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                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

FORM 10-KSB (MARK ONE)

[X]   ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES  EXCHANGE ACT OF
      1934

      FOR THE FISCAL YEAR ENDED JULY 31, 2004

                                       OR

[_]   TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
      OF 1934


      FOR THE TRANSITION PERIOD FROM ________ TO________

                         COMMISSION FILE NUMBER 0-29248

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

                              SMARTIRE SYSTEMS INC.
                 (Name of small business issuer in its charter)

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

    YUKON TERRITORY, CANADA                                   N/A
(State or other jurisdiction of                         (I.R.S. Employer
 incorporation or organization)                          Identification No.)

                            #150 - 13151 VANIER PLACE
                   RICHMOND, BRITISH COLUMBIA, CANADA V6V 2J1
               (Address of principal executive offices) (Zip Code)

                                  604-276-9884
                           (Issuer's telephone number)

       SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT: NONE

         SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:

                                  COMMON STOCK

                              (TITLE OF EACH CLASS)

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

           Check if disclosure  of delinquent  filers in response to Item 405 of
Regulation  S-B is not  contained  in  this  form,  and no  disclosure  will  be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [_]

           State issuer's revenues for its most recent fiscal year: $1,658,279

At October 15, 2004,  the  aggregate  market value of the voting and  non-voting
common  equity held by  non-affiliates  computed by reference to the average bid
and asked price of such common equity, was $6,621,193 .

           The number of shares  outstanding  of our  Company's  common stock at
October 15, 2004 was 217,224,375.

           Transitional Small Business Disclosure Format (check one):
[_] Yes [X] No

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<PAGE>
                                      INDEX
                                                                            Page
                                                                          Number
    PART I

    Item 1.   Description of Business                                          3

    Item 2.   Description of Property                                         29

    Item 3.   Legal Proceedings                                               29

    Item 4.   Submission of Matters to a Vote of Security Holders             29

    PART II

    Item 5.   Market for Common Equity and Related Stockholder Matters        30

    Item 6.   Management's Discussion and Analysis or Plan of Operation       35

    Item 7.   Financial Statements                                            47

    Item 8.   Changes In and Disagreements With Accountants on
              Accounting and Financial Disclosure                             47

    Item 8A.  Controls and Procedures                                         47

    PART III

    Item 9.   Directors, Executive Officers, Promoters and Control
              Persons; Compliance with Section 16(a) of the Exchange Act      48

    Item 10.  Executive Compensation                                          52

    Item 11.  Security Ownership of Certain Beneficial Owners
              and Management                                                  57

    Item 12.  Certain Relationships and Related Transactions                  59

    Item 13.  Exhibits and Reports on Form 8-K                                60

    Item 14.  Principal Accountant Fees and Services                          61


                                       2
<PAGE>

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

THIS  ANNUAL  REPORT  ON  FORM  10-KSB,  INCLUDING  EXHIBITS  THERETO,  CONTAINS
FORWARD-LOOKING  STATEMENTS  WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,
AS AMENDED.  THESE  FORWARD-LOOKING  STATEMENTS ARE TYPICALLY  IDENTIFIED BY THE
WORDS "ANTICIPATES",  "BELIEVES",  "EXPECTS", "INTENDS",  "FORECASTS",  "PLANS",
"FUTURE",  "STRATEGY",  OR WORDS OF SIMILAR MEANING. VARIOUS FACTORS COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN THE  FORWARD-LOOKING
STATEMENTS, INCLUDING THOSE DESCRIBED IN "RISK FACTORS" IN THIS FORM 10-KSB. THE
COMPANY  ASSUMES NO  OBLIGATIONS TO UPDATE THESE  FORWARD-LOOKING  STATEMENTS TO
REFLECT ACTUAL  RESULTS,  CHANGES IN  ASSUMPTIONS,  OR CHANGES IN OTHER FACTORS,
EXCEPT AS REQUIRED BY LAW.

PART I

           As used in this annual  report on Form  10-KSB,  "we,"  "us,"  "our,"
"SmarTire"   and  "our  Company"   refer  to  SmarTire   Systems  Inc.  and  our
subsidiaries, unless the context otherwise requires.

ITEM 1.    DESCRIPTION OF BUSINESS

           We (together with our  subsidiaries)  are engaged in the  development
and marketing of tire  monitoring  systems (TMS)  designed for improved  vehicle
safety,  performance,  reliability and fuel  efficiency.  During the fiscal year
ended  July  31,  2004,  we  earned  revenues  primarily  from  the sale of tire
monitoring systems (TMS) for passenger cars. Our principal executive offices are
located at #150 - 13151 Vanier Place,  Richmond,  British Columbia,  Canada, V6V
2J1. We were incorporated  under the laws of the Province of British Columbia on
September 8, 1987, and were continued  under the laws of the Yukon  Territory to
become a Yukon corporation  effective  February 6, 2003. Our telephone number is
(604) 276-9884.

           We have three wholly owned subsidiaries:  SmarTire Technologies Inc.,
SmarTire USA Inc. and SmarTire Europe Limited.  SmarTire  Technologies  Inc. was
incorporated on June 3, 1988 under the laws of the Province of British Columbia,
and was the original developer of our patented technology.  SmarTire USA Inc., a
Delaware  corporation  incorporated on May 16, 1997, is our exclusive  marketing
agency for SmarTire in North America.  SmarTire Europe Limited, a United Kingdom
corporation  incorporated  on February  25,  1998,  is our  exclusive  sales and
distribution  operation for Europe.  SmarTire Europe's head office is located at
Park 34, Southmead Industrial Park, Didcot, Oxfordshire, England, OX11 7WB.

           We are a "foreign  private  issuer",  as such term is defined in Rule
3b-4 under the Securities Exchange Act of 1934. However, we have elected to file
with the  Securities  and Exchange  Commission  the same reports that a domestic
registrant  would be  required  to file under  section  13(a) of the  Securities
Exchange Act of 1934.

           Our  consolidated  financial  statements  are stated in United States
Dollars and are prepared in  accordance  with United States  Generally  Accepted
Accounting Principles (GAAP).

BUSINESS OF OUR COMPANY

General Overview

           We  were   formed  to  develop  and  market   remote  data   sensing,
transmission  and processing  products  incorporating  patented  technologies to
satisfy emerging market requirements in the transportation  industry.  Currently
we are focused on developing and marketing  technically advanced tire monitoring
systems (TMS) for the transportation and automotive industries.

                                       3
<PAGE>

Corporate History

           We were  incorporated  under  the  laws of the  Province  of  British
Columbia as TTC/Truck Tech Corp. on September 8, 1987. We were formed to develop
and  market  remote  data  sensing,   transmission   and   processing   products
incorporating  patented  technologies to satisfy emerging market requirements in
the transportation industry.

           Our Company was continued under the Business  Corporations Act (Yukon
Territory)  effective February 6, 2003. As a result, our Memorandum and Articles
which constituted our constitutional  documents while we were a British Columbia
company have been superseded and replaced by Articles of Continuance  filed with
the  Yukon  Registrar  of  Corporations   under  section  190  of  the  Business
Corporations  Act (Yukon  Territory) and By-law No. 1, being a by-law adopted by
our board of directors relating generally to the transaction of the business and
affairs of our Company.  Our continuance as a Yukon  corporation was approved by
special  resolution  adopted by our  shareholders  at the annual general meeting
held on December 12, 2002.

           On July 29,  1988,  we  acquired  all of the issued  and  outstanding
shares of Delta  Transportation  Products  Ltd., and  subsequently  caused it to
change its name to  SmarTire  Technologies  Inc.  effective  June 3,  1998.  Our
initial product, based on technology developed by Delta Transportation  Products
Ltd.,  consisted of a wireless tire monitoring  systems (TMS) designed for large
ore hauling trucks and wheeled loaders that are utilized in the mining industry.

           We  completed  our initial  public  offering on the  Vancouver  Stock
Exchange  (now the TSX Venture  Exchange)  on September  11, 1989.  On April 13,
1995,  we changed  our name to UniComm  Signal Inc. On  December  24,  1997,  we
changed our name to SmarTire  Systems Inc.  and  effected a reverse  stock split
pursuant  to which our  common  stock was  consolidated  on a 1 for 8 basis.  On
December 16, 1998,  our common stock  commenced  trading on the Nasdaq  SmallCap
Market. On March 12, 1999, we voluntarily delisted our common stock from trading
on the  Vancouver  Stock  Exchange.  On May 28,  2003,  our common  stock ceased
trading on the  Nasdaq  SmallCap  Market  and is now quoted on the OTC  Bulletin
Board.

           On  December  6, 1996,  we  acquired  the Low Tire  Pressure  Warning
Division  of EPIC  Technologies,  Inc.  of  Norwalk,  Ohio.  The assets  that we
acquired from EPIC included  specialized testing equipment,  patents and certain
contractual  rights,  including the rights under a production  program that EPIC
had established with Ford Motor Company.  Under that production program, the Low
Tire Pressure  Warning  System that we acquired from EPIC was offered by Ford as
an option on  Lincoln  Continentals  until  the end of  December  2001 when that
particular model was discontinued.

           Our  acquisition  of  EPIC's  Low  Tire  Pressure   Warning  Division
accelerated  our entry into the passenger car market.  Recognizing  the emerging
demand for tire monitoring  systems (TMS) in passenger cars and light trucks, we
modified the new car version of the  technology  that we had acquired  from EPIC
for use in existing  vehicles.  This  product was launched  into the  automotive
aftermarket in June 1997 to support the market  introduction  of run-flat tires.
Automotive  aftermarket  products  are  sold as  optional  add-on  products  for
automobiles and are produced by third-party  suppliers such as our Company.  The
aftermarket   consists  of  retailers   including  tire  retailers,   automotive
electronic  stores  and  accessory  shops,   which  sell  products  directly  to
consumers.  Aftermarket  products are  distinguishable  from original  equipment
manufacturers  - or so-called "OEM" - products which are sold as options offered
directly by or through the  manufacturer of the automobile.  OEM products may be
produced  by  third  party  suppliers  as  well,  but  are  sold  to  automobile
manufacturers  rather than to end-users.  The tire monitoring systems (TMS) that
we  supplied  to Ford for use on  Lincoln  Continentals  is an example of an OEM
product.

           During 1997, Goodyear,  Michelin and  Bridgestone/Firestone  approved
our  Company's  first  generation  tire  monitoring  systems (TMS) for sale with
run-flat or extended mobility tires. Run-flat tires allow drivers to drive up to
50 miles on a tire that has lost all of its air pressure. These tires perform so
well without any air pressure that an approved tire monitoring  systems (TMS) is
required with the purchase of each set.  Otherwise the operator may  unknowingly
drive on the tire  until it fails or is no longer  repairable.  Tire  monitoring
systems  (TMS) for both  run-flat  and  conventional  tires are  distributed  as
aftermarket   products,   primarily   through   independent   tire  dealers  and
distributors and automobile service centers.


                                       4
<PAGE>

           Our  acquisition  of EPIC's Low Tire Pressure  Warning  Division also
facilitated our entry into the motorsport market.  Originally  developed by EPIC
and Penske Racing,  our motorsport tire monitoring systems (TMS) was distributed
exclusively  by Pi Research  of  Cambridge,  England.  It is widely used by Indy
racing  teams.  We do  not  anticipate  further  sales  of our  motorsport  tire
monitoring systems (TMS) to Pi Research as they now manufacture and market their
own system.

           On April 20, 1998, we established a strategic alliance with TRW Inc.,
a large U.S.-based automotive parts supplier. The strategic alliance was founded
on four  agreements  between the parties:  an Equity  Agreement,  a  Cooperation
Engineering Agreement,  an Original Equipment Manufacturer License Agreement and
a Manufacturing  Agreement.  The agreements  provided for joint  engineering and
development  activities  between  the  parties,  and TRW was  granted  exclusive
marketing  and  distribution  rights  for  some of our  Company's  products.  In
addition, TRW had exclusive rights in the original equipment market for any tire
monitoring  products  that it  developed  jointly  with us and we had  exclusive
rights in the automotive aftermarket.

           Effective  August 31, 2001, we  restructured  our strategic  alliance
with TRW. As a result of the  restructuring,  most of the agreements that we had
entered into with TRW in 1998 were cancelled.  However,  TRW retained its equity
position  in our  Company.  By  ending  our  collaboration  with TRW in  product
development and by providing that neither we nor TRW will have exclusive  rights
to any products, the restructuring effectively provided us with immediate access
to all levels of the global automotive and transportation industries.

           During  May  2002  we  entered  into  a  non-binding   Memorandum  of
Understanding  with Visteon  Corporation,  a global  supplier of products to the
automotive industry, to develop and market tire monitoring solutions for the OEM
market.  Our Memorandum of  Understanding  matured into a formal agreement dated
December  10,  2002 which  contemplated  collaboration  between  our Company and
Visteon to develop  and market  more  advanced  tire  monitoring  systems  (TMS)
systems for passenger  vehicles and light trucks,  and to jointly  explore other
opportunities  for  tire  monitoring  products  such as the  commercial  vehicle
market. Under the agreement,  we also granted Visteon rights to manufacture some
of our  products.  On July 16, 2003,  we formally  ended our  relationship  with
Visteon Corporation.

           On September  24,  2002,  we and Pirelli  Pneumatici  signed a Supply
Agreement  for tire  monitoring  systems  (TMS) that  measure the  pressure  and
temperature of car,  truck and motorcycle  tires.  The tire  monitoring  systems
(TMS) are produced  and tested by our Company,  and marketed and sold by Pirelli
under the name X-PressureTM. The systems went on sale by the end of 2002 through
Pirelli's tire distribution  channels in Italy, Germany,  United Kingdom,  Spain
and  Switzerland.  During  October 2002,  we made our first  shipment to Pirelli
under the Supply  Agreement.  Pirelli is currently testing our second generation
motorcycle system.

           In December  2002,  we entered into an eight-year  supply  commitment
letter  for  tire  monitoring  systems  (TMS) to be  offered  as part of the OEM
package on certain vehicles produced by Aston Martin. We are committed to supply
the systems in response to purchase  orders  submitted by Aston Martin from time
to time. Aston Martin initially installed TPS on the V12 Vanquish.  In September
2004, it began to  purchasing  TMS for  installation  on its DB9 model that went
into production earlier in 2004.

           We completed the development and launch of our second generation tire
monitoring systems (TMS) for the passenger car and light truck market during the
fiscal year ended July 31, 2001.  We  introduced  our  motorcycle  tire pressure
monitoring  system (TPMS) for sale into the  aftermarket  in September  2002. We
recently introduced a substantially  improved second generation  motorcycle tire
pressure  monitoring system (TPMS) at the Indy Motorcycle  Dealers Show, held in
Indianapolis,  Indiana in mid-February 2004. During May 2004 this product became
commercially  available  and we began  shipping it to our  customers.  In August
2004, we discovered that the sensor/transmitter may break during installation on
the subset of motorcycle rims with curved rim surfaces when the strap is torqued
to its required value.  On September 14, 2004 we contacted the National  Highway
Transportation Safety Administration (NHTSA) to determine if a Safety Defect and


                                       5
<PAGE>

Non Compliance Report was required and was advised that this was necessary.  Our
remedy for the defect was to recall  100% of affected  sensor/transmitter  items
from the field and replace both recalled and inventory  sensor/transmitters with
sensor/transmitters  previously  manufactured by a different  supplier that have
been  tested and known to use  plastics  that  provide the  required  mechanical
properties.  Additionally to ensure that transmitters are used only on rims with
flat  drop  center  wells  (as  originally  designed  for) and not  curved,  the
additional precautionary steps were taken:

      o     Adding  improved  warnings and  instruction  sheet to new product as
            well as  product  in  inventory  at dealers  and  distributors  that
            clarify flat rim drop center well application only

      o     Removal of tire pressure  monitoring  system  (TPMS) on  motorcycles
            with rims with curved drop center wells

           We  anticipate  the cost of this  recall  will be  approximately  $US
67,000. In addition, we are currently working on a solution to enable us to sell
our tire pressure  monitoring system (TPMS) on motorcycles with rims with curved
drop center wells.

           In  February  2003,  we  signed  a  manufacturing,  co-marketing  and
development agreement with Hyundai Autonet Company,  Ltd., an established Korean
automotive  electronics supplier.  Under this agreement,  Hyundai Autonet and we
will co-develop,  manufacture and distribute tire monitoring products to Hyundai
Autonet original equipment vehicle manufacturers and the automotive  aftermarket
in Korea.  The agreement  provides for the payment to us by Hyundai Autonet of a
total  of  $300,000  in fees,  to  cover  the cost to  develop  a  receiver  and
transmitter  that  can be used  in the  Korean  and  Japanese  markets.  Initial
payments  totaling  $165,000 were made by Hyundai  Autonet upon execution of our
agreement, and the balance of $135,000 is payable upon the attainment of certain
milestones  including the completion of validation testing of these products and
the launch of these products in South Korea.  We originally  expected to receive
an ongoing revenue stream through the sales of proprietary components to Hyundai
Autonet  beginning  in early  2004.  However  due to delays in  attaining  these
milestones,  we now expect revenue from the sale of these components to commence
in early 2005.

           In  October  2003,  we  signed  a  contract   manufacturing  services
agreement with Hyundai Autonet Company (HACO). Under the terms of the agreement,
HACO will manufacture the Company's proprietary line of tire pressure monitoring
systems (TPMS) for sale and distribution  globally by SmarTire.  HACO's tier one
manufacturing status provides SmarTire the opportunity to compete on a worldwide
basis with higher quality  products,  an increased volume  capability and a more
flexible cost structure.

           On  September  8, 2003,  we entered  into an  agreement  in principle
appointing  Beijing Boom  Technology  Co. Ltd. as the Master  Distributor of our
tire pressure  monitoring  systems  (TPMS) in mainland  China.  The agreement in
principle led to a formal Master  Distributor  Agreement  between us and Beijing
Boom Technology  dated October 17, 2003,  which provides for an initial two year
term ending on October 9, 2005 and  automatic  renewal for  successive  one-year
terms subject to  termination  by either party on giving 90 days' advance notice
in writing.  Beijing Boom Technology has agreed to purchase over $1.5 million in
aftermarket  passenger  car tire  pressure  monitoring  systems  (TPMS) at fixed
intervals  during the first year of the agreement.  Beijing Boom Technology must
submit  purchase  orders to us for these  products  in  accordance  with a fixed
delivery  schedule  covering the first year of the  agreement,  and must pay for
each  shipment  before the products are shipped  until March 2004.  Beijing Boom
Technology  may return  products  to us,  but any  products  which are  returned
without our prior  written  consent are subject to a charge  equal to 50% of the
invoiced  value of such  products.  As Beijing  Boom  Technology  has not placed
orders in accordance  with the fixed  delivery  schedule,  we have  continued to
require them to make an advance payment to us prior to each shipment.

           In order to maintain its status as our Master  Distributor  in China,
Beijing  Boom  Technology  must also  purchase  approximately  $3.9  million  in
additional  aftermarket  passenger car tire pressure  monitoring  systems (TPMS)
during  the  second  year of the  agreement.  Per our  agreement,  Beijing  Boom
Technology was to also establish a network of certified dealers in all provinces
of China by May 1, 2004.  Although  several dealers have been  established,  the
milestone has not been reached.  However,  in June 2004 we verbally  agreed with
Beijing Boom  Technology  that the milestone be changed  towards  establishing a
network of certified  dealers in all major  cities in China.  Subject to Beijing
Boom  Technology  meeting  these  milestones,  we have agreed not to appoint any
other master  distributor for mainland China during the initial two-year term of
the Master Distributor Agreement.


                                       6
<PAGE>

           On September  12, 2003 we entered into a development  agreement  with
Vansco  Ltd.  This  agreement  provides  for the  merging  of  Vansco's  vehicle
communication  expertise  with our proven radio  frequency  (RF)  technology  to
create a high  sensitivity,  weatherproof,  J1939 controller area network (CAN),
chassis-mounted  receiver.  The J1939  controller area network (CAN) is the most
widely used communication  standard in commercial  vehicles today,  allowing for
multiplexing,  receiving and transmitting of signals from various sources.  When
controller  area network  (CAN)  technology  is combined  with our high pressure
sensors,  we anticipate that this joint development  effort will result in a new
tire pressure  monitoring system (TPMS) targeted directly at original  equipment
manufacturers (OEMs) of commercial trucks, buses, agricultural, construction and
recreational  vehicles.  The new receiver  module is  completing  its final test
phase with the first pilot build of 300 units  scheduled to be completed  during
the month of October 2004.  Currently the receiver  module and  associated  tire
pressure  monitoring  sensors  are also being  tested and  evaluated  by several
selected Original Equipment Manufacturers (OEMs). The 300 units will be utilized
to meet test demands from Original Equipment  Manufacturers  (OEMs). Vansco will
be manufacturing the module for us.

           On October 10, 2003 we entered into a  Co-Marketing  and  Development
agreement with Haldex Brake  Products Ltd., and a related Supply  Agreement with
Haldex. Under the terms of this agreement, we will engage in a joint development
program to integrate our tire pressure  monitoring  systems (TPMS) with Haldex's
brake systems,  with the view to creating commercial high pressure tire pressure
monitoring systems (TPMS) for marketing and resale by Haldex. We anticipate that
any new products that result from our collaboration with Haldex will be targeted
at both Original  Equipment  Manufacturers  (OEMs) and aftermarket  applications
predominately for trailers.  Once development is complete, we plan to execute on
the Supply Agreement with Haldex.

           On June 3, 2004, in conjunction with its Master Distributor in China,
Beijing  Boom  Technology  Co.  Ltd.,  we finalized a major sales order with its
exclusive dealer in Taiwan, Chu Chang International Ltd.  ("CCIL").The order was
valued at  approximately  $5 million  and was to be  secured  by an  irrevocable
letter of credit.  To date, we have not shipped any product to CCIL as they have
not provided us with an irrevocable letter of credit.

Government Regulations

           Our products are subject to  regulation  by the  government  agencies
responsible  for  radio  frequencies  in each  country  that our  tire  pressure
monitoring  systems  (TPMS)  will be sold.  For  example,  in the United  States
approval must be received from the Federal  Communications  Commission  for each
product.  Some countries require  additional  governmental  approvals in certain
circumstances.  For example, in the United Kingdom,  all electronic equipment to
be installed in emergency  and police  vehicles  must be approved by the Vehicle
Installation Development Group, a governmental body. And, as a practical matter,
certain non-governmental approvals may be necessary for market acceptance of our
products in certain countries.  For example, the approval of TUV (an independent
testing company) is considered  necessary to market our tire pressure monitoring
systems (TPMS) in Germany.

           We believe that we have all of the necessary  governmental  approvals
for our current tire pressure  monitoring  systems (TPMS) in our intended market
countries.  As each new tire pressure  monitoring system (TPMS) is introduced to
the market, we intend to apply for the necessary approvals.

           During  our  fiscal  year ended  July 31,  2001,  the  United  States
Government enacted the Transportation  Recall Enhancement,  Accountability,  and
Documentation  Act of 2000,  commonly  known as the TREAD Act. The TREAD Act was
implemented  to  address  perceived  safety  concerns  resulting  from poor tire
maintenance,  tread  separation  and tire  blowouts.  The TREAD Act, among other
things,  requires  that the  National  Highway  Traffic  Safety  Administration,
commonly referred to by its acronym,  NHTSA, develop rules and regulations which
require all new passenger  cars,  light trucks and  multipurpose  passenger vans
sold after  November 1, 2003 to have tire  pressure  monitoring  systems  (TPMS)
installed  as standard  equipment.  The TREAD Act  requires  that tire  pressure
monitoring  systems  (TPMS)  must be  capable  of  warning  drivers if a tire is
significantly under-inflated.  The mandated rules and regulations were scheduled
to be finalized in November 2001 for implementation in 2003.


                                       7
<PAGE>

           In July 2001,  the National  Highway  Traffic  Safety  Administration
(NHTSA) published and circulated a Notice of Proposed Rule Making which included
provisions  related to the tire  monitoring  requirements  of the TREAD Act. The
Notice of Proposed  Rule Making  outlined  the  parameters  of systems  that the
National Highway Traffic Safety Administration  (NHTSA) would consider compliant
with  the  legislation   and  the  proposed   periods  for  complying  with  the
regulations. Two forms of tire monitoring technologies were to be considered:

           1) Direct tire monitoring  technologies are based on dedicated sensor
           / transmitters located within the cavity of the tire that are usually
           mounted on the wheel. The transmitter monitors and measures contained
           air  pressure and  temperature  within each tire and  transmits  this
           information to a receiver  located in or around the instrument  panel
           of the vehicle. Our products are an example of a direct system.

           2) Indirect  tire  monitoring  technologies  typically  work with the
           vehicle's   anti-lock  brake  system.  Most  indirect  tire  pressure
           monitoring  systems (TPMS) compare each wheel's rotational speed with
           the   rotational   speed  of  other  wheels.   If  one  tire  becomes
           significantly  under-inflated  while  the  others  remain  at  proper
           pressure,  the indirect system eventually detects the problem because
           that wheel's rotational speed is on average slightly higher than that
           of other wheels.

           In the Notice of Proposed Rule Making,  the National  Highway Traffic
Safety  Administration  (NHTSA) concluded that direct  measurement  systems have
major  advantages over indirect systems as they: o actually measure the pressure
in each  tire  and  can  detect  when  any  tire  or  combination  of  tires  is
under-inflated, including when all tires are under-inflated;

      o     operate while the vehicle is stationary;

      o     are highly accurate and can detect small pressure losses,  some even
            as low as 1 pound per square inch;

      o     provide  full time  monitoring  even when the  vehicle  is driven on
            bumpy roads,  has  mismatched  tires or has a tire out of balance or
            alignment;

      o     do not need  substantial time to calibrate the system and reduce the
            very real possibility for human error; and

      o     can tell the operator which tire is under-inflated.

           On May 31, 2002, the National  Highway Traffic Safety  Administration
(NHTSA)  issued part one of a two-part  final rule.  Part one  established a new
Federal  Motor  Vehicle  Safety   Standard  that  requires  that  tire  pressure
monitoring systems (TPMS) be installed in passenger vehicles and light trucks to
warn the driver when a tire is below specified pressure levels. During the first
year of the implementation schedule, beginning November 1, 2003, at least 10% of
each auto  manufacturer's  total  production must be equipped with tire pressure
monitoring systems (TPMS).  This requirement  increases to 35% during the second
year, 65% by the third and 100% after October 31, 2006.

           Part one of the  National  Highway  Traffic  Safety  Administration's
(NHTSA) final rule  contemplated  two compliance  options during the period from
November 1, 2003 to October  31,  2006.  Under the first  compliance  option,  a
vehicle's tire pressure monitoring system (TPMS) must alert the driver if one or
more tires,  up to four tires, is 25% or more  under-inflated.  Under the second
compliance option, a vehicle's tire pressure monitoring system (TPMS) must alert
the  driver if any of the  vehicle's  tires is 30% or more  under-inflated.  The
second compliance option was adopted by National Highway Traffic Safety


                                       8
<PAGE>

Administration  (NHTSA) because indirect tire pressure monitoring systems (TPMS)
are currently  not capable of meeting the stricter  four-tire,  25%  requirement
under the first  compliance  option,  and it was  deemed  appropriate  to permit
manufacturers  to continue  to use current  indirect  tire  pressure  monitoring
systems (TPMS) while they work to improve those systems.

           At the time that it  issued  the first  part of its final  rule,  the
National Highway Traffic Safety  Administration  (NHTSA) announced that it would
be closely  monitoring  the  performance of indirect  measurement  tire pressure
monitoring  systems  (TPMS)  under the second  compliance  option.  We initially
expected that the National Highway Traffic Safety  Administration  (NHTSA) would
issue the second part of its final rule on or before March 1, 2005,  and that it
would, at that time,  announce whether indirect tire pressure monitoring systems
(TPMS) based on anti-lock brake systems would be a permissible compliance option
under the TREAD Act after October 31, 2006.  However,  due to a Court of Appeals
ruling  discussed  below, we no longer hold these  expectations as to the timing
and content of the second part of the final rule.

           Three not-for-profit  advocacy  organizations,  Public Citizen, Inc.,
New York Public  Interest  Research Group and The Center for Auto Safety filed a
petition in United States Court of Appeals for the Second Circuit seeking review
of the National Highway Traffic Safety Administration's  (NHTSA) final rule. The
Secretary  of  Transportation  was named as the  respondent  in the matter,  and
Alliance of Automobile  Manufacturers was an intervener.  On August 6, 2003, the
United States Court of Appeals, Second Circuit, granted the petition for review,
vacated the National Highway Traffic Safety Administration's (NHTSA) final rule,
and remanded the matter to the National  Highway  Traffic Safety  Administration
(NHTSA) for further rulemaking proceedings in a manner consistent with the court
decision.

           The  court  stated  that  the   National   Highway   Traffic   Safety
Administration  (NHTSA) decision to adopt the second  compliance option was both
contrary to law and  arbitrary,  but that the  adoption of the first  compliance
option was  appropriate.  In coming to this  conclusion,  the court  found that,
according to the rule-making  record, the one-tire,  30 percent  under-inflation
standard  contemplated by the second compliance option would allow automakers to
install  indirect  tire  pressure  monitoring  systems  (TPMS) that fail to warn
drivers in approximately  half of the instances in which tires are significantly
under-inflated,  and that the  four-tire,  25 percent  under-inflation  standard
contemplated by the first  compliance  option would prevent more injuries,  save
more lives and be more cost-effective.

           On September 10, 2004 the NHTSA's  (National  Highway  Traffic Safety
Administration)  issued a Notice of Proposed Rulemaking (NPRM) document defining
their current position.  Comments on the proposed Rulemaking must be received on
or  before  60 days  after  date of  publication  (of the  NRPM) in the  Federal
Register.   The  National  Highway  Traffic  Safety  Administration  (NHTSA)  is
proposing a new Federal Motor Vehicle Safety  Standard  (FMVSS)  requirement for
four tire, 25-percent  under-inflation detection. The rule proposes requirements
for covered  vehicles  manufactured  on or after September 1, 2005. The National
Highway Traffic Safety  Administration  (NHTSA) is proposing the following phase
in schedule:

      o     50  percent  of a vehicle  manufacturer's  light  vehicles  would be
            required  to  comply  with  the  standard   during  the  first  year
            (September 1, 2005 to August 31, 2006);

      o     90 percent  during the second year  (September 1, 2006 to August 31,
            2007;

      o     all light vehicles thereafter.

The National Highway Traffic Safety Administration (NHTSA) is also proposing the
following:

      o     to require vehicle  manufacturers to assure  compliance with Federal
            Motor Vehicle Safety  Standard 138 (FMVSS) with the tires  installed
            on the vehicle at the time of the initial sale;

      o     to require the tire pressure monitoring system (TPMS) to be equipped
            with a  telltale  that  would  alert the  driver of a tire  pressure
            monitoring (TPM)  malfunction.  The malfunction  warning be provided
            either  through  a  separate,   dedicated   telltale  or  through  a
            distinctive warning delivered by the low pressure telltale

      o     the use of a specific  test course  (i.e.,  the Southern loop of the
            tread wear test course,  San Angelo,  Texas) which is both objective
            and representative of a range of driving conditions;


                                       9
<PAGE>

      o     the tire pressure monitoring system (TPMS) would be required to warn
            the driver when the tire  pressure  in one or more of the  vehicle's
            tires,  up to a total of four tires, is 25 percent or more below the
            vehicle  manufacturer's  recommended cold inflation pressure for the
            tire,  or a minimum  level of pressure  specified  in the  standard,
            whichever pressure is higher

      o     vehicle   manufacturers   would  be  required  to  certify   vehicle
            compliance  under  the  standard  with the  tires  installed  on the
            vehicle at the time of the initial vehicle sale;

      o     the tire  pressure  monitoring  system  (TPMS)  would be required to
            include a low tire  pressure  warning  telltale  (Yellow)  that must
            remain  illuminated  as long as any of the  vehicle's  tires remains
            significantly  under  inflated and the  vehicle's  ignition  locking
            system  is in the  "On"  ("Run")  position.  The  telltale  must  be
            extinguished   when  all  of  the   vehicle's   tires  cease  to  be
            significantly  under inflated.  The tire pressure  monitoring system
            (TPMS) low tire  pressure  warning  telltale  would be  required  to
            perform a bulb-check at vehicle startup;

      o     the tire pressure monitoring system (TPMS) also would be required to
            include a malfunction  indicator to alert the driver when the system
            is  non-operational,  and thus  unable to provide the  required  low
            pressure warning. The National Highway Traffic Safety Administration
            (NHTSA) is  proposing  that the  malfunction  would be  indicated by
            either:

            (1)   separate dedicated telltale (Yellow) or;

            (2)   designing the low pressure telltale so that it flashes for one
                  minute when a malfunction is detected after which the telltale
                  will remain illuminated as long as the ignition locking system
                  is  in  the  "On"   ("Run")   position.   This   flashing  and
                  illumination  sequence would be repeated upon each  subsequent
                  vehicle start up until the situation has been corrected

      o     the tire pressure  monitoring system (TPMS) would not be required to
            monitor  the spare tire (if  provided)  either  when it is stowed or
            when it is installed on the vehicle;

      o     For vehicle's  certified under the standard,  vehicle  manufacturers
            would be required to provide in the owners manual an  explanation of
            the purpose of the low tire pressure warning telltale, the potential
            consequences of significantly  under-inflated  tires, the meaning of
            the  telltale  when it is  illuminated,  and what  action the driver
            should take when the telltale is illuminated.

           To encourage early  compliance,  the National  Highway Traffic Safety
Administration (NHTSA) is proposing to permit carry-forward credits for vehicles
that are certified as complying with the standard and that are  manufactured  on
or after the effective date of the final rule.  However,  beginning September 1,
2007 all covered vehicles would be required to comply with the standard, without
regard to any earlier  carry forward  credits.  It will not be  permissible  for
dealer to install  tires on a new  vehicle  that would take the  vehicle  out of
compliance  with  the tire  pressure  monitoring  system  (TPMS)  standard.  the
National  Highway Traffic Safety  Administration  (NHTSA) is proposing to permit
vehicle  manufactures  to  incorporate  a  second,  red light to  accompany  the
continuously illuminated yellow tire pressure monitoring system (TPMS) telltale,
which  would  be  illuminated  when  pressure  in  one  or  more  tires  becomes
dangerously  under-inflated,  as  determined  by the  manufacturer.  It  will be
permissible to incorporate the tire pressure  monitoring  system (TPMS) telltale
as part of a  reconfigurable  display,  provided  that the  illumination  of the
yellow telltale is continuous  while one or more tires are  under-inflated.  The
National  Highway  Traffic  Safety  Administration  (NHTSA)  will  retain  their
discretion  regarding how they will structure  phase in  requirements  for small
volume  manufacturers (5,000 vehicles or less for the North American market) and
will  make  such  determination  on a case by  case  basis.  Original  equipment
manufacturers' (OEM's) are free to select a low pressure alert level at a higher
level than the 25 percent below placard.

           Our direct  measurement  tire monitoring  systems (TMS) products meet
the standard for tire pressure  monitoring  established by the National  Highway
Traffic  Safety  Administration  (NHTSA).   Accordingly,  we  believe  the  auto
manufacturers must accelerate their  implementation plans in order to meet these
new National  Highway  Traffic Safety  Administration  (NHTSA) which will create
additional   opportunities   to  market  our  products  to  Original   equipment
manufacturers'  (OEM's) in the automobile  industry.  In addition,  although the
TREAD Act only  applies to  passenger  automobiles,  we believe that other motor
vehicles,  including  medium and heavy  trucks,  buses and  motorcycles  will be
impacted  by  this  legislation  in  subsequent  years.  We  also  believe  that
compliance  with  the  TREAD  Act  by  European,  Japanese,  Chinese  and  other
automakers  will  accelerate  the  adoption  of tire  monitoring  systems  (TMS)
globally.


                                       10
<PAGE>

Strategic Relationships

           Our strategy includes the establishment of alliances to assist in the
development  and  marketing  of our  products and  technologies.  Key  strategic
alliances include:

(a)        Hyundai Autonet Co. Ltd.

           On February 6, 2003,  we signed an agreement  with  Hyundai  Autonet,
pursuant to which we and Hyundai Autonet have agreed to co-develop,  manufacture
and distribute tire monitoring  systems (TMS) products to the OEM market and the
automotive  aftermarket  in  Korea.   Originally  founded  in  1985  as  Hyundai
Automotive Electronics Division,  Hyundai Autonet is a subsidiary of the Hyundai
Auto Group, a large Korean  conglomerate of companies.  Hyundai Autonet has been
contracted  by  its  sister  company,  Hyundai  Motor  Corporation,  to  develop
commercial vehicle tire monitoring systems (TMS).

           On October  17,  2003,  we signed a contract  manufacturing  services
agreement with Hyundai  Autonet  Company  (HACO),  a leading  Korean  automotive
electronics  supplier and a subsidiary of Hyundai Group.  Under the terms of the
agreement, HACO will manufacture the Company's proprietary line of tire pressure
monitoring systems (TPMS) for sale and distribution globally by SmarTire. HACO's
tier one  manufacturing  status will provide SmarTire the opportunity to compete
on  a  worldwide  basis  with  higher  quality  products,  an  increased  volume
capability and a more flexible cost structure.

(b)        SensoNor ASA

           In 1998,  TRW,  SensoNor  and our Company  developed  an  application
specific  integrated sensor (ASIS) for use in tire monitoring  systems (TMS). On
December  15, 1999,  we entered into a  development  and supply  agreement  with
SensoNor,  relating  in  part  to the  development  of an  application  specific
integrated sensor (ASIS) for commercial  vehicle tire monitoring  systems (TMS).
SensoNor,  based in Horten,  Norway,  is a producer  of sensors  for  automotive
applications.

           SensoNor and our Company  subsequently  entered  into an  Application
Specific Integrated Sensor (ASIS) Purchase and Supply Contract dated November 1,
2001,  pursuant to which we paid  SensoNor a fee of  $500,000.  The SensoNor low
pressure ASIS is used in our low pressure transmitters.

(c)        GE Nova Sensor

           In 2004, our ASIS procurement strategy was refined to begin procuring
the  high  pressure  ASIS  from GE  Novasensor.  Low  pressure  ASIS's  would be
purchased from both GE Nova Sensor and SensoNor.

(d)        Alligator Ventilfabrik GmbH

           On December 10, 1999,  we entered into an agreement to develop  valve
stem  designs  and  tire   monitoring   electronic   packaging  for  new  market
applications and new tire monitoring  technologies  with Alligator  Ventilfabrik
GmbH ("Alligator").  Based in Giengen, Germany,  Alligator is currently supplies
us with valve stems that allow the attachment of tire monitoring  sensors inside
the tire.

(e)        Transense Technologies plc

           On  December 2, 1999,  we entered  into a  licensing  agreement  with
Transense  Technologies  of  Oxfordshire,  England,  pursuant  to  which we were
granted a  non-exclusive,  worldwide  right to develop  and  market  Transense's
Surface  Acoustic  Wave  technology  for  use  in  tire  monitoring.   Transense
researches,  develops  and markets  the use of its  patented  technology  in the
automotive industry. To date, we have not used Transense's Surface Acoustic Wave
technology for use in our tire monitoring applications.


