UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
Washington,
DC 20549
FORM
10-K
(Mark
One)
R
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For
the fiscal year ended December 31, 2016
or
☐
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For
the transition period from ______ to
______
COATES
INTERNATIONAL, LTD.
(Exact
name of registrant as specified in its charter)
Commission
File Number: 000-33155
Delaware
|
|
22-2925432
|
(State
or other jurisdiction of incorporation or organization)
|
|
(I.R.S.
Employer Identification No.)
|
2100
Highway 34 & Ridgewood Road, Wall Township, New Jersey 07719
(Address
of principal executive offices) (Zip Code)
|
Registrant’s
telephone number, including area code:
(732) 449-7717
Securities
registered under Section 12(b) of the Exchange Act:
|
|
|
|
Title
of each class:
|
|
Name
of each exchange on which registered:
|
None
|
|
None
|
|
Securities
registered under Section 12(g) of the Exchange Act:
|
(Title
of class)
None
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes
☐
No
þ
Indicate
by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes
☐
No
þ
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
þ
No
☐
Indicate
by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes
þ
No
☐
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not
contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
þ
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer
☐
|
Accelerated filer
☐
|
|
|
Non-accelerated
filer (Do not check if a smaller reporting company)
☐
|
Smaller
reporting company
þ
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
☐
No
þ
State
the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price
at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day
of the registrant’s most recently completed second fiscal quarter: $1,287,255.
As
of April 12, 2017, the number of outstanding shares of the registrant’s common stock, par value $0.0001 per share
was 3,177,788,855.
Documents
Incorporated by Reference: None.
COATES
INTERNATIONAL, LTD.
ANNUAL
REPORT ON FORM 10-K
DECEMBER
31, 2016
CONTENTS
FORWARD-LOOKING
STATEMENTS
This
Annual Report on Form 10-K (this “Report”) contains “forward-looking statements” within the meaning of
Section 27A of the Securities Act of 1933, and Section 21E of the Exchange Act of 1934, as amended. Forward-looking statements
discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements may
include words such as “anticipate,” “believe,” “estimate,” “intend,” “could,”
“should,” “would,” “may,” “seek,” “plan,” “might,” “will,”
“expect,” “predict,” “project,” “forecast,” “potential,” “continue”
negatives thereof or similar expressions. These forward-looking statements are found at various places throughout this Report
and include information concerning possible or assumed future results of our operations; business strategies; future cash flows;
financing plans; plans and objectives of management; any other statements regarding future operations, future cash needs, business
plans and future financial results, and any other statements that are not historical facts.
From
time to time, forward-looking statements also are included in our other periodic reports on Forms 10-Q and 8-K, in our press releases,
in our presentations, on our website and in other materials released to the public. Any or all of the forward-looking statements
included in this Report and in any other reports or public statements made by us are not guarantees of future performance and
may turn out to be inaccurate. These forward-looking statements represent our intentions, plans, expectations, assumptions and
beliefs about future events and are subject to risks, uncertainties and other factors. Many of those factors are outside of our
control and could cause actual results to differ materially from the results expressed or implied by those forward-looking statements.
In light of these risks, uncertainties and assumptions, the events described in the forward-looking statements might not occur
or might occur to a different extent or at a different time than we have described. You are cautioned not to place undue reliance
on these forward-looking statements, which speak only as of the date of this Report. All subsequent written and oral forward-looking
statements concerning other matters addressed in this Report and attributable to us or any person acting on our behalf are expressly
qualified in their entirety by the cautionary statements contained or referred to in this Report.
Except
to the extent required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a result
of new information, future events, a change in events, conditions, circumstances or assumptions underlying such statements, or
otherwise.
For
a discussion of factors that we believe could cause our actual results to differ materially from expected and historical results
see “Item 1A — Risk Factors” below.
PART
I
Item
1. Business
General
Coates
International, Ltd. ("we" or the "Company") has been developing over a period of more than 20 years the patented
Coates Spherical Rotary Valve
®
(“CSRV
®
”) system technology which is adaptable for use
in piston-driven internal combustion engines of many types. Independent testing of various engines in which we incorporated our
CSRV
®
system technology (“CSRV
®
Engines”) confirmed meaningful fuel savings when compared
with internal combustion engines based on the conventional “poppet valve” assembly prevalent in most internal combustion
engines throughout the world. In addition, our CSRV
®
Engines produced only ultra-low levels of harmful emissions
while in operation. Engines operating on the CSRV
®
system technology can be powered by a wide selection of fuels.
We believe that these three major advantages of the CSRV
®
system technology constitute the first revolutionary
technological advancement of the internal combustion engine suitable for large scale production since its introduction more than
one hundred years ago.
The
CSRV
®
system is designed to replace the intake and exhaust conventional “poppet valves” currently used
in almost all piston-driven stationary, automotive, motorcycle, and marine engines. Unlike conventional valves which protrude
into the engine combustion chamber, the Coates
®
rotary valve system utilizes spherical valves that rotate in a
cavity formed between a two-piece cylinder head. The Coates rotary valve system uses approximately 1/10th the moving parts of
conventional poppet valve assemblies. As a result of these design improvements, management believes that the engines incorporating
the Coates rotary valve system (Coates engines®) will last significantly longer and will require less lubrication over the
life of the engine, as compared to conventional engines. In addition, Coates rotary valves can be designed with a larger opening
into the engine cylinder than conventional valves so that more fuel and air can be inducted into and expelled from the cylinder
in a shorter period of time. Larger valve openings permit higher revolutions-per-minute (RPM’s) and permit higher compression
ratios with lower combustion chamber temperatures, allowing the Coates engine® to produce more power than equivalent conventional
engines. The CSRV
®
engine is a highly thermal-efficient power unit.
We
have been granted an exclusive license to this technology from our founder, George J. Coates and his son, Gregory G. Coates (the
“Coates License Agreement”), in the Territory defined to include North America, Central America and South America
(the “Americas”).
Since
inception, the bulk of our development costs and related operational costs have been funded through cash generated from the
sales of our common stock, issuances of promissory notes and convertible promissory notes, capital contributions, licensing
fees for our CSRV
®
system technology, revenue from the performance of contractual research and development
activities involving the CSRV
®
system technology, sales of a small number of natural gas powered
CSRV
®
industrial electric power generator sets (“Gen Sets”) and a gain on the sale of the land and
building that serves as our principal operating facility. During the years ended December 31, 2016 and 2015, we did not have
any sales and we had revenues from research and development of $29,200 and $94,200, respectively. For the years ended
December 31, 2016 and 2015, we incurred net losses of ($8,356,000) and ($10,204,000), respectively.
The
accumulated net losses from inception of the Company through December 31, 2016 amounted to approximately ($65,327,000). We
may continue to be unprofitable until the CSRV
®
Engine is successfully introduced into the marketplace, or we
receive substantial licensing revenues. These accumulated losses were substantially related to research and development of
our intellectual property, patent filing and maintenance costs, costs incurred related to efforts to raise additional working
capital and general and administrative expenses in connection with our operations. During the year ended December 31, 2016,
we raised $642,000 of new working capital from sales of registered shares of common stock under equity purchase agreements,
issuances of promissory notes to related parties, issuances of convertible promissory notes, private sales of common stock
and common stock warrants and licensing revenues.
Coates
International, Ltd. is a Delaware corporation
organized in October 1991 as successor-in-interest
to a Delaware corporation of the same name incorporated in August 1988. Our operations are located in Wall Township, New Jersey
(approximately 60 miles outside of New York City). We maintain a website at the following address:
www.coatesengine.com
.
Through a link on our website to the U.S. Securities and Exchange Commission (“SEC”) website,
www.sec.gov
,
we provide free access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange
Act of 1934, as amended (the “1934 Act”) as soon as reasonably practicable after electronic filing with the SEC. Our
Code of Business Conduct and Ethics for our directors, officers and employees can be viewed on our website at
www.coatesengine.com
.
We will post on our website any waivers of, or amendments to, such code of ethics. Our website and the information contained therein
or linked thereto are not incorporated by reference into this report.
Background
Coates
Spherical Rotary Valve
®
System Technology
The
internal combustion engine has been in use for more than 100 years and is the most widely used engine in the world. Industry sources
indicate that there are more than 120 million new combustion engines built in the world every year and that 40 million engines
are rebuilt annually. In the late 1960’s and 1970’s, most vehicle combustion engines in the United States were running
at a compression ratio of 12 to 1 which resulted in an engine thermal efficiency of approximately 35 percent. The rest of the
engine’s power is lost in friction, pumping and heat loss. It was learned that lead additives in fuel created unacceptable
health risks, therefore the lead was removed. The use of unleaded gasoline created a number of technical problems, principally
related to overheating of the engine compression chamber, causing pre-ignition and resulting in damage to the engine. The problem
was largely solved by lowering engine compression ratios, thereby lowering thermal efficiency from approximately 35% to approximately
22%. This loss of efficiency reduces gas mileage and engine performance. Efficiency can be improved by increasing “volumetric
efficiency” at maximum RPM’s, but conventional poppet valves tend to “float” or bounce at higher RPM’s
and are consequently unable to deliver adequate air to the cylinder. In an attempt to solve this problem, engine manufacturers
increased the number of poppet valves per cylinder but this approach created other problems that cause unburned fuel to escape
through the exhaust valve stems leading to a loss of power, lower gas mileage, and increased pollutants. However, variable valve
timing can partially solve these additional problems, but that solution involves additional moving parts that eventually degrade
and wear out. Also, variable valve timing on quick deceleration can cause piston and valve contact with resultant serious damage
to the engine. Furthermore, conventional valves with solid “valve lifters” as opposed to hydraulic valve lifters must
have clearances readjusted periodically. Poppet valves are the most troublesome part of the internal combustion engine. The basic
inefficiencies of the conventional poppet valve design result in engine inefficiency and decreases in engine life, thermal efficiency,
fuel efficiency, engine power output and increased pollution.
Conventional
poppet valves also have significant environmental deficiencies. Conventional exhaust valve stems are lubricated with engine oil
which burns off in the combustion chamber and is expelled through the exhaust directly into the atmosphere. Intake valves are
also lubricated with engine oil, which is washed off and forced into the combustion chamber with the air and fuel mixture. This
slows combustion, produces further emissions and eventually clogs the catalytic converter.
Management
believes that the patented CSRV
®
system solves or significantly mitigates these problems. Coates rotary valves®
are vented and charged on the opposite side of each valve sphere and rotate away from the combustion chamber, reducing combustion
chamber constant temperature and allowing higher compression ratios that make the engine significantly more efficient and powerful.
We
have successfully adapted our technology to industrial engines to power electric generators, and intend to begin to manufacture
and market engines utilizing our proprietary designs operating on a multitude of fuels such as LNG, CNG, propane, flare-off gas
and hydrogen.
Hydrogen
Reactor Technology Owned by George J. Coates
George
J. Coates has developed a hydrogen reactor which rearranges H
2
O water molecules into HOH molecules also known as Hydroxy-Gas.
The Hydroxy-Gas produced by the hydrogen reactor is then harvested for use as a type of fuel. Mr. Coates intends to continue with
development of this technology to enable the harvested Hydroxy-Gas to be utilized as the fuel source to power our patented CSRV
®
engines. The next phase of this research and development will focus on powering larger, industrial engines. If successful,
this application will only require a ready supply of water and would be suitable for stationary engines and generators. Conventional
internal combustion engines employing poppet valve assemblies require lubrication and would experience excessive heat and friction
if powered with Hydroxy-Gas. This, in turn, would cause the engines to burn out in a rather short period of time. The materials
and components of the CSRV
®
engines do not require such lubrication and because of their design, are able to operate
relatively trouble-free on Hydroxy-Gas as the engine fuel. There can be no assurance that this technology can be developed successfully,
or that if developed, it will be feasible to penetrate the internal combustion engine market with this technology.
We
previously agreed to collaborate with WTF Asia International Ltd. (“WTF Asia”), a Hong Kong-based entity to develop
this technology and apply it to large industrial gen set engines. We have designed and integrated the switchgears, controls, load
bank and emissions equipment into the hydrogen reactor/gen set (“Coates Assembled Components”). In December 2016,
we entered into an exclusive license with Secure Supplies Mexico LLC and Secure Supplies USA LLC (collectively “Secure Supplies”)
for Coates CSRV
®
electric power hydrogen generator sets and engines. We have since recommended that Secure Supplies
and WTF Asia directly coordinate this development as a joint effort due to their inherent synergies in developing hydrogen powered
generation of electric power. WTF Asia would be responsible for building additional components based on technology already developed
that will enable the hydrogen reactor to adequately power larger CSRV
®
commercial and industrial engines. Further
development of this technology has been placed on a lower priority at this time in order to enable the Company to focus on the
fulfilling orders under the License Agreement with Secure Supplies.
Applications
for patent protection of this technology will be filed upon completion of the research and development. Although at this time
no arrangements have been made between us and George J. Coates, owner of the technology, regarding licensing of the hydrogen reactor,
Mr. Coates has provided his commitment to license this technology to us once the related patent protection is in place. Accordingly,
the Company does not currently have any rights to manufacture, use, sell and distribute the Hydrogen Reactor technology, should
it become commercially feasible to manufacture and distribute products powered by the Hydroxy-Gas fuel. We have been responsible
for all costs incurred to date, related to the development of this technology.
Markets
The
design of the CSRV
®
system technology provides us with the flexibility to retrofit our existing internal combustion
engines of all sizes and applications to appeal to a number of different geographic and product markets. In addition, the CSRV
®
system technology has been designed to operate effectively on a wide range of alternative fuels. Accordingly, there are
no technical barriers that need to be overcome in order to strategically target economically feasible markets for products powered
by internal combustion engines including, but not limited to the following: engines for electric power generators for various
applications ranging from home use to the largest industrial complexes to augmented “grid” installations; engines
to power motorcycles, automobiles, light trucks, heavy trucks, machinery, railroads, marine engines, military equipment, light
aircraft, helicopters, lawn mowers, snowmobiles and jet skis, etc.
According
to the most recent available data in a table published by the Federal Highway Administration of the U.S. Department of Transportation
titled “Highway Statistics 2015,” there were total U.S. vehicle registrations for the fifty states as follows:
Automobiles
|
|
|
Buses
|
|
|
Trucks
|
|
|
Motorcycles
|
|
|
Total
|
|
|
112,864,228
|
|
|
|
888,907
|
|
|
|
141,256,148
|
|
|
|
8600,936
|
|
|
|
263,610,219
|
|
Strategy
Our
long-term objective is to become a leader throughout the Americas in the design, manufacture, licensing to third party manufacturers
and sales and distribution of our CSRV
®
internal combustion engines for a wide variety of uses. Our primary targeted
market is the industrial electric power generator market. We have adapted the CSRV
®
system technology to manufacture
our 14.0 liter inline, 6-cylinder, 855 cubic inch engine industrial generator fueled by natural gas (“Natural Gas Gen Sets”),
one of many types of Natural Gas Gen Sets. Commencing in or before the second quarter of 2016, we intend to adapt our technology
to develop a 1MW CSRV
®
Hydrogen Gen Set in connection with an exclusive license with Secure Supplies as more fully
discussed hereinafter under “Material Agreements”. In parallel to penetrating the commercial/industrial generators
market, we intend to adapt the CSRV
®
system technology to be used in other markets, in which internal combustion
engines are used, such as motor vehicles, motorcycles, trucks, ships, trains, military equipment, light aircraft, helicopters
and others.
Operational
Plan
Manufacturing,
Sales and Distribution
We
have completed development of the CSRV
®
system technology-based Natural Gas Gen Sets and are prepared to commence
the production phase of our operations, provided we raise sufficient new working capital to first produce and field test a number
of additional engine generators.
During the second quarter of 2017, we
intend to adapt our technology to develop a 1MW CSRV
®
Hydrogen Gen Set in connection with an exclusive license
with Secure Supplies as more fully discussed hereinafter under “Material Agreements”. Secure Supplies has
indicated that it intends to place orders with us for 1MW Hydrogen Gen Sets for its business plan.
While we have not been successful in starting up our manufacturing operations, we continue to endeavor to do so and at such
time that we may be successful, plan to sell CSRV® engine generators to Almont Energy, Inc., (“Almont”) under
a sublicense agreement covering the territory of Canada. Almont is a privately held, independent third party entity based
in Alberta, Calgary, Canada.
We
may also pursue other opportunities to enter into licensing arrangements with third party manufacturers with existing industry
experience and manufacturing capacity.
We
intend to take advantage of the fact that essentially all the components of the CSRV
®
generator engine may be readily
sourced and acquired from subcontractors, and, accordingly, expect to manufacture the engine generator by developing assembly
lines within owned manufacturing facilities. We intend to initially commence production of Gen Sets on a small scale. This will
enable us to prove our concept for the CSRV
®
system technology and we expect this will dovetail with the existing
substantial demand in the marketplace. We plan to address this demand by establishing large scale manufacturing operations in
the United States. Transitioning to large scale manufacturing is expected to require a substantial increase in our work force
and substantial capital expenditures.
Our
ability to establish such manufacturing operations, recruit plant workers, finance initial manufacturing inventories and fund
capital expenditures is highly dependent on our ability to successfully raise substantial new working capital in an amount and
at a pace which matches our business plans. Potential sources of such new working capital include sales of our equity and/or debt
securities through private placement, pursuing and entering into additional sublicensing agreements with OEM’s and/or distributors
and positive working capital generated from sales of our CSRV
®
products once we raise sufficient new working capital
and commence production. Although we have been successful in raising sufficient working capital to continue our ongoing operations,
we have encountered very challenging credit and equity investment markets, and have not been able to raise sufficient new working
capital to enable us to commence production of our CSRV
®
products. There can be no assurance that we will be successful
in raising adequate new working capital or even any new working capital to carry out our business plans.
The
recent trading price range of our common stock at a fraction of a penny has introduced additional risk and difficulty to our challenge
to secure needed additional working capital.
Sublicensing
In
December 2016, we executed an exclusive license with Secure Supplies covering Coates CSRV
®
electric
power hydrogen generator sets and engines for distribution, use, sale and lease in the territory of North America. Secure
Supplies employs a combination of solar generated power and hydrogen cell technology to generate hydrogen gas. It intends to
integrate its technology with the Coates CSRV
®
system technology to power larger industrial Hydrogen Gen Sets
to be utilized in establishing power generation plants throughout North America. Secure Supplies has indicated it intends
to procure CSRV
®
Engine Generators adapted to run on hydrogen fuel (“Hydrogen Gen
Sets”). Development of the first production Generator Set is anticipated to commence during the second quarter of 2017.
The license agreement provides for a license fee of $1 million which, to date has not been paid and a down payment of 50% of
the total order value with each order placed. We intend to devote a substantial amount of resources during the remainder of
2017 to develop larger CSRV
®
system technology industrial engines powered by hydrogen gas, capable of
generating up to 1MW of electrical power output, in connection with this sublicense agreement.
In
February 2015, we granted a non-exclusive distribution sublicense to Renown Power Development, Ltd., a China-based sales and distribution
company (“Renown”) covering the territory defined as the Western Hemisphere. Under this sublicense, Renown will be
permitted to sell, lease and distribute CSRV
®
products. We received an initial non-refundable deposit of $500,000
to date. In addition, after Renown receives an aggregate of $10,000,000, it is required to pay us 25% of all funds it receives
from any and all sources
, until it fully pays the contractual licensing fee.
.
Coates
Power has agreed to initially source its production parts and components from us. In February 2015, we received cash with an order
from Coates Power for approximately $131,000 of production parts and components, at cost, in connection with its plans to manufacture
two initial Gen Sets. In June, 2015, by mutual consent of the parties, it was agreed that we would assemble two completed Gen
Sets for shipment to Coates Power in China in lieu of shipping the parts and components. This amount is included in Deposits in
the accompanying balance sheet at December 31, 2016.
Material
Agreements
License
Agreement – George J. Coates and Gregory G. Coates
We
hold a license from George J. Coates and Gregory G. Coates which provides us with the right to use, manufacture, distribute, lease
and sublicense the patented CSRV
®
system technology (the “Coates License Agreement”) in the territory
defined as the Western Hemisphere. Under the Coates License Agreement, we were granted an exclusive, perpetual, royalty-free,
fully paid-up license to the intellectual property that specifically relates to an internal combustion engine that incorporates
the CSRV
®
system technology (the “CSRV
®
Engine”) and that is currently owned or controlled
by them (the “CSRV
®
Intellectual Property”), plus any CSRV
®
Intellectual Property that
is developed by them during their employment with us. In the event of insolvency or bankruptcy of the Company, the licensed rights
would terminate and revert back to George J. Coates and Gregory G. Coates.
Exclusive
Distribution Sublicense Agreement with Secure Supplies
This
material sublicense agreement, which was consummated in December 2016, is discussed in detail above under the section titled “
Sublicensing
.”
Non-Exclusive
Distribution Sublicense Agreement with Renown Power Development, Ltd.
This
material sublicense agreement, which was consummated in February 2015, is discussed in detail above under the section titled
“Sublicensing.”
Sublicense
Agreement with Almont Energy, Inc. for the Territory of Canada
In 2010, Almont Energy Inc. (“Almont”), a privately held, independent third-party entity based in Alberta, Canada
became the assignee of a sublicense which covers the use of the CSRV® system technology in the territory of Canada in
the oil and gas industry (the “Canadian License”). This sublicense is currently inactive because the parties have
not fulfilled their obligations thereunder due to our delay in starting up production and delivery of CSRV® products to
Almont. The parties mutually agreed to consider the basis on which the license could be reactivated at such time that we are
successful in starting up manufacturing operations.
Equity
Purchase and Registration Rights Agreement
In
July 2014, we entered into an equity purchase agreement (the “2014 EP Agreement”) with Southridge Partners II LP,
a Delaware limited partnership (“Southridge”). Pursuant to the terms of the 2014 EP Agreement, Southridge committed
to purchase up to 40,000,000 shares of our common stock, in exchange for consideration not to exceed Ten Million ($10,000,000)
Dollars. In June 2015, the 2014 EP Agreement automatically terminated because Southridge had purchased all 40,000,000 shares of
common stock permitted under the 2014 EP Agreement. On July 29, 2015, we entered into a new 3-year equity purchase agreement (the
“2015 EP Agreement”) with Southridge. Pursuant to the terms of the 2015 EP Agreement, Southridge committed to purchase
up to 205,000,000 shares of our common stock, in exchange for consideration not to exceed Twenty Million ($20,000,000) Dollars
on the same terms and conditions as the 2014 EP Agreement. In December 2016, the 2015 EP Agreement automatically terminated because
Southridge had purchased all 205,000,000 shares of common stock permitted under the 2015 EP Agreement.
The
terms of the 2014 and 2015 EP Agreements provided that the purchase price for the shares of common stock shall be equal to 94%
of the lowest closing price of the common stock during the ten trading days that comprise the defined pricing period. The Company
is entitled to exercise a Put to Southridge by delivering a Put Notice, which requires Southridge to remit the dollar amount stated
in the Put Notice at the end of the pricing period, provided, however, that for each day during the pricing period, if any, that
the daily closing price of the Company’s common stock is (i) 25% or more below the Floor Price, as defined, or (ii) below
the Floor Price, if any, stipulated in the Put Notice issued by the Company, then the dollar amount of the Put shall be reduced
by 10% for each such day. The Company may stipulate a Floor Price below which, no shares of common stock may be sold by Southridge,
however, the Floor price shall not be lower than the lowest daily volume weighted average price of the common stock during the
ten trading days preceding the date of the Put Notice.
The
Company also entered into a registration rights agreement (the “Registration Rights Agreement”) with Southridge. Pursuant
to the terms of the Registration Rights Agreement, on July 30, 2015, the Company filed a registration statement with the SEC covering
205,000,000 shares of common stock underlying the 2015 EP Agreement which was declared effective August 5, 2015.
During
the year ended December 31, 2016, the Company sold 172,494,090 registered shares of common stock to Southridge and received proceeds
of $199,000 under the 2015 EP Agreement.
During
the year ended December 31, 2015, the Company (i) sold all of the 40,000,000 registered shares of common stock to Southridge and
received proceeds of $207,000 under the 2014 EP Agreement, and (ii) sold 32,505,910 registered shares of common stock to Southridge
and received proceeds of $200,000 under the 2015 EP Agreement.
Competition
Management
believes that the Coates Engine
®
generators which are based on the CSRV
®
system technology will
provide substantially enhanced efficiencies in power generation and longevity. We believe that the Coates Engines
®
will outperform other comparable natural gas-fueled electric generator engines currently utilized in the energy conversion market.
Notwithstanding
our perceived competitive advantages, the power generation market is a highly competitive industry currently occupied by extremely
large companies such as Caterpillar, Inc., which owns MAK, Perkins and FG Wilson, Detroit Diesel Corporation, AB Volvo, Cummins
and Marathon, among others. These companies have far greater financial and other resources than we do and already occupy segments
of the power generation market. In order to successfully penetrate this industry, the Coates Engines
®
will have
to produce the performance and durability results anticipated by management and sell at a price or prices that will enable it
to effectively compete and gain entrance into this market.
Parts
and Supplies
To
date, management has utilized the services of various vendors and suppliers available throughout the United States to provide
all of the parts necessary to produce the Coates Engines
®
. We intend to continue to purchase all of our raw materials
and parts, manufactured to our specifications, from a wide assortment of suppliers. We have signed a letter of intent with Marathon
Electric Manufacturing Corp. for the supply of generators and components. We also entered into an agreement with Cummins Power
Systems (a business owned by Cummins Inc.) to supply industrial engine blocks and components to us for our manufacturing activities.
We intend to initially commence the assembly of the Coates Engines
®
at our existing New Jersey facility and to
subsequently acquire additional facilities to increase our manufacturing capacity, as needed.
Licenses and Patents
The Coates License Agreement grants us
an exclusive, perpetual, royalty-free, fully paid-up license in the territory of North, Central and South America, to use all intellectual
property rights that are currently owned or controlled by the licensors that directly relate to an internal combustion engine that
includes the CSRV
®
system technology. The license also covers any new or improved technology and related intellectual
property rights that are directly related to the CSRV
®
Engine system technology developed by the licensors during
their employment with us.
Included in the license are intellectual
property rights for 17 patents registered in the United States; certain patents registered in Canada, Mexico, in countries in Central
and South America relating to the CSRV
®
system technology; and one U.S. patent application filed by Mr. George J.
Coates. These patents are owned by George J. Coates and Gregory G. Coates. Under our license agreement, we are obligated to pay
for all costs relating to the ongoing maintenance of the patents.
We rely upon patents, trade secrets, know-how
and continuing technological innovation to develop and maintain our competitive position. We can provide no assurance that we can
successfully limit unauthorized or wrongful disclosures of trade secrets or otherwise confidential information. In addition, to
the extent we rely on trade secrets and know-how to maintain our competitive technological position, there can be no assurance
that others might not independently develop the same, similar or superior techniques.
We have also granted sublicenses to Secure
Supplies, Renown Power Development, Ltd. and Almont Energy, Inc. as discussed in more detail under the section titled “Plan
of Operations,” The sublicense with Almont is currently in an inactive status.
Environmental Regulatory Compliance
All of our engines,
including the Coates Engine
®
, will be subject to extensive environmental laws, rules and regulations that impose
standards for emissions and noise. Initially, compliance with the emissions standards promulgated by the U.S. Environmental Protection
Agency ("EPA"), as well as those imposed by the State of New Jersey and other jurisdictions where we expect our engines
will be used, will have to be achieved in order to successfully market the Coates Engine
®
.
When selling individual engines, we are not subject to the governmental standards as set forth in 40CFR (Code of Federal Regulations)
1048, which regulates environmental standards for natural gas-powered industrial engines. In this case, the purchaser or sublicensee
becomes responsible for complying with applicable governmental standards in its territory. We believe that our natural gas powered
engine/generators comply with governmental standards as set forth in 40CFR (Code of Federal Regulations) 1048, that regulates environmental
standards for natural gas-powered industrial engines. Our ability to comply with applicable and future emissions standards is necessary
for us to enter and continue to operate in the power generation and other markets. Failure to comply with these standards could
result in a material adverse effect on our business and financial condition.
Employees
At December 31, 2016, we had 5 employees, including
George J. Coates and his son Gregory G. Coates, who perform management, assembly and research and development functions. Bernadette
Coates, the spouse of George J. Coates, is employed as an administrative manager for the Company.
