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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 20-F

(Mark one)



| ̈ |  | REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------------

OR



|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ------------------------------------------------------------------------------------

For the fiscal year ended December 31, 2011

OR



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------

OR



| ̈ |  | SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | -------------------------------------------------------------------------------------------

Commission file number: 000-31212



|                   
|-------------------
|METAL STORM LIMITED

(Exact Name of Registrant as Specified in its Charter)



|         
|---------
|Australia

(Jurisdiction of Incorporation or Organization)



|                                                  
|--------------------------------------------------
|29 Sudbury Street Darra, Queensland 4076 Australia

(Address of principal executive offices)



|                                                                                                                                       
|---------------------------------------------------------------------------------------------------------------------------------------
|Brett Farmer Company Secretary Telephone: +61 7 3147 8600
Facsimile: +61 7 3147 8610 29 Sudbury Street Darra, Queensland 4076
Australia

(Name, telephone, e-mail and/or facsimile number and address of company contact person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

None

Securities
registered or to be registered pursuant to Section 12(g) of the Act:



|                                                                                                    
|----------------------------------------------------------------------------------------------------
|Ordinary Shares in the form of American Depositary Shares, evidenced by American Depositary Receipts

(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

Indicate the number of outstanding shares of each of the
issuers classes of capital or common stock as of the date of the close of the period covered by the annual report.

2,782,478,264 Fully Paid Ordinary Shares

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.    Yes   ̈    No  x

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes   ̈    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) for the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ̈

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule
405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files).    Yes   ̈    No  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large
accelerated filer   ̈                 Accelerated
filer   ̈                 Non-accelerated filer  x

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this
filing:



|             |  |                                                                                                          |  |         
|------------ |  | -------------------------------------------------------------------------------------------------------- |  | --------
|U.S. GAAP   ̈ |  | International Financial Reporting Standards as issued by the International Accounting Standards Board  x |  | Other   ̈

If Other has been checked in response to the previous question, indicate by check mark which
financial statement item the registrant has elected to follow.     ̈  Item 17     ̈  Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act).    Yes   ̈    No  x









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Table of Contents



|          |  |                                                                                  |  |      |    | 
|--------- |  | -------------------------------------------------------------------------------- |  | ---- | -- | 
|          |  |                                                                                 
|          |  |                                                                                  |  | Page |   
|          |  |                                                                                 
|Item 1.   |  | Identity of Directors, Senior Management and Advisors                            |  |      | 2  | 
|          |  |                                                                                 
|Item 2.   |  | Offer Statistics and Expected Timetable                                          |  |      | 2  | 
|          |  |                                                                                 
|Item 3.   |  | Key Information                                                                  |  |      | 2  | 
|          |  |                                                                                 
|Item 4.   |  | Information on Metal Storm                                                       |  |      | 11 | 
|          |  |                                                                                 
|Item 4A.  |  | Unresolved Staff Comments                                                        |  |      | 20 | 
|          |  |                                                                                 
|Item 5.   |  | Operating and Financial Review and Prospects                                     |  |      | 20 | 
|          |  |                                                                                 
|Item 6.   |  | Directors, Senior Management and Employees                                       |  |      | 29 | 
|          |  |                                                                                 
|Item 7.   |  | Major Shareholders and Related Party Transactions                                |  |      | 33 | 
|          |  |                                                                                 
|Item 8.   |  | Financial Information                                                            |  |      | 34 | 
|          |  |                                                                                 
|Item 9.   |  | The Offer and Listing                                                            |  |      | 34 | 
|          |  |                                                                                 
|Item 10.  |  | Additional Information                                                           |  |      | 36 | 
|          |  |                                                                                 
|Item 11.  |  | Quantitative and Qualitative Disclosure about Market Risk                        |  |      | 50 | 
|          |  |                                                                                 
|Item 12.  |  | Description of Securities Other than Equity Securities                           |  |      | 50 | 
|          |  |                                                                                 
|Item 13.  |  | Defaults, Dividend Arrearages and Delinquencies                                  |  |      | 51 | 
|          |  |                                                                                 
|Item 14.  |  | Material Modifications to the Rights of Security Holders and the Use of Proceeds |  |      | 52 | 
|          |  |                                                                                 
|Item 15.  |  | Controls and Procedures                                                          |  |      | 52 | 
|          |  |                                                                                 
|Item 16A. |  | Audit Committee Financial Expert                                                 |  |      | 53 | 
|          |  |                                                                                 
|Item 16B. |  | Code of Ethics                                                                   |  |      | 53 | 
|          |  |                                                                                 
|Item 16C. |  | Principal Accountant Fees and Services                                           |  |      | 53 | 
|          |  |                                                                                 
|Item 16D. |  | Exemptions from the Listing Standards for Audit Committees                       |  |      | 53 | 
|          |  |                                                                                 
|Item 16E. |  | Purchases of Equity Securities by the Issuer and Affiliated Purchasers           |  |      | 53 | 
|          |  |                                                                                 
|Item 16F. |  | Change in Registrants Certifying Accountant                                     |  |      | 54 | 
|          |  |                                                                                 
|Item 16G. |  | Corporate Governance                                                             |  |      | 54 | 
|          |  |                                                                                 
|Item 17.  |  | Financial Statements                                                             |  |      | 55 | 
|          |  |                                                                                 
|Item 18.  |  | Financial Statements                                                             |  |      | 55 | 
|          |  |                                                                                 
|Item 19.  |  | Exhibits                                                                         |  |      | 55 | 



