Cost 1,920,532 1,907,780
Less: Accumulated Depreciation 313,873 272,958
---------- ----------
Totals $1,606,659 $1,634,822
------ ========== ==========
The Company's land and building was acquired from a related party [See Note 9].
As more fully described in Note 2, CIL's policy is to depreciate its property,
plant and equipment, which has a net book value of $$1,606,659 at December 31,
1996, over its remaining useful life principally using the straight-line method.
It is reasonably possible that the Company's estimate that the carrying amount
of its property, plant and equipment will be recoverable from future operations
will change in the near term given the uncertainty about the Company's ability
to continue as a going concern as more fully discussed in Note 5.
[9] Related Party Transactions
Due from Stockholder - Due from stockholder represents payments by CIL of the
automobile insurance of George J. Coates in the amounts of $3,430 and $6,986
during the years ended December 31, 1996 and 1995, respectively. The balance at
December 31, 1995, also includes foreign patent costs incurred by the Company on
behalf of George Coates, which costs were expensed in 1996 in consideration of a
granting of certain rights to the Company as more fully described in Note 13.
Amounts due bear interest at the rate of 7% and have no stated terms of
repayment.
Due to Stockholder - Due to stockholder represents working capital loans made to
the Company in the amount of $8,000 during the year ended December 31, 1996. The
loans are non-interest bearing and have no stated terms of repayment.
Due from Affiliated Companies - Due from affiliated companies represents working
capital loans made to companies of which George J. Coates is the sole
stockholder. During 1996, the Company loaned these affiliated companies $2,312.
During 1995, the Company received $513,660 in repayment of amounts due from
affiliated companies relating to the Millwest License Agreement [which is more
fully described in Note 13]. The loans are non-interest bearing and have no
stated terms of repayment.
Subcontract Labor - The Company subcontracts its project expense [payroll,
insurance and supplies] from an entity which George J. Coates is the sole
stockholder. During the years ended December 31, 1996 and 1995, $181,500 and
$187,889, respectively, were paid for these services.
F-16
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #10
- ------------------------------------------------------------------------------
[9] Related Party Transactions [Continued]
Purchase of Land and Building - From August 1990 through February 1993, CIL
subleased the Company's Wall Township, New Jersey, facility [the "Facility"]
from George J. Coates, and then from the George J. Coates 1991 Family
Partnership [the "Partnership" eventually purchasing the Facility from
unaffiliated third parties for $1,500,000 in February 1993]. Pursuant to the
February 6, 1995 consent judgment, George J. Coates was ordered to cause the
Partnership to transfer the Facility to CIL with CIL obtaining title to the
Facility and assuming a $300,000 mortgage loan obligation [See Note 14].
Patents and Licenses - As more fully described in Note 13, CIL has executed
agreements with Nicholson McLaren Engines ["Nicholson McLaren"] Ltd. of London,
United Kingdom and its affiliates. John Nicholson, President of Nicholson
McLaren, is a less than 1% stockholder of CIL.
[10] Commitments and Contingencies
The Company is a defendant in various lawsuits incident to the ordinary course
of business. It is not possible to determine the probable outcome or the amount
of liability, if any, under these lawsuits; however, in the opinion of
management, the disposition of these lawsuits will not have a material adverse
effect on the Company's financial position, results of operations, or cash
flows.
As more fully discussed in Note 4 to the financial statements, George J. Coates,
principal and controlling shareholder and chief executive officer of CIL, per
the original consent order of the Court, was ordered to pay up to the first
$773,500 of amounts due to Rescinding Shareholders. Per the August 19, 1996,
court order, new Potential Investors have taken the place of the Rescinding
Shareholders. To the extent that Mr. Coates is unable to pay any such amounts to
the Potential Investors, CIL is required to pay same and is thus contingently
liable for such amounts as it may have to pay should Mr. Coates not fulfill all
or part of his primary commitment on amounts due to Potential Investors. It is
at least reasonably possible that the above circumstances will change in the
near term due to future confirming events and the effect of any such change
would be material to the financial statements.
[11] Reclassification
Certain items pertaining to the prior year have been reclassified to conform
with the current year's presentation.
[12] New Authoritative Accounting Pronouncement
The Financial Accounting Standards Board ["FASB"] has issued Statement of
Financial Accounting Standards ["SFAS"] No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities.
" SFAS No. 125 is effective for transfers and servicing of financial assets
and extinguishment of liabilities occurring after December 31, 1996.
