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 of 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, 2017 and 2016, we did not have any sales and we had revenues from research and development
of $19,200 and $29,200, respectively. For the years ended December 31, 2017 and 2016, we incurred net losses of ($8,386,000) and
($8,356,000), respectively. The accumulated net losses from inception of the Company through December 31, 2017, amounted to approximately
($73,713,000). 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, 2017, we
raised $955,000 of new working capital from issuances of convertible promissory notes, issuances of promissory notes to related
parties, sales of registered shares of common stock under equity purchase agreements and private sales of common stock and common
stock warrants.
The
Company is a Delaware Corporation which was 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 caused 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, once we raise sufficient working capital, 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.
Hydroxy-Gas has a different molecular structure than hydrogen gas which will power the Hydrogen Gen Sets. 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 developing Hydrogen
Gen Sets. 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 Sets. We have determined that it is no longer feasible
to work with WTF Asia due to the owner’s health and concerns with the status of WTF Asia’s technology. The Company
intends to independently pursue further development of this technology.
We
anticipate that application 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, 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.
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 2016,” there were total U.S. vehicle registrations for the fifty states as follows:
Automobiles
|
|
|
Buses
|
|
|
Trucks
|
|
|
Motorcycles
|
|
|
Total
|
|
|
112,961,266
|
|
|
|
976,161
|
|
|
|
146,182,276
|
|
|
|
8.679.380
|
|
|
|
268,799,083
|
|
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. 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.
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.
Sublicensing
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. Renown has not made any payments towards this license
during the years ended December 31, 2017 and 2016. Until Coates Power can begin production of CSRV
®
products for
Renown, we will not receive any further monies from our sublicense with Renown.
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, 2017.
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
®
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.
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.
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 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
®
, are 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
We currently have four
(4) employees, including George J. Coates and his son Gregory G. Coates, who perform management, assembly and research and
development functions. None of our employees are represented by a labor union or are a party to a collective bargaining agreement. We believe that
we have good relations with our employees.
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 we file 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 ($73,713,210); and, as of
December 31, 2017 had a stockholders’ deficiency of ($6,009,408) and negative working capital of ($7,467,000). In addition,
our mortgage loan which had a principal balance of $1,273,158 at December 31, 2017, matures in July 2018. We will be required
to renegotiate the terms of an extension of the mortgage loan or successfully refinance the property with another mortgage lender,
if possible. Failure to do so could adversely affect our financial position and results of operations. Further, the recent trading
price range of our common stock has introduced additional risk and difficulty to our 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 13, 2018 with respect to our financial statements as of and for the year ended December 31, 2017 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, 2017, we met our obligations as they became due by raising additional
working capital of $955,004 from issuances of convertible promissory notes, issuances of promissory notes
to related parties and sales of registered shares of common stock under an equity purchase agreement.
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
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 and potential sales
of Gen Sets.
|
|
●
|
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 materials 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, 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:
|
●
|
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 had only minimal sales of CSRV
®
engine generators. 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 2018 unless we can either
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 2018.
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, 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.
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. 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 trend has been established to continue to introduce 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 such 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 88% of votes on
matters submitted to a vote of the outstanding common stockholders at April 13, 2018, 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 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 13, 2018,
we had approximately $415,000 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 13, 2018, 281,378 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.
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.
The accompanying notes are an integral part
of these financial statements.
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,
2017
|
|
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
|
|
|
Additional Paid-In
|
|
|
Accumulated
|
|
|
Total Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Deficiency
|
|
Balance, January 1, 2016
|
|
|
250
|
|
|
$
|
-
|
|
|
|
17,464
|
|
|
$
|
18
|
|
|
|
5,183,956
|
|
|
$
|
518
|
|
|
$
|
51,671,409
|
|
|
$
|
(56,970,998
|
)
|
|
$
|
(5,299,053
|
)
|
Issuance of anti-dilution shares of Series B Convertible Preferred Stock to related parties
|
|
|
|
|
|
|
|
|
|
|
64,389
|
|
|
|
64
|
|
|
|
|
|
|
|
|
|
|
|
6,875,449
|
|
|
|
|
|
|
|
6,875,513
|
|
Conversion of convertible promissory notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,745,724
|
|
|
|
675
|
|
|
|
751,593
|
|
|
|
|
|
|
|
752,268
|
|
Conversion of promissory notes to related parties to common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,056,592
|
|
|
|
106
|
|
|
|
156,737
|
|
|
|
|
|
|
|
156,843
|
|
Issuance of common stock under equity purchase agreement with Southridge Partners II, LP
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
862,470
|
|
|
|
86
|
|
|
|
199,220
|
|
|
|
|
|
|
|
199,306
|
|
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
|
|
|
-
|
|
|
|
-
|
|
|
|
(590
|
)
|
|
|
(1
|
)
|
|
|
589,910
|
|
|
|
59
|
|
|
|
(58
|
)
|
|
|
|
|
|
|
-
|
|
Issuance of common stock and warrants
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
575,000
|
|
|
|
57
|
|
|
|
74,943
|
|
|
|
|
|
|
|
75,000
|
|
Net loss for the year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8,356,092
|
)
|
|
|
(8,356,092
|
)
|
Balance, December 31, 2016
|
|
|
250
|
|
|
|
-
|
|
|
|
81,263
|
|
|
|
81
|
|
|
|
15,013,652
|
|
|
|
1,501
|
|
|
|
60,128,626
|
|
|
|
(65,327,090
|
)
|
|
|
(5,196,882
|
)
|
Issuance of anti-dilution shares of Series B Convertible Preferred Stock to related parties
|
|
|
|
|
|
|
|
|
|
|
147,215
|
|
|
|
147
|
|
|
|
|
|
|
|
|
|
|
|
5,659,260
|
|
|
|
|
|
|
|
5,659,407
|
|
Conversion of convertible promissory notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
21,879,384
|
|
|
|
2,188
|
|
|
|
766,641
|
|
|
|
|
|
|
|
768,829
|
|
Issuance of Series A Preferred Stock
|
|
|
3,351
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,216
|
|
|
|
|
|
|
|
17,220
|
|
Beneficial conversion feature on convertible promissory notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
981,214
|
|
|
|
|
|
|
|
981,214
|
|
Imputed interest on promissory note payable to related party
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
142,580
|
|
|
|
|
|
|
|
142,580
|
|
Conversions of Series B Convertible Preferred Stock to common stock
|
|
|
|
|
|
|
|
|
|
|
(7
|
)
|
|
|
-
|
|
|
|
6,860
|
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
-
|
|
Issuance of common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43,443
|
|
|
|
4
|
|
|
|
4,340
|
|
|
|
|
|
|
|
4,344
|
|
Payment for fractional shares resulting from reverse stock split
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(97
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
Net loss for the year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8,386,120
|
)
|
|
|
(8,386,120
|
)
|
Balance, December 31, 2017
|
|
|
3,601
|
|
|
$
|
4
|
|
|
|
228,471
|
|
|
$
|
228
|
|
|
|
36,943,242
|
|
|
$
|
3,694
|
|
|
$
|
67,699,876
|
|
|
$
|
(73,713,210
|
)
|
|
$
|
(6,009,408
|
)
|
The accompanying notes are an integral part
of these financial statements.