                                       11
<PAGE>

Product Development

           Our technology provides drivers with real time information  regarding
tire pressure and temperature  changes.  This information  provides the consumer
and  commercial  markets with  improved  vehicle  safety,  performance  and fuel
economy.   Our  products  have  been   engineered  and  designed  for  universal
application. The sensor / transmitter can be installed on virtually any tire and
wheel  combination.  Each  sensor /  transmitter  contains a custom  application
specific  integrated  sensor  (ASIS).  A receiver  unit  mounted in the  vehicle
provides appropriate alarm indications with optional digital readout.

           The custom application  specific integrated sensor (ASIS) is a single
micro-electronic  package containing  pressure and temperature  sensing elements
and a digital logic state  machine that  functions as the brains of the sensor /
transmitter.  This chip is robust in design, optimizes battery life and provides
various modes of sensing and communicating  which ensure faster  transmission of
data when  problems  occur.  Packaged on a  miniaturized  circuit board with the
application  specific  integrated  sensor (ASIS) are various  components and our
radio frequency technology.  Using this wireless radio frequency technology, the
data is transmitted through the tire to a remote receiver.

           Our  company's   products  feature   transmitter   options  providing
different   installation   choices  for  various  automotive   applications.   A
strap-mounted  transmitter  attached  to the  wheel  offers  the most  universal
installation  for a wide  range of tire and wheel  assemblies.  A  valve-mounted
transmitter  attached  to the base of the  valve  offers an  adjustable,  secure
in-tire  installation  for specific wheel / rim profiles.  Once  installed,  the
sensor  /  transmitters  do  not  require  ongoing  maintenance.  The  sensor  /
transmitters  communicate to remote  receivers and the data is displayed  inside
the vehicle. We have developed three display options for the aftermarket (basic,
integrated  full function and remote full function) as well as telltale  lights,
switch blanks and digital displays for OEM and port of entry applications.

           We have recently developed OEM passenger car solutions to support the
level of demand that our management anticipates from potential customers in this
market sector. The OEM transmitter features a 50% size and weight reduction over
our current generation  transmitter,  as well as innovative new mounting options
including bonding directly to the wheel as well as a more innovative valve mount
approach.  We are currently  marketing our existing products to small and medium
sized original equipment manufacturers.

           We introduced our motorcycle tire pressure  monitoring  system (TPMS)
for sale into the  aftermarket  in  September  2002.  We recently  introduced  a
substantially  improved second  generation  motorcycle tire pressure  monitoring
system (TPMS) at the Indy Motorcycle Dealers Show, held in Indianapolis, Indiana
in  mid-February  2004.  During  May,  2004  this  product  became  commercially
available  and  we  began  shipping  it to our  customers.  As  discussed  under
"corporate  history",  we  encountered  a component  defect  issue as well as an
application  issue with curved rims and initiated a recall in September 2004. We
have  corrected  the  component  defect  issue and are  currently  working  on a
solution to supply TPMS to motorcycles with curved rims.

           On September  12, 2003 we entered into a development  agreement  with
Vansco  Ltd.  This  agreement  provides  for the  merging  of  Vansco's  vehicle
communication  expertise with SmarTire's  proven radio frequency (RF) technology
to create a high sensitivity, weatherproof, J1939 controller area network (CAN),
chassis-mounted  receiver.  The J1939  controller area network (CAN) is the most
widely used communication  standard in commercial  vehicles today,  allowing for
multiplexing,  receiving and transmitting of signals from various sources.  When
controller  area network  (CAN)  technology  is combined  with our high pressure
sensors,  we anticipate that this joint development  effort will result in a new
tire pressure  monitoring  system (TPMS) targeted directly at OEMs of commercial
trucks, buses,  agricultural,  construction and recreational  vehicles.  The new
receiver module is completing its final test phase with the first pilot build of
300 units scheduled to be completed during the month of October 2004.  Currently
the receiver  module and associated  tire pressure  monitoring  sensors are also
being  tested and  evaluated  by several  selected  OEMs.  The 300 units will be
utilized to meet test demands  from OEMs who  manufacture  commercial  vehicles.
Vansco will be manufacturing the module for us.


                                       12
<PAGE>

           On October 10, 2003 we entered into a  Co-Marketing  and  Development
agreement with Haldex Brake  Products Ltd., and a related Supply  Agreement with
Haldex. Under the terms of this agreement, we will engage in a joint development
program to integrate our tire pressure  monitoring  systems (TPMS) with Haldex's
brake systems,  with the view to creating commercial high pressure tire pressure
monitoring systems (TPMS) for marketing and resale by Haldex. We anticipate that
any new products that result from our collaboration with Haldex will be targeted
at both  OEM and  aftermarket  applications  predominately  for  trailers.  Once
development is complete, we plan to execute on the Supply Agreement with Haldex.

           During July 2004, we  successfully  completed  the initial  prototype
test  phase of a new  battery-less  tire  pressure  and  temperature  monitoring
system. With the automotive  industry in search of a tire monitoring  technology
that does not rely on  batteries,  we believe that our next  generation  of tire
monitoring systems could set a new standard.

           Current  tire  monitoring  systems  use  battery  power  to  transmit
pressure and temperature information from sensors inside the tires to a receiver
located within the vehicle.  Our new technology involves a passive sensor inside
each tire that is energized by an antenna located within each wheel arch.

           We are  continuing to advance our  battery-less  system,  that offers
significant   improvements   over  current   battery   powered  tire  monitoring
technologies.  Elimination  of the  battery in the sensor  greatly  reduces  its
weight,  size and cost.  Sensor life and  reliability  are increased and battery
disposal issues are eliminated,  creating an  environmentally  "green" solution.
This new  approach  to tire  monitoring  allows  tires to be  rotated or changed
without  re-programming the system. It also tracks tire revolutions,  a critical
variable in predicting tire life.

Marketing

           Our subsidiaries,  SmarTire USA and SmarTire Europe, were established
to market our tire monitoring systems (TMS) products.  SmarTire USA and SmarTire
Europe were  mandated to  establish a  distribution  network for the  automotive
aftermarket  including the supporting  sales and support  infrastructure  and to
create OEM opportunities with automotive manufacturers.

           As a result of the  enactment of the TREAD Act and the  restructuring
of our strategic alliance with TRW, we have substantially  changed our marketing
strategy to take advantage of OEM business for vehicles manufactured or imported
into the United States. We expect that, as tire monitoring  systems (TMS) become
standard equipment for new passenger vehicles in the United States over the next
few years, demand for tire monitoring systems (TMS) will increase on a worldwide
basis.

           With the  implementation  of the TREAD Act, we expect that demand for
tire  monitoring  technology  will be initiated  by the big three United  States
automakers:  General Motors,  DaimlerChrysler and Ford. Some European automotive
groups  have  already  used  tire  monitoring  as  a  means  to  add  value  and
differentiate  models.  Due to the large volume of import vehicles to the United
States,  it is expected that the thirty different  automakers in Europe plus the
twelve from Asia will meet the TREAD Act requirements for North America.  Adding
tire  monitoring to domestic  European and Asian  vehicles  would trigger a much
larger demand for tire monitoring  systems (TMS) than was  anticipated  prior to
introduction of the TREAD Act.

           Our Company's current marketing  strategy is to focus on sales of our
tire  monitoring  systems  (TMS) for OEM  applications  in all  market  sectors:
passenger cars, light trucks, motorcycles, recreational vehicles, commercial and
industrial  applications.  In approaching the OEM market,  we expect to position
ourselves as a complete system and associated technology provider.  Our strategy
is to provide high  quality  products to the OEM market  which  incorporate  the
highest  level of technology  possible,  at a  competitive  price.  Our strategy
requires that, among other things, we minimize our manufacturing costs.


                                       13
<PAGE>

           We intend to achieve this in conjunction  with Hyundai Autonet a Tier
One supplier of automotive  parts in Korea.  Tier One suppliers  produce systems
and subsystems  for original  equipment  manufacturers.  We believe that Hyundai
Autonet possesses competitive world-class manufacturing  capabilities which will
directly complement our specialized technical know-how, and thereby help to give
us an improved  industry  presence.  We also hope to work closely  together with
Hyundai Autonet to secure Asian contracts with certain automobile manufacturers,
for the  supply of  fully-integrated  tire  monitoring  solutions  for  selected
automobile platforms.

           While we expect that the greatest demand for tire monitoring  systems
(TMS) in the United States will be at the original equipment  manufacturer level
for passenger vehicles and commercial  vehicles,  we will continue to market our
products  through  installation  at either the new car  dealer or  port-of-entry
level.  We refer to this  opportunity  as car accessory  programs and motorcycle
accessory programs. These programs may be used to provide an OEM quality product
that is not  installed at the factory.  Car and  motorcycle  accessory  programs
opportunities  also  exist  in  Europe  due  to  the  number  and  diversity  of
automakers.

           We completed the development and launch of our second generation tire
monitoring systems (TMS) for the passenger car and light truck market during the
fiscal year ended July 31, 2001.  We  introduced  our  motorcycle  tire pressure
monitoring  system (TPMS) for sale into the  aftermarket  in September  2002. We
recently introduced a substantially  improved second generation  motorcycle tire
pressure  monitoring system (TPMS) at the Indy Motorcycle  Dealers Show, held in
Indianapolis,  Indiana in mid-February 2004. During May 2004 this product became
commercially  available  and we began  shipping it to our  customers.  In August
2004, we discovered that the sensor/transmitter may break during installation on
the subset of motorcycle rims with curved rim surfaces when the strap is torqued
to its required value.  On September 14, 2004 we contacted the National  Highway
Transportation Safety Administration (NHTSA) to determine if a Safety Defect and
Non  Compliance  Report was required  and was advised  that this was  necessary.
SmarTire's   remedy   for  the   defect   was  to   recall   100%  of   affected
sensor/transmitter  items from the field and replace both recalled and inventory
sensor/transmitters  with  sensor/transmitters   previously  manufactured  by  a
different  supplier that have been tested and known to use plastics that provide
the required mechanical properties.  Additionally SmarTire wishes to ensure that
transmitters  are used only on rims with flat drop center  wells (as  originally
designed for) and not curved. The additional precautionary steps were taken:

      o     Adding  improved  warnings and  instruction  sheet to new product as
            well as  product  in  inventory  at dealers  and  distributors  that
            clarify flat rim drop center well application only

      o     Removal of tire pressure  monitoring  system  (TPMS) on  motorcycles
            with rims with curved drop center wells

           We  anticipate  the cost of this  recall  will be  approximately  $US
67,000. In addition, we are currently working on a solution to enable us to sell
our tire pressure  monitoring system (TPMS) on motorcycles with rims with curved
drop center wells.

           The aftermarket  opportunity  currently consists of a niche market in
the  enthusiast  and high  performance  segment.  To access this niche,  we have
worked to establish a wholesale  distribution  network in Europe, while in North
America we have sought to work directly with major retail distributors.

           In June 2004, we released tire pressure monitoring systems (TPMS) for
high pressure tires.  These high pressure systems are designed for use by buses,
recreational and commercial vehicles. Maintaining proper tire inflation on large
vehicles is important to maximizing  fuel  economy,  tire life and the safety of
the driver and  cargo.  We believe  this  market  segment  provides  us with our
largest  sales  opportunities  and our  products are being tested by many of the
worlds premier RV, Truck and Bus manufacturers.

Competition

           As a whole,  the tire  monitoring  systems (TMS) industry is still in
its early  stages.  There have been very few  products  available in the market.
Tire monitoring  products can generally be divided among two basic types, direct
technology and indirect monitoring technologies. As described in the NHTSA's


                                       14
<PAGE>

(National  Highway Traffic Safety  Administration)  report,  and discussed above
under the heading  "Business  of our company - Government  Regulations,"  direct
tire  monitoring  technology  such as that  employed in our  company's  products
currently provide substantial  advantages over indirect  monitoring  technology.
However,  several of our  competitors  and potential  competitors  have long and
established relationships with automobile OEMs and suppliers,  which may make it
difficult  for  us to  compete  in  the  OEM  market.  Additionally,  automobile
manufacturers  may elect to develop their own tire  monitoring  systems (TMS) to
comply with the TREAD Act.

Our main  competitors  with  respect to direct  tire  monitoring  systems  (TMS)
include the following:

      o     Schrader  Bridgeport,  claims to be the world's largest  producer of
            tire valves and tire-pressure  measurement  equipment with over $140
            million in annual sales. The tire monitoring systems (TMS) developed
            by Schrader has been used on  Chevrolet  Corvettes  since 1996.  The
            Schrader tire monitoring systems (TMS) was also used on the Plymouth
            Prowler  during its five-year  production run from 1997 to 2002. The
            product  is  being  aggressively  marketed  at the OEM  level.  As a
            transmitter supplier, Schrader has teamed with receiver suppliers to
            recently win OEM contracts. In the aftermarket,  Schrader has joined
            with Johnson Controls in the launch of their PSI-branded product.

      o     German  based  BERU has  acquired  Doduco  and its  tire  monitoring
            technology. That company is presently working with and approved by a
            consortium of five German vehicle  manufacturers.  To our knowledge,
            the system  requires the use of  transmitters  attached to the valve
            stem (inside the tire / wheel assembly),  receiving antennas at each
            of the  wheel  wells,  wiring  harness  for  conveying  data  to the
            receiver  and some form of  in-dash  display.  This  system has been
            developed for the OEM market only.

      o     Pacific  Industrial  Co. Ltd., a Japanese  company,  has developed a
            product  that  measures  the air pressure in each tire and sends the
            data to a  receiver  mounted  inside a  vehicle.  The  products  are
            available on a few Asian vehicles and, to date, are not commercially
            available in North  America.  We believe  that the Pacific  products
            resemble  the  BERU  approach  to tire  monitoring  with  additional
            antennas  and  wiring  harnesses.  o TRW  Automotive  U.S.  LLC is a
            producer of safety and  security  systems for the global  automotive
            market. It supplies advanced technology products and services to the
            automotive  markets.  From  December 1998 to August 2001, we and TRW
            jointly developed  advanced tire monitoring  technology and each has
            access to this technology,  which  encompasses our current products.
            During  this  period,   we  and  TRW  jointly   developed  a  common
            application  specific  integrated  sensor  (ASIS) chip for  existing
            products.

      o     Siemens Automotive merged with Atecs Mannesmann AG to create Siemens
            Automotive AG, a large supplier of high-tech  automotive  electronic
            systems.   The  combined  company's  product  portfolio  focuses  on
            electronic modules and systems including  anti-lock brake system and
            airbag  electronics.  Siemens Automotive has entered the market, and
            offers direct tire monitoring systems (TMS) to OEMs.

           There are several  indirect  monitoring or anti-lock  brake  systems,
either available on the market or in prototype  stages.  To the knowledge of our
company's  management,  none of  these  prototype  systems  currently  meet  the
proposed  guidelines set out in the September 10, 2004 National  Highway Traffic
Safety  Administration's  Notice of Proposed Rule Making.  Given the substantial
advantages  of direct  monitoring  technology,  we do not believe that  indirect
monitoring  technology  will be a  significant  competitor  in the  short  term.
However,  it is  likely  that  the  performance  of  indirect  measurement  tire
monitoring systems (TMS) will continue to improve,  and they will likely benefit
from the fact that they are the least  expensive way of complying  with the tire
monitoring  systems (TMS) standard for vehicles  already equipped with anti-lock
braking systems.

           With respect to commercial vehicle tire monitoring systems (TMS), the
major tire  companies  have been  developing  medium  truck tires  incorporating
electronic chips in the sidewall to provide tire tracking  information  possibly
including pressure,  temperature and  identification.  Their disadvantage is the
inability to provide real-time,  dynamic values to the driver,  which eliminates
any early warning capability while operating the vehicle. Further, it seems that
currently  there are no additional  functions that can be programmed  into these
static systems, limiting their integration into other fleet management programs.


                                       15
<PAGE>

           There are a number of companies  that are  marketing  tire  inflation
systems into the commercial  trailer market.  While these systems do not provide
tire monitoring  systems (TMS)  information to the driver,  they utilize the air
lines in the trailer to supply air  pressure to a tire that is  experiencing  an
air loss. This allows the driver to continue to operate the vehicle. This system
is not available on the tractor or truck unit itself.

           One  potential  future  development  that could affect the market for
both passenger car and commercial  vehicle tire monitoring is the development of
a "smart chip".  This is a computer  chip that could  transmit data and would be
manufactured  into tires.  We believe that Goodyear and  Bridgestone / Firestone
have both completed some development of such a computer chip.

Raw Materials and Principal Suppliers

           We contract the  manufacture of our products to third parties.  These
manufacturers  normally provide turnkey  operations  whereby the manufacturer is
responsible for purchasing the component  parts for our tire monitoring  systems
(TMS).  Presently,  we purchase component parts and deliver them to our contract
manufacturer.   We  also  purchase  component  parts  on  our  own  account  for
engineering and prototype  development  purposes.  Certain of the components and
raw  materials  used in our products  are  difficult  to obtain  and/or  require
purchase  commitments far in advance of the manufacturing date. At present,  our
relationships  with our current  suppliers are generally good and we expect that
the  suppliers  will be able to meet the  anticipated  demand  for our  products
through fiscal year 2005.

Dependence on Certain Customers

           Due to the early stage  development  of the tire  monitoring  systems
(TMS) market in general and for our Company's,  we are still  dependent on major
customers.  During  fiscal  2004 we  earned  29% of our  revenue  from one major
customer.  We expect that this dependence will be reduced as we start to realize
sales  through our  relationships  with new  customers and through our strategic
alliances, including our alliance with Hyundai Autonet.

Proprietary Protection

           Our intellectual  property is important to protecting our competitive
advantage and expanding our tire monitoring  systems (TMS) market share. We rely
on a combination of patents, trade secret laws,  confidentiality  procedures and
contractual provisions to protect our intellectual property.

           We hold  several  patents  for our  current  technologies,  which are
listed below:

o     United  States  Patent  5,231,872  addresses  the  technology  in our tire
      monitoring  product. It was issued on August 3, 1993 and expires August 3,
      2010.

o     United States Patent  5,285,189  addresses the  technology in our abnormal
      tire  condition  warning  system.  It was issued on  February  8, 1994 and
      expires February 8, 2011. We purchased this patent from EPIC Technologies,
      Inc. in December 1996.

o     United  States  Patent  5,335,540  addresses  the  technology  in our tire
      monitoring  product. It was issued on August 9, 1994 and expires August 9,
      2011.

o     United States Patent 5,559,484  addresses  certain  technology in our data
      logging tire monitor with condition predictive  capabilities and integrity
      checking.  It was issued on September  24, 1996 and expires  September 24,
      2013. We purchased  this patent from EPIC  Technologies,  Inc. in December
      1996.


                                       16
<PAGE>

o     United States Patent 5,945,908  addresses  certain other technology in our
      data  logging  tire monitor with  condition  predictive  capabilities  and
      integrity checking. It was issued on August 31, 1999 and expires on August
      31,  2016.  We  purchased  this  patent  from EPIC  Technologies,  Inc. in
      December 1996.

o     United  States  Patent  4,653,445  addresses  the  technology in an Engine
      Protection  System  product.  It was issued on March 31,  1987 and expired
      March 31, 2004.

o     United  States  Patent  6,357,883  addresses  the  technology  for a wheel
      component with a cavity for mounting a housing for measurement  apparatus.
      It was issued on March 19, 2002 and expires on March 19, 2019.

           In addition to our patents,  we also have access to a number of other
patents under our license agreements with Transense and TRW.

           We  entered  into a license  agreement  on  September  30,  1999 with
Transense based in Oxfordshire,  United Kingdom. Transense researches,  develops
and exploits the use of its patented  Surface  Acoustic  Wave  technology in the
automotive  industry.  The license  agreement  grants SmarTire a  non-exclusive,
worldwide  right  to  develop  and  market  Transense's  Surface  Acoustic  Wave
technology for use in tire monitoring systems (TMS).

           As discussed  elsewhere in this annual report,  we  restructured  our
strategic  alliance  with  TRW  effective  August  31,  2001.  As  part  of  the
restructuring, we received a royalty-free license from TRW to utilize technology
developed  during  the term of the  Cooperative  Engineering  Agreement  that is
patented,  now or in the future, by TRW. We have granted a parallel royalty-free
license to TRW.

Research and Development

           We  spent  the  following   amounts  on  engineering,   research  and
development  activities  during the fiscal years ended July 31,  2004,  2003 and
2002:

           2004 - $1,654,690

           2003 - $1,177,935

           2002 - $1,727,606

           These  expenses  were  incurred  in the  development  of  our  second
generation tire monitoring systems (TMS). We expect that our annual research and
development  expenses  will  continue to increase  as we work to  integrate  our
current  products into  automobile  platforms of various OEMs seeking to satisfy
the TREAD Act  requirements,  and as we complete work on other products that are
currently in development.


                                       17
<PAGE>

Number of Total Employees and Number of Full-time Employees

           At July 31, 2004,  we had 48 full-time  employees,  15 of whom are in
marketing,  22 of whom are in  engineering,  research and  development and 11 of
whom  are  administrative  and  executive  personnel.  There  is  no  collective
bargaining agreement in place. We also had one engineer on a contract basis.

RISK FACTORS

                    RISKS RELATED TO OUR BUSINESS AND COMPANY

The  following  factors,  among  others,  could cause  actual  results to differ
materially  from those  contained in  forward-looking  statements in this annual
report.  The risks  described  below are not the only ones  facing our  Company.
Additional  risks  not  presently  known  to us may  also  impair  our  business
operations.

AS OF THE DATE OF THIS ANNUAL REPORT ON FORM 10-KSB, WE DO NOT HAVE A SUFFICIENT
NUMBER OF AUTHORIZED  SHARES OF COMMON STOCK WITH RESPECT TO THOSE SHARES OF OUR
COMMON STOCK,  THOSE SHARES  ISSUABLE UPON CONVERSION OF DEBENTURES AND EXERCISE
OF WARRANTS PURSUANT TO OUR FINANCING ARRANGEMENTS.

As of the date of this Annual Report on Form 10-KSB, we do not have a sufficient
number of authorized  shares of common stock with respect to those shares of our
common stock,  those shares  issuable upon conversion of Debentures and exercise
of Warrants pursuant to our financing  arrangements.  We are seeking shareholder
approval in order to amend our Articles of  Incorporation to increase our number
of authorized shares of common stock at our 2004 Meeting of Shareholders.  There
can be no assurance that we will obtain such shareholder  approval. If we do not
receive such approval to increase our  authorized  shares of common stock,  then
the  securities  purchased  in  the  Offerings  cannot  be  sold,  and  are  not
convertible or exercisable into shares of our common stock.

WE REQUIRE  ADDITIONAL  FINANCING  IN ORDER TO  CONTINUE  IN BUSINESS AS A GOING
CONCERN,  THE  AVAILABILITY OF WHICH IS UNCERTAIN.  WE MAY BE FORCED BY BUSINESS
AND ECONOMIC CONDITIONS TO ACCEPT FINANCING TERMS WHICH WILL REQUIRE US TO ISSUE
OUR  SECURITIES  AT A DISCOUNT,  WHICH COULD  RESULT IN FURTHER  DILUTION TO OUR
EXISTING STOCKHOLDERS.

           As discussed under the heading, "Management's Discussion and Analysis
- Liquidity and Capital Resources," we require additional  financing to fund our
operations.  We have taken the steps  necessary to draw down  amounts  under the
$15,000,000  equity line of credit  facility  that we have arranged with Cornell
Capital  Partners,  LP.  However,  business and economic  conditions may make it
unfeasible or  undesirable  for us to draw down amounts under the equity line of
credit at every opportunity.  For example, it would be unfeasible for us to draw
down amounts under the equity line if we did not have enough registered shares.

           In conjunction with our financial advisors, Cornell Capital Partners,
LP., we are pursuing  various  financing  alternatives to meet our immediate and
long-term  financial  requirements.  There can be no assurance  that  additional
financing  will be available to us when needed or, if available,  that it can be
obtained on commercially  reasonable  terms. In addition,  any additional equity
financing may involve  substantial  dilution to our stockholders.  If we fail to
raise  sufficient  financing to meet our immediate cash needs, we will be forced
to scale down or perhaps  even cease the  operation of our  business,  which may
result in the loss of some or all of your investment in our common stock.

           In addition,  in seeking debt or equity private placement  financing,
we may be forced by business and economic  conditions to accept terms which will
require us to issue our  securities  at a discount  from the  prevailing  market
price or face  amount,  which could  result in further  dilution to our existing
stockholders.

OUR STANDBY EQUITY  DISTRIBUTION  AGREEMENT WITH CORNELL  CAPITAL  PARTNERS,  LP
LIMITS THE NUMBER OF SHARES OF COMMON STOCK THAT WE CAN REQUIRE  CORNELL CAPITAL
PARTNERS,  LP TO  PURCHASE  TO NOT  MORE  THAN  9.99%  OF OUR  THEN  ISSUED  AND
OUTSTANDING  SHARES OF COMMON STOCK IN CONNECTION WITH EACH DRAW DOWN, WHICH MAY
FURTHER  LIMIT OUR  ABILITY TO DRAW DOWN  AMOUNTS  THAT WE REQUEST AND WHICH MAY
CAUSE US TO  SIGNIFICANTLY  CURTAIL  THE SCOPE OF OUR  OPERATIONS  AND ALTER OUR
BUSINESS PLAN.


                                       18
<PAGE>

           Our  Standby  Equity  Distribution  Agreement  with  Cornell  Capital
Partners,  LP provides that we may not sell shares of our common stock  pursuant
to our draw down right under the  agreement if the draw down would result in the
issuance of more than 9.99% of our then issued and  outstanding  common stock to
Cornell  Capital  Partners,  LP. For example,  on October 15, 2004,  217,224,375
shares of our common stock were issued and  outstanding.  Assuming that we would
have otherwise been in a position to effect a draw down under the equity line of
credit facility, the 9.99% restriction would have prevented us from selling more
than 21,700,715  shares to Cornell Capital  Partners,  LP at that time. We would
have realized net proceeds from the draw down of approximately  $564,587,  after
deduction of a 2% discount, 5% fee payable to Cornell Capital Partners, LP and a
$500 escrow fee payable to the escrow agent.

           Since trading in stock quoted on the OTC Bulletin Board is often thin
and  characterized  by wide  fluctuations  in trading  prices,  Cornell  Capital
Partners,  LP may have  difficulty  reselling the shares that it purchases under
the Standby  Equity  Distribution  Agreement.  For  example,  August 1, 2004 and
September 30, 2004 the average  daily trading  volume of our common stock on the
OTC Bulletin Board was 3,910,941  shares,  and the closing price of one share of
our common stock during this period ranged from $0.034 to $0.094. This, in turn,
may require that draw downs be delayed until Cornell  Capital  Partners,  LP has
sold a sufficient number of shares to stay within the 9.99% restriction.  We may
have to significantly curtail the scope of our operations and alter our business
plan if,  at the  time of any draw  down  under  the  equity  line,  this  9.99%
restriction  results in our  inability  to draw down some or all of the  amounts
requested in any draw down notice.

WE HAVE A HISTORY OF OPERATING LOSSES AND FLUCTUATING  OPERATING RESULTS,  WHICH
RAISE SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN.

           Since  inception  through July 31, 2004, we have  incurred  aggregate
losses of  $59,018,256.  Our loss from operations for the fiscal year ended July
31, 2004 was $6,973,571 and for year ended July 31, 2003 was  $6,387,160.  There
is no assurance that we will operate  profitably or will generate  positive cash
flow in the future.  In  addition,  our  operating  results in the future may be
subject to significant  fluctuations due to many factors not within our control,
such as the unpredictability of when customers will order products,  the size of
customers' orders, the demand for our products, and the level of competition and
general economic conditions.

           Although we are confident that revenues will increase, we also expect
an increase in development costs and operating costs. Consequently, we expect to
incur  operating  losses and negative  cash flow until our products  gain market
acceptance sufficient to generate a commercially viable and sustainable level of
sales,  and/or additional  products are developed and commercially  released and
sales of such products made so that we are operating in a profitable manner.

WE MAY EXPERIENCE  SIGNIFICANT  AND RAPID GROWTH IF WE ARE ABLE TO CAPITALIZE ON
THE EXPANSION OF THE TIRE MONITORING  MARKET. IF WE ARE UNABLE TO HIRE AND TRAIN
STAFF TO HANDLE SALES AND  MARKETING OF OUR PRODUCTS AND MANAGE OUR  OPERATIONS,
SUCH GROWTH COULD MATERIALLY AND ADVERSELY AFFECT US.

           We intend to proceed with  initiatives  intended to capitalize on the
expansion  of the tire  monitoring  market that is  occurring as a result of the
enactment by the TREAD Act. This could potentially lead to significant and rapid
growth in the scope and complexity of our business. Any inability on our part to
manage  such  growth  effectively  will have a  material  adverse  effect on our
product  development,  business,  financial condition and results of operations.
Our ability to manage and sustain growth  effectively  will depend,  in part, on
the ability of our management to implement appropriate  management,  operational
and  financial  systems  and  controls,  and the  ability of our  management  to
successfully hire, train, motivate and manage employees.

TECHNOLOGICAL CHANGES IN OUR INDUSTRY COULD RENDER OUR PRODUCTS  NON-COMPETITIVE
OR OBSOLETE AND CONSEQUENTLY AFFECT OUR ABILITY TO GENERATE REVENUES.

           The markets in which we operate are subject to technological  change,
evolving industry standards and changes in customer demands. The introduction of
products  embodying new technologies and the emergence of new industry standards
can render existing products obsolete and unmarketable, including ours. Although
we are confident that our tire monitoring  systems (TMS) technology and products


                                       19
<PAGE>

are  technologically  advanced and  currently  competitive,  we believe that our
long-term  success  will  depend upon our  ability to  continuously  develop new
products and to enhance our current  products and  introduce  them promptly into
the  market.  If we are not able to develop  and  introduce  new  products,  our
business,  financial  condition  and results of  operations  could be  adversely
affected.

WE DO CARRY A REASONABLE  AMOUNT OF PRODUCT LIABILITY  INSURANCE.  HOWEVER THERE
CAN BE NO ASSURANCE  THAT OUR EXISTING  INSURANCE  COVERAGE WOULD BE ADEQUATE IN
TERM AND SCOPE TO PROTECT US AGAINST MATERIAL  FINANCIAL EFFECTS IN THE EVENT OF
A SUCCESSFUL CLAIM.

           We could be subject to claims in connection with the products that we
sell.  There can be no  assurance  that we would have  sufficient  resources  to
satisfy any liability resulting from any such claim, or that we would be able to
have our customers  indemnify or insure us against any such liability.  Although
we have product and directors and officers liability insurance,  there can be no
assurance  that our  insurance  coverage  would be adequate in term and scope to
protect  us against  material  financial  effects  in the event of a  successful
claim.  We  currently  do  not  carry  commercial  general  liability  insurance
providing  comprehensive product liability coverage in all instances.  We may in
the future  obtain such  insurance  provided  it can be  obtained at  reasonable
prices.  However,  there can be no assurance  that such  coverage,  if obtained,
would be adequate in term and scope to protect us.

SUBSTANTIALLY ALL OF OUR ASSETS AND A MAJORITY OF OUR DIRECTORS AND OFFICERS ARE
OUTSIDE  THE  UNITED  STATES,  WITH  THE  RESULT  THAT IT MAY BE  DIFFICULT  FOR
INVESTORS TO ENFORCE WITHIN THE UNITED STATES ANY JUDGMENTS  OBTAINED AGAINST US
OR ANY OF OUR DIRECTORS OR OFFICERS.

           Substantially all of our assets are located outside the United States
and we do not currently maintain a permanent place of business within the United
States.  In addition,  a majority of our  directors  and officers are  nationals
and/or  residents  of  countries  other  than the  United  States,  and all or a
substantial  portion of such  persons'  assets are  located  outside  the United
States.  As a result,  it may be difficult for  investors to enforce  within the
United  States any judgments  obtained  against us or our officers or directors,
including  judgments  predicated  upon the  civil  liability  provisions  of the
securities laws of the United States or any state thereof.

THE LOSS OF OUR MAJOR CUSTOMERS WOULD MATERIALLY AND ADVERSELY AFFECT US.

           During  fiscal  2004,  we earned  29% of our  revenue  from one major
customer.  Accordingly,  the loss of this major  customer  would  materially and
adversely affect us. The loss of any major customer,  or significant  reductions
by  either of them in  buying  our  products,  or any  inability  on our part to
collect accounts receivable from them, would materially and adversely affect our
business and results of operations.

WE MAY EXPERIENCE  DIFFICULTY IN OBTAINING COMPONENTS AND RAW MATERIALS,  AND WE
COULD BE MATERIALLY AND ADVERSELY AFFECTED AS A RESULT.

           Our current  products,  and the  products  that we may provide in the
future,  embody new  technologies.  Certain of the  components and raw materials
used in our products are difficult to obtain and/or require purchase commitments
to be made by us far in advance of the  manufacturing  date.  The  inability  to
obtain sufficient quantities of components or raw materials, or the inability to
forecast purchase requirements  accurately,  could adversely affect our business
and results of operations. Similarly, commitments to purchase components and raw
materials in excess of customer  demand for our products  could  materially  and
adversely affect our results of operations.

THE LOSS OF ANY OF OUR CONTRACT  MANUFACTURERS  WOULD  MATERIALLY  AND ADVERSELY
AFFECT US.

           We contract  the  manufacture  of our products to third  parties.  In
certain cases,  we do not have an  alternative  source of  manufacturing,  and a
suitable  replacement would be time-consuming  and expensive to obtain.  If, for
any reason, one of our third party manufacturers is unable or refuses to produce
our products, our business,  financial condition and results of operations would
be materially and adversely affected.


                                       20
<PAGE>


WE DEPEND TO A SIGNIFICANT  EXTENT ON CERTAIN KEY PERSONNEL,  THE LOSS OF ANY OF
WHOM MAY MATERIALLY AND ADVERSELY AFFECT OUR COMPANY.

           Our success depends to a significant  extent on the continued service
of certain key management personnel,  including Robert Rudman, our President and
Chief  Executive  Officer,   Al  Kozak,  our  Chief  Operating   Officer,   Jeff
Finkelstein, our Chief Financial Officer, Erwin Bartz, our Director of Technical
Operations,  and Shawn Lammers,  our  Vice-President,  Engineering.  The loss or
interruption  of  services  from one or more of these  personnel,  for  whatever
reason,  could have a material adverse effect on us. In the event of the loss of
services of such  personnel,  no assurances can be given that we will be able to
obtain the services of adequate  replacement  personnel.  We do not maintain key
person insurance on the lives of any of our officers or employees.

                   RISKS RELATED TO OUR FINANCING ARRANGEMENTS

WE HAVE ISSUED CONVERTIBLE  DEBENTURES AND OUR OBLIGATIONS UNDER THE CONVERTIBLE
DEBENTURES  POSE  RISKS TO THE  PRICE OF OUR  COMMON  STOCK  AND OUR  CONTINUING
OPERATIONS.

           We have issued discounted  convertible  debentures,  in the aggregate
principal  amount  of  $3,493,590,  maturing  on April 1,  2006 of which  amount
$1,612,798  remain  outstanding  as at October  15,  2004.  In  addition  to the
discounted convertible debentures, we have also issued 8% convertible debentures
in the aggregate principal amount of $1,700,000 maturing July 16, 2006, of which
amount $275,000 remain outstanding as at October 15, 2004. The discounted and 8%
convertible  debentures provide that in certain  circumstances the holder of the
debentures  may convert  the  outstanding  principal  and, in the case of the 8%
convertible  debentures,  accrued interest, into shares of our common stock. The
purchasers  of  the  discounted   convertible   debentures  and  8%  convertible
debentures also hold an aggregate of 14,612,857 warrants.

           The terms and conditions of the  convertible  debentures  pose unique
and  special  risks to our  continuing  operations  and the price of our  common
stock. Some of those risks are outlined below.

THE HOLDERS OF THE DISCOUNTED AND 8% CONVERTIBLE  DEBENTURES  HAVE THE OPTION OF
CONVERTING THE CONVERTIBLE  DEBENTURES  INTO SHARES OF OUR COMMON STOCK,  AND WE
MAY  ELECT  TO  MAKE  THE  MONTHLY  REDEMPTION  PAYMENTS  UNDER  THE  DISCOUNTED
CONVERTIBLE  DEBENTURES  IN  SHARES  OF OUR  COMMON  STOCK.  IF THE  CONVERTIBLE
DEBENTURES  ARE  CONVERTED,  THERE WILL BE DILUTION OF YOUR SHARES OF OUR COMMON
STOCK.

           The  issuance  of shares  of our  common  stock  upon  conversion  or
redemption of the discounted convertible debentures,  and upon the conversion of
the 8% convertible debentures, will result in dilution to the interests of other
holders of our common stock, since the holders of the convertible debentures may
sell all of the resulting shares into the public market.

           The principal amount of the discounted  convertible debentures may be
converted  at the option of the holders into shares of our common stock at a set
price of $0.22 per share,  subject to adjustment  pursuant to the  anti-dilution
provisions as set forth in the convertible debentures. In addition, we may elect
to make the  monthly  redemption  payments  in shares of our  common  stock at a
conversion  price  equal to the  lesser  of (a) the set price of $0.22 per share
(subject to adjustment pursuant to the anti-dilution provisions contained in the
debentures),  and (b) 85% of the average of the 20 closing  prices of our common
stock.

           As at October 15, 2004, we had issued 31,759,908 shares of our common
stock for monthly payments on our discounted  convertible  debenture and holders
of 8%  convertible  debentures had converted a total of $1,455,054 of principal,
and related  interest,  resulting  in the issuance of  11,511,079  shares of our
common  stock.  The balance of the 8%  convertible  debentures  in the aggregate
amount of $275,000 may be  converted at a conversion  price of $0.028 per share,
subject  to  adjustment  as set  forth in the  convertible  debentures.  Accrued
interest on any  principal  amount that is so converted  will be converted  into
shares of our  common  stock at a  conversion  price  equal to 90% of the 20-day
average closing bid price.


                                       21
<PAGE>


           The  purchasers of the  discounted  convertible  debentures  received
warrants to acquire up to an aggregate of 7,939,978  shares of our common stock,
exercisable  for a period of two years.  These  warrants were  exercised  during
September 2004.

           The purchasers of the 8% convertible  debentures received warrants to
acquire up to an aggregate of 13,076,922 shares of our common stock, exercisable
for a period of five years. They also hold additional  warrants to acquire up to
an aggregate of 1,535,935  shares of our common stock,  exercisable for a period
of five years.

           Each   convertible   debenture   and  each   warrant  is  subject  to
anti-dilution  protection upon the occurrence of certain events. If, among other
things, we or any of our subsidiaries  offers, sells or otherwise disposes of or
issues any of our common stock (or any equity,  debt or other instrument that is
at any time over its life convertible into or exchangeable for our common stock)
at an effective  price per share that is less than the  conversion  price of the
convertible debenture or the exercise price of the warrant, the conversion price
or the  exercise  price of the warrant  will be reduced to equal such  effective
price.