The provisions of SFAS No. 125 must be applied prospectively; retroactive
application is prohibited, and early application is not allowed.
SFAS No. 125 is not expected to have a material impact on the Company.
Some provisions of SFAS No. 125, which are unlikely to apply to the Company
have been deferred by the FASB.
F-17
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #11
- ------------------------------------------------------------------------------
[13] Patents and Licenses
Development of the Coates System technology was initiated by George J. Coates,
CIL's founder, principal and controlling stockholder and chief executive
officer, in the late 1970's and development efforts have been conducted
continuously since such time. From July 1982 through May 1993, seven United
States patents [the "Coates Patents"][as well as a number of foreign patents],
were issued to George J. Coates with respect to the Coates System. The consent
order allowed George J. Coates the alternative to elect to retain title to his
patents on the condition that he either: (a) grant to CIL an exclusive and
irrevocable license to utilize and exploit the patents, or (b) reimburse CIL for
all monies expended in the preparation, application and/or prosecution of the
patents, including but not limit to, legal fees paid by CIL. George J. Coates
elected to reimburse CIL and retain possession of the patents and did so during
1995. In February 1995, George J. Coates and his son Gregory Coates each granted
CIL a non-exclusive license to manufacture, sell and grant sublicenses with
respect to products based on the Coates Patents within the United States, its
territories and possessions [the "Licensed Areas"]. The licenses were
non-exclusive so that neither George J. Coates nor Gregory Coates were
prohibited from granting similar licenses to other parties within the Licenses
Areas or to otherwise compete directly with CIL. The licenses expire in the
event of bankruptcy or similar insolvency of CIL. CIL agreed to pay a $5,500,000
license fee to George J. Coates in consideration for his grant to CIL of the
non-exclusive license payable at management's discretion but in no event later
than February 17, 1998. In September 1995, this arrangement was modified. CIL
and George J. Coates agreed that instead of the $5,500,000 payment, CIL would
issue 275,000 shares of Series A Stock to Mr. Coates, which cost the Company
charged to research and development for the year ended December 31, 1995.
Because the license granted to CIL was non-exclusive, the Coates' are not
prohibited from granting similar licenses to other parties outside the Licensed
Areas. In addition, George J. Coates holds patents issued by foreign
jurisdictions with respect to the Coates System, the rights to which he has not
licensed to CIL.
In February 1996, George J. Coates and Gregory Coates executed a non-competition
agreement agreeing not to compete with CIL in the manufacture, assembly, use or
sale of internal combustion engines utilizing the technology falling within the
scope of the Coates Patents in the Licensed Areas and not to grant any exclusive
or non-exclusive license in the Licensed Areas except through CIL, while CIL
remains an independent, viable company and is in compliance with the terms and
conditions of the above described licenses.
In February 1994, a license agreement was executed with Millwest Corporation of
Dumas, Texas ["Millwest"] granting Millwest a five year exclusive license to
retrofit pre-existing internal combustion engine blocks [excluding air-cooled
engines and engines used for racing competition] by replacing the pre-existing
valve system with the Coates Spherical Rotary Valve System in the United States,
its territories and possessions, Canada and Mexico, the five year term to
commence after payment to CIL by Millwest on or before May 4, 1994 of a
$10,000,000 licensing fee. The agreement also provided Millwest with a
non-exclusive license to manufacture the Coates Spherical Rotary Valve System
subject to the payment of royalties. Additional payments of $1,666,666 were
required to be paid to CIL on the third, fourth and fifth anniversary of the
effectiveness of the license. An additional $15,000,000 payment is due on
February 5, 1999. Pursuant to the agreement, Millwest made an initial $500,000
payment in February 1994 to a company owned by George J. Coates. Pursuant to the
consent judgments [as also discussed in the second paragraph of Note 4], George
J. Coates was ordered to cause the transfer to CIL of all licensing fees and
other funds paid to persons or entities other than CIL related to an interest in
the Coates Patents or in the technology embodied in the Coates Patents. In this
regard, in 1995 CIL received approximately $513,000 from the company owned by
George J. Coates that originally received the $500,000 initial payment from
Millwest; such payment representing the $500,000 amount from Millwest plus
accrued interest related thereto.
F-18
<PAGE>
COATES INTERNATIONAL LTD.