Coates International, Ltd.
Statements of Cash Flows
|
|
For the Years Ended
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Net Cash Flows Used in Operating Activities
|
|
|
|
|
|
|
|
|
Net loss for the year
|
|
$
|
(8,386,120
|
)
|
|
$
|
(8,356,093
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock-based compensation expense
|
|
|
5,676,626
|
|
|
|
6,875,514
|
|
Interest accrued, but not paid
|
|
|
1,000,534
|
|
|
|
601,053
|
|
Loss on conversion of convertible notes
|
|
|
264,474
|
|
|
|
143,418
|
|
Increase (decrease) in fair value of embedded derivative liabilities
|
|
|
205,524
|
|
|
|
(479,455
|
)
|
Depreciation and amortization
|
|
|
48,995
|
|
|
|
48,370
|
|
Non-cash portion of inventory used for research and development
|
|
|
-
|
|
|
|
60,101
|
|
Recognition of non-cash licensing revenues
|
|
|
(19,200
|
)
|
|
|
(19,200
|
)
|
Changes in Operating Assets and Liabilities:
|
|
|
|
|
|
|
|
|
Inventory
|
|
|
87,872
|
|
|
|
26,535
|
|
Other assets
|
|
|
3,477
|
|
|
|
(37,910
|
)
|
Accounts payable and accrued liabilities
|
|
|
3,452
|
|
|
|
293,369
|
|
Deferred compensation payable
|
|
|
349,005
|
|
|
|
350,173
|
|
Net Cash Used in Operating Activities
|
|
|
(765,361
|
)
|
|
|
(494,125
|
)
|
|
|
|
|
|
|
|
|
|
Net Cash Used in Investing Activities:
|
|
|
|
|
|
|
|
|
Acquisition of property, plant and equipment
|
|
|
-
|
|
|
|
(11,493
|
)
|
|
|
|
.
|
|
|
|
|
|
Cash Flows Provided by Financing Activities:
|
|
|
|
|
|
|
|
|
Issuance of convertible promissory notes
|
|
|
810,050
|
|
|
|
175,750
|
|
Issuance of promissory notes to related parties
|
|
|
102,011
|
|
|
|
182,143
|
|
Issuance of common stock under equity purchase agreements
|
|
|
42,944
|
|
|
|
199,306
|
|
Issuance of common stock
|
|
|
-
|
|
|
|
75,000
|
|
Licensing Fee Revenue
|
|
|
-
|
|
|
|
10,000
|
|
Repayment of promissory notes and accrued interest to related parties
|
|
|
(132,000
|
)
|
|
|
(93,000
|
)
|
Repayment of mortgage loan
|
|
|
(60,000
|
)
|
|
|
(55,000
|
)
|
Finance Lease Obligation Payments
|
|
|
-
|
|
|
|
(8,625
|
)
|
Net Cash Provided by Financing Activities
|
|
|
763,005
|
|
|
|
485,574
|
|
Net Decrease in Cash
|
|
|
(2,356
|
)
|
|
|
(20,044.00
|
)
|
Cash, beginning of period
|
|
|
9,163
|
|
|
|
29,207.00
|
|
Cash, end of period
|
|
$
|
6,807
|
|
|
$
|
9,163
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information:
|
|
|
|
|
|
|
|
|
Cash paid during the year for interest
|
|
$
|
161,069
|
|
|
$
|
161,069
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Non-cash Financing Activities:
|
|
|
|
|
|
|
|
|
Conversion of convertible promissory notes
|
|
$
|
714,942
|
|
|
$
|
714,942
|
|
The accompanying notes are an integral part
of these financial statements.
Coates
International, Ltd.
Notes
to Financial Statements
December
31, 2017 and 2016
(All
amounts rounded to thousands of United States dollars)
1.
THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature
of Organization
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. Mr. Coates 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. 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 has been postponed in order to focus on potential new sublicense agreements for Gen Sets powered by
hydrogen gas fuel. 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 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 Sets. We have determined that it is no longer feasible
to work with WTF Asia due to the owner’s health and concerns with the status of WTF Asia’s technology. The Company
intends to independently pursue further development of this technology at some indefinite point in the future.
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.
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 capital 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, imputed interest arising from the amortization
of discount on convertible promissory notes 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, 2017, had a stockholders’ deficiency of ($6,009,000). In addition, our mortgage loan which had a principal balance of $1,273,000
at December 31, 2017, matures in July 2018. The Company will be required to renegotiate the terms of an extension of the mortgage
loan or successfully refinance the property with another mortgage lender, if possible. Failure to do so could adversely affect
the Company’s financial position and results of operations. Further, the recent trading price range of the Company’s
common stock 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
December 31, 2017, the Company had negative working capital of ($7,467,000) compared with negative working capital of ($5,411,000)
at the end of 2016.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
During
the years ended December 31, 2017 and 2016, the Company raised $959,000 and $642,000, respectively, of new working capital from
the following:
|
Description
|
|
2017
|
|
|
2016
|
|
|
Issuances of convertible promissory
notes
|
|
$
|
810,000
|
|
|
$
|
176,000
|
|
|
Issuances of promissory notes to
related parties
|
|
|
102,000
|
|
|
|
182,000
|
|
|
Sales of common stock under equity
purchase agreements
|
|
|
43,000
|
|
|
|
199,000
|
|
|
Private sales of shares of common
stock and common stock warrants
|
|
|
-
|
|
|
|
75,000
|
|
|
Licensing
fee revenue
|
|
|
-
|
|
|
|
10,000
|
|
|
|
|
$
|
955,000
|
|
|
$
|
642,000
|
|
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, 2016 have been reclassified in order
to make them comparable to the amounts presented for the year ended December 31, 2017.