           The following table sets forth the number and percentage of shares of
our common stock that would be issuable if:

           -      the  entire  principal  amount of the  discounted  convertible
                  debentures and the 8% convertible  debentures of $1,887,798 is
                  converted or redeemed at the current conversion price of $.028

<TABLE>
<CAPTION>

--------------------------------------------- -------------------- ---------------------- ---------------------- -------------------
                                               NUMBER OF SHARES
                                                   ISSUABLE
                                                ON CONVERSION/
                                                 REDEMPTION OF
                                                 DISCOUNTED AND 8%   SHARES ISSUED OR
                                                  CONVERTIBLE      ISSUABLE ON EXERCISE                              PERCENTAGE OF
                DESCRIPTION                      DEBENTURES(1)          OF WARRANTS           TOTAL SHARES            CLASS(2)(3)
--------------------------------------------- -------------------- ---------------------- ---------------------- -------------------
<S>                                           <C>                  <C>                    <C>                    <C>
DEBENTURES IN THE AGGREGATE PRINCIPAL
AMOUNT OF $1,887,798 ARE CONVERTED/REDEEMED
AT A CONVERSION PRICE OF $0.028.                  67,421,357            14,612,857             82,034,214               27.41%
--------------------------------------------- -------------------- ---------------------- ---------------------- -------------------
</TABLE>

(1) Represents the number of shares issuable if all of the outstanding principal
under  all of the  discounted  convertible  debentures  and  the 8%  convertible
debentures were  converted/redeemed  at the indicated conversion price. For ease
of reference,  any shares of common stock that may be issued upon  conversion of
interest under the 8% convertible debentures have been excluded. The outstanding
principal under the 8% convertible  debentures  bears interest at the rate of 8%
per annum, calculated on the basis of a 360-day year.
(2) Based on  217,224,375  common shares issued and  outstanding  on October 15,
2004.
(3) Percentage of the total  outstanding  common stock represented by the shares
issuable on  conversion/redemption  of the discounted convertible debentures and
the 8% convertible debentures, and upon exercise of the warrants, without regard
to any contractual or other  restriction on the number of securities the selling
stockholders may own at any point in time. The actual number of shares of common
stock  issued  or  issuable  upon the  conversion/redemption  of the  discounted
convertible  debentures  is  subject to  adjustment  pursuant  to  anti-dilution
provisions  contained  in the  debentures  which  may or may  not be  triggered,
depending upon factors which cannot be predicted by us at this time.


                                       22
<PAGE>


THE  CONVERTIBLE  DEBENTURES  PROVIDE FOR VARIOUS  EVENTS OF DEFAULT  THAT WOULD
ENTITLE THE HOLDERS TO REQUIRE US TO IMMEDIATELY  REPAY 120% OF THE  OUTSTANDING
PRINCIPAL  AMOUNT,  PLUS ACCRUED AND UNPAID  INTEREST,  IN CASH.  IF AN EVENT OF
DEFAULT OCCURS,  WE MAY BE UNABLE TO IMMEDIATELY  REPAY THE AMOUNT OWED, AND ANY
REPAYMENT MAY LEAVE US WITH LITTLE OR NO WORKING CAPITAL IN OUR BUSINESS.

           We  will be  considered  in  default  of the  discounted  convertible
debentures  and the 8%  convertible  debentures if any of the following  events,
among others, occurs:

           (a) we fail to pay  any  amount  due  under a  convertible  debenture
           within  five  days  of any  notice  sent to us by the  holder  of the
           convertible debenture that we are in default of our obligation to pay
           the amount;
           (b) we fail to comply with any of the other  agreements  contained in
           the  convertible  debenture  after we are given  fifteen days written
           notice of such non-compliance;
           (c) we breach any of our  obligations  under the  related  securities
           purchase agreement or the related  registration  rights agreement and
           the breach is not cured by us within  fifteen  days after our receipt
           of written notice of such breach;
           (d) we or any of our subsidiaries become bankrupt or insolvent;
           (e) we breach any of our  obligations  under any other debt or credit
           agreements involving an amount exceeding $150,000,  unless the breach
           is cured by us within  fifteen  days and the  breach is waived by the
           other party to the debt or credit agreement;
           (f) our common  stock  ceases to be  eligible  for  quotation  on the
           principal  market for our common  stock  (currently  the OTC Bulletin
           Board),  and  fails to be quoted or listed  for  trading  on  another
           principal  market  (defined to mean the OTC Bulletin  Board,  the New
           York Stock Exchange,  American Stock Exchange,  the NASDAQ  Small-Cap
           Market or the NASDAQ National Market) within five trading days;
           (g) we agree to sell or dispose of more than 33% of our assets in one
           or more  transactions,  or we agree to redeem or repurchase more than
           an insignificant  number of shares of our outstanding common stock or
           any other equity securities of our company; or
           (h) we fail to issue shares of our common stock to the holder  within
           five trading days of the conversion  date specified in any conversion
           notice delivered in respect of a convertible debenture by the holder.

           If an event of default occurs, the holder of a convertible  debenture
can elect to require us to pay a mandatory  prepayment amount generally equal to
120% of the  outstanding  principal  amount,  plus all other  accrued and unpaid
amounts under the convertible debenture.

           Some of the events of default  include matters over which we may have
some,  little or no control.  If a default  occurs and we cannot pay the amounts
payable under the convertible debentures in cash (including any interest on such
amounts and any  applicable  late fees under the  convertible  debentures),  the
holders of the  debentures  may  protect and  enforce  their  rights or remedies
either by suit in equity or by action at law, or both,  whether for the specific
performance  of any  covenant,  agreement  or other  provision  contained in the
convertible  debentures,  in the related securities purchase agreement or in any
document  or  instrument  delivered  in  connection  with  or  pursuant  to  the
convertible debentures, or to enforce the payment of the outstanding convertible
debentures  or any other legal or equitable  right or remedy.  In addition,  any
repayment  that we are  required  to make may leave us with little or no working
capital in our  business.  This would have an adverse  effect on our  continuing
operations.

SALES OF A  SUBSTANTIAL  NUMBER OF SHARES OF OUR  COMMON  STOCK  INTO THE PUBLIC
MARKET BY THE  HOLDERS OF THE  CONVERTIBLE  DEBENTURES,  AND BY CORNELL  CAPITAL
PARTNERS, LP UNDER OUR $15,000,000 EQUITY LINE OF CREDIT FACILITY, MAY RESULT IN
A  SIGNIFICANT  DOWNWARD  PRESSURE  ON THE PRICE OF OUR  COMMON  STOCK AND COULD
AFFECT THE ABILITY OF OUR  STOCKHOLDERS  TO REALIZE THE CURRENT TRADING PRICE OF
OUR COMMON  STOCK.  IF WE ARE ABLE AND ELECT TO DRAW DOWN ANY  AMOUNT  UNDER THE
EQUITY LINE OF CREDIT FACILITY,  CORNELL CAPITAL PARTNERS,  LP WOULD BE ENTITLED
TO PURCHASE  SHARES UNDER THE FACILITY AT A 2% DISCOUNT,  WHICH MIGHT  ENCOURAGE
CORNELL CAPITAL PARTNERS,  LP TO IMMEDIATELY SELL SUCH SHARES. IN ADDITION,  THE
MERE  PROSPECT  OF SALES OF SUCH A  SUBSTANTIAL  NUMBER OF SHARES OF OUR  COMMON
STOCK COULD DEPRESS THE MARKET PRICE FOR OUR COMMON STOCK.


                                       23
<PAGE>


           Holders of the discounted  convertible  debentures and 8% convertible
debentures  may acquire and resell up to 67,421,357  shares of our common stock,
subject to  adjustment,  upon  conversion of the remaining  principal  under the
convertible debentures,  and up to an additional 14,612,857 shares of our common
stock, subject to adjustment,  upon exercise of certain outstanding common share
purchase warrants.

           In  addition,  on May 19, 2004,  we entered  into our Standby  Equity
Distribution   Agreement  with  Cornell  Capital  Partners,  LP,  an  accredited
investor,  in connection with the 24-month,  $15.0 million equity line of credit
facility.  The agreement  contemplates the potential future issuance and sale of
up to $15.0 million of our common stock to Cornell Capital Partners, LP, subject
to  restrictions  and other  obligations  (including  the  requirement  that the
underlying  shares of common stock  issuable to the investor  under the facility
shall  have  been  registered  on an  appropriate  registration  form  under the
Securities Act of 1933).

           For each share of common  stock  purchased  under the Standby  Equity
Distribution  Agreement,  Cornell  Capital  Partners  will pay 98% of the lowest
closing bid price of our common stock on the Over-The-Counter Bulletin Board for
the five trading days  immediately  following the notice date. This discount may
give Cornell Capital Partners,  LP an incentive to immediately  resell any stock
that it  acquires  from us, in order to realize a gain  equal to the  difference
between the market price of the stock (being the price at which Cornell  Capital
Partners,  LP would sell) and the discounted  price which it would have paid for
the  stock.  Any  decreasing  trend  in the  market  price  of our  stock  could
potentially  result in an  acceleration of sales of the stock by Cornell Capital
Partners,  LP, since any gains that Cornell  Capital  Partners,  LP will realize
from the sale of the stock will  decrease  as the market  price  approaches  the
discounted price that Cornell Capital Partners, LP would have paid for it.

           The  resale  of  common  stock  by  the  holders  of  our  discounted
convertible  debentures,  and by Cornell Capital Partners, LP, will increase the
number of our publicly  traded  shares,  which could depress the market price of
our common stock,  and thereby affect the ability of our stockholders to realize
the current  trading price of our common stock.  Moreover,  as all the shares we
issue to the  holders of our  discounted  convertible  debentures  or to Cornell
Capital Partners,  LP will be available for immediate resale,  the mere prospect
of our sales to it could depress the market price for our common stock.

ASSUMING THE DRAWDOWN OF  $11,750,000  ON OUR $15 MILLION  EQUITY LINE OF CREDIT
RESULTING IN THE ISSUANCE OF 419,642,857  SHARES OF OUR COMMON STOCK PURSUANT TO
OUR EQUITY LINE OF CREDIT  FACILITY  AT AN ISSUE PRICE OF $0.028 PER SHARE,  THE
EFFECTIVE  PRICE PAID FOR EACH SHARE WOULD EXCEED THE NET TANGIBLE BOOK VALUE OF
EACH SHARE AS AT JULY 31,  2004 BY  $0.018,  REPRESENTING  A DILUTION  FACTOR OF
35.7%.

           Assuming  the  issuance  of  419,642,857  shares of our common  stock
pursuant to our equity line of credit facility with Cornell Capital Partners, LP
at a discounted  issue price of $0.028 per share,  the effective  price paid for
each share would exceed the net tangible book value of each share as at July 31,
2004 by $0.02, representing a dilution factor of 29.3%. The following table sets
forth the dilution for the common stock that will be issuable based upon the net
tangible  book value  attributable  to each share of our common stock as at July
31, 2004.


<TABLE>
<CAPTION>
<S>                                                                                                <C>               <C>
    Issue price                                                                                                       $0.028(1)
    Net tangible book value before the issue of the common stock(2)                                $0.003
    Increase in net tangible book value attributable to the issue of the common stock               0.015

    Net tangible book value after the issue of the common stock(3)                                                      0.018
                                                                                                                        -----
    Dilution per share                                                                                                  $0.010
                                                                                                                        ======
    Percentage of dilution in relation to the net tangible book value per share prior
    to the issue of the common stock                                                                                    35.7%
</TABLE>


                                       24
<PAGE>


(1) After taking into account the 2% discount that Cornell Capital Partners,  LP
is entitled to receive under the Standby Equity  Distribution  Agreement.  It is
assumed for  illustrative  purposes that the price of our common stock is $0.028
per share at all material times.
(2) As at July 31, 2004.
(3) Represents  aggregate  proceeds from the issue of the common stock, less the
5% fee paid to Cornell Capital Partners, LP.


ASSUMING THE ISSUANCE OF 419,642,857  SHARES OF OUR COMMON STOCK PURSUANT TO OUR
EQUITY LINE OF CREDIT FACILITY, AND ASSUMING THAT THE HOLDERS OF THE CONVERTIBLE
DEBENTURES AND CERTAIN WARRANT HOLDERS CONVERT THEIR  CONVERTIBLE  DEBENTURES OR
EXERCISE THEIR  WARRANTS,  THERE WILL BE SUBSTANTIAL  DILUTION OF YOUR SHARES OF
OUR COMMON STOCK.

           Our  Standby  Equity  Distribution  Agreement  with  Cornell  Capital
Partners,  LP dated May 19, 2004  contemplates the potential future issuance and
sale of up to $15.0 million of our common stock to Cornell Capital Partners, LP,
subject to  certain  restrictions  and other  obligations.  Given our  company's
current  capital  needs and the market price of our common  stock,  we presently
have no intention of drawing down the entire  $15.0  million  amount  unless the
market price of our common stock  increases.  Accordingly,  our  company's  good
faith estimate of the number of shares that we will issue pursuant to the equity
line in addition  to the  82,248,930  shares  previously  issued is  419,642,587
shares. Of this amount, 7,751,070 shares are registered.

           As disclosed above in this section  outlining certain "Risk Factors,"
the holders of the discounted  convertible debentures may ultimately convert the
full amount of the convertible  debentures and exercise all of their outstanding
warrants. They may then sell all of the resulting shares into the public market.
This will  result in dilution to the  interests  of other  holders of our common
stock.

           The following table sets forth the number and percentage of shares of
           our common  stock that would be issuable  if:

           -      the  entire   principal   amount  of  the  discounted  and  8%
                  convertible  debentures of $1,887,798 is converted or redeemed
                  at  $0.28  as a  result  of  an  adjustment  pursuant  to  the
                  anti-dilution  provisions  contained  in  the  debentures  and
                  419,642,857  shares of our common  stock are issued to Cornell
                  Capital Partners,  LP under the equity line of credit facility
                  are issued at $0.028.


                                       25
<PAGE>


<TABLE>
<CAPTION>

---------------------------------------------------------------------------------------------------------------------------------
                                                    NUMBER OF SHARES
                                                      ISSUABLE ON
                                                      CONVERSION/
                                                     REDEMPTION OF
                                                       DISCOUNTED
                               SHARES ISSUABLE TO     CONVERTIBLE      SHARES ISSUED OR
                                 CORNELL CAPITAL   DEBENTURES AND 8%      ISSUABLE ON
   DESCRIPTION OF POSSIBLE     PARTNERS, LP UNDER     CONVERTIBLE         EXERCISE OF                           PERCENTAGE OF
           SCENARIO                EQUITY LINE       DEBENTURES(1)         WARRANTS          TOTAL SHARES        CLASS(2)(3)
---------------------------------------------------------------------------------------------------------------------------------
<S>                            <C>                 <C>                <C>                 <C>                <C>

$11,750,000  IS DRAWN DOWN
UNDER THE EQUITY LINE OF
CREDIT AT A PRICE OF $0.028,
DISCOUNTED AND 8% CONVERTIBLE
DEBENTURES IN THE AGGREGATE
PRINCIPAL AMOUNT OF
$1,887,798 ARE CONVERTED/          419,642,857         67,421,357         14,612,857         501,677,071           69.78%
REDEEMED AT A CONVERSION
PRICE OF $0.028.
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Represents the number of shares  issuable if all of the principal  under all
of the discounted  convertible  debentures and 8%  convertible  debentures  were
converted/redeemed at the indicated conversion price. For ease of reference, any
shares of common stock that may be issued upon  conversion of interest under the
8% convertible  debentures have been excluded.  The outstanding  principal under
the 8%  convertible  debentures  bears  interest  at the  rate of 8% per  annum,
calculated on the basis of a 360-day year.
(2) Based on 217,224,375  common shares issued and  outstanding on September 30,
2004.
(3) Percentage of the total outstanding  common stock represented by 419,642,857
shares that may become  issuable under the equity line of credit  facility,  the
shares  issuable  on   conversion/redemption   of  the  discounted   convertible
debentures and the 8% convertible debentures, and upon exercise of the warrants,
without  regard  to any  contractual  or  other  restriction  on the  number  of
securities the selling stockholders may own at any point in time.

WE REQUIRE  ADDITIONAL  FINANCING  IN ORDER TO  CONTINUE  IN BUSINESS AS A GOING
CONCERN,  THE  AVAILABILITY OF WHICH IS UNCERTAIN.  WE MAY BE FORCED BY BUSINESS
AND ECONOMIC CONDITIONS TO ACCEPT FINANCING TERMS WHICH WILL REQUIRE US TO ISSUE
OUR  SECURITIES  AT A DISCOUNT,  WHICH COULD  RESULT IN FURTHER  DILUTION TO OUR
EXISTING STOCKHOLDERS.

           As discussed under the heading, "Management's Discussion and Analysis
- Liquidity and Capital Resources," we require additional  financing to fund our
operations.  We have taken the steps  necessary to draw down  amounts  under the
$15,000,000  equity line of credit  facility  that we have arranged with Cornell
Capital  Partners,  LP.  However,  business and economic  conditions may make it
unfeasible or  undesirable  for us to draw down amounts under the equity line of
credit at every opportunity,

           In conjunction with our financial advisors, Cornell Capital Partners,
LP., we are pursuing  various  financing  alternatives to meet our immediate and
long-term  financial  requirements.  There can be no assurance  that  additional
financing  will be available to us when needed or, if available,  that it can be
obtained on commercially  reasonable  terms. In addition,  any additional equity
financing may involve  substantial  dilution to our stockholders.  If we fail to
raise  sufficient  financing to meet our immediate cash needs, we will be forced
to scale down or perhaps  even cease the  operation of our  business,  which may
result in the loss of some or all of your investment in our common stock.


                                       26
<PAGE>


           In addition,  in seeking debt or equity private placement  financing,
we may be forced by business and economic  conditions to accept terms which will
require us to issue our  securities  at a discount  from the  prevailing  market
price or face  amount,  which could  result in further  dilution to our existing
stockholders.

OUR STANDBY EQUITY  DISTRIBUTION  AGREEMENT WITH CORNELL  CAPITAL  PARTNERS,  LP
LIMITS THE NUMBER OF SHARES OF COMMON STOCK THAT WE CAN REQUIRE  CORNELL CAPITAL
PARTNERS,  LP TO  PURCHASE  TO NOT  MORE  THAN  9.99%  OF OUR  THEN  ISSUED  AND
OUTSTANDING  SHARES OF COMMON STOCK IN CONNECTION WITH EACH DRAW DOWN, WHICH MAY
FURTHER  LIMIT OUR  ABILITY TO DRAW DOWN  AMOUNTS  THAT WE REQUEST AND WHICH MAY
CAUSE US TO  SIGNIFICANTLY  CURTAIL  THE SCOPE OF OUR  OPERATIONS  AND ALTER OUR
BUSINESS PLAN.

           Our  Standby  Equity  Distribution  Agreement  with  Cornell  Capital
Partners,  LP provides that we may not sell shares of our common stock  pursuant
to our draw down right under the  agreement if the draw down would result in the
issuance of more than 9.99% of our then issued and  outstanding  common stock to
Cornell  Capital  Partners,  LP. For example,  on October 15, 2004,  217,224,375
shares of our common stock were issued and  outstanding.  Assuming that we would
have otherwise been in a position to effect a draw down under the equity line of
credit facility, the 9.99% restriction would have prevented us from selling more
than 21,700,715  shares to Cornell Capital  Partners,  LP at that time. We would
have realized net proceeds from the draw down of approximately  $564,587,  after
deduction of a 2% discount, 5% fee payable to Cornell Capital Partners, LP and a
$500 escrow fee payable to the escrow agent.

           Since trading in stock quoted on the OTC Bulletin Board is often thin
and  characterized  by wide  fluctuations  in trading  prices,  Cornell  Capital
Partners,  LP may have  difficulty  reselling the shares that it purchases under
the Standby Equity Distribution Agreement.  For example, between October 1, 2003
and December 31, 2003,  the average daily trading  volume of our common stock on
the OTC Bulletin Board was 1,418,460 shares,  and the closing price of one share
of our common stock during this period  ranged from $0.179 to $0.265.  This,  in
turn, may require that draw downs be delayed until Cornell Capital Partners,  LP
has sold a sufficient number of shares to stay within the 9.99% restriction.  We
may have to  significantly  curtail  the scope of our  operations  and alter our
business plan if, at the time of any draw down under the equity line, this 9.99%
restriction  results in our  inability  to draw down some or all of the  amounts
requested in any draw down notice.

TRADING  ON THE OTC  BULLETIN  BOARD MAY BE  SPORADIC  BECAUSE IT IS NOT A STOCK
EXCHANGE, AND STOCKHOLDERS MAY HAVE DIFFICULTY RESELLING THEIR SHARES.

           Our  common  stock is quoted on the OTC  Bulletin  Board.  Trading in
stock quoted on the OTC Bulletin Board is often thin and  characterized  by wide
fluctuations in trading  prices,  due to many factors that may have little to do
with the company's operations or business prospects.  Moreover, the OTC Bulletin
Board is not a stock  exchange,  and trading of  securities  on the OTC Bulletin
Board is often more sporadic than the trading of securities listed on the Nasdaq
SmallCap.  Accordingly,  you may have difficulty reselling any of the shares you
purchase from the selling stockholders.  In addition, since our common stock was
traded on the Nasdaq SmallCap  Market until May 28, 2003, past trading  activity
in our common stock should not be relied upon as necessarily being indicative of
future trading activity in our common stock.

WE MAY  POSSIBLY  LACK  SUFFICIENT  AUTHORIZED  SHARES TO FULLY DRAW DOWN ON OUR
EQUITY LINE OF CREDIT FACILITY WITH CORNELL CAPITAL, LP.

           There is a  possibility  that we may not  currently  have  sufficient
authorized  common  stock to fully draw down the equity line of credit  facility
with Cornell Capital, LP, and a proposal may be required to be placed before our
shareholders  to facilitate  an increase in the number of  authorized  shares of
common stock at some point during the twenty-four  month term of our equity line
of credit facility agreement with Cornell Capital, LP.


                                       27
<PAGE>


                        RISKS RELATED TO OUR COMMON STOCK

FUTURE SALES OF OUR COMMON STOCK MAY CAUSE OUR STOCK PRICE TO DECLINE.

           Our stock  price may  decline  by future  sales of our  shares or the
perception  that such sales may occur. If we issue  additional  shares of common
stock in private  financings under an exemption from the registration laws, then
those shares will  constitute  "restricted  shares" as defined in Rule 144 under
the  Securities  Act.  The  restricted  shares  may  only be  sold  if they  are
registered  under  the  Securities  Act,  or sold  under  Rule 144,  or  another
exemption from registration under the Securities Act.

            Some of our outstanding restricted shares of common stock are either
eligible  for  sale  pursuant  to Rule 144 or have  been  registered  under  the
Securities Act for resale by the holders.  We are unable to estimate the amount,
timing,  or  nature  of  future  sales of  outstanding  common  stock.  Sales of
substantial  amounts  of our  common  stock in the  public  market may cause the
stock's market price to decline. See "Description of Securities."

OUR STOCK PRICE CAN BE EXTREMELY VOLATILE.

           Our common stock is traded on the OTC Bulletin Board. There can be no
assurance  that an active public  market will continue for the common stock,  or
that the market  price for the common  stock will not decline  below its current
price. Such price may be influenced by many factors,  including, but not limited
to, investor  perception of us and our industry and general  economic and market
conditions.  The  trading  price of the  common  stock  could be subject to wide
fluctuations in response to  announcements  of our business  developments or our
competitors,  quarterly  variations  in operating  results,  and other events or
factors. In addition, stock markets have experienced extreme price volatility in
recent years. This volatility has had a substantial  effect on the market prices
of companies,  at times for reasons  unrelated to their  operating  performance.
Such broad  market  fluctuations  may  adversely  affect the price of our common
stock.

WE DO NOT EXPECT TO PAY DIVIDENDS.

           We have not paid dividends since  inception on our common stock,  and
we do not contemplate  paying dividends in the foreseeable  future on our common
stock in order to use all of our earnings,  if any, to finance  expansion of our
business plans.

IF WE FAIL TO REMAIN CURRENT ON OUR REPORTING REQUIREMENTS,  WE COULD BE REMOVED
FROM THE OTC BULLETIN BOARD WHICH WOULD LIMIT THE ABILITY OF  BROKER-DEALERS  TO
SELL OUR SECURITIES AND THE ABILITY OF STOCKHOLDERS TO SELL THEIR  SECURITIES IN
THE SECONDARY MARKET.

           Companies  trading on the OTC  Bulletin  Board,  such as us,  must be
reporting  issuers under Section 12 of the  Securities  Exchange Act of 1934, as
amended,  and must be current in their  reports  under  Section  13, in order to
maintain price  quotation  privileges on the OTC Bulletin  Board.  If we fail to
remain current on our reporting  requirements,  we could be removed from the OTC
Bulletin Board. As a result,  the market  liquidity for our securities  could be
severely  adversely  affected by limiting the ability of  broker-dealers to sell
our securities and the ability of stockholders  to sell their  securities in the
secondary market.

OUR  COMMON  STOCK IS  SUBJECT  TO THE  "PENNY  STOCK"  RULES OF THE SEC AND THE
TRADING MARKET IN OUR  SECURITIES IS LIMITED,  WHICH MAKES  TRANSACTIONS  IN OUR
STOCK CUMBERSOME AND MAY REDUCE THE VALUE OF AN INVESTMENT IN OUR STOCK.

           The Securities  and Exchange  Commission has adopted Rule 15g-9 which
establishes the definition of a "penny stock," for the purposes  relevant to us,
as any equity  security  that has a market price of less than $5.00 per share or
with an  exercise  price of less  than  $5.00  per  share,  subject  to  certain
exceptions.  For any  transaction  involving a penny stock,  unless exempt,  the
rules require:

      o     that a broker or dealer approve a person's  account for transactions
            in penny stocks; and

      o     the broker or dealer  receive from the investor a written  agreement
            to the  transaction,  setting forth the identity and quantity of the
            penny stock to be purchased.


                                       28
<PAGE>


           In order to  approve a person's  account  for  transactions  in penny
stocks, the broker or dealer must:

      o     obtain financial information and investment experience objectives of
            the person; and

      o     make a  reasonable  determination  that  the  transactions  in penny
            stocks are  suitable  for that person and the person has  sufficient
            knowledge  and  experience  in  financial  matters  to be capable of
            evaluating the risks of transactions in penny stocks.

           The broker or dealer must also deliver, prior to any transaction in a
penny stock, a disclosure  schedule prescribed by the Commission relating to the
penny stock market, which, in highlight form:

      o     sets  forth  the  basis on  which  the  broker  or  dealer  made the
            suitability determination; and

      o     that the broker or dealer received a signed,  written agreement from
            the investor prior to the transaction.

           Generally,  brokers may be less  willing to execute  transactions  in
securities  subject to the "penny stock" rules.  This may make it more difficult
for  investors  to dispose of our common stock and cause a decline in the market
value of our stock.

           Disclosure  also has to be made about the risks of investing in penny
stocks  in  both  public  offerings  and in  secondary  trading  and  about  the
commissions payable to both the broker-dealer and the registered representative,
current  quotations for the securities and the rights and remedies  available to
an  investor  in cases of fraud in penny stock  transactions.  Finally,  monthly
statements  have to be sent  disclosing  recent price  information for the penny
stock held in the account and information on the limited market in penny stocks.


ITEM 2.    DESCRIPTION OF PROPERTY

           Our  principal  executive  offices are located at #150 - 13151 Vanier
Place,  Richmond,  British Columbia,  V6V 2J1. We leased this 15,364 square foot
facility for a five year term ending August 31, 2005. This facility  consists of
an office and  administration  area,  an  engineering  department,  a  prototype
production facility and a warehouse.

           Our subsidiary,  SmarTire Europe Limited,  leases a 9,069 square foot
facility at Park 34, Didcot, Oxfordshire,  United Kingdom OX11 7WB for a 15 year
term  ending  February  20,  2016.  This  facility  consists  of an  office  and
administration area and a warehousing area.

ITEM 3.    LEGAL PROCEEDINGS

           Subsequent to year end, the Company  defaulted on payments to holders
of its  discounted  convertible  debentures.  As  disclosed  in our 8-K's  filed
between  September 13 and October 1, 2004,  in response to the default,  certain
debenture  holders  filed legal  actions  against the Company.  On September 24,
2004, the Company and holders of the discounted convertible debentures signed an
agreement which provided for:  withdrawal of legal action; an immediate exercise
of 18,226,274  warrants at $0.03 for gross  proceeds of $546,788;  conversion of
$734,389 of debentures into 24,479,630  common shares; a lock-up  provision that
establishes  a daily  limit on the  number of  shares  that can be traded by the
debenture holders.


ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

           There was no matter submitted during the fourth quarter of the fiscal
year  covered  by  this  report  to a vote  of  security  holders,  through  the
solicitation of proxies or otherwise.


                                       29
<PAGE>


PART II

ITEM 5.    MARKET FOR COMMON EQUITY AND RELATED  STOCKHOLDER  MATTERS MARKET FOR
           COMMON STOCK

           Our common stock is quoted on the OTC Bulletin Board under the symbol
"SMTR.OB".

           Until  May 28,  2003,  our  common  stock was  quoted  on the  Nasdaq
SmallCap Market under the symbol "SMTR". The following  quotations obtained from
Canada  Stockwatch  reflect the high and low bids for our common  stock based on
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual  transactions.  The high and low bid prices of our common stock
for the periods indicated below are as follows:

           ----------------------------------------------------------
                   QUARTER ENDED           HIGH             LOW
           ----------------------------------------------------------
                   July 31, 2004          $0.055          $0.052
           ----------------------------------------------------------
                  April 30, 2004          $0.120           $0.106
           ----------------------------------------------------------
                 January 31, 2004         $0.195           $0.185
           ----------------------------------------------------------
                 October 31, 2003         $0.22            $0.215
           ----------------------------------------------------------
                   July 31, 2003          $0.39            $0.135
           ----------------------------------------------------------
                  April 30, 2003          $0.48            $0.07
           ----------------------------------------------------------
                 January 31, 2003         $0.83            $0.31
           ----------------------------------------------------------
                 October 31, 2002         $1.27            $0.38
           ----------------------------------------------------------

           Our common shares are issued in registered  form.  Pacific  Corporate
Trust Company (10th Floor, 625 Howe Street, Vancouver, British Columbia, V6C 3B8
(telephone:  (604)  689-9853,  facsimile  (604)  689-8144) is the  registrar and
transfer agent for our common shares.

           As of October 15,  2004,  we had  217,224,375  shares of common stock
outstanding and approximately 458 stockholders of record.

DIVIDEND POLICY

We have never  declared or paid  dividends  on our common  stock,  and we do not
anticipate  that we will do so in the  foreseeable  future.  We intend to retain
future  earnings,  if any, for use in our  operations  and the  expansion of our
business.

Recent Unregistered Sales of Securities

           On October 14, 2004, we issued  10,714,286 shares of our common stock
to the purchaser in a standby equity facility at a price of $0.028 per share, in
payment of a $300,000  drawdown on the equity line of credit.  We relied on Rule
506 of Regulation D and/or  Section 4(2) of the Securities Act of 1933 to effect
this issuance.

           On October 05, 2004, we issued  12,500,000 shares of our common stock
to the purchaser in a standby equity facility at a price of $0.032 per share, in
payment of a $400,000  drawdown on the equity line of credit.  We relied on Rule
506 of Regulation D and/or  Section 4(2) of the Securities Act of 1933 to effect
this issuance.

           On September  27,  2004,  we issued  12,500,000  shares of our common
stock to the  purchaser  in a standby  equity  facility  at a price of $0.04 per
share, in payment of a $500,000 drawdown on the equity line of credit. We relied
on Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 to
effect this issuance.


                                       30
<PAGE>

           Between  September 22, 2004 and October 4, 2004, we issued 56,833,691
shares  to the  escrow  agent  of the  holders  of  the  discounted  convertible
debentures of which 14,127,787  shares were returned to treasury.  18,226,274 of
these  shares  were issued  pursuant  to the  exercise of warrants at a price of
$0.03 per share and  24,479,630  were issued at an effective  price of $0.03 per
share to repay a portion of the discounted convertible  debenture.  We relied on
section  3(a)(9)  and/or  section 4(2) of the  Securities Act of 1933 in issuing
these shares.

           Between  September  17,  2004  and  September  22,  2004,  we  issued
16,667,667  shares of our  common  stock to the  purchaser  in a standby  equity
facility at a price of $0.03 per share, in payment of a $500,000 drawdown on the
equity line of credit. We relied on Rule 506 of Regulation D and/or Section 4(2)
of the Securities Act of 1933 to effect this issuance.

           On September 8, 2004, we issued  6,756,757 shares of our common stock
to the purchaser in a standby equity facility at a price of $0.037 per share, in
payment of a $250,000  drawdown on the equity line of credit.  We relied on Rule
506 of Regulation D and/or  Section 4(2) of the Securities Act of 1933 to effect
this issuance.

           On August 30, 2004, we issued 6,250,000 shares of our common stock to
the  purchaser in a standby  equity  facility at a price of $0.04 per share,  in
payment of a  $250,000  drawdown  on the  equity  line of credit and 58,824 as a
result of a miscalculation of shares necessary to close the Advance Notice dated
August 13, 2004.  We relied on Rule 506 of  Regulation D and/or  Section 4(2) of
the Securities Act of 1933 to effect this issuance.

           On August 20, 2004, we issued 2,941,176 shares of our common stock to
the  purchaser in a standby  equity  facility at a price of $.051 per share,  in
payment of a $150,000  drawdown on the equity line of credit.  We relied on Rule
506 of Regulation D and/or  Section 4(2) of the Securities Act of 1933 to effect
this issuance.

           On August 9, 2004, we issued  3,000,000 shares of our common stock to
the  purchaser in a standby  equity  facility at a price of $.050 per share,  in
payment of a $150,000  drawdown on the equity line of credit.  We relied on Rule
506 of Regulation D and/or  Section 4(2) of the Securities Act of 1933 to effect
this issuance.

           On July 21, 2004, we issued  4,237,288  shares of our common stock to
the  purchaser in a standby  equity  facility at a price of $.059 per share,  in
payment of a $250,000  drawdown on the equity line of credit.  We relied on Rule
506 of Regulation D and/or  Section 4(2) of the Securities Act of 1933 to effect
this issuance.

           On July 12, 2004, we issued  3,846,154  shares of our common stock to
the  purchaser in a standby  equity  facility at a price of $.065 per share,  in
payment of a $250,000  drawdown on the equity line of credit.  We relied on Rule
506 of Regulation D and/or  Section 4(2) of the Securities Act of 1933 to effect
this issuance.

           On July 1, 2004,  we issued to Hawk  Associates,  Inc.,  a warrant to
purchase  up to 250,000  shares of our  common  stock,  exercisable  at any time
during the five-year  period  ending on June 30, 2009,  at an exercise  price of
$0.20 per share.  We issued these  warrants  pursuant to Rule 506 and/or section
4(2) of the Securities Act of 1933, in partial payment of an engagement fee.

           On June 22, 2004, we issued  2,777,778  shares of our common stock to
the  purchaser in a standby  equity  facility at a price of $.090 per share,  in
payment of a $250,000  drawdown on the equity line of credit.  We relied on Rule
506 of Regulation D and/or  Section 4(2) of the Securities Act of 1933 to effect
this issuance.

           On June 1, 2004, we issued a total of 1,399,676  shares of our common
stock,  at a deemed  issue  price of $0.1040  per share,  to the  holders of the
discounted  convertible debentures (described below), upon exercise of our right
to  effect  payment  of the  first  monthly  redemption  amount  due  under  the
discounted  convertible  debentures in shares of our common stock.  We relied on
section  3(a)(9)  and/or  section 4(2) of the  Securities Act of 1933 in issuing
these shares.


                                       31
<PAGE>

           By conversion  notice effective June 17, 2004, a holder of discounted
convertible   debentures  elected  to  convert  $50,000  outstanding  under  the
convertible  debentures.  In response,  we issued  480,769  shares of our common
stock to the debenture  holder relying on section  3(a)(9) of the Securities Act
of 1933.

           By conversion  notice effective June 14, 2004,  holders of discounted
convertible  debentures  elected  to  convert  $208,000  outstanding  under  the
convertible  debentures.  In response,  we issued 2,000,000 shares of our common
stock to the debentures  holder relying on section 3(a)(9) of the Securities Act
of 1933.

           By  conversion  notice  effective  June  8,  2004,  a  holder  of  8%
convertible debentures (described below) elected to convert $50,000 of principal
and $3,633 in accrued interest outstanding under the convertible debentures.  In
response,  we issued 521,444 shares of our common stock to the debenture  holder
relying on section 3(a)(9) of the Securities Act of 1933. We also issued 192,307
shares of our common stock to the debenture holder relying on section 3(a)(9) of
the  Securities  Act of 1933 that were owed from the April 15,  2004  conversion
notice (described below).

           On May 25, 2004,  we issued  3,509,615  shares of our common stock to
the purchaser in standby  equity  facility at a deemed price of $.104 per share,
in payment of a commitment  fee ($365,000) and 96,154 shares of our common stock
as a  placement  fee  ($10,000) . We relied on Rule 506 of  Regulation  D and/or
Section 4(2) of the Securities Act of 1933 to effect this issuance.

           On May 20, 2004,  1,000,000  warrants  were  exercised at an exercise
price  of $0.12  per  share to a  non-U.S.  person  upon  exercise  of  warrants
previsouly  granted to it. The shares  were  issued in an  offshore  transaction
relying on Regulation S under the Securities Act of 1933.

           On May 19,  2004,  we entered  into a $15.0  million  standby  equity
distribution   agreement  with  Selling  stockholder  relying  on  Rule  506  of
Regulation D and/or Section 4(2) of the Securities Act of 1933. We may draw down
the facility at its  discretion  provided  that each draw down is at least seven
trading  days apart,  and the  maximum  amount that may be drawn down at any one
time is limited to $500,000  and  advance  notice is  required.  The term of the
equity line of credit is 24 months. At the time of draw down against the line of
credit we will issue common shares equal to that amount advanced  divided by 98%
of the lowest bid price on the five  consecutive  days after the date of notice.
On each date of advance of funds,  we are to pay 5%  placement  fee. We may draw
down the facility as the registration statement was deemed effective on June 14,
2004.

           On May 3, 2004,  we issued a total of 1,299,699  shares of our common
stock,  at a deemed  issue  price of $0.112  per  share,  to the  holders of the
discounted  convertible debentures (described below), upon exercise of our right
to  effect  payment  of the  first  monthly  redemption  amount  due  under  the
discounted  convertible  debentures in shares of our common stock.  We relied on
section  3(a)(9)  and/or  section 4(2) of the  Securities Act of 1933 in issuing
these shares.

           On April 30, 2004,  500,000  warrants  were  exercised at an exercise
price of  $0.104  per share to a  non-U.S.  person  upon  exercise  of  warrants
previously  granted to it. The shares  were  issued in an  offshore  transaction
relying on Regulation S under the Securities Act of 1933.