Available information
Our website address is www.coatesengine.com. We do not intend our website address to be an active link
or to otherwise incorporate by reference the contents of the website into this Report. The public may read and copy any materials
the Company files with the U.S. Securities and Exchange Commission (the “SEC”) at the SEC's Public Reference Room
at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0030. The SEC maintains an Internet website (http://www.sec.gov) that contains reports, proxy
and information statements and other information regarding issuers that file electronically with the SEC.
Item 1A.
Risk Factors
You should carefully consider the risks described below, together with all of the other information included in this report,
in considering our business and prospects. The risks and uncertainties described below are not the only ones facing the Company.
Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business
operations. The occurrence of any of the following risks could harm our business, financial condition or results of operations.
Risk Factors Relating to Our Financial Condition:
Our Independent Registered Public Accountants
have expressed substantial doubt about our ability to continue as a going concern.
As shown in the accompanying financial
statements, we have incurred recurring losses from operations of ($65,327,000); and, as of December 31, 2016 had a
stockholders’ deficiency of ($5,197,000) and negative working capital of ($5,411,000). In addition, the recent trading
price range of the Company’s common stock at a fraction of a penny has introduced additional risk and difficulty to the
Company’s challenge to secure needed additional working capital. These factors raise substantial doubt about our
ability to continue as a going concern within one year after the date of filing of this annual report on Form 10-K. Our
Independent Registered Public Accountants have stated in their Auditor’s Report dated April 14, 2017 with respect to
our financial statements as of and for the year ended December 31, 2016 that these circumstances raise substantial doubt
about our ability to continue as a going concern. The financial statements do not include any adjustments that might be
necessary should we become unable to continue as a going concern.
The substantial doubt about our ability to
continue as a going concern has been reported, as required by generally accepted accounting principles, since 1995. In spite of
this continuing doubt, we have developed a long history of meeting our obligations as they come due, year after year. During the
year ended December 31, 2016, we met our obligations as they became due by raising additional working capital of $642,000 of new
working capital from sales of registered shares of common stock under equity purchase agreements, issuances of promissory notes
to related parties, issuances of convertible promissory notes, private sales of common stock and common stock warrants and licensing
revenues.
Although there can be no assurance that we
will be able to overcome this doubt in the future, our management believes that we can continue to meet our obligations as they
come due in consideration of the following:
|
●
|
We
anticipate that the license fee and cash down payments with orders from Secure Supplies during 2017 will be sufficient to ensure
that we are able to meet our obligations as they become due. We also anticipate that we will be focused on developing the prototype
Hydrogen Gen Set in 2017 that will enable us to commence repetitive production for Secure Supplies.
|
|
●
|
In
addition, we expect to continue to raise working capital from a number of sources to
meet our ongoing obligations as they become due. These sources may include deposits on
new sublicense agreements, sales of common stock and warrants, proceeds from issuances
of convertible notes, and proceeds from promissory notes issued to related parties.
|
|
●
|
Finally,
management has instituted a cost control program intended to restrict variable costs
requiring an outlay of cash to only those expenses that are necessary to carry out our
activities related to research and development activities, entering the production phase
of operations, developing additional commercially feasible applications of the CSRV
®
system technology, seeking additional sources of working capital and covering general
and administrative costs in support of such activities.
|
We
have significant immediate capital needs and our ability to raise funds on terms acceptable to us is highly uncertain.
We will
need additional working capital from equity and/or financing transactions in the near future for a number of uses, including:
|
●
|
Purchasing
raw material inventory and hiring plant workers to commence our production phase.
|
|
●
|
Expanding
manufacturing capacity.
|
|
●
|
Developing
an expanded management team to oversee the expanded scope of our operating activities
upon commencement of production.
|
|
●
|
Developing
our engineering, administrative and marketing and sales organizations.
|
|
●
|
Expanding
our research and development programs with respect to the CSRV
®
system
technology and applying the CSRV
®
system technology to engines used in
various commercially viable applications.
|
|
●
|
Implementation
of new systems, processes and procedures to support growth.
|
|
●
|
Ongoing
general and administrative expenses.
|
Additional
sources of working capital may not be available on terms acceptable to us, or may not be available at all.
As
with any business, many aspects of our operations and our future outlook are subject to events and influences which are not within
our control. This could have an adverse impact on us and our results of operations. For example:
`
|
●
|
The
recent trading price range of the Company’s common stock at a fraction of a penny
has introduced additional risk and difficulty to the Company’s challenge to secure
needed additional working capital.
|
|
●
|
Demand
for our technology and products could be significantly reduced.
|
|
●
|
Estimates
used in the preparation of our financial statements may need to be revised.
|
Risk
Factors Relating to Our Product Development:
Limited
production and sales of CSRV
®
engine generators.
To
date, we have only had only minimal sales of CSRV
®
engine generators and received limited revenues from research
and development a number of years ago. We have not been able to move into the CSRV
®
engine generator production
phase of our business because we have not been successful in raising sufficient new working capital.
We
expect to continue to incur losses until we commence production and distribution of products incorporating our CSRV
®
system technology. We may not be profitable or operating cash flow positive in 2017 unless we can begin to generate positive
cash flows from sales of CSRV
®
Engine products or receive cash proceeds from new licensing agreements for our CSRV
®
system technology. In addition, we may not be profitable or operating cash flow positive for several additional years after
2017.
[DISCUSS NEW UPDATES ON SECURE SUPPLIES]
The
Coates CSRV
®
System Technology may not have the performance characteristics and longevity that we expect
which may adversely affect our future revenues.
The
Coates Engine
®
has only been tested to a very limited degree in a “real world” environment. Commercial
use of our industrial engines may not have the performance characteristics that we expect. Similarly, until the Coates Engine
®
has been in use for a substantial period of time, there is no certain way to ascertain its expected longevity. Superior
performance and longevity are essential elements of our ability to penetrate the power generation and other markets. Our failure
to do so would have a material adverse effect on our business and, unless remedied on a timely basis we might be forced to close
our operations.
Risk
Factors Relating to Our Business:
Our
Success Depends to a Large Extent on Our Founder George J. Coates and His Son Gregory G. Coates, the Loss of Either of Whom Could
Disrupt Our Business Operations.
Our
future success will depend in substantial part on the continued services of George J. Coates and, to a lesser extent, Gregory
G. Coates. The loss of the services of George J. Coates and/or Gregory G. Coates could impede implementation of our business plan
and reduce our opportunity for profitability. We expect that our future market capitalization will be highly dependent on the
productivity of George J. Coates. If the employment of George J. Coates was to cease for any reason before we have hired additional
senior management and engineering personnel, our business would be materially adversely affected and we may have to discontinue
operations. We do not have employment agreements in place with George J. Coates and Gregory G. Coates. Although George J. Coates
is our majority shareholder and Gregory G. Coates is a major shareholder of the Company, a risk exists that they could voluntarily
terminate their employment with us at any time and for any reason. In such case, either or both of them could establish one or
more new businesses that might compete with ours. We do not maintain key person insurance on either George J. Coates or Gregory
G. Coates.
We
may encounter substantial competition in our business and our failure to compete may adversely affect our ability to generate
revenue.
The
power generation market is a highly competitive industry currently occupied by extremely large companies. These companies have
far greater financial and other resources than we do and already occupy segments of the power generation market. In order to successfully
penetrate this industry, the Coates Engine
®
will have to produce the performance and durability results anticipated
by management and sell at a price that will enable it to effectively compete and gain entrance into this market.
Our
Dependence on Third Party Suppliers for Key Components of Our Products Could Delay Shipment of Our Products and Reduce Our Sales.
We
depend on certain domestic suppliers for the delivery of components used in the assembly of our products. Our reliance on third-party
suppliers creates risks related to our potential inability to obtain an adequate supply of components or subassemblies and reduced
control over pricing and timing of delivery of components and sub-assemblies. Specifically, we depend on suppliers of short engine
blocks, custom pistons, custom spherical rotary valves, valve seals, carriers, springs, value added services and other miscellaneous
components and parts for our products. Any interruption of supply for any material components of our products could significantly
delay the shipment of our products and have a material adverse effect on our revenues, profitability and financial condition.
Our
short term business success relies upon our sublicensing agreement with Secure Supplies and the Canadian licensing agreement which
has been assigned to Almont.
In order to ensure our successful performance under the sublicense with Secure Supplies,
we will need to timely develop a prototype Hydrogen Gen Set which requires adapting the CSRV® system technology to operate
effectively in larger industrial engines such as a V-16 and/or V-12. This will also entail an evaluation of the qualities of hydrogen
gas in order to assess the potential electric power output from such Hydrogen Gen Sets. There can be no assurance that we can
successfully develop this prototype on a timely basis or that the electric power output will meet expectations. If we are not
successful in developing the Hydrogen Gen Set technology and/or in meeting expectations for the electrical power output, it would
have a material adverse effect on our financial positon, cash flows and results of operations.
Our sublicense with Almont is currently inactive because the parties have not fulfilled their obligations thereunder due to
our delay in starting up production and delivery of CSRV® products to Almont. The parties mutually agreed to consider
the basis on which the license could be reactivated at such time that the Company is successful in starting up its manufacturing
operations. As long as we are unable to commence such operations, our brand, business prospects, financial condition and operating
results continue to be materially, adversely affected.
We
may be subject to claims with respect to the infringement of intellectual property rights of others, which could result in substantial
costs and diversion of our financial and management resources to defend such claims and/or lawsuits and could harm our business.
We
cannot be certain that our licensed rights to the patented engine designs and technologies will not infringe upon patents, copyrights
or other intellectual property rights held by third parties. While we know of no basis for any claims of this type, the existence
of and ownership of intellectual property can be difficult to verify and we have not made an exhaustive search of all patent filings.
Additionally, most patent applications are kept confidential for twelve to eighteen months, or longer, and we would not be able
to search for potentially conflicting claims that they make. We may become subject to legal proceedings and claims from time-to-time
relating to the intellectual property of others in the ordinary course of our business. If we are found to have violated the intellectual
property rights of others, we may be enjoined from using such intellectual property, and we may incur licensing fees or be forced
to develop alternative technology or obtain other licenses. In addition, we may incur substantial expenses in defending against
any third party infringement claims and be diverted from devoting time to our business and operational issues, regardless of the
merits of any such claim. Successful infringement or licensing claims against us may result in substantial monetary damages, which
may materially disrupt the conduct of our business and have a material adverse effect on our reputation, business, financial condition
and results of operations.
Our
success is dependent on protecting our intellectual property rights.
We
rely on a combination of patent, copyright, trademark and trade secret protections to protect our rights under our license to
the proprietary technology. We cannot assure you that these trademarks and patents will not be challenged, invalidated, or circumvented,
or that the rights granted under those registrations will provide competitive advantages to us.
In
addition, there is currently no understanding in place regarding the ownership of new intellectual property not directly related
to the CSRV
®
system technology, developed by either George J. Coates or Gregory G. Coates while employed by us.
As a result, there is a risk that we may not derive any benefit from such newly developed intellectual property.
In
the event of insolvency or bankruptcy, the intellectual property rights licensed to us would automatically revert back to George
J. Coates and Gregory G. Coates.
Under
our license agreement for the CSRV
®
system technology, in the event of insolvency or bankruptcy, our intellectual
property rights and our rights to license the intellectual property would automatically revert back to George J. Coates and Gregory
G. Coates. This would result in a lower potential recovery of investment by, and/or liquidation value to, our stockholders.
We
have very limited marketing and sales experience.
We
have no marketing or sales experience. The sales process is expected to be lengthy, in part because of skepticism about the performance
of the Coates Engine
®
. We are evaluating alternative marketing and sales channels, distributors, sublicensees and
marketing partners. We may never successfully market and sell the Coates Engine
®
.
We
have only a small number of employees, and in order to grow our business we will need to hire significant additional personnel.
We
need to hire, train and retain additional employees for all aspects of our business if we are to achieve our production and sales
goals. Our success will also depend on our ability to attract and retain a staff of qualified managerial, engineering and manufacturing
plant workers. Qualified individuals are in high demand and are often subject to competing offers. We cannot be certain that we
will be able to attract and retain the qualified personnel we need for our business. If we are unable to hire additional personnel
as needed, it would have a material adverse effect on our business and operations. In particular, we need trained engineers and
sales personnel to educate potential customers and provide post-installation customer support.
As
a publicly reporting company, we incur substantial expenses to comply with the reporting requirements which could have a detrimental
effect on our business and finances, the value of our stock and the ability of stockholders to resell their stock.
Since
we are subject to the information and reporting requirements pursuant to Section 15(d) of the Exchange Act, as well as other disclosure
requirements such as the proxy rules, going private rules and many tender offer provisions, our stockholders will not have access
to the short-swing reporting and profit receiving protections or information that is provided by beneficial ownership reporting
requirements of the U.S. securities laws. Additional SEC regulations already in place have also substantially increased the accounting,
legal, and other costs related to becoming and remaining a publicly reporting company. In the current regulatory environment,
a recent trend has been established to continue to introduce substantial additional regulations affecting financial markets and
publicly reporting companies. There can be no assurance that new regulations introduced in the future, will not significantly
increase the cost of compliance for publicly traded companies. If we do not meet the public company reporting requirements designed
to make current information about our company available to market makers, they will not be able to trade our stock. In addition,
if we do not comply with the public company reporting requirements, we will be in default of our convertible promissory notes,
which provide for substantial penalties in such event and would likely have a material adverse effect on our financial condition
and results of operations. The public company costs of preparing and filing annual and quarterly reports, making interactive reporting
of our financial statement in XBRL format available to stockholders, providing other information to the SEC and furnishing audited
reports to stockholders, cause our expenses to be higher than they would be if we were privately-held and not subject to public
company reporting regulatory requirements. In addition, we may incur substantial expenses in connection with the preparation of
registration statements required to be filed in connection with the registration of securities under the Securities Act of 1933.
These increased costs may be material and may include the hiring of additional employees and/or the retention of additional advisors
and professionals. Our failure to comply with federal securities laws could result in private or governmental legal action against
us and/or our officers and directors, which could have a detrimental effect on our business and finances, the value of our common
stock, and the ability of stockholders to resell their stock.
We
may be exposed to potential risks, penalties and expenses resulting from the Sarbanes Oxley Act of 2002.
In
addition to the costs of compliance with having our shares of common stock listed on the OTC Pink Sheets, there are substantial
penalties that could be imposed upon us if we fail to comply with all regulatory requirements. In particular, under the Sarbanes-Oxley
Act of 2002 we are required to include in our annual report our assessment of the effectiveness of our internal control over financial
reporting as of the end of our fiscal year.
We
may become subject to product liability and/or warranty claims, which could harm our financial condition and liquidity if we are
not able to successfully defend or insure against such claims.
We
do not currently maintain product liability insurance for our CSRV
®
products. We intend to make a proper assessment
of the product liability risk related to our products and we may apply for product liability insurance, to the extent believed
necessary in the future and at the time that our working capital is sufficient for this purpose. Any lawsuit seeking significant
monetary damages may have a material adverse effect on our business and financial condition. We may not be able to secure product
liability insurance coverage on commercially acceptable terms or at reasonable costs when needed, particularly if we do face liability
for our products and are forced to make a claim under our policy. In addition, a product liability claim could generate substantial
negative publicity about our CSRV
®
products and business, and inhibit or prevent commercialization of other future
CSRV
®
products, which would have a material adverse effect on our brand, business, prospects, financial condition
and operating results.
While
our products are tested for quality, our products nevertheless may fail to meet customer expectations from time-to-time. Also,
not all defects are immediately detectible. Failures could result from faulty design or problems in manufacturing. In either case,
we could incur significant costs to repair and/or replace defective products under warranty. Liability claims could require us
to spend significant time and money in litigation and pay significant damages. As a result, any of these claims, whether or not
valid or successfully prosecuted, could have a substantial, adverse effect on our business and financial results. In addition,
although we plan on putting product liability insurance in place, the amount of damages awarded against us in such a lawsuit may
exceed the policy limits of such insurance. Further, in some cases, product redesigns and/or rework may be required to correct
a defect and such occurrences could adversely impact future business with affected customers. Our business, financial condition,
results of operations and liquidity could be materially and adversely affected by any unexpected significant warranty costs.
Risk
Factors Relating to Our Common Stock:
Our
common stock is thinly traded, so you may be unable to sell at or near ask prices or at all if you need to sell your shares to
raise money or otherwise desire to liquidate your shares.
Our
common stock has historically been sporadically or “thinly-traded” on the OTC Pink Sheets, meaning that the number
of persons interested in purchasing our common stock at or near ask prices at any given time may be relatively small or nonexistent.
This situation is attributable to a number of factors, including the fact that we are a small company which is relatively unknown
to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales
volume, and that even if we came to the attention of such persons, they tend to be risk-averse and would be reluctant to follow
an unproven company such as ours or purchase or recommend the purchase of our shares until such time as we became more seasoned
and viable. In addition, due to the current trading price range of our common stock many broker/dealers will not agree to honor
sell orders or clear trades in our common stock. In this case, shareholders may be required to open a new brokerage account with
one of the broker/dealers that is willing to honor sell orders in our common stock. There can be no assurance that such a broker/dealer
would not impose higher commission rates on such sell orders than might be customary for more actively traded stocks trading in
higher price ranges. It is also possible that the number of buyers in the market for our common stock could be reduced if a potential
investor expects that the effort to sell shares of our common stock is too cumbersome.
As
a consequence, there may be periods of several days or more when trading activity in our shares is minimal or non-existent, as
compared to a mature issuer which has a large and steady volume of trading activity that will generally support continuous sales
without an adverse effect on share price. It is possible that a broader or more active public trading market for our common
stock will not develop or be sustained, or that current trading levels will continue.
Because
we do not intend to pay dividends for the foreseeable future, stockholders will only benefit from an investment in our common
stock if it appreciates in value.
We
have never declared any dividends and our board of directors does not intend to declare and distribute dividends in the near future. The
declaration, payment and amount of any future dividends will be made at the discretion of the board of directors and will depend
upon, among other things, the results of our operations, cash flows, financial condition, operating and capital requirements,
and other factors as the board of directors considers relevant. There is no assurance that future dividends will be
paid, and, if dividends are paid, there is no assurance with respect to the amount of any such dividends. We currently intend
to retain our future earnings, if any, to finance further research and development, commence production of the Coates Engine
®
and pay for our general and administrative expenses. As a result, the success of an investment in our common stock will
depend upon any future appreciation in its value. There is no assurance that our common stock will appreciate in value or even
maintain the price at which stockholders have purchased their shares.
Because
we will be subject to the “penny stock” rules if the shares are quoted on the OTC Pink Sheets, the level of trading
activity in the shares may be reduced and shareholders may be unable to sell their shares.
The
SEC has adopted regulations which generally define a “penny stock” to be any equity security that has a market price
of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities
will likely be covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell
to persons other than established customers and accredited investors. The penny stock rules require a broker-dealer, prior to
a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form
prepared by the SEC that provides information about penny stocks and the nature and level of risks in the penny stock market.
The broker-dealer also must provide the customer with current bid and other quotations for the penny stock, the compensation of
the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny
stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information,
must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing
before or with the customer’s confirmation. In addition, the penny stock rules require that prior to executing a transaction
in a penny stock not otherwise exempt from these rules; the broker-dealer must make a special written determination that the penny
stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These
disclosure and suitability requirements may have the effect of reducing the level of trading activity in the secondary market
for a stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers
to trade our securities. We believe that the penny stock rules discourage investor interest in, and limit the marketability of,
our capital stock. Trading of our capital stock may be restricted by the SEC’s “penny stock” regulations which
may limit a stockholder’s ability to buy and sell our stock.
George
J. Coates and his family own a majority of our common stock allowing them to unilaterally determine the outcome of all matters
submitted to our stockholders for approval, which influence may or may not conflict with our interests and the interests of our
other stockholders.
George
J. Coates, together with members of his family and related trusts, are beneficially entitled to approximately 90.2% of votes on
matters submitted to a vote of the outstanding common stockholders at April 12, 2017 and will therefore be able to unilaterally
determine the outcome of all matters submitted to our stockholders for approval, including the election of our directors and other
corporate actions. There can be no assurance that the votes of George J. Coates and his family on matters submitted to a vote
by our shareholders in the future will not conflict with our interests and the interest of our other shareholders.
You
may be unable to sell your common stock at or above your purchase price, which may result in substantial losses to you.
The
following factors may add to the volatility in the price of our common stock: actual or anticipated variations in our quarterly
or annual operating results; government regulations, announcements of significant acquisitions, strategic partnerships or joint
ventures; our capital commitments; dilution of stockholders’ interests through additional issuances of new shares of common
stock; and additions or departures of our key personnel. Many of these factors are beyond our control and may decrease the market
price of our common stock, regardless of our operating performance. We cannot make any predictions or projections as to what the
prevailing market price for our common stock will be at any time, including as to whether our common stock will sustain its current
market price, or as to what effect that the sale of shares or the availability of common stock for sale at any time will have
on the prevailing market price.
Trading
in our common stock may be volatile, which may result in substantial declines in its market price.
Our common
stock is likely to experience significant volatility in response to periodic variations in:
|
●
|
Our
success in commencing our production phase of operations.
|
|
●
|
Results
of testing of the CSRV
®
system technology as it is designed and adapted
for various commercially feasible applications.
|
|
●
|
Our
prospects for entering into new potentially profitable license agreements for our technology.
|
|
●
|
Performance
of the CSRV
®
system technology in the field.
|
|
●
|
Improvements
in engine technology by our competitors.
|
|
●
|
Changes
in general conditions in the economy or the financial markets.
|
The
market may also experience significant volatility which can affect the market prices of securities issued by many companies; often
for reasons unrelated to their operating performance, and may adversely affect the price of our common stock. The market for our
common stock is limited. We cannot assure that an active trading market can be maintained. In such case, our stockholders may
find it difficult to dispose of shares of our common stock and, as a result, may suffer a loss of all or a substantial portion
of their investment.
Our
issuance of additional common stock in exchange for services or to repay debt would dilute your proportionate ownership and voting
rights and could have a negative impact on the market price of our common stock.
Our
board of directors may, from time to time, approve the issuance of shares of common stock to pay for debt or services, without
further approval by our stockholders based upon such factors as our board may deem relevant at that time. As of April 12, 2017,
we had approximately $140,000 face amount of convertible debt outstanding. This debt, if not prepaid within 180 days after the
date of the convertible note, is convertible into shares of our common stock at a 30% to 38% discount from the contractually defined
trading price of our stock over a defined stock price measurement period which precedes the date of conversion. It is possible
that we will issue additional securities to pay for services and reduce debt in the future.
Anti-dilution
protection for George J. Coates, Gregory G. Coates and Barry C. Kaye, stock awards to our officers and directors and exercise
of stock options will cause additional shares of our common stock to be issued which will dilute the ownership interest and share
of dividends of existing shareholders.
We
have granted stock options to officers, directors, consultants and advisers, which may be exercised and converted into shares
of our common stock. In addition, we grant stock awards and provide for anti-dilution protection to key officers and directors
which may be in the form of shares of common stock or instruments convertible into shares of common stock, including Series B
Convertible Preferred Stock. At April 12, 2017, 16,981,089 shares of Series B Convertible Preferred Stock issued to key officers,
which are also directors, each of which is convertible into 1,000 shares of common stock on the 2
nd
anniversary date
after issuance, were issued and outstanding. The occurrence of these events will dilute the ownership interest and share of any
dividends declared by the Company and could depress the market price of our common stock.
Item
1B. Unresolved Staff Comments.
Not applicable.
Item
2. Properties.
We
own our executive offices and research and development facility, which is located in an approximately 29,000 square foot building
on approximately 7 acres in Wall Township, New Jersey, approximately 60 miles outside of New York City.
In
our research and development operations, we own and utilize milling machines, lathes, grinders, hydraulic lifts and presses, tooling,
a dynamometer, emission testing machines and computerized drafting and printing equipment. All such equipment is in good condition.
We believe our current facilities are sufficient for our current needs and will be adequate, or that suitable additional or
substitute space will be available on commercially reasonable terms, for the foreseeable future.
Item
3. Legal Proceedings.
We
are currently not involved in any litigation that we believe could have a materially adverse effect on our financial condition
or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board,
government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of our company
or any of our subsidiaries, threatened against or affecting our company, our common stock, any of our subsidiaries or of our company’s
or our company’s subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could
have a material adverse effect
.
Item
4. Mine Safety Disclosure.
Not
applicable.
PART
II
Item
5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
(a) Market Information
Our
common stock is traded on the OTC Pink Sheets under the ticker symbol COTE. The closing price of the common stock on April 12,
2017 was $0.0005 per share. The high and low closing bid prices for trading of our stock for each of the quarters during 2016
and 2015, are as follows:
|
|
1
st
Quarter
|
|
|
2
nd
Quarter
|
|
|
3
rd
Quarter
|
|
|
4
th
Quarter
|
|
2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
$
|
0.0044
|
|
|
$
|
0.0022
|
|
|
$
|
0.0019
|
|
|
$
|
0.0008
|
|
Low
|
|
$
|
0.0012
|
|
|
$
|
0.0004
|
|
|
$
|
0.0003
|
|
|
$
|
0.0005
|
|
2015:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
$
|
0.0140
|
|
|
$
|
0.0600
|
|
|
$
|
0.0195
|
|
|
$
|
0.0075
|
|
Low
|
|
$
|
0.0020
|
|
|
$
|
0.0010
|
|
|
$
|
0.0032
|
|
|
$
|
0.0024
|
|
In
March 2015, the majority stockholder authorized the board of directors to declare at some indefinite point in the future, a reverse
stock split at such time as the board of directors determines, in its sole discretion, is appropriate based on market conditions
and the Company’s financial condition, results of operations and financial prospects. The Board may select a conversion
ratio which shall be in the range of from (a) one new post-split share of common stock for 5 old pre-split shares of common stock
(a 1:5 ratio) to (b) one new post-split share of common stock for 200 old pre-split shares of common stock (a 1:200 ratio). The
wide range of ratios was established to provide maximum flexibility, so that the board would not be limited in choosing a ratio
that was in the best interest of the company and its shareholders in the event that a reverse stock split is ever declared. The
Board is under no obligation to actually declare a reverse stock split and may never act on this authorization, unless it first
properly considers all conditions and factors and concludes that it is appropriate to do so. This authorization will continue
in force until revoked by a corporate action consented to by the majority stockholder or by a vote of the stockholders.
(b) Holders
At
April 12, 2017, the number of holders of record of our common stock was 757. Because shares of our common stock are held by depositaries,
brokers and other nominees, the number of beneficial holders of our shares is substantially larger than the number of stockholders
of record.
(c) Dividends
We
have never declared or paid any cash dividends on shares of our common or preferred stock. We currently intend to retain earnings,
if any, to fund the development and growth of our business and do not anticipate paying cash dividends in the foreseeable future.
Our payment of any future dividends will be at the discretion of our board of directors after taking into account various factors,
including our financial condition, operating results, cash needs and growth plans.
(d)
Securities Authorized for Issuance under Equity Compensation Plan
2006
Stock Option and Incentive Plan
Our 2006 Stock
Option and Incentive Plan (the “2006 Stock Plan”) was adopted by our board of directors and by consent of George
J. Coates, majority shareholder, was adopted by our shareholders. The 2006 Stock Plan provides for the grant of stockbased
awards to employees, officers and directors of, and consultants or advisors to, the Company and its subsidiaries. Under the
2006 Stock Plan, we may grant options that are intended to qualify as incentive stock options (“incentive stock options”)
within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”), options not intended
to qualify as incentive stock options (“non-statutory options”), restricted stock and other stock-based awards.
Incentive stock options may be granted only to our employees. A total of 12,500,000 shares of common stock may be issued upon
the exercise of options or other awards granted under the 2006 Stock Plan. The maximum number of shares with respect to which
awards may be granted in any calendar year to any employee under the 2006 Stock Plan shall not exceed 25% of the total number
of shares authorized. All shares of common stock under this plan have been granted in the form of stock options.