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CURRENCY OF PRESENTATION AND EXCHANGE RATES

All references herein to A$ and $ are to Australian dollars. All references herein to US$ and
U.S. dollar are to United States dollars. Except as otherwise stated, all monetary amounts in this annual report are presented in Australian dollars. When necessary, historic data were converted at the applicable rate for the date or
year indicated.

For your convenience, we have translated some Australian dollar amounts into U.S. dollar amounts at the noon
buying rate in The City of New York for cable transfers in Australian dollars as certified for customs purposes by the Federal Reserve Bank of New York (the noon buying rate). On April 13, 2012, the noon buying rate for Australian
dollars into U.S. dollars was A$1.00 = US$1.0372.

The following table contains information for the noon buying rate for the
Australian dollar into U.S. dollars for the periods indicated.



|                        |  |             |        |  |                 |  |        |      |  |  |        |  |  |  |        | 
|----------------------- |  | ----------- | ------ |  | --------------- |  | ------ | ---- |  |  | ------ |  |  |  | ------ | 
|                        |  | AtPeriodEnd |        |  | AverageRate (1) |  |        | High |  |  | Low    | 
|Year ended December 31, |  |             |        |  |                 |  |        |      |  |  |        |  |  |  |        | 
|2007                    |  |             | 0.8776 |  |                 |  | 0.8444 |      |  |  | 0.9369 |  |  |  | 0.7724 | 
|2008                    |  |             | 0.6983 |  |                 |  | 0.8499 |      |  |  | 0.9797 |  |  |  | 0.6073 | 
|2009                    |  |             | 0.8979 |  |                 |  | 0.7988 |      |  |  | 0.9293 |  |  |  | 0.6301 | 
|2010                    |  |             | 1.0122 |  |                 |  | 0.9199 |      |  |  | 1.0153 |  |  |  | 0.8172 | 
|2011                    |  |             | 1.0251 |  |                 |  | 1.0332 |      |  |  | 1.1026 |  |  |  | 0.9453 | 
|Month                   |  |             |        |  |                 |  |        |      |  |  |        |  |  |  |        | 
|September 2011          |  |             | 0.9744 |  |                 |  | 1.0220 |      |  |  | 1.0750 |  |  |  | 0.9744 | 
|October 2011            |  |             | 1.0610 |  |                 |  | 1.0168 |      |  |  | 1.0707 |  |  |  | 0.9453 | 
|November 2011           |  |             | 1.0244 |  |                 |  | 1.0112 |      |  |  | 1.0366 |  |  |  | 0.9686 | 
|December 2011           |  |             | 1.0251 |  |                 |  | 1.0122 |      |  |  | 1.0298 |  |  |  | 0.9904 | 
|January 2012            |  |             | 1.0598 |  |                 |  | 1.0415 |      |  |  | 1.0651 |  |  |  | 1.0215 | 
|February 2012           |  |             | 1.0777 |  |                 |  | 1.0732 |      |  |  | 1.0806 |  |  |  | 1.0629 | 
|March 2012              |  |             | 1.0367 |  |                 |  | 1.0526 |      |  |  | 1.0803 |  |  |  | 1.0326 | 



|(1) | Determined by averaging noon buying rates on the last day of each full month during the period.
|--- | -----------------------------------------------------------------------------------------------