           By  conversion  notice  effective  April  15,  2004,  a holder  of 8%
convertible   debentures  (described  below)  elected  to  convert  $100,000  of
principal  and  $6,067 in accrued  interest  outstanding  under the  convertible
debentures.  In response,  we issued  823,680  shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.

           On April 2, 2004, we issued a total of 1,399,676 shares of our common
stock,  at a deemed  issue  price of $0.1040  per share,  to the  holders of the
discounted  convertible debentures (described below), upon exercise of our right
to  effect  payment  of the  first  monthly  redemption  amount  due  under  the
discounted  convertible  debentures in shares of our common stock.  We relied on
section  3(a)(9)  and/or  section 4(2) of the  Securities Act of 1933 in issuing
these shares.


                                       32
<PAGE>

           On March 2, 2004, we issued a total of 1,033,851 shares of our common
stock,  at a deemed  issue  price of $0.1408  per share,  to the  holders of the
discounted  convertible debentures (described below), upon exercise of our right
to  effect  payment  of the  first  monthly  redemption  amount  due  under  the
discounted  convertible  debentures in shares of our common stock.  We relied on
section  3(a)(9)  and/or  section 4(2) of the  Securities Act of 1933 in issuing
these shares.

           On  February  3,  2004,  we issued a total of  812,045  shares of our
common  stock,  at a deemed  issue  price of $0.1613  per  share,  to six of the
holders  of  the  discounted  convertible  debentures  (described  below),  upon
exercise of our right to effect payment of the first monthly  redemption  amount
due under the discounted  convertible  debentures in shares of our common stock.
We relied on section  3(a)(9)  and/or section 4(2) of the Securities Act of 1933
in issuing these shares.

           By  conversion  notice  effective  January 27,  2004,  a holder of 8%
convertible debentures (described below) elected to convert $84,000 of principal
and $3,621 in accrued interest outstanding under the convertible debentures.  In
response,  we issued 667,331 shares of our common stock to the debenture  holder
relying on section 3(a)(9) of the Securities Act of 1933.

           By  conversion  notice  dated  January  12,  2004,  a  holder  of  8%
convertible   debentures  (described  below)  elected  to  convert  $130,000  of
principal  and  $5,171 in accrued  interest  outstanding  under the  convertible
debentures.  In response,  we issued 1,030,965 shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.

           On December 24,  2003,  we closed a private  placement of  discounted
convertible debentures in the aggregate principal amount of $3,493,590, maturing
April 1, 2006, to seven accredited investors pursuant to Rule 506 and/or section
4(2) of the Securities Act of 1933, for gross proceeds of $2,725,000.  Principal
under each  discounted  convertible  debenture may be converted by the holder in
whole or in part and from time to time at a conversion price of $0.22 per share,
subject to adjustment as set forth in the convertible debentures. The discounted
convertible  debentures  are subject to mandatory  redemption  in equal  monthly
payments.  We may elect to make the monthly redemption payments in shares of our
common stock at a  conversion  price equal to the lesser of (a) the set price of
$0.22 per share (subject to adjustment pursuant to the anti-dilution  provisions
contained  in the  debentures),  and (b) 85% of the  average  of the 20  closing
prices  of  our  common  stock  immediately  preceding  the  applicable  monthly
redemption  date,  provided that certain  conditions are met. In connection with
this private placement, each purchaser of discounted convertible debentures also
received a warrant to purchase  that number of shares of our common  stock equal
to 50% the principal amount of such purchaser's  convertible  debentures divided
by the set  conversion  price  of $0.22  per  share.  Warrants  to  purchase  an
aggregate  total of 7,939,978  shares of our common  stock were issued,  and are
exercisable until December 24, 2006 at an exercise price of $0.25 per share.

           On December 24, 2003, we issued to HPC Capital  Management,  a broker
dealer registered pursuant to section 15 of the Securities Exchange Act of 1934,
a warrant to  purchase  up to 109,000  shares of our common  stock,  exercisable
until  December 24,  2006,  at an exercise  price of $0.25 per share.  We issued
these warrants pursuant to Rule 506 and/or section 4(2) of the Securities Act of
1933,  in partial  payment  of  placement  fee in  connection  with the  private
placement of the discounted convertible debentures.

           On  November  10,  2003,  in  consideration  for their  agreement  to
immediately  exercise a total of  7,478,635  outstanding  warrants  at a reduced
exercise price of $0.1771 per share,  we issued to three of the four  purchasers
of our 7%  convertible  debentures  (described  below),  a  total  of  7,478,635
additional warrants  exercisable for a period of five years at an exercise price
of  $0.1771  per  share.  The  outstanding  warrants  that were  exercised  were
originally issued with an exercise price of $0.2645 per share. We issued a total
of 7,478,635  shares of our common  stock upon the  exercise of the  outstanding
warrants  for  gross  proceeds  of  $1,324,466,  and  the  7,478,635  additional
warrants,  pursuant to Rule 506 and/or  section  4(2) of the  Securities  Act of
1933. Each of the purchasers  represented that it is an "accredited investor" as
defined in Rule 501 of the Securities Act of 1933.


                                       33
<PAGE>

           On  October  27,  2003,  in   consideration   for  its  agreement  to
immediately  exercise a total of  3,290,596  outstanding  warrants  at a reduced
exercise  price of $0.20 per share,  we issued to one of the four  purchasers of
the 7%  convertible  debentures,  Palisades  Master  Fund,  a total of 3,290,596
additional warrants  exercisable for a period of five years at an exercise price
of $0.20 per share. The outstanding warrants that were exercised were originally
issued  with an  exercise  price of  $0.2645  per  share.  We  issued a total of
3,290,596  shares of our  common  stock  upon the  exercise  of the  outstanding
warrants for gross proceeds of $658,119,  and the 3,290,596 additional warrants,
pursuant to Rule 506 and/or  section  4(2) of the  Securities  Act of 1933.  The
purchaser represented that it is an "accredited investor" as defined in Rule 501
of the  Securities  Act of 1933. In light of the reduced  exercise  price of the
additional  warrants issued to the other three warrant holders,  we subsequently
agreed to reduce the exercise price of the 3,290,596  additional warrants issued
to Palisades Master Fund, and the exercise price of 194,000 warrants  previously
issued to HPC Capital  Management,  from $0.20 to $0.1771  per share.  All other
terms of the  warrants,  including  their  expiry  date,  remain  the  same.  In
addition,  we paid $75,354.65 to Palisades Master Fund as an early participation
bonus,  being an amount equal to the difference  between the aggregate  exercise
price  that  Palisades  Master  Fund paid  upon the  exercise  of its  3,290,596
outstanding  warrants at $0.20 per share and the aggregate  exercise  price that
Palisades  Master  Fund would have paid if it had had the benefit of the reduced
exercise price of $0.1771 per share.

           On October 27, 2003, in consideration of its agreement to immediately
exercise  a total of  194,000  outstanding  warrants,  we issued to HPC  Capital
Management,  a broker dealer registered pursuant to section 15 of the Securities
Exchange Act of 1934, a total of 194,000 additional warrants,  exercisable for a
period of five years at an exercise  price of $0.20 per share.  We issued  these
warrants pursuant to Rule 506 and/or section 4(2) of the Securities Act of 1933.
HPC  Capital  Management  represented  that it is an  "accredited  investor"  as
defined in Rule 501 of the Securities Act of 1933.

           By  conversion  notice  dated  October  21,  2003,  a  holder  of  8%
convertible debentures (described below) elected to convert $75,000 of principal
and $1,600 in accrued interest outstanding under the convertible debentures.  In
response,  we issued 585,525 shares of our common stock to the debenture  holder
relying on section 3(a)(9) of the Securities Act of 1933.

           By  conversion  notice  dated  October  10,  2003,  a  holder  of  7%
convertible debentures (described below) elected to convert $66,667 of principal
and $1,503 in accrued interest outstanding under the convertible debentures.  In
response,  we issued 522,626 shares of our common stock to the debenture  holder
relying on section 3(a)(9) of the Securities Act of 1933.

           By  conversion   notice  dated  October  9,  2003,  a  holder  of  8%
convertible   debentures  (described  below)  elected  to  convert  $300,000  of
principal  and  $5,333 in accrued  interest  outstanding  under the  convertible
debentures.  In response,  we issued 2,343,623 shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.

           By  conversion   notice  dated  October  6,  2003,  a  holder  of  8%
convertible   debentures  (described  below)  elected  to  convert  $156,000  of
principal  and  $2,808 in accrued  interest  outstanding  under the  convertible
debentures.  In response,  we issued 1,219,366 shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.

           By  conversion   notice  dated  October  3,  2003,  a  holder  of  7%
convertible   debentures  (described  below)  elected  to  convert  $100,000  of
principal  and  $2,119 in accrued  interest  outstanding  under the  convertible
debentures.  In response,  we issued  784,164  shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933

           By  conversion   notice  dated  October  1,  2003,  a  holder  of  8%
convertible   debentures  (described  below)  elected  to  convert  $200,000  of
principal  and  $3,778 in accrued  interest  outstanding  under the  convertible
debentures.  In response,  we issued 1,562,763 shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.


                                       34
<PAGE>

           By  conversion  notice  dated  September  24,  2003,  a holder  of 8%
convertible   debentures  (described  below)  elected  to  convert  $100,000  of
principal  and  $2,061 in accrued  interest  outstanding  under the  convertible
debentures.  In response,  we issued  783,930  shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.

           By  conversion  notice  dated  September  10,  2003,  a holder  of 7%
convertible   debentures  (described  below)  elected  to  convert  $130,000  of
principal  and  $1,560 in accrued  interest  outstanding  under the  convertible
debentures.  In response,  we issued 1,010,612 shares of our common stock to the
debenture holder relying on section 3(a)(9) of the Securities Act of 1933.

           By conversion notices dated September 9, 2003 and September 10, 2003,
a holder of 7%  convertible  debentures  (described  below)  elected  to convert
$70,000  and  $50,000  of  principal  and  $840  and  $611 in  accrued  interest
outstanding  under the convertible  debentures.  In response,  we issued 932,769
shares of our common stock to the debenture holder relying on section 3(a)(9) of
the Securities Act of 1933.

           By  conversion   notice  dated  August  27,  2003,  a  holder  of  7%
convertible debentures (described below) elected to convert $80,000 of principal
and $764 in accrued interest  outstanding under the convertible  debentures.  In
response,  we issued 620,694 shares of our common stock to the debenture  holder
relying on section 3(a)(9) of the Securities Act of 1933.

           On August 15, 2003,  we issued to Epoch  Financial  Group,  Inc.,  an
accredited  investor,  a warrant to purchase up to 300,000  shares of our common
stock,  exercisable at any time during the five-year period ending on August 15,
2008, at an exercise price of $0.17 per share. We issued these warrants pursuant
to Rule 506  and/or  section  4(2) of the  Securities  Act of 1933,  in  partial
payment of an engagement fee.

           On August 14,  2003,  we issued to HPC Capital  Management,  a broker
dealer registered pursuant to section 15 of the Securities Exchange Act of 1934,
a total of 200,000 fully-paid and non-assessable shares of our common stock at a
deemed price of $0.17 per share.  We issued  these  shares  pursuant to Rule 506
and/or  section 4(2) of the  Securities  Act of 1933,  in partial  payment of an
engagement fee.

ITEM 6.    MANAGEMENT'S DISCUSSION AND ANALYSIS

           The  following  discussion  of our  financial  condition,  changes in
financial  condition and results of  operations  for the fiscal years ended July
31, 2004, 2003 and 2002,  should be read in conjunction  with the audited annual
financial statements and the notes thereto.

           Our  consolidated  financial  statements  are stated in United States
Dollars and are prepared in  accordance  with United States  Generally  Accepted
Accounting Principles.

RESULTS OF OPERATIONS

FISCAL YEAR ENDED JULY 31, 2004 VS. FISCAL YEAR ENDED JULY 31, 2003

Revenue

           Gross  revenue for the fiscal year ended July 31, 2004  decreased  to
$1,658,279  from  $1,802,596  for our  fiscal  year ended  July 31,  2003.  This
decrease in revenue was a result of the following:

o     Sales of aftermarket passenger car tire monitoring systems (TMS) decreased
      to $1,087,395 for fiscal 2004 from $1,141,210 for fiscal 2003.

o     Sales of original  equipment  manufacturer  ("OEM")  passenger car systems
      decreased to $166,202 for fiscal 2004 from $174,880 for fiscal 2003.


                                       35
<PAGE>

o     Sales of aftermarket  motorcycle  systems  decreased to $37,744 for fiscal
      2004  compared to $183,589  for fiscal  2003.  We  recently  introduced  a
      substantially   improved  second   generation   motorcycle  tire  pressure
      monitoring  system (TPMS) at the Indy  Motorcycle  Dealers  Show,  held in
      Indianapolis,  Indiana in mid-February  2004. During May 2004 this product
      became  commercially  available and we began shipping it to our customers.
      In August 2004, we discovered that the sensor/transmitter may break during
      installation  on the subset of  motorcycle  rims with curved rim  surfaces
      when the strap is torqued to its required  value. On September 14, 2004 we
      contacted  the  National  Highway   Transportation  Safety  Administration
      (NHTSA) to  determine  if a Safety  Defect and Non  Compliance  Report was
      required  and was  advised  that this was  necessary.  Our  remedy for the
      defect was to recall  100% of affected  sensor/transmitter  items from the
      field and replace both  recalled and  inventory  sensor/transmitters  with
      sensor/transmitters  previously  manufactured by a different supplier that
      have been  tested and known to use  plastics  that  provide  the  required
      mechanical  properties.  Additionally to ensure that transmitters are used
      only on rims with flat drop center wells (as originally  designed for) and
      not curved, the additional precautionary steps were taken:

      o     Adding  improved  warnings and  instruction  sheet to new product as
            well as  product  in  inventory  at dealers  and  distributors  that
            clarify flat rim drop center well application only

      o     Removal of tire pressure  monitoring  system  (TPMS) on  motorcycles
            with rims with curved drop center wells

            We  anticipate  the cost of this  recall will be  approximately  $US
            67,000.  In  addition,  we are  currently  working on a solution  to
            enable  us to sell our tire  pressure  monitoring  system  (TPMS) on
            motorcycles  with rims with curved drop center wells.  To date,  the
            response  to the  recall by our  customers  has been very  positive.
            Although  interest  in  the  motorcycle   product  by  existing  and
            potential  customers  remains  positive,  it is difficult  for us to
            predict  what the  volume  of sales  will be,  as this  will  depend
            primarily on market acceptance.

o     Sales of aftermarket recreational vehicle systems were $118,357 for fiscal
      2004 compared to $26,383 for fiscal 2003. These sales include sales of our
      high pressure  transmitters  that were released in our fourth  quarter and
      sales of low pressure  sensors to monitor the wheels of a towed vehicle or
      trailer that was  introduced  during our first  quarter  ended October 31,
      2003.

o     Sales of OEM  recreational  vehicle  systems were $64,454 for fiscal 2004.
      The  majority of these  sales  occurred  in the fourth  quarter  after the
      release our high pressure transmitters. Although it is difficult for us to
      predict  what the volume of sales  will be, we  anticipate  a  substantial
      increase in sales during the next fiscal year.

o     Sales of  aftermarket  high pressure  monitoring  systems for use on buses
      were  $42,406 for fiscal 2004.  All of these sales  occurred in our fourth
      quarter after the release our high pressure  transmitters.  Although it is
      difficult  for us to  predict  what  the  volume  of  sales  will  be,  we
      anticipate a substantial increase in sales during the next fiscal year.

o     Sales  of  aftermarket  high  pressure   monitoring  systems  for  use  on
      commercial  vehicles were $22,733 for fiscal 2004. Our customers purchased
      these  systems in the fourth  quarter  after the release our high pressure
      transmitters.  The majority of these systems are currently  being used for
      test purposes.  Although it is difficult for us to predict what the volume
      of sales will be, we anticipate a substantial increase in sales during the
      next fiscal year.

o     Sales of off-the-road (OTR) tire monitoring systems were $1,088 for fiscal
      2004  compared to $58,395 for fiscal  2003.  Our  off-the-road  (OTR) tire
      pressure monitoring system (TPMS) utilizes a high-pressure transmitter and
      is designed primarily for off-the-road (OTR) heavy industrial applications
      and commercial  applications.  The system may potentially be used not only
      on large mining trucks, but also heavy mobile equipment (such as tractors,
      wheeled loaders,  graders and the like).  Sales of our off-the-road  (OTR)
      tire  monitoring  systems to date have been limited to those systems which
      are  designed  for use on  large  mining  trucks.  We  anticipate  that an
      increase  in  sales  of this  product  in  fiscal  2005  now  that we have
      successfully completed  commercializing the wireless gateway receiver that
      has been developed with Vansco.


                                       36
<PAGE>

o     Revenue of $94,800  was  recorded  for  engineering  changes to modify our
      products  pursuant  to our  Manufacturing,  Co-Marketing  and  Development
      Agreement  with  Hyundai  Autonet  Co. Ltd.  for fiscal  2004  compared to
      $173,400 for the fiscal 2003.  Revenue is determined by the  percentage of
      completion method.

o     Sales of the motorsport  tire  monitoring  systems (TMS) decreased to $nil
      for fiscal 2004 from $44,739 for fiscal 2003.  As indicated  above,  we do
      not anticipate  further sales of our motorsport  tire  monitoring  systems
      (TMS) as our exclusive motorsport  distributor,  Pi Research of Cambridge,
      England,  now manufactures and markets their own system.  Accordingly,  we
      have  discontinued  production of our motorsport tire  monitoring  systems
      (TMS).

o     Sales of  miscellaneous  products were $23,100 for fiscal 2004 compared to
      $nil for fiscal 2003.

           The  miscellaneous  products that accounted for $23,100 during fiscal
2004 consisted primarily of dataloggers, which are used to facilitate testing by
our OEM customers.

           On September 10, 2004 the NHTSA's  (National  Highway  Traffic Safety
Administration)  issued a Notice of Proposed Rulemaking (NPRM) document defining
their current position.  Comments on the proposed Rulemaking must be received on
or  before  60 days  after  date of  publication  (of the  NRPM) in the  Federal
Register.  NHTSA  is  proposing  a new  FMVSS (Federal  Motor  Vehicle  Safety
Standards) requirement for four tire, 25-percent  under-inflation detection. The
rule  proposes  requirements  for  covered  vehicles  manufactured  on or  after
September 1, 2005. NHTSA is proposing the following phase in schedule:

o     50 percent of a vehicle manufacturer's light vehicles would be required to
      comply  with the  standard  during  the first year  (September  1, 2005 to
      August 31, 2006);

o     90 percent during the second year (September 1, 2006 to August 31, 2007);

o     all light vehicles thereafter.

NHTSA is also proposing the following:

o     to require vehicle  manufacturers to assure compliance with FMVSS 138 with
      the tires installed on the vehicle at the time of the initial sale;

o     to require  the TPMS to be equipped  with a telltale  that would alert the
      driver of a TPMS malfunction.  The malfunction  warning be provided either
      through a separate,  dedicated  telltale or through a distinctive  warning
      delivered by the low pressure telltale

o     the use of a specific  test course  (i.e.,  the Southern loop of the tread
      wear  test  course,  San  Angelo,  Texas)  which  is  both  objective  and
      representative of a range of driving conditions;

o     the TPMS would be required  to warn the driver  when the tire  pressure in
      one or more of the  vehicle's  tires,  up to a total of four tires,  is 25
      percent  or  more  below  the  vehicle  manufacturer's   recommended  cold
      inflation  pressure for the tire, or a minimum level of pressure specified
      in the standard, whichever pressure is higher

o     vehicle  manufacturers  would be  required to certify  vehicle  compliance
      under the standard with the tires  installed on the vehicle at the time of
      the initial vehicle sale;

o     the TPMS would be required to include a low tire pressure warning telltale
      (Yellow)  that must  remain  illuminated  as long as any of the  vehicle's
      tires remains  significantly  under  inflated and the  vehicle's  ignition
      locking  system is in the "On"  ("Run")  position.  The  telltale  must be
      extinguished  when all of the  vehicle's  tires cease to be  significantly
      under  inflated.  The TPMS's low tire pressure  warning  telltale would be
      required to perform a bulb-check at vehicle startup;

o     the TPMS also would be  required  to include a  malfunction  indicator  to
      alert the driver  when the system is  non-operational,  and thus unable to
      provide the  required low pressure  warning.  NHTSA is proposing  that the
      malfunction would be indicated by either (1) separate  dedicated  telltale
      (Yellow) or (2) designing the low pressure telltale so that it flashes for
      one minute when a  malfunction  is detected  after which the telltale will
      remain  illuminated as long as the ignition  locking system is in the "On"
      ("Run")  position.  This  flashing  and  illumination  sequence  would  be
      repeated  upon each  subsequent  vehicle  start up until the situation has
      been corrected


                                       37
<PAGE>

o     the TPMS would not be  required  to monitor  the spare tire (if  provided)
      either when it is stowed or when it is installed on the vehicle;

o     For vehicle's certified under the standard, vehicle manufacturers would be
      required to provide in the owners manual an  explanation of the purpose of
      the low tire pressure  warning  telltale,  the potential  consequences  of
      significantly under-inflated tires, the meaning of the telltale when it is
      illuminated,  and what action the driver  should take when the telltale is
      illuminated.

           To  encourage  early   compliance,   NHTSA  is  proposing  to  permit
carry-forward  credits for vehicles  that are  certified  as complying  with the
standard and that are  manufactured  on or after the effective date of the final
rule.  However,  beginning  September  1,  2007 all  covered  vehicles  would be
required  to comply  with the  standard,  without  regard to any  earlier  carry
forward credits. It will not be permissible for dealer to install tires on a new
vehicle that would take the vehicle out of  compliance  with the TPMS  standard.
NHTSA is proposing to permit vehicle  manufactures to incorporate a second,  red
light to accompany the  continuously  illuminated  yellow TPMS  telltale,  which
would be  illuminated  when  pressure in one or more tires  becomes  dangerously
under-inflated,  as determined by the  manufacturer.  It will be  permissible to
incorporate the TPMS telltale as part of a reconfigurable display, provided that
the  illumination of the yellow  telltale is continuous  while one or more tires
are under-inflated.  NHTSA will retain their discretion  regarding how they will
structure phase in requirements for small volume manufacturers (5000 vehicles or
less for North American  Market) and will make such  determination  on a case by
case  basis.  OEM's are free to select a low  pressure  alert  level at a higher
level than the 25 percent below placard.

           Our direct  measurement  tire monitoring  systems (TMS) products meet
the standard for tire pressure monitoring established by NHTSA. Accordingly,  we
believe the auto  manufacturers  must accelerate their  implementation  plans in
order to meet these new NHTSA  which will  create  additional  opportunities  to
market our products to OEMs in the automobile  industry.  In addition,  although
the TREAD Act only applies to passenger automobiles, we believe that other motor
vehicles,  including  medium and heavy  trucks,  buses and  motorcycles  will be
impacted  by  this  legislation  in  subsequent  years.  We  also  believe  that
compliance  with  the  TREAD  Act  by  European,  Japanese,  Chinese  and  other
automakers  will  accelerate  the  adoption  of tire  monitoring  systems  (TMS)
globally.

           It is  difficult  to predict  the  magnitude  of the  expected  sales
increase or the exact timing of the increase since our products will continue to
face  competition from other tire monitoring  systems (TMS)  manufactured by our
competitors,  and the  timing  of  additional  legislative  initiatives  on tire
safety,  if  any,  in the  United  States  and  abroad  remains  uncertain.  Our
management  expects that,  as tire  monitoring  systems  (TMS) becomes  standard
equipment for new passenger  vehicles,  demand for tire monitoring systems (TMS)
as dealer installed options and aftermarket products will gradually decline.

           Our  current  strategy  involves  generating  revenue  from  products
available to meet today's demand for dealer  installed  options and  aftermarket
products combined with the pursuit of OEM business.  However, the pursuit of OEM
business  will  involve new  challenges  for  management,  including  overcoming
existing  relationships  that certain of our  competitors  currently  enjoy with
automakers.

Gross Margin

           Gross margin on product sales decreased to 12.8% for fiscal 2004 from
23% for fiscal 2003. The decrease occurred due to the following factors:

      1)    our product  mix of systems  sold in the fiscal 2004 had lower gross
            margins than the product mix of systems sold in the fiscal 2003;

      2)    our provision for our  motorcycle  recall  (discussed  above) in the
            amount of $66,801 decreased our fiscal 2004 margin by 4%;

During our third  quarter,  we shifted the majority of our production to Hyundai
Autonet, and as we expected,  our gross margin increased in our third and fourth
quarters,  after excluding the cost of the motorcycle recall. Although we expect
that our  gross  margin  will  continue  to  increase  in fiscal  2005,  this is
dependent on the cost of components and the sales contracts that we enter into.


                                       38
<PAGE>

Expenses

           Expenses  increased to $7,186,287 for fiscal 2004 from $6,802,391 for
fiscal 2003, as increases in marketing,  engineering,  research and  development
expenses and depreciation  and amortization  were partially offset by a decrease
in general and administration expenses.

           Engineering,   research  and   development   expenses   increased  to
$1,654,690 for fiscal 2004 from  $1,177,935  for fiscal 2003.  This increase was
primarily  attributed  to an  increase in  prototype  development  expenses,  an
increase  in product  testing on products  that we have  released in the current
fiscal year, an increase in the number of patents and approval applications, and
an  increase  in the number of  engineering  employees  and  engineering-related
wages.

           Marketing  expenses  increased  to  $1,821,122  for fiscal  2004 from
$1,448,326  for fiscal 2003.  The increase was primarily a result of an increase
in travel and higher marketing-related wages, which increased as a result of the
recruitment of a V.P. of Sales and Marketing. This increase was partially offset
by lower tradeshow expenditures. Trade show expenses in fiscal 2003 included the
cost of  attending  the  Automechanika  show,  which is held in Europe every two
years.  Fiscal 2003 also included  expenses of $130,000 in  connection  with the
termination of a management agreement;  50% of this amount or $65,000 was booked
as marketing expenses and 50% was booked as general and administrative expenses.

           General and  administrative  expenses  decreased  to  $2,338,758  for
fiscal  2004 from  $2,939,260  for  fiscal  2003.  The  decrease  was  primarily
attributed   to  lower   professional   fees,   investor   relation   costs  and
administration  wages.  Professional fees for fiscal 2003 included an expense of
$315,044 to settle certain potential  unquantified  claims threatened by certain
offshore investors against our Company.  Administrative wages decreased as there
were less  administrative  employees  during fiscal 2004 and as explained above,
our general and  administrative  expenses  for year ended July 31, 2003  include
$65,000 that was incurred in  connection  with the  termination  of a management
contract. The decrease was partially offset by an increase in insurance costs.

           Depreciation  and  amortization  expense  increased to $1,371,717 for
fiscal 2004 from  $1,236,870  for fiscal  2003.  Depreciation  and  amortization
expense  is  expected  to  remain at  approximately  its  current  level for the
foreseeable future.

           Interest and finance charges  increased to $4,031,820 for fiscal 2004
from $3,722,505 for fiscal 2003. The charges for fiscal 2004 included $3,302,272
in interest and finance charges on our 7% and 8% convertible debentures, and our
discounted convertible debentures,  $262,965 related to the issuance of our $15M
equity line of credit with Talisman  Management  Limited which we do not plan to
use,  $179,917 related to the issuance of promissory notes totaling  $1,500,000,
plus a payment in November 2003 of $75,355 paid to Palisades  Master Fund,  L.P.
as an early participation bonus. As discussed below under the heading "Liquidity
and  Capital  Resources,"  on October  27,  2003,  in order to  encourage  early
exercise  of certain  outstanding  warrants by  Palisades  Master Fund and three
additional  warrant holders,  we offered to reduce the exercise price of a total
of  10,769,231  outstanding  warrants from $0.2645 per share to $0.20 per share.
Palisades  Master Fund elected to accept our offer,  but on November 6, 2003, in
order to encourage early exercise of the warrants by the remaining three warrant
holders,  we offered to reduce the  exercise  price of the  remaining  7,478,635
warrants from $0.2645 per share to $0.1771 per share. As a result,  we agreed to
pay the $75,355 early  participation  bonus to Palisades  Master Fund,  being an
amount  equal to the  difference  between  the  aggregate  exercise  price  that
Palisades Master Fund paid upon the exercise of 3,290,596  outstanding  warrants
at $0.20 per share and the aggregate  exercise price that Palisades  Master Fund
would have paid if it had the benefit of the reduced  exercise  price of $0.1771
per  share.  The fair  value of the early  participation  bonus is  included  in
interest expense.

           Interest  and finance  charges of  $3,722,505  were  incurred  during
fiscal 2003, including $3,720,250 in interest and finance charges on 10%, 5%, 7%
and 8% redeemable convertible debentures, a 12% promissory note and a $5 million
equity line of credit issued during fiscal 2003.  The $5 million  equity line of
credit was terminated on July 22, 2004.


                                       39
<PAGE>

Interest Income

           Interest  income of $5,873 was earned for fiscal  2004 as compared to
$2,835 for fiscal 2003.  This increase was due to slightly  higher  average cash
balances maintained during fiscal 2004.

Foreign exchange gain

           A foreign  exchange  gain of $12,492  was  earned for fiscal  2004 as
compared to $192,201 for fiscal 2003.  Foreign  exchange gains or losses are due
to fluctuations in currency exchange rates and are impossible to predict.

FISCAL YEAR ENDED JULY 31, 2003 VS. FISCAL YEAR ENDED JULY 31, 2002

Revenue

           Gross  revenue for the fiscal year ended July 30, 2003  increased  to
$1,802,596  from  $1,012,344  for the  fiscal  year ended  July 31,  2002.  This
increase in revenue was a result of the following:

o     Sales of aftermarket passenger car tire monitoring systems (TMS) increased
      to $1,141,210 for fiscal 2003 from $791,217 for fiscal 2002.

o     Sales of original equipment  manufacturer  ("OEM") - passenger car systems
      increased  to $174,880  for fiscal  2003 from  $164,588  for fiscal  2002.
      Fiscal 2002 included  sales under the Lincoln  Continental  program of our
      first generation  product that were  discontinued by Ford Motor Company at
      the end of  December  31,  2001.  Without  the sales of $43,711  under the
      Lincoln  Continental  program for fiscal 2002, sales for fiscal 2002 would
      have been $120,847.

o     Sales of motorcycle tire monitoring systems (TMS) were $183,589 for fiscal
      2003 compared to $nil for fiscal 2002.

o     Sales of "off-the-road"  tire monitoring systems (TMS) designed for mining
      vehicle  applications  were  $58,395 for fiscal 2003  compared to $nil for
      fiscal 2002. These tire monitoring systems (TMS) are currently  undergoing
      on-vehicle validation.

o     Revenue of $173,400  was recorded  for  engineering  changes to modify our
      products  pursuant  to our  Manufacturing,  Co-Marketing  and  Development
      Agreement  with Hyundai  Autonet Co. Ltd. for fiscal 2003 compared to $nil
      for the fiscal 2002. Revenue is determined by the percentage of completion
      method.

o     Sales of the motorsport tire monitoring systems (TMS) decreased to $44,739
      for fiscal 2003 from $56,539 for fiscal 2002.  As indicated  above,  we do
      not anticipate  further sales of our motorsport  tire  monitoring  systems
      (TMS) as our exclusive motorsport  distributor,  Pi Research of Cambridge,
      England,  now manufactures and markets their own system.  Accordingly,  we
      have  discontinued  production of our motorsport tire  monitoring  systems
      (TMS).

o     Sales of  recreational  vehicle  products  were  $26,383  for fiscal  2003
      compared to $nil for fiscal 2002.

Gross Margin

           Gross margin on product  sales  decreased to 23% for fiscal 2003 from
31% for fiscal 2002. The decrease occurred as the product mix of systems sold in
fiscal 2003 had lower  gross  margins  than the  product mix of systems  sold in
fiscal 2002.  The gross  margins  continued  to be affected by the  reduction in
carrying value of first generation product inventory in the 1999 fiscal year.


                                       40
<PAGE>

Expenses

           Expenses  decreased to $6,802,391 for fiscal 2003 from $7,038,843 for
fiscal 2002, as a result of decreases in  engineering,  research and development
expenses and  marketing  expenses.  Reductions in these  expenses  (discussed in
greater detail below) were partially offset by higher general and administration
expenses and depreciation and amortization expenses.

           Engineering,   research  and   development   expenses   decreased  to
$1,177,935  for  fiscal  2003  from  $1,727,606  for  fiscal  2002.  The  higher
engineering, research and development expenses for fiscal 2002 were attributable
primarily  to a  $500,000  expenditure  for  non-recoverable  development  costs
incurred with a key component supplier for future product development activities
in that fiscal year. This expenditure was a one-time expense with this supplier.
The  nature  of our  activities  could  result  in  other  future  non-recurring
engineering,  research  and  development  expenditures.  A decrease in prototype
development  expenses,  lower travel costs and lower expenditures on patents and
approvals  also  contributed  to  the  decrease  in  engineering,  research  and
development  expenses  between fiscal 2002 and fiscal 2003,  although these cost
savings were partially offset by an increase in engineering-related-wages due to
an increase in the number of engineering employees.

           Marketing  expenses  decreased  to  $1,448,326  for fiscal  2003 from
$1,527,644  for fiscal 2002.  This decrease was mainly due to lower  advertising
and promotion costs, as well as lower travel costs.  This decrease was partially
offset by higher marketing-related wages and tradeshow expenditures.  Wages were
higher as we incurred expenses of $130,000 in connection with the termination of
a  management  agreement;  50% of this  amount,  or $65,000,  is included in the
marketing  expenses  for  fiscal  2003,  and 50% was  included  in  general  and
administrative  expenses  for the  year.  The  balance  of the  increase  in our
marketing  expenses was a result of trade show  expenses,  including the cost of
attending the Automechanika show, which is held in Europe every two years.

           General and  administrative  expenses  increased  to  $2,939,260  for
fiscal 2003 from  $2,631,215 for fiscal 2002. The increase is attributable to an
increase in professional fees, filing fees, insurance premiums and an expense of
$315,044 to settle certain potential  unquantified  claims threatened by certain
offshore investors against our Company.  Professional fees increased as a result
of filing registration  statements with the Securities and Exchange  Commission.
As explained above, general and administrative expenses include $65,000 that was
incurred in  connection  with the  termination  of a  management  contract.  The
increase was partially offset by lower travel and capital expenses.

           Depreciation  and  amortization  expense  increased to $1,236,870 for
fiscal 2003 from  $1,152,378  for fiscal  2002.  Depreciation  and  amortization
expense  is  expected  to  remain at  approximately  its  current  level for the
foreseeable future.

           Interest  and finance  charges of  $3,722,505  were  incurred  during
fiscal 2003, including $3,720,250 in interest and finance charges on 10%, 5%, 7%
and 8% redeemable convertible debentures, a 12% promissory note and a $5 million
equity line of credit issued during fiscal 2003.

Interest Income

           Interest  income of $2,835 was earned for fiscal  2003 as compared to
$18,735 for fiscal 2002.  This  decrease was due to lower  average cash balances
maintained and lower interest rates during fiscal 2003.

Foreign exchange gain

           A foreign  exchange  gain of  $192,201  was earned for fiscal 2003 as
compared to $24,015 for fiscal  2002.  The  increase  was  primarily  due to the
decrease in the value of the US dollar  against the Canadian  dollar  during the
year,  which  resulted in foreign  exchange gains on the settlement of US dollar
liabilities outstanding at July 31, 2002 during fiscal 2003.


                                       41
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

CURRENT POSITION

           We have  continued to finance our  activities  primarily  through the
issuance and sale of securities. We have incurred losses from operations in each
year since  inception.  As at July 31, 2004,  we had an  accumulated  deficit of
$59,018,256. Our net loss for fiscal 2004 was $10,987,026 compared to $9,914,629
for fiscal 2003. As of July 31, 2004,  our  stockholders'  equity was $3,466,216
and we had working capital of $732,405.

           Our cash  position  at July 31,  2004 was  $112,951  as  compared  to
$1,843,694 at July 31, 2003.  This decrease was due to the net decrease from our
operating, financing and investing activities as described below.

           Our net loss of $10,987,026 for fiscal 2004 includes non-cash charges
of $1,371,717 for  depreciation  and  amortization,  $3,842,107 for interest and
finance  expense  and  $98,175  for shares  and  warrants  issued  for  services
received.  Decreases in non-cash  working capital during this period amounted to
$1,860,812. Non-cash working capital changes included increases in inventory and
prepaid  expenses and a decrease in receivables and accounts payable and accrued
liabilities.  An increase in  inventory  of  $2,391,749  accounted  for the most
significant use of cash for working capital.  This increase was primarily due to
the procurement of components for production builds at Hyundai Autonet.

During fiscal 2004, we realized aggregate gross cash proceeds of $7,170,265 from
financing activities as follows:

           On October 27, 2003, in order to encourage  early exercise of a total
of  10,769,231   warrants  issued  to  the  purchasers  of  our  7%  convertible
debentures, we offered to reduce the exercise price of the warrants from $0.2645
per share to $0.20 per share.  The offer was open for  acceptance by the warrant
holders  until  November  4, 2003.  In  consideration  of the  warrant  holders'
agreement to immediately exercise their respective warrants, we offered to issue
to the  participating  warrant  holders one additional  warrant for each warrant
that was exercised.  One of the warrant  holders,  Palisades  Master Fund,  L.P.
accepted our offer and  exercised a total of 3,290,596  outstanding  warrants at
the reduced  exercise price of $0.20 per share. On October 27, 2003, we issued a
total of 3,290,596  five-year warrants to Palisades Master Fund,  exercisable at
an exercise  price of $0.20 per share,  resulting in gross proceeds of $658,119.
The additional  warrants were to be exercisable for a period of five years at an
exercise price of $0.20 per share.

           On October  27,  2003,  our  former  investment  banker  HPC  Capital
Management, also agreed to immediately exercise 194,000 outstanding common stock
purchase  warrants  dated  May 16,  2003,  in  consideration  of  receiving  one
additional  five-year warrant with an exercise price of $0.20 per share for each
warrant  so  exercised.  Of  the  194,000  warrants  exercised  by  HPC  Capital
Management under this  arrangement,  180,000 were exercised at an exercise price
of US$0.13 per share and 14,000 were  exercised at an exercise  price of US$0.10
per share, resulting in gross proceeds of $24,800.

           On  November 6, 2003,  in order to  encourage  early  exercise of the
warrants  by the  remaining  three  warrant  holders,  we  offered to reduce the
exercise  price of the  remaining  7,478,635  warrants from $0.2645 per share to
$0.1771 per share.  The offer was open for  acceptance  by the  warrant  holders
until November 19, 2003. In consideration  of the warrant holders'  agreement to
immediately  exercise  their  respective  warrants,  we  offered to issue to the
participating  warrant  holders one additional  warrant for each warrant that is
exercised. The additional warrants are exercisable for a period of five years at
an exercise price of $0.1771 per share.