[A DEVELOPMENT STAGE COMPANY]
NOTES TO FINANCIAL STATEMENTS, Sheet #12
- ------------------------------------------------------------------------------
[13] Patents and Licenses [Continued]
While Millwest made an initial $500,000 payment pursuant to the agreement in
February 1994, it has failed to pay the additional $9,500,000 to activate the
license. CIL has placed Millwest on notice that it is in default. In June 1995,
Millwest informed CIL of an intention to activate the license agreement claiming
that financing had been arranged to do so but to date, no additional payments
have been received by CIL from Millwest and no assurances can be given that any
additional payments will be made; accordingly no additional revenue has been
recognized beyond the aforementioned $500,000 received during the year ended
December 31, 1994.
In February 1996, George J. Coates and Gregory Coates granted CIL the right to
retain any monies, including royalties received from Nicholson McLaren Engines
Ltd. ["Nicholson McLaren"] of London, United Kingdom, and its affiliates, or
from Noble Motor Sport of London, United Kingdom [manufacturer of Ascari racing
cars] and its affiliates, for manufacture, sale, use or assembly of internal
combustion engines anywhere in the world using the technology falling within the
scope of the Coates Patents [U.S. and foreign]. The grant is effective while CIL
remains an independent, viable company and is in compliance with the terms and
conditions of the above described licenses. In consideration for these grants,
CIL agreed to pay all outstanding Coates Patent fees [U.S. and foreign] as well
as all such fees incurred subsequently.
In April 1996, CIL executed a license agreement with Nicholson McLaren granting
Nicholson McLaren a non-exclusive license to assemble, use, sell, and lease
internal combustion engines incorporating the Coates Spherical Rotary Valve
System within the "European Patent Community," which includes but is not limited
to Austria, Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Portugal,
Spain, Sweden, Switzerland, and the United Kingdom. In consideration of the
rights granted under the license agreement, Nicholson McLaren agrees to pay CIL
a total licensing fee of $5 million payable $37,375 upon receipt of the first
demonstration model by Nicholson McLaren from CIL; another $37,375 upon receipt
of the second; with the balance to be paid out of sales, if any, of internal
combustion engines modified with the Coates Spherical Rotary Valve System
assembled by Nicholson McLaren with components purchased from CIL. The license
agreement also gives Nicholson McLaren the right to obtain a manufacturing
license from CIL against payment of royalties on the manufacture of components
at a rate to be established. The Company recognized revenue of $37,375 in April
1996 upon receipt of cash from Nicholson McLaren after delivery of the first
demonstration model. CIL has waived payment of the second demonstration model
which was delivered in July 1996. CIL has retained ownership of this second
model which is being demonstrated by Nicholson McLaren for potential customers
on behalf of CIL. The payment schedule with respect to the balance of the
licensing fee, which is based on sales, if any, has not yet been finalized by
the parties. As discussed in Note 9, John Nicholson, President of Nicholson
McLaren, purchased shares of CIL Series A Stock in 1996.
In June 1996, CIL executed a Sales Representative Agreement retaining an
affiliate of Nicholson McLaren as its exclusive sales representative in the
United Kingdom and Europe for the sale of the Coates technology for a four-year
term. The agreement provides for a sliding scale commission varying from 5% of
the first $1 million in Net Product Billings [as defined] to 1% of the fifth $1
million in Net Product Billings and all amounts in excess thereof.
[14] Mortgage Payable
The $210,000 mortgage payable is collateralized by the land and the building
that the Company uses as its principal place of business. The mortgage bears
interest at the rate of 9% per annum and was due February 3, 1994. The Company
is making interest only payments on the mortgage and the mortgagor is not
demanding full payment until December 31, 1997. The entire mortgage payable
balance has been classified as a current liability. The mortgage is guaranteed
by George J. Coates [See Note 9].
. . . . . . . . . . . . . .
F-19
<PAGE>
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On August 7, 1996, CIL dismissed the firm of Warner, Berman & Lott,
Certified Public Accountants, P.A. ("WB&L") which firm was its principal
independent accounting firm previously engaged to audit CIL's financial
statements.
WB&L's report with respect to CIL's financial statements for the years
ended December 31, 1994 and 1995 did not contain an adverse opinion or a
disclaimer of opinion. However, such report did include a modification of the
auditors' standard report, stating that "...the company has suffered recurring
losses from operations since inception and has a net capital deficiency that
raise substantial doubt about its ability to continue as a going concern....The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty."
The decision to dismiss WB&L and to retain a new principal independent
accounting firm was approved by CIL's board of directors.
During the two fiscal years ended December 31, 1995, there were no
disagreements between CIL and WB&L on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreement, if not resolved to the satisfaction of WB&L, would have caused it
to make a reference to the subject matter of the disagreement in connection with
its report.