2014 Stock Option and Incentive Plan
The Company established a 2014 Stock Option and Incentive Plan (the “2014 Stock Plan”)
which was adopted by the Company’s board on May 30, 2014 and by our shareholders on February 27, 2015 by consent of George
J. Coates in his capacity as the majority stockholder. The 2014 Stock Plan provides for the grant of stock-based awards to employees,
officers and directors of, and consultants or advisors to, the Company and its subsidiaries, if any. Under the 2014 Stock Plan,
the Company may grant ISO’s, non-statutory options, restricted stock and other stock-based awards. ISO’s may be granted
only to employees of the Company. A total of 50,000,000 shares of common stock may be issued upon the exercise of options or other
awards granted under the 2014 Stock Plan. The maximum number of shares with respect to which awards may be granted during any
one year to any employee under the 2014 Stock Plan shall not exceed 25% of the 50,000,000 shares of common stock authorized by
the 2014 Stock Plan. At December 31, 2016, none of the shares of common stock authorized under the 2014 Stock Plan had been granted.
The 2006 Stock Plan and the 2014 Stock Plan (the “Stock Plans”) are administered by the board and the Compensation
Committee. Subject to the provisions of the Stock Plans, the board and the Compensation Committee each has the authority to select
the persons to whom awards are granted and determine the terms of each award, including the number of shares of common stock subject
to the award. Payment of the exercise price of an award may be made in cash, in a “cashless exercise” through a broker,
or if the applicable stock option agreement permits, shares of common stock, or by any other method approved by the board or Compensation
Committee. Unless otherwise permitted by the Company, awards are not assignable or transferable except by will or the laws of
descent and distribution.
Upon the consummation of an acquisition of the business of the Company, by merger or otherwise, the
board shall, as to outstanding awards (on the same basis or on different bases as the board shall specify), make appropriate provision
for the continuation of such awards by the Company or the assumption of such awards by the surviving or acquiring entity and by
substituting on an equitable basis for the shares then subject to such awards either (a) the consideration payable with respect
to the outstanding shares of common stock in connection with the acquisition, (b) shares of stock of the surviving or acquiring
corporation or (c) such other securities or other consideration as the board deems appropriate, the estimated fair market value
of which (as determined by the board in its sole discretion) shall not materially differ from the estimated fair market value
of the shares of common stock subject to such awards immediately preceding the acquisition. In addition to or in lieu of the foregoing,
with respect to outstanding stock options, the board may, on the same basis or on different bases as the board shall specify,
upon written notice to the affected optionees, provide that one or more options then outstanding must be exercised, in whole or
in part, within a specified number of days of the date of such notice, at the end of which period such options shall terminate,
or provide that one or more options then outstanding, in whole or in part, shall be terminated in exchange for a cash payment
equal to the excess of the estimated fair market value (as determined by the board in its sole discretion) for the shares subject
to such Options over the exercise price thereof. Unless otherwise determined by the board (on the same basis or on different bases
as the board shall specify), any repurchase rights or other rights of the Company that relate to a stock option or other award
shall continue to apply to consideration, including cash, that has been substituted, assumed or amended for a stock option or
other award pursuant to these provisions. We may hold in escrow all or any portion of any such consideration in order to effectuate
any continuing restrictions.
The board may at any time provide that any stock options shall become immediately exercisable in full or in part, that any
restricted stock awards shall be free of some or all restrictions, or that any other stock-based awards may become exercisable
in full or in part or free of some or all restrictions or conditions, or otherwise realizable in full or in part, as the case
may be.
The board of directors or Compensation Committee may, in its sole discretion, amend, modify or terminate any award
granted or made under the Stock Plan, so long as such amendment, modification or termination would not materially and adversely
affect the participant.
The following table sets forth information with respect to our securities authorized for issuance
as of April 12, 2017, under our 2006 and 2014 Stock Option and Incentive Plans:
|
|
Number of securities to be issued upon exercise of outstanding options, rights and warrants
|
|
|
Weighted average exercise price of outstanding options, rights and warrants
|
|
|
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)
|
|
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
Equity Compensation plans approved by security holders:
|
|
|
12,500,000
|
|
|
$
|
0.182
|
|
|
|
50,000,000
|
|
Equity Compensation plans without approval by security holders
|
|
|
None
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Total
|
|
|
12,500,000
|
|
|
$
|
0.182
|
|
|
|
50,000,000
|
|
No stock options or other stock-based awards have been granted under the 2014 Stock Option and Incentive Plan.
Transfer
Agent and Registrar
American Stock Transfer & Trust Company is currently the transfer agent and registrar for our common stock.
Its address is 6201 15th Avenue, Brooklyn, NY 11219. Its phone number is (800) 937-5449.
Recent
Sales of Unregistered Securities
The
following issuances of securities during the year ended December 31, 2016 were exempt from registration pursuant to Section 4(2),
and Regulation D promulgated under the Securities Act. We made this determination based on the representations of the Investors
which included, in pertinent part, that such Investors were “accredited investors” within the meaning of Rule 501
of Regulation D promulgated under the Securities Act, and that such Investors were acquiring our common stock, for investment
purposes for their own respective accounts and not as nominees or agents, and not with a view to the resale or distribution thereof,
and that the Investors understood that the shares of our common stock may not be sold or otherwise disposed of without registration
under the Securities Act or an applicable exemption therefrom.
In a series of transactions,
an aggregate of $752,000 principal amount of convertible promissory notes, including accrued interest was converted by the
holders into 1,349,144,802 unregistered shares of our common stock.
For the year ended December 31, 2016, 11,937,537, 872,014
and 68,266 shares of Series B were issued to George J. Coates, Gregory G. Coates and Barry C. Kaye, respectively, having an
estimated fair value of $7,060,000, $494,000 and $39,000, respectively.
Rule
10B-18 Transactions
During the year ended December
31, 2015, there were no repurchases of the Company’s common stock by the Company.
Item
6. Selected Financial Data.
We
are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide
the information under this item.
Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Cautionary
Notice Regarding Forward-Looking Statements
THE FOLLOWING DISCUSSION OF OUR PLAN OF OPERATION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL
STATEMENTS AND RELATED NOTES TO THE FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS REPORT. THIS DISCUSSION CONTAINS FORWARD-LOOKING
STATEMENTS THAT RELATE TO FUTURE EVENTS OR OUR FUTURE FINANCIAL PERFORMANCE. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS,
UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE OUR ACTUAL RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS TO BE MATERIALLY
DIFFERENT FROM ANY FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY THESE FORWARD-LOOKING
STATEMENTS. THESE RISKS AND OTHER FACTORS INCLUDE, AMONG OTHERS, THOSE LISTED UNDER “FORWARD-LOOKING STATEMENTS”
AND “RISK FACTORS” AND THOSE INCLUDED ELSEWHERE IN THIS REPORT.
Background
We
have completed development of the Coates spherical rotary valve engine (“CSRV
®
”) system technology.
This technology has been successfully applied to natural gas fueled industrial electric power CSRV
®
generator engines
(“Gen Sets”), automobile engines, residential generators and high performance racing car engines. We have also designed
and retrofitted the CSRV
®
system technology into a diesel engine which is suitable for and can be applied to heavy
trucks. As explained in more detail below, we intend to devote a substantial amount of resources during the remainder of 2017
to develop Hydrogen Gen Sets, capable producing up to 1MW of electrical power output in connection with a newly granted sublicense
agreement with Secure Supplies.
In
December 2016, we executed an exclusive license with Secure Supplies covering Hydrogen Gen Sets in the territory of North America.
Secure Supplies employs a combination of solar generated power and hydrogen cell technology to generate hydrogen gas. It expects
to procure 400 Hydrogen Gen Sets for Phase I of its project to install power generation plants throughout North America. The Company
intends to sell each such Generator Set for $1 million. Development of the first production Generator Set is anticipated to commence
during or before the second quarter of 2017.
In
February 2015, we granted a $100 million non-exclusive distribution sublicense to a China-based sales and distribution company
that covers distribution in the territory of the Western Hemisphere. We also undertook to procure parts and components to commence
limited production of our Gen Sets. We have complete production of an initial next generation 855 cubic inch industrial Gen Set.
We intend to perform quality control on these Gen Sets, after which we will begin ramping up production for sales and distribution
to end users.
Independent
testing on internal combustion engines incorporating the CSRV® system technology indicated the following advantages would
be derived from this technology:
|
●
|
Better
fuel efficiency
|
|
●
|
Reduced harmful emissions
|
Based
on more than ten years of operating a Mercedes 300 with an SE 280 engine retrofitted with the CSRV® system technology, the
following advantages were demonstrated:
|
●
|
Longer intervals between
engine servicing, and
|
|
●
|
Longer engine life than conventional internal
combustion engines.
|
We
continue to be engaged in new research and development activities from time-to-time in connection with applying this technology
to other commercially feasible internal combustion engine applications and intend to manufacture engines and/or license the CSRV
®
system technology to third party Original Equipment Manufacturers (“OEM’s”) for multiple other applications
and uses.
Hydrogen
Reactor Technology Owned by George J. Coates
George
J. Coates has developed a hydrogen reactor which rearranges H
2
O water molecules into HOH molecules also known as Hydroxy-Gas.
Hydroxy-Gas has a different molecular structure than hydrogen gas which will power the Gen Sets for Secure Supplies. It consists
of two hydrogen atoms. The Hydroxy-Gas produced by the hydrogen reactor can then be harvested for use as a type of fuel. While
Mr. Coates intends to continue with development of this technology to enable the harvested Hydroxy-Gas to be utilized as the fuel
source to power our patented CSRV
®
engines, development is being intentionally postponed in order to focus on the
new sublicense agreement with Secure Supplies. The next phase of this research and development will focus on powering larger,
industrial engines. If successful, this application will only require a ready supply of water and would be suitable for stationary
engines and generators. Conventional internal combustion engines employing poppet valve assemblies require lubrication and would
experience excessive heat and friction if powered with Hydroxy-Gas. This, in turn, would cause the engines to burn out in a rather
short period of time. The materials and components of the CSRV
®
engines do not require such lubrication and because
of their design, are able to operate relatively trouble-free on Hydroxy-Gas as the engine fuel. There can be no assurance that
this technology can be developed successfully, or that if developed, it will be feasible to penetrate the internal combustion
engine market with this technology.
We
previously agreed to collaborate on the development of this technology with WTF Asia International Ltd. (“WTF Asia”),
a Hong Kong-based entity to enable it to be applied to large industrial gen set engines. We have designed and integrated the switchgears,
controls, load bank and emissions equipment into the hydrogen reactor/gen set (“Coates Assembled Components”). We
recently recommended that Secure Supplies and WTF Asia directly coordinate this development as a joint effort due to their inherent
synergies in developing hydrogen powered generation of electric power. WTF Asia would be responsible for building additional components
based on technology already developed that will enable the hydrogen reactor to adequately power larger CSRV
®
commercial
and industrial engines.
Applications
for patent protection of this technology would be filed upon completion of the research and development. Although at this time
no arrangements have been made between us and George J. Coates, owner of the technology, regarding licensing of the hydrogen reactor,
Mr. Coates has provided his commitment to license this technology to us once the related patent protection is in place. Accordingly,
we do not currently have any rights to manufacture, use, sell and distribute the hydrogen reactor technology, should it become
commercially feasible to manufacture and distribute products powered by the Hydroxy-Gas fuel. We have been responsible for all
costs incurred to date related to the development of this technology.
Plan
of Operation
Manufacturing,
Sales and Distribution
We
have completed development of the CSRV
®
system technology-based generator engine and during 2016 completed retrofitting
a next generation Cummins industrial engine with our CSRV
®
engine technology. This unit is being used to attract
new licensing transactions and other manufacturing activities. We will need to raise sufficient new working capital to ramp up
our own manufacturing and distribution operations.
As
discussed above, we plan to devote substantial resources for the remainder of 2017 to development of the substantially more powerful
Hydrogen Gen Set for Secure Supplies.
We
intend to take advantage of the fact that essentially all the parts and components of the CSRV
®
generator engine
may be readily sourced and acquired from U.S. based suppliers and subcontractors, and, accordingly, expect to manufacture Gen
Sets by developing assembly lines within owned manufacturing facilities. The initial limited production will enable us to prove
our concept for the CSRV
®
system technology and we expect this will dovetail with the existing demand in the marketplace.
We plan to address this demand by establishing large scale manufacturing operations in the United States. Transitioning to large
scale manufacturing is expected to require a substantial increase in our work force, securing additional manufacturing capacity
and substantial capital expenditures.
Our
ability to establish such manufacturing operations, recruit plant workers, finance initial manufacturing inventories and fund
capital expenditures is highly dependent on our ability to successfully raise substantial new working capital in an amount and
at a pace which matches our business plans. Potential sources of such new working capital include (i) licensing fees from new
sublicensing agreement, (ii) positive working capital generated from sales of our CSRV
®
products and (iii) issuance
of promissory notes to related parties and issuance of convertible notes. Although we have been successful in raising sufficient
working capital to continue our ongoing operations, we have encountered very challenging credit and equity investment markets,
and have not been able to raise sufficient new working capital to enable us to commence production of our Gen Sets. There can
be no assurance that we will be successful in raising adequate new working capital or even any new working capital to carry out
our business plans. The recent trading price range of our common stock at a fraction of a penny has introduced additional risk
and difficulty to our challenge to secure needed additional working capital.
Sublicensing
We
plan to sublicense the CSRV
®
system technology to multiple OEM’s in order to take advantage of third party
manufacturers’ existing production capacity and resources by signing OEM agreements.
Sublicensing
agreements with Secure Supplies and Renown which are already in place are discussed under “
Item 1: Business, Operational
Plan, Sublicensing.”
Significant
Estimates
The
preparation of our financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”)
requires our management to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosures
of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during
the reporting period. These significant estimates include determining the fair value of convertible promissory notes containing
embedded derivatives as a result of variable conversion rate provisions, determining a value for Series A Preferred Stock and
Series B Convertible Preferred Stock issued in connection with anti-dilution provisions in place, assigning useful lives to our
property, plant and equipment, determining an appropriate amount to reserve for obsolete and slow moving inventory, providing
a valuation allowance for deferred tax assets, assigning expected lives to and estimating the rate of forfeitures of stock options
granted and selecting a volatility factor for the Company’s stock options in order to estimate the fair value of the Company’s
stock options on the date of grant. Actual results could differ from those estimates.
Results
of Operations for the Years Ended December 31, 2016 and 2015
Our
principal business activities and efforts during 2016 and 2015 were devoted to (i) retrofitting a Cummins next generation industrial
natural gas engine with our CSRV
®
engine technology, (ii) undertaking efforts to raise additional working capital
in order to fund ongoing operations (iii) research and development of the hydrogen reactor technology and (iv) negotiating a US
$100 Million non-exclusive distribution license with Renown Power Development, Ltd., a China-based company which was consummated
in February 2015.
Although
we incurred substantial net losses for the years ended December 31, 2016 and 2015 of ($8,356,092) and ($10,203,819), respectively,
it is important to consider that a substantial portion of these losses resulted from non-cash expenses required to be recorded
for financial reporting purposes in accordance with GAAP. These net losses should be considered in view of the fact that actual
cash used in operating activities amounting to ($494,125) and ($949,230) in 2016 and 2015, respectively, was significantly less
than these reported net losses. The differences between the reported net losses incurred in 2016 and 2015 are described in detail
in the section “Liquidity and Capital Resources”.
Revenue
There
were no sales in 2016 and 2015.
Sublicensing
fee revenue for the years ended December 31, 2016 and 2015 amounted to $29,200 and $94,200, respectively. Sublicensing fees are
being recognized by amortizing the license deposit of $300,000 on the Canadian License over the approximate remaining life of
the last CSRV
®
technology patent in force. Sublicensing fee revenue for 2016 included $10,000 in connection with
the sublicense agreement with Secure Supplies. Sublicensing fee revenue for 2015 included the recognition of $75,000 deposit from
an abandoned sublicensing agreement that was recognized as revenue.
Expenses
Research
and Development Expenses
Research
and development activities in 2016 and 2015 were primarily related to retrofitting a Cummins next generation industrial natural
gas engine with our CSRV
®
engine technology, the hydrogen reactor project and continuing development of production
parts and components for CSRV
®
Industrial
Gen Sets. Research and development expenses decreased by $172,268 or 41.3% to $244,877 in 2016 from $417,145 in 2015. This net
decrease is primarily due to (i) a $169,700 decrease in the amount of compensation and benefits allocated to research and development
activities in (ii) a $2,568 decrease in parts and materials utilized in research and development in 2016.
Stock-based
Compensation Expense
Stock
based compensation expense decrease by $698,989 to $6,875,514 in 2016 from $7,574,503 in 2015. For the years ended December 31,
2016 and 2015, 12,706,904 and 2,907,247 shares of Series B Convertible Preferred Stock were issued for anti-dilution to George
J. Coates, Gregory G. Coates and Barry C. Kaye, respectively. In spite of this increase in the number of shares issued for anti-dilution,
stock-based compensation decreased due to the lower trading price range of the Company’s common stock price during 2016
as compared to 2015, which resulted in a lower value of the shares issued being charged to expense in 2016.
Compensation
and Benefits
Compensation
and benefits increased by $172,268 to $450,222 in 2016 from $277,935 in 2015. This increase was due primarily due to a decrease
of $169,700 in the amount of salaries and benefits allocated to and reported as research and development expenses.
General
and Administrative Expenses
General
and administrative expenses decreased by ($136,291) to $403,253 in 2016 from $539,544 in 2015. The net decrease in 2016 was primarily
related to decreases in legal and professional fees of ($38,413), building expenses of ($12,719), investor relations costs of ($12,182), non-capitalizable equipment purchases of $(10,158), office expenses of ($7,896), marketing costs of ($6,667), printing
costs of ($6,460), state and local taxes of ($4,936) financing costs of ($3,734), repairs and maintenance of ($3,626), property
taxes of ($3,403), utilities of ($3,141), warehouse expenses of ($2,403), miscellaneous income and expenses of ($12,955), and
a net decrease in all other expenses of ($7,598).
In
order to preserve our working capital, George J. Coates, Gregory G. Coates, Barry C. Kaye and Bernadette Coates have voluntarily
agreed to defer payment of their compensation. As of April 12, 2017, the amount of their unpaid, deferred compensation amounted
to $980,385, $76,203, $227,875 and $261,200, respectively. This deferred compensation is intended to be paid when we are successful
in our efforts to raise sufficient new working capital.
Depreciation
and Amortization
Depreciation
and amortization expense decreased to $
48,370 in 2016 from $52,552 in 2015.
Loss
from Operations
A
loss from operations of ($7,993,036) was incurred in 2016 compared with a loss from operations of ($8,767,497) in 2015.
Other
Expense
Increase
in Estimated Fair Value of Embedded Liabilities
The
estimated fair value of embedded liabilities, which relates to outstanding convertible promissory notes, is remeasured at each
balance sheet date. For the years ended December 31, 2016 and 2015, other income (expense) was recorded to reflect the decrease
(increase) in the fair value of embedded liabilities of $479,455 and ($157,232), respectively.
Loss
on conversion of convertible notes
For
the years ended December 31, 2016 and 2015, the Company realized a loss on conversion of convertible notes of ($143,118) and ($273,160),
respectively.
Interest
Expense
Interest
expense decreased to $
699,093 in 2016 from $1,005,930 in 2015. Interest expense
in 2016 consisted of non-cash interest related to convertible promissory notes of $296,130, interest on promissory notes to related
parties of $292,702, mortgage loan interest of $95,234, and net other interest of $15,027. Interest expense in 2015 consisted
of non-cash interest related to convertible promissory notes of $652,773, interest on promissory notes to related parties of $217,638,
mortgage loan interest of $100,162, interest expense related to the sale/leaseback of equipment of $32,398 and net other interest
of $2,959.
Deferred
Taxes
In
2016 and 2015, the change in deferred taxes was fully offset by a valuation allowance, resulting in a $-0- net income tax provision.
Net
Loss
For
the year ended December 31, 2016, we incurred a net loss of
($8,356,092) or
($0.00) per share, as compared with net loss of ($10,203,819) or ($0.01) per share for 2015. Included in the net losses for the
years ended December 31, 2016 and 2015 was $
7,229,801 and $8,886,738, respectively,
of non-cash expenses, net of non-cash revenues.
Liquidity
and Capital Resources
Our
cash position at December 31, 2016 was $9,163, a decrease of $20,044 from our cash position of $29,207 at December 31, 2015. We
had a working capital deficit of ($5,411,111) at December 31, 2016 which represents a reduction in the deficit of $64,847 compared
to the ($5,475,958) of negative working capital at December 31, 2015. Our current liabilities of $5,658,784 at December 31, 2016,
decreased by $73,516 from $5,732,300 at December 31, 2015. This net decrease primarily resulted from (i) a ($479,455) net decrease
in derivative liability related to convertible promissory notes, (ii) a ($362,309) decrease in the carrying amount of convertible
notes, net of unamortized discount, partially and (iii) a decrease of $20,632 decrease in other current liabilities, partially
offset by (i) a 438,607 increase in accounts payable and accrued liabilities and (ii) an increase in deferred compensation payable
of $350,173.
Operating
activities utilized cash of ($494,128) for the year ended December 31, 2016, a decrease of $455,105 from the cash utilized for
operating activities of ($949,230) for the year ended December 31, 2015. Cash utilized by operating activities in the year ended
December 31, 2016 resulted primarily from (i) a cash basis net loss of ($1,126,292) (after adding back non-cash stock-based compensation
expense of $6,875,514, non-cash interest expense of $601,053, a non-cash loss on conversion of convertible notes of $143,418,
depreciation and amortization of $48,370 and the non-cash portion of inventory used in research and development of $60,101, partially
offset by a non-cash decrease in embedded derivative liabilities related to convertible notes of ($479,455) and recognition of
non-cash licensing revenues of ($19,200); and (ii) a decrease in inventory of $26,535, an increase in deferred offering costs
and other assets of ($37,910), an increase of $293,369 in accounts payable and accrued liabilities and an increase in deferred
compensation payable of $350,173.
Cash
used for investing activities consisted of $11,493 for acquisitions of property, plant and equipment in 2016.
Cash
generated from financing activities amounted to $485,574 in 2016. This was comprised of $199,306 from sales of common stock under
an equity purchase agreement with Southridge Partners II LP,
issuances of promissory notes to related
parties of $182,143, issuances of convertible promissory notes aggregating $175,750, issuances of common stock and warrants of
$75,000, sublicensing fee revenue of $10,000, partially offset by net repayments of promissory notes held by related parties of
($93,000), principal repayments of ($55,000) on the mortgage loan payable and repayments of a finance lease obligation amounting
to ($8,625).
Going
Concern
We
have incurred net recurring losses since inception, with an accumulated deficit amounting to ($65,327,090), as of December
31, 2016 and had a stockholders’ deficiency of ($5,196,882). We will need to obtain additional working capital in order
to continue to cover our ongoing cash expenses.
These
factors raise substantial doubt about our ability to continue as a going concern. In addition, the current economic
environment, which is characterized by tight credit markets, investor uncertainty about how to safely invest funds and low
investor confidence, has introduced additional risk and difficulty to our challenge to secure needed additional working
capital. Our Independent Registered Public Accountants have stated in their Auditor’s Report dated April 14, 2017 with
respect to our financial statements as of and for the year ended December 31, 2016 that these circumstances raise substantial
doubt about our ability to continue as a going concern.
During
2016, we restricted variable costs to only those expenses that are necessary to perform activities related to efforts to negotiate
sublicenses of our CSRV
®
products,
raising working capital to enable us to commence production of our CSRV
®
system technology products, research and
development and general administrative costs in support of such activities.
During
the years ended December 31, 2016 and 2015, we raised $
642,199 and $1,107,761,
respectively, of new working capital from sales of registered shares common stock under an equity purchase agreement, issuances
of promissory notes to related parties, issuances of convertible promissory notes, sales of our common stock and common stock
warrants in 2016 and sublicensing fee revenue in 2016.
Our
financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
Sources
of working capital and new funding being pursued by us include (i) issuances of convertible promissory notes, (ii) sublicensing
fees from prospective new sublicensees, (iii) manufacturing and sales of CSRV
®
Units, (iv) issuances of additional
promissory notes to related parties and (v) sales of common stock and warrants. There can be no assurance that we will be successful
in securing any of these sources of additional funding. In this event, we may be required to substantially or completely curtail
our operations, which could have a material adverse affect on our operations and financial condition.
At
December 31, 2016, current liabilities were comprised of promissory notes due to related parties aggregating $1,454,699, legal
and professional fees of $1,452,653, deferred compensation of $1,272,317, accrued interest payable of $501,736, accrued general
and administrative expenses of $391,927, an embedded derivative liability related to convertible promissory notes of $153,472,
deposits with orders of $150,595, accrued research and development expenses of $114,859, the current portion of license deposits
of $60,725, the current portion of a mortgage loan amounting to $60,000 and convertible promissory notes, net of unamortized discount
of $45,801.
Contractual
Obligations and Commitments
The
following table summarizes our contractual obligations and commitments at December 31, 2016:
|
|
|
|
|
Due Within
|
|
|
|
Total
|
|
|
2017
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
Promissory notes to related parties
|
|
$
|
1,454,699
|
|
|
$
|
1,454,699
|
|
|
$
|
-
|
|
Mortgage loan payable
|
|
|
1,333,158
|
|
|
|
65,000
|
|
|
|
1,268,158
|
|
Deferred compensation
|
|
|
1,272,317
|
|
|
|
1,272,317
|
|
|
|
-
|
|
Convertible promissory notes
|
|
|
99,000
|
|
|
|
99,000
|
|
|
|
-
|
|
Total
|
|
$
|
4,159,174
|
|
|
$
|
2,891,016
|
|
|
$
|
1,268,158
|
|
Critical
Accounting Policies
The
Company’s significant accounting policies are presented in the Company’s notes to financial statements for the period
ended December 31, 2016 which are contained in this filing, the Company’s 2016 Annual Report on Form 10-K. The significant
accounting policies that are most critical and aid in fully understanding and evaluating the reported financial results include
the following:
The
Company prepares its financial statements in conformity with generally accepted accounting principles in the United States of
America. These principals require management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Management believes that these estimates are reasonable and have been discussed
with the Board of Directors; however, actual results could differ from those estimates.
Long-lived
assets such as property, equipment and identifiable intangibles are reviewed for impairment whenever facts and circumstances indicate
that the carrying value may not be recoverable. When required, impairment losses on assets to be held and used are
recognized based on the fair value of the asset. The fair value is determined based on estimates of future cash flows,
market value of similar assets, if available, or independent appraisals, if required. If the carrying amount of the
long-lived asset is not recoverable from its undiscounted cash flows, an impairment loss is recognized for the difference between
the carrying amount and fair value of the asset. When fair values are not available, the Company estimates fair value
using the expected future cash flows discounted at a rate commensurate with the risk associated with the recovery of the assets. We
did not recognize any impairment losses for any periods presented.
Other
significant estimates include determining the fair value of convertible promissory notes containing embedded derivatives and variable
conversion rates, determining a value for Series A Preferred Stock and Series B Convertible Stock issued and certain limited anti-dilution
rights granted to George J. Coates, assigning useful lives to the Company’s property, plant and equipment, determining an
appropriate amount to reserve for obsolete and slow moving inventory, estimating a valuation allowance for deferred tax assets,
assigning expected lives to, and estimating the rate of forfeitures of, stock options granted and selecting a trading price volatility
factor for the Company’s common stock in order to estimate the fair value of the Company’s stock options on the date
of grant or other appropriate measurement date. Actual results could differ from those estimates.
New
Accounting Pronouncements
Revenue
Recognition
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which amends the existing accounting
standards for revenue recognition. ASU 2014-09 is based on principles that govern the recognition of revenue at an amount an entity
expects to be entitled to when products are transferred to customers. In August 2015, the FASB issued ASU No. 2015-14, Revenue
from Contracts with Customers (Topic 606) – Deferral of the Effective Date, which defers the effective date of ASU 2014-09
for one year and permits early adoption. Accordingly, the Company may adopt the standard in either its first quarter of 2018 or
2019.
In
April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606) – Identifying Performance
Obligations and Licensing (“ASU 2016-10”), which amends the guidance in ASU 2014-09 related to identifying performance
obligations and accounting for licenses of intellectual property. The Company will adopt ASU 2016-10 with ASU 2014-09. The Company
is currently evaluating the impact of adopting the new revenue recognition standard, as amended, but does not expect it to have
a material impact on its financial statements.