           On November 10, 2003, all of the remaining warrant holders,  Crescent
International Ltd., Alpha Capital AG and Goldplate Investment Partners, accepted
our offer and exercised a total of 7,478,635 outstanding warrants at the reduced
exercise price of $0.1771 per share.


                                       42
<PAGE>

           On December 24,  2003,  we closed a private  placement of  discounted
unsecured   convertible   debentures  in  the  aggregate   principal  amount  of
$3,493,590.  We  issued  the  convertible  debentures  at a 22%  original  issue
discount from the face  principal  amount (based on a notional  interest rate of
11% per annum for each year of the two-year term of the  debentures),  resulting
in gross  proceeds  of  $2,725,000,  before the  deduction  of a  $218,000  cash
placement fee subsequently paid to HPC Capital  Management and other expenses of
the offering.  The  discounted  convertible  debentures  do not  otherwise  bear
interest,  and will mature on April 1, 2006. The outstanding principal amount of
each debenture may be converted at any time into shares of our common stock,  in
whole or in part, at the option of the holder of the debenture at a set price of
$0.22 per share. The discounted  convertible debentures are subject to mandatory
redemption in equal monthly payments,  payable in cash. We may elect to make the
monthly redemption  payments in shares of our common stock at a conversion price
equal to the lesser of:

           (a) the set price of $0.22 per share (subject to adjustment  pursuant
           to the anti-dilution provisions contained in the debentures), and

           (b) 85% of the average of the closing prices of the Company's  common
           stock for twenty days  immediately  preceding the applicable  monthly
           redemption date,  provided that certain conditions are met, including
           the condition that the  underlying  shares of common stock shall have
           been registered under the Securities Act of 1933, as amended.

           On  February  5, 2004,  we  notified  the  holders of the  discounted
convertible  debentures  that  we  had  elected  to  effect  the  first  monthly
redemption  payment  in  shares,  and  that the  election  should  continue  for
subsequent  redemption  periods  until  revised.  One  of  the  holders  of  the
discounted  convertible  debentures  exercised  its right to  receive  its first
monthly redemption payment, in the amount of $14,583, in cash.

           On April 28, 2004,  the Company  irrevocably  notified the  debenture
holders that it would make the monthly  redemption  payments in cash  commencing
June 1, 2004 until otherwise notified.

           On October 14, 2003,  an employee  exercised  79,400  employee  stock
options at $0.20 per stock option.

           On April 15, 2004,  the Company  received  gross proceeds of $750,000
upon the issuance of an unsecured  short-term  promissory  note to an accredited
investor.  The note bears  interest  at a rate of 8% per annum and is  repayable
within 120 days of issuance with accrued  interest.  As a commitment fee to loan
the Company money, the holder of the note received $75,000.

           On April  30,  2004,  500,000  warrants  were  exercised  at  $0.104.
Pursuant to the  anti-dilution  provisions  contained in certain  warrants,  the
exercise  price of 25,290,153  warrants  outstanding  were reduced to $0.104 per
share,  which was the deemed price per share of the common stock that was issued
to effect  the April 1, 2004  redemption  payment  of the  Company's  discounted
convertible debentures maturing April 1, 2006.

           On May 19,  2004,  we received  gross  proceeds of $750,000  upon the
issuance of an unsecured  short-term  promissory note to an accredited investor.
The note bears  interest at a rate of 8% per annum and is  repayable  within 120
days of issuance with accrued interest.  As a commitment fee to loan the Company
money, the holder of the note received $75,000.

           On May 19,  2004,  we  entered  into a  Standby  Equity  Distribution
Agreement  with  Cornell  Capital  Partners,  LP,  an  accredited  investor,  in
connection with a 24-month,  $15.0 million equity line of credit  facility.  The
agreement  contemplates  the potential  future  issuance and sale of up to $15.0
million of our common stock to Cornell Capital Partners,  LP, subject to certain
restrictions  and other  obligations.  As the the  underlying  shares  have been
registered with the Securities and Exchange  Commission,  we are able to request
advances.  To July 31,  2004,  we have drawn down  $750,000.  We may continue to
request advances until Cornell Capital Partners has advanced  $15,000,000 or two
years after the effective date of the registration  statement,  whichever occurs
first.  Cornell Capital Partners is a private limited partnership whose business
operations are conducted through its general partner, Yorkville Advisors, LLC.


                                       43
<PAGE>

           Pursuant  to the equity line of credit,  we may,  at our  discretion,
periodically  sell to Cornell Capital  Partners during the  effectiveness of the
related  registration  statement,  shares of common  stock for a total  purchase
price of up to $15.0  million.  Each such periodic sale of shares is known as an
advance or drawdown. We may request an advance every 7 trading days. The maximum
amount of each advance is $500,000. Each advance will close 6 trading days after
we give  written  notice of such  advance,  at which  time we will  deliver  the
appropriate  number of shares of our common stock to Cornell  Capital  Partners,
L.P.  against  payment of the  advance  amount.  For each share of common  stock
purchased under the equity line of credit, Cornell Capital Partners will pay 98%
of the  lowest  closing  bid  price on the OTC  Bulletin  Board,  or such  other
principal  market on which our common  stock may then be traded,  for the 5 days
immediately  following the notice date.  Further,  Cornell Capital Partners will
retain 5% of each advance as a fee.

           The amount of capital  available under the equity line of credit will
not be dependent  on the price or volume of our common  stock.  Cornell  Capital
Partners may not own more than 9.9% of our outstanding common stock at any time.
Because Cornell Capital  Partners can repeatedly  acquire and sell shares,  this
limitation  does not limit the potential  dilutive effect or the total number of
shares  that  Cornell  Capital  Partners  may  receive  under the equity line of
credit.

           We have  issued to  Cornell  Capital  Partners  14,370,835  shares of
common stock of which  10,861,220  were pursuant to three draw downs of $250,000
and 3,509,615  shares of common stock as a commitment  fee under the equity line
of credit.  In addition,  we have also issued, as a placement fee, 96,154 shares
of our common stock to Newbridge Securities Corporation.

           The  net  proceeds  realized  or to be  realized  by  us  from  these
transactions have and are to be used for debt repayment, working capital and the
purchase of capital assets.

           During fiscal 2004, we also  purchased  certain  capital assets at an
aggregate  cost of $446,780.  The majority of these capital  assets were sent to
Hyundai  Autonet  in Korea to  facilitate  production  of our  aftermarket  tire
pressure monitoring systems (TPMS) for passenger cars and motorcycles.

           Our  management  projects that we will require a minimum of $6.3-$8.5
million to fund our debt  repayment,  ongoing  operating  expenses  and  working
capital requirements through July 31, 2005.

           Between  August 1, 2004 and October 15,  2004,  the Company  realized
gross cash proceeds of $2,746,788  from draw downs  totalling  $2.2 Million from
our $15  Million  equity  line of  credit  and  $546,788  from the  exercise  of
warrants.

           However,  due to the  uncertainty  of our ability to meet our current
operating  and  capital  expenses,  in their  report on the annual  consolidated
financial   statements  for  fiscal  2004,  our  independent  auditors  included
additional  comments in their  Auditors'  report  indicating  concerns about our
ability to continue as a going concern.  Our consolidated  financial  statements
contain  additional note disclosures  describing the  circumstances  that led to
this  disclosure  by  our  independent  auditors.   The  consolidated  financial
statements do not include any adjustments  that might result from the outcome of
this uncertainty.

           As the  continuation  of our  business is  dependent  upon  obtaining
further  financing,  successful and sufficient  market acceptance of our current
products and any new products that we may introduce,  the continuing  successful
development of our products and related technologies,  and, finally, achieving a
profitable level of operations.  The issuance of additional equity securities by
us could result in a significant dilution in the equity interests of our current
stockholders.   Obtaining  commercial  loans,  assuming  those  loans  would  be
available, will increase our liabilities and future cash commitments.

           We plan to raise any additional  capital required to meet the balance
of our estimated  funding  requirements  for the next twelve  months,  primarily
through the private placement of our securities (including shares issuable under
our $15.0 Million standby equity  distribution  agreement with Cornell  Capital,
assuming that we will meet all conditions to effect  drawdowns under equity line
of credit facility).  We may also realize cash proceeds upon the exercise of our
outstanding warrants, which cannot be assured.

FUTURE OPERATIONS

           Presently,  our revenues are not  sufficient  to meet  operating  and
capital expenses. We have incurred operating losses since inception, and this is
likely to continue for the foreseeable future.


                                       44
<PAGE>

           Our  management  projects that we will require a minimum of $6.3-$8.5
million to fund our debt  repayment,  ongoing  operating  expenses  and  working
capital requirements through July 31, 2005 as follows:

Marketing                                    $ 1,500,000         $ 2,000,000
Engineering, research and development          1,200,000           1,700,000
General and administrative                     2,200,000           2,500,000
Capital Purchases                                150,000             400,000
Debt repayment                                 1,500,000           2,518,962
General Working Capital                         (250,000)           (618,962)
                                             -----------         -----------
TOTAL                                        $ 6,300,000         $ 8,500,000
                                             ===========         ===========

(1)   Assumes  monthly  repayments on the discounted  convertible  debentures of
      $145,566 in cash  commencing  January 1, 2004.  The amount of cash used to
      redeem  the  discounted  convertible  debentures  may  be  less  than  the
      September  30,  2004  balance   outstanding   of  $1,612,798  as  per  the
      forbearance  and escrow  agreement dated September 24, 2004, the debenture
      holders  have the option,  after  December  31, 2004,  of  converting  the
      convertible  debenture  in whole or in part into  shares of our common our
      common  stock at $0.03 per share  (subject to  adjustment  pursuant to the
      anti-dilution provisions contained in the debentures).

           Our  working  capital  requirements  are  impacted  by our  inventory
requirements.  Therefore,  any  increase  in  sales  of  our  products  will  be
accompanied not only by an increase in revenues,  but also by an increase in our
working capital requirements.  Our new products,  the market acceptance of which
will  impact on our  inventory  needs and  therefore  will impact on our working
capital requirements, include the following:

           o      Our  motorcycle  tire  pressure  monitoring  system (TPMS) was
                  introduced for sale into the aftermarket in September 2002. We
                  introduced  a   substantially   improved   second   generation
                  motorcycle   tire   pressure   monitoring   system  (TPMS)  in
                  mid-February,  2004 and began  delivery  of this system to our
                  distributors in May 2004. We had a recall in September and are
                  currently  working on a solution  for curved rims that we plan
                  to introduce into the market in January 2005.

           o      During  our fiscal  year,  we  introduced  low  pressure  tire
                  monitoring systems (TPMS) for the recreational vehicle market.
                  Marketed as "RoadVoiceTM" and "TrailerVoiceTM", they represent
                  the first tire monitoring systems targeted specifically at the
                  recreational vehicle, towed vehicle and trailer markets.

           o      During our fiscal  year,  we  introduced  high  pressure  tire
                  monitoring systems (TPMS) for the recreational vehicle market,
                  bus and commercial market.

           o      In May,  2004, we completed the  development of a new wireless
                  gateway  receiver to facilitate  the  manufacture  of pressure
                  monitoring  systems (TPMS) for commercial  vehicles,  which we
                  expect to commence in fiscal 2005.

           The continuation of our business is dependent upon obtaining  further
financing,  market  acceptance of our current products and any new products that
we may  introduce,  the  continuing  successful  development of our products and
related technologies, and, finally, achieving a profitable level of operations.


                                       45
<PAGE>

           As  discussed   above  under  the  heading   "Liquidity  and  Capital
Resources,  we plan to raise any additional capital required to meet the balance
of our estimated funding  requirements  through July 31, 2005, primarily through
the  private  placement  of  our  securities   (including  the  registration  of
additional  shares of our common stock for issuance upon use of our $15M standby
equity distribution agreement entered into on May 19, 2004).

           The issuance of additional  equity securities by us could result in a
significant  dilution  in the  equity  interests  of our  current  stockholders.
Obtaining  commercial  loans,  assuming  those  loans would be  available,  will
increase our liabilities and future cash commitments.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

           Our  consolidated  financial  statements and  accompanying  notes are
prepared in accordance  with  generally  accepted  accounting  principles in the
United  States.  Preparing  financial  statements  requires  management  to make
estimates  and  assumptions   that  affect  the  reported   amounts  of  assets,
liabilities, revenue, and expenses. These estimates and assumptions are affected
by   management's   application   of  accounting   policies.   We  believe  that
understanding  the basis and nature of the  estimates and  assumptions  involved
with the following aspects of our consolidated  financial statements is critical
to an understanding of our financials.

GOING CONCERN

           As at July 31, 2004, we had an  accumulated  deficit of  $59,018,256.
Our net loss for the year was  $10,987,026  compared  to  $9,914,629  for fiscal
2003. As of July 31, 2004,  our  stockholders'  equity was $3,466,216 and we had
working capital of $732,405.

           We require additional financing to fund our operations. During fiscal
2004, we used $7,535,839  cash in operating  activities and $446,780 to purchase
capital assets.  Accordingly,  during fiscal 2004, we raised gross cash proceeds
of $7,154,385  from the exercise of warrants of $2,179,385,  $2,725,000 from the
issuance of 22% discounted convertible debentures,  $1,500,000 from the issuance
of two  unsecured  promissory  notes,  $750,000  from the  draw  down on our $15
Million  Equity line of credit and $15,880 from the  exercise of employee  stock
options.

           Between  August 1, 2004 and October 15,  2004,  the Company  realized
gross cash proceeds of $2,346,788  from draw downs  totalling $1.8 Million from
our $15  Million  equity  line of  credit  and  $546,788  from the  exercise  of
warrants.

           Although we have  successfully  registered the $15.0 million  standby
equity  distribution  agreement,  which,  as discussed  elsewhere in this annual
report,  we only have 7,751,070  registered shares remaining under the agreement
and  there  can be no  assurance  that we will  be able to  register  additional
shares.  Our consolidated  financial  statements have been prepared on the going
concern basis, which assumes that adequate sources of financing will be obtained
as required and that our assets will be realized, and liabilities settled in the
ordinary course of business.  Accordingly, our consolidated financial statements
do not  include  any  adjustments  related to the  recoverability  of assets and
classification  of assets and liabilities  that might be necessary  should we be
unable to continue as a going concern.

INVENTORY

           Inventory is carried at the lower of cost,  determined  on a weighted
average  cost  method,  and  net  realizable  value.  The  determination  of net
realizable  value is based on several  assumptions and estimates.  We provide an
allowance  that we  consider  to be  reasonable  for  non-moving  or slow moving
inventory items and for items with expected future  realizable  value lower than
cost. These assumptions and estimates may be inaccurate and may be revised.

           The  markets  in  which  we  compete  are  rapidly  changing  due  to
technological  developments  and increasing  focus on automotive  safety.  Other
companies  offer  products  similar to those  offered by us, and target the same
customers  as  we  do.  Many  of  these  companies  have  substantially  greater
financial,  marketing  and  technical  resources.  We also  anticipate  that the
competition  within  these  markets  will  increase  as demand for the  products
escalates.  It is possible  that new  competitors  or alliances  among  existing
competitors  may emerge and such  competitors  may rapidly  acquire  significant
market share and make it difficult for us to sell our current inventory.  All of
these elements could reduce the net realizable value of our inventory.


                                       46
<PAGE>

WARRANTY OBLIGATIONS

           On an ongoing  basis,  we record our best  estimate  of our  warranty
obligations and product  returns  related to products sold.  These estimates are
made after the consideration of contractual  warranty obligations and historical
experience.  Unforeseen events,  including increased technological  difficulties
with  products,  could occur that have not been  anticipated  in estimating  the
warranty  provision.  Additional  costs  or  estimates  will  be  recognized  as
determinable.

REVENUE RECOGNITION

           Our Company recognizes  revenue when there is persuasive  evidence of
an arrangement,  goods are shipped and title passes, collection is probable, and
the fee is fixed or determinable.  Customer  acceptance is used as the criterion
for revenue recognition when the product sold does not have an established sales
history  to  allow   management  to  reasonably   estimate  returns  and  future
provisions.  Provisions  are  established  for  estimated  product  returns  and
warranty  costs at the time the  revenue  is  recognized.  Our  Company  records
deferred  revenue  when cash is received  in advance of the revenue  recognition
criteria being met. Revenue from engineering  services is recognized on services
as they are  rendered  and  pre-defined  milestones  are  achieved.  Engineering
services revenue for the year were $94,800 (2003-$173,400 and 2002 - nil).

OTHER ASSETS

           Other assets are recorded at cost and are being  amortized  over five
years on a straight  line  basis.  Other  assets are  comprised  of  licenses to
manufacture  and sell tire  monitoring  systems (TMS) to the original  equipment
manufacturers. On an ongoing basis, management assesses whether the expected net
recoverable  amount of the licenses exceeds the book value of the licenses.  The
net recoverable amount is determined on a projected cash flow basis,  discounted
at an appropriate  rate. In making our cash flow  estimates,  we consider recent
market trends and transactions, as well as reasonable estimates of future events
based on current economic  characteristics.  Although we expect to generate cash
flow from sales to the  original  equipment  manufacturer  market  place,  it is
possible  that we will  not  generate  cash  flow  from  sales  to the  original
equipment manufacturer  marketplace in excess of net book value, or that we will
generate cash flow from sales to the original equipment  manufacturer  market in
future years after the other assets have been fully amortized.

ITEM 7.    FINANCIAL STATEMENTS

           Our  consolidated   financial   statements  are  included   beginning
immediately  following the signature page to this report. See Item 13 for a list
of the financial statements and financial statement schedules included.

ITEM 8.    CHANGES IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
           FINANCIAL DISCLOSURE

           None.

ITEM 8A.   CONTROLS AND PROCEDURES

           Our Company's  Chief Executive  Officer and Chief  Financial  Officer
have evaluated our Company's  disclosure  controls and procedures within 90 days
prior to the date of filing of this  Annual  Report on Form  10-KSB.  Management
believes  that our  Company's  current  internal  controls  and  procedures  are
effective  and designed to ensure that  information  required to be disclosed by
our Company in its  periodic  reports is  recorded,  processed,  summarized  and
reported,  within the  appropriate  time periods  specified by the SEC, and that
such information is accumulated and communicated to our Company's CEO and CFO as
appropriate to allow timely decisions to be made regarding required disclosure.


                                       47
<PAGE>

           As of October 15, 2004, there were no significant  corrective actions
taken by our  Company or other  changes  made to these  internal  controls.  Our
Company's  management  does not believe there were changes in other factors that
could  significantly  affect  these  controls  subsequent  to  the  date  of the
evaluation.

PART III

ITEM 9.    DIRECTORS,   EXECUTIVE  OFFICERS,   PROMOTERS  AND  CONTROL  PERSONS;
           COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

THE FOLLOWING  TABLE SETS FORTH THE NAMES,  AGES AND POSITIONS HELD WITH RESPECT
TO EACH DIRECTOR AND EXECUTIVE OFFICER OF OUR COMPANY DURING FISCAL 2004.

<TABLE>
<CAPTION>

----------------------------------------------------------------------------------------------------------
NAME                POSITION HELD WITH OUR COMPANY          AGE  DATE FIRST ELECTED OR APPOINTED
----------------------------------------------------------------------------------------------------------
                                                   DIRECTORS
----------------------------------------------------------------------------------------------------------
<S>                 <C>                                     <C>  <C>
John Bolegoh(1)     Director                                 60  Director since December 2, 1993.
----------------------------------------------------------------------------------------------------------
William Cronin      Director                                 57  Director since June 7, 2001.
----------------------------------------------------------------------------------------------------------
Martin Gannon       Director                                 52  Director since February 3, 2003.
----------------------------------------------------------------------------------------------------------
Johnny Christiansen Director                                 49  Director since August 14, 2003.
----------------------------------------------------------------------------------------------------------
Robert Rudman       Director, President, CEO and Chairman    57  Director since September 22, 1993,
                                                                 President and CEO since January 19,
                                                                 1996, and Chairman since June 4, 1999.
----------------------------------------------------------------------------------------------------------
Al Kozak            Director, Chief Operating Officer        55  Director since November 20, 2002, and
                                                                 Chief Operating Officer since May 1,
                                                                 2002.
----------------------------------------------------------------------------------------------------------
                                   EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
----------------------------------------------------------------------------------------------------------
Jeff Finkelstein    Chief Financial Officer                  43  Chief Financial Officer since October
                                                                 23, 2002.
----------------------------------------------------------------------------------------------------------
Erwin Bartz         Director of Technical Operations         43  Vice President of Business Development
                                                                 since January 3, 2001.
----------------------------------------------------------------------------------------------------------
Shawn Lammers       Vice President, Engineering              37  Vice President, Engineering since
                                                                 January 1, 1997.
----------------------------------------------------------------------------------------------------------
John Taylor-Wilson  Vice President Sales and Marketing       48  Vice President Sales and Marketing
                                                                 since August 11, 2003. (2)
----------------------------------------------------------------------------------------------------------
</TABLE>

(1)   John  Bolegoh  served as a director of our Company  during the fiscal year
      ended July 31, 2004 until his resignation on June 14, 2004.

(2)   John Taylor-Wilson was terminated on October 14, 2004.


                                       48
<PAGE>

           The  directors  of our Company  are  elected at each  annual  general
meeting and hold office  until the next  annual  general  meeting or until their
successors are appointed.

BUSINESS EXPERIENCE

           The  following  is a brief  account  of the  education  and  business
experience  during  at least  the past five  years of each  director,  executive
officer  and key  employee,  indicating  the  principal  occupation  during that
period,  and the name and principal  business of the  organization in which such
occupation and employment were carried out.

William Cronin

           Mr. Cronin has been a director since June, 2001 and previously served
as a director from November 17, 1995 to April 25, 1998.  Since 1986,  Mr. Cronin
has been the  owner of  Madison  Financial  Services,  a  registered  investment
adviser  firm  located in Madison,  Connecticut,  specializing  in tax,  pension
investing planning strategies and portfolio management.

Martin Gannon

           Mr. Gannon joined our Company as a director on February 3, 2003.  Mr.
Gannon has been a Certified Public  Accountant since 1973. He has been a partner
and the vice president of the accounting firm of Barron Gannon & Co., P.C. since
1982.  In his advisory role to his  clientele,  he has assisted  companies  from
their inception to maturity.

Johnny Christiansen

           Mr. Christiansen joined our Company as a director on August 14, 2003.
Mr.  Christiansen  resides in Norway.  He has a strong knowledge of our business
and  industry  as he served as the  President  of SensoNor  asa from  1999-2002.
SensoNor is a  Norwegian  company  and a leading  provider  of tire  monitoring,
airbag  and  rollover   sensors  for  the   automotive   industry.   During  Mr.
Christiansen's  tenure as its President,  SensoNor raised more than $100 million
in financing and signed  contracts for more than $400 million.  Before 1999, Mr.
Christiansen  served as a director  of various  companies,  including  Davis AS,
Kongsberg Norcontrol Systems,  Norcontrol Training AS and Norcontrol  Automation
AS.

Robert Rudman

           Mr.  Rudman has been a director  since  September,  1993.  Mr. Rudman
joined our Company in March,  1993 as the Chief Financial  Officer after serving
as an  independent  financial  consultant for several  months.  He was appointed
Chief  Executive  Officer  of our  Company on January  19,  1996,  and served as
President from January 19, 1996 to June 4, 1999, when he was appointed  Chairman
of the Board.  Mr.  Rudman was  reappointed  President of our Company  effective
April  1,  2000.  He is a  Chartered  Accountant  with 15  years  of  experience
assisting public companies listed primarily on the Vancouver Stock Exchange (now
the TSX Venture Exchange).  Prior to joining our Company, Mr. Rudman was manager
of a  California-based  sales  contract  financing  firm.  Previously,  he was a
partner in a  consulting  firm  providing  professional  assistance  to publicly
traded  companies.  Mr. Rudman became a Chartered  Accountant in 1974 and worked
with Laventhol & Horwath and Price Waterhouse & Co. in Winnipeg, Manitoba.

Jeff Finkelstein

           Mr. Finkelstein is a Chartered Accountant,  who has been acting Chief
Financial  Officer of our Company since May 17, 2002. He was formally  appointed
as our Chief  Financial  Officer  on  October  23,  2002.  He has  served as our
controller  since February 22, 1999.  From 1996 to 1999, he served as controller
of Golden Knight Resources Inc., a Toronto Stock Exchange listed public company,
and Silver  Standard  Resources,  a Nasdaq listed public  company.  From 1993 to
1995,  he served as  controller  of a private  distribution  company after eight
years as a public accountant.


                                       49
<PAGE>

Erwin Bartz

           Mr. Bartz was appointed  Vice  President of Business  Development  in
2003. He has overall responsibility for defining product strategies and roadmaps
as well  as  developing  strategic  alliances.  He was  formerly  our  Director,
Technical   Operations  since  January  2001  with  responsibility  for  overall
technical  operations  including  engineering and manufacturing.  Mr. Bartz is a
Professional Engineer with 20 years of engineering experience.  Prior to joining
our  Company,   Mr.  Bartz  spent  ten  years  as  Manager  of  Engineering  and
Manufacturing at Finning (Canada),  the Caterpillar dealer for British Columbia,
Alberta,   United  Kingdom  and  Chile,   with  corporate   responsibility   for
engineering,  product review, heavy manufacturing and new equipment preparation.
Previously,  he held the  Engineering  Manager role at Weldco  Beales,  a custom
attachment  manufacturer for the mobile equipment  market,  and also worked as a
design engineer for the Chapman  Industries,  a Hitachi  distributor and general
manufacturer of purpose-built machinery and equipment.

Al Kozak

           Mr. Kozak joined us as Chief Operating Officer on May 1, 2002. He was
subsequently appointed to our board of directors on November 20, 2002. Mr. Kozak
is  a  seasoned  executive  with  strong  operational  management  and  business
development experience in fast-paced,  high growth,  technology companies.  From
May 2000 to April  2001,  Mr.  Kozak was the  President  and  founder  of Siwash
Ventures  where he assembled  an advisory  board of senior  executives  from the
Vancouver  area to analyze and  recommend  investment  and business  development
strategies  to technology  companies.  From 1992 to 1998 he held the position of
President with Digital Courier  International,  Inc., an industry  extranet that
networked  over  7,000  radio  stations,  1500  advertising  and 400  production
facilities.  In 1998 when the company sold its assets and  technology to Digital
Generations  Systems  Inc.,  he held the position of VP,  Marketing and Business
Development for two years.

Shawn Lammers

           Mr. Lammers has been with us since our inception. He currently serves
as the Vice President  Engineering and is responsible for the development of the
patented remote sensing technology utilized in SmarTire's products.  He has been
the chief engineer in respect to the design,  development  and production of our
passenger car tire  monitoring  system,  the commercial  vehicle tire monitoring
system and the  industrial  equipment  tire  monitoring  systems  (TMS).  He has
developed software for MS-DOS, Windows, UNIX Workstations and Amiga platforms.

FAMILY RELATIONSHIPS

           There  are no  family  relationships  between  any  of our  Company's
directors or executive officers.

INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS

           None of our  directors,  executive  officers,  promoters  or  control
persons have been involved in any of the  following  events during the past five
years:

           1.        any bankruptcy petition filed by or against any business of
                     which  such  person  was a  general  partner  or  executive
                     officer  either at the time of the bankruptcy or within two
                     years prior to that time;

           2.        any conviction in a criminal proceeding or being subject to
                     a pending criminal proceeding (excluding traffic violations
                     and other minor offences);

           3.        being  subject  to any  order,  judgment,  or  decree,  not
                     subsequently  reversed,  suspended or vacated, of any court
                     of  competent  jurisdiction,   permanently  or  temporarily
                     enjoining,  barring,  suspending or otherwise  limiting his
                     involvement in any type of business,  securities or banking
                     activities; or


                                       50
<PAGE>

           4.        being  found by a court  of  competent  jurisdiction  (in a
                     civil  action),  the  Commission or the  Commodity  Futures
                     Trading  Commission  to have  violated  a federal  or state
                     securities  or  commodities  law,  and the judgment has not
                     been reversed, suspended, or vacated.

SECTION 16(A) REPORTING

           Since our Company is a "foreign  private  issuer",  our  insiders are
exempt from the  reporting  requirements  of Section  16(a) of the United States
Securities  Exchange  Act of 1934,  as amended  (the "1934  Act").  Among  other
things,  Section 16(a) of the 1934 Act requires certain  "reporting  persons" of
any issuer with any class of equity  securities  registered  under Section 12 of
the 1934 Act to file with the United States  Securities and Exchange  Commission
reports of ownership and changes in ownership of  securities  of the  registered
class. Reporting persons consist of directors, executive officers and beneficial
owners of more than 10% of the securities of the registered  class. We are aware
that certain persons, who would be subject to such reporting  requirements,  but
for the fact that we are a "foreign  private  issuer",  have  voluntarily  filed
reports under Section 16(a) of the 1934 Act during fiscal 2004.  However, we are
not in a position to comment on the completeness of such filings.

CODE OF ETHICS

           Effective October 3, 2003, our Company's board of directors adopted a
Code of Business  Conduct and Ethics and  Compliance  Program  that  applies to,
among other persons,  our Company's President and Chief Executive Officer (being
our principal executive  officer),  our Company's Chief Financial Officer (being
our  principal  financial and  accounting  officer and  controller),  as well as
persons performing similar functions.  As adopted,  our Code of Business Conduct
and Ethics sets forth written  standards  that are designed to deter  wrongdoing
and to promote:

           (1)       honest and ethical conduct,  including the ethical handling
                     of  actual  or  apparent   conflicts  of  interest  between
                     personal and professional relationships;
           (2)       full, fair, accurate, timely, and understandable disclosure
                     in reports and  documents  that we file with, or submit to,
                     the Securities and Exchange  Commission and in other public
                     communications made by us;
           (3)       compliance with  applicable  governmental  laws,  rules and
                     regulations;
           (4)       the prompt internal  reporting of violations of the Code of
                     Business  Conduct  and Ethics to an  appropriate  person or
                     persons  identified  in the Code of  Business  Conduct  and
                     Ethics; and
           (5)       accountability  for  adherence  to  the  Code  of  Business
                     Conduct and Ethics.

           Our Code of Business Conduct and Ethics requires, among other things,
that all of our Company's  personnel  shall be accorded full access to our Chief
Financial  Officer with  respect to any matter  which may arise  relating to the
Code of Business Conduct and Ethics. Further, all of our Company's personnel are
to be accorded full access to our Company's  Audit  Committee if any such matter
involves  an alleged  breach of the Code of  Business  Conduct and Ethics by the
Chief  Financial  Officer or by any person who would be  considered an "insider"
for the purposes of our Company's Insider Trading Compliance Policy by virtue of
such person's relationship to the Chief Financial Officer.

           In addition,  our Code of Business Conduct and Ethics emphasizes that
all  employees,   and   particularly   managers  and/or   supervisors,   have  a
responsibility   for  maintaining   financial   integrity  within  our  Company,
consistent  with  generally  accepted   accounting   principles,   and  federal,
provincial  and state  securities  laws.  Any employee who becomes  aware of any
incidents   involving   financial   or   accounting    manipulation   or   other
irregularities,  whether by  witnessing  the  incident or being told of it, must
report it to his or her immediate supervisor or to our Company's Chief Financial
Officer.  If the  incident  involves  an alleged  breach of the Code of Business
Conduct and Ethics by the Chief Financial Officer, the incident must be reported
to any member of our  Company's  Audit  Committee.  Any  failure to report  such
inappropriate  or  irregular  conduct  of  others is to be  treated  as a severe
disciplinary  matter.  It is against our Company policy to retaliate against any
individual who reports in good faith the violation or potential violation of our
Company's Code of Business Conduct and Ethics by another.


                                       51
<PAGE>

           Our Code of Business  Conduct and Ethics is filed  herewith  with the
Securities and Exchange Commission as exhibit 14.1 to this annual report. A copy
of the Code of Business  Conduct and Ethics is posted on our Internet website at
www.smartire.com.  We will also  provide a copy of the Code of Business  Conduct
and Ethics to any person without charge, upon request.  Requests can be sent to:
SmarTire Systems Inc., #150 - 13151 Vanier Place,  Richmond,  British  Columbia,
Canada V6V 2J1 or via email to investor--relations@smartire.com

ITEM 10.   EXECUTIVE COMPENSATION

SUMMARY OF EXECUTIVE COMPENSATION

           Particulars of compensation awarded to, earned by or paid to:

           (a)       our Company's chief executive officer (the "CEO");

           (b)       each  of  our  Company's   four  most  highly   compensated
                     executive  officers who were serving as executive  officers
                     at the end of the most recently  completed  fiscal year and
                     whose total salary and bonus exceeds $100,000 per year; and

           (c)       any additional  individuals for whom disclosure  would have
                     been  provided   under  (b)  but  for  the  fact  that  the
                     individual  was not serving as an executive  officer of our
                     Company at the end of the most  recently  completed  fiscal
                     year;

(the "Named Executive  Officers") are set out in the summary  compensation table
below.

           During fiscal 2004, six (6) individuals  served as executive officers
of the Company at various times:  Robert  Rudman,  Al Kozak,  Jeff  Finkelstein,
Erwin Bartz, Shawn Lammers, and John Taylor-Wilson.  Mr. Finkelstein earned less
than $100,000 in total salary and bonuses during fiscal 2004, and, therefore, is
not considered a "Named Executive Officer."

<TABLE>
<CAPTION>
====================================================================================================================================
                                                     SUMMARY COMPENSATION TABLE
------------------------------------------------------------------------------------------------------------------------------------
                                  Annual Compensation                                     Long Term Compensation
------------------------------------------------------------------------------------------------------------------------------------
                                                                                  Awards                           Payouts
------------------------------------------------------------------------------------------------------------------------------------
Name and Principal     Year      Salary      Bonus   Other   Annual  Securities       Restricted    LTIP Payouts  All Other
Position                                             Compen-sation(1)Underlying       Shares or                   Compen-sation
                                                                     Options/SARs     Restricted
                                                                     Granted (#)      Share Units
------------------------------------------------------------------------------------------------------------------------------------
<S>                    <C>      <C>        <C>      <C>             <C>              <C>            <C>          <C>
Robert Rudman          2004      $217,478    Nil     Nil             1,079,500        Nil           Nil           Nil

President, Chairman    2003      $194,543    Nil     Nil                232,000       Nil           Nil           Nil
and Chief Executive
Officer                2002      $185,377    Nil     Nil                  90,000      Nil           Nil           Nil
------------------------------------------------------------------------------------------------------------------------------------
Al Kozak               2004      $164,983    Nil     Nil                683,000       Nil           Nil           Nil

Chief Operating        2003      $147,585    Nil     Nil                111,000       Nil           Nil           Nil
Officer
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                                                 52
<PAGE>

<TABLE>
<CAPTION>
====================================================================================================================================
                                                     SUMMARY COMPENSATION TABLE
------------------------------------------------------------------------------------------------------------------------------------
                                  Annual Compensation                                     Long Term Compensation
------------------------------------------------------------------------------------------------------------------------------------
                                                                                  Awards                           Payouts
------------------------------------------------------------------------------------------------------------------------------------
Name and Principal     Year      Salary      Bonus   Other   Annual  Securities       Restricted    LTIP Payouts  All Other
Position                                             Compen-sation(1)Underlying       Shares or                   Compen-sation
                                                                     Options/SARs     Restricted
                                                                     Granted (#)      Share Units
------------------------------------------------------------------------------------------------------------------------------------
<S>                    <C>      <C>        <C>      <C>             <C>              <C>            <C>          <C>
Erwin Bartz            2004      $121,113    Nil     Nil                390,000       Nil           Nil           Nil

Vice-President,        2003      $108,341    Nil     Nil                  55,000      Nil           Nil           $5,826(2)
Business Development
------------------------------------------------------------------------------------------------------------------------------------

Shawn Lammers          2004      $108,739    Nil     Nil                332,600       Nil           Nil           Nil

Vice-President,        2003        $94,589   Nil     Nil                  15,100      Nil           Nil           Nil

Engineering            2002        $86,296   Nil     Nil                  10,000      Nil           Nil           Nil
------------------------------------------------------------------------------------------------------------------------------------
John Taylor-Wilson     2004      $102,576    Nil     Nil                450,000       Nil           Nil           $5,229(3)
====================================================================================================================================
</TABLE>

*     The average of the closing  foreign  exchange  rates for fiscal  2004,  as
      calculated by using the reported daily rates posted by the Federal Reserve
      Bank of New York,  was  CDN$1.3386 to every  US$1.00.  For the purposes of
      this table,  executive compensation paid in Canadian currency to the Named
      Executive  Officers has been converted into United States  currency at the
      rate of CDN$1.3386 to every US$1.00

(1)   The value of  perquisites  and other  personal  benefits,  securities  and
      property for the Named Executive Officers that do not exceed the lesser of
      $50,000 or 10% of the total of the annual salary and bonus is not reported
      herein.

(2)   Mr. Bartz earned sales commissions of $5,826 in fiscal 2003.

(3)   Mr. Taylor-Wilson earned sales commissions of $5,229 in fiscal 2004.

           The  following  table  sets  forth  for each of the  Named  Executive
Officers  certain  information  concerning  stock options granted to them during
fiscal 2004. Our Company has never issued stock appreciation rights. Our Company
grants options that generally vest immediately at an exercise price equal to the
fair market value of a share of common stock as  determined by its closing price
on the OTC Bulletin Board. Until May 28, 2003, the exercise price was determined
by its  closing  price on the Nasdaq  SmallCap  Market.  The term of each option
granted is generally  five years from the date of grant.  Options may  terminate
before  their  expiration  dates if the  optionee's  status  as an  employee  is
terminated or upon the optionee's death or disability.


                                       53
<PAGE>

OPTION/SAR GRANTS IN THE LAST FISCAL YEAR

<TABLE>
<CAPTION>
=================================================================================================
                            NUMBER OF        % OF TOTAL
                            SECURITIES       OPTIONS/ SARS
                            UNDERLYING       GRANTED TO
                            OPTIONS/ SARS    EMPLOYEES IN     EXERCISE PRICE
NAME                        GRANTED (#)      FISCAL YEAR      ($/SHARE)        EXPIRATION DATE
=================================================================================================
<S>                         <C>              <C>              <C>              <C>
Robert Rudman 1,669,500     18.2%            $0.20            August 12, 2008
-------------------------------------------------------------------------------------------------
Al Kozak                    1,123,000        12.2%            $0.20            August 12, 2008
-------------------------------------------------------------------------------------------------
Erwin Bartz                    615,000,       6.7%            $0.20            August 12, 2008
-------------------------------------------------------------------------------------------------
Shawn Lammers                  557,600        6.1%            $0.20            August 12, 2008
-------------------------------------------------------------------------------------------------
John Taylor-Wilson             450,000        4.9%            $0.20            August 12, 2008
=================================================================================================
</TABLE>

           The  following  table  sets forth for each  Named  Executive  Officer
certain information  concerning the number of shares subject to both exercisable
and   unexercisable   stock  options  as  of  July  31,  2004.  The  values  for
"in-the-money"  options are calculated by determining the difference between the
fair market value of the  securities  underlying the options as of July 31, 2004
($0.055 per share) and the exercise price of the individual's  options. No Named
Executive Officer exercised options during fiscal 2004.