However during the interim period subsequent to December 31, 1995, a
disagreement arose between WB&L and CIL concerning the fiscal 1995 financial
statements. The issue is whether a bank account known as the "CIL Transfer
Account" maintained at NatWest Bank in Wall, New Jersey was an asset of CIL's at
December 31, 1995. The balance in said account at December 29, 1995 was
$508,428.44. CIL's balance sheet at December 31, 1995 with respect to which WB&L
issued its report, included this account as an asset of CIL. In July 1996, CIL's
management and its attorneys, with the approval of its board of directors,
discussed this issue with WB&L and advised WB&L that as such account was not an
asset of CIL's at December 31, 1995, that CIL's financial statements for the
year ended December 31, 1995 were in error and should be revised and reissued
with a new auditor's report. WB&L refused to accede to management's request to
issue a new report with respect to financial statements revised in such manner.
WB&L stated in part;
"...When we issued our opinion we were attesting to the presentation of
the company's financial position as represented to us by management and
based on the evidence collected during the course of our audit. If
management now determines that this account does not belong to the
company we cannot present our opinion that the financial statements
present fairly in all material respects, the financial position of the
company. Accordingly, we would have no choice but to withdraw our
opinion concerning these financial statements."
As a result of this disagreement, CIL's board of directors decided to dismiss
WB&L as CIL's principal independent accountants.
With the exception of the disagreement referred to above, CIL is
unaware of the occurrence of any of the kinds of events described in
subparagraphs (A) through (D) of Item 304(a)(1)(v) of Regulation S-B as
promulgated by the SEC.
16
<PAGE>
On August 7, 1996, CIL engaged the certified public accounting firm of
Moore Stephens, P.C. ("MSPC") to serve as its principal independent accounting
firm and to reaudit its financial statements for the year ended December 31,
1995 and, if necessary, 1994. Prior to the engagement, CIL's management and its
attorneys consulted with a principal of MSPC and apprised him of the facts
underlying the above described disagreement with WB&L. The MSPC principal stated
that he could not advise as to the type of report his firm would issue until it
had completed an independent review of the facts and had completed its audit of
the year (or years) in question. WB&L's views with respect to this issue are
stated above.
By order dated December 30, 1996, United States District Judge Kimba
Wood determined that the transfer account was not a CIL asset at December 31,
1995 and CIL's revised financial statements at December 31, 1995 as audited by
MSPC do not include the balance in such account as a CIL asset.
17
<PAGE>
COATES INTERNATIONAL LTD.
PART III
Item 9. Directors and Executive Officers, Promoters and Control Persons,
Compliance with Section 16(a) of the Exchange Act
At December 31, 1996, the executive officers and directors of CIL were
as follows:
Name Age Position
George J. Coates 56 President, Treasurer, Chief Executive
Officer, Chief
Financial Officer and Director
Richard W. Evans 65 Secretary and Director
Michael J. Suchar D.D.S. 41 Director
George J. Coates has been employed by CIL since its inception as
president and chief executive officer. Mr. Coates is an Irish citizen but has
been granted resident alien status in the United States. See"Item 3" herein
as to the final consent judgment executed by George J. Coates in connection with
an SEC complaint and as to his arrest and release after a four day
incarceration based on allegations similar to those contained in the
SEC complaint. On May 30, 1995, a United States Magistrate Judge of the
United States District Court for the Southern District of New York signed
an order in response to a request by the office of the United States
Attorney for the Southern District of New York dismissing without prejudice,
the criminal complaint against George J. Coates.
Richard W. Evans became a director of CIL in May 1996. Dr. Evans, who
holds an Ed.D. degree from Rutgers University, was a Supervisor a
Highland Park High School in Highland Park, New Jersey, a post he held for
more than the preceding five years until his retirement in June 1996. Dr. Evans
will not devote a substantial portion of his working time to the business of CIL
Michael J. Suchar became a director of CIL in May 1996. Dr. Suchar,
who holds a Doctor of Dental Surgery degree from the Temple University Dental
School, has been a practicing pediatric dentist for more than the
preceding five years. Dr. Suchar will not devote a substantial portion of his
working time to the business of CIL.
Compliance with Section 16(a) of the Exchange Act
CIL's only class of outstanding capital stock, its Series A Preferred
Stock, is not registered pursuant to Section 16(a) of the Exchange Act so that
filings of Forms 3, 4 and 5 in compliance with such Section are not required.