Reverse
Stock Split
The
Company effected a one-for-200 reverse stock split of all of its outstanding shares of common stock, Series A Preferred Stock,
Series B Convertible Preferred Stock, common stock warrants and stock options as of the close of trading on December 1, 2017.
All prior year balances of shares of capital stock, warrants and stock options outstanding and all presentations and disclosures
of transactions in shares of capital stock, warrants and stock options have been restated on a pro forma basis as if the reverse
stock split had occurred prior to the beginning of the year ended December 31, 2016. Such restatements include calculations regarding
the Company’s weighted average shares outstanding and loss per share.
The
following presents the amounts previously reported before the reverse stock split and restated balances reflected in the accompanying
balance sheets and statements of stockholders’ deficiency as of January 1, 2016 and December 31, 2016:
|
|
|
December
31, 2016
|
|
|
January
1, 2016
|
|
|
|
|
Originally
Reported
|
|
|
Restatement
Adjustment
|
|
|
As
Restated
|
|
|
Originally
Reported
|
|
|
Restatement
Adjustment
|
|
|
As
Restated
|
|
|
Common Stock
|
|
$
|
300,273
|
|
|
($
|
298,772
|
)
|
|
$
|
1,501
|
|
|
$
|
103,679
|
|
|
($
|
103,161
|
)
|
|
$
|
518
|
|
|
Series A Preferred Stock
|
|
|
50
|
|
|
|
(50
|
)
|
|
|
-
|
|
|
|
50
|
|
|
|
(50
|
)
|
|
|
-
|
|
|
Series B Convertible Preferred Stock
|
|
|
16,253
|
|
|
|
(16,172
|
)
|
|
|
81
|
|
|
|
3,493
|
|
|
|
(3,475
|
)
|
|
|
18
|
|
|
Additional Paid-in Capital
|
|
|
59,813,632
|
|
|
|
314,994
|
|
|
|
60,128,626
|
|
|
|
51,564,723
|
|
|
|
106,686
|
|
|
|
51,671,409
|
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Revenue
Recognition
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 a 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, 2017 and
2016 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. 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.
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.
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Deferred
Compensation
Deferred
compensation represents salaries of George J. Coates, Gregory G. Coates, Bernadette Coates and one employee 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, Bernadette Coates and one employee have been
repaid with interest thereon. Deferred compensation owed to Gregory G. Coates will be paid at such time that the Company has sufficient
working capital. During the year ended December 31, 2017, $10,000 of deferred compensation was paid to George J. Coates. No other payments
of deferred compensation were made during the years ended December 31, 2017 and 2016.
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. Deferred tax assets and the
valuation allowance at December 31, 2017 and 2016, have been adjusted to reflect the change in effective tax rates that went into
effect as of January 1, 2018, pursuant to the Tax Cuts and Jobs Act of 2017.
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.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
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. Net loss per share was determined on a pro forma basis
assuming the one-for-200 reverse stock split, which occurred
upon the close of trading on December 1, 2017, had
instead occurred as of January 1, 2016.
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 13.
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.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
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, 2017 and 2016 deferred licensing costs, comprised of expenditures for patent costs incurred pursuant to the CSRV
®
licensing agreement, net of accumulated amortization, amounted to $34,000 and $38,000, respectively. Amortization expense
for the years ended December 31, 2017 and 2016 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, 2017, the unamortized balance was $170,000. Amortization of this amount
is as follows:
Year
Ending
|
|
Amount
|
|
2018
|
|
|
19,000
|
|
2019
|
|
|
19,000
|
|
2020
|
|
|
19,000
|
|
2021
|
|
|
19,000
|
|
Thereafter
|
|
|
94,000
|
|
|
|
$
|
170,000
|
|
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. Renown intends to source CSRV
®
products from Coates Power, Ltd., a China-based company formed for the purpose of manufacturing CSRV
®
products
(“Coates Power”). Coates Power has not been able to commence operations due to ongoing delays in obtaining necessary
support and approval from the Chinese government in spite of continuing efforts by Renown to do so on its behalf. This has been
and continues to be a long, arduous process because the government is addressing this at a very slow pace. As of December 31,
2017, the Company has only received an initial non-refundable deposit of $500,000. Until Coates Power can begin production of CSRV
®
products for Renown, the Company
will not receive any further monies from its sublicense with Renown.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
At
this time, as the Company’s intellectual property rights only 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, a trust controlled by George J. Coates. Coates Power and Renown are controlled
and managed by Mr. James Pang, the Company’s liaison agent in China.
The
Company received a $131,000 cash deposit with an order from Coates Power to produce two Gen Sets. This amount is included in Deposits
in the accompanying balance sheets at December 31, 2017 and 2016. The Company intends to build and ship these two generators at
such time that Coates Power is able to commence production in accordance with the manufacturing license agreement and there is
sufficient working capital for this purpose.
7.
INVENTORY
Inventory
at December 31, consisted of the following:
|
|
2017
|
|
|
2016
|
|
Raw materials
|
|
$
|
104,000
|
|
|
$
|
178,000
|
|
Work-in-process
|
|
|
-
|
|
|
|
13,000
|
|
Total
|
|
$
|
104,000
|
|
|
$
|
191,000
|
|
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. The Almont deposit is being 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, 2017, the Company has recognized a total of $130,000 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, 2017 and 2016.
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 entered into an exclusive sublicense agreement with a group of companies under common ownership referred
to as the Secure Supplies Companies (“Secure Supplies”). Under this sublicense agreement, Secure Supplies intended
to procure a substantial number of large industrial CSRV
®
electric power generators powered by hydrogen gas. Secure
Supplies is in default under the sublicense agreement for failure to pay the licensing fee that was due upon signing. In September
2017 the Company declared Secure Supplies in default and canceled the sublicense agreement. In the event that Secure Supplies
is able to adequately fund its operating plan, the Company would consider entering into a new, non-exclusive sublicense agreement.
The Company intends to sublicense hydrogen powered CSRV
®
electric power generators to other interested third parties
on a non-exclusive basis.