Stock
Compensation
In
March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718), which simplified certain
aspects of the accounting for share-based payment transactions, including income taxes, classification of awards and classification
in the statement of cash flows. ASU 2016-09 will be effective for the Company beginning in its first quarter of 2018. The Company
is currently evaluating the impact of adopting the new stock compensation standard, but does not expect it to have a material
impact on its financial statements.
Financial
Instruments
In
January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10) (“ASU 2016-01”),
which updates certain aspects of recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 will
be effective for the Company beginning in its first quarter of 2019. The Company does not believe the adoption of the new financial
instruments standard will have a material impact on its financial statements.
Inventory
Measurement
In
July 2015, the FASB issued ASU No. 2015-11, “Inventory – Simplifying the Measurement of Inventory (Topic 330)”.
This update requires that inventory value be measured at the lower of cost or net realizable value. Net realizable value is the
estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.
Currently, generally accepted accounting principles require that inventory be valued at the lower of cost or market price to replace
the inventory. This update is to become effective for annual and interim financial statements for fiscal years ending after December
15, 2016. This update is required to be applied prospectively. The Company is currently evaluating the impact of this update;
however, at this time it does not expect it will have a material impact on its financial statements.
Income
Taxes
In
November 2015,
FASB issued ASU No. 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification
of Deferred Taxes”. This update was designed to simplify the presentation of deferred taxes by eliminating the requirement
to separately classify the current and non-current portion of deferred tax assets and liabilities. Accordingly, this update will
require that all deferred tax assets and liabilities be presented as non-current. This update will become effective for annual
periods beginning after December 15, 2016, and interim periods within those annual periods. The Company is currently evaluating
the impact of this update, however, at this time it does not expect it will have a material effect on its financial statements.
Off-Balance
Sheet Arrangements
We have no off-balance sheet arrangements.
Item
7A. Quantitative and Qualitative Disclosures about Market Risk.
We
are not required to provide the information required by this Item because we are a smaller reporting company.
Item
8. Financial Statements and Supplementary Data.
Reference
is made to the Financial Statements as of and for the Years ended December 31, 2016 and 2015 beginning on page F-1.
Item
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
On April 18, 2016, we were informed by our independent registered public accounting firm, Cowan, Gunteski & Co., P.A.
(“Cowan”), that it has transferred its SEC practice to MSPC. As a result of the transfer and upon notice by “Cowan”
to the Company on April 18, 2016, “Cowan” in effect has resigned as our independent registered public accounting
firm and MSPC became our independent registered public accounting firm. The engagement of MSPC as our independent registered
public accounting firm was ratified and approved by our Board of Directors on April 21, 2016.
Item
9A. Controls and Procedures.
(a)
Evaluation of Disclosure Controls and Procedures
Pursuant
to Rule 13a-15(b) under the 1934 Act, the Company carried out an evaluation, with the participation of our management, including
the Company’s Chief Executive Officer (“CEO”) (the Company’s principal executive officer) and Chief Financial
Officer (“CFO”) (the Company’s principal financial and accounting officer), of the effectiveness of the Company’s
disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the end of the period covered
by this report. Based upon that evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls
and procedures are effective to ensure that information required to be disclosed by the Company in the reports that the Company
files or submits under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in
the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management,
including the Company’s CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.
(b)
Management's Annual Report on Internal Control over Financial Reporting.
The
management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for
the Company. Our internal control system was designed to, in general, provide reasonable assurance to the Company’s
management and board regarding the preparation and fair presentation of published financial statements, but because of its inherent
limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our
management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. The
framework used by management in making that assessment was the criteria set forth in the document entitled “ Internal Control
– Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that
assessment, our management has determined that as of December 31, 2016, the Company’s internal control over financial reporting
was effective for the purposes for which it is intended.
This
annual report does not include an attestation report of the Company’s
independent
registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to
attestation by the Company's independent registered public accounting firm as we are a smaller reporting company and are not required
to provide the report.
(c)
Changes in Internal Controls over Financial Reporting
There
were no changes in our internal controls over financial reporting that occurred during the fourth quarter of the fiscal year
ended December 31, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
Item
9B. Other Information.
None.
PART
III
Item
10. Directors, Executive Officers and Corporate Governance.
Executive
Officers and Directors
The
following table lists the current members of our board of directors and our executive officers as of April 12, 2017. Our
directors hold office until their successors have been duly elected and qualified. Executive officers are elected by the
Board of Directors and serve at the discretion of the directors. The address for our directors is c/o Coates
International, Ltd., Highway 34 & Ridgewood Road, Wall Township, New Jersey 07719. The board of directors did not meet during the year ended December 31, 2016.
Name
|
|
Age
|
|
Position
|
|
|
|
|
|
George J. Coates
|
|
77
|
|
Director, Chairman of the Board, Chief Executive Officer and President
|
|
|
|
|
|
Gregory G. Coates
|
|
46
|
|
Director, Secretary and President, Technology Division
|
|
|
|
|
|
Barry C. Kaye
|
|
63
|
|
Director, Treasurer and Chief Financial Officer
|
|
|
|
|
|
Jack Perkowski
|
|
68
|
|
Director *, **
|
|
|
|
|
|
Dr. Frank Adipietro
|
|
59
|
|
Director *, ***
|
|
|
|
|
|
Richard Whitworth
|
|
68
|
|
Director *, **, ***
|
* Serves
as an independent director.
** Serves
as a member of our audit committee.
*** Serves
as a member of our compensation committee.
George
J. Coates
is our founder and, with the exception of a short period of time of less than one year, has served from the inception
of the Company as a director, Chairman of the Board of Directors, President and Chief Executive Officer. Mr. Coates is also the
majority stockholder.
George
J. Coates
has served two apprenticeships in Europe while attending the College of Technology in London, and as an associate
member of the Society of Automotive Engineers (“SAE”) where he received The City and Guilds of London for electrical
and mechanical engineering. He is a former management director of SCR Motor Engineers of Europe and holds the certificate of Ministry
of Transport in the United Kingdom. He worked as an engineer for Rolls Royce and Mercedes Benz, BLMC, Austin, and D. Napier. He
holds approximately 300 patents worldwide on innovations and technologies, including the CSRV
®
system technology
and a turbine engine, among others. He invented coolant disc brakes and a hydraulic suspension. Mr. Coates is a licensed inspector
of the New Jersey Motor Vehicle Commission.
He
has delivered lectures and presentations at:
|
|
●
|
RWTH Aachen University,
Aachen, Germany
|
●
|
University of Birmingham,
Birmingham, England
|
●
|
Rutgers University,
Newark, New Jersey, USA.
|
He
is a member of the American Society of Mechanical Engineers and SAE. He received awards in 1995 for achievement in designs in
automotive engineering from the SAE. He also received awards in 2001 for outstanding achievements in Mechanical Engineering from
the American Society of Mechanical Engineers. Mr. Coates has extensive experience in international corporate business and has
developed many longtime associates and contacts in the business and scientific communities around the world.
Gregory
G. Coates
became a director of the Company in October 2006, and had served as the Chairman of our Board of Directors until
March 2007. In October 2006, he became our President – Technology Division. For more than thirty years, Gregory G. Coates
has worked with us as a design engineer, working in research and development, designing and building the CSRV
®
system technology and adapting this technology to various existing applications. He created some of our licensed inventions, and
patented certain of them. Gregory G. Coates is an Associate Member of the Society of Automotive Engineers, Inc., and a Member
of the American Society of Mechanical Engineers. He graduated from the College of Technology in Ireland. He invented and patented
the Multi Sequential Fuel Management System
®
, a vital component of our CSRV
®
engines and also holds patents on other innovative technologies.
Barry
C. Kaye
became a director of the Company in October 2006 and has been serving as our Treasurer and Chief Financial Officer
since October 2006. Mr. Kaye is a Certified Public Accountant in both New York and New Jersey. Mr. Kaye served as Vice President,
Finance from 2009 to 2010 for Results Media, LLC, a company that provided direct mail marketing services. From 2006 to 2009, Mr.
Kaye served as Vice President, Finance and Operations for Corporate Subscription Management Services, LLC, a company that processes
orders as agent for various publishers. Since 1999, he has been serving as an Executive Business Consultant with BCK Business
Consulting which provides various business consulting services to the business community. From 2004 to 2005, Mr. Kaye served as
Corporate Controller of Development Corporation for Israel, a registered broker-dealer that distributes bonds of the government
of Israel. He was the Vice President, Finance & Operations for Alliance Corner Distributors, Inc., a company engaged in sales
and distribution of video games and other forms of digital entertainment media from 2003 to 2004. From 1987 to 1999, he served
as Group Vice President, Finance at Sharp Electronics Corporation, a $3.5 billion company engaged in sales and distribution of
consumer electronics, office equipment products and microelectronic components, where he was responsible for all finance and “back
office” operations. From 1976 to 1987, Mr. Kaye worked for Arthur Andersen & Co. where he achieved the position of Senior
Audit Manager. He is a member of the American Institute of Certified Public Accountants as well as a member of the New York and
New Jersey State Societies of Certified Public Accountants. Mr. Kaye received his Bachelor of Science in Accounting degree, graduating
with Cum Laude distinction from Brooklyn College of the City University of New York.
Jack
Perkowski
became a director of the Company in February 2015. He was also elected to serve as Chairman of our Audit Committee
of the Board of Directors. Mr. Perkowski is widely recognized as an expert on doing business in China. Jack graduated Cum Laude
from Yale University and with High Distinction from Harvard Business School where he was named a Baker Scholar. He spent eighteen
years on Wall Street, rising to head of investment banking at PaineWebber. Jack demonstrated his visionary leadership by devoting
three years investigating opportunities in Asia and China, well before others would learn to appreciate the significant role that
China would come to play in the global economy. This led to the founding of ASIMCO Technologies, a major industrial enterprise,
which he built and managed for fifteen years.
Under
Jack’s leadership, ASIMCO gained a reputation for developing local management and integrating a broad based China operation
into the global economy. ASIMCO grew into one of the largest automobile components manufacturers in China with 12,000 employees
at 17 plants in 8 provinces. ASIMCO was twice named one of the “Ten Best Employers in China” in surveys conducted
by Hewitt Associates and leading news organizations in Asia. In 2008, Jack was designated by China Auto News, as one of “30
Outstanding Entrepreneurs in China’s Auto Components Industry over the 30 Years of Economic Reform,” the only foreigner
to receive this distinction.
He
authored “Managing the Dragon: How I’m Building a Billion Dollar Business in China”, and provides timely insights
into ongoing developments in the country on
www.managingthedragon.com
. His articles on China, its economy and developing
a business in the country have been published in the Wall Street Journal, the Far Eastern Economic Review, the Huffington Post,
Am Cham’s China Brief and Business Forum China. Jack is a frequent speaker to university and business school groups, corporate
and industry conferences and leading professional organizations such as the Council on Foreign Relations, the Asia Society and
the YPO, and has been interviewed on CNN, CNBC, Fox, BBC, NPR, and CCTV. Jack’s unique journey to China has been featured
in many articles on the subject.
Jack
serves on the Board of Directors of Credit First Financial Leasing Co., Inc., China’s first independent auto leasing company,
and OC3 Entertainment, the leading provider of facial animation software in the world. Previously, Jack served on the Board of
Directors and as the head of the Special Committee of NASDAQ listed Fushi Copperweld, Inc., the world’s leading bimetallic
company, which went private in 2013. Jack is also a member of the China Advisory Council of Magna International, Inc., one of
the largest suppliers to the auto industry, and a member of JP Morgan’s “China Expert Series.” Jack has also
been named a Distinguished Speaker at the University of Virginia’s Darden School of Business.
In
April 2009, Jack founded JFP Holdings, a merchant banking firm focused on China, where he now serves as Managing Partner. JFP
Holdings is headquartered in Beijing, has representatives in the United States, Japan and the United Kingdom, and was established
to help Western companies bring their products, technology and know-how to China and assist Chinese companies with global expansion.
The
JFP Holdings team includes management and investment professionals with deep experience in China and significant investment banking
experience. JFP Holdings is uniquely positioned to assist Western companies develop their strategies for the China market and
to help them implement and fund their China strategies. With its knowledge of both China and the world’s developed markets,
JFP Holdings provides Chinese companies with value added advice on their overseas expansion plans.
Dr.
Frank J. Adipietro
became a director of the Company in October 2006. Dr. Adipietro earned an M.D. degree from SUNY Downstate
Medical School, Brooklyn, New York. He has also earned a Bachelor of Science degree from New York University, graduating with
Phi Beta Kappa and Magna Cum Laude distinction. He has been practicing in the area of anesthesia and interventional pain management
for more than thirty years. He serves as President of the Medical Staff at Eastern Long Island Hospital in Greenport, New York
since 2009 and serves on numerous hospital committees as well. Vice Chairman of the Board of Trustees since 1999. He was affiliated
with Lenox Hill Hospital, New York, NY for more than twelve years in the field of Cardiothoracic Anesthesia.
Richard
Whitworth
became a director of the Company in October 2006. Mr. Whitworth earned a Bachelor of Science degree from the University
of Florida and has completed extensive post-graduate coursework and seminars in Law, Public Administration, Health Policy, Finance,
Criminal Justice, Social Work and Education. He has been serving as the president of the Whitworth Group Inc. for more than the
past 20 years. The Whitworth Group specializes in governmental and public relations, organizational development and financial
services. Prior to that, he was the Director for the DWI Program Office for the Florida Supreme Court from 1979 to 1987. From
1976 to 1978 he was the Director of Prevention for the Florida Association Drug Abuse Treatment and Education Centers, Inc. From
1974 to 1976 he served as Specialist, Health and Mental Health, Aging Program Office for the Department of Health and Rehabilitation
Services. Prior to that, he was the Director of Prevention for the Drug Abuse Program under the direction of the Department of
Health and Rehabilitation Services.
Family
Relationships
George
J. Coates is the father of Gregory G. Coates. Bernadette Coates, the spouse of George J. Coates, is employed as an administrative
manager of the Company. No other family relationships exist between the directors and executive officers of the Company.
Board
Committees
Our
board of directors established an audit committee and a compensation committee in October 2006. All of the members of each of
these standing committees are independent as defined under NASDAQ rules and, in the case of the audit committee, the independence
requirements contemplated by Rule 10A-3 under the Securities Exchange Act.
Audit
Committee
Jack
Perkowski is the Chairman and Richard Whitworth is a member of the audit committee. The audit committee’s responsibilities
include: appointing, approving the compensation of, and assessing the independence of our independent auditor; overseeing
the work of our independent auditor, including through the receipt and consideration of reports from the independent auditor; reviewing
and discussing with management and our independent auditor our annual and quarterly financial statements and related disclosures; monitoring
our internal control over financial reporting, disclosure controls and procedures, and code of business conduct and ethics; discussing
our risk management policies; establishing policies regarding hiring employees from our independent auditor and procedures for
the receipt and retention of accounting related complaints and concerns; communicating independently with our independent auditor
and management; and preparing the audit committee report required by SEC rules to be included in our proxy statements, if
any.
All
audit services and all non-audit services, except de minimis non-audit services, must be approved in advance by the audit committee.
Our
board of directors has determined that it does not have a member of its audit committee that qualifies as an "audit committee
financial expert" as defined in Item 407(d)(5)(ii) of Regulation S-K, and is "independent" as the term is used
in Item 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934, as amended. We have not been able to identify a
qualified audit committee financial expert to serve in such capacity.
During
each of the years ended December 31, 2016 and 2015, the Audit Committee held four audit committee meetings.
In connection with the audit of our financial statements as of and the year ended December 31, 2016
by
MSPC, our Independent Public Accounting Firm and in connection with the audit of our financial statements
as of and
the year ended December 31, 2015 by Cowan, Gunteski & Co., P.A.
(“Cowan”), our Independent Public Accounting Firm, our audit committee has communicated with MSPC and Cowan for those
respective years, regarding the matters required to be discussed by the Statement on Auditing Standards No. 61 as adopted by the
Public Company Accounting Oversight Board (“PCAOB”) in Rule 3200T. In addition, the audit committee has received the
written disclosures and the letter from MSPC and Cowan for those respective years required by Independence Standards Board Standard
No. 1 as adopted by the PCAOB in Rule 3600T and has discussed with MSPC and Cowan their independence for those respective years.
The
audit committee has reviewed and discussed our audited financial statements as of and for each of the two years ended December
31, 2015 with management and based on this review and discussion has recommended to the board of directors that such audited financial
statements be included in this annual report on Form 10-K for filing with the Securities and Exchange Commission.
Compensation
Committee
Dr. Frank
J. Adipietro and Richard Whitworth serve on the compensation committee. The compensation committee’s responsibilities include:
|
●
|
annually
reviewing and approving corporate goals and objectives relevant to compensation of our
chief executive officer;
|
|
●
|
determining
the compensation of our chief executive officer;
|
|
●
|
reviewing
and approving, or making recommendations to our board of directors with respect to the
compensation of our other executive officers;
|
|
●
|
overseeing
an evaluation of our senior executives;
|
|
●
|
overseeing
and administering our cash and equity incentive plans; and
|
|
●
|
reviewing
and making recommendations to our board with respect to director compensation.
|
The
Compensation Committee did not meet during the years ended December 31, 2016 and 2015. There were no changes to any executive’s
compensation during this period.
Corporate
Governance
We
believe that good corporate governance is important to ensure that, as a public company, we will manage for the long-term benefit
of our stockholders. In that regard, we have established and adopted charters for the audit committee and compensation committee,
as well as a code of business conduct and ethics applicable to all of our directors, officers and employees. Our code of business
conduct and ethics can be viewed on our website at
www.coatesengine.com
.
Compensation
Committee Interlocks and Insider Participation
George
J. Coates, Gregory G. Coates and Barry C. Kaye are executive officers and members of our board of directors. None of our executive
officers serves as a member of our compensation committee, audit committee or other committee serving an equivalent function.
None of the current members of the compensation committee of our board have ever been employed by us.
Liability
Limitations and Indemnification
The
following description is intended as a summary only and is qualified in its entirety by reference to our amended and restated
certificate of incorporation and amended and restated by-laws incorporated by reference as exhibits into this report. We refer
in this section to our amended and restated certificate of incorporation as our certificate of incorporation, and we refer to
our amended and restated by-laws as our by-laws.
Our
certificate of incorporation and by-laws limit the liability of directors to the maximum extent permitted by Delaware law. Delaware
law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary
duties as directors, except liability for:
|
●
|
any
breach of their duty of loyalty to the corporation or its stockholders;
|
|
●
|
acts
or omissions that are not in good faith or that involve intentional misconduct or a knowing
violation of law;
|
|
●
|
unlawful
payments of dividends or unlawful stock repurchases or redemptions; or
|
|
●
|
any
transaction from which a director derived an improper personal benefit.
|
The
limitations do not apply to liabilities arising under the federal securities laws and do not affect the availability of equitable
remedies, including injunctive relief or rescission.
Our
certificate of incorporation and by-laws provide that we will indemnify our directors and officers, and may indemnify other employees
and agents, to the maximum extent permitted by law. We believe that indemnification under our by-laws covers at least negligence
and gross negligence on the part of indemnified parties. Our by-laws also permit us to secure insurance on behalf of any officer,
director, employee or agent for any liability arising out of actions taken in his or her capacity as an officer, director, employee
or agent, regardless of whether the by-laws would permit indemnification.
Insofar
as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers and controlling
persons under our certificate of incorporation or by-laws or the indemnification agreements we have entered into with our directors
and officers, we have been advised that in the opinion of the SEC, this indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable.
Involvement
in Certain Legal Proceedings
We
are currently not involved in any litigation that we believe could have a materially adverse effect on our financial condition
or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board,
government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of our company
or any of our subsidiaries, threatened against or affecting our company, our common stock, any of our subsidiaries or of our company’s
or our company’s subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could
have a material adverse effect.
To
the best of our knowledge, none of our directors or executive officers has, during the past ten years:
|
●
|
been
convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding
traffic violations and other minor offenses);
|
|
●
|
had
any bankruptcy petition filed by or against the business or property of the person, or
of any partnership, corporation or business association of which he was a general partner
or executive officer, either at the time of the bankruptcy filing or within two years
prior to that time;
|
|
●
|
been
subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated,
of any court of competent jurisdiction or federal or state authority, permanently or
temporarily enjoining, barring, suspending or otherwise limiting, his involvement in
any type of business, securities, futures, commodities, investment, banking, savings
and loan, or insurance activities, or to be associated with persons engaged in any such
activity;
|
|
●
|
been
found by a court of competent jurisdiction in a civil action or by the Securities and
Exchange Commission or the Commodity Futures Trading Commission to have violated a federal
or state securities or commodities law, and the judgment has not been reversed, suspended,
or vacated;
|
|
●
|
been
the subject of, or a party to, any federal or state judicial or administrative order,
judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including
any settlement of a civil proceeding among private litigants), relating to an alleged
violation of any federal or state securities or commodities law or regulation, any law
or regulation respecting financial institutions or insurance companies including, but
not limited to, a temporary or permanent injunction, order of disgorgement or restitution,
civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition
order, or any law or regulation prohibiting mail or wire fraud or fraud in connection
with any business entity; or
|
|
●
|
been
the subject of, or a party to, any sanction or order, not subsequently reversed, suspended
or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the
Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity
Exchange Act), or any equivalent exchange, association, entity or organization that has
disciplinary authority over its members or persons associated with a member.
|
Code of Business Conduct and Ethics
Our
code of business conduct and ethics can be viewed on our website at
www.coatesengine.com
.
Item
11. Executive Compensation.
The
following table sets forth the compensation of specified executive officers and directors for the years ended December 31, 2016
and 2015:
Summary
Compensation Table
Name and Principal Position
|
|
Year
|
|
Salary
|
|
|
Anti-dilution and Stock Awards
|
|
|
Interest
|
|
|
All Other
Compensation
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
George J. Coates
|
|
2016
|
|
$
|
250,000
|
(1)
|
|
$
|
7,060,266
|
(2)
|
|
$
|
29,939
|
(3)
|
|
$
|
16,072
|
(4)
|
|
$
|
7,356,277
|
|
Chief Executive Officer and President
|
|
2015
|
|
|
250,000
|
(1)
|
|
|
7,439,024
|
(2)
|
|
|
57,863
|
(3)
|
|
|
17,685
|
(4)
|
|
|
7,764,572
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Barry C. Kaye
|
|
2016
|
|
|
-
|
|
|
|
38,639
|
(5)
|
|
|
105,149
|
(6)
|
|
|
102,400
|
(6)
|
|
|
245,784
|
|
Chief Financial Officer and Treasurer
|
|
2015
|
|
|
-
|
|
|
|
39,646
|
(5)
|
|
|
-
|
|
|
|
111,000
|
(7)
|
|
|
122,646
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gregory G. Coates
|
|
2016
|
|
|
150,280
|
(8)
|
|
|
493,646
|
(10)
|
|
|
-
|
|
|
|
21,941
|
(4)
|
|
|
665,867
|
|
President, Technology Division
|
|
2015
|
|
|
155,769
|
(9)
|
|
|
506,427
|
(10)
|
|
|
-
|
|
|
|
22,200
|
(4)
|
|
|
684,396
|
|
|
(1)
|
For
each
of the two years ended December 31, 2016 and 2015, George J. Coates was paid $-0- of
this salary amount and $250,000 of his salary was deferred until such time that we have
sufficient working capital to pay such deferred compensation.
|
|
(2)
|
During
the years ended December 31, 2016 and 2015, George J. Coates received
11,937,537
and 2,708,430 shares, respectively, of Series B Convertible Preferred Stock with estimated
fair values of $7,060,266 and $7,439,024, respectively, pursuant to an anti-dilution
agreement.
|
|
(3)
|
Represents
interest earned by George J. Coates on promissory notes from the Company for working
capital he provided for operations amounting to $29,939 and $57,863 for the years ended
December 31, 2016 and 2015, respectively.
|
|
(4)
|
Other
compensation for
George J. Coates
and Gregory G. Coates consisted of health, dental and life insurance for the years ended
December 31, 2016 and 2015.
|
|
(5)
|
During
the year ended December 31,
2016 and 2015, Barry C. Kaye received
68,266 and 14,435 shares, respectively, of Series B Convertible Preferred Stock with
estimated fair values of $38,639 and $39,648, respectively, pursuant to an anti-dilution
agreement.
|
|
(6)
|
This
amount includes $102,400 of compensation earned in 2016 and $105,149 of accrued interest
on unpaid compensation during the period from March 2012 through December 2016.
During
the year ended December 31, 2016, Barry C. Kaye was paid compensation of $6,000 of this
amount. As of December 31, 2016, Mr. Kaye was owed $202,400 of compensation he earned
during the period from January 2015 to December 31, 2016 and $105,149 of accrued interest.
These amount is included in accounts payable and accrued liabilities in the Company’s
balance sheet at December 31, 2016.
|
|
(7)
|
During
the year ended December 31, 2015, Barry C. Kaye was paid compensation of $83,000.
|
|
(8)
|
For
the year ended December 31, 2016, Gregory G. Coates was paid $117,347 of this salary
amount and $32,933 of his salary was deferred until such time that we have sufficient
working capital to pay such deferred compensation.
|
|
(9)
|
Includes
salary paid to Gregory G. Coates for vacation earned, but not taken.
|
|
(10)
|
During
the years ended December 31, 2016 and 2015, Gregory G. Coates received 872,014 and 184,382
shares, respectively, of Series B Convertible Preferred Stock with estimated fair values
of $493,564 and $506,427, respectively, pursuant to an anti-dilution agreement.
|
Outstanding
Equity Awards at Fiscal Year End
The
following table presents the outstanding equity awards to our executives as of December 31, 2016:
Name
|
|
Number of Securities Underlying Unexercised Options
that are Exercisable
|
|
|
Number of Securities Underlying Unexercised Options that are Unexercisable
|
|
|
Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options
|
|
|
Exercise Price
|
|
|
Option Expiration Date
|
George J. Coates
|
|
|
1,000,000
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
0.440
|
|
|
10/23/2021
|
|
|
|
50,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.430
|
|
|
11/3/2024
|
|
|
|
275,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.400
|
|
|
11/18/2025
|
|
|
|
1,800,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.250
|
|
|
7/26/2026
|
|
|
|
1,815,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.060
|
|
|
6/24/2027
|
Gregory G. Coates
|
|
|
500,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.440
|
|
|
10/23/2021
|
|
|
|
1,800,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.240
|
|
|
8/8/2026
|
|
|
|
351,500
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.028
|
|
|
4/30/2029
|
Barry C. Kaye
|
|
|
125,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.440
|
|
|
10/17/2021
|
|
|
|
100,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.042
|
|
|
12/9/2028
|
|
|
|
351,500
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.028
|
|
|
4/30/2029
|
Vesting
of the stock options is subject to acceleration under certain circumstances in the event of an acquisition of the Company.
Director
Compensation
A
compensation program was adopted by the board of directors which provides for compensation to our directors in the amount of $1,000
per day, plus reasonable travel expenses. This compensation plan further provides for the granting of stock options to our non-employee
directors from time to time under our 2014 Stock Option and Incentive Plan to purchase our common stock at an exercise price equal
to the quoted closing price of our common stock on the day prior to the date of grant.
We
did not pay any compensation to our non-employee directors for the years ended December 31, 2016 and 2015.
Employment
contracts, termination of employment and change-in-control arrangements
There
are currently no employment contracts with any of our employees and there have been no terminations or change-in-control arrangements.
Item
12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The
following table sets forth information with respect to the beneficial ownership of our common stock as of
April 12, 2017 for:
|
●
|
each
of our executive officers and directors;
|
|
●
|
all
of our executive officers and directors as a group; and
|
|
●
|
any
other beneficial owner of more than 5% of our outstanding common stock.
|
Beneficial
ownership is determined in accordance with the rules of the SEC. These rules generally attribute beneficial ownership of securities
to persons who possess sole or shared voting power or investment power with respect to those securities and include ordinary shares
issuable upon the exercise of stock options that are immediately exercisable or exercisable within 60 days. Except as otherwise
indicated, all persons listed below have sole voting and investment power with respect to the shares beneficially owned by them,
subject to applicable community property laws. The information is not necessarily indicative of beneficial ownership for any other
purpose.