FORWARD-LOOKING STATEMENTS

Certain statements in this annual report may constitute forward-looking statements. Such forward-looking statements are based on the beliefs of our management as well as assumptions based on
information available to us. When used in this annual report, the words anticipate, believe, estimate, project, intend and expect and similar expressions, as they relate to us
or our management, are intended to identify forward-looking statements. Such forward-looking statements reflect our current views with respect to future events and are subject to certain known and unknown risks, uncertainties and assumptions. Many
factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements. These include, but are not
limited to, risks or uncertainties associated with the development of our technology, our ability to obtain government research and development grants, our ability to raise additional capital and repay or restructure our convertible note debt, our
ability to protect our proprietary technology, the market for our products, government regulation in Australia and the United States, changes in tax and other laws, changes in competition, the loss of key personnel and other factors identified under
Item 3D Key Information  Risk Factors of this annual report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those
described in this annual report as anticipated, believed, estimated or expected. Accordingly, you should not place undue reliance on these forward-looking statements. These statements speak only as of the date of this annual report and shall not be
revised or updated to reflect events after the date of this document.



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PART I

Item 1. Identity of Directors, Senior Management and Advisers

Not applicable.

Item 2. Offer Statistics and Expected
Timetable

Not applicable.

Item 3. Key Information

A. Selected Financial Data

The following table presents our selected financial information at the dates and for each of the years indicated. You
should read the following information together with the information contained in Item 5 Operating and Financial Review and Prospects, as well as our financial statements and the related notes and other financial information
appearing elsewhere in this annual report.

This annual report is prepared in accordance with International Financial
Reporting Standards (IFRS) and interpretations adopted by the International Accounting Standards Board (IASB).

Our financial statements for 2011, 2010, 2009, 2008 and 2007 have been prepared in Australian dollars and in accordance with IFRS as issued by the IASB.

Our selected financial data set forth below are presented in accordance with IFRS. Statement of Comprehensive Income data for the years
ended December 31, 2011, 2010 and 2009 and the Statement of Financial Position data as at December 31, 2011 and 2010 have been derived from our audited financial statements, which are included elsewhere in this annual report.