Sublicensing
fee revenue for the years ended December 31, 2017 and 2016 amounted to $19,000 and $29,000, respectively. Included in sublicensing
fee revenue for 2016, was a $10,000 sublicensing fee received from Secure Supplies.
9.
PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment at cost, less accumulated depreciation, consists of the following at December 31:
|
|
2017
|
|
|
2016
|
|
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
|
|
|
|
57,000
|
|
|
|
|
3,028,000
|
|
|
|
3,028,000
|
|
Less: Accumulated
depreciation
|
|
|
(996,000
|
)
|
|
|
(952,000
|
)
|
Total
|
|
$
|
2,032,000
|
|
|
$
|
2,076,000
|
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Depreciation
expense amounted to $45,000 and $44,000 for the years ended December 31, 2017 and 2016, 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 matures in July 2018. Interest expense for the years ended December 31, 2017
and 2016 on this mortgage amounted to $99,000 and $95,000, 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, 2017 and 2016 was $1,273,000
and $1,333,000, respectively. The mortgage loan may be prepaid in whole, or, in part, at any time without penalty. The Company
will be required to renegotiate the terms of a further extension of the mortgage loan or successfully refinance the property with
another mortgage lender, if possible. Failure to do so, could adversely affect the Company’s financial position and results
of operations.
The
loan is collateralized by a security interest in all of the Company’s assets, the pledge of 25,000 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.
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts
payable and accrued liabilities at December 31, consisted of the following:
|
|
2017
|
|
|
2016
|
|
Legal and professional
fees
|
|
$
|
1,427,000
|
|
|
$
|
1,452,000
|
|
Accrued interest expense
|
|
|
582,000
|
|
|
|
502,000
|
|
General and administrative expenses
|
|
|
420,000
|
|
|
|
392,000
|
|
Research and development costs
|
|
|
115,000
|
|
|
|
115,000
|
|
Total
|
|
$
|
2,544,000
|
|
|
$
|
2,461,000
|
|
13.
PROMISSORY NOTES TO RELATED PARTIES
Promissory
Notes Issued to George J. Coates
During
the years ended December 31, 2017 and 2016, the Company issued, in a series of transactions, promissory notes to George J. Coates
and received cash proceeds of $50,000 and $177,000, respectively. During the years ended December 31, 2017 and 2016 the Company
repaid promissory notes to George J. Coates in cash in the aggregate principal amount of $33,000 and $30,000, respectively, and
$48,000 and $63,000 of interest in 2017 and 2016, respectively. In addition, during the year ended December 31, 2016, the Company
and Mr. Coates mutually agreed to convert a total of $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 dates 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, 2017, the outstanding balance consisted of $20,000 of principal and $318,000 of
accrued interest.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
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 $1,418,000 at December 31, 2017 which is payable on demand. During the year ended December
31, 2017, the Company repaid $20,000 principal amount of this promissory note. Interest at the rate of 10%
per annum amounting to $143,000 and $144,000 has been imputed on this promissory note for the years ended December 31, 2017 and
2016, respectively.
Promissory
Notes Issued to Bernadette Coates
During
the years ended December 31, 2017 and 2016, the Company issued, in a series of transactions, promissory notes to Bernadette Coates,
spouse of George J. Coates, and received cash proceeds of $52,000 and $-0-, respectively. During the years ended December 31,
2017 and 2016 the Company repaid promissory notes to Bernadette Coates in cash in the aggregate principal amount of $31,000 and
$-0-. The promissory notes are payable on demand and provide for interest at the rate of 17% per annum, compounded monthly. At
December 31, 2017, the outstanding balance consisted of $29,000 of principal and $95,000 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. Accrued interest
on this note amounted to $1,000 at December 31, 2017.
For
the years ended December 31, 2017 and 2016, aggregate interest expense on all promissory notes to related parties amounted to
$223,000 and $293,000, respectively.
14. CONVERTIBLE
PROMISSORY NOTES AND EMBEDDED DERIVATIVE LIABILITY
From
time to time, the Company issues convertible promissory notes. At December 31, 2017, there was $186,000 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, 2017 and 2016, $867,000 and $190,000, respectively, of convertible promissory notes were issued.
The notes may be converted into unregistered shares of the Company’s common stock at discounts ranging from 30% to 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 defined trading period ranging from 10 to 25 trading days 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.
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 ranging from 25% to 50% of the principal
amount of the convertible note at any time prior to becoming eligible for conversion.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
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,
2017
|
|
|
December 31,
2016
|
|
Level 1 Inputs
|
|
$
|
-
|
|
|
$
|
-
|
|
Level 2 Inputs
|
|
|
359,000
|
|
|
|
153,000
|
|
Level 3 Inputs
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
359,000
|
|
|
$
|
153,000
|
|
In
a series of transactions, during the year ended December 31, 2017, convertible promissory notes with an aggregate principal balance
of $726,000, including accrued interest thereon were converted into 21,879,033 unregistered shares of common stock. The Company
incurred a loss on these conversions amounting to $264,000 for the year ended December 31, 2017. Included in this loss is $43,000
related to the issuance of 1,063,351 unregistered shares of common stock pursuant to the provisions of certain convertible notes
which require additional shares of common stock to be issued if the trading price, as defined, declines during the 23-trading
day period after conversions shares are delivered to the convertible noteholder.
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 6,745,724 unregistered shares of common stock. The Company
incurred a loss on these conversions amounting to $143,000 for the year ended December 31, 2016. Included in this loss is $37,000
related to the issuance of 315,716 unregistered shares of common stock pursuant to the provisions of certain convertible notes
which require additional shares of common stock to be issued if the trading price, as defined, declines during the 23-trading
day period after conversions shares are delivered to the convertible noteholder.
At
December 31, 2017, the Company had reserved 46,037,325 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.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
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 120,000,000 shares of common stock, par value, $0.0001 per share (the “Common Stock”).
At
the close of trading in the Company’s common stock on December 1, 2017, a 1:200 reverse stock split of all of the Company’s
shares of common stock, shares of preferred stock, common stock warrants and stock options became effective. Shareholders were
paid cash-in-lieu of any fractional shares that would have resulted in connection with the reverse stock split. The reverse stock
split was approved by the board of directors and the George J. Coates, the majority stockholder by means of a written consent.
For purposes of presenting the accompanying financial statements for the years ended December 31, 2017 and 2016, all balances,
transactions and calculations were restated on a pro forma basis as if the reverse stock split occurred prior to the beginning
of the year ended December 31, 2016.