Percentage
ownership calculations are based on 3,177,788,855 shares outstanding as of April 12
,
2017
. Addresses of named beneficial owners are c/o Coates International, Ltd., 2100 Highway 34
& Ridgewood Road, Wall Township, New Jersey 07719.
|
|
Beneficial Ownership
|
|
|
|
|
|
|
|
|
|
Shares Beneficially Owned
|
|
Name of Beneficial Owner
|
|
Outstanding Shares
Beneficially Owned
|
|
|
Right
to Acquire Within 60 Days After April 12,
2017
|
|
|
Number
|
|
|
Percentage
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
George J. Coates
|
|
|
579,912,070
|
(1)
|
|
|
2,329,621,000
|
(2)
|
|
|
2,909,533,070
|
|
|
|
51.80
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gregory G. Coates
|
|
|
14,032,520
|
|
|
|
172,437,500
|
(3)
|
|
|
186,470,020
|
|
|
|
3.32
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Barry C. Kaye
|
|
|
5,648,358
|
|
|
|
9,318,500
|
(4)
|
|
|
14,916,858
|
|
|
|
0.27
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dr. Frank Adipietro
|
|
|
3,735,364
|
|
|
|
827,000
|
|
|
|
4,562,364
|
|
|
|
0.08
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Richard Whitworth
|
|
|
-
|
|
|
|
25,000
|
|
|
|
25,000
|
|
|
|
0.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Jack Perkowski
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All executive officers and directors as a group (6 persons)
|
|
|
603,328,312
|
|
|
|
2,512,229,000
|
|
|
|
3,115,507,312
|
|
|
|
55.47
|
%
|
|
(1)
|
Includes
1,956,960 shares owned by Mr. Coates' spouse and 1,165,507 shares owned by The Coates
Trust, a trust controlled by George J. Coates as Trustee. Beneficial ownership of these
shares is disclaimed by George J. Coates.
|
|
(2)
|
Includes
2,324,861
shares of Series B Convertible Preferred Stock which are eligible for conversion into
2,324,681,000 shares of common stock
and 4,940,000 vested common
stock options.
|
|
(3)
|
Includes
169,786 shares of Series B Convertible Preferred Stock which are eligible for conversion
into 169,786,000 shares of common stock and 2,651,500 vested common stock options.
|
|
(4)
|
Includes
9,318 shares of Series B Convertible Preferred Stock which are eligible for conversion
into 9,318,000 shares of common stock and 576,500 vested common stock options.
|
Item
13. Certain Relationships and Related Transactions, and Director Independence.
Certain
Relationships and Related Transactions
A
related person is defined as any person who is (1) a director or executive officer of the registrant, (2) any nominee for director,
(3) any immediate family member of a director or executive officer of the registrant or of any nominee for director, (4) any person
who is known to the Company to be the beneficial owner of more than 5% of any class of the registrant’s voting securities
and (5) any immediate family of any person who is known to the Company to be the beneficial owner of more than 5% of any class
of the registrant’s voting securities.
Promissory
Notes to Related Parties
Promissory
Notes due to George J. Coates
During
the years ended December 31, 2016 and 2015, we issued, in a series of transactions, promissory notes to George J. Coates and received
cash proceeds of $177,000 and $70,000, respectively. During the years ended December 31, 2016 and 2015 the Company repaid promissory
notes to George J. Coates in cash in the aggregate principal amount of $93,000 and $120,000, respectively, which included $ 63,000
of interest in 2016. In addition, the Company and Mr. Coates mutually agreed to convert $159,000 of promissory notes into common
stock of the Company at exercise prices ranging from $0.0006 to $0.0011 per share. The exercise price was determined to be the
closing trading price of the Company’s common stock on the date of conversion. The promissory notes are payable on demand
and provide for interest at the rate of 17% per annum, compounded monthly. At December 31, 2016, the outstanding balance was $314,975,
including accrued interest.
Promissory
Note Issued to Gregory G. Coates
The
Company has a non-interest bearing note payable to Gregory G. Coates, son of George J. Coates, President, Technology Division
and Director, with a principal balance of $1,438,000, which is payable on demand. During the year ended December 31, 2015, the
Company repaid $24,000 principal amount of this promissory note. As required by GAAP, interest at the rate of 10% per annum amounting
to $144,000 and $145,000 has been imputed on this promissory note for the years ended December 31, 2016 and 2015, respectively.
Promissory
Notes Issued to Bernadette Coates
During
the year ended December 31, 2015, the Company partially repaid promissory notes to Bernadette Coates, spouse of George J. Coates,
in the aggregate principal amount of $36,000, respectively. The promissory notes are payable on demand and provided for interest
at the rate of 17% per annum, compounded monthly. At December 31, 2016, the outstanding balance was $86,262, including accrued
interest.
Share
Issuances - Series B Convertible Preferred Stock
We
provide anti-dilution protection to George J. Coates, Gregory G. Coates and Barry C. Kaye whenever new shares our common stock
are issued to any other parties. Such anti-dilution may be in the form of an award of either (i) shares of Series A Preferred
Stock which entitles the holder to 10,000 votes per share on any matters brought before the common stockholders for a vote; or,
(ii) shares of Series B Convertible Preferred Stock which are convertible into shares of our common stock on the second anniversary
after the date of issuance and entitle the holder to 1,000 votes per share on any matters brought before the common stockholders
for a vote.
For
the year ended December 31, 2016, 11,937,537, 872,014 and 68,266 shares of Series B were issued to George J. Coates, Gregory G.
Coates and Barry C. Kaye, respectively, having an estimated fair value of $7,060,000, $494,000 and $39,000, respectively.
For
the year ended December 31, 2015, 2,708,430, 184,382 and 14,435 shares of Series B were issued to George J. Coates, Gregory G.
Coates and Barry C. Kaye, respectively, having an estimated fair value of $7,495,000, $510,000 and $40,000, respectively.
During
the year ended December 31, 2016, George J. Coates and Barry C. Kaye converted 115,006 shares and 2,976 shares of Series B into
115,006,000 and 2,976,000 shares of our common stock, respectively.
At
December 31, 2016, there were 16,252,584 shares of Series B outstanding. In the event that all of these shares were converted,
once the conversion restrictions lapse, an additional 16,252,584,000 new unregistered shares of common stock would be issued.
On a pro forma basis, based on the number of shares of common stock outstanding at December 31, 2016, this would dilute the ownership
percentage of non-affiliated stockholders from 70.7% to 8.7%.
Stock
Option Grants
No
stock options were issued during the years ended December 31, 2016 and 2015.
During
the year ended December 31, 2015, stock options to purchase 703,000 shares of common stock at an exercise price of $0.028 per
share became vested and 30,000 stock options with an exercise price of $1.00 per share expired. The estimated fair value of stock
options which vested during the year ended December 31, 2015 was $20,000.
Compensation
For
the years ended December 31, 2016 and 2015, George J. Coates earned base compensation of $250,000 and $250,000, respectively,
payment of which has been deferred until we have sufficient working capital.
For
the years ended December 31, 2016 and 2015, Gregory G. Coates earned base compensation of $150,280 and $155,769, respectively.
Payment of $32,934 of his compensation in 2016 has been deferred until we have sufficient working capital. The compensation in
2015 included payment for vacation earned, but not taken.
For
the years ended December 31, 2016 and 2015, Bernadette Coates, spouse of George J. Coates, earned base compensation of $67,240
and $67,240, respectively, payment of which has been deferred until we have has sufficient working capital.
Consulting
Fees
During
the years ended December 31, 2016 and 2015, Barry C. Kaye, Treasurer and Chief Financial Officer was paid compensation of $6,000
and $83,000, respectively. For the year ended December 31, 2016, Mr. Kaye earned compensation of $102,000, which was not paid
and is being deferred until we have sufficient working capital to remit payment to him. During the year ended December 31, 2016,
the Company agreed to accrue interest on the balance of his deferred compensation retroactive to when it began being deferred
in May 2012 and, accordingly, recorded interest expense of $105,000. This amount is included in interest expense in the accompanying
statement of operations for the year ended December 31, 2016. Interest continues to be accrued on the unpaid balance. At December
31, 2016, the total amount of Mr. Kaye’s unpaid, deferred compensation, including accrued interest thereon, was $308,000.
This amount is included in accounts payable and accrued liabilities in the accompanying balance sheet at December 31, 2016.
Personal
Guaranty and Pledge of Stock
The
Company’s mortgage loan on its headquarters is collateralized by the pledge of five million shares of common stock of the
Company owned by George J. Coates, which were deposited into escrow for the benefit of the lender and by his personal guaranty.
Director
Independence
We
have used the definition of “independence” contained in the listing rules of the NASDAQ Stock Market to make the determination
as to whether or not our directors are independent, because our common stock is not currently listed on a national securities
exchange. NASDAQ Listing Rule 5605(a)(2) provides that an “independent director” is a person other than an officer
or employee of the Company or any other individual having a relationship which, in the opinion of the Company’s board of
directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The NASDAQ
listing rules provide that a director cannot be considered independent if:
|
●
|
the
director is, or at any time during the past three years was, an employee of the company;
|
|
●
|
the
director or a family member of the director accepted any compensation from the company
in excess of $120,000 during any period of 12 consecutive months within the three years
preceding the independence determination (subject to certain exclusions, including, among
other things, compensation for board or board committee service);
|
|
●
|
a
family member of the director is, or at any time during the past three years was, an
executive officer of the company;
|
|
●
|
the
director or a family member of the director is a partner in, controlling stockholder
of, or an executive officer of an entity to which the company made, or from which the
company received, payments in the current or any of the past three fiscal years that
exceed 5% of the recipient’s gross revenue for that year or $200,000, whichever
is greater (subject to certain exclusions);
|
|
●
|
the
director or a family member of the director is employed as an executive officer of an
entity where, at any time during the past three years, any of the executive officers
of the company served on the compensation committee of such other entity; or the director
or a family member of the director is a current partner of the company’s outside
auditor, or at any time during the past three years was a partner or employee of the
company’s outside auditor, and who worked on the company’s audit.
|
The
following table sets forth the members of our board of directors that are independent and certain board committee assignments:
Dr.
Frank Adipietro
|
|
Director
*, **
|
|
|
|
Jack
Perkowski
|
|
Director
*, ***
|
|
|
|
Richard
Whitworth
|
|
Director
*, **, ***
|
* Serves
as an independent director.
** Serves
as a member of our compensation committee.
*** Serves
as a member of our audit committee.
Item
14. Principal Accounting Fees and Services.
On
April 18, 2016, we were informed by our independent registered public accounting firm, Cowan, Gunteski & Co., P.A. (“Cowan”),
that it has transferred its SEC practice to MSPC. As a result of the transfer and upon notice by “Cowan” to the Company
on April 18, 2016, “Cowan” in effect has resigned as our independent registered public accounting firm and MSPC became
our independent registered public accounting firm. The engagement of MSPC as our independent registered public accounting firm
was ratified and approved by our Board of Directors on April 21, 2016.
MSPC
did not bill us for any services during the year ended December 31, 2015.
Audit
Fees
During
the year ended December 31, 2016, MSPC billed us in the aggregate $22,500 for professional services rendered for their reviews
of the quarterly financial statements included in our Forms 10-Q for each of the each of the three quarters in 2016.
During
the year ended December 31, 2016, Cowan billed us in the aggregate $47,500 for professional services rendered for their audit
of our annual financial statements for the years ended December 31, 2015, included in our Form 10-K.
During
the year ended December 31, 2015, Cowan billed us in the aggregate $74,000 for professional services rendered for their audit
of our annual financial statements for the years ended December 31, 2014, included in our Form 10-K and their reviews of the quarterly
financial statements included in our Forms 10-Q for each of the three quarters in 2015.
Audit-related
Fees
We
did not incur any audit-related fees during the year ended December 31, 2016.
For
the year ended December 31, 2015, Cowan billed us $16,383 in connection with providing their consent to the inclusion of our audited
financial statements in a registration statement and the amendments thereto on Form S-1.
Tax
Fees
We
did not incur any tax fees during the years ended December 31, 2016 and 2015.
All
Other Fees
The
Company did not incur any other fees related to services rendered by our principal auditors for the fiscal years ended December
31, 2016 and 2015.
The
Securities and Exchange Commission adopted rules which require that before our auditor is engaged by us to render any auditing
or permitted non-audit related service, the engagement be:
|
●
|
approved
by our audit committee; or
|
|
●
|
entered
into pursuant to pre-approval policies and procedures established by the audit committee,
provided the policies and procedures are detailed as to the particular service, the audit
committee is informed of each service, and such policies and procedures do not include
delegation of the audit committee’s responsibilities to management.
|
All
of the above services were approved in accordance with the above adoptive rules of the Securities and Exchange Commission.
PART
IV
Item
15. Exhibits, Financial Statement Schedules.
(a)
Documents Filed as Part of this Report.
|
(1)
|
Financial
Statements.
|
Audited
financial statements of Coates International, Inc. as of December 31, 2016 and 2015 and for the years then ended are presented
beginning on page F-1.
|
(2)
|
Financial
Statement Schedules.
|
None
Exhibit
No.
|
|
Description
|
|
|
|
3.1(i)
(1)
|
|
Certificate
of Amendment of Certificate of Incorporation filed with the Secretary of State of Delaware on August 19, 1997
|
|
|
|
3.1(iii)
(1)
|
|
Certificate
of Amendment of Certificate of Incorporation filed with the Secretary of State of Delaware on May 19, 2000
|
|
|
|
3.1(iv)
(1)
|
|
Certificate
of Amendment of Certificate of Incorporation filed with the Secretary of State of Delaware
on August 31, 2001
|
|
|
|
3.1(v)
(2)
|
|
Certificate
of Amendment of Certificate of Incorporation filed with the Secretary of State of Delaware
on September 12, 2007
|
|
|
|
3.1(vi)
(3)
|
|
Certificate
of Amendment of Certificate of Incorporation filed with the Secretary of State of Delaware,
dated May 29, 2015
|
|
|
|
3.1(vii)
(22)
|
|
Certificate
of Amendment of Certificate of Incorporation filed with the Secretary of State of Delaware,
dated June 17, 2016
|
|
|
|
3.2
(1)
|
|
Bylaws
|
|
|
|
4.1
(4)
|
|
Certificate of Designation, Preferences and Rights of Series A Preferred Stock, effective April 30, 2009
|
|
|
|
4.2
(4)
|
|
Certificate of Amendment of Certification of Designation, Preferences and Rights of Series A Preferred Stock, effective May 24, 2011
|
|
|
|
4.3
(5)
|
|
Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stock, dated January 14, 2014
|
|
|
|
4.4
(6)
|
|
Certificate of Amendment of Designation of Series B Convertible Preferred Stock, dated March 9, 2015
|
|
|
|
4.5
(22)
|
|
Certificate of Amendment of Designation of Series B Convertible Preferred Stock, dated February 23, 2016
|
|
|
|
4.6
(22)
|
|
Certificate of Amendment of Designation of Series B Convertible Preferred Stock, dated November 14, 2016
|
|
|
|
10.1
(7)
|
|
License Agreement, dated September 29, 1999, with Well to Wire Energy, Inc.
|
|
|
|
10.2
(7)
|
|
Amendment No. 1 to License Agreement with Well to Wire Energy Inc. dated April 6, 2000
|
|
|
|
10.3
(7)
|
|
Amendment No. 2 to License Agreement with Well to Wire Energy Inc. dated July 21, 2000
|
|
|
|
10.4
(8)
|
|
2006 Employee Stock Option and Incentive Plan adopted on October 25, 2006
|
|
|
|
10.5
(9)
|
|
Amended and Restated License Agreement between the Company and George J. Coates and Gregory G. Coates dated April 6, 2007
|
|
|
|
10.6
(10)
|
|
License Agreement between the Company and Well to Wire Energy, Inc. dated January 29, 2008 and executed on April 7, 2008
|
|
|
|
10.7
(10)
|
|
Escrow Agreement between the Company and Well to Wire Energy, Inc. dated April 11, 2008
|
|
|
|
10.8
(11)
|
|
Memorandum of Understanding dated February 8, 2010 among the Company, Well to Wire Energy, Inc. and Almont Energy, Inc. covering the consent of the Company to the assignment of the Canadian License, Research and Development Agreement, Rights to the US Licensing Agreement and the Right of First Refusal.
|
|
|
|
10.9
(12)
|
|
Letter from Cummins confirming supply arrangement with Coates International, Ltd.
|
|
|
|
10.10
(13)
|
|
2014 Employee Stock Option and Incentive Plan adopted on May 31, 2014
|
|
|
|
10.11
(14)
|
|
License Agreement between the Company and Renown Power Development, Ltd., executed February 24, 2015.
|
|
|
|
10.12
(15)
|
|
Equity Purchase Agreement between the Company and Southridge Partners II LP, dated July 29, 2015
|
|
|
|
10.13
(15)
|
|
Registration Rights Agreement between the Company and Southridge Partners II LP, dated July 29, 2015
|
|
|
|
10.14
(16)
|
|
Secured Convertible Promissory Notes issued to Typenex Co-Investment, LLC, dated August 14, 2015
|
|
|
|
10.15
(16)
|
|
Securities Purchase Agreement Between the Company and Typenex Co-Investment, LLC, dated J August 14, 2015
|
|
|
|
10.16
(17)
|
|
Convertible Promissory Note Issued to GW Holdings Group, LLC, dated August 15, 2016
|
|
|
|
10.17
(17)
|
|
Securities Purchase Agreement Between the Company and GW Holdings Group, LLC, dated August 15, 2016
|
|
|
|
10.18
(18)
|
|
Convertible Promissory Note Issued to APG Capital Holding, LLC dated September 28, 2016
|
|
|
|
10.19
(18)
|
|
Securities Purchase Agreement Between the Company and APG Capital Holding, LLC, dated September 28, 2016
|
|
|
|
10.20
(21)
|
|
Convertible Promissory Note Issued to Adar Abays, LLC dated December 15, 2016
|
|
|
|
10.21
(21)
|
|
Securities Purchase Agreement Between the Company and Adar Abays, LLC dated December 15, 2016
|
|
|
|
10.22
(19)
|
|
Convertible Promissory Note Issued to Power Up Funding Lending Group Ltd., dated January 5, 2017
|
|
|
|
10.23
(19)
|
|
Securities Purchase Agreement Between the Company and Power Up Funding Lending Group Ltd., dated January 5, 2017
|
|
|
|
10.24
(20)
|
|
License Agreement Between the Company and Various Secure Supplies entities, dated December 5, 2016
|
|
(1)
|
Incorporated by reference from the Company’s Registration Statement filed May 31, 2007 on Form SB-2 with the Securities and Exchange Commission, File No. 333-143406.
|
|
|
|
|
(2)
|
Incorporated by reference from the Company’s Schedule 14C DEF filed with the Securities and Exchange Commission on October 1, 2007.
|
|
|
|
|
(3)
|
Incorporated by reference from the Company’s Registration Statement filed July 30, 2015 on Form S-1 with the Securities and Exchange Commission, File No. 333-205959.
|
|
(4)
|
Incorporated by reference from the Company’s Form 10-K filed with the Securities and Exchange Commission on April 16, 2013.
|
|
|
|
|
(5)
|
Incorporated by reference from the Company’s Form 10-K filed with the Securities and Exchange Commission on March 31, 2014.
|
|
|
|
|
(6)
|
Incorporated by reference from the Company’s Form 10-K filed with the Securities and Exchange Commission on March 30, 2015.
|
|
|
|
|
(7)
|
Incorporated by reference from the Company's Registration Statement and amendments thereto filed September 11, 2001 on Form 10-SB12G with the Securities and Exchange Commission, File No. 000-33155.
|
|
|
|
|
(8)
|
Incorporated by reference from the Company’s Form 10-KSB/A for the year ended December 31, 2005 filed on October 25, 2006.
|
|
|
|
|
(9)
|
Incorporated by reference from the Company’s Form 10-KSB for the year ended December 31, 2006.
|
|
|
|
|
(10)
|
Incorporated by reference from the Company’s Form 8-K filed with the Securities and Exchange Commission on April 11, 2008.
|
|
|
|
|
(11)
|
Incorporated by reference from the Company’s Form 10-K for the year ended December 31, 2009.
|
|
|
|
|
(12)
|
Incorporated by reference to the Company’s Registration Statement on Form S-1 filed on June 24, 2011.
|
|
|
|
|
(13)
|
Incorporated by reference from the Company’s Form S-1 filed with the Securities and Exchange Commission on August 19, 2014.
|
|
|
|
|
(14)
|
Incorporated by reference from the Company’s Form 10-K for the fiscal year ended December 31, 2014.
|
|
|
|
|
(15)
|
Incorporated by reference from the Company’s Form S-1 filed with the Securities and Exchange Commission on July 30, 2015.
|
|
|
|
|
(16)
|
Incorporated by reference from the Company’s Form 8-K filed with the Securities and Exchange Commission on August 20, 2015.
|
|
|
|
|
(17)
|
Incorporated by reference from the Company’s Form 8-K filed with the Securities and Exchange Commission on August 19, 2016.
|
|
|
|
|
(18)
|
Incorporated by reference from the Company’s Form 10-Q filed with the Securities and Exchange Commission on November 10, 2016.
|
|
|
|
|
(19)
|
Incorporated by reference from the Company’s Form 8-K filed with the Securities and Exchange Commission on January 11, 2017.
|
|
|
|
|
(20)
|
Incorporated by reference from the Company’s Form 8-K filed with the Securities and Exchange Commission on December
15, 2016.
|
|
|
|
|
(21)
|
Filed herewith.
|
|
|
|
|
(22)
|
In accordance with SEC Release 33-8238, Exhibit 32.1 and 32.2 are being furnished and not filed.
|
*
Furnished
herewith.
SIGNATURES
Pursuant
to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, on April 14, 2017.
|
COATES INTERNATIONAL, LTD.
|
|
|
|
|
By:
|
/s/ George J. Coates
|
|
|
George J. Coates, Chairman and
Chief Executive Officer
|
|
|
|
|
By:
|
/s/ Barry C. Kaye
|
|
|
Barry C. Kaye, Chief Financial Officer
|
Pursuant
to the requirement 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 dates indicated.
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
/s/
George J. Coates
|
|
Director,
Chairman, Chief Executive Officer and President
|
|
April
14, 2017
|
George
J. Coates
|
|
(principal
executive officer)
|
|
|
|
|
|
|
|
/s/
Gregory G. Coates
|
|
Director,
Secretary and President-Technology Division
|
|
April
14, 2017
|
Gregory
G. Coates
|
|
|
|
|
|
|
|
|
|
/s/
Barry C. Kaye
|
|
Director,
Treasurer, Chief Financial Officer
|
|
April
14, 2017
|
Barry
C. Kaye
|
|
(principal
financial and accounting officer)
|
|
|
|
|
|
|
|
/s/
John Perkowski
|
|
Director
|
|
April
14, 2017
|
John
Perkowski
|
|
|
|
|
|
|
|
|
|
/s/
Frank J. Adipietro
|
|
Director
|
|
April
14, 2017
|
Frank
J. Adipietro
|
|
|
|
|
|
|
|
|
|
/s/
Richard Whitworth
|
|
Director
|
|
April
14, 2017
|
Richard
Whitworth
|
|
|
|
|
Coates International, Ltd.
Index to Financial Statements
December 31, 2016 and 2015
MSPC
CERTIFIED PUBLIC ACCOUNTANTS
340 NORTH AVENUE
CRANFORD, NJ 07016
Report of Independent Registered Public Accounting
Firm
To the Board of Directors and
Stockholders of Coates International, Ltd.
We have audited the accompanying balance sheet
of Coates International, Ltd. as of December 31, 2016, and the related statements of operations, stockholders’ deficiency,
and cash flows for the year ended December 31, 2016. Coates International, Ltd.’s management is responsible for these financial
statements. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the financial statements referred
to above present fairly, in all material respects, the financial position of Coates International, Ltd. as of December 31, 2016,
and the results of its operations and its cash flows for the year ended December 31, 2016, in conformity with accounting principles
generally accepted in the United States of America.
The accompanying financial statements have
been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the
Company continues to have negative cash flows from operations, recurring losses from operations, and a stockholders’ deficiency.
These conditions raise substantial doubt about its ability to continue as a going concern. Management’s plans regarding these
matters are also described in Note 1. The financial statements do not include any adjustments that may result from the outcome
of this uncertainty.
/s/
MSPC
|
|
|
|
Cranford,
New Jersey
|
|
April 14,
2017
|
|
Report
of Independent Registered Public Accounting Firm
To
the Board of Directors and
Stockholders
of Coates International, Ltd.
We
have audited the accompanying balance sheet of Coates International, Ltd. as of December 31, 2015, and the related statements
of operations, stockholders’ deficiency, and cash flows for the year then ended. Coates International, Ltd ‘s, management
is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based
on our audit.
We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial
reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures
that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
In
our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Coates
International, Ltd. as of December 31, 2015, and the results of its operations and its cash flows for the year ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
The
accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed
in Note 1 to the financial statements, the Company continues to have negative cash flow from operations, recurring losses from
operations and a stockholders’ deficiency. These conditions raise substantial doubt about its ability to continue as a going
concern. Management’s plans regarding these matters are also described in Note 1. The financial statements do not include
any adjustments that may result from the outcome of this uncertainty.
/s/
Cowan, Gunteski & Co., P.A.
April
14, 2016
Tinton Falls, NJ
Coates
International, Ltd.
Balance
Sheets
As
of December 31,
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Assets
|
Current Assets
|
|
|
|
|
|
|
Cash
|
|
$
|
9,163
|
|
|
$
|
29,207
|
|
Inventory
|
|
|
191,482
|
|
|
|
218,018
|
|
Deferred offering costs and other
assets
|
|
|
47,028
|
|
|
|
9,117
|
|
Total Current Assets
|
|
|
247,673
|
|
|
|
256,342
|
|
Property, plant and equipment, net
|
|
|
2,076,396
|
|
|
|
2,108,990
|
|
Deferred licensing costs, net
|
|
|
38,166
|
|
|
|
42,449
|
|
Total Assets
|
|
$
|
2,362,235
|
|
|
$
|
2,407,781
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders' Deficiency
|
Current Liabilities
|
|
|
|
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
$
|
2,461,175
|
|
|
$
|
2,022,568
|
|
Promissory notes to related parties
|
|
|
1,454,699
|
|
|
|
1,455,882
|
|
Deferred compensation payable
|
|
|
1,272,317
|
|
|
|
922,144
|
|
Derivative liability related to convertible promissory
notes
|
|
|
153,472
|
|
|
|
632,927
|
|
Deposits
|
|
|
150,595
|
|
|
|
150,595
|
|
Current portion of license deposits
|
|
|
60,725
|
|
|
|
60,725
|
|
Current portion of mortgage loan payable
|
|
|
60,000
|
|
|
|
60,000
|
|
Convertible promissory notes, net of unamortized discount
|
|
|
45,801
|
|
|
|
408,110
|
|
Current portion of finance lease
obligation, net of unamortized discount
|
|
|
-
|
|
|
|
19,349
|
|
Total Current Liabilities
|
|
|
5,658,784
|
|
|
|
5,732,300
|
|
|
|
|
|
|
|
|
|
|
Non-current portion of mortgage loan payable
|
|
|
1,273,158
|
|
|
|
1,328,159
|
|
Non-current portion of license
deposits
|
|
|
627,175
|
|
|
|
646,375
|
|
Total Liabilities
|
|
|
7,559,117
|
|
|
|
7,706,834
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Stockholders' Deficiency
|
|
|
|
|
|
|
|
|
Preferred stock, $0.001 par value, 100,000,000 shares authorized:
|
|
|
|
|
|
|
|
|
Series A Preferred Stock, 1,000,000 shares designated,
50,000 shares issued and outstanding at December 31, 2016 and 2015
|
|
|
50
|
|
|
|
50
|
|
Series B Convertible Preferred Stock,75,000,000 and 5,000,000
shares designated and 16,252,584 and 3,492,749 shares issued and outstanding at December 31, 2016 and 2015, respectively
|
|
|
16,253
|
|
|
|
3,493
|
|
Common Stock, $0.0001 par value, 12,000,000,000 shares
authorized, 3,002,730,366 shares issued and outstanding at December 31, 2016 and 2,000,000,000 shares authorized, 1,036,791,116
shares issued and outstanding at December 31, 2015
|
|
|
300,273
|
|
|
|
103,679
|
|
Additional paid-in capital
|
|
|
59,813,632
|
|
|
|
51,564,723
|
|
Accumulated deficit
|
|
|
(65,327,090
|
)
|
|
|
(56,970,998
|
)
|
Total Stockholders' Deficiency
|
|
|
(5,196,882
|
)
|
|
|
(5,299,053
|
)
|
Total Liabilities and Stockholders'
Deficiency
|
|
$
|
2,362,235
|
|
|
$
|
2,407,781
|
|
The
accompanying notes are an integral part of these financial statements.