18
<PAGE>
Item 10. Executive Compensation
None of CIL's executive officers has an employment contract with CIL.
With respect to each of calendar years 1994, 1995 and 1996, no executive officer
had compensation paid or accrued in excess of $100,000 for any such year except
for George J. Coates, CIL's chief executive officer, whose compensation was as
follows:
SUMMARY COMPENSATION TABLE
Annual Compensation
Year Ended
Name December 31 Salary
George J. Coates, 1996 $184,908
Chief Executive Officer 1995 $183,549*
1994 $175,553
- ------------
* CIL had agreed to pay a $5,500,000 license fee to George J. Coates in
consideration for his grant to CIL of a non-exclusive license. See "Item
1-Business-Patents and Licenses." The fee was payable at management's discretion
but in no event later than February 17, 1998. In September 1995, this
arrangement was modified. CIL and George J. Coates agreed that instead of the
$5,500,000 payment, CIL would issue 275,000 shares of Series A Preferred Stock
to Mr. Coates as the license fee. The shares were issued to Mr. Coates in
November 1995.
To date, no employee stock options have been granted by CIL.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth as of December 31, 1996 the ownership of
CIL Series A Preferred Stock by (i) each person known by CIL to be the
beneficial owner of more than 5% of the outstanding Series A Preferred Stock,
(ii) each director and executive officer of CIL who owned shares, and (iii) all
directors and executive officers as a group.
Shares of Series A
Name of Stock Beneficially Owned
Beneficial Owner Number Percent
George J. Coates* 4,769,000 shs 80%
Gregory Coates* 318,150 shs 5%
Richard W. Evans 26,000 shs -%
Michael J. Suchar 5,500 shs -%
All directors and executive 4,800,500 shs 80%
officers as a Group (three persons)
- ---------
* c/o CIL, Highway 34 & Ridgewood Road, Wall Township, New Jersey 07719.
19
<PAGE>
Item 12. Certain Relationships and Related Transactions
After its February 1993 purchase of CIL's office and product
development facility in Wall Township, New Jersey (the "Facility") from
unaffiliated third parties, The George J. Coates 1991 Family Partnership, L.P.
(the "Partnership") continued the lease of the Facility to CIL. Pursuant to the
February 6, 1995 final consent judgment described in "Item 3" herein, George J.
Coates was ordered to cause the Partnership to transfer the Facility to CIL and
the transfer was effected on February 21, 1995 with CIL obtaining title to the
Facility and assuming the $300,000 mortgage loan obligation, the residue of the
$400,000 mortgage note issued by the Partnership at the time of its purchase of
the Facility. At the time of such transfer, all accrued rents in the aggregate
amount of $287,100 owed by CIL to the Partnership were forgiven. CIL's "Loan
Receivable Officer" account on its financial statement was adjusted accordingly.
CIL is obligated to indemnify George J. Coates from any liability he may suffer
based on the remaining mortgage loan on the Facility. In December 1995, CIL made
an additional $50,000 principal payment against this mortgage loan thereby
reducing the principal balance to $250,000. An additional aggregate $40,000 paid
by CIL in May and July 1996 reduced the balance to $210,000. The mortgagees have
agreed to reduce the mortgage balance by an additional $50,000 to $160,000 upon
issuance to them of an aggregate 2,500 shares of CIL Series A Preferred Stock
but to date, said shares have not been issued.
In January 1992, CIL, which had previously been assigned George J.
Coates' ownership rights in the Coates Patents, transferred such rights back to
George J. Coates in return for an exclusive right to negotiate licenses and
transfers of technology associated with the Coates Patents. The final consent
judgment permitted George J. Coates to retain title to the Coates Patents
provided that he reimbursed CIL for all the monies it expended in the
preparation, application and prosecution of the Patents. The amount due was
determined by management to total $434,639 of which $98,834 was offset from
other amounts due to George J. Coates prior to December 31, 1994. The $335,805
balance was paid to CIL in 1995. See "Item 1 - Business-Patents and Licenses" as
to a non-exclusive license with respect to the Coates Patents granted to CIL by
George J. Coates and Gregory Coates.
Pursuant to the final consent judgment, George J. Coates was ordered to
cause the transfer to CIL of all licensing fees and other funds paid to persons
or entities other than CIL in connection with the acquisition by the payor of an
interest in the Patents or in the technology embodied in the Patents. On
February 24, 1995, the $500,000 licensing fee paid by Millwest Corporation in
1994 and held in a bank account entitled "Coates International Licensing"
together with $12,144 of interest thereon was paid over to CIL. See "Item 1 -
Business-Patents and Licenses" and "Item 3" herein.