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES

<TABLE>
<CAPTION>
====================================================================================================================================
                                                       NUMBER OF SECURITIES UNDERLYING          VALUE  OF   UNEXERCISED IN-THE-MONEY
                                      AGGREGAGE        UNEXERCISED OPTIONS/SARS AT FY-END (#)   OPTIONS/SARS AT FY-END ($)
                    SHARES ACQUIRED   VALUE REALIZED
NAME                ON EXERCISE (#)   ($)              EXERCISABLE / UNEXERCISABLE              EXERCISABLE / UNEXERCISABLE
------------------------------------------------------------------------------------------------------------------------------------
<S>                 <C>               <C>              <C>            <C>                       <C>          <C>
 Robert Rudman       Nil               Nil               1,501,000           68,000              Nil                  Nil

 Al Kozak            Nil               Nil                 926,000           24,000              Nil                  Nil

 Erwin Bartz         Nil               Nil                 536,666           18,334              Nil                  Nil

 Shawn Lammers       Nil               Nil                 435,166            5,034              Nil                  Nil

 John Taylor-Wilson  Nil               Nil                 450,000            Nil                Nil                  Nil
====================================================================================================================================
</TABLE>

EMPLOYMENT  CONTRACTS  AND  TERMINATION  OF  EMPLOYMENT  AND  CHANGE IN  CONTROL
ARRANGEMENTS

           Effective  August 1,  1999,  our Board of  Directors  approved  a new
management  agreement  with  Robert  Rudman,  which  calls for payment of a base
salary of CDN$273,000  (approximately  $200,000 at current  exchange  rates) per
annum  subject to  increase  from time to time plus  incentive  compensation  as
determined by our Company's  incentive  compensation  plan.  Effective August 1,
2000, Mr. Rudman's salary was increased to CDN$290,000  (approximately $212,000)
per annum. Our Company's  incentive  compensation plan expired on July 31, 2002.
The agreement with Mr. Rudman requires us to pay a termination  allowance in the
event of the termination of Mr. Rudman's  employment  other than for just cause.
The termination allowance is equal to the annual salary.


                                       54
<PAGE>

           Effective  January 3,  2001,  our Board of  Directors  approved a new
management  agreement with Erwin Bartz, which calls for payment of a base salary
of CDN$150,000  (approximately $110,000) per annum subject to increase from time
to time plus  incentive  compensation  as determined by our Company's  incentive
compensation plan. Effective August 1, 2001, Mr. Bartz's salary was increased to
CDN$155,000  (approximately  $114,000) per annum.  Effective August 1, 2002, Mr.
Bartz's salary was increased to CDN$161,500  (approximately  $118,000) per annum
plus a  commission  based on sales to and margins in the  passenger  car vehicle
market. Our Company's incentive  compensation plan expired on July 31, 2002. The
agreement with Mr. Bartz requires us to pay a termination allowance in the event
of the  termination  of Mr.  Bartz'  employment  other than for just cause.  The
termination allowance is equal to the annual salary.

           Effective  August 1,  1999,  our Board of  Directors  approved  a new
management  agreement  with Shawn  Lammers,  which  calls for  payment of a base
salary of CDN$120,000 (approximately $88,000) per annum subject to increase from
time  to  time  plus  incentive  compensation  as  determined  by our  Company's
incentive  compensation plan.  Effective August 1, 2000, Mr. Lammers' salary was
increased to CDN$127,200  (approximately $93,000) per annum. Effective August 1,
2001, Mr. Lammers' salary was increased to CDN$135,000  (approximately  $99,000)
per annum.  Effective  August 1, 2002,  Mr.  Lammers'  salary was  increased  to
CDN$144,000   (approximately   $106,000)  per  annum.  Our  Company's  incentive
compensation  plan  expired on July 31, 2002.  The  agreement  with Mr.  Lammers
requires us to pay a termination  allowance in the event of the  termination  of
Mr. Lammers' employment other than for just cause. The termination  allowance is
equal to the annual salary.

           Effective  May  1,  2002,  our  Board  of  Directors  approved  a new
management  agreement with Al Kozak, which calls for payment of a base salary of
CDN$220,000  (approximately $161,000) per annum subject to increase from time to
time plus  incentive  compensation  as  determined  by our  Company's  incentive
compensation plan. Our Company's incentive compensation plan expired on July 31,
2002. The agreement with Mr. Kozak requires us to pay a termination allowance in
the event of the  termination of Mr. Kozak's  employment  except for just cause.
The termination allowance is equal to the annual salary.

           Effective  October  23,  2002,  our  Board of  Directors  approved  a
management  agreement  with Jeff  Finkelstein,  which calls for the payment of a
base salary of CDN$120,000 (approximately $88,000) per annum subject to increase
from time to time.  Effective  August 1,  2003,  Mr.  Finkelstein's  salary  was
increased to CDN$130,000 (approximately $102,783) per annum. This agreement with
Mr. Finkelstein  requires us to pay a termination  allowance in the event of the
termination  of Mr.  Finkelstein  other  than for just  cause.  The  termination
allowance is as follows:

o     three months salary if terminated before April 23, 2003,

o     six months  salary if  terminated  between  April 23, 2003 and October 23,
      2003,

o     nine months salary if terminated  between October 23, 2003 and October 23,
      2004, and twelve months salary if terminated after October 23, 2004.

           Effective  March 31, 2003,  as a temporary  measure to help  preserve
working capital for our Company,  each of the Named Executive  Officers verbally
agreed to a 20%  reduction  in the cash that he may  receive as his base  salary
under his management  agreement.  We agreed to periodically  issue shares of our
common stock to each of the Named  Executive  Officers to make up the balance of
the base salary that he would  otherwise be entitled to receive in cash. On July
18, 2003,  the 20% in salary that we had withheld  since March 31, 2003 was paid
in cash to the  Named  Executive  Officers  and the 20%  reduction  in cash  was
cancelled.

           Effective  August  11,  2003,  our  Board  of  Directors  approved  a
management agreement with John Taylor-Wilson,  which calls for payment of a base
salary  of  CDN$140,000   (approximately  $103,000)  per  annum  plus  quarterly
commissions  ranging  from 5% to 100%  of the  base  salary  amount  if  certain
predetermined  performance  criteria  in  connection  with  his  duties  as Vice
President Sales and Marketing are met. Mr.  Taylor-Wilson may, with the approval
of our  compensation  committee,  elect to receive  his salary,  commission  and


                                       55
<PAGE>

termination  allowance,  if any, in such number of shares of our common stock as
will be  determined  based on the five day average  closing price for our common
stock. Pursuant to the agreement, we also issued to Mr. Taylor-Wilson a total of
450,000  stock options  pursuant to our 2002 Stock  Incentive  Plan  (Non-U.S.),
exercisable  for five  years at an  exercise  price  equal to 115% of the 10 day
average  closing price for our common stock as at August 13, 2003. The agreement
is  subject to the  following  termination  provisions:

o     if we  terminate  the  agreement  for any reason other than for just cause
      within  three  months,  we  will  have  no  further   obligations  to  Mr.
      Taylor-Wilson;

o     if we  terminate  the  agreement  for any reason other than for just cause
      after three  months and within six  months,  we will be required to either
      continue  to pay Mr.  Taylor-Wilson  his salary  and to  provide  him with
      benefits for a period of three months from the date of termination  or, at
      our option, to pay him three months' salary in lieu of notice;

o     if we  terminate  the  agreement  for any reason other than for just cause
      after six months and within twelve  months,  we will be required to either
      continue  to pay Mr.  Taylor-Wilson  his salary  and to  provide  him with
      benefits  for a period of six months from the date of  termination  or, at
      our option, to pay him six months' salary in lieu of notice;

o     if we  terminate  the  agreement  for any reason other than for just cause
      after twelve months and within twenty-four  months, we will be required to
      either  continue  to pay Mr.  Taylor-Wilson  his salary and to provide him
      with benefits for a period of nine months from the date of termination or,
      at our option, to pay him nine months' salary in lieu of notice; and

o     if we  terminate  the  agreement  for any reason other than for just cause
      after  twenty-four  months,  we will be required to either continue to pay
      Mr. Taylor-Wilson his salary and to provide him with benefits for a period
      of twelve months from the date of  termination  or, at our option,  to pay
      him twelve months' salary in lieu of notice.

           We are currently negotiating Mr. Taylor-Wilson's severance.

           Other  than  as  discussed   above,  our  Company  has  no  plans  or
arrangements  in respect of  remuneration  received  or that may be  received by
Named  Executive  Officers  of our  company in fiscal  2004 to  compensate  such
officers in the event of termination of employment (as a result of  resignation,
retirement,  change of  control)  or a change of  responsibilities  following  a
change of control,  where the value of such  compensation  exceeds  $100,000 per
Named Executive Officer.

COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS

           Directors  and  executive  officers  receive,  on  an  annual  basis,
incentive stock options to purchase shares of our common stock as awarded by our
Board of Directors in consultation with the compensation committee.

           Effective  January  30,  2003,  we  instituted  a  formal  directors'
compensation policy whereby directors are compensated for all meetings that they
attend in person at the rate of $1,000 per day, and for all  meetings  that they
participate by  teleconference or other electronic means at the rate of $500 per
day.  Directors  who  participate  in a meeting of any committee of the Board of
Directors  are  entitled  to  compensation  at the  rate  of  $500  per  day for
attendance  in  person,  and at the  rate of $300 per day for  participation  by
teleconference  or other  electronic  means.  Such fees are payable  only if the
meeting of the Board or of a committee of the Board, as the case may be, is more
than one-half hour in duration. Directors are also entitled to reimbursement for
reasonable travel and other  out-of-pocket  expenses incurred in connection with
attendance at meetings of our Board of  Directors,  as well as a per diem travel
time allowance of $500 per day.

           Our Board of Directors may award special remuneration to any director
undertaking  any special  services on our behalf other than services  ordinarily
required of a director. Other than indicated herein, no director received and/or
accrued any  compensation  for his services as a director,  including  committee
participation and/or special assignments.


                                       56
<PAGE>

           There  are no  arrangements  or plans in  which we  provide  pension,
retirement or similar benefits for directors or executive officers.

           We have adopted eight formal stock incentive plans, two of which were
approved by our  shareholders at our 1998 Annual General  Meeting,  two of which
were approved at our 2000 Annual General  Meeting,  two of which were adopted at
our 2002 Annual General  Meeting,  and two of which were adopted by our board of
directors  on August 11, 2003.  Four of the stock  incentive  plans  provide for
awards to eligible  employees  of our  company or of any related  entity who are
resident in the United States and/or  subject to taxation in the United  States;
the other four stock  incentive  plans provide for awards to all other  eligible
employees of our company or of any related entity.

           To date,  we have  granted  to  directors,  officers,  employees  and
consultants  incentive  stock  options to  purchase  shares of our common  stock
subject to and in accordance with the prevailing  policies of the stock exchange
on  which  our  shares  were  then  listed.  Options  are  granted  based on the
assessment  by our  Board of  Directors  and/or  compensation  committee  of the
optionee's past and present  contribution  to the success of our company.  These
options are not transferable and are exercisable from the date granted until the
earliest  of (i) such  number  of years (up to ten  years)  from the date of the
grant,  or (ii) such number of days  following  the death of the  optionee as is
specified in each optionee's option agreement.

           Other than the management agreements, the advisory agreements and the
stock incentive plans discussed  herein,  we presently have no material bonus or
profit sharing plans pursuant to which cash or non-cash  compensation  is or may
be paid to our directors or executive officers.

ITEM 11.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT VOTING
           SECURITIES AND PRINCIPAL HOLDERS THEREOF

           The authorized capital of our Company consists of: 300,000,000 shares
of common stock without par value;  and 100,000 shares of preferred stock with a
par  value  of CDN  $1,000  per  share.  As of  October  15,  2004,  there  were
217,224,375  issued  and  outstanding  shares of  common  stock and no issued or
outstanding shares of preferred stock.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

PRINCIPAL STOCKHOLDERS

           The  following  table sets  forth,  as of October 15,  2004,  certain
information with respect to the beneficial ownership of our common stock by each
stockholder known by us to be the beneficial owner of more than 5% of our common
stock and by each of our current directors and executive  officers.  Each person
has sole voting and investment power with respect to the shares of common stock,
except  as  otherwise  indicated.  Beneficial  ownership  consists  of a  direct
interest in the shares of common stock, except as otherwise indicated.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------
                                                   AMOUNT AND NATURE OF              PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER               BENEFICIAL OWNERSHIP             OF CLASS(1)
--------------------------------------------------------------------------------------------------
<S>                                                <C>                             <C>
William Cronin                                          684,746(2)                       *
180 Concord Drive
Madison, Connecticut, USA  06443
--------------------------------------------------------------------------------------------------
Martin Gannon                                           410,000(3)                       *
1275 Post Road
Fairfield, Connecticut, USA  06824
--------------------------------------------------------------------------------------------------
</TABLE>


                                       57
<PAGE>

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------
                                                   AMOUNT AND NATURE OF              PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER               BENEFICIAL OWNERSHIP             OF CLASS(1)
--------------------------------------------------------------------------------------------------
<S>                                                <C>                             <C>
Johnny Christiansen                                     250,000                          *
Spurvestien 24
3189 Horten, Norway
--------------------------------------------------------------------------------------------------
Robert Rudman                                         1,590,410(4)                      *
#40 - 5740 Garrison Road
Richmond, BC   V7C 5E7
--------------------------------------------------------------------------------------------------
Al Kozak                                                926,000(5)                       *
25841 116 Avenue
Maple Ridge, BC  V4R 1Z6
--------------------------------------------------------------------------------------------------
Jeff Finkelstein                                        424,950(6)                       *
3460 Regent Street
Richmond, BC  V7E 2N1
--------------------------------------------------------------------------------------------------
Erwin Bartz                                             555,000(7)                       *
21 Arrow-Wood Place
Port Moody, BC  V3H 4E9
--------------------------------------------------------------------------------------------------
Shawn Lammers                                           441,719(8)                       *
3460 Regent Street
Richmond, BC  V7E 2N1
--------------------------------------------------------------------------------------------------
Directors and Executive Officers as a Group           5,282,825(10)                    2.37%
--------------------------------------------------------------------------------------------------
Cornell Capital Partners, LP
101 Hudson St-Suite 3606                             12,941,584                        5.62%
Jersey City NJ 07302
--------------------------------------------------------------------------------------------------
</TABLE>

*     Represents less than 1% of our Company's outstanding stock

(1)   Based on 217,224,375  shares of common stock issued and  outstanding as of
      October 15, 2004.  Beneficial  ownership is determined in accordance  with
      the rules of the Securities and Exchange Commission and generally includes
      voting or investment power with respect to securities. Except as otherwise
      indicated,  we believe  that the  beneficial  owners of the  common  stock
      listed above,  based on  information  furnished by such owners,  have sole
      investment  and voting  power  with  respect  to such  shares,  subject to
      community property laws where applicable.

(2)   Includes  options  to acquire up to  597,500  Common  Shares,  exercisable
      within sixty days.

(3)   Includes  options  to acquire up to  400,100  Common  Shares,  exercisable
      within sixty days.

(4)   Includes  10,257 Common Shares owned by Mr.  Rudman's wife. Mr. Rudman has
      sole voting and dispositive  power over such shares.  Includes  options to
      acquire up to 1,590,410 Common Shares, exercisable within sixty days.

(5)   Consists of options to acquire up to 926,000  Common  Shares,  exercisable
      within 60 days.

(6)   Includes  options  to acquire up to  419,200  Common  Shares,  exercisable
      within 60 days.

(7)   Consists of options to acquire up to 555,000  Common  Shares,  exercisable
      within 60 days.


                                       58
<PAGE>

(8)   Includes  options  to acquire up to  440,200  Common  Shares,  exercisable
      within 60 days.

(9)   Includes  options  to acquire up to  450,000  Common  Shares,  exercisable
      within 60 days.

(10)  Includes  options to acquire up to 5,607,000  Common  Shares,  exercisable
      within 60 days.

CHANGES IN CONTROL

           We are unaware of any contract or other  arrangement the operation of
which may at a subsequent date result in a change of control of SmarTire,  other
than  the  conversion  of our  outstanding  convertible  debentures  in  certain
circumstances.

EQUITY COMPENSATION PLAN INFORMATION

              The following table provides  certain  information with respect to
all of our  Company's  equity  compensation  plans in effect as of September 30,
2004.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------
PLAN CATEGORY               NUMBER OF SECURITIES TO BE ISSUED      WEIGHTED AVERAGE EXERCISE     NUMBER OF SECURITIES
                            UPON EXERCISE OF OUTSTANDING OPTIONS,  PRICE OF OUTSTANDING          REMAINING AVAILABLE FOR
                            WARRANTS AND RIGHTS                    OPTIONS, WARRANTS AND RIGHTS  FUTURE ISSUANCE
----------------------------------------------------------------------------------------------------------------------------
<S>                         <C>                                    <C>                           <C>
Equity compensation plans                                1,216,000                          0.49                  1,380,400
approved by stockholders
----------------------------------------------------------------------------------------------------------------------------
Equity compensation plans                                7,343,800                          0.64                  2,867,300
not approved by
stockholders
----------------------------------------------------------------------------------------------------------------------------
Total                                                    8,559,800                          0.62                  4,247,700
----------------------------------------------------------------------------------------------------------------------------
</TABLE>

ITEM 12.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

           Other  than  as  listed  below,  we  have  not  been a  party  to any
transaction, proposed transaction, or series of transactions in which the amount
involved exceeds $60,000, and in which, to our knowledge,  any of our directors,
officers,  five  percent  beneficial  security  holders,  or any  member  of the
immediate  family  of the  foregoing  persons  has had or will  have a direct or
indirect material interest.

           Mr. Becerra, a director of our Company until his resignation on March
17,  2003,  is a principal of West Sussex  Trading  Inc.  During the fiscal year
ended July 31, 2003, we paid West Sussex  Trading Inc.  $215,108 for  consulting
and financial  advisory services and have issued 621,143 share purchase warrants
(224,000 at an exercise  price of $0.10,  160,000 at an exercise price of $0.50,
60,000 at an  exercise  price of $0.67,  80,000 at an  exercise  price of $0.70,
57,143 at an exercise price of $0.35, and 40,000 at an exercise price of $0.10),
which will expire on various dates between  December 20, 2007 and July 24, 2008.
During fiscal 2002, we paid West Sussex Trading Inc. $115,900 for consulting and
financial  advisory  services and issued  46,900 share  purchase  warrants at an
exercise  price of $1.70,  expiring on January 18, 2005.  During fiscal 2001, we
paid West Sussex  Trading Inc.  $78,510 for  consulting  and financial  advisory
services.  Our Advisory  Agreement with West Sussex Trading Inc. dated September
4, 2002 (filed with the Securities  and Exchange  Commission on October 25, 2002
as an  exhibit  to our annual  report on Form  10-KSB for fiscal  2002) has been
terminated effective March 17, 2003.


                                       59
<PAGE>

           Bernard  Pinsky,  a director of our Company until July 11, 2002, is a
partner in the law firm of Clark,  Wilson  and  during the years  ended July 31,
2002 and 2001, we paid to Clark, Wilson $98,752 and $79,858,  respectively,  for
legal services.

           The promoters of our Company are our directors and officers.

ITEM 13.   EXHIBITS AND REPORTS ON FORM 8-K

(a)        The following documents are filed as part of this report:

           Consolidated Financial Statements. See "Index" on Page F-1;

           Auditors' Report, dated September 10, 2004;

           Consolidated Balance Sheets at July 31, 2004 and July 31, 2003;

           Consolidated Statements of Operations and Deficit for the Years Ended
           July 31, 2004, July 31, 2003 and July 31, 2002;

           Consolidated  Statements of  Stockholders'  Equity and  Comprehensive
           Income  (Loss) for the Years Ended July 31,  2004,  July 31, 2003 and
           July 31, 2002;

           Consolidated  Statements  of Cash Flows for the Years  Ended July 31,
           2004, July 31, 2003 and July 31, 2002; and

           Notes to Consolidated Financial Statements.

(b)        Exhibits. See "Exhibit Index".

(c)        Reports on form 8-K.

           On August 6, 2003 we filed an  Amended  Current  Report on Form 8-K/A
           relating  to a news  release  dated  July  28,  2003  announcing  new
           financing arrangements.

           On September 10, 2003 we filed a Current  Report on Form 8-K relating
           to a news release dated  September 10, 2003 announcing that we signed
           an agreement in principle appointing Beijing Boom Technology Co. Ltd.
           as the Master  Distributor  of our tire pressure  monitoring  systems
           (TPMS) in mainland China.

           On October 22, 2003 we filed a Current Report on Form 8-K relating to
           a news release dated October 20, 2003  announcing  our  Manufacturing
           Agreement with Hyundai Autonet Company, Ltd.

           On October 23, 2003 we filed a Current Report on Form 8-K relating to
           our news release dated October 22, 2003  announcing that we finalized
           the  agreement  appointing  Beijing Boom  Technology  Co. Ltd. as the
           Master Distributor of our tire pressure  monitoring systems (TPMS) in
           mainland China.

           On October 24, 2003 we filed a Current Report on Form 8-K relating to
           our Manufacturing Agreement with Hyundai Autonet Company, Ltd.

           On November  13, 2003 we filed a Current  Report on Form 8-K relating
           to the exercise of certain outstanding warrants at a reduced exercise
           price, and the issuance of additional replacement warrants.

           On December  23, 2003 we filed a Current  Report on Form 8-K relating
           to the amendment of our articles of  continuance  effective  December
           15, 2003.


                                       60
<PAGE>

           On January 5, 2004 we filed a Current  Report on Form 8-K relating to
           a news release dated January 5, 2004  announcing a private  placement
           of discounted unsecured convertible debentures.

           On January 7, 2004 we filed an Amended  Current  Report on Form 8-K/A
           relating to our news release  dated  October 22, 2003 in which we had
           announced the finalization of the agreement  appointing  Beijing Boom
           Technology  Co. Ltd. as the Master  Distributor  of our tire pressure
           monitoring systems (TPMS) in mainland China. The Form 8-K/A was filed
           for  the   purpose  of   re-filing   the   agreement   with   certain
           previously-omitted information included.

           On April 21, 2004 we filed a Current  Report on Form 8-K  relating to
           the issuance of a Promissory note.

           On June 14, 2004 we filed a Current  Report on Form 8-K relating to a
           major sales order with Chu Chang International Ltd.

           On September 13, 2004 we filed a Current  Report on Form 8-K relating
           to the filing of a claim by Palisades  Master Fund, L.P, PEF Advisors
           and Bristol Investment Fund, Ltd against us.

           On September 17, 2004 we filed a Current  Report on Form 8-K relating
           to the filing of a claim by Alpha Capital  Aktiengesellschaft against
           us.

           On October 1, 2004 we filed a Current  Report on Form 8-K relating to
           the  settlement  of a claim by Alpha Capital  Aktiengesellschaft  and
           Palisades Master Fund, L.P, PEF Advisors and Bristol Investment Fund,
           Ltd against us and the issuance of 12,500,000  shares of common stock
           in  consideration  of a $500,000 advance notice on its Standby Equity
           Distribution Agreement with Cornell Capital Partners L.P.

           On October 12, 2004 we filed a Current Report on Form 8-K relating to
           the issuance of 12,500,000 shares of common stock in consideration of
           a  $400,000  advance  notice  on  its  Standby  Equity   Distribution
           Agreement with Cornell Capital Partners L.P.

ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES

           Audit  Fees.  The  aggregate   fees  billed  by  our  auditors,   for
professional  services  rendered for the audit of the Company's annual financial
statements  for the years  ended July 31,  2004 and July 31,  2003,  and for the
reviews of the financial  statements included in the Company's Quarterly Reports
on Form 10-QSB and to review registration statements submitted to the Securities
and Exchange  Commission  during  those  fiscal years were  $111,170 and $79,956
respectively.

           Tax Fees.  The Company  incurred  fees to auditors of $5,230 and $663
for tax compliance  matters during the fiscal years ended July 31, 2004 and July
31, 2003, respectively.


                                       61
<PAGE>

EXHIBIT
NUMBER     DESCRIPTION
-------    ---------------------------------------------------------------------

3.1        Certificate of  Incorporation of TTC/Truck Tech Corp. dated September
           8, 1987 (1)

3.2        Memorandum and Articles of TTC/Truck Tech Corp. (1)

3.3        Memorandum of TTC/Truck Tech Corp. dated September 2, 1987 (1)

3.4        Altered Memorandum of TTC/Truck Tech Corp. dated October 25, 1991 (1)

3.5        Certificate  of Change of Name from  TTC/Truck  Tech Corp. to UniComm
           Signal Inc. dated April 13, 1994.(1)

3.6        Certificate  of Change of Name from  UniComm  Signal Inc. to SmarTire
           Systems Inc. dated December 24, 1997.(1)

3.7        Special  Resolution  and Altered  Memorandum  of UniComm  Signal Inc.
           dated October 28, 1994.(1)

3.8        Special  Resolution  and Altered  Memorandum  of UniComm  Signal Inc.
           dated January 17, 1997.(1)

3.9        Special  Resolution and Altered  Memorandum of SmarTire  Systems Inc.
           dated November 17, 1995.(1)

3.10       Special  Resolution and Altered  Memorandum of SmarTire  Systems Inc.
           dated January 16, 1998.(1)

3.11       Special  Resolution and Altered  Memorandum of SmarTire  Systems Inc.
           dated December 5, 2000.(4)

3.12       Substituted  Articles of SmarTire  Systems Inc.  adopted  December 5,
           2000.(4)

3.13       Articles  of  Continuance,  dated  January  29,  2003  and  effective
           February 6, 2003.(9)

3.14       Certificate of amendment issued to SmarTire Systems Inc. by the Yukon
           Registrar of  Corporations  effective  December 15, 2003 and attached
           Articles of Amendment of SmarTire  Systems  Inc.  dated  Decmeber 11,
           2003.(21)

3.15       Certificate of Registration  of Restated  Articles issued to SmarTire
           Systems  Inc.  by  the  Yukon  Registrar  of  Corporations  effective
           December 15, 2003, and attached Restated Articles of Incorporation of
           SmarTire Systems Inc. dated December 11, 2003.(21)

3.16       By-Law No. 1, dated February 6, 2003.(9)

10.1       Product Licensing Agreement dated May 5, 1998 between our Company and
           Advantage Enterprises Inc.(2)(3)

10.2       Management  Agreement  between our Company and Shawn Lammers dated as
           of August 1, 1999.(3)

10.3       Management  Agreement  between our Company and Robert Rudman dated as
           of August 1, 1999.(3)

10.4       Management  Agreement between SmarTire Europe Limited and Ian Bateman
           dated as of December 9, 1999.(3)

10.5       License  Agreement  dated  September 20, 1999 between our Company and
           Transense Technologies plc.(3)(2)

10.6       Management  agreement between our Company and Erwin Bartz dated as of
           January 3, 2001.(5)


                                       62
<PAGE>

EXHIBIT
NUMBER     DESCRIPTION
-------    ---------------------------------------------------------------------

10.7       License  agreement  dated August 31, 2001 between our Company and TRW
           Inc.(6)(2)

10.8       License  agreement  dated  August 31, 2001  between TRW Inc.  and our
           Company.(6)(2)

10.9       Management agreement between our Company and Al Kozak dated as of May
           1, 2002.(7)

10.10      Advisory  agreement  between our Company and Impact  Capital  Limited
           dated October 25, 2002.(8)

10.11      Management  agreement  between our Company and Jeff Finkelstein dated
           as of October 25, 2002.(8)

10.12      Supply  agreement  between our Company and Pirelli  Pneumatici  dated
           September 24, 2002.(8)(2)

10.13      Manufacturing, Co-Marketing and Development Agreement, dated February
           6, 2003,  between  SmarTire  Systems  Inc.  and  Hyundai  Autonet Co.
           Ltd.(12)

10.14      Warrant  Certificate  dated May 16,  2003  registered  in the name of
           Dunwoody Brokerage Services, Inc.(12)

10.15      Stock Purchase  Warrant dated May 16, 2003  registered in the name of
           HPC Capital Management.(12)

10.16      Form  of  Stock  Purchase   Warrant  for  Impact   Capital   Partners
           Limited.(12)

10.17      Securities  Purchase  Agreement,  dated  as of July 17,  2003,  among
           SmarTire  Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
           AG,   Crescent   International   Ltd.,   and   Goldplate   Investment
           Partners.(13)

10.18      Registration  Rights  Agreement,  dated  as of July 17,  2003,  among
           SmarTire  Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
           AG,   Crescent   International   Ltd.,   and   Goldplate   Investment
           Partners.(13)

10.19      Escrow  Agreement,  dated as of July 17, 2003, among SmarTire Systems
           Inc. and Palisades  Master Fund,  L.P.,  Alpha  Capital AG,  Crescent
           International  Ltd.,   Goldplate   Investment  Partners  and  Feldman
           Weinstein, LLP, as escrow agent.(13)

10.20      Form of 8% Convertible Debenture.(13)

10.21      Form of Stock Purchase Warrant.(13)

10.22      Stock Purchase Warrant,  dated as of July 17, 2003, registered in the
           name of HPC Capital Management.(13)

10.23      Common Stock Purchase  Agreement,  dated as of July 23, 2003, between
           SmarTire Systems Inc. and Talisman Management Limited.(13)


                                       63
<PAGE>

EXHIBIT
NUMBER     DESCRIPTION
-------    ---------------------------------------------------------------------

10.24      Registration  Rights  Agreement,  dated as of July 23, 2003,  between
           SmarTire Systems Inc. and Talisman Management Limited.(13)

10.25      Escrow  Agreement,  dated as of July 23, 2003, among SmarTire Systems
           Inc.,  Talisman  Management  Limited and Feldman  Weinstein,  LLP, as
           escrow agent.(13)

10.26      Stock Purchase Warrant,  dated as of July 23, 2003, registered in the
           name of Talisman Management Limited.(13)

10.27      Stock Purchase Warrant,  dated as of July 23, 2003, registered in the
           name of HPC Capital Management.(13)

10.28      Management  Agreement  between our  Company  and John  Taylor-Wilson,
           dated as of August 1, 2003.(13)

10.29      Engagement  Letter  between our  Company and HPC Capital  Management,
           dated August 12, 2003.(13)

10.30      Stock Purchase Warrant, dated August 15, 2003, registered in the name
           of Epoch Financial Group, Inc.(13)

10.31      Agreement  in   Principle   between  our  Company  and  Beijing  Boom
           Technology Limited dated September 8, 2003(14)(2)

10.32      Master  Distribution  Agreement  between SmarTire Systems and Beijing
           Boom Technology Co. Ltd. dated October 17, 2003 (14)(2)

10.33      Contract  Manufacturing  Services  Agreement between SmarTire Systems
           Inc. and Hyundai Autonet Company dated October 17, 2003.(16)(2)

10.34      Letter Agreement dated October 27, 2003 between SmarTire Systems Inc.
           and HPC Capital Management.(18)

10.35      Stock  Purchase  Warrant,  dated October 27, 2003,  registered in the
           name of HPC Capital Management.(18)

10.36      Letter Agreement dated October 27, 2003 between SmarTire Systems Inc.
           and Palisades Master Fund, L.P.(18)

10.37      Stock  Purchase  Warrant,  dated October 27, 2003,  registered in the
           name of Palisades Master Fund, L.P.(18)

10.38      Letter Agreement dated November 6, 2003 between SmarTire Systems Inc.
           and Crescent International Ltd.(19)

10.39      Stock Purchase  Warrant,  dated November 10, 2003,  registered in the
           name of Crescent International Ltd. (19)

10.40      Letter Agreement dated November 6, 2003 between SmarTire Systems Inc.
           and Alpha Capital AG(19)

10.41      Stock Purchase Warrant,  November 10, 2003, registered in the name of
           Alpha Capital AG(19)

10.42      Letter Agreement dated November 6, 2003 between SmarTire Systems Inc.
           and Goldplate Investment Partners(19)

10.43      Stock Purchase  Warrant,  dated November 10, 2003,  registered in the
           name of Goldplate Investment Partners(19)


                                       64
<PAGE>

EXHIBIT
NUMBER     DESCRIPTION
-------    ---------------------------------------------------------------------

10.44      Amending Letter  Agreement  dated November 10, 2003 between  SmarTire
           Systems Inc. and HPC Capital Management(19)

10.45      Amended  Stock  Purchase  Warrant,  dated  as of  October  27,  2003,
           registered in the name of HPC Capital Management(19)

10.46      Amending Letter  Agreement  dated November 10, 2003 between  SmarTire
           Systems Inc. and Palisades Master Fund, L.P.(19)

10.47      Amended  Stock  Purchase  Warrant,  dated  as of  October  27,  2003,
           registered in the name of Palisades Master Fund, L.P.(19)

10.48      Development  Agreement  dated  September  12, 2003  between  SmarTire
           Systems Inc. and Vansco Ltd.(20)

10.49      Co-Marketing and Development Agreement dated October 10, 2003 between
           Haldex Brake Products Ltd. and SmarTire Systems Inc.(20)

10.50      Supply Agreement dated October 10, 2003 between SmarTire Systems Inc.
           and Haldex Brake Products Ltd.(20)

10.51      Securities Purchase  Agreement,  dated as of December 19, 2003, among
           SmarTire  Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
           AG, Crescent International Ltd., Goldplate Investment Partners, Gamma
           Opportunity  Capital  Partners,  LP, PEF  Advisors  Ltd.  and Bristol
           Investment Fund, Ltd.(22)

10.52      Registration  Rights Agreement,  dated as of December 24, 2003, among
           SmarTire  Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
           AG, Crescent International Ltd., Goldplate Investment Partners, Gamma
           Opportunity  Capital  Partners,  LP, PEF  Advisors  Ltd.  and Bristol
           Investment Fund, Ltd. (22)

10.53      Escrow  Agreement,  dated as of December  24,  2003,  among  SmarTire
           Systems Master Fund, L.P.,  Alpha Capital AG, Crescent  International
           Ltd.,  Goldplate  Investment  Partners,   Gamma  Opportunity  Capital
           Partners,  LP, PEF Advisors Ltd.,  Bristol  Investment Fund, Ltd. and
           Feldman Weinstein, LLP, as escrow agent(22)

10.54      Form of Discounted Convertible Debenture(22)

10.55      Form of Addendum to Discounted Convertible Debenture(22)

10.56      Form of Stock Purchase Warrant(22)

10.57      Placement  Fee  Payment  and  Subscription  Agreement,  dated  as  of
           December  24,  2003,  between  SmarTire  Systems Inc. and HPC Capital
           Management(22)

10.58      Stock Purchase Warrant,  dated as of December 24, 2003, registered in
           the name of HPC Capital Management(22)

10.59      Amendment  Agreement  between  SmarTire  Systems  Inc.  and  Talisman
           Management Limited dated January 21, 2004,  amending the Common Stock
           Purchase Agreement between the parties dated as of July 23, 2003(22)

10.60      Amendment  Agreement  between  SmarTire  Systems  Inc.  and  Talisman
           Management Limited dated January 21, 2004,  amending the Registration
           Rights Agreement between the parties dated as of July 23, 2003(22)


                                       65
<PAGE>

EXHIBIT
NUMBER     DESCRIPTION
-------    ---------------------------------------------------------------------

10.61      Form of Promissory note issued to Cornell Capital Partners, LP(23)

10.62      Standby Equity Distribution Agreement dated May 19, 2004(24)

10.63      Registration Rights Agreement dated May 19, 2004(24)

10.64      Escrow Agreement with Cornell Capital Partners, LP(24)

10.65      Dealer and Supply  Agreement  between SmarTire Systems Inc, Chu Chang
           International  Ltd, Beijing Boom Technology Co. Ltd. dated as of June
           3, 2004(25)

10.66      Forbearance and Escrow Agreement(26)

14.1       Code of Business Conduct and Ethics Compliance Program (16)

21.1       SmarTire Technologies Inc.

21.2       SmarTire USA Inc.

21.3       SmarTire Europe Limited

23.2       Consent of KPMG LLP**

31.1       Certification  pursuant to section 302 of the  Sarbanes-Oxley  Act of
           2002**

31.2       Certification  pursuant to section 302 of the  Sarbanes-Oxley  Act of
           2002**

32.1       Certification  pursuant to18 U.S.C. section 1350, as adopted pursuant
           to section 906 of the Sarbanes-Oxley Act of 2002**

32.2       Certification  pursuant to18 U.S.C. section 1350, as adopted pursuant
           to section 906 of the Sarbanes-Oxley Act of 2002**

**         Filed herewith.

(1)        Incorporated  by reference  to Form 10-KSB filed with the  Securities
and Exchange Commission on August 18, 1998.

(2)        Portions  of the  Exhibit  have  been  omitted  pursuant  to an order
granting confidential treatment under the Securities Exchange Act of 1934.

(3)        Incorporated  by  reference  to SmarTire  Systems  Inc.'s Form 10-QSB
filed with the Securities and Exchange Commission on March 16, 2000.

(4)        Incorporated by reference to SmarTire Systems Inc.'s definitive Proxy
Statement and Information Circular on Schedule 14A filed with the Securities and
Exchange Commission on October 31, 2000.

(5)        Incorporated  by  reference  to SmarTire  Systems  Inc.'s Form 10-KSB
filed with the Securities and Exchange Commission on October 26, 2001.

(6)        Incorporated  by reference to SmarTire  Systems  Inc.'s Form 10-KSB/A
filed with the Securities and Exchange Commission on August 19, 2002.


                                       66
<PAGE>

(7)        Incorporated  by  reference  to SmarTire  Systems  Inc.'s Form 10-KSB
filed with the Securities and Exchange Commission on October 25, 2002.

(8)        Incorporated  by  reference  to SmarTire  Systems  Inc.'s Form 10-QSB
filed with the Securities and Exchange Commission on December 13, 2002.

(9)       Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed
with the Securities and Exchange Commission on January 23, 2003.

(10)       Incorporated  by  reference  to  Post-Effective  Amendment  No.  1 to
SmarTire  Systems  Inc.'s  Form SB-2  filed  with the  Securities  and  Exchange
Commission on March 14, 2003.

(11)       Incorporated  by  reference  to  Post-Effective  Amendment  No.  3 to
SmarTire  Systems  Inc.'s  Form SB-2  filed  with the  Securities  and  Exchange
Commission on May 2, 2003.

(12)       Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed
with the Securities and Exchange Commission on June 4, 2003.

(13)       Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed
with the Securities and Exchange Commission on August 18, 2003.

(14)       Incorporated  by reference to SmarTire  Systems Inc.'s Form 8-K filed
with the Securities and Exchange Commission on September 10, 2003.

(15)       Incorporated  by  reference  to SmarTire  Systems  Inc.'s Form 10-KSB
filed with the Securities and Exchange Commission on October 25, 2003.

(16)       Incorporated by reference to SmarTire Systems Inc.'s Form 8-K/A filed
with the Securities and Exchange Commission on January 7, 2004.

(17)       Incorporated  by reference to SmarTire  Systems Inc.'s Form 8-K filed
with the Securities and Exchange Commission on October 24, 2003.