Coates
International, Ltd.
Statements
of Operations
|
|
For the Years Ended
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Sublicensing fee revenue
|
|
$
|
29,200
|
|
|
$
|
94,200
|
|
Total Revenues
|
|
|
29,200
|
|
|
|
94,200
|
|
Expenses:
|
|
|
|
|
|
|
|
|
Research and development costs
|
|
|
244,877
|
|
|
|
417,145
|
|
Stock-based compensation expense
|
|
|
6,875,514
|
|
|
|
7,574,503
|
|
Compensation and benefits
|
|
|
450,222
|
|
|
|
277,953
|
|
General and administrative expenses
|
|
|
403,253
|
|
|
|
539,544
|
|
Depreciation and amortization
|
|
|
48,370
|
|
|
|
52,552
|
|
Total Operating Expenses
|
|
|
8,022,236
|
|
|
|
8,861,697
|
|
Loss from Operations
|
|
|
(7,993,036
|
)
|
|
|
(8,767,497
|
)
|
Other Income (Expense):
|
|
|
|
|
|
|
|
|
Decrease (increase) in estimated fair value of embedded
derivative liabilities
|
|
|
479,455
|
|
|
|
(157,232
|
)
|
Loss on conversion of convertible notes
|
|
|
(143,418
|
)
|
|
|
(273,160
|
)
|
Interest expense
|
|
|
(699,093
|
)
|
|
|
(1,005,930
|
)
|
Total other income (expense)
|
|
|
(363,056
|
)
|
|
|
(1,436,322
|
)
|
Loss Before Income Taxes
|
|
|
(8,356,092
|
)
|
|
|
(10,203,819
|
)
|
Provision for income taxes
|
|
|
-
|
|
|
|
-
|
|
Net Loss
|
|
$
|
(8,356,092
|
)
|
|
$
|
(10,203,819
|
)
|
|
|
|
|
|
|
|
|
|
Basic net loss per share
|
|
$
|
-
|
|
|
$
|
(0.01
|
)
|
Basic weighted average shares outstanding
|
|
|
2,063,617,900
|
|
|
|
799,640,609
|
|
Diluted net loss per share
|
|
$
|
-
|
|
|
$
|
(0.01
|
)
|
Diluted weighted average shares outstanding
|
|
|
2,063,617,900
|
|
|
|
799,640,609
|
|
The
accompanying notes are an integral part of these financial statements.
Coates
International, Ltd.
Statements
of Stockholders' Deficiency
For
the Two Years Ended December 31, 2016
|
|
Series
A Preferred Stock, $0.001 par value per share
|
|
|
Series
B Preferred Stock, $0.001 par value per share
|
|
|
Common
Stock, $0.0001
par value per share
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Additional
Paid-In Capital
|
|
|
Accumulated
Deficit
|
|
|
Total
Stockholders' Deficiency
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
January 1, 2015
|
|
|
50,000
|
|
|
$
|
50
|
|
|
|
585,502
|
|
|
$
|
586
|
|
|
|
443,508,090
|
|
|
$
|
44,351
|
|
|
$
|
41,288,663
|
|
|
$
|
(46,767,179
|
)
|
|
$
|
(5,433,529
|
)
|
Issuance
of anti-dilution shares of Series B Convertible Preferred Stock to related parties
|
|
|
|
|
|
|
|
|
|
|
2,907,247
|
|
|
|
2,907
|
|
|
|
|
|
|
|
|
|
|
|
8,040,040
|
|
|
|
|
|
|
|
8,042,947
|
|
Conversion
of convertible promissory notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
520,777,116
|
|
|
|
52,078
|
|
|
|
922,447
|
|
|
|
|
|
|
|
974,525
|
|
Issuance
of common stock under equity purchase agreements with Southridge Partners II, LP
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
72,505,910
|
|
|
|
7,250
|
|
|
|
400,011
|
|
|
|
|
|
|
|
407,261
|
|
Beneficial
conversion feature on convertible promissory notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
761,563
|
|
|
|
|
|
|
|
761,563
|
|
Imputed
interest on promissory note payable to related party
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
145,443
|
|
|
|
|
|
|
|
145,443
|
|
Stock-based
compensation expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,556
|
|
|
|
|
|
|
|
6,556
|
|
Net
loss for the year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,203,819
|
)
|
|
|
(10,203,819
|
)
|
Balance,
December 31, 2015
|
|
|
50,000
|
|
|
|
50
|
|
|
|
3,492,749
|
|
|
|
3,493
|
|
|
|
1,036,791,116
|
|
|
|
103,679
|
|
|
|
51,564,723
|
|
|
|
(56,970,998
|
)
|
|
|
(5,299,053
|
)
|
Issuance
of anti-dilution shares of Series B Convertible Preferred Stock to related parties
|
|
|
|
|
|
|
|
|
|
|
12,877,817
|
|
|
|
12,878
|
|
|
|
|
|
|
|
|
|
|
|
6,862,636
|
|
|
|
|
|
|
|
6,875,514
|
|
Conversion
of convertible promissory notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,349,144,802
|
|
|
|
134,915
|
|
|
|
617,353
|
|
|
|
|
|
|
|
752,268
|
|
Conversion
of promissory notes to related parties to common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
211,318,358
|
|
|
|
21,132
|
|
|
|
135,711
|
|
|
|
|
|
|
|
156,843
|
|
Issuance
of common stock under equity purchase agreement with Southridge Partners II, LP
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
172,494,090
|
|
|
|
17,249
|
|
|
|
182,056
|
|
|
|
|
|
|
|
199,305
|
|
Beneficial
conversion feature on convertible promissory notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
255,093
|
|
|
|
|
|
|
|
255,093
|
|
Imputed
interest on promissory note payable to related party
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
144,240
|
|
|
|
|
|
|
|
144,240
|
|
Conversions
of Series B Convertible Preferred Stock to common stock
|
|
|
|
|
|
|
|
|
|
|
(117,982
|
)
|
|
|
(118
|
)
|
|
|
117,982,000
|
|
|
|
11,798
|
|
|
|
(11,680
|
)
|
|
|
|
|
|
|
-
|
|
Issuance
of common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
115,000,000
|
|
|
|
11,500
|
|
|
|
63,500
|
|
|
|
|
|
|
|
75,000
|
|
Net
loss for the year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8,356,092
|
)
|
|
|
(8,356,092
|
)
|
Balance,
December 31, 2016
|
|
|
50,000
|
|
|
$
|
50
|
|
|
|
16,252,584
|
|
|
$
|
16,253
|
|
|
|
3,002,730,366
|
|
|
$
|
300,273
|
|
|
$
|
59,813,632
|
|
|
$
|
(65,327,090
|
)
|
|
$
|
(5,196,882
|
)
|
The
accompanying notes are an integral part of these financial statements.
Coates
International Ltd.
Statements
of Cash Flows
|
|
For the Years Ended
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Net Cash Flows Used in Operating Activities
|
|
|
|
|
|
|
Net loss for the year
|
|
$
|
(8,356,092
|
)
|
|
$
|
(10,203,819
|
)
|
Adjustments to reconcile net loss to net cash used in
operating activities:
|
|
|
|
|
|
|
|
|
Stock-based compensation expense
|
|
|
6,875,514
|
|
|
|
7,574,503
|
|
Interest accrued, but not paid
|
|
|
601,053
|
|
|
|
878,251
|
|
(Decrease) increase in fair value of embedded derivative
liabilities
|
|
|
(479,455
|
)
|
|
|
157,232
|
|
Loss on conversion of convertible notes
|
|
|
143,418
|
|
|
|
273,160
|
|
Depreciation and amortization
|
|
|
48,370
|
|
|
|
52,552
|
|
Non-cash portion of inventory used for research and development
|
|
|
60,101
|
|
|
|
45,240
|
|
Recognition of non-cash licensing revenues
|
|
|
(19,200
|
)
|
|
|
(94,200
|
)
|
Changes in Operating Assets and Liabilities:
|
|
|
|
|
|
|
|
|
Inventory
|
|
|
26,535
|
|
|
|
(170,744
|
)
|
Deferred offering costs and other assets
|
|
|
(37,910
|
)
|
|
|
35,757
|
|
Accounts payable and accrued liabilities
|
|
|
293,368
|
|
|
|
54,127
|
|
Deferred compensation payable
|
|
|
350,173
|
|
|
|
317,240
|
|
Deposits
|
|
|
-
|
|
|
|
131,471
|
|
Net Cash Used in Operating Activities
|
|
|
(494,125
|
)
|
|
|
(949,230
|
)
|
|
|
|
|
|
|
|
|
|
Net Cash Used in Investing Activities:
|
|
|
|
|
|
|
|
|
Acquisition of property, plant
and equipment
|
|
|
(11,493
|
)
|
|
|
(38,249
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows Provided by Financing Activities:
|
|
|
|
|
|
|
|
|
Issuance of common stock under equity purchase agreements
|
|
|
199,306
|
|
|
|
407,261
|
|
Issuance of promissory notes to related parties
|
|
|
182,143
|
|
|
|
70,000
|
|
Issuance of convertible promissory notes
|
|
|
175,750
|
|
|
|
630,500
|
|
Issuance of common stock and warrants
|
|
|
75,000
|
|
|
|
-
|
|
Sublicensing fee revenue
|
|
|
10,000
|
|
|
|
-
|
|
Repayment of promissory notes to related parties
|
|
|
(93,000
|
)
|
|
|
(179,623
|
)
|
Repayment of mortgage loan
|
|
|
(55,000
|
)
|
|
|
(60,126
|
)
|
Finance lease obligation payments
|
|
|
(8,625
|
)
|
|
|
(62,102
|
)
|
Repayment of convertible promissory
notes
|
|
|
-
|
|
|
|
(52,750
|
)
|
Net Cash Provided by Financing
Activities
|
|
|
485,574
|
|
|
|
753,160
|
|
Net Decrease in Cash
|
|
|
(20,044
|
)
|
|
|
(234,319
|
)
|
Cash, beginning of period
|
|
|
29,207
|
|
|
|
263,526
|
|
Cash, end of period
|
|
$
|
9,163
|
|
|
$
|
29,207
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash
Flow Information:
|
|
|
|
|
|
|
|
|
Cash paid during the year for interest
|
|
$
|
161,069
|
|
|
$
|
190,682
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Non-cash
Financing Activities:
|
|
|
|
|
|
|
|
|
Conversion of convertible promissory
notes
|
|
$
|
714,942
|
|
|
$
|
978,209
|
|
The
accompanying notes are an integral part of these financial statements.
Coates
International, Ltd.
Notes
to Financial Statements
December
31, 2016 and 2015
(All
amounts rounded to thousands of United States dollars)
1.
THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature
of Organization
Coates
International, Ltd. (the “Company” or “CIL”) is a Delaware corporation organized in October 1991 as successor-in-interest
to a Delaware corporation of the same name incorporated in August 1988. Coates International, Ltd. operates in Wall
Township, New Jersey.
The
Company has acquired the exclusive licensing rights to the patented Coates spherical rotary valve (“CSRV®”) system
technology in North America, Central America and South America (the “CSRV® License”). The CSRV® system technology
has been developed over a period of more than 20 years by the Company’s founder George J. Coates, President and Chief Executive
Officer, and his son Gregory G. Coates. The CSRV® system technology is adaptable for use in piston-driven internal combustion
engines of many types and has been patented in the United States and numerous countries throughout the world. The Company is endeavoring
to raise working capital to commence production of natural gas powered CSRV® industrial electric power generator sets (“Gen
Sets)” and is also seeking to enter into sublicense agreements with third party, original equipment manufacturers (“OEM’s”)
which provide for licensing fees. The Company is also continuing with research and development of a hydrogen reactor to harvest
Hydroxy-Gas from water with the intent to power the Company’s products, including large industrial Gen Sets. George J. Coates,
owner of the hydrogen reactor technology, has committed to license this technology to the Company once the related patent protection
is in place.
Management
believes that the CSRV® engines provide the following advantages as compared to conventional internal combustion engines designed
with “poppet valves”:
|
●
|
Improved
fuel efficiency
|
|
●
|
Lower
levels of harmful emissions
|
|
●
|
Adaptability
to numerous types of engine fuels
|
|
●
|
Longer
intervals between engine servicing
|
The
CSRV
®
system technology is designed to replace the intake and exhaust conventional “poppet valves”
currently used in almost all piston-driven, automotive, truck, motorcycle, marine and electric power generator engines, among
others. Unlike conventional valves which protrude into the engine cylinder, the CSRV
®
system technology utilizes
spherical valves that rotate in a cavity formed between a two-piece cylinder head. The CSRV
®
system technology
utilizes significantly fewer moving parts than conventional poppet valve assemblies. As a result of these design improvements,
management believes that engines incorporating the CSRV
®
system technology (“Coates Engines”) will
last significantly longer and will require less lubrication over the life of the engine, as compared to conventional engines.
In addition, CSRV
®
Engines can be designed with larger openings into the engine cylinder than with conventional
valves so that more fuel and air can be inducted into, and expelled from, the cylinder in a shorter period of time. Larger valve
openings permit higher revolutions-per-minute (RPM’s) and permit higher compression ratios with lower combustion chamber
temperatures, allowing the Coates Engine
®
to produce more power than equivalent conventional engines. The extent
to which higher RPM’s, greater volumetric efficiency and thermal efficiency can be achieved with the CSRV® system technology,
is a function of the engine design and application.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Hydrogen
Reactor Technology Owned by George J. Coates
George
J. Coates has developed a hydrogen reactor which rearranges H
2
O water molecules into HOH molecules also known as Hydroxy-Gas.
Hydroxy-Gas has a different molecular structure than hydrogen gas which will power the Gen Sets for Secure Supplies. It consists
of two hydrogen atoms. The Hydroxy-Gas produced by the hydrogen reactor can then be harvested for use as a type of fuel. While
Mr. Coates intends to continue with development of this technology to enable the harvested Hydroxy-Gas to be utilized as the fuel
source to power our patented CSRV
®
engines, development is being intentionally postponed in order to focus on the
new sublicense agreement with Secure Supplies. The next phase of this research and development will focus on powering larger,
industrial engines. If successful, this application will only require a ready supply of water and would be suitable for stationary
engines and generators. Conventional internal combustion engines employing poppet valve assemblies require lubrication and would
experience excessive heat and friction if powered with Hydroxy-Gas. This, in turn, would cause the engines to burn out in a rather
short period of time. The materials and components of the CSRV
®
engines do not require such lubrication and because
of their design, are able to operate relatively trouble-free on Hydroxy-Gas as the engine fuel. There can be no assurance that
this technology can be developed successfully, or that if developed, it will be feasible to penetrate the internal combustion
engine market with this technology.
The
Company and WTF Asia International Ltd. (“WTF Asia”), a Hong Kong-based entity previously agreed to collaborate on
the development of this technology to enable it to be applied to large industrial gen set engines. The Company has designed and
integrated the switchgears, controls, load bank and emissions equipment into the hydrogen reactor/gen set (“Coates Assembled
Components”). The Company recently recommended that Secure Supplies and WTF Asia directly coordinate this development as
a joint effort due to their inherent synergies in developing hydrogen powered generation of electric power. WTF Asia would be
responsible for building additional components based on technology already developed that will enable the hydrogen reactor to
adequately power larger CSRV
®
commercial and industrial engines.
Applications
for patent protection of this technology would be filed upon completion of the research and development. Although at this time
no arrangements have been made between the Company and George J. Coates, owner of the technology, regarding licensing of the hydrogen
reactor, Mr. Coates has provided his commitment to license this technology to the Company once the related patent protection is
in place. Accordingly, the Company does not currently have any rights to manufacture, use, sell and distribute the hydrogen reactor
technology, should it become commercially feasible to manufacture and distribute products powered by the Hydroxy-Gas fuel. The
Company has been responsible for all costs incurred to date related to the development of this technology.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Basis
of Presentation
The
accompanying financial statements of the Company have been prepared in accordance with accounting principles generally accepted
in the United States (“GAAP”) and rules and regulations of the Securities and Exchange Commission (the “SEC”).
Since
the Company’s inception, the Company has been responsible for the development costs of the CSRV
®
technology
in order to optimize the value of the licensing rights and has incurred related operational costs, the bulk of which have been
funded primarily through cash generated from licensing fees, sales of stock, short term convertible promissory notes, capital
contributions, loans made by George J. Coates, Gregory G. Coates, Bernadette Coates, his spouse and certain directors, fees received
from research and development of prototype models and a small number of CSRV
®
engine generator sales. The Company
has incurred substantial cumulative losses from operations since its inception. Losses from operations are expected to continue
until the Coates Engines
®
are successfully introduced into and accepted in the marketplace, or the Company receives
substantial licensing revenues. These losses from operations were substantially related to research and development of the Company’s
intellectual property rights, patent filing and maintenance costs and general and administrative expenses. The Company has also
incurred substantial non-cash expenses for stock-based compensation and the conversion of convertible promissory notes into common
stock.
As
shown in the accompanying financial statements, the Company has incurred recurring losses from operations and, as of December
31, 2016, had a stockholders’ deficiency of ($5,197,000). In addition, the recent trading price range of the Company’s
common stock at a fraction of a penny has introduced additional risk and difficulty to the Company’s challenge to secure
needed additional working capital. These factors raise substantial doubt about the Company’s ability to continue as a going
concern. Management has instituted a cost control program intended to restrict variable costs to only those expenses that are
necessary to complete its activities related to entering the production phase of operations, develop additional commercially feasible
applications of the CSRV
®
system technology, seek additional sources of working capital and cover general and administrative
costs in support of such activities. The Company has been actively undertaking efforts to secure new sources of working capital.
At the December 31, 2016, the Company had negative working capital of ($5,411,000) compared with negative working capital of ($5,476,000)
at the end of 2015.
During
the years ended December 31, 2016 and 2015, the Company raised $642,000 and $1,108,000, respectively, of new working capital from
the following:
|
Description
|
|
2016
|
|
|
2015
|
|
|
Sales of common stock under equity purchase agreements
|
|
$
|
199,000
|
|
|
$
|
407,000
|
|
|
Issuances of promissory notes to related parties
|
|
|
182,000
|
|
|
|
70,000
|
|
|
Issuance of convertible promissory notes
|
|
|
176,000
|
|
|
|
631,000
|
|
|
Private sales of shares of common stock and common stock warrants
|
|
|
75,000
|
|
|
|
-
|
|
|
Licensing revenue
|
|
|
10,000
|
|
|
|
-
|
|
|
|
|
$
|
642,000
|
|
|
$
|
1,108,000
|
|
The
Company continues to actively seek out new sources of working capital; however, there can be no assurance that it will be successful
in these efforts. The accompanying financial statements do not include any adjustments that might be necessary if the Company
is unable to continue as a going concern.
Certain
amounts included in the accompanying financial statements for the year ended December 31, 2015 have been reclassified in order
to make them comparable to the amounts presented for the year ended December 31, 2016.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Revenue
Recognition
Sales
and cost of sales are recognized at the time of shipment, provided the risk of loss has transferred to the customer and collection
of the sales price is reasonably assured. Shipping arrangements and costs are the responsibility of the customer.
Revenue
from research and development activities is recognized when collection of the related revenues is reasonably assured and, when
applicable, in accordance with Accounting Standards Update No. 2010-17, “Milestone Method of Revenue Recognition, a consensus
of the FASB Emerging Issues Task Force”. This standard provides guidance on defining a milestone and permits recognition
of revenue from research and development that is contingent upon achievement of one or more specified milestones defined in the
research and development arrangements which meet specified criteria for such revenue recognition.
Deposits
represent cash deposits received with orders to purchase Gen Sets.
License
deposits, which are non-refundable, were received from the granting of sublicenses and are recognized as earned, generally commencing
upon acceptance by the licensee. At that time, license revenue will be recognized ratably over the period of time that the sublicense
has been granted using the straight-line method. Upon termination of a sublicense agreement, non-refundable license deposits,
less any costs related to the termination of the sublicense agreement, are recognized as revenue. Revenue from research and development
activities is recognized when earned and realization is reasonably assured, provided that financial risk has been transferred
from the Company to its customer.
The
Company is recognizing the license deposit of $300,000 on the Canadian License as revenue on a straight-line basis over the approximate
remaining life through 2027 of the last CSRV
®
technology patent in force.
Research
and Development
Research
and development costs are expensed when incurred. Included in accounts payable and accrued liabilities at December 31, 2016 and
2015 is $115,000 for the estimated remediation costs of previously sold Gen Sets that were determined to have cracked heads.
Intellectual
Property
Under
a licensing agreement with George J. Coates and Gregory G. Coates, the Company obtained the rights to manufacture, use and sell
the CSRV
®
engine technology throughout the territory defined as the Western Hemisphere. In accordance with GAAP,
the Company is not permitted to record a value for this intellectual property because it was obtained from principal stockholders,
and, accordingly this intangible asset is not reflected in the accompanying financial statements.
Licensing
Costs
Under
the CSRV
®
Licensing Agreement for the CSRV
®
engine technology, the Company is responsible for all
costs in connection with applying for and maintaining patents to protect the CSRV
®
system technology. Such costs
are expensed as incurred.
Advertising
and Marketing Costs
Advertising
costs, which are included in marketing expenses, are expensed when incurred. Advertising expense amounted to $-0- and $7,000 for
the years ended December 31, 2016 and 2015, respectively.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Stock-Based
Compensation
Stock-based compensation expense, which does not require
any outlay of cash, consists of the following:
|
●
|
The
estimated fair value of shares of the Company’s capital stock issued to key employees
for anti-dilution protection pursuant to a resolution of the board of directors. This
includes restricted shares of Series A Preferred Stock and Series B Convertible Stock.
In 2014, the Company arranged for an independent professional services firm to determine
the estimated fair value of Series A Preferred Stock issued in August 2014 and Series
B Preferred Stock issued in July 2014. The approach to arriving at the estimated fair
value of the Series A Preferred Stock and the Series B Convertible Preferred Stock were
determined to have a close correlation to the trading price of the Company’s common
stock. Accordingly, upon each subsequent issuance of shares of the Series A Preferred
Stock and Series B Convertible Preferred Stock, the original estimated fair values determined
by the independent valuation is adjusted, on a pro rata basis, to reflect the closing
price of the Company’s common stock on each date of issuance.
|
|
●
|
Compensation
expense relating to stock options and stock awards under its stock option and incentive
plans is recognized as an expense using the fair value measurement method. Under the
fair value method, the estimated fair value of awards to employees is charged to income
on a straight-line basis over the requisite service period, which is the earlier of the
employee’s retirement eligibility date or the vesting period of the award.
|
Deferred
Compensation
Deferred
compensation represents salaries of George J. Coates, Gregory G. Coates and Bernadette Coates earned but not paid in order to
preserve the Company’s working capital. The Company intends to repay these amounts at such time that it has sufficient working
capital and after the related party notes to George J. Coates and Bernadette Coates have been repaid with interest thereon. Deferred
compensation owed to Gregory G. Coates will be paid at such time that it has sufficient working capital.
Inventory
Inventory
consists of raw materials and work-in-process, including overhead and is stated at the lower of cost or market determined by the
first-in, first-out method. Inventory items designated as obsolete or slow moving are reduced to net realizable value. Market
value is determined using current replacement cost.
Property,
Plant and Equipment
Property,
plant and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful life
of the assets: 40 years for buildings and building improvements, 3 to 7 years for machinery and equipment and 5 to 10 years for
furniture and fixtures. Repairs and maintenance expenditures, which do not extend the useful lives of the related assets, are
expensed as incurred.
In
the event that facts and circumstances indicate that long-lived assets may be impaired, an evaluation of recoverability is performed.
Should such evaluation indicate that there has been an impairment of one or more long-lived assets, the cost basis of such assets
would be adjusted accordingly, at that time.
Income
Taxes
Deferred
income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities
that will result in taxable or deductible amounts in the future. Such deferred income tax asset and liability computations are
based on enacted tax laws and rates applicable to periods in which the differences are expected to affect taxable income. Valuation
allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized and are adjusted
when conditions indicate that deferred tax assets will be realized. Income tax expense (benefit) is the tax payable or refundable
for the period, plus or minus the change during the period in deferred tax assets and liabilities.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
The
Company evaluates any uncertain tax positions for recognition by determining if the weight of available evidence indicates it
is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes.
In the event recognition of an uncertain tax position is indicated, the Company measures the tax benefit as the largest amount
which is more than 50% likely of being realized upon ultimate settlement. This process of evaluating and estimating uncertain
tax positions and tax benefits requires the consideration of many factors, which may require periodic adjustments and which may
not accurately forecast actual outcomes. Interest and penalties, if any, related to tax contingencies would be included in income
tax expense.
Loss
per Share
Basic
net loss per share is based on the weighted average number of common shares outstanding without consideration of potentially dilutive
shares of common stock. Diluted net income per share is based on the weighted average number of common and potentially dilutive
common shares outstanding, when applicable.
Use
of Estimates
The
preparation of the Company’s financial statements in conformity with GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period. These significant estimates
include determining the fair value of convertible promissory notes containing embedded derivatives and variable conversion rates,
determining a value for shares of Series A Preferred Stock and Series B Convertible Preferred Stock issued, assigning useful lives
to the Company’s property, plant and equipment, determining an appropriate amount to reserve for obsolete and slow moving
inventory, estimating a valuation allowance for deferred tax assets, assigning expected lives to, and estimating the rate of forfeitures
of, stock options granted and selecting a trading price volatility factor for the Company’s common stock in order to estimate
the fair value of the Company’s stock options on the date of grant or other appropriate measurement date. Actual results
could differ from those estimates.
2.
CONCENTRATIONS OF CREDIT AND BUSINESS RISK
The
Company maintains cash balances with one financial institution. Monies on deposit are currently fully insured by the Federal Deposit
Insurance Corporation.
The
Company’s operations are devoted to the development, application and marketing of the CSRV
®
system technology
which was invented by George J. Coates, the Company’s founder, Chairman, Chief Executive Officer, President and controlling
stockholder. Development efforts have been conducted continuously during this time. From July 1982 through May 1993, seven U.S.
patents as well as a number of foreign patents were issued with respect to the CSRV
®
system technology. Since inception
of the Company in 1988, all aspects of the business have been completely dependent upon the activities of George J. Coates. The
loss of George J. Coates’ availability or service due to death, incapacity or otherwise would have a material adverse effect
on the Company's business and operations. The Company does not presently have any key-man life insurance in force for Mr. Coates.
3.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash,
Other Assets, Accounts Payable and Accrued Liabilities and Other Liabilities
With
the exception of convertible promissory notes, the carrying amount of these items approximates their fair value because of the
short term maturity of these instruments. The convertible promissory notes are reported at their estimated fair value, determined
as described in more detail in Note 14.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Limitations
Fair
value estimates are made at a specific point in time, based on relevant market information and information about the financial
instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore
cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
4.
LICENSING AGREEMENT AND DEFERRED LICENSING COSTS
The
Company holds a manufacturing, use, lease and sale license from George J. Coates and Gregory G. Coates for the CSRV
®
system technology in the territory defined as the Western Hemisphere (the “License Agreement”). Under the License
Agreement, George J. Coates and Gregory G. Coates granted to the Company an exclusive, perpetual, royalty-free, fully paid-up
license to the intellectual property that specifically relates to an internal combustion engine that incorporates the CSRV
®
system technology (the “CSRV
®
Engine”) and that is currently owned or controlled by them (the
“CSRV
®
Intellectual Property”), plus any CSRV
®
Intellectual Property that is developed
by them during their employment with the Company. In the event of insolvency or bankruptcy of the Company, the licensed rights
would terminate and ownership would revert back to George J. Coates and Gregory G. Coates.
Under
the License Agreement, George J. Coates and Gregory G. Coates agreed that they will not grant any Western Hemisphere licenses
to any other party with respect to the CSRV
®
Intellectual Property.