Through 1996, CIL subcontracted for its project labor expense with
Coates Precision Engineering, Inc., an entity controlled by George J. Coates.
The amounts paid to such subcontractor with respect to 1995 and 1996 were
$187,889 and $181,500 respectively. These payments constitute a direct pass
through to the subcontractor of payroll, workers' compensation and
hospitalization insurance expense and management believes the arrangement was in
CIL's best interests.
In the second half of calendar 1995 and during calendar 1996, CIL was
primarily dependent for its working capital on capital contributions made by
Gregory Coates, the son of George J. Coates, a principal (5% or greater)
stockholder and until January 1996, an executive officer and a director of CIL.
Such capital contributions advanced by Gregory Coates in 1995 and 1996
aggregated $404,549 and $1,132,523 respectively. The funds for such advances
were obtained from sales of Gregory Coates' shares of CIL Series A Preferred
Stock at a price of $20 per share.
20
<PAGE>
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No.* Description of Exhibit
3.1 CIL's Restated Certificate of Incorporation.
3.2 CIL's By-Laws.
4.1 Form of Certificate for CIL's Series A Non-Cumulative
Convertible Preferred Stock.
Exhibit No. Description of Exhibit
10.1 Deed dated February 21, 1995 transferring title to CIL's
Principal Facility at Route 34
and Ridgewood Road, Wall Township, N.J. from The George J.
Coates 1991 Family
Partnership, L.P. (the "Partnership") to CIL.
10.2 Assumption and Indemnification Agreement dated February 21,
1995 between the partnership and CIL.
10.3 License Agreement dated February 17, 1995 between George J.
Coates and CIL and
First and Second Amendments thereto dated July 17, 1995.
10.3(a) Third Amendment dated September 21, 1995 to License
Agreement dated February 17, 1995 between George J. Coates and CIL.
10.4 License Agreement dated February 22, 1993 between Gregory Coates
and CIL and First Amendment thereto dated July 17, 1995.
10.5 Prototype Manufacturing Agreement dated July 16, 1991 between
CIL, George J. Coates and Harley-Davidson, Inc.
10.6* License Agreement dated February 4, 1994 by and between CIL,
Coates International Licensing Partnership, L.P., George J.
Coates and Millwest Corporation.
10.7* Securities and Exchange Commission Complaint filed on July 22,
1994 in the United States District Court for the Southern
District of New York (94 Civ. 5361) against George J. Coates, CIL
and related entities.
10.8* Final Consent Judgment of CIL in the above action initiated by
the Commission (94 Civ. 5361).
10.9* Final Consent Judgment of George J. Coates in the above action
initiated by the Commission (94 Civ. 5361).
- ------------
* Incorporated by reference to the exhibit filed with CIL's
Registration Statement on Form S-1
(File No. 33-94884).
21
<PAGE>
(b) Reports on Form 8-K
CIL did not file any reports on Form 8-K during the quarter ended
December 31, 1996.
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.
October , 1997 By: /s/ George J. Coates
-----------------------
George J. Coates, President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
Signature Title Date
/s/ George J. Coates Director (Principal Executive October , 1997
George J. Coates Principal Financial Officer, Principal
Accounting Officer
/s/ Richard W. Evans Director October , 1997
- ------------------------------
Richard W. Evans
/s/ Michael J. Suchar Director October , 1997
- ------------------------------
Michael J. Suchar
23
<PAGE>
24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet and the consolidated statements of operations and
is qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-mos
<FISCAL-YEAR-END> dec-31-1996
<PERIOD-END> dec-31-1996
<CASH> 13,641
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 144,033
<CURRENT-ASSETS> 157,674
<PP&E> 1,606,659
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,783,303
<CURRENT-LIABILITIES> 2,271,945
<BONDS> 0
0
5,963
<COMMON> 0
<OTHER-SE> (494,605)
<TOTAL-LIABILITY-AND-EQUITY> 1,783,303
<SALES> 37,375
<TOTAL-REVENUES> 37,375
<CGS> 0
<TOTAL-COSTS> 1,601,822
<OTHER-EXPENSES> (1,121)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 36,784
<INCOME-PRETAX> 1,600,110
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,600,110
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,600,110
<EPS-PRIMARY> (.27)
<EPS-DILUTED> (.27)
</TABLE>