|                                                       |  |                                           |               |   |        |  |               |        |  |  |             |   |  |        |             |   |  |  |             |  
|------------------------------------------------------ |  | ----------------------------------------- | ------------- | - | ------ |  | ------------- | ------ |  |  | ----------- | - |  | ------ | ----------- | - |  |  | ----------- | -
|                                                       |  | As of and for the year ended December 31, |              
|                                                       |  | 2011A$                                    |               |   | 2010A$ |  |               | 2009A$ |  |  | 2008A$      |   |  | 2007A$ |            
|Income Statement data in accordance with IFRS:         |  |                                           |               |   |        |  |               |        |  |  |             |   |  |        |             |   |  |  |             |  
|Revenue                                                |  |                                           | 1,318,082     |   |        |  | 3,345,016     |        |  |  | 1,112,481   |   |  |        | 2,933,346   |   |  |  | 3,205,381   |  
|Expenses                                               |  |                                           | (4,589,552    | ) |        |  | (7,978,366    | )      |  |  | (6,670,590  | ) |  |        | (7,220,211  | ) |  |  | (8,269,116  | )
|Loss before finance costs and tax                      |  |                                           | (3,233,141    | ) |        |  | (4,633,350    | )      |  |  | (5,558,109  | ) |  |        | (4,286,865  | ) |  |  | (5,063,735  | )
|Finance costs                                          |  |                                           | (2,761,748    | ) |        |  | (4,304,903    | )      |  |  | (5,749,555  | ) |  |        | (6,369,138  | ) |  |  | (4,934,415  | )
|Income tax                                             |  |                                           |              |   |        |  |              |        |  |  |            |   |  |        |            |   |  |  |            |  
|Loss after tax                                         |  |                                           | (6,033,218    | ) |        |  | (8,938,253    | )      |  |  | (11,307,664 | ) |  |        | (10,656,003 | ) |  |  | (9,998,150  | )
|Loss attributable to members of the parent             |  |                                           | (6,033,218    | ) |        |  | (8,938,253    | )      |  |  | (11,307,664 | ) |  |        | (10,656,003 | ) |  |  | (9,998,150  | )
|Basic and diluted loss per share(1)                    |  |                                           | (0.0030       | ) |        |  | (0.0064       | )      |  |  | (0.0122     | ) |  |        | (0.0122     | ) |  |  | (0.0117     | )
|Weighted average ordinary number of shares outstanding |  |                                           | 2,030,705,830 |   |        |  | 1,395,910,416 |        |  |  | 930,322,973 |   |  |        | 871,930,746 |   |  |  | 855,496,215 |  
|Balance Sheet data in accordance with IFRS:            |  |                                           |               |   |        |  |               |        |  |  |             |   |  |        |             |   |  |  |             |  
|Total current assets                                   |  |                                           | 717,670       |   |        |  | 1,722,527     |        |  |  | 376,634     |   |  |        | 8,701,884   |   |  |  | 17,069,966  |  
|Total assets                                           |  |                                           | 1,080,417     |   |        |  | 2,146,956     |        |  |  | 829,640     |   |  |        | 9,267,524   |   |  |  | 18,788,277  |  
|Total current liabilities                              |  |                                           | 20,156,995    |   |        |  | 20,636,341    |        |  |  | 20,006,958  |   |  |        | 22,397,651  |   |  |  | 21,812,546  |  
|Long term obligations (including finance leases)       |  |                                           | 915,109       |   |        |  |              |        |  |  | 23,686      |   |  |        | 63,168      |   |  |  | 283,301     |  
|Total liabilities                                      |  |                                           | 21,072,104    |   |        |  | 20,636,341    |        |  |  | 20,030,644  |   |  |        | 22,460,789  |   |  |  | 22,095,847  |  
|Contributed equity                                     |  |                                           | 81,926,463    |   |        |  | 77,683,753    |        |  |  | 70,075,033  |   |  |        | 66,209,718  |   |  |  | 65,428,400  |  
|Total equity                                           |  |                                           | (19,991,687   | ) |        |  | (18,489,385   | )      |  |  | (19,201,004 | ) |  |        | (13,193,265 | ) |  |  | (3,307,570  | )
|Other financial data:                                  |  |                                           |               |   |        |  |               |        |  |  |             |   |  |        |             |   |  |  |             |  
|Dividends per share                                    |  |                                           |              |   |        |  |              |        |  |  |            |   |  |        |            |   |  |  |            |  



|(1) | Basic and diluted loss per share is calculated as net loss for the period divided by adjusted weighted average number of ordinary shares outstanding for the same
period. The number of ordinary shares outstanding is adjusted to include ordinary shares subsequently issued for no consideration. A significant number of ordinary shares could be issued upon conversion of the convertible notes or exercise of the
options issued to Noteholders. These ordinary shares are not included in EPS because the Company has incurred net losses and recognising them in the adjusted weighted average number of ordinary shares outstanding would be anti-dilutive.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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B. Capitalization and Indebtedness

Not applicable.

C. Reasons
for Offer and Use of Proceeds

Not applicable.

D. Risk Factors

There is substantial doubt regarding Metal Storms ability to
continue as a going concern.

In order to meet Metal Storms objectives to develop, manufacture and market commercial
products effectively, we will require additional funding until such time that product sales are of sufficient volume to generate positive cash flows from operations. This has taken longer and has cost more than originally anticipated. Based on the
expected levels of operating expenditures, in order to continue its operations, Metal Storm will require additional capital.

In June 2010 we entered into an agreement with Dutchess Opportunity Fund II LP (Dutchess) for an equity line of credit
facility for the sum of A$25.0 million (the Dutchess Equity Line Facility). The Dutchess Equity Line Facility allows Metal Storm to drawdown sums of money in cycles of up to five trading days and issue ordinary shares to Dutchess as
consideration. The amount of each drawdown is variable up to A$200,000 and initiated at the discretion of Metal Storm. The level of funding provided for by the Dutchess Equity Line Facility is variable, which creates uncertainty over the cash
inflows we may receive over the next 12 months. The level of funding available under the Dutchess Equity Line Facility includes the possibility of certain adjustment events. Adjustment events may reduce the level of funding received in a particular
tranche by 20% for every day an adjustment event occurs. Additionally, the level of funds likely to be provided under the Dutchess Equity Line Facility may be less than our historical cash requirements and managements forecasts for business
operations. To date, the Dutchess Equity Line Facility has been supplemented by equity placements, however, the availability of such placements in the future is uncertain.