The
following common stock transactions occurred during the year ended December 31, 2017:
|
●
|
In
a series of transactions, convertible promissory notes with an aggregate principal balance
of $767,000, including accrued interest thereon, were converted into 21,879,384 unregistered
shares of common stock.
|
|
●
|
In
May 2017, the Company issued 44,443 shares of stock to a lender as payment for interest
due on a $25,000 short term loan which was repaid in full. The amount of such interest
was $4,000.
|
|
●
|
In
February 2017, Barry C. Kaye converted 6.86 shares of Series B Convertible Preferred
Stock into 6,860 restricted shares of common stock.
|
|
●
|
Fractional
shares resulting from the reverse stock split, amounting to the equivalent of 97 post-reverse
stock split shares of common stock were canceled as the holders were paid cash in lieu
of receiving such fractional shares.
|
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 6,745,724 unregistered shares of common stock.
|
|
●
|
In
a series of transactions during the year ended December 31, 2016, the Company issued
862,470 registered shares of its common stock to Southridge Partners II LP (“Southridge”)
under the 2015 EP Agreement, as discussed in Note 18, 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 575,000 unregistered shares of its common stock and 575,000 common
stock warrants to purchase one unregistered share of its common stock at exercise prices
ranging from $0.10 to $0.20 per share, in consideration for $75,000.
|
|
●
|
During
the year ended December 31, 2016, George J. Coates and Barry C. Kaye converted 575.03
shares and 14.88 shares of Series B into 575,030 and 14,880 restricted shares of the
Company’s common stock, respectively.
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
|
●
|
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 2,852,291 restricted, unregistered shares
of the Company’s common stock at conversion rates ranging from $0.12 to $0.22 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 1,795,699 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.
|
At
December 31, 2017, the Company had reserved 6,428,895 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 350,000 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”), 5,000 shares
designated, 3,601 and 250 shares issued and outstanding as of December 31, 2017 and 2016,
respectively. 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 outstanding shares of Series A are owned by George J. Coates, which entitle him to
2,500,000 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.
During
the year ended December 31, 2017, the Company issued 3,351 shares of Series A with an estimated fair value of $17,000 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 1,056,592 shares of common
stock upon conversion of promissory notes from the Company which he held with a principal amount of $157,000 and 575,030 shares
of common stock upon conversion of 575.03 shares of Series B Convertible Preferred Stock, par value $0.001 per share (“Series
B”).
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
|
●
|
Series
B Convertible Preferred Stock, par value $0.001 per share, 345,000 shares designated
and 228,471 and 81,263 shares issued and outstanding as of December 31, 2017 and 2016,
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, 2017, 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, 2017, consisted of 211,105, 16,130 and 1,236 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
|
|
|
2018
|
|
|
2019
|
|
George J. Coates
|
|
|
211,105
|
|
|
|
74,506
|
|
|
|
136,599
|
|
Gregory G. Coates
|
|
|
16,130
|
|
|
|
5,484
|
|
|
|
10,646
|
|
Barry C. Kaye
|
|
|
1,236
|
|
|
|
413
|
|
|
|
823
|
|
During
the year ended December 31, 2017,
136,599, 10,646 and 823 shares of Series B were issued to George J. Coates, Gregory
G. Coates and Barry C. Kaye, respectively, having an estimated fair value of $5,204,000, $423,000 and $27,000, respectively.
These amounts were included in stock-based compensation expense in the accompanying statement of operations for the year
ended December 31, 2017.
During
the year ended December 31, 2017, Barry C. Kaye converted 6.86 shares of Series B into 6,860 shares of the Company’s common
stock, respectively.
During
the year ended December 31, 2016, 59,694, 4,360 and 335 shares of Series B were issued to George J. Coates, Gregory G. Coates
and Barry C. Kaye, respectively, having an estimated fair value of $6,386,000, $455,000 and $35,000, respectively. These amounts
were included in stock-based compensation expense in the accompanying statement of operations for the year ended December 31,
2016.
During
the year ended December 31, 2016, George J. Coates and Barry C. Kaye converted 575.03 shares and 14.88 shares of Series B into
575,030 and 14,880 shares of the Company’s common stock, respectively.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
In
the event that all of the 228,471 shares of Series B outstanding at December 31, 2017, were converted once the conversion restrictions
lapse, an additional 228,471,000 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, 2017, this would dilute the ownership percentage of non-affiliated stockholders
from 91.8% to 12.8%.
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.
INCOME (LOSS) PER SHARE
At
December 31, 2017, there were stock warrants outstanding to purchase 751,725 shares of common stock at exercise prices ranging
from $0.10 to $13.50 per share, vested stock options outstanding to acquire 62,350 shares of common stock at exercise prices ranging
from $5.60 to $88.00 per share and $186,000 of convertible promissory notes outstanding, which on a pro forma basis assuming all
such promissory notes were converted into shares of common stock using the contractual conversion price determined as of the close
of trading on the last trading day of 2017, would have been convertible into 17,275,869 shares of common stock.
At
December 31, 2016, there were stock warrants outstanding to purchase 751,725 shares of common stock at exercise prices ranging
from $0.10 to $24.00 per share, vested stock options outstanding to acquire 62,350 shares of common stock at exercise prices ranging
from $5.60 to $88.00 per share and $99,000 of convertible promissory notes outstanding, which on a pro forma basis assuming all
such promissory notes were converted into shares of common stock using the contractual conversion price determined as of the close
of trading on the last trading day of 2016, would have been convertible into 1,596,774 shares of common stock.
For
the years ended December 31, 2017 and 2016, 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.
17.
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. After adjusting for the reverse stock split, a total of 62,500
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 62,500 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.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
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.
After adjusting for the reverse stock split, a total of 250,000 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 250,000 shares of common stock covered by the
2014 Stock Plan. At December 31, 2017, none of the shares of common stock authorized under the 2014 Stock Plan had been granted
as stock options or awarded.
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, 2017 and 2016.