(18)       Incorporated  by  reference  to  Pre-Effective  Amendment  No.  1  to
SmarTire  Systems  Inc.'s  registration  statement on Form SB-2/A filed with the
Securities Exchange Commission on November 4, 2003.

(19)       Incorporated  by reference to SmarTire  Systems Inc.'s Form 8-K filed
with the Securities and Exchange Commission on November 13, 2003.

(20)       Incorporated  by  reference  to SmarTire  Systems  Inc.'s Form 10-QSB
filed with the Securities and Exchange Commission on December 12, 2003.

(21)       Incorporated  by reference to SmarTire  Systems Inc.'s Form 8-K filed
with the Securities and Exchange Commission on December 23, 2003.

(22)       Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed
with the Securities Exchange Commission on January 15, 2004.

(23)       Incorporated  by reference to SmarTire  Systems Inc.'s 8-K filed with
the Securities Exchange Commission on April 28, 2004.


                                       67
<PAGE>

(24)       Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed
with the Securities Exchange Commission on June 2, 2004.

(25)       Incorporated  by reference to SmarTire  Systems Inc.'s 8-K filed with
the Securities Exchange Commission on June 15, 2004.

(26)       Incorporated  by reference to SmarTire  Systems Inc.'s 8-K filed with
the Securities Exchange Commission on October 1, 2004.


                                       68
<PAGE>

SIGNATURES

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

SMARTIRE SYSTEMS INC.

By:   /s/ Robert V. Rudman
      --------------------------------------
      Robert V. Rudman, CA
      President, Chairman and
      Chief Executive Officer

Date: October 29, 2004

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities indicated on October 28, 2004:

SIGNATURES


/s/ Robert Rudman
----------------------------------------------------
Robert Rudman, President, CEO, Chairman and Director
(Principal Executive Officer)


/s/ Jeff Finkelstein
----------------------------------------------------
Jeff Finkelstein, Chief Financial Officer
(Principal Financial and Accounting Officer)


/s/ Al Kozak
----------------------------------------------------
Al Kozak, Chief Operating Officer and Director


/s/ William Cronin
----------------------------------------------------
William Cronin, Director


/s/ Martin Gannon
----------------------------------------------------
Martin Gannon, Director


/s/ Johnny Christiansen
----------------------------------------------------
Johnny Christiansen, Director


                                       69
<PAGE>

     Consolidated Financial Statements
     (Expressed in United States dollars)
     (Prepared in accordance with U.S. generally accepted accounting principles)

     SMARTIRE SYSTEMS INC.

     Years ended July 31, 2004, 2003 and 2002
<PAGE>

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUTING FIRM

TO THE SHAREHOLDERS OF SMARTIRE SYSTEMS INC.

We have audited the  consolidated  balance sheets of SmarTire Systems Inc. as at
July  31,  2004  and  2003  and  the  consolidated   statements  of  operations,
stockholders'  equity and comprehensive income (loss) and cash flows for each of
the  years in the  three  year  period  ended  July 31,  2004.  These  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

We conducted our audits in accordance with Canadian  generally accepted auditing
standards and the standards of the Public  Company  Accounting  Oversight  Board
(United  States).  Those standards  require that we plan and perform an audit to
obtain  reasonable  assurance  whether  the  financial  statements  are  free of
material  misstatement.  An audit includes examining,  on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by  management,  as well as  evaluating  the  overall  financial  statement
presentation.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of the Company as at
July 31, 2004 and 2003 and the results of its  operations and its cash flows for
each of the years in the three year  period  ended July 31,  2004 in  accordance
with U.S. generally accepted accounting principles.

On  September  10, 2004,  except for note 16 which is as of October 5, 2004,  we
reported  separately  to the  shareholders  of the  Company on the  consolidated
balance sheets as at July 31, 2004 and 2003 and the  consolidated  statements of
operations  and  deficit  and  cash  flows  for  the  years  then  ended,  which
consolidated  financial  statements  were prepared in  accordance  with Canadian
generally accepted accounting principles.

/s/ KPMG LLP

Chartered Accountants

Vancouver, Canada
September 10, 2004, except for note 16
  which is as of October 5, 2004

COMMENTS BY AUDITOR FOR U.S. READERS ON CANADA - U.S. REPORTING DIFFERENCE

In the United States,  reporting  standards for auditors require the addition of
an explanatory  paragraph  (following the opinion  paragraph) when the financial
statements are affected by conditions and events that cast substantial  doubt on
the Company's ability to continue as a going concern, such as those described in
note 2 to the  financial  statements.  Our  report  to  the  shareholders  dated
September  10,  2004,  except for note 16 which is as of  October  5,  2004,  is
expressed in accordance with Canadian reporting  standards which do not permit a
reference to such events and conditions in the report of independent  registered
public  accounting  firm when these are  adequately  disclosed in the  financial
statements.

/s/ KPMG LLP

Chartered Accountants

Vancouver, Canada
September 10, 2004, except for note 16
 which is as of October 5, 2004
<PAGE>

<TABLE>
<CAPTION>

SMARTIRE SYSTEMS INC.
Consolidated Balance Sheets
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

July 31, 2004 and 2003

-----------------------------------------------------------------------------------------------------------------------------
                                                                                                    2004                 2003
-----------------------------------------------------------------------------------------------------------------------------
<S>                                                                                        <C>                  <C>
Assets

Current assets:
      Cash and cash equivalents                                                             $    112,951         $  1,843,694
      Receivables, net of allowance for doubtful accounts
         of nil (2003 - nil)                                                                     259,508              405,885
      Inventory (note 4)                                                                       3,245,807              806,846
      Prepaid expenses                                                                           189,477              165,792
-----------------------------------------------------------------------------------------------------------------------------
                                                                                               3,807,743            3,222,217

Capital assets (note 5)                                                                          824,616              550,458

Deferred financing costs (note 10)                                                               157,020              183,259

Other assets (note 6)                                                                          2,147,749            3,129,658
-----------------------------------------------------------------------------------------------------------------------------
                                                                                            $  6,937,128         $  7,085,592
=============================================================================================================================

Liabilities and Stockholders' Equity

Current liabilities:
      Accounts payable and accrued liabilities                                              $  1,293,251         $    788,267
      Deferred revenue                                                                            10,830               10,018
      Promissory notes payable (note 7)                                                        1,500,000                   --
      Current portion of convertible debentures                                                  271,257                   --
-----------------------------------------------------------------------------------------------------------------------------
                                                                                               3,075,338              798,285
Convertible debentures, net of equity portion of $1,525,253
      (2003 - $1,966,664) (note 8)                                                               395,574                    3

Stockholders' equity:
      Share capital (note 9):
         Preferred shares, par value $1,000 Cdn per share:
             100,000 shares authorized
             Issued and outstanding: none
         Common shares, without par value:
                300,000,000 shares authorized (July 31, 2003-200,000,000)
                103,130,761 shares issued and outstanding at
                   July 31, 2004 (July 31, 2003 -55,039,065)                                  58,368,020           48,204,995
      Additional paid-in capital                                                               4,417,323            6,681,893
      Deficit                                                                                (59,018,256)         (48,031,230)
      Accumulated other comprehensive loss                                                      (300,871)            (568,354)
-----------------------------------------------------------------------------------------------------------------------------
                                                                                               3,466,216            6,287,304
-----------------------------------------------------------------------------------------------------------------------------
                                                                                            $  6,937,128         $  7,085,592
=============================================================================================================================
</TABLE>

Going concern (note 2)
Commitments and contingencies (note 14)
Subsequent events (note 16)

See accompanying notes to consolidated financial statements.

Approved on behalf of the Board



______________________________Director      ___________________________ Director
Robert V. Rudman                            Bill Cronin


                                                                               1
<PAGE>

<TABLE>
<CAPTION>

SMARTIRE SYSTEMS INC.
Consolidated Statements of Operations
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

----------------------------------------------------------------------------------------------------------------------------
                                                                              2004                 2003                 2002
----------------------------------------------------------------------------------------------------------------------------
<S>                                                                   <C>                  <C>                  <C>
Revenue                                                               $  1,658,279         $  1,802,596         $  1,012,344

Cost of goods sold                                                       1,445,563            1,387,365              699,955
----------------------------------------------------------------------------------------------------------------------------
                                                                           212,716              415,231              312,389

Expenses:
        Depreciation and amortization                                    1,371,717            1,236,870            1,152,378
        Engineering, research and development                            1,654,690            1,177,935            1,727,606
        General and administrative                                       2,338,758            2,939,260            2,631,215
        Marketing                                                        1,821,122            1,448,326            1,527,644
----------------------------------------------------------------------------------------------------------------------------
                                                                         7,186,287            6,802,391            7,038,843
----------------------------------------------------------------------------------------------------------------------------

Loss from operations                                                    (6,973,571)          (6,387,160)          (6,726,454)

Other earnings (expenses):
        Interest income                                                      5,873                2,835               18,735
        Net interest and financing expenses                             (4,031,820)          (3,722,505)            (145,472)
        Foreign exchange gain                                               12,492              192,201               24,015
----------------------------------------------------------------------------------------------------------------------------
                                                                        (4,013,455)          (3,527,469)            (102,722)
----------------------------------------------------------------------------------------------------------------------------
Loss for the year                                                     $(10,987,026)        $ (9,914,629)        $ (6,829,176)
============================================================================================================================

Basic and diluted loss per share                                      $      (0.13)        $      (0.37)        $      (0.41)

Weighted average number of common
      shares used in the computation of basic
        and diluted loss per share (note 13)                            83,356,095           26,771,427           16,743,977
============================================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.


                                                                               2
<PAGE>

<TABLE>
<CAPTION>

SMARTIRE SYSTEMS INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

====================================================================================================================================
Years ended July 31, 2004, 2003 and 2002


                                                                                            Accumulated
                               Common shares      Additional      Deferred                        other
                          ----------------------     paid-in         stock                comprehensive  Stockholders'Comprehensive
                              Shares      Amount     capital  compensation       Deficit           loss        equity  income (loss)
------------------------------------------------------------------------------------------------------------------------------------
                                            $           $           $               $           $              $            $
Balance at July 31, 2001  15,159,369  37,566,083     683,462       (40,773)  (31,287,425)      (806,198)     6,115,149   (5,779,943)
====================================================================================================================================
<S>                       <C>         <C>         <C>         <C>            <C>          <C>            <C>           <C>
Issuance of common
  shares for cash
  upon private
  placements, net
  of issuance costs
  of $551,569              3,352,000   4,650,289          --            --            --             --      4,650,289           --
Exercise of warrants
  for cash, net of
  issuance costs
  of $10,890                 200,000     298,110          --            --            --             --        298,110           --
Fair value of
  warrants issued
  on private placement            --          --     206,340            --            --             --        206,340           --
Forfeiture of
  stock options                   --          --      (4,341)        4,341            --             --             --           --
Compensation
  expense                         --          --          --        19,427            --             --         19,427           --
Loss for the
  period                          --          --          --            --    (6,829,176)            --     (6,829,176)  (6,829,176)
Translation
  adjustment                      --          --          --            --            --       (171,093)      (171,093)    (171,093)
------------------------------------------------------------------------------------------------------------------------------------
Balance at July
  31, 2002                18,711,369  42,514,482     885,461       (17,005)  (38,116,601)      (977,291)     4,289,046   (7,000,269)
====================================================================================================================================

Issuance of common
  shares for cash
  upon private
  placements, net
  of issuance costs
  of $289,172
  (note 9(a))              6,964,286   1,810,828          --            --            --             --      1,810,828           --
Intrinsic value of
  beneficial
  conversion feature
  of convertible
  debentures plus
  fair value of
  warrants issued
  (note 8)                        --          --   5,157,521            --            --             --      5,157,521           --
Conversion of
  convertible
  debenture and
  accrued interest
  to common shares
  net of issuance
  costs of $628,526
  (note 8)                24,381,133   3,024,395          --            --            --             --      3,024,395           --
Exercise of warrants
  for cash, net of
  issuance costs
  of $61,060 (note 9(b))   3,300,000     298,940          --            --            --             --        298,940           --
Issuance of shares
  as fees on equity
  line of credit
  (note 9(c))                478,412     300,000          --            --            --             --        300,000           --
------------------------------------------------------------------------------------------------------------------------------------

Balance carried forward   53,835,200  47,948,645   6,042,982       (17,005)  (38,116,601)      (977,291)    14,880,730           --
</TABLE>


                                                                               3
<PAGE>


<TABLE>
<CAPTION>

SMARTIRE SYSTEMS INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) (Continued)
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002
====================================================================================================================================
                                                                                            Accumulated
                               Common shares      Additional      Deferred                        other
                          ----------------------     paid-in         stock                comprehensive  Stockholders'Comprehensive
                              Shares      Amount     capital  compensation       Deficit           loss        equity  income (loss)
------------------------------------------------------------------------------------------------------------------------------------
                                            $           $           $               $           $              $            $
<S>                       <C>         <C>         <C>         <C>            <C>          <C>            <C>          <C>
Balance brought forward   53,835,200  47,948,645   6,042,982       (17,005)  (38,116,601)      (977,291)    14,880,730           --

Fair value of agent's
  warrants issued on
  private placements and
  convertible debentures
  (notes 8 and 9)                 --          --     502,367            --            --             --        502,367           --
Debt settlement through
  issuance of common
  shares (note 9(d))         353,865      77,850          --            --            --             --         77,850           --
Issuance of shares and
  repricing of warrants
  to settle a potential
  claim (note 9(e))          850,000     178,500     136,544            --            --             --        315,044           --
Compensation expense              --          --          --        17,005            --             --         17,005           --
Loss for the period               --          --          --            --    (9,914,629)            --     (9,914,629)  (9,914,629)
Translation adjustment            --          --          --            --            --        408,937        408,937      408,937
------------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 2003  55,039,065  48,204,995   6,681,893            --   (48,031,230)      (568,354)     6,287,304   (9,505,692)
====================================================================================================================================

Exercise of stock options
  for cash (note 9 (j))       79,400      15,880          --            --            --             --         15,880           --
Intrinsic value of
  beneficial conversion
  feature of convertible
  debentures plus fair
  value of warrants
  issued (note 8)                 --          --   2,457,023            --            --             --      2,457,023           --
Conversion of convertible
  debentures and accrued
  interest to common
  shares allocated pro-rata
  between additional
  paid-in-capital and
  common shares, net of
  issuance costs of
  $156,133 (note 8)       20,882,076   5,344,961  (2,788,277)           --            --             --      2,556,684           --
Exercise of warrants for
  cash, net of issuance
  costs of $78,370
  (note 9(f))             12,463,231   3,702,985  (1,601,970)           --            --             --      2,101,015           --
Issuance of shares and
  warrants as fees for
  services
  received (note 9(g))       200,000      34,800      63,375            --            --             --         98,175           --
Fair value of agent's
  warrants issued on
  private placement of
  convertible debentures
  (note 8(d))                     --          --      15,699            --            --             --         15,699           --
Issuance of shares as
  fees on equity line of
  credit (note 9(h))       3,605,769     375,000    (375,000)           --            --             --             --           --
Cash cost incurred for
  equity line (note 9(h))         --          --     (35,420)           --            --             --        (35,420)          --
Shares issued upon draw
  downs on equity line
  of credit, net of
  issuance cost of
  $60,601 (note 9(h))     10,861,220     689,399          --            --            --             --        689,399
Loss for the period               --          --          --            --   (10,987,026)                  (10,987,026) (10,987,026)
Translation adjustment            --          --          --            --            --        267,483        267,483      267,483
------------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 2004 103,130,761  58,368,020   4,417,323            --   (59,018,256)      (300,871)     3,466,216  (10,719,543)
====================================================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.


                                                                               4
<PAGE>


<TABLE>
<CAPTION>

SMARTIRE SYSTEMS INC.

Consolidated Statements of Cash Flows
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)


Years ended July 31, 2004, 2003 and 2002

===============================================================================================================================
                                                                             2004                   2003                   2002
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>                    <C>                    <C>
Cash provided by (used for):
Operating activities:
      Loss for the year                                              $(10,987,026)          $ (9,914,629)          $ (6,829,176)
      Items not affecting cash:
         Depreciation and amortization                                  1,371,717              1,236,870              1,152,378
         Stock-based compensation                                              --                 17,005                 19,427
         Non-cash interest and finance charges                          3,842,107              3,694,914                     --
         Issuance of shares and warrants for services received             98,175                     --                     --
         Issuance of shares and repricing of warrants to settle a
            potential claim (note 9(c))                                        --                315,044                     --
      Changes in non-cash working capital:
         Receivables                                                      170,127               (182,366)                (5,266)
         Deferred revenue                                                      --                  9,423                     --
         Deferred financing expense                                            --                 (5,000)                    --
         Inventory                                                     (2,391,749)               594,333                151,249
         Prepaid expenses                                                 (13,984)               240,861               (294,769)
         Accounts payable and accrued liabilities                         374,794               (434,556)               346,652
-------------------------------------------------------------------------------------------------------------------------------

      Net cash used in operating activities                            (7,535,839)            (4,428,101)            (5,459,505)

Investing activities:
      Purchase of capital assets                                         (446,780)               (62,978)              (164,886)
      Purchase of other asset                                                  --                     --               (500,000)
-------------------------------------------------------------------------------------------------------------------------------

      Net cash used in investing activities                              (446,780)               (62,978)              (664,886)

Financing activities:
      Cash received on exercise of stock options                           15,880                     --                     --
      Issuance of common shares                                                --              2,100,000              5,173,500
      Cash received on exercise of warrants (note 9 (f))                2,179,385                360,000                309,000
      Proceeds from convertible debentures (note 8)                     2,725,000              5,618,000                     --
      Proceeds from promissory note (note 7)                            1,500,000                250,000                     --
      Proceeds from equity line of credit (note 9)                        750,000                     --                     --
      Financing costs                                                    (626,696)              (886,799)              (316,871)
      Repayment of promissory notes (notes 6 and 7)                      (305,715)            (1,600,000)            (1,450,000)
-------------------------------------------------------------------------------------------------------------------------------

      Net cash provided by financing activities                         6,237,854              5,841,201              3,715,629

Effect of exchange rate differences on cash
      and cash equivalents                                                 14,022                (32,396)                 4,473
-------------------------------------------------------------------------------------------------------------------------------

Net increase (decrease) in cash and cash equivalents                   (1,730,743)             1,317,726             (2,404,289)

Cash and cash equivalents, beginning of year                            1,843,694                525,968              2,930,257
-------------------------------------------------------------------------------------------------------------------------------

Cash and cash equivalents, end of year                               $    112,951           $  1,843,694           $    525,968
===============================================================================================================================

Supplementary information:
      Interest and finance charges paid                              $    189,713           $     27,591           $     92,093
Non-cash investing and financing activities:
      Purchase of other asset through issuance of promissory note              --                     --              2,800,000
      Fair value of agents warrants issued in conjunction with
         financings                                                        15,699                502,367                206,340
      Shares issued for financing services on private placement                --                     --                 28,358
      Settlement of debt through issuance of common shares
         (note 9(d))                                                           --                 77,850                     --
      Conversion of convertible debentures to common shares             2,556,684              3,024,395                     --
      Issuance of shares as consideration for equity line of credit       375,000                300,000                     --
      Financing costs included in accounts payable                         52,859                 30,000                     --
===============================================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.


                                                                               5
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

1.    OPERATIONS:

      The Company and its subsidiaries develop and market products incorporating
      wireless data transmission and processing technologies,  primarily for the
      automotive  markets.  The  Company's  primary  product is a wireless  tire
      monitoring  system  which  it  currently  markets  for  use  on  passenger
      vehicles,  motorcycles,  recreational  vehicles,  trucks,  buses and other
      pneumatic  tire  applications.  All sales of its  product are made in this
      industry segment.

2.    GOING CONCERN:

      The Company  requires  additional  financing to fund its  operations.  The
      Company  has  incurred  recurring  operating  losses  and has a deficit of
      $59,018,256  and working  capital of $732,405 as at July 31, 2004.  During
      the year ended July 31,  2004,  the  Company  used cash of  $7,982,619  in
      operating and investing activities.

      The Company is pursuing  various  alternatives  to meet its  immediate and
      long-term financial requirements. During fiscal 2004, the Company realized
      gross   cash   proceeds   of   $7,170,265   from   financing    activities
      (2003-$8,328,000) and arranged a $15.0 million equity line of credit (note
      9(h)) to fund its  operations.  Subsequent  to the  year-end,  the Company
      raised gross  proceeds of $2,746,788  (note 16). There can be no assurance
      that the  Company  can draw down  amounts  under the equity line of credit
      when  required  and that  additional  financing  will be  available to the
      Company  when  needed  or,  if  available,  that  it  can be  obtained  on
      commercially  reasonable terms.  These consolidated  financial  statements
      have been  prepared on the going concern basis which assumes that adequate
      sources of financing  will be obtained as required and that the  Company's
      assets will be realized and liabilities  settled in the ordinary course of
      business.  Accordingly,  these  consolidated  financial  statements do not
      include  any  adjustments  related  to the  recoverability  of assets  and
      classification  of assets and liabilities  that might be necessary  should
      the Company be unable to continue as a going concern.

3.    SIGNIFICANT ACCOUNTING POLICIES:

      (a)   Basis of presentation:

            These consolidated  financial statements include the accounts of the
            Company  and  its  wholly-owned  subsidiaries,  SmarTire  USA  Inc.,
            SmarTire  Europe  Limited,   and  SmarTire   Technologies  Inc.  All
            intercompany balances and transactions have been eliminated.

      (b)   Research and development costs:

            Research and development  costs are expensed as incurred.  Equipment
            used in research and  development is  capitalized  only if it has an
            alternative future use.

      (c)   Cash and cash equivalents:

            Cash  and  cash  equivalents   includes  investments  in  short-term
            investments  with a term to  maturity  when  acquired  of 90 days or
            less.


                                                                               6
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

3.    SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

      (d)   Inventory:

            Inventory  of raw  materials  are  recorded  at the  lower  of cost,
            determined on a first-in, first-out basis, and net realizable value.
            Inventory of finished goods and work-in progress are recorded at the
            lower of average  cost and net  realizable  value.  Average  cost is
            determined  using the  weighted-average  method and includes invoice
            cost, duties and freight where applicable plus direct labour applied
            to the product and an applicable share of manufacturing  overhead. A
            provision  for  obsolescence  for  slow  moving  inventory  items is
            estimated by  management  based on  historical  and expected  future
            sales and is included in cost of goods sold.

      (e)   Capital assets:

            Capital  assets  are  recorded  at cost.  Depreciation  of  computer
            hardware and software and office and shop  equipment is provided for
            on  the  declining  balance  basis  at  30%  per  annum.   Leasehold
            improvements  are depreciated  over the lesser of their useful lives
            or the term of the lease.

      (f)   Other assets:

            Other  assets  include  the  license  to  manufacture  and sell tire
            monitoring systems to the original  equipment vehicle  manufacturers
            (note 6). Other assets are recorded at cost and are being  amortized
            over five years on a straight-line basis.

      (g)   Impairment of long-lived assets:

            The Company monitors the recoverability of long-lived assets,  based
            on  estimates   using   factors   such  as  expected   future  asset
            utilization,  business  climate and future  undiscounted  cash flows
            expected  to  result  from the use of the  related  assets  or to be
            realized on sale. The Company  recognizes an impairment  loss if the
            projected  undiscounted  future cash flows is less than the carrying
            amount.  The amount of the  impairment  charge,  if any, is measured
            equal to the excess of the carrying  value over the expected  future
            cash flows discounted using the Company's average cost of funds.

      (h)   Revenue recognition:

            The Company recognizes revenue when there is persuasive  evidence of
            an  arrangement,  goods are shipped and title passes,  collection is
            probable, and the fee is fixed or determinable.  Customer acceptance
            is used as the  criterion for revenue  recognition  when the product
            sold does not have an established  sales history to allow management
            to reasonably estimate returns and future provisions. Provisions are
            established for estimated  product returns and warranty costs at the
            time the revenue is recognized. The Company records deferred revenue
            when cash is received in advance of the revenue recognition criteria
            being met.  Revenue  from  engineering  services  is  recognized  on
            services  as  they  are  rendered  and  pre-defined  milestones  are
            achieved.  Engineering  services  revenue for the year were  $94,800
            (2003-$173,400 and 2002 - nil).


                                                                               7
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

3.    SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

      (i)   Loss per share:

            Basic loss per share  computations are based on the weighted average
            number of shares  outstanding  during  the year.  If in a period the
            Company has outstanding dilutive stock options and warrants, diluted
            loss per share is calculated using the treasury stock method.

      (j)   Income taxes:

            The Company  accounts for income taxes in accordance  with the asset
            and liability method.  Under this method,  deferred income taxes are
            recognized for the future income tax  consequences  attributable  to
            differences  between the financial  statement  carrying  amounts and
            their  respective  income  tax  bases  and for loss  and tax  credit
            carryforwards.  Deferred  tax assets and  liabilities  are  measured
            using enacted tax rates  expected to apply to taxable  income in the
            years in which temporary differences are expected to be recovered or
            settled. The effect on deferred income tax assets and liabilities of
            a change in tax  rates is  recognized  in  income  in the  period of
            enactment.  Deferred  income tax assets are  evaluated  and if their
            realization  is not  considered  to be "more  likely  than  not",  a
            valuation allowance is provided.

      (k)   Warranty costs:

            The Company  accrues  warranty costs upon the recognition of related
            revenue,  based  on its  best  estimates,  with  reference  to  past
            experience. See note 14(c).

      (l)   Foreign currency translation:

            The  Company's  functional  or  primary  operating  currency  is the
            Canadian dollar. The Company's financial  statements are prepared in
            Canadian  dollars  before  translation  to the US  dollar  reporting
            currency.  The Company  translates  transactions in currencies other
            than the  Canadian  dollar  at the  exchange  rate in  effect on the
            transaction date.  Monetary assets and liabilities  denominated in a
            currency  other  than the  Canadian  dollar  are  translated  at the
            exchange  rates in effect at the balance  sheet date.  The resulting
            exchange  gains and  losses  are  recognized  in  earnings.  Amounts
            reported in Canadian dollars have been translated into US dollars as
            follows:  assets and  liabilities  are translated into US dollars at
            the rate of exchange in effect at the balance sheet date and revenue
            and  expense  items  are  translated  at the  average  rates for the
            period.  Unrealized  gains and losses resulting from the translation
            into the reporting  currency are  accumulated in  accumulated  other
            comprehensive loss, a separate component of stockholders' equity.


                                                                               8
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

3.    SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

      (m)   Use of estimates:

            The   preparation  of  financial   statements  in  conformity   with
            accounting  principles  generally  accepted in the United  States of
            America requires management at the date of the financial  statements
            to make estimates and assumptions  that affect the reported  amounts
            of assets and  liabilities  and disclosure of contingent  assets and
            liabilities at the date of the financial statements and the reported
            amounts  to  revenues  and  expenses  during the  reporting  period.
            Significant areas requiring the use of estimates include  estimating
            the net  realizable  value of  inventory,  the future cash flows for
            assessing  the net  recoverable  amount  of  long-lived  assets  and
            warranty reserve. Actual results may differ from those estimates.

      (n)   Stock-based compensation:

            The Company has elected under FAS 123,  Accounting  for  Stock-based
            Compensation,  to  account  for  employee  stock  options  using the
            intrinsic  value  method.  This method is  described  in  Accounting
            Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued
            to Employees,  and related  interpretations.  As the Company  grants
            stock options with an exercise  price not less than the market value
            of  the  underlying   common  shares  on  the  date  of  grant,   no
            compensation  expense is required to be recognized under APB 25. FAS
            123 uses the fair  value  method  of  calculating  the cost of stock
            option grants. Had compensation cost for employee stock options been
            determined  by this  method,  net loss and net loss per share  would
            have been as follows:

<TABLE>
<CAPTION>

            ===================================================================================================================
                                                                             2004                   2003                   2002
            -------------------------------------------------------------------------------------------------------------------
            <S>                                                      <C>                    <C>                    <C>

            Net loss:
              As reported                                            $(10,987,026)          $ (9,914,629)          $ (6,829,176)
              Stock-based compensation expense
                recognized using intrinsic value method                        --                 17,005                 19,427
              Stock-based compensation expense
                determined under fair value based
                method for all awards                                  (1,291,736)              (738,339)            (1,076,749)
            -------------------------------------------------------------------------------------------------------------------

              Pro forma                                              $(12,278,762)          $(10,635,963)          $ (7,886,498)
            ===================================================================================================================

            Basic and diluted loss per share:
              As reported                                                   (0.13)                 (0.37)                 (0.41)
              Pro forma                                                     (0.15)                 (0.40)                 (0.47)
            ===================================================================================================================
</TABLE>


                                                                               9
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

3.    SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

      (n)   Stock-based compensation (continued):

            The Company recognizes compensation expense on a straight-line basis
            over the vesting  period  beginning  on the date the stock option is
            granted.

            The fair value of each option and warrant  granted is  estimated  on
            the date of grant using the  Black-Scholes  option  valuation  model
            with the following range of weighted average assumptions.

<TABLE>
<CAPTION>

            ===================================================================================================================
                                                                             2004                   2003                   2002
            -------------------------------------------------------------------------------------------------------------------
            <S>                                                      <C>                    <C>                    <C>
            Expected dividend yield                                             0%                     0%                     0%
            Expected stock price volatility                               139-152%               128-155%                   129%
            Risk-free interest rate                                     3.28-4.08%               3.6-4.3%                  4.35%
            Expected life of options and warrants                       3-5 years              2-5 years              1-2 years

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

            Weighted-average  fair values of options granted during the year are
            as follows:

            ===================================================================================================================
                                                                             2004                   2003                   2002
            -------------------------------------------------------------------------------------------------------------------

            Options whose exercise price at date of grant:
              Equals the market price of stock                       $       0.07           $       0.72           $         --
              Exceeds the market price of stock                              0.16                   0.94                   2.07
              Is less than the market price of stock                           --                     --                     --
            ===================================================================================================================
</TABLE>

            The  Company  recognizes  compensation  expense  for stock  options,
            common  stock and other  instruments  issued  to  non-employees  for
            services   received   based  upon  the  fair  value  of  the  equity
            instruments  issued as the services are performed and the instrument
            is earned.

            If the exercise price of employee stock option award is not fixed in
            the  functional  currency  of the  Company  or in the  currency  the
            employee is paid,  the award is  accounted  for as a variable  award
            until the award is exercised, forfeited, or expires unexercised. The
            Company  measures  compensation  as the  amount by which the  quoted
            market value of the common shares of the Company's  stock covered by
            the grant exceeds the option price, with changes in the market price
            included in the measurement of loss.

      (o)   Comprehensive income:

            Under  SFAS 130,  Reporting  Comprehensive  Income,  the  Company is
            required to report comprehensive  income, which includes net loss as
            well as changes in equity from non-owner sources.  The other changes
            in equity included in comprehensive income for the periods presented
            comprise the foreign currency  cumulative  translation  adjustments.
            Accumulated   other   comprehensive   loss  is   presented   in  the
            consolidated  statements of stockholders'  equity and  comprehensive
            income (loss).


                                                                              10
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

3.    SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

      (p)   Recent accounting pronouncements:

            In  December  2003,  the FASB  issued  FASB  Interpretation  No.  46
            (revised   December  2003),   Consolidation  of  Variable   Interest
            Entities,  which addresses how a business enterprise should evaluate
            whether it has a controlling financial interest in an entity through
            means other than voting rights and  accordingly  should  consolidate
            the  entity.   FIN  46R  replaces   FASB   Interpretation   No.  46,
            Consolidation  of Variable  Interest  Entities,  which was issued in
            January  2003.  The  Company  will be  required  to apply FIN 46R to
            variable  interest in VIEs created  after  December  31,  2003.  For
            variable  interests  in VIEs  created  before  January 1, 2004,  the
            Interpretation  will be applied  beginning on July 31, 2004. For any
            VIEs that  must be  consolidated  under  FIN 46R that  were  created
            before January 1, 2004, the assets,  liabilities and  noncontrolling
            interests of the VIE initially  would be measured at their  carrying
            amounts  with any  difference  between  the net amount  added to the
            balance  sheet  and  any   previously   recognized   interest  being
            recognized  as the  cumulative  effect of an accounting  charge.  If
            determining the carrying amounts is not  practicable,  fair value at
            the date FIN 46R first  applies  may be used to measure  the assets,
            liabilities  and  noncontrolling  interest  of the VIE.  The Company
            currently  has no  variable  interest  entities,  hence  there is no
            impact of FIN 46R on these consolidated financial statements.

            In April 2003, the FASB issued FAS No. 149,  "Amendment of Statement
            133 on  Derivative  Instruments  and Hedging  Activities"  ("FAS No.
            149"), which amends and clarifies financial accounting and reporting
            for derivative instruments, including certain derivative instruments
            embedded in other  contracts,  and for hedging  activities under FAS
            No.  133.  FAS No. 149 is to be applied  prospectively  for  certain
            contracts  entered into or modified after June 30, 2003. The Company
            has  adopted FAS No.  149,  which had no effect on our  consolidated
            financial statements.

            FASB Statement No. 150, Accounting for Certain Financial Instruments
            with  Characteristics  of both Liabilities and Equity, was issued in
            May   2003.   This   Statement   establishes   standards   for   the
            classification and measurement of certain financial instruments with
            characteristics  of both liabilities and equity.  The Statement also
            includes required  disclosures for financial  instruments within its
            scope. For the Company,  the Statement was effective for instruments
            entered into or modified  after May 31, 2003 and  otherwise  will be
            effective as of August 1, 2004,  except for  mandatorily  redeemable
            financial instruments.  For certain mandatorily redeemable financial
            instruments,  the  Statement  will be  effective  for the Company on
            August 1, 2005.  The effective  date has been deferred  indefinitely
            for  certain  other  types  of  mandatorily   redeemable   financial
            instruments.  The Company  has  adopted  FAS No.  150,  which had no
            impact on these consolidated financial statements.


                                                                              11
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

4.    Inventory:

<TABLE>
<CAPTION>

      =============================================================================================================
                                                                                        2004                   2003
      -------------------------------------------------------------------------------------------------------------
      <S>                                                                       <C>                     <C>
      Raw materials                                                              $ 1,515,438            $   318,512
      Work in progress                                                               554,421                 59,599
      Finished goods                                                               1,175,948                428,735
      -------------------------------------------------------------------------------------------------------------
                                                                                 $ 3,245,807            $   806,846
      =============================================================================================================


5.    CAPITAL ASSETS:

      =============================================================================================================
                                                                                 Accumulated               Net book
      2004                                                       Cost           amortization                  Value
      -------------------------------------------------------------------------------------------------------------

         Computer hardware and software                  $    697,178           $    509,980            $   187,198
         Office and shop equipment                          1,336,068                786,049                550,019
         Leasehold improvements                               207,327                119,928                 87,399
      -------------------------------------------------------------------------------------------------------------
                                                         $  2,240,573           $  1,415,957            $   824,616
      =============================================================================================================

      =============================================================================================================
                                                                                 Accumulated               Net book
         2003                                                    Cost           amortization                  Value
      -------------------------------------------------------------------------------------------------------------

      Computer hardware and software                     $    600,781           $    415,801            $   184,980
      Office and shop equipment                               886,748                609,095                277,653
      Leasehold improvements                                  192,515                104,690                 87,825
      -------------------------------------------------------------------------------------------------------------
                                                         $  1,680,044           $  1,129,586            $   550,458
      =============================================================================================================
</TABLE>


6.    OTHER ASSETS:

      On December 13, 2000, the Company entered into an Assignment and Amendment
      Agreement  with TRW Inc.  ("TRW")  that  transferred  to the  Company  the
      license to manufacture  and sell tire  monitoring  systems to the original
      equipment  vehicle  manufacturers  of most  medium and heavy duty  trucks.
      Consideration  consisted  of  490,072  shares  of common  stock  valued at
      $1,337,500,  based on the market value of the Company's  stock at the date
      of purchase, plus cash of $400,000.

      On August 31,  2001,  the  Company and TRW entered  into an  agreement  to
      restructure  their strategic  alliance.  Under the terms of restructuring,
      the  Company  and TRW  agreed to  terminate  a number of  agreements.  The
      Company has the right to manufacture and sell tire  monitoring  systems to
      the original equipment vehicle manufacturers market ("OEM"). Consideration
      consisted of a promissory note of $2.8 million,  carrying an interest rate
      of 6% per annum plus cash of  $500,000.  The balance of  principal  in the
      amount of  $1,350,000  owed at July 31, 2002 was repaid during fiscal 2003
      and interest of $97,542 on this balance was forgiven by TRW.


                                                                              12
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

6.    OTHER ASSETS (CONTINUED):

      The rights are being amortized over five years on a straight-line basis.

<TABLE>
<CAPTION>

      =============================================================================================================
                                                                                 Accumulated               Net book
      2004                                                       Cost           amortization                  Value
      -------------------------------------------------------------------------------------------------------------
      <S>                                                <C>                    <C>                     <C>
      OEM - most medium and heavy duty trucks            $  1,737,500           $  1,190,402            $   547,098
      OEM - all other vehicles                              3,300,000              1,699,349              1,600,651
      -------------------------------------------------------------------------------------------------------------
                                                         $  5,037,500           $  2,889,751            $ 2,147,749
      =============================================================================================================


      =============================================================================================================
                                                                                 Accumulated              Net book
         2003                                                    Cost           amortization                 Value
      -------------------------------------------------------------------------------------------------------------
      OEM - most medium and heavy duty Trucks            $  1,737,500           $    845,850            $   891,650
      OEM - all other vehicles                              3,300,000              1,061,992              2,238,008
      -------------------------------------------------------------------------------------------------------------
                                                         $  5,037,500            $ 1,907,842            $ 3,129,658
      =============================================================================================================
</TABLE>

      Management  believes  that  the net  book  value of its  other  assets  of
      $2,147,749 as at July 31, 2004 is  recoverable  based on  expectations  of
      future  cash  flows from the  Company's  future  sales of tire  monitoring
      systems.  Management's  belief  is  based  on an  undiscounted  cash  flow
      analysis of management's  current best estimate of projected  annual sales
      to the  passenger  vehicle and light  truck OEM market  plus  management's
      projected sales to the heavy truck OEM market.

7.    PROMISSORY NOTES:

      During the year,  the Company  received total gross proceeds of $1,500,000
      upon the issuance of two unsecured short-term promissory notes of $750,000
      each, to an accredited investor.  Each note bears interest at a rate of 8%
      per annum and was  repayable  on August 13,  2004 and  September  16, 2004
      respectively (see note 16 for subsequent events). As a commitment fee, the
      holder of the notes received a total of $150,000.