At
December 31, 2016 and 2015 deferred licensing costs, comprised of expenditures for patent costs incurred pursuant to the CSRV
®
licensing agreement, net of accumulated amortization, amounted to $38,000 and $42,000, respectively. Amortization expense
for the years ended December 31, 2016 and 2015 amounted to $4,000 and $4,000, respectively.
5.
AGREEMENT ASSIGNED TO ALMONT ENERGY, INC.
In
2010, Almont Energy Inc. (“Almont”), a privately held, independent third-party entity based in Alberta, Canada became
the assignee of a sublicense which covers the use of the CSRV
®
system technology in the territory of Canada in the oil and gas industry (the “Canadian License”).
This
sublicense is currently inactive because the parties have not fulfilled their obligations thereunder due to the Company's delay
in starting up production and delivery of CSRV® products to Almont. The parties mutually agreed to consider the basis on which
the license could be reactivated at such time that the Company is successful in starting up its manufacturing operations.
In prior years, the Company received a non-refundable
$300,000 deposit on the Canadian License. As the Company continues to be desirous of commencing shipments of its CSRV
®
products to Almont under the sublicense at such time that it is able to start up production operations, it has continued
to amortize this deposit into income over the period until expiration of the last CSRV
®
system technology patent
in force. At December 31, 2016, the unamortized balance was $190,000. Amortization of this amount is as follows:
Year Ending
|
|
Amount
|
|
2017
|
|
$
|
19,000
|
|
2018
|
|
|
19,000
|
|
2019
|
|
|
19,000
|
|
2020
|
|
|
19,000
|
|
2021
|
|
|
19,000
|
|
Thereafter
|
|
|
94,000
|
|
|
|
$
|
190,000
|
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
6.
NON-EXCLUSIVE DISTRIBUTION SUBLICENSE WITH RENOWN POWER DEVELOPMENT, LTD.
In
February 2015, the Company granted a non-exclusive distribution sublicense to Renown Power Development, Ltd., a China-based sales
and distribution company (“Renown”) covering the territory defined as the Western Hemisphere. Under this sublicense,
Renown will be permitted to sell, lease and distribute CSRV
®
products. The Company received an initial non-refundable
deposit of $500,000 through December 31, 2016. In addition, after Renown receives aggregate cash flow of $10,000,000, it is required
to pay the Company 25% of all funds it receives from any and all sources
until it fully pays the contractual licensing
fee.
In addition, Coates Power, Ltd., a China-based manufacturing
company (“Coates Power”) intends to produce CSRV
®
products in China. At this time, as the Company's
intellectual property rights cover the territory of North America, it does not have any rights to enter into a manufacturing and
sale license agreement with Coates Power. These rights are currently held by George J. Coates, Gregory G. Coates and The Coates
Trust. Coates Power and Renown are controlled and managed by Mr. James Pang, the Company's liaison agent in China.
Coates
Power has agreed to initially source its production parts and components from the Company. In February 2015, the Company
received cash with an order from Coates Power for approximately $131,000 of production parts and components, at cost, in
connection with its plans to manufacture two initial Gen Sets. In June, 2015, by mutual consent of the parties, it was agreed
that the Company would assemble two completed Gen Sets for shipment to Coates Power in China in lieu of shipping the parts
and components. The $131,000 is included in Deposits in the accompanying balance sheet at December 31, 2016.
7.
INVENTORY
Inventory
at December 31, consisted of the following:
|
|
2016
|
|
|
2015
|
|
Raw materials
|
|
$
|
178,000
|
|
|
$
|
554,000
|
|
Work-in-process
|
|
|
13,000
|
|
|
|
51,000
|
|
Finished goods
|
|
|
-
|
|
|
|
-
|
|
Less: Reserve for obsolescence
|
|
|
-
|
|
|
|
(387,000
|
)
|
Total
|
|
$
|
191,000
|
|
|
$
|
218,000
|
|
8.
LICENSE DEPOSITS
License
deposits consist of monies received as deposits on sublicense agreements, primarily comprised of deposits from Renown in the amount
of $498,000 and from Almont in the amount of $300,000. These deposits are to be recognized as income on a straight-line basis
over the remaining period until expiration of the last remaining CSRV
®
patent in force in 2027. Through December
31, 2016, the Company has recognized a total of $110,000 of the Almont deposit as revenue. The Company expects that sublicense-related
activities by Renown may commence within the next twelve months and that it will begin recognizing revenue at that time. Recognition
of revenue from the Almont license is included in the statements of operations for the years ended December 31, 2016 and 2015.
The current portion of the license deposits represents the portion of the license deposits expected to be recognized as revenue
within one year from the balance sheet date. The balance of the license deposits is included in non-current license deposits.
In
December 2016, the Company executed an exclusive license with Secure Supplies Mexico LLC and Secure Supplies USA LLC (collectively
“Secure Supplies”) of Coates CSRV
®
electric power hydrogen generator sets and engines for distribution,
use, sale and lease in the territory of North America. Secure Supplies employs a combination of solar generated power and hydrogen
cell technology to generate hydrogen gas. It intends to integrate its technology with the Coates CSRV
®
system technology
to power Engine Generator Sets to be utilized in establishing power generation plants throughout North America. Secure Supplies
has indicated it intends to procure CSRV
®
Engine Generators adapted to run on hydrogen fuel (“Hydrogen Gen
Sets”), capable of producing up to 1MW of electrical power output.
Upon execution of this agreement, Secure Supplies was
to pay a one-time licensing fee of $1,000,000 to the Company. In addition, a royalty fee of $50 per engine or gen set sold to
Secure Supplies, is to be paid to The Coates Trust, a private trust controlled by George J. Coates, regardless of the size or
type of CSRV
®
engine. A 50% down payment on all CSRV
®
products shall be paid to the Company with
each order presented. The balance due on each order shall be paid at the time the order has been staged for delivery from the
Company's manufacturing plant.
As
of the date of this filing, the Company had not received a $1,000,000, one-time upfront license fee as required by
the agreement and cannot determine when, and if, the fee will be collected. Accordingly, the Company has not recorded a
$1,000,000 receivable for the past due upfront license fee or recognized such unpaid amount due as revenue related to this
license agreement for the year ended December 31, 2016.
Sublicensing
fee revenue for the years ended December 31, 2016 and 2015 amounted to $29,000 and $94,000, respectively. Included in sublicensing
fee revenue for the year ended December 31, 2016, is a $10,000 payment from Secure Supplies in connection with the license agreement
for hydrogen powered CSRV
®
Gen Sets. Included in sublicensing fee revenue for the year ended December 31, 2015
is $75,000 non-refundable sublicense fee deposit received in 2002 that was abandoned by the licensee.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
9.
PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment at cost, less accumulated depreciation, consists of the following at December 31:
|
|
2016
|
|
|
2015
|
|
Land
|
|
$
|
1,235,000
|
|
|
$
|
1,235,000
|
|
Building
|
|
|
964,000
|
|
|
|
964,000
|
|
Building improvements
|
|
|
83,000
|
|
|
|
83,000
|
|
Machinery and equipment
|
|
|
689,000
|
|
|
|
689,000
|
|
Furniture and fixtures
|
|
|
57,000
|
|
|
|
46,000
|
|
|
|
|
3,028,000
|
|
|
|
3,017,000
|
|
Less: Accumulated depreciation
|
|
|
(952,000
|
)
|
|
|
(908,000
|
)
|
Total
|
|
$
|
2,076,000
|
|
|
$
|
2,109,000
|
|
Depreciation
expense amounted to $44,000 and $48,000 for the years ended December 31, 2016 and 2015, respectively.
10.
MORTGAGE LOAN PAYABLE
The
Company has a mortgage loan on the land and building that serves as its headquarters and research and development facility which
bears interest at the rate of 7.5% per annum and which matures in July 2018. Interest expense for the years ended December 31,
2016 and 2015 on this mortgage amounted to $95,000 and $100,000, respectively. The loan requires monthly payments of interest,
plus $5,000 which is being applied to the principal balance. The remaining principal balance at December 31, 2016 and 2015 was
$1,333,000 and $1,388,000, respectively. The mortgage loan may be prepaid in whole, or, in part, at any time without penalty.
The
loan is collateralized by a security interest in all of the Company’s assets, the pledge of five million shares of common
stock of the Company owned by George J. Coates, which were deposited into escrow for the benefit of the lender and the personal
guarantee of George J. Coates. The Company is not permitted to create or permit any secondary mortgage or similar liens on the
property or improvements thereon without prior consent of the lender.
11.
FINANCE LEASE OBLIGATION
In
2013, the Company entered into a sale/leaseback financing arrangement pursuant to which it sold its research and development and
manufacturing equipment in consideration for net cash proceeds of $133,000. This lease terminated in February 2016, upon which
the Company reacquired title to the equipment. The effective interest rate on this lease was 36.6%.
In
accordance with GAAP, this sale/leaseback was required to be accounted for as a financing lease. Under this accounting method,
the equipment and accumulated depreciation remained on the Company’s books and records as if the Company still owned the
equipment.
For
the years ended December 31, 2016 and 2015, interest expense on this lease amounted to $2,000 and $32,000, respectively, which
is included in interest expense in the accompanying statements of operations.
12.
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts
payable and accrued liabilities at December 31, consisted of the following:
|
|
2016
|
|
|
2015
|
|
Legal and professional fees
|
|
$
|
1,452,000
|
|
|
$
|
1,368,000
|
|
Accrued interest expense
|
|
|
502,000
|
|
|
|
376,000
|
|
General and administrative expenses
|
|
|
392,000
|
|
|
|
164,000
|
|
Research and development costs
|
|
|
115,000
|
|
|
|
115,000
|
|
Total
|
|
$
|
2,461,000
|
|
|
$
|
2,023,000
|
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
13.
PROMISSORY NOTES TO RELATED PARTIES
Promissory
Notes Issued to George J. Coates
During
the years ended December 31, 2016 and 2015, the Company issued, in a series of transactions, promissory notes to George J. Coates
and received cash proceeds of $177,000 and $70,000, respectively. During the years ended December 31, 2016 and 2015 the Company
repaid promissory notes to George J. Coates in cash in the aggregate principal amount of $30,000 and $120,000, respectively, which
included $63,000 of interest in 2016. In addition, the Company and Mr. Coates mutually agreed to convert $159,000 of promissory
notes into common stock of the Company at exercise prices ranging from $0.0006 to $0.0011 per share. The exercise price was determined
to be the closing trading price of the Company’s common stock on the date of conversion. The promissory notes are payable
on demand and provide for interest at the rate of 17% per annum, compounded monthly. At December 31, 2016, the outstanding balance consisted of $4,000 of principal and $315,000 of accrued interest.
Promissory
Note Issued to Gregory G. Coates
The
Company has a non-interest bearing note payable to Gregory G. Coates, son of George J. Coates, President, Technology
Division and Director, with a principal balance of $1,438,000 at December 31, 2016, which is payable on demand. During the
year ended December 31, 2015, the Company repaid $24,000 principal amount of this promissory note. As required by GAAP,
interest at the rate of 10% per annum amounting to $144,000 and $145,000 has been imputed on this promissory note for the
years ended December 31, 2016 and 2015, respectively.
Promissory
Notes Issued to Bernadette Coates
During
the year ended December 31, 2015, the Company partially repaid promissory notes to Bernadette Coates, spouse of George J. Coates,
in the aggregate principal amount of $36,000. The promissory notes are payable on demand and provide for interest
at the rate of 17% per annum, compounded monthly. At December 31, 2016, the outstanding balance consisted of $7,000 of principal and $79,000 of accrued interest.
Promissory
Note to Employee
During
the year ended December 31, 2016, the Company issued a promissory note to an employee and received cash proceeds of $5,000. The
promissory note is payable on demand and provides for interest at the rate of 17% per annum, compounded monthly.
For
the years ended December 31, 2016 and 2015, aggregate interest expense on all promissory notes to related parties amounted to
$293,000 and $218,000, respectively.
14. CONVERTIBLE
PROMISSORY NOTES AND EMBEDDED DERIVATIVE LIABILITY
From
time to time, the Company issues convertible promissory notes. At December 31, 2016, there was $99,000 principal amount of convertible
promissory notes outstanding. The net proceeds from these convertible notes were used for general working capital purposes. During
the years ended December 31, 2016 and 2015, $190,000 and $659,000, respectively, of convertible promissory notes were issued The
notes may be converted into unregistered shares of the Company’s common stock at a discount of 38% of the defined trading
price of the common stock on the date of conversion. The defined trading prices are based on the trading price of the stock during
a 25-day trading period immediately preceding the date of conversion. The conversion rate discount establishes a beneficial conversion
feature (“BCF”) or unamortized discount, which is required to be valued and accreted to interest expense over the
six-month period until the conversion of the notes into restricted shares of common stock is permitted. In addition, the conversion
formula meets the conditions that require accounting for convertible notes as derivative liability instruments.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
All
of the convertible notes become convertible, in whole, or in part, beginning on the six month anniversary of the issuance date
and may be prepaid at the option of the Company, generally with a prepayment penalty of 50% of the principal amount of the convertible
note at any time prior to becoming eligible for conversion.
In
accordance with GAAP, the estimated fair value of the embedded derivative liability related to the convertible notes is required
to be remeasured at each balance sheet date. The fair value measurement accounting standard establishes a valuation hierarchy
for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs
by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use
in valuing the asset or liability developed based on independent market data sources. Unobservable inputs are inputs that reflect
the Company’s assumptions about the factors market participants would use in valuing the asset or liability developed based
upon the best information available. The valuation hierarchy is composed of three categories. The three levels of the fair value
hierarchy are as follows:
|
●
|
Level
1 – Inputs are quoted prices (unadjusted) in active markets for identical assets
or liabilities.
|
|
●
|
Level
2 – Inputs include quoted prices in active markets for similar assets or liabilities,
quoted prices for identical or similar assets or liabilities in markets that are not
active, and inputs other than quoted prices that are observable for the asset or liability,
either directly or indirectly.
|
|
●
|
Level
3 – Inputs to the fair value measurement are unobservable inputs or valuation techniques.
|
The
estimated fair value of the embedded derivative liabilities related to promissory notes outstanding was measured as the aggregate
estimated fair value, based on Level 2 inputs, which included the average of the quoted daily yield curve rates on six-month and
one-year treasury securities and, because the actual volatility rate on the Company’s common stock is not available, a conservative
estimated volatility rate of 200%.
The
embedded derivative liability arises because, based on historical trading patterns of the Company’s stock, the formula for
determining the Conversion Rate is expected to result in a different Conversion Rate than the closing price of the stock on the
actual date of conversion (hereinafter referred to as the “Variable Conversion Rate Differential”). The estimated
fair values of the derivative liabilities have been calculated based on a Black-Scholes option pricing model.
The
following table presents the Company's fair value hierarchy of financial assets and liabilities measured at fair value on:
|
|
December 31,
2016
|
|
|
December 31,
2015
|
|
|
|
|
|
|
|
|
Level 1 Inputs
|
|
$
|
-
|
|
|
$
|
-
|
|
Level 2 Inputs
|
|
|
153,000
|
|
|
|
633,000
|
|
Level 3 Inputs
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
153,000
|
|
|
$
|
633,000
|
|
In
a series of transactions, during the year ended December 31, 2016, convertible promissory notes with an aggregate principal balance
of $715,000, including accrued interest thereon were converted into 1,349,144,802 unregistered shares of common stock. The Company
incurred a loss on these conversions amounting to $143,000 for the year ended December 31, 2016.
In
a series of transactions, during the year ended December 31, 2015, convertible promissory notes with an aggregate principal balance
of $974,000, including accrued interest thereon were converted into 520,777,120 unregistered shares of common stock. The Company
incurred a loss on these conversions amounting to $273,000 for the year ended December 31, 2015. In two transactions, during the
year ended December 31, 2015, the Company also repaid $54,000 of a convertible promissory note, including accrued interest thereon
without penalty.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
At
December 31, 2016, the Company had reserved 1,122,964,000 shares of its unissued common stock for conversion of convertible promissory
notes.
The
Company made the private placement of these securities in reliance upon Section 4(2) of the Securities Act of 1933, as amended
(the “Act”), Rule 506 of Regulation D, and the rules and regulations promulgated thereunder, and/or upon any other
exemption from the registration requirements of the Act, as applicable.
15.
CAPITAL STOCK
Common
Stock
The
Company’s common stock is traded on OTC Pink Sheets. Investors can find real-time quotes and market information for the
Company at
www.otcmarkets.com
market system under the ticker symbol COTE. The Company is authorized to issue up to 12,000,000,000
shares of common stock, par value, $0.0001 per share (the “Common Stock”). In June 2016, the Company increased the
number of authorized shares of its common stock from 2,000,000,000 to 12,000,000,000.
In
March 2015, the majority stockholder authorized the board of directors to declare at some indefinite point in the future, a reverse
stock split at such time as the board of directors determines, in its sole discretion, is appropriate based on market conditions
and the Company’s financial condition, results of operations and financial prospects. The Board may select a conversion
ratio which shall be in the range of from (a) one new post-split share of common stock for 5 old pre-split shares of common stock
(a 1:5 ratio) to (b) one new post-split share of common stock for 200 old pre-split shares of common stock (a 1:200 ratio). The
Board is under no obligation to actually declare the reverse stock split and may never act on this authorization, unless it properly
considers all conditions and factors and concludes that it is appropriate to do so. This authorization will continue in force
until revoked by a corporate action consented to by the majority stockholder or by a vote of the stockholders.
The
following common stock transactions occurred during the year ended December 31, 2016:
|
●
|
In
a series of transactions during the year ended December 31, 2016, convertible promissory
notes with an aggregate principal balance of $715,000, including accrued interest thereon
were converted into 1,349,144,802 unregistered shares of common stock.
|
|
●
|
In
a series of transactions during the year ended December 31, 2016, the Company issued
172,494,090 registered shares of its common stock to Southridge Partners II LP (“Southridge”)
under the 2015 EP Agreement, as discussed in Note 20, in consideration for $199,000.
The proceeds were used for general working capital. The Company is required to deliver
shares of its common stock to Southridge with each Put Notice based on the dollar amount
of the Put Notice and the trading price of the common stock.
|
|
●
|
During
the year ended December 31, 2016, the Company made private sales, pursuant to stock purchase
agreements, of 115,000,000 unregistered shares of its common stock and 115,000,000 common
stock warrants to purchase one unregistered share of its common stock at exercise prices
ranging from $0.0005 to $0.001 per share, in consideration for $75,000.
|
|
●
|
During
the year ended December 31, 2016, in a series of transactions by mutual consent between
the Company and George J. Coates, $472,000 principal amount of promissory notes, including
accrued interest of $315,000, was converted into 570,458,147 restricted, unregistered
shares of the Company’s common stock at conversion rates ranging from $0.0006 to
$0.0011 per share, which was the closing trading price of the stock on the respective
dates of conversion. Effective December 31, 2016, by mutual agreement between the Company
and Mr. Coates, the $315,000 portion of these conversions that represented accrued interest
was rescinded. Accordingly, Mr. Coates returned 359,139,789 shares of the Company’s
common stock which were restored to authorized, unissued status and the $315,000 was
restored on the Company’s books as unpaid, accrued interest at December 31, 2016.
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
The
following common stock transactions occurred during the year ended December 31, 2015:
|
●
|
In
a series of transactions during the year ended December 31, 2015, convertible promissory
notes with an aggregate principal balance of $974,000, including accrued interest thereon
were converted into 520,777,116 unregistered shares of common stock.
|
|
●
|
In
a series of transactions during the year ended December 31, 2015, the Company issued
72,505,910 registered shares of its common stock to Southridge Partners II LP (“Southridge”)
under the 2014 and 2015 EP Agreements, as discussed in Note 22, in consideration for
$407,000. The proceeds were used for general working capital. The Company is required
to deliver shares of its common stock to Southridge with each Put Notice based on the
dollar amount of the Put Notice and the trading price of the common stock. At December
31, 2015, there were 15,000,000 shares of common stock held by Southridge which had not
been sold. These shares may be held by Southridge until sold under a future Put Notice
or until the Company requests that they be returned.
|
At
December 31, 2016, the Company had reserved 1,285,778,911 shares of its common stock to cover the potential conversion of convertible
securities and exercise of stock options and warrants.
Preferred
Stock and Anti-dilution Rights
The
Company is authorized to issue 100,000,000 shares of preferred stock, par value, $0.001 per share (the “Preferred Stock”).
The Company may issue any class of the Preferred Stock in any series. The board is authorized to establish and designate series,
and to fix the number of shares included in each such series and the relative rights, preferences and limitations as between series,
provided that, if the stated dividends and amounts payable on liquidation are not paid in full, the shares of all series of the
same class shall share ratably in the payment of dividends including accumulations, if any, in accordance with the sums which
would be payable on such shares if all dividends were declared and paid in full, and in any distribution of assets other than
by way of dividends in accordance with the sums which would be payable on such distribution if all sums payable were discharged
in full. Shares of each such series when issued shall be designated to distinguish the shares of each series from shares of all
other series.
There
are two series of Preferred Stock that have been designated to date from the total 100,000,000 authorized shares of Preferred
Stock. These are as follows:
|
●
|
Series
A Preferred Stock, par value $0.001 per share (“Series A”), 1,000,000 shares
designated and 50,000 shares issued and outstanding as of December 31, 2016 and 2015.
Shares of Series A entitle the holder to 10,000 votes per share on all matters brought
before the shareholders for a vote. These shares are not entitled to receive dividends
or share in distributions of capital and have no liquidation preference. All 50,000 outstanding
shares of Series A are owned by George J. Coates, which entitle him to 500 million votes
in addition to his voting rights from the shares of common stock and the shares of Series
B he holds.
|
The
Company may issue additional shares of Series A Preferred Stock to Mr. Coates if deemed necessary to provide anti-dilution protection
and maintain his ownership percentage of eligible votes.
Issuances
of shares of Series A to George J. Coates do not have any effect on the share of dividends or liquidation value of the holders
of the Company’s common stock. However, the voting rights of the holders of the Company’s common stock are diluted
with each issuance.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
|
●
|
Series
B Convertible Preferred Stock, par value $0.001 per share, 75,000,000 and 5,000,000 shares
designated and 16,252,584 and 3,492,749 shares issued and outstanding as of December
31, 2016 and 2015, respectively. Shares of Series B do not earn any dividends and may
be converted at the option of the holder at any time beginning on the second annual anniversary
date after the date of issuance into 1,000 unregistered shares of the Company’s
common stock. Holders of the Series B are entitled to one thousand votes per share held
on all matters brought before the shareholders for a vote.
|
In
the event that either (i) the Company enters into an underwriting agreement for a secondary public offering of securities, or
(ii) a change in control of the Company is consummated representing 50% more of the then outstanding shares of Company’s
common stock, plus the number of shares of common stock into which any convertible preferred stock is convertible, regardless
of whether or not such shares are otherwise eligible for conversion, then the Series B may be immediately converted at the option
of the holder into restricted shares of the Company’s common stock.
The
Company provides anti-dilution protection for certain of its key employees. For each new share of common stock issued by the Company
to non-Coates family members in the future, additional shares of Series B will be issued to maintain their fixed ownership percentage
of the Company. The fixed ownership percentage is adjusted for acquisitions and dispositions of common stock, not related to conversions
of Series B Convertible Preferred Stock, by these key employees. At December 31, 2016, the fixed ownership percentages were as
follows:
|
1.
|
George
J. Coates – 80.63%
|
|
2.
|
Gregory
G. Coates – 6.10%
|
|
3.
|
Barry
C. Kaye – 0.048%
|
These
anti-dilution provisions do not apply to new shares of common stock issued in connection with exercises of employee stock options,
a secondary public offering of the Company’s securities or a merger or acquisition.
The
number of shares of Series B outstanding at December 31, 2016, consisted of 15,072,894, 1,096,989 and 82,701 shares held by George
J. Coates, Gregory G. Coates and Barry C. Kaye, respectively. The number of shares of Series B that become convertible into common
stock, by year are as follows:
|
|
Total
|
|
|
2017
|
|
|
2018
|
|
George J. Coates
|
|
|
15,072,894
|
|
|
|
3,135,357
|
|
|
|
11,937,537
|
|
Gregory G. Coates
|
|
|
1,096,989
|
|
|
|
224,975
|
|
|
|
872,014
|
|
Barry C. Kaye
|
|
|
82,701
|
|
|
|
14,435
|
|
|
|
68,266
|
|
For
the year ended December 31, 2016, 11,937,537, 872,014 and 68,266 shares of Series B were issued to George J. Coates, Gregory G.
Coates and Barry C. Kaye, respectively, having an estimated fair value of $7,060,000, $494,000 and $39,000, respectively. These
amounts were included in stock-based compensation expense in the accompanying statement of operations for the year ended December
31, 2016.
For
the year ended December 31, 2015, 2,708,430, 184,382 and 14,435 shares of Series B were issued to George J. Coates, Gregory G.
Coates and Barry C. Kaye, respectively, having an estimated fair value of $7,495,000, $510,000 and $40,000, respectively. These
amounts were included in stock-based compensation expense in the accompanying statement of operations for the year ended December
31, 2015.
During
the year ended December 31, 2016, George J. Coates and Barry C. Kaye converted 115,006 shares and 2,976 shares of Series B into
115,006,000 and 2,976,000 shares of the Company’s common stock, respectively.
In
the event that all of the 16,252,584 shares of Series B outstanding were converted, once the conversion restrictions lapse, an
additional 16,252,584,000 new unregistered shares of common stock would be issued. On a pro forma basis, based on the number of
shares of common stock outstanding at December 31, 2016, this would dilute the ownership percentage of non-affiliated stockholders
from 70.7% to 8.7%.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
To
the extent that additional shares of Series B are issued under the anti-dilution plan, the non-affiliated stockholders’
percentage ownership of the Company would be further diluted.
16. SUBLICENSING
FEE REVENUE
Sublicensing
fee revenue for the years ended December 31, 2016 and 2015, amounted to $94,000 and $29,000, respectively. Included in sublicensing
fee revenue for the year ended December 31, 2016, is a $10,000 payment from Secure Supplies in connection with the license agreement
for hydrogen powered CSRV
®
Gen Sets. Included in sublicensing fee revenue for the year ended December 31, 2015
is a $75,000 non-refundable sublicense fee deposit received in 2002 that was abandoned by the licensee. The Company is recognizing
the license deposit of $300,000 on the Canadian Licensee as revenue on a straight-line basis over the approximate remaining life
until 2027 of the last CSRV
®
technology patent in force.
17.
INCOME (LOSS) PER SHARE
At
December 31, 2016, there were stock warrants outstanding to purchase 150,344,911 shares of common stock at exercise prices ranging
from $0.0005 to $0.12 per share and vested stock options outstanding to acquire 12,470,000 shares of common stock at exercise
prices ranging from $0.028 to $0.44 per share.
At
December 31, 2015, there were stock warrants outstanding to purchase 35,344,911 shares of common stock at exercise prices ranging
from $0.005 to $0.12 per share and vested stock options outstanding to acquire 12,470,000 shares of common stock at exercise prices
ranging from $0.028 to $0.44 per share.
For
the years ended December 31, 2016 and 2015, none of the potentially issuable shares of common stock were assumed to be converted
because the Company incurred a net loss in those periods and the effect of including them in the calculation would have been anti-dilutive.
18.
STOCK OPTIONS
The
Company’s 2006 Stock Option and Incentive Plan (the “Stock Plan”) was adopted by the Company’s board in
October 2006. In September 2007, the Stock Plan, by consent of George J. Coates, majority shareholder, was adopted by our shareholders.
The Stock Plan provides for the grant of stock-based awards to employees, officers and directors of, and consultants or advisors
to, the Company and its subsidiaries, if any. Under the Stock Plan, the Company may grant options that are intended to qualify
as incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (“ISO’s”),
options not intended to qualify as incentive stock options (“non-statutory options”), restricted stock and other stock-based
awards. ISO’s may be granted only to employees of the Company. A total of 12,500,000 shares of common stock may be issued
upon the exercise of options or other awards granted under the Stock Plan. The maximum number of shares with respect to which
awards may be granted during any one year to any employee under the Stock Plan shall not exceed 25% of the 12,500,000 shares of
common stock covered by the Stock Plan. All of the shares of common stock authorized under the Stock Plan have been granted and
no further grants may be awarded thereunder.