There
were no unvested stock options outstanding at December 31, 2017.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
A
summary of the activity in the Company’s Stock Option Plan is as follows (all amounts adjusted to the reverse stock split,
as if it had occurred on January 1, 2016):
|
|
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,
1/1/16
|
|
$
|
5.60
– $88.00
|
|
|
|
62,350
|
|
|
|
11
|
|
|
|
62,350
|
|
|
$
|
36.34
|
|
|
$
|
33.84
|
|
Stock
options vested
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Stock
options expired
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Balance,
12/31/16
|
|
$
|
5.60
– 88.00
|
|
|
|
62,350
|
|
|
|
10
|
|
|
|
62,350
|
|
|
|
36.34
|
|
|
|
33.84
|
|
Stock
options vested
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Stock
options expired
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Balance,
12/31/17
|
|
$
|
5.60 – $88.00
|
|
|
|
62,350
|
|
|
|
9
|
|
|
|
62,350
|
|
|
$
|
36.34
|
|
|
$
|
33.84
|
|
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.
|
The
following table sets forth information with respect to stock options outstanding at December 31, 2017:
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
|
|
|
5,000
|
|
|
$
|
88.00
|
|
|
10/23/2021
|
|
|
President
|
|
|
250
|
|
|
|
80.00
|
|
|
11/4/2024
|
|
|
|
|
|
1,375
|
|
|
|
80.00
|
|
|
11/17/2025
|
|
|
|
|
|
9,000
|
|
|
|
50.00
|
|
|
7/25/2026
|
|
|
|
|
|
9,075
|
|
|
|
12.00
|
|
|
6/24/2027
|
Gregory
G. Coates
|
|
Director
and President, Technology Division
|
|
|
2,500
|
|
|
|
88.00
|
|
|
10/23/2021
|
|
|
|
|
|
9,000
|
|
|
|
48.00
|
|
|
8/8/2026
|
|
|
|
|
|
1,757
|
|
|
|
5.60
|
|
|
4/30/2029
|
Barry
C. Kaye
|
|
Director,
Treasurer and Chief Financial
|
|
|
625
|
|
|
|
88.00
|
|
|
10/18/2021
|
|
|
Officer
|
|
|
500
|
|
|
|
8.40
|
|
|
2/11/2028
|
|
|
|
|
|
1,758
|
|
|
|
5.60
|
|
|
4/30/2029
|
Dr.
Frank J. Adipietro
|
|
Non-employee
Director
|
|
|
125
|
|
|
|
88.00
|
|
|
3/28/2022
|
|
|
|
|
|
250
|
|
|
|
80.00
|
|
|
11/3/2024
|
|
|
|
|
|
425
|
|
|
|
80.00
|
|
|
11/17/2025
|
|
|
|
|
|
3,335
|
|
|
|
12.00
|
|
|
6/24/2027
|
Dr.
Richard W. Evans
|
|
Consultant
|
|
|
125
|
|
|
|
88.00
|
|
|
3/28/2022
|
|
|
|
|
|
250
|
|
|
|
78.00
|
|
|
12/27/2024
|
|
|
|
|
|
1,000
|
|
|
|
50.00
|
|
|
2/15/2026
|
|
|
|
|
|
15,625
|
|
|
|
12.00
|
|
|
6/20/2027
|
Dr.
Michael J. Suchar
|
|
Consultant
|
|
|
125
|
|
|
|
88.00
|
|
|
3/28/2022
|
Richard
Whitworth
|
|
Non-employee
Director
|
|
|
125
|
|
|
|
88.00
|
|
|
3/28/2022
|
William
Wolf. Esq.
|
|
Outside
General Counsel
|
|
|
125
|
|
|
|
88.00
|
|
|
4/4/2022
|
(1)
All outstanding stock options are fully vested.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
18.
EQUITY PURCHASE AND REGISTRATION RIGHTS AGREEMENTS
In
July 2015, the Company entered into an equity purchase agreement (the “EP Agreement”) with Southridge Partners II
LP (“Southridge”). Pursuant to the terms of the EP Agreement, Southridge committed to purchase up to 1,025,000 shares
of the Company’s common stock. In December 2016, the EP Agreement automatically terminated because Southridge had purchased
all 1,025,000 registered shares of common stock under the EP Agreement.
The
terms of the 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 was entitled
to exercise a Put to Southridge by delivering a Put Notice, which required 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 was below the Floor Price, if any, stipulated in the Put Notice issued
by the Company, then the dollar amount of the Put would be reduced by 10% for each such day.
The
Company also entered into a registration rights agreement (the “Registration Rights Agreement”) with Southridge, pursuant
to which the Company filed a registration statement with the SEC covering 1,025,000 shares of common stock underlying the EP Agreement,
which was declared effective August 5, 2015.
In
January 2017, the Company received proceeds of $43,000 from sales of 380,707 registered shares of common stock at the end of 2016,
under the EP Agreement. During the year ended December 31, 2016, the Company sold 862,470 registered shares of common stock to
Southridge and received proceeds of $156,000 under the EP Agreement.
19.
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 decreased by ($4,273,000) and increased by $3,340,000 for the years ended December 31, 2017 and 2016, respectively.