                                                                              13
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

8.    Convertible debentures:

<TABLE>
<CAPTION>
      =============================================================================================================
                                                                                                         Balance to
                                                           Face value                   Debt            be accreted
                                                              of debt              component          to operations
      -------------------------------------------------------------------------------------------------------------
      <S>                                                <C>                     <C>                  <C>
      Balance as at July 31, 2002                        $         --           $         --           $         --

      10% redeemable convertible debentures
        with cash financing cost of $76,177 (a)               750,000                 66,000                684,000

      5% redeemable convertible debentures
        with cash financing cost of $94,000 and
        discount of $32,000 (b)                               400,000                257,143                142,857

      7% and 8% convertible debentures with
        cash financing cost of $483,022 (c)                 4,500,000                      3              4,499,997
      -------------------------------------------------------------------------------------------------------------

      Initial allocation                                    5,650,000                323,146              5,326,854

      Accretion of deemed debt discount to
        interest                                                   --              3,329,778             (3,329,778)

      Conversion of 10%, 5% and $2,533,333 of
        7% convertible debentures to common
        shares (a, b, c)                                   (3,683,333)            (3,652,921)               (30,412)
      -------------------------------------------------------------------------------------------------------------

      Balance as at July 31, 2003                           1,966,667                      3              1,966,664

      Issuance of 11% discounted  convertible  debenture
        with cash finance cost of $264,894 and discount
        of $768,590(d)                                      3,493,590              1,036,567              2,457,023

      Accretion of deemed debt discount to interest
        expense                                                    --              3,236,921             (3,236,921)

      Discount in convertible debentures (d)                       --               (768,590)               768,590

      Conversion of 7%, 8% and $840,681 of discounted
        convertible debentures to common shares (c, d)
                                                           (2,532,355)            (2,532,355)                    --

      Cash payment on discounted convertible
        debentures (d)                                       (305,715)              (305,715)                    --
      -------------------------------------------------------------------------------------------------------------

      Balance as at July 31, 2004                           2,622,187                666,831              1,955,356

      Less:  current portion of convertible debentures
                                                            1,714,284                271,257              1,443,027
      -------------------------------------------------------------------------------------------------------------
                                                         $    907,903           $    395,574          $     512,329
      =============================================================================================================
</TABLE>


                                                                              14
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

8.    CONVERTIBLE DEBENTURES (CONTINUED):

      (a)   In the first private  placement during the year ended July 31, 2003,
            the Company  realized  gross cash proceeds of $500,000 and $250,000,
            respectively,  from the issuance of 10% redeemable convertible notes
            of  the  Company  plus  150,000  share  purchase   warrants  on  the
            completion of a private placement  effected pursuant to Regulation S
            under the  Securities  Act of 1933.  The  agreements  were signed on
            September  20,  2002 and the notes  were to mature on  December  20,
            2002.

            On November 4, 2002, the holders  converted these  convertible notes
            into  1,500,000  units.  Each unit consisted of one common share and
            one share  purchase  warrant.  Each  warrant  entitles the holder to
            purchase one  additional  common share at an exercise price of $0.50
            per share until  November 4, 2005.  On  conversion  of these  senior
            convertible  notes,  the carrying value of debt and accrued interest
            was reclassified to common shares included in stockholders'  equity.
            Interest  accretion  of  $684,000  was charged to the  statement  of
            operations as interest expense during the year ended July 31, 2003.

            Each  warrant  initially  entitled the holder to purchase one of the
            Company's common shares and is exercisable at a price of $1.25 on or
            before  September  20, 2005,  on which date the warrant will expire.
            These warrants were subsequently repriced to $0.10 on May 6, 2003 as
            described in note 9(e).

            For accounting  purposes,  the Company  calculated the fair value of
            warrants  issued  using the  Black-Scholes  model using the weighted
            average  assumptions  as  disclosed  in note 3(n) and the  intrinsic
            value of the  beneficial  conversion  feature,  which  in  aggregate
            totals $684,000,  and initially  recorded these values as additional
            paid-in capital. The intrinsic value is the amount by which the fair
            value of the  underlying  common shares at the date of the agreement
            exceeds the conversion price.

            Advisors  to the private  placement  received a cash  commission  of
            $60,000  or 8% on the face  value of the  notes  and  120,000  share
            purchase  warrants  exercisable  at a price  equal to the  lesser of
            conversion  price of the  convertible  notes into  common  shares or
            $0.50.  The Company also incurred an additional cash cost of $16,177
            to secure the funding.  The warrants are exercisable over five years
            and expire on November 4, 2007.  The fair value of these warrants at
            the date of grant was  $51,393.  The fair value of the  warrants was
            estimated  on the date of issuance  using the  Black-Scholes  option
            valuation model.

      (b)   In the second  private  placement  during  fiscal 2003,  the Company
            issued senior subordinated  redeemable  convertible  debentures to a
            private  investment  company bearing  interest at 5% per annum.  The
            Company closed the first tranche on November 21, 2002 and the second
            tranche on January 31, 2003. In each tranche,  the Company  received
            proceeds  of  $184,000  for  the  issuance  of a  debenture  in  the
            principal amount of $200,000.  Total net cash proceeds after finance
            charges were  $274,000.  Each debenture was issued at an 8% discount
            from the face principal amount. Advisors to the placement received a
            cash commission of $64,000 and 68,325 warrants.  Additional expenses
            of $30,000  were  incurred for this  transaction.  The fair value of
            these  warrants at the date of grant was  estimated at $15,626.  The
            fair value of these  warrants was  estimated on the date of issuance
            using the Black-Scholes option valuation model.


                                                                              15
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

8.    CONVERTIBLE DEBENTURES (CONTINUED):

      (b)   Continued:

            For accounting purposes,  the Company calculated the intrinsic value
            of the beneficial  conversion feature which amounted to $142,857 and
            initially  recorded its value as  additional  paid-in  capital.  The
            remaining balance of $257,143 was recorded as liability.

            The  commission  and fair  value of the  warrant  were  recorded  as
            financing  costs.  These  debentures were converted to common shares
            between  February  10,  2003 and May 16, 2003 at  conversion  prices
            ranging  from $0.064 to $0.28.  Interest  accretion  of $142,857 was
            charged to the statement of operations  as interest  expense  during
            the year ended July 31, 2003.

      (c)   On June 17,  2003,  the  Company  closed a private  placement  of 7%
            convertible debentures in three tranches pursuant to (c) Rule 506 of
            Regulation D under the Securities Act of 1933, for gross proceeds of
            $2,800,000.  On July 17, 2003, the Company  closed  another  private
            placement  of 8%  convertible  debentures  pursuant  to Rule  506 of
            Regulation D under the Securities Act of 1933, for gross proceeds of
            $1,700,000.  Net cash proceeds from the convertible  debentures were
            $4,016,978.

            In connection with the offering of the convertible  debentures,  the
            Company  issued  23,846,153  common share  purchase  warrants  which
            expire between July 17, 2008 and November 10, 2008.  Advisors to the
            transactions  received a cash  commission  of  $360,000  and 180,000
            share  purchase  warrants:  112,000  share  purchase  warrants for a
            period of five  years,  and 68,000  share  purchase  warrants  for a
            period of three  years.  At July 31, 2004 the  warrants  entitle the
            holders to purchase common shares of the Company at $0.059 per share
            (subject  to  adjustment  pursuant to the  anti-dilution  provisions
            contained in the warrants).  The fair value of these warrants at the
            date of grant was  estimated  at  $77,640  using  the  Black-Scholes
            option  valuation  model  using  weighted  average   assumptions  as
            disclosed in note 3(n). Additional expenses related to this offering
            were $123,022 plus 100,000 share purchase warrants  exercisable at a
            price of $0.135 per share for a period of five years.  The financing
            cost  will  be  amortized  over  the  lesser  of  the  life  of  the
            convertible  debentures or the date of redemption or conversion into
            common shares.

            Interest on the debentures is payable  quarterly on March 1, June 1,
            September  1 and  December  1, and at  maturity,  in cash or, at the
            Company's  option,  in shares of the  Company's  common  stock at an
            interest  conversion price equal to 90% of the lesser of the average
            closing bid price during the 20 trading days  immediately  preceding
            the interest  payment date, or the average  closing bid price during
            the 20  trading  days  immediately  preceding  the date on which the
            shares are issued if such shares are issued and delivered  after the
            interest  payment date. The Company's  right to elect to pay accrued
            interest  in  shares  of its  common  stock is  subject  to  certain
            conditions,  including  the  requirement  that  there  shall  be  an
            effective registration statement qualifying the resale of the common
            stock to be issued to the holders of the  convertible  debentures in
            lieu of a cash  interest  payment.  All  overdue  accrued and unpaid
            interest under the convertible  debentures will be subject to a late
            fee at the rate of 18% per annum.


                                                                              16
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

8.    CONVERTIBLE DEBENTURES (CONTINUED):

      (c)   Continued:

            The Company may not prepay any  portion of the  principal  amount on
            any convertible  debenture  without the prior written consent of the
            holder of the debenture.

            The  Company  will  be  considered  in  default  of the  convertible
            debentures if certain events occur. Once an event of default occurs,
            the  holder of a  convertible  debenture  can elect the  Company  to
            immediately  repay a mandatory  prepayment amount as outlined in the
            agreement.

            If an event of default occurs, the holder of a convertible debenture
            can elect to require  the Company to  immediately  repay a mandatory
            prepayment amount equal to the greater of:

            (i)   120%  of the  principal  amount  of the  debenture,  plus  all
                  accrued and unpaid interest and any other amounts  outstanding
                  in respect of the debenture; or

            (ii)  120%  of the  principal  amount  of the  debenture,  plus  all
                  accrued and unpaid interest and any other amounts  outstanding
                  in respect of the debenture,  divided by the conversion  price
                  of the debenture, and multiplied by the greater of:

                  A.    the last reported closing bid price for our common stock
                        on the date on which the payment is due, or

                  B.    the last reported closing bid price for our common stock
                        on the date on which the payment actually paid.

            For  accounting  purposes,  the proceeds  from the issuance of these
            convertible  debentures  were  primarily  allocated to fair value of
            warrants issued and the intrinsic value of the beneficial conversion
            feature,  which amounts to $2,799,997 and  $1,700,000  respectively.
            The fair  value of the  warrants  was  calculated  using  the  Black
            Scholes  option model using  assumptions  as disclosed in note 3(n).
            The remaining  value of the proceeds of $3 was allocated to debt and
            is  being  accreted  to the  redemption  value  of  the  convertible
            debentures  over the period from the date of issuance to the initial
            maturity dates of May 19, 2005 and July 16, 2006.

            During the year ended July 31, 2003,  $2,533,333  of  principal  and
            $12,846 of interest were converted  into common shares  resulting in
            the issuance of  19,564,102  common  shares.  Interest  accretion of
            $2,533,322  was charged to the  statement of  operations as interest
            expense upon conversion of convertible debentures.


                                                                              17
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

8.    CONVERTIBLE DEBENTURES (CONTINUED):

      (c)   Continued:

            During the year ended July 31, 2004,  $1,691,667  of  principal  and
            $41,270 of interest were converted  into common shares  resulting in
            the issuance of  13,601,799  common  shares.  Interest  accretion of
            $1,732,935  was charged in the  statement of  operations as interest
            expense upon conversion of convertible debentures.

            As at July 31, 2004, $275,000 of the convertible  debenture remained
            outstanding.

      (d)   On December  24,  2003,  the Company  closed a private  placement of
            discounted  unsecured   convertible   debentures  in  the  aggregate
            principal  amount of $3,493,590.  The Company also issued  7,939,978
            warrants exercisable at $0.25 (subject to adjustment pursuant to the
            anti-dilution  provisions  contained in the warrants) with an expiry
            period of 5 years. The Company issued the convertible  debentures at
            a 22% original issue discount from the face principal  amount (based
            on a  notional  interest  rate of 11% per annum for each year of the
            two-year  term of the  debentures),  resulting in gross  proceeds of
            $2,725,000.  The  discount of $768,590  has been netted  against the
            face value of debentures  and is being  amortized  over the maturity
            period.  Advisors to the  transaction  received a cash commission of
            $218,000 and 109,000 three year share purchase warrants  exercisable
            at a price of $0.25 each  (subject  to  adjustment  pursuant  to the
            anti-dilution  provisions contained in the warrants). The fair value
            of these warrants at the date of grant was estimated at $15,699. The
            fair value of these  warrants was  estimated on the date of issuance
            using the Black-Scholes  option valuation model using the volatility
            141%,  risk free  interest  rate 3.28%,  expected life of warrants 3
            years.  In  addition,  expenses  of $46,894  for  professional  fees
            related  to  this   transaction   were   incurred.   The  discounted
            convertible  debentures do not  otherwise  bear  interest,  and will
            mature on April 1, 2006. The  outstanding  principal  amount of each
            debenture  may be converted at any time into shares of the Company's
            common  stock,  in whole or in part,  at the option of the holder of
            the  debenture  at a set  price  of  $0.22  per  share  (subject  to
            adjustment pursuant to the anti-dilution provisions contained in the
            debentures).  The Company will make the monthly redemption  payments
            of $145,566 over two years in cash unless during the twenty  trading
            day prior notice period  immediately prior to the applicable monthly
            redemption date the Company irrevocably  notifies the holder that it
            will issue  underlying  shares in lieu of cash at a conversion price
            equal to the lesser of:

            (i)   the set  price of  $0.22  per  share  (subject  to  adjustment
                  pursuant  to the  anti-dilution  provisions  contained  in the
                  debentures), and

            (ii)  85% of the  average  of the  closing  prices of the  Company's
                  common  stock  for  twenty  days  immediately   preceding  the
                  applicable  monthly  redemption  date,  provided  that certain
                  conditions   are  met,   including  the  condition   that  the
                  underlying  shares of common stock shall have been  registered
                  under the Securities Act of 1933, as amended.


                                                                              18
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

8.    CONVERTIBLE DEBENTURES (CONTINUED):

      (d)   Continued:

            For  accounting  purposes,  the proceeds  from the issuance of these
            convertible  debentures  were  allocated  to the  fair  value of the
            warrants issued and the intrinsic value of the beneficial conversion
            feature which amounts to $861,351 and $1,595,672,  respectively. The
            fair value of the warrants was  calculated  using the  Black-Scholes
            option  valuation  model  using  assumptions  consistent  with those
            disclosed in note 3(n).  The remaining  proceeds of  $1,036,567  was
            allocated to debt and is being accreted to the  redemption  value of
            the  convertible   debentures  over  the  maturity  period.  Monthly
            redemption  payments for  February,  March,  April and May 2004 were
            made in  shares  of the  Company,  except  for one cash  payment  of
            $14,583.  Monthly  redemption  payments of $145,566 for each of June
            and July were made in cash.  During the year,  holders of discounted
            convertible   debentures  also  converted  $273,000  of  convertible
            debentures into common shares.  This resulted in additional interest
            accretion of $240,085. During the year ended July 31, 2004, interest
            accretion of  $1,206,762  was charged to the statement of operations
            as interest expense.

9.    SHARE CAPITAL:

      (a)   During the year ended July 31, 2003,  the Company  issued  6,964,286
            units in five separate private placements for gross cash proceeds of
            $2,100,000,  each  effected  pursuant  to  Regulation  S  under  the
            Securities Act of 1933.  6,964,286 units consist of 6,964,286 common
            shares and 5,714,286 share purchase warrants.  Each warrant entitles
            the holder to purchase  one  additional  common share at an exercise
            price  ranging  from  $0.10 to  $0.85.  Warrants  begin to expire in
            November 4, 2005.  These  warrants were repriced to have an exercise
            price of $0.10 per share on May 6, 2003 (note 9(e)). Advisors to the
            private placement were paid a commission of $168,000 and were issued
            291,143 share purchase warrants  exercisable at a price ranging from
            $0.10 to  $0.85.  The fair  value of these  warrants  at the date of
            grant was estimated at $121,172. The fair value of these warrants is
            estimated  on the date of issuance  using the  Black-Scholes  option
            valuation model using the weighted average  assumptions as disclosed
            in note 3(n). The fair value of the warrants  issued to the advisors
            and commission paid is recorded as share issue cost.


                                                                              19
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

9.    SHARE CAPITAL (CONTINUED):

      (b)   The Company also  realized  gross cash  proceeds of $360,000 and net
            cash proceeds of $334,400  from the exercise of 3,300,000  warrants.
            Advisors to the  transactions  received a cash commission of $25,600
            and 224,000 share purchase warrants exercisable at a price of $0.10.
            The fair value of these  warrants at the date of grant was estimated
            at $35,460 by the Black-Scholes  option valuation using the weighted
            average assumptions as disclosed in note 3(n). The fair value of the
            warrants were recorded as share issue costs.

      (c)   The Company also  arranged a $15.0  million and $5.0 million  equity
            line of credit facilities from separate private investment companies
            during 2003.  Neither facility has been used nor registered with the
            Securities and Exchange Commission.  The $5.0 million equity line of
            credit  facility was  cancelled  on July 22,  2004.  During the year
            ended  July 31,  2004,  the  Company  decided  not to use the  $15.0
            million  equity  line of credit  facility  as it entered  into a new
            equity line of credit facility (note 9(h).

            (i)   The Company issued 1,250,000  warrants  exercisable at a price
                  of $0.1955 per share for three years as consideration  for the
                  $15.0 million  equity line of credit.  The fair value of these
                  warrants at the date of grant is estimated  at $178,259  using
                  the Black-Scholes  option valuation using the weighted average
                  assumptions  as disclosed in note 3(n).  The fair value of the
                  warrant was  expensed as an interest  and finance  cost during
                  fiscal 2004.

            (ii)  On the date of execution  of the $5.0  million  equity line of
                  credit  facility,  the Company  issued  shares worth  $290,000
                  based on the trading price of the stock of the Company on that
                  day.  Shares worth $10,000 were issued to the placement  agent
                  on February 26, 2003.  The Company has recorded the fair value
                  of the common shares as an interest and financing expense.

      (d)   On April 3, 2003, the Company issued to the former managing director
            of SmarTire  Europe  Limited a total of 353,865  common  shares at a
            deemed price of $0.22 per share,  in partial  payment and settlement
            of the Company's  obligation  to pay him a termination  allowance in
            connection with the termination of his management agreement, without
            cause, on October 15, 2002.


                                                                              20
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

9.    SHARE CAPITAL (CONTINUED):

      (e)   On May 6, 2003,  the Company issued 850,000 shares at a deemed price
            of $0.21 per share to an accredited  investor and repriced 1,000,000
            warrants  previously  issued to the  investor on December  20, 2002,
            thereby  reducing the  exercise  price of the warrant from $0.70 per
            share to $0.10 per  share.  An  aggregate  of  3,614,286  additional
            warrants  previously issued to other investors were also repriced to
            an exercise price of $0.10 per share.  These  transactions  were all
            effected  pursuant to Regulation S under the Securities Act of 1933,
            and were effected in consideration  of certain releases  provided by
            the  investors  to the  Company  in  respect  of  certain  potential
            unquantified claims threatened by the investors against the Company.
            The fair value of the shares is $178,500  based on the deemed  price
            of $0.21 and the incremental fair value of the warrants is $136,544.
            The fair value of the warrant is  estimated  on the date of issuance
            by the  Black-Scholes  option  valuation  model  using the  weighted
            average  assumptions as disclosed in note 3(n). The incremental fair
            value of these warrants and the value of shares issued were recorded
            as an administrative expense.

      (f)   For the year ended July 31, 2004,  the Company  realized  gross cash
            proceeds of $2,179,385 and net cash proceeds of $2,101,015  from the
            exercise  of warrants as  follows:

            (i)   On April 30, 2004,  500,000  warrants were exercised at $0.104
                  resulting  in gross  cash  proceeds  of  $52,000  and net cash
                  proceeds of $49,920.

            (ii)  On October 27, 2003, the Company  offered  warrant holders who
                  were issued  warrants with an exercise price of $0.2645 on May
                  15,  2003 in  connection  with  the  convertible  debenture  a
                  reduction in their exercise price to $0.20 plus one additional
                  warrant at $0.20 if they exercised their warrants.  A total of
                  3,290,596  warrants were exercised.  In addition,  the Company
                  granted 194,000 additional warrants  exercisable at a price of
                  $0.20  per  share  for five  years to a  shareholder  who also
                  exercised  their  warrants.  On November 6, 2003, the exercise
                  price of the 7,478,635  warrants  initially granted at $0.2645
                  were reduced to $0.1771 and were  exercised for gross proceeds
                  of $1,324,466.

                  During  October  and  November  2003,  the  fair  value of the
                  10,963,231  warrants  of  $1,601,970   initially  recorded  as
                  additional  paid in capital was  reclassified to share capital
                  on exercise of the warrants.

            (iii) On May 20, 2004,  the Company  realized gross cash proceeds of
                  $120,000  from  the  exercise  of  1,000,000  warrants  at  an
                  exercise price of $0.12 per share.


                                                                              21
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

9.    Share capital (continued):

      (g)   During the year ended July 31, 2004,  200,000  common  shares with a
            fair  market  value of $0.174  per  share,  300,000  share  purchase
            warrants with an exercise price of $0.17 per share and 250,000 share
            purchase  warrants  with an  exercise  price of $0.20 per share were
            issued for services  received.  The fair value of these  warrants at
            the date of grant was estimated at $63,375.  The fair value of these
            warrants  was   estimated   on  the  date  of  issuance   using  the
            Black-Scholes  option  valuation  model using the  weighted  average
            assumptions  consistent  with those as described in note 3(n).  Fair
            value of common shares and warrants of $98,175 has been exercised.

      (h)   On May 19, 2004, the Company  arranged a $15 million  Standby Equity
            Distribution  Agreement  from  a  private  investment  company.  The
            Company  may,  at its  discretion,  draw down  $500,000  every seven
            business days, subject to an effective  registration  statement.  In
            consideration  for each draw down,  the Company  will sell shares of
            common  stock at a 2% discount to the lowest  closing bid prices for
            the 5 trading days after an advance  notice is given by the Company.
            In  addition,  5% of each  advance  will be  retained by the private
            investment company as a commission.

            On June 1, 2004, the Company filed a registration statement with the
            Securities  and  Exchange  Commission  to  register  the $15 million
            equity line of credit that was declared  effective on June 14, 2004.
            On June 1, 2004, the Company issued 3,605,769 shares at an effective
            price of $0.104 per share as payment for the $365,000 commitment fee
            and  $10,000  placement  agency fee  related to the  Standby  Equity
            Distribution  Agreement.  The Company also incurred additional costs
            of $35,420 in fees to prepare and file the  registration  statement.
            During the year ended July 31, 2004, the Company effected three draw
            downs of $250,000  each at prices of $.090,  $.065 and $.059,  which
            resulted  in the  issuance  of  10,861,220  common  shares  and  net
            proceeds  of  $689,399.   In  addition,   the  Company  incurred  an
            additional $60,000 as a financing expense to advisors of the Standby
            Equity Distribution Agreement of which $30,000 is payable as at July
            31, 2004.

      (i)   On December 15, 2003, the Company's  authorized common share capital
            was increased to 300,000,000 pursuant to a special resolution of the
            shareholders adopted at the annual and special annual meeting of the
            Company held on December 11, 2003.


                                                                              22
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

9.    SHARE CAPITAL (CONTINUED):

      (j)   Stock-based compensation plans:

            At July 31,  2004,  the Company had eight  stock-based  compensation
            plans that are described below:

            (i)   Under the "1998 US Stock Incentive Plan" the Company may grant
                  options to its employees for up to 300,000 common shares.

                  Under the "1998  Stock  Incentive  Plan" the Company may grant
                  options to its employees for up to 600,000 common shares.

            (ii)  Under the "2000 US Stock Incentive Plan" the Company may grant
                  options to its employees for up to 200,000 common shares.

                  Under the "2000  Stock  Incentive  Plan" the Company may grant
                  options to its employees for up to 800,000 common shares.

            (iii) Under the "2002 US Stock Incentive Plan" the Company may grant
                  options to its employees for up to 100,000 common shares.

                  Under the "2002  Stock  Incentive  Plan" the Company may grant
                  options to its employees for up to 900,000 common shares.

            (iv)  Under the "2003 US Stock Incentive Plan" the Company may grant
                  options to its employees for up to 2,000,000 common shares.

                  Under the "2003  Stock  Incentive  Plan" the Company may grant
                  options to its employees for up to 8,000,000 common shares.

            The options currently outstanding under the "2003 US Stock Incentive
            Plan" and the "2003  Stock  Incentive  Plan" vest  immediately.  The
            options  currently  outstanding  under the "1998 US Stock  Incentive
            Plan" and the "2000 and 2002 Stock  Incentive  Plan"  generally vest
            from two to four  years,  with the first 20% to 33%  vesting  at the
            date of grant and the balance vesting  annually at each  anniversary
            date of the grant  thereafter.  The exercise price of each option is
            based on the fair  value of the  common  stock at the date of grant.
            These options have a five year term.

<TABLE>
<CAPTION>
================================================================================================================================
                                               2004                              2003                            2002
                                   ----------------------------      ---------------------------      --------------------------
                                                       Weighted                         Weighted                        Weighted
                                                        average                          average                         average
                                                       exercise                         exercise                        exercise
                                           Shares         price            Shares          price            Shares         price
--------------------------------------------------------------------------------------------------------------------------------
<S>                                <C>             <C>               <C>           <C>                <C>           <C>
Outstanding, beginning of year          1,714,400  $       2.54         1,677,250  $        3.08         1,458,750  $       3.20
   Options granted                      9,169,600          0.20           778,300           1.42           484,700          2.88
   Options exercised                      (79,400)        (0.20)               --             --                --         (2.00)
   Options forfeited                   (2,334,800)        (0.38)         (741,150)         (2.80)         (266,200)        (3.40)
--------------------------------------------------------------------------------------------------------------------------------
Outstanding, end of year                8,469,800  $       0.63         1,714,400  $        2.54         1,677,250  $       3.08
================================================================================================================================
</TABLE>


                                                                              23
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

9.    SHARE CAPITAL (CONTINUED):

      (j)   Stock-based compensation plans (continued):

<TABLE>
<CAPTION>
=====================================================================================================================
                                     Options outstanding                               Options exercisable
                      -------------------------------------------------  --------------------------------------------
                                              Weighted
                                               average         Weighted                                      Weighted
                                             remaining          average                                       average
Range of                        Number     contractual         exercise                Number                exercise
exercise prices              of shares            life            price           exercisable                   price
---------------------------------------------------------------------------------------------------------------------
<S>                         <C>            <C>                <C>                <C>                          <C>
$0.085 -0.20                 6,900,200            4.07            $0.20             6,900,200                   $0.20
$0.37  -1.00                   136,134            3.46             0.52               136,134                    0.52
$1.16 - 6.76                 1,433,466            2.07             2.71             1,222,337                    2.78
---------------------------------------------------------------------------------------------------------------------
$0.85 - 6.76                 8,469,800            3.72            $0.63             8,258,671                   $0.59
=====================================================================================================================
</TABLE>

            The Company  normally  issues options to directors at fixed exercise
            prices.  75,000  options  issued to directors and  outstanding as at
            July  31,  2004  (2002  -  75,000)  vested  immediately,  but if not
            exercised each year, there is an annual 20% increase in the exercise
            price  until the  options  expire.  For  accounting  purposes  these
            options are  considered  to be  variable in nature and  compensation
            expense is recorded to the extent of  increases  in the market value
            of the underlying common shares as compared to the exercise price at
            each reporting period.

            Where options  issued after January 18, 2001 have an exercise  price
            in a currency that is not either the (a) functional  currency of the
            Company,  or (b) the  currency in which the  employee  is paid,  the
            options  are  to be  accounted  for as  variable  plan  options  and
            compensation expense will be recorded equal to changes in the market
            value of the underlying common shares at each reporting period.  The
            Company  normally grants options in U.S. dollars when the functional
            currency of the Company is the Canadian  dollar.  Most  employees of
            the Company are paid in either  Canadian  dollars or British  pounds
            sterling.  Accordingly,  these employee options are considered to be
            variable options.

            The  compensation  expense for these  variable  options for the year
            ended July 31, 2004 is nil (2003 - nil).  In addition,  compensation
            expense is recognized to the extent that options are granted  having
            an  exercise  price  less than the  market  price of the  underlying
            common stock on the date of grant.

      (k)   Warrants:

            As at July 31,  2004,  warrants  outstanding  were  exercisable  for
            37,483,485  (2003 - 32,154,507)  common  shares of the Company.  The
            warrants  entitle  the  holders  to  purchase  common  shares of the
            Company at prices  ranging from $0.059 to $2.80 per share and expire
            on various dates until June 30, 2009.

            The exercise price of warrants  issued were not less than the market
            price of the Company's common shares at the date of issuance.


                                                                              24
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

10.   DEFERRED FINANCING COSTS:

<TABLE>
<CAPTION>
      =======================================================================================================================
                                                                                                    2004                 2003
      -----------------------------------------------------------------------------------------------------------------------
      <S>                                                                                   <C>                  <C>
      Equity line of credit
        Fair value of agents warrants (note 9(c))                                           $         --         $    178,259
        Professional fees                                                                             --                5,000
      -----------------------------------------------------------------------------------------------------------------------
                                                                                                      --              183,259
      Convertible debenture (note 8)
        Commission                                                                               218,000                   --
        Fair value of agents warrants                                                             15,699                   --
        Professional fees                                                                         46,894                   --
      -----------------------------------------------------------------------------------------------------------------------
                                                                                                 280,593                   --
      Amortization                                                                              (123,573)                  --
      -----------------------------------------------------------------------------------------------------------------------
                                                                                                 157,020                   --
      -----------------------------------------------------------------------------------------------------------------------
                                                                                            $    157,020         $    183,259
      =======================================================================================================================


      The deferred charges related to the discounted  convertible  debenture are
      being amortized over the maturity  period.  During the year,  $123,573 was
      amortized and charged to interest expense.


11.   FINANCIAL INSTRUMENTS:

      (a)   Fair value of financial instruments:

            The  carrying  values  of cash  and cash  equivalents,  receivables,
            accounts payable and accrued  liabilities,  promissory notes payable
            and  convertible  debentures  approximate  their fair  values due to
            being  in a ready  cash  form or the  short-term  maturity  of these
            instruments.

      (b)   Credit risk:

            The majority of the Company's  activities  are  concentrated  in the
            automotive industry and sales are primarily to a few major customers
            (note 15). To reduce credit risk, management performs ongoing credit
            evaluations  of its  customers'  financial  condition.  The  Company
            maintains  reserves  for  potential  credit  losses  based on a risk
            assessment of its customers.

      (c)   Foreign currency risk:

            The Company  operates  internationally  which gives rise to the risk
            that  cash  flows  may  be  adversely   impacted  by  exchange  rate
            fluctuations.  To July 31,  2004,  the Company has not entered  into
            derivatives  or other  hedging  instruments  to mitigate its foreign
            exchange risk.


                                                                              25
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

12.   INCOME TAXES:

      (a)   Effective tax rate:

            The  effective  income tax rates differ from the Canadian  statutory
            rates for the following reasons:

      ===================================================================================================================
                                                                       2004                   2003                   2002
      -------------------------------------------------------------------------------------------------------------------

      Canadian statutory tax rate                                      36.4%                  38.5%                  41.7%

      Computed tax expense                                  $    (3,999,277)       $    (3,817,132)      $     (2,847,766)
      Foreign losses tax affected at lower rates                      5,162                192,027                128,066
      Reduction in effective tax rates                             (339,481)                    --                483,059
      Permanent and other differences                             1,352,012                387,870                975,676
      Change in valuation allowance                               2,981,584              3,237,235              1,260,965
      -------------------------------------------------------------------------------------------------------------------
                                                            $            --        $            --       $             --
      ===================================================================================================================

      (b)   Deferred tax assets and liabilities:

      ===================================================================================================================
                                                                       2004                   2003                   2002
      -------------------------------------------------------------------------------------------------------------------
      Deferred tax assets:
         Fixed and other assets, accounting
             depreciation in excess of tax                  $     1,220,775                861,607       $        519,987
         Loss carryforwards                                      16,534,418             14,148,423             11,472,671
         Scientific research and development
             expenses                                               382,971                359,733                319,525
         Share issue costs                                          549,499                373,523                192,718
         Others                                                      37,207                     --                  1,150
      -------------------------------------------------------------------------------------------------------------------
      Total gross deferred tax assets                            18,724,870             15,743,286             12,506,051
      Valuation allowance                                       (18,724,870)           (15,743,286)           (12,506,051)
      -------------------------------------------------------------------------------------------------------------------
      Net deferred tax assets                               $            --        $            --   $                  -
      ===================================================================================================================
</TABLE>


                                                                              26
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

12.   INCOME TAXES (CONTINUED):

      (b)   Deferred tax assets and liabilities (continued):

            In  assessing  the  realizability  of future tax assets,  Management
            considers  whether it is more likely  than not that some  portion or
            all  of the  future  tax  assets  will  be  realized.  The  ultimate
            realization   of  the  future  tax  assets  is  dependent  upon  the
            generation  of future  taxable  income  during the  periods in which
            those temporary differences become deductible.

            For Canadian tax purposes, the Company has approximately $31,500,000
            of non-capital  losses for income tax purposes available at July 31,
            2004 to reduce  taxable  income of future  years.  These losses will
            expire as follows:

            ====================================================================
            2005                                                    $  3,200,000
            2006                                                       7,600,000
            2007                                                         200,000
            2008                                                       4,400,000
            2009                                                       5,600,000
            2010                                                       4,900,000
            2011                                                       5,600,000
            --------------------------------------------------------------------
                                                                    $ 31,500,000
            ====================================================================

            Additionally,  for Canadian tax purposes, the Company has scientific
            research and  development  expenditures  of $1,080,000  available to
            reduce future taxable income indefinitely.

            For United  States  tax  purposes,  the  Company  has  approximately
            $6,100,000 of net operating losses for income tax purposes available
            at July 31, 2004 to reduce  taxable  income of future  years.  These
            losses will expire as follows:

            ====================================================================
            2012                                                    $    100,000
            2013                                                       1,000,000
            2019                                                       1,800,000
            2020                                                       1,300,000
            2021                                                         400,000
            2022                                                         800,000
            2023                                                         300,000
            2024                                                         400,000
            --------------------------------------------------------------------
                                                                    $  6,100,000
            ====================================================================

            For United  Kingdom tax  purposes,  the  Company  has  approximately
            $9,600,000 of non-capital  losses for income tax purposes  available
            at July 31, 2004 to reduce  taxable  income of future  years.  These
            losses may be carried forward indefinitely.


                                                                              27
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

13.   EARNINGS (LOSS) PER SHARE:

      The weighted average number of shares  outstanding used in the computation
      of earnings (loss) per share were as follows:

<TABLE>
<CAPTION>
      ===============================================================================================
                                                            2004               2003              2002
      -----------------------------------------------------------------------------------------------
      <S>                                             <C>                <C>               <C>
      Weighted-average shares used in computation
        of basic earnings (loss) per share            83,356,095         26,771,427        16,743,977

      Weighted average shares from assumed
        conversion of dilutive warrants and options           --                 --                --
      -----------------------------------------------------------------------------------------------
      Fully diluted weighted average number
        of common shares                              83,356,095         26,771,427        16,743,977
      ===============================================================================================
</TABLE>


14.   COMMITMENTS AND CONTINGENCIES:

      (a)   The Company is committed to the following  payments under  operating
            leases,  and service  agreements for premises and certain  equipment
            and consultants:

            ====================================================================
            2005                                                  $    1,372,953
            2006                                                         218,325
            2007                                                         182,176
            2008                                                         143,303
            2009                                                         142,570
            2010                                                         139,907
            ====================================================================


      (b)   Cash and  short-term  investments  are used to  secure  credit  card
            advances in the amount of $15,000 (2003 - $25,000).

      (c)   Product warranties:

            The Company  provides for  estimated  warranty  costs at the time of
            product sale.  Warranty  expense accruals are based on best estimate
            with  reference  to  historical  claims   experience.   As  warranty
            estimates are based on forecasts, actual claim costs may differ from
            amounts  provided.  An analysis of changes in liability  for product
            warranties follows:

            ===================================================================
            Balance, August 1, 2002                                 $     9,114

            Provision increase                                           29,946
            Expenditures                                                (18,622)
            --------------------------------------------------------------------
            Balance, July 31, 2003                                       20,438

            Provision increase                                           85,934
            Expenditures                                                (16,512)
            --------------------------------------------------------------------
            Balance, July 31, 2004                                   $   89,860
            ====================================================================


                                                                              28
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

15.   SEGMENTED INFORMATION:

      The Company operates in the wireless tire monitoring  technology industry.
      Management of the Company makes decisions about allocating resources based
      on this one operating segment. Geographic information is as follows:


      Revenue from external customers:

<TABLE>
<CAPTION>
      =============================================================================================
                                                            Revenue from
                                                         external customers
                                 ------------------------------------------------------------------
                                              2004                     2003                    2002
      ---------------------------------------------------------------------------------------------
      <S>                        <C>                  <C>                       <C>
      United States              $         651,089     $            509,228     $           524,516
      United Kingdom                       225,517                  261,905                 266,638
      Italy                                     --                  391,169                  12,629
      China                                514,365                  243,866                      --
      Other                                267,308                  396,428                 208,561
      ---------------------------------------------------------------------------------------------
                                 $       1,658,279     $          1,802,596     $         1,012,344
      =============================================================================================

      As at July 31, 2004, 53% (July 31, 2003-73%) of the Company's fixed assets
      were in  Canada,  17% (July 31,  2003-27%)  were in Europe and 30% were in
      Korea (July 31,  2003-nil).  Major customers,  representing 10% or more of
      total sales, include:

      =============================================================================================
                                              2004                     2003                    2002
      ---------------------------------------------------------------------------------------------

      Customer A                 $         484,433     $                 --     $                --
      Customer B                                --                  391,169                  12,629
      Customer C                            28,472                  125,413                 143,487
      Customer D                           113,888                  109,270                 187,314
      =============================================================================================
</TABLE>

16.   SUBSEQUENT EVENTS:

      (a)   Between  August 9, 2004 and  October 5,  2004,  the  Company  issued
            60,673,423  shares at effective  prices  ranging from $0.03 to $0.05
            per share pursuant to the Standby Equity Distribution  Agreement for
            gross  proceeds of $2,200,000  and net proceeds of  $2,086,500.  The
            issuance of these  shares  reduced the set price that the holders of
            the convertible  debentures can convert the  convertible  debentures
            into common  stock and the  exercise  price of  14,612,907  warrants
            outstanding to $0.037.

      (b)   Subsequent to year end, the Company defaulted on payments to holders
            of  its  discounted  convertible  debentures.  In  response  to  the
            default,  certain  debenture holders filed legal actions against the
            Company.  On  September  24,  2004,  the  Company and holders of the
            discounted convertible debentures signed an agreement which provided
            for: withdrawal of legal action; an immediate exercise of 18,226,274
            warrants at $0.03 for gross  proceeds of $546,788 and  conversion of
            $734,389 of debentures into  24,479,630  common shares and a lock-up
            provision  that  establishes  a daily  limit on the number of shares
            that can be traded by the debenture holders.


                                                                              29
<PAGE>


SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2004, 2003 and 2002

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

16.   SUBSEQUENT EVENTS (CONTINUED):

      (c)   Between August 1, 2004 and October 5, 2004, the Company repaid
            $651,837 of principal and $49,663 in accrued interest on its
            promissory notes. The Company obtained an extension to November 30,
            2004 to repay the balance due on the promissory notes.

17.   COMPARATIVE FIGURES:

      Certain  figures  have  been  reclassified  to  conform  to the  financial
      statement presentation adopted for the current year.


                                                                              30