The
Company established a 2014 Stock Option and Incentive Plan (the “2014 Stock Plan”) which was adopted by the Company’s
board on May 30, 2014. On March 2, 2015, the 2014 Stock Plan, by consent of George J. Coates, majority shareholder, was adopted
by our shareholders. The 2014 Stock Plan provides for the grant of stock-based awards to employees, officers and directors of,
and consultants or advisors to, the Company and its subsidiaries, if any. Under the 2014 Stock Plan, the Company may grant ISO’s,
non-statutory options, restricted stock and other stock-based awards. ISO’s may be granted only to employees of the Company.
A total of 50,000,000 shares of common stock may be issued upon the exercise of options or other awards granted under the 2014
Stock Plan. The maximum number of shares with respect to which awards may be granted during any one year to any employee under
the 2014 Stock Plan shall not exceed 25% of the 50,000,000 shares of common stock covered by the 2014 Stock Plan. At December
31, 2016, none of the shares of common stock authorized under the 2014 Stock Plan had been granted as stock options or awarded.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
The
Stock Plan and the 2014 Stock Plan (the “Stock Plans”) are administered by the board and the Compensation Committee.
Subject to the provisions of the Stock Plans, the board and the Compensation Committee each has the authority to select the persons
to whom awards are granted and determine the terms of each award, including the number of shares of common stock subject to the
award. Payment of the exercise price of an award may be made in cash, in a “cashless exercise” through a broker, or
if the applicable stock option agreement permits, shares of common stock, or by any other method approved by the board or Compensation
Committee. Unless otherwise permitted by the Company, awards are not assignable or transferable except by will or the laws of
descent and distribution.
Upon
the consummation of an acquisition of the business of the Company, by merger or otherwise, the board shall, as to outstanding
awards (on the same basis or on different bases as the board shall specify), make appropriate provision for the continuation
of such awards by the Company or the assumption of such awards by the surviving or acquiring entity and by substituting on an
equitable basis for the shares then subject to such awards either (a) the consideration payable with respect to the outstanding
shares of common stock in connection with the acquisition, (b) shares of stock of the surviving or acquiring corporation,
or (c) such other securities or other consideration as the board deems appropriate, the fair market value of which (as determined
by the board in its sole discretion) shall not materially differ from the fair market value of the shares of common stock subject
to such awards immediately preceding the acquisition. In addition to, or in lieu of the foregoing, with respect to outstanding
stock options, the board may, on the same basis or on different bases as the board shall specify, upon written notice to the affected
optionees, provide that one or more options then outstanding must be exercised, in whole or in part, within a specified number
of days of the date of such notice, at the end of which period such options shall terminate, or provide that one or more options
then outstanding, in whole or in part, shall be terminated in exchange for a cash payment equal to the excess of the fair market
value (as determined by the board in its sole discretion) for the shares subject to such stock options over the exercise price
thereof. Unless otherwise determined by the board (on the same basis or on different bases as the board shall specify), any
repurchase rights or other rights of the Company that relate to a stock option or other award shall continue to apply to consideration,
including cash, that has been substituted, assumed or amended for a stock option or other award pursuant to these provisions.
The Company may hold in escrow all or any portion of any such consideration in order to effectuate any continuing restrictions.
The
board may at any time provide that any stock options shall become immediately exercisable in full or in part, that any restricted
stock awards shall be free of some or all restrictions, or that any other stock-based awards may become exercisable in full or
in part or free of some or all restrictions or conditions, or otherwise realizable in full or in part, as the case may be.
The
board or Compensation Committee may, in its sole discretion, amend, modify or terminate any award granted or made under the Stock
Plan, so long as such amendment, modification or termination would not materially and adversely affect the participant.
No
stock options were issued during the years ended December 31, 2016 and 2015.
During
the year ended December 31, 2015, stock options to purchase 703,000 shares of common stock at an exercise price of $0.028 per
share became vested and 30,000 stock options with an exercise price of $1.00 per share expired. The estimated fair value of stock
options which vested during the year ended December 31, 2015 was $20,000.
There
were no unvested stock options outstanding at December 31, 2016.
During
the years ended December 31, 2016 and 2015, the Company recorded non-cash stock-based compensation expense related to employee
stock options amounting to $-0- and $7,000, respectively.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
A
summary of the activity in the Company’s Stock Option Plan is as follows:
|
|
Exercise Price Per Share
|
|
|
Number Outstanding
|
|
|
Weighted Average Remaining Contractual Life
|
|
|
Number Exercisable
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Fair Value Per Stock Option at Date of Grant
|
|
Balance, 1/1/15
|
|
$
|
0.028 – $1.000
|
|
|
|
12,500,000
|
|
|
|
12
|
|
|
|
11,797,000
|
|
|
$
|
0.184
|
|
|
$
|
0.169
|
|
Stock options vested
|
|
|
0.028
|
|
|
|
-
|
|
|
|
|
|
|
|
703,000
|
|
|
|
|
|
|
|
|
|
Stock options expired
|
|
|
1.000
|
|
|
|
(30,000
|
)
|
|
|
|
|
|
|
(30,000
|
)
|
|
|
|
|
|
|
|
|
Balance, 12/31/15
|
|
|
0.028 – 0.440
|
|
|
|
12,470,000
|
|
|
|
11
|
|
|
|
12,470,000
|
|
|
|
0.182
|
|
|
|
0.169
|
|
Stock options vested
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Stock options expired
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Balance, 12/31/16
|
|
$
|
0.028
– $0.440
|
|
|
|
12,470,000
|
|
|
|
10
|
|
|
|
12,470,000
|
|
|
|
0.182
|
|
|
|
0.169
|
|
The
weighted average fair value of the Company's stock options was estimated using the Black-Scholes option pricing model which requires
highly subjective assumptions including the expected stock price volatility. These assumptions were as follows:
●
|
|
Historical stock price volatility
|
|
|
139% - 325
|
%
|
●
|
|
Risk-free interest rate
|
|
|
0.21% - 4.64
|
%
|
●
|
|
Expected life (in years)
|
|
|
4
|
|
●
|
|
Dividend yield
|
|
|
0.00
|
|
The
valuation assumptions were determined as follows:
●
|
Historical
stock price volatility: The Company utilized the volatility in the trading of its common stock computed for the 12 months
of trading immediately preceding the date of grant.
|
●
|
Risk-free
interest rate: The Company bases the risk-free interest rate on the interest rate payable on U.S. Treasury securities in effect
at the time of the grant for a period that is commensurate with the assumed expected option life.
|
●
|
Expected
life: The expected life of the options represents the period of time options are expected to be outstanding. The Company has
very limited historical data on which to base this estimate. Accordingly, the Company estimated the expected life based on
its assumption that the executives will be subject to frequent blackout periods during the time that the stock options will
be exercisable and based on the Company’s expectation that it will complete its research and development phase and commence
its initial production phase. The vesting period of these options was also considered in the determination of the expected
life of each stock option grant.
|
●
|
No
expected dividends.
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
The
following table sets forth information with respect to stock options outstanding at December 31, 2016:
Name
|
|
Title
|
|
Number of Shares of Common Stock Underlying Stock
Options
(1)
|
|
|
Exercise Price per Share
|
|
|
Option
Expiration
Date
|
|
|
|
|
|
|
|
|
|
|
|
George J. Coates
|
|
Chairman, Chief Executive Officer
and President
|
|
|
1,000,000
50,000
275,000
1,800,000
1,815,000
|
|
|
$
|
0.440
0.430
0.400
0.250
0.060
|
|
|
10/23/2021
11/4/2024
11/17/2025
7/25/2026
6/24/2027
|
Gregory G. Coates
|
|
Director
and President, Technology Division
|
|
|
500,000
1,800,000
351,500
|
|
|
|
0.440
0.240
0.028
|
|
|
10/23/2021
8/8/2026
4/30/2029
|
Barry C. Kaye
|
|
Director, Treasurer and Chief Financial Officer
|
|
|
125,000
100,000
351,500
|
|
|
|
0.440
0.042
0.028
|
|
|
10/18/2021
2/11/2028
4/30/2029
|
Dr. Frank J. Adipietro
|
|
Non-employee Director
|
|
|
25,000
50,000
85,000
667,000
|
|
|
|
0.440
0.430
0.400
0.060
|
|
|
3/28/2022
11/3/2024
11/17/2025
6/24/2027
|
Dr. Richard W. Evans
|
|
Consultant
|
|
|
25,000
50,000
200,000
3,125,000
|
|
|
|
0.440
0.390
0.250
0.060
|
|
|
3/28/2022
12/27/2024
2/15/2026
6/20/2027
|
Dr. Michael J. Suchar
|
|
Consultant
|
|
|
25,000
|
|
|
|
0.440
|
|
|
3/28/2022
|
Richard Whitworth
|
|
Non-employee Director
|
|
|
25,000
|
|
|
|
0.440
|
|
|
3/28/2022
|
William Wolf. Esq.
|
|
Outside General Counsel
|
|
|
25,000
|
|
|
|
0.440
|
|
|
4/4/2022
|
(1)
All outstanding stock options are fully vested.
19.
EQUITY PURCHASE AND REGISTRATION RIGHTS AGREEMENTS
In
July 2014, the Company entered into an equity purchase agreement (the “2014 EP Agreement”) with Southridge Partners
II LP, a Delaware limited partnership (“Southridge”). Pursuant to the terms of the 2014 EP Agreement, Southridge committed
to purchase up to 40,000,000 shares of the Company’s common stock. In June 2015, the 2014 EP Agreement automatically terminated because Southridge had purchased all 40,000,000
shares of common stock permitted under the 2014 EP Agreement. On July 29, 2015, the Company entered into a new 3-year equity purchase
agreement (the “2015 EP Agreement”) with Southridge. Pursuant to the terms of the 2015 EP Agreement, Southridge committed
to purchase up to 205,000,000 shares of the Company’s common stock on the same terms and conditions as the 2014 EP Agreement. In December 2016, the 2015 EP Agreement automatically
terminated because Southridge had purchased all 205,000,000 registered shares of common stock under the 2015 EP Agreement.
The
terms of the 2014 and 2015 EP Agreements provided that the purchase price for the shares of common stock shall be equal to 94%
of the lowest closing price of the common stock during the ten trading days that comprise the defined pricing period. The Company
is entitled to exercise a Put to Southridge by delivering a Put Notice, which requires Southridge to remit the dollar amount stated
in the Put Notice at the end of the pricing period, provided, however, that for each day during the pricing period, if any, that
the daily closing price of the Company’s common stock is (i) 25% or more below the Floor Price, as defined, or (ii) below
the Floor Price, if any, stipulated in the Put Notice issued by the Company, then the dollar amount of the Put shall be reduced
by 10% for each such day. The Company may stipulate a Floor Price below which, no shares of common stock may be sold by Southridge,
however, the Floor price shall not be lower than the lowest daily volume weighted average price of the common stock during the
ten trading days preceding the date of the Put Notice.
The
Company also entered into a registration rights agreement (the “Registration Rights Agreement”) with Southridge. Pursuant
to the terms of the Registration Rights Agreement, on July 30, 2015, the Company filed a registration statement with the SEC covering
205,000,000 shares of common stock underlying the 2015 EP Agreement which was declared effective August 5, 2015.
During
the year ended December 31, 2016, the Company sold 172,494,090 registered shares of common stock to Southridge and received proceeds
of $199,000 under the 2015 EP Agreement.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
During
the year ended December 31, 2015, the Company (i) sold all 40,000,000 registered shares of common stock to Southridge and received
proceeds of $207,000 under the 2014 EP Agreement, and (ii) sold 32,505,910 registered shares of common stock to Southridge and
received proceeds of $200,000 under the 2015 EP Agreement.
20.
INCOME TAXES
Deferred
income taxes are determined using the liability method for the temporary differences between the financial reporting basis and
income tax basis of the Company’s assets and liabilities. Deferred income taxes are measured based on the tax rates expected
to be in effect when the temporary differences are included in the Company’s tax return. Deferred tax assets and liabilities
are recognized based on anticipated future tax consequences attributable to differences between financial statement carrying amounts
of assets and liabilities and their respective tax bases.
Deferred
tax assets increased by $3,340,000 and $3,672,000 for the years ended December 31, 2016 and 2015, respectively. These amounts
were fully offset by a corresponding increase in the tax valuation allowance resulting in no net change in deferred tax assets,
respectively, during these periods.
No
liability for unrecognized tax benefits was required to be reported at December 31, 2016 and 2015. Based on the Company's
evaluation, it has concluded that there are no significant uncertain tax positions requiring recognition in the Company's financial
statements. The Company's evaluation was performed for the tax years ended 2012 through 2015, the only periods subject
to examination. The Company believes that its income tax positions and deductions will be sustained on audit and does
not anticipate that adjustments, if any, will result in a material change to its financial position. For the years ended December
31, 2016 and 2015, there were no penalties or interest related to the Company’s income tax returns.
Total
deferred tax assets and valuation allowances are as follows at December 31:
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Current deferred tax asset - inventory reserve
|
|
$
|
195,000
|
|
|
$
|
195,000
|
|
|
|
|
|
|
|
|
|
|
Non-Current Deferred Tax Assets:
|
|
|
|
|
|
|
|
|
Stock-based compensation expense
|
|
|
10,022,000
|
|
|
|
7,272,000
|
|
Net operating loss carryforwards
|
|
|
7,558,000
|
|
|
|
7,213,000
|
|
Deferred compensation not paid within 2.5 months
|
|
|
509,000
|
|
|
|
369,000
|
|
Accrued liabilities not paid
|
|
|
466,000
|
|
|
|
451,000
|
|
Accrued interest on notes to related parties
|
|
|
199,000
|
|
|
|
140,000
|
|
Total long-term deferred tax assets
|
|
|
18,784,000
|
|
|
|
15,445,000
|
|
Total deferred tax assets
|
|
|
18,979,000
|
|
|
|
15,639,000
|
|
Less: valuation allowance
|
|
|
(18,979,000
|
)
|
|
|
(15,639,000
|
)
|
Net deferred tax assets
|
|
$
|
-
|
|
|
$
|
-
|
|
The
differences between income tax (benefit) provision in the financial statements and the income tax (benefit) provision computed
at the U.S. Federal statutory rate of 34% at December 31 are as follows:
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Federal tax provision at the statutory rate
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
State income tax benefit, net of federal benefit
|
|
|
(0.8
|
)
|
|
|
(0.9
|
)
|
Stock-based compensation expense
|
|
|
(32.9
|
)
|
|
|
(29.7
|
)
|
Deferred compensation not paid within 2.5 months
|
|
|
(1.7
|
)
|
|
|
0.6
|
|
Accrued interest not deductible for tax return purposes
|
|
|
(1.7
|
)
|
|
|
(3.4
|
)
|
Net change in net operating loss carryforwards
|
|
|
(4.5
|
)
|
|
|
(7.2
|
)
|
Loss on conversion of convertible notes
|
|
|
(0.7
|
)
|
|
|
(1.1
|
)
|
Decrease (increase) in estimated fair value of embedded derivative liabilities
|
|
|
2.3
|
|
|
|
(0.6
|
)
|
Accrued liabilities not deductible for tax return purposes
|
|
|
(0.2
|
)
|
|
|
(0.1
|
)
|
Total
|
|
|
(6.2
|
)
|
|
|
(8.4
|
)
|
Valuation allowance
|
|
|
6.2
|
|
|
|
8.4
|
|
Effective tax rate
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
At
December 31, 2016, the Company had available, $20,494,000 of net operating loss carryforwards which may be used to reduce future
federal taxable income, expiring between 2018 and 2036. At December 31, 2016, the Company had available $10,154,000 of net operating
loss carryforwards which may be used to reduce future state taxable income, expiring between 2029 and 2036.
21.
RELATED PARTY TRANSACTIONS
Licensing
Agreement for CSRV
®
System Technology
The
Company’s intellectual property rights for the CSRV
®
System Technology are derived from the licensing agreement
with George J. Coates and Gregory G. Coates, as more fully discussed in Note 4.
The Company pays for all costs of new patent filings and patent maintenance on intellectual property licensed to it by George
J. Coates and Gregory G. Coates. For the years ended December 31, 2016 and 2015, these costs amounted to $39,000 and $38,000,
respectively.
Non-Exclusive
distribution sublicense to Renown Power Development, Ltd.
The
Company has granted a non-exclusive distribution sublicense to Renown, as more fully discussed in Note 6. Renown is controlled
by James Pang, the Company’s exclusive liaison agent in China.
Issuances
of Common Stock upon Conversion of Series B Convertible Preferred Stock
Issuances
of common stock to related parties upon conversion of Series B Convertible Preferred Stock during the year ended December 31,
2016 is discussed in detail in Note 15.
Issuances
of Promissory Notes to Related Parties
Issuances
of promissory notes to related parties during the years ended December 31, 2016 and 2015 to related parties are discussed in detail
in Note 13.
Promissory
notes issued to George J. Coates, Bernadette Coates and an employee are payable on demand and provide for interest at the rate
of 17% per annum, compounded monthly. The promissory note issued to Gregory G. Coates is non-interest bearing, however, the Company
imputes interest at a rate of 10% per annum, which has been charged to interest expense in the accompanying statements of operations.
At
December 31, 2016, accrued, unpaid interest on outstanding promissory notes to related parties, aggregated $394,000.
Stock
Options
Stock
options previously granted to related parties which became vested during the year ended December 31, 2015 are more fully discussed
in Note 18.
Issuances
and Conversions of Preferred Stock
Shares
of Series A Preferred Stock awarded to George J. Coates during the years ended December 31, 2016 are discussed in detail in Note
15.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Shares
of Series B Convertible Preferred Stock awarded to George J. Coates, Gregory G. Coates and Barry C. Kaye and shares converted
during the year ended December 31, 2016 and 2015 are discussed in detail in Note 15.
Personal
Guaranty and Stock Pledge
In
connection with the Company’s mortgage loan on the Company’s headquarters facility, George J. Coates has pledged certain
of his shares of common stock of the Company to the extent required by the lender and provided a personal guaranty as additional
collateral.
Compensation
and Benefits Paid
The
approximate amount of compensation and benefits, all of which were approved by the board, paid to George J. Coates, Gregory G.
Coates and Bernadette Coates, exclusive of stock-based compensation for unregistered, restricted shares of Preferred Stock awarded
to George J. Coates and Gregory G. Coates and non-cash, stock-based compensation for employee stock options granted to Gregory
G. Coates is summarized as follows:
|
|
|
For the Year Ended,
|
|
|
|
|
2016
|
|
|
2015
|
|
|
George J. Coates (a) (b)
|
|
$
|
16,000
|
|
|
$
|
18,000
|
|
|
Gregory G. Coates (c) (d) (e)
|
|
|
139,000
|
|
|
|
178,000
|
|
|
Bernadette Coates (f)
|
|
|
5,000
|
|
|
|
4,000
|
|
|
(a)
|
For
the years ended December 31, 2016 and 2015, George J. Coates earned additional base compensation
of $250,000 and $250,000, respectively, payment of which is being deferred until the
Company has sufficient working capital. At December 31, 2016 and 2015, the total amount of deferred compensation was $981,000 and $731,000, respectively. These amounts
are included in deferred compensation in the accompanying balance sheets at December 31, 2016 and 2015.
|
|
(b)
|
During
the year ended December 31, 2016 and 2015, George J. Coates was awarded 11,937,537 and
2,708,430 shares of Series B Convertible Preferred Stock, respectively, with an estimated
fair value of $7,060,000 and $7,495,000, respectively, for anti-dilution. Each share
of Series B Convertible Preferred Stock becomes convertible into 1,000 shares of common
stock at any time after the second anniversary after the date of issuance.
|
|
(c)
|
For
the year ended December 31, 2016, Gregory G. Coates earned additional base compensation
of $33,000, payment of which is being deferred until the Company has sufficient working
capital. This amount is included in deferred compensation in the accompanying balance
sheet at December 31, 2016.
|
|
(d)
|
Includes
compensation paid in 2015 for vacation earned but not taken.
|
|
(e)
|
During
the years ended December 31, 2016 and 2015, Gregory G. Coates was awarded 872,014 and
184,382 shares of Series B Convertible Preferred Stock with an estimated fair value of
$494,000 and $510,000, respectively, for anti-dilution. Each share of Series B Convertible
Preferred Stock becomes convertible into 1,000 shares of common stock at any time after
the second anniversary after the date of issuance.
|
|
(f)
|
For
the years ended December 31, 2016 and 2015, Bernadette Coates earned additional base
compensation of $67,000 and $67,000, respectively, payment of which is being deferred
until the Company has sufficient working capital. At December 31, 2016 and 2015, the total amount of deferred compensation was $259,000 and $191,000, respectively. These amounts
are included in deferred compensation in the accompanying balance sheets at December 31, 2016 and 2015.
|
During
the years ended December 31, 2016 and 2015, Barry C. Kaye, Treasurer and Chief Financial Officer was paid compensation of $6,000
and $83,000, respectively. For the year ended December 31, 2016, Mr. Kaye earned compensation of $102,000, which was not paid
and is being deferred until the Company has sufficient working capital to remit payment to him. During the year ended December
31, 2016, the Company agreed to accrue interest on the balance of his deferred compensation retroactive to when it began being
deferred in May 2012 and, accordingly, recorded interest expense of $105,000. This amount is included in interest expense in the
accompanying statement of operations for the year ended December 31, 2016. Interest continues to be accrued on the unpaid balance.
At December 31, 2016, the total amount of Mr. Kaye’s unpaid, deferred compensation, including accrued interest thereon,
was $308,000. This amount is included in accounts payable and accrued liabilities in the accompanying balance sheet at December
31, 2016. During the years ended December 31, 2016 and 2015, Barry C. Kaye was awarded 68,266 and 14,435 shares of Series B Convertible
Preferred Stock, respectively, with an estimated fair value of $39,000 and $40,000, respectively, for anti-dilution. Each share
of Series B Convertible Preferred Stock becomes convertible into 1,000 shares of common stock at any time after the second anniversary
after the date of issuance.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
22.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The
following table summarizes our contractual obligations and commitments at December 31, 2016:
|
|
|
|
|
Due Within
|
|
|
|
Total
|
|
|
2017
|
|
|
2018
|
|
Promissory notes to related parties
|
|
$
|
1,455,000
|
|
|
$
|
1,455,000
|
|
|
$
|
-
|
|
Mortgage loan payable
|
|
|
1,333,000
|
|
|
|
65,000
|
|
|
|
1,268,000
|
|
Deferred compensation
|
|
|
1,272,000
|
|
|
|
1,272,000
|
|
|
|
-
|
|
Convertible promissory notes
|
|
|
99,000
|
|
|
|
99,000
|
|
|
|
-
|
|
Total
|
|
$
|
4,159,000
|
|
|
$
|
2,891,000
|
|
|
$
|
1,268,000
|
|
23.
LITIGATION AND CONTINGENCIES
The
Company is not a party to any litigation that is material to its business.
24.
RECENTLY ISSUED ACCOUNTING STANDARDS
Revenue
Recognition
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which amends the existing accounting
standards for revenue recognition. ASU 2014-09 is based on principles that govern the recognition of revenue at an amount an entity
expects to be entitled to when products are transferred to customers. In August 2015, the FASB issued ASU No. 2015-14, Revenue
from Contracts with Customers (Topic 606) – Deferral of the Effective Date, which defers the effective date of ASU 2014-09
for one year and permits early adoption. Accordingly, the Company may adopt the standard in either its first quarter of 2018 or
2019.
In
April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606) – Identifying Performance
Obligations and Licensing (“ASU 2016-10”), which amends the guidance in ASU 2014-09 related to identifying performance
obligations and accounting for licenses of intellectual property. The Company will adopt ASU 2016-10 with ASU 2014-09. The Company
is currently evaluating the impact of adopting the new revenue recognition standard, as amended, but does not expect it to have
a material impact on its financial statements.
Stock
Compensation
In
March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718), which simplified certain
aspects of the accounting for share-based payment transactions, including income taxes, classification of awards and classification
in the statement of cash flows. ASU 2016-09 will be effective for the Company beginning in its first quarter of 2018. The Company
is currently evaluating the impact of adopting the new stock compensation standard, but does not expect it to have a material
impact on its financial statements.
Financial
Instruments
In
January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10) (“ASU 2016-01”),
which updates certain aspects of recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 will
be effective for the Company beginning in its first quarter of 2019. The Company does not believe the adoption of the new financial
instruments standard will have a material impact on its financial statements.
Inventory
Measurement
In
July 2015, the FASB issued ASU No. 2015-11, “Inventory – Simplifying the Measurement of Inventory (Topic 330)”.
This update requires that inventory value be measured at the lower of cost or net realizable value. Net realizable value is the
estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.
Currently, generally accepted accounting principles require that inventory be valued at the lower of cost or market price to replace
the inventory. This update is to become effective for annual and interim financial statements for fiscal years ending after December
15, 2016. Earlier application is permitted. This update is required to be applied prospectively. The Company is currently evaluating
the impact of this update; however, at this time it does not expect it will have a material impact on its financial statements.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
25.
SUBSEQUENT EVENTS
Issuance
of Convertible Promissory Notes
During
the period from January 1 to April 12, 2017, the Company issued two convertible promissory notes and received net proceeds
of $90,000 after transaction costs. The holders may convert the convertible note at any time beginning six months after funding,
into shares of the Company's common stock at a conversion price ranging from 62% to 70% of the trading price, as defined, of the
Company’s common stock over a specified trading period prior to the date of conversion.
Conversion
of Convertible Promissory Notes
During
the period from January 1 to April 12, 2017, convertible promissory notes with an aggregate balance of $56,000, including
accrued interest thereon, were converted into 170,872,980 unregistered shares of the Company’s common stock.
Issuance
of Promissory Note
In
March 2017, the Company issued a $25,000 promissory note which matures in May 2017. Interest is payable upon maturity in
the form of 10,000,000 shares of unregistered, restricted shares of the Company's common stock. The note provides for late
payment fees of 750,000 additional shares of unregistered, restricted shares of the Company's common stock for each month
after maturity that payment is late until repaid. In addition, the Company agreed to extend warrants held by the lender to
purchase 10,839,752 shares of common stock that were scheduled to expire in 2017 for an additional five years and modify the
exercise price to $0.0015.
In April 2017, the Company issued a $5,000 promissory note which matures in June 2017. Interest is payable at the rate of
25% per annum. If the promissory note is not repaid within 60 days, 2,000,000 shares of unregistered, restricted shares of
the Company's common stock will be issued to the holder.
Conversion
of Series B Convertible Preferred Stock
During the period from January 1 to April 12, 2017, Barry C. Kaye converted 1,372 shares of Series B Convertible Stock
into 1,372,000 shares of common stock.
Issuance
of Anti-dilution shares
In
January 2017, the Company issued 670,219 shares of Series A Preferred Stock to George J. Coates representing anti-dilution shares
to restore Mr. Coates’ percentage of eligible votes to 85.7%. This percentage increased during the year ended December 31,
2016 as a result of Mr. Coates’ acquisition of 211,318,358 shares of common stock upon conversion of promissory notes from
the Company which he held with a principal amount of $157,000 and 115,006,000 shares of common stock upon conversion of 115,006
shares of Series B Convertible Preferred Stock.
During
the period from January 1 to April 12, 2017, the Company issued 772,066, 119,331 and 9,393 shares of Series B Convertible
Preferred Stock to George J. Coates, Gregory G. Coates and Barry C. Kaye, respectively, representing anti-dilution shares related
to newly issued shares of common stock. The estimated fair value of these shares was $199,000, $39,000 and $3,000, respectively.
Issuances and
Repayments
of 17% Promissory Notes to Related Parties
During
the period from January 1 to April 12, 2017, the Company issued promissory notes totalling $18,000 and partially
repaid promissory notes due to George J. Coates amounting to $4,000, including accrued interest. During the period from
January 1 to April 12, 2017, the Company issued a $21,000 of promissory notes and partially repaid promissory notes to
Bernadette Coates amounting to $4,000. These promissory notes bear interest at the rate of 17% per annum and are payable on
demand.
Deferred
Compensation
As
of April 12, 2017, George J. Coates, Gregory G. Coates, Barry C. Kaye and Bernadette Coates agreed to additional deferral of
their compensation amounting to $62,000, $43,000, $35,000 and $19,000, respectively, bringing their total deferred
compensation to $980,000, $76,000, $260,000 and $261,000, respectively.
F-30