The decrease in 2017 primarily resulted from a reduction in the corporate income tax rate from 34% to 21% under Tax Cuts and Jobs
Act of 2017, partially offset by a $1,609,000 increase in deferred tax assets. These amounts were fully offset by a corresponding
(decrease) 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, 2017 and 2016. 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 2013 through 2016, 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, 2017 and 2016, there were no penalties or interest related to the Company’s income tax returns.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
Total
deferred tax assets and valuation allowances are as follows at December 31:
|
|
2017
|
|
|
2016
|
|
Current
deferred tax asset - inventory reserve
|
|
$
|
137,000
|
|
|
$
|
195,000
|
|
|
|
|
|
|
|
|
|
|
Non-Current Deferred Tax Assets:
|
|
|
|
|
|
|
|
|
Stock-based compensation
expense
|
|
|
8,639,000
|
|
|
|
10,022,000
|
|
Net operating
loss carryforwards
|
|
|
5,091,000
|
|
|
|
7,558,000
|
|
Deferred compensation
not paid within 2.5 months
|
|
|
363,000
|
|
|
|
509,000
|
|
Accrued liabilities
not paid
|
|
|
313,000
|
|
|
|
466,000
|
|
Accrued
interest on notes to related parties
|
|
|
163,000
|
|
|
|
199,000
|
|
Total
long-term deferred tax assets
|
|
|
14,569,000
|
|
|
|
18,784,000
|
|
Total deferred tax assets
|
|
|
14,706,000
|
|
|
|
18,979,000
|
|
Less: valuation
allowance
|
|
|
(14,706,000
|
)
|
|
|
(18,979,000
|
)
|
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 21% and 34% at December 31 2017 and 2016, respectively, are as follows:
|
|
2017
|
|
|
2016
|
|
Federal tax provision
at the statutory rate
|
|
|
21.0
|
%
|
|
|
34.0
|
%
|
State income tax benefit, net of
federal benefit
|
|
|
(0.8
|
)
|
|
|
(0.9
|
)
|
Stock-based compensation expense
|
|
|
(19.0
|
)
|
|
|
(29.7
|
)
|
Deferred compensation not paid within
2.5 months
|
|
|
(1.2
|
)
|
|
|
0.6
|
|
Accrued interest not deductible for
tax return purposes
|
|
|
(3.3
|
)
|
|
|
(3.4
|
)
|
Net change in net operating loss
carryforwards
|
|
|
29.8
|
|
|
|
(7.2
|
)
|
Loss on conversion of convertible
notes
|
|
|
(0.9
|
)
|
|
|
(1.1
|
)
|
Increase in estimated fair value
of embedded derivative liabilities
|
|
|
(0.7
|
)
|
|
|
(0.6
|
)
|
Accrued liabilities
not deductible for tax return purposes
|
|
|
0.2
|
|
|
|
(0.1
|
)
|
Total
|
|
|
25.1
|
|
|
|
(8.4
|
)
|
Valuation
allowance
|
|
|
(25.1
|
)
|
|
|
8.4
|
|
Effective
tax rate
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
At
December 31, 2017, the Company had available, $20,717,000 of net operating loss carryforwards which may be used to reduce future
federal taxable income, expiring between 2018 and 2037. At December 31, 2017, the Company had available $10,294,000 of net operating
loss carryforwards which may be used to reduce future state taxable income, expiring between 2029 and 2037.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
20.
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 properties licensed to it by George J. Coates and Gregory G. Coates. For the years ended
December 31, 2017 and 2016, these costs amounted to $32,000 and $39,000, 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 years ended December 31,
2017 and 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, 2017 and 2016, 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, 2017, accrued, unpaid interest on outstanding promissory notes to related parties, aggregated $414,000.
Stock
Options
Stock
options previously granted to related parties, all of which are fully vested are more fully discussed in Note 17.
Issuances
and Conversions of Preferred Stock
Shares
of Series A Preferred Stock awarded to George J. Coates during the years ended December 31, 2017 are discussed in detail in Note
15.
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, 2017 and 2016, 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.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
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,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
George J. Coates (a) (b)
|
|
$
|
26,000
|
|
|
$
|
16,000
|
|
|
Gregory G. Coates (c) (d) (e)
|
|
|
58,000
|
|
|
|
139,000
|
|
|
Bernadette Coates (f)
|
|
|
-0-
|
|
|
|
5,000
|
|
|
(a)
|
For
the years ended December 31, 2017 and 2016, George J. Coates earned additional base compensation
of $240,000 and $250,000, respectively, payment of which is being deferred until the
Company has sufficient working capital. At December 31, 2017 and 2016, the total amount
of deferred compensation was $1,221,000 and $981,000, respectively. These amounts are
included in deferred compensation in the accompanying balance sheets at December 31,
2017 and 2016.
|
|
(b)
|
During
the year ended December 31, 2017, the Company issued 3,351 shares of Series A Preferred
Stock with an estimated fair value of $17,000 to George J. Coates representing anti-dilution
shares to restore Mr. Coates’ percentage of eligible votes to 85.7%.
|
|
(c)
|
During
the year ended December 31, 2017 and 2016, George J. Coates was awarded 136,599 and 59,694
shares of Series B Convertible Preferred Stock, respectively, with an estimated fair
value of $5,204,000 and $6,386,000, 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 of the date of issuance.
|
|
(d)
|
For
the years ended December 31, 2017 and 2016, Gregory G. Coates earned additional base
compensation of $110,000 and $33,000, respectively, payment of which is being deferred
until the Company has sufficient working capital. At December 31, 2017 and 2016, the
total amount of deferred compensation was $143,000 and $33,000, respectively. These amounts
are included in deferred compensation in the accompanying balance sheets at December
31, 2017 and 2016.
|
|
(e)
|
During
the years ended December 31, 2017 and 2016, Gregory G. Coates was awarded 10,646 and
4,360 shares of Series B Convertible Preferred Stock with an estimated fair value of
$423,000 and $455,000, 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 of the date of issuance.
|
|
(f)
|
For
the year ended December 31, 2016, Bernadette Coates, who retired at the end of third
quarter of 2016, earned additional base compensation of $50,000, respectively, payment
of which is being deferred until the Company has sufficient working capital. At December
31, 2017 and 2016, the total amount of deferred compensation was $242,000. These amounts
are included in deferred compensation in the accompanying balance sheets at December
31, 2017 and 2016.
|
During
the years ended December 31, 2017 and 2016, Barry C. Kaye, Treasurer and Chief Financial Officer was paid compensation of
$63,000 and $6,000, respectively. For the years ended December 31, 2017 and 2016, Mr. Kaye earned compensation of $113,000
and $102,000, respectively, 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 at
the rate of 17% per annum, 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. During the year
ended December 31, 2017, interest accrued on Mr. Kaye’s deferred compensation amounted to $60,000. At December 31,
2017, the total amount of Mr. Kaye’s unpaid, deferred compensation, including accrued interest thereon, was $418,000.
This amount is included in accounts payable and accrued liabilities in the accompanying balance sheet at December 31, 2017.
During the years ended December 31, 2017 and 2016, Barry C. Kaye was awarded 823 and 335 shares of Series B Convertible
Preferred Stock, respectively, with an estimated fair value of
$27,000 and $35,000, 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 of the date of issuance.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
At
December 31, 2017, the Company owed deferred compensation to an employee in the amount of $16,000, 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, 2017.
21.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The
following table summarizes the Company’s contractual obligations and commitments at December 31, 2017, all of which are
payable during the year ended December 31, 2018:
Deferred compensation
|
|
$
|
1,621,322
|
|
Promissory notes to related parties
|
|
|
1,472,409
|
|
Mortgage loan payable
|
|
|
1,273,158
|
|
Convertible
promissory notes
|
|
|
186,444
|
|
Total
|
|
$
|
4,553,333
|
|
22.
LITIGATION AND CONTINGENCIES
The
Company is not a party to any litigation that is material to its business.
23.
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.
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
24.
SUBSEQUENT EVENTS
Section
3(a)10 Exempt Securities Transaction
On
March 19, 2018, the Company entered into a Settlement Agreement and Stipulation (the “Settlement Agreement”) with
Livingston Asset Management LLC, a Florida limited liability company (“LAM”), pursuant to which the Company agreed
to issue common stock to LAM in exchange for the settlement of $69,000 (the “Settlement Amount”) of past-due obligations
and accounts payable of the Company. LAM purchased the obligations and accounts payable from certain vendors of the Company as
described below.
On
April 2, 2018, the Circuit Court of Baltimore County, Maryland (the “Court”), entered an order (the “LAM Order”)
approving, among other things, the fairness of the terms and conditions of an exchange in reliance upon an exemption from registration
provided for in Section 3(a)(10) of the Securities Act of 1933, as amended (the “Securities Act”), in accordance with
a stipulation of settlement, pursuant to the Settlement Agreement between the Company and LAM. Pursuant to the court order, LAM
commenced an action against the Company to recover an aggregate of $69,000 of past-due obligations and accounts payable of the
Company, which LAM had purchased from certain vendors of the Company pursuant to the terms of separate claim purchase agreements
between LAM and each of such vendors (the “LAM Assigned Accounts”). The LAM Assigned Accounts relate to certain accounting
services provided to the Company and a supplier invoice. The Settlement Agreement became effective and binding upon the Company
and LAM upon execution of the Order by the Court on April 2, 2018.
Pursuant
to the terms of the Settlement Agreement approved by the LAM Order, on April 2, 2018, the Registrant agreed to issue shares to
LAM (the “LAM Settlement Shares”) of the Registrant’s common stock at a 30% discount from the selling price
of the settlement shares sold by LAM, as defined in the settlement agreement. The Settlement Agreement provides that the LAM Settlement
Shares will be issued in one or more tranches, as necessary, sufficient to satisfy the settlement amount through the issuance
of freely trading securities issued in reliance upon an exemption provided for in Section 3(a)(10) of the Securities Act. The
parties reasonably estimate that the fair market value of the LAM Settlement Shares to be received by LAM is equal to approximately
$99,000. Additional tranche requests shall be made as requested by LAM until the LAM Settlement Amount is paid in full.
The
Settlement Agreement provides that in no event shall the number of shares of Common Stock issued to LAM or its designee in connection
with the Settlement Agreement, when aggregated with all other shares of Common Stock then beneficially owned by LAM and its affiliates
(as calculated pursuant to Section 13(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”),
and the rules and regulations thereunder), result in the beneficial ownership by LAM and its affiliates (as calculated pursuant
to Section 13(d) of the Exchange Act and the rules and regulations thereunder) at any time of more than 9.99% of the Common Stock.
The
Company is required to reserve a sufficient number of shares of its Common Stock to provide for issuances thereof, upon full satisfaction
of the Settlement Amount.
On April 6, 2018, the Company issued 4,480,000
shares of Common Stock to LAM, upon which LAM paid $40,000 of the Settlement Amount of the Company's past due accounts payable
purchased by LAM in accordance with the Settlement Agreement.
Certificate
of Validation
On
April 2, 2018, the Company filed a certificate of validation with the state of Delaware,
which had retroactive effect
to the close of trading in the Corporation’s common stock on December 1, 2017, in order to:
|
(i)
|
cure
certain technical, procedural defects related to the 1:200 reverse stock split, which
became effective at the close of trading on December 31, 2017,
|
|
(ii)
|
clarify
that the reverse stock split effected a 1:200 reduction in the number of the Corporation’s
authorized shares of common stock, from 12,000,000,000 to 60,000,000, with retroactive
effect to the close of trading on December 1, 2017,
|
Coates
International, Ltd.
Notes
to Financial Statements – (Continued)
|
(iii)
|
clarify
that the reverse stock split effected 1:200 reduction in the number of authorized shares
of the Corporation’s preferred stock, from 100,000,000 to 500,000 with retroactive
effect to the close of trading on December 1, 2017; and,
|
|
(iv)
|
concurrently
therewith, further amend the Corporation’s Amended Certificate of Articles of Incorporation
with the State of Delaware to increase the number of the Corporation’s authorized
shares of common stock, par value $0.0001 from 60,000,000 to 120,000,000 and reduce the
number of authorized shares of the Corporation’s preferred stock, par value $0.001
from 500,000 to 350,000.
|
The
above corporate action was authorized by the board of directors on February 28, 2018, and by means of obtaining the written consent
of George J. Coates, the sole majority stockholder, was approved by the shareholders on March 1, 2018.
Issuance
of Convertible Promissory Notes
During
the period from January 1, 2018 to April 13, 2018, the Company issued convertible promissory notes and received aggregate net
proceeds of $265,000, 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, 2018 to April 13, 2018, convertible promissory notes with an aggregate balance of $90,000, including
accrued interest thereon, were converted into 9,715,685 unregistered shares of the Company’s common stock.
Issuance
of Anti-dilution shares
During
the period from January 1, 2018 to April 13, 2018, the Company issued 48,915, 3,702 and 290 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 $545,000, $41,000 and $3,000, respectively.
Repayment of 17% Promissory Notes to
Related Parties
During
the period from January 1, 2018 to April 13, 2018, the Company partially repaid promissory notes to George J. Coates,
Gregory G. Coates.
Bernadette Coates and one employee amounting to $20,000, $15,000, $15,000 and $5,000, respectively.
These promissory notes bear interest at the rate of 17% per annum and are payable on demand.
Deferred
Compensation
As
of April 13, 2018, George J. Coates, Gregory G. Coates and Barry C. Kaye agreed to additional deferral of their compensation amounting
to $72,000, $22,000, and $39,000, respectively, and Barry C. Kaye was paid $35,000 of his deferred compensation bringing their
total deferred compensation to $1,293,000, $164,000, and $257,000, respectively.
Compensatory
Arrangement with Board Member
In
April 2018, the Company entered into a compensatory arrangement with Richard Whitworth, a member of the board of directors,
pursuant to which the Company will pay Mr. Whitworth 10% of sales billed and collected from new business acquired as a direct
result of Mr. Whitworth's efforts.
F-30