The number of shares that may be issued under the Dutchess Equity Line Facility and other equity placements is likely to exceed the limit imposed by Australian Securities Exchange (ASX)
listing rule 7.1. Therefore we will require shareholder approval to issue shares in excess of the limits prescribed by the listing rules of the ASX (ASX Listing Rules). The ASX Listing Rules also require that shares issued pursuant to
shareholder approval must be issued within three months of that approval. Metal Storm is likely to make equity placements and use the Dutchess Equity Line Facility consistently throughout its term and as such will be required to continually seek
shareholder approval for the issue of shares that exceed the limit prescribed by ASX Listing Rule 7.1. If we are unable to obtain shareholder approval, we may not be able to issue shares and therefore receive funds under the Dutchess Equity Line
Facility. Additionally, even upon obtaining shareholder approval, the funds to be received under the Dutchess Equity Line Facility are expected to be less than our historical operating cash requirements. As a result, additional sources of capital
may be required in order to continue operations.

In September 2006, we raised A$27.5 million under a rights offer of
convertible notes (Rights Offer) in Australia and New Zealand. At meetings of our shareholders and Noteholders, both held on August 29, 2011, it was agreed to extend the maturity date of the convertible notes from September 1,
2011 to March 1, 2012. At another meeting of our shareholders and Noteholders, both held on January 12, 2012, the maturity date of the convertible notes was extended to March 1, 2015 (the Maturity Date).

At the Maturity Date, Metal Storm must redeem the convertible notes unless a noteholder has elected to convert them into ordinary shares
or they have been redeemed prematurely by agreement. Unless the convertible notes that are currently outstanding are converted, we will be required to repay approximately A$18.9 million to redeem the convertible notes on the Maturity Date. The
magnitude of a capital raising required to repay the convertible notes is significantly greater than we have been able to source in recent years. In the absence of improved business performance, conversion or restructuring of the convertible notes,
or a significant capital raising, we will not be in a position to satisfy the liability to the Noteholders. We cannot assure you that we will be successful in generating revenue or obtaining financing to redeem the convertible notes when they become
due on the Maturity Date.

There can be no assurance that we will be able to raise sufficient capital to continue our
operations and redeem the convertible notes on the Maturity Date. If we are unsuccessful in our efforts to obtain sufficient financing to continue to fund our current operations and redeem the convertible notes on the Maturity Date, we will be
required to significantly reduce or cease operations altogether. Accordingly, there exists a substantial doubt about Metal Storms ability to continue as a going concern. If we do not have reasonable grounds to believe that we will be
successful in our efforts to obtain sufficient financing to continue to fund our operations and redeem the convertible notes at the Maturity Date, we will be required to appoint an administrator under Australias bankruptcy system.



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##### Table of Contents

Our financial statements have been prepared on the basis of a going concern. If we are
unable to raise additional capital when required, the basis of going concern may not be appropriate. Therefore, Metal Storm would realize the value of its assets and extinguish its liabilities at amounts other than amounts in the financial
statements. No adjustments have been made to the financial statements relating to the recoverability and classification of the assets carrying amounts or classification of liabilities that might be necessary should Metal Storm no longer be a going
concern.

We may be required to redeem convertible notes before the Maturity Date, which redemption could cause us to become insolvent.

In connection with the Rights Offer, Metal Storm entered into a Trust Deed in 2006, which was amended and restated on
July 30, 2009 (the Trust Deed). On the occurrence of a default event under the Trust Deed prior to the Maturity Date, Metal Storm must, if required by the trustee, redeem all convertible notes outstanding by payment of the face
value of the convertible note together with all accrued but unpaid interest. In the event of early redemption of the convertible notes, Metal Storm would have to raise funds to meet such obligations. It is likely that we will not be able to do so in
a timely manner, or at all, in which case Metal Storm could become insolvent.

We will need to raise additional capital and this may not be
on favorable terms.

Metal Storm will require additional capital in the near term to fund product development programs. In
addition, we may seek to exploit business opportunities that will require us to raise additional capital from equity or debt sources. In particular, developing and commercializing new technology and products to develop our business could require a
significant commitment of additional resources that could, in turn, require us to obtain additional funding. We may also require further funds to pursue regulatory clearances, prosecute and defend our intellectual property rights, develop marketing
capabilities and fund operating expenses.

We expect that a major capital raising will enable us to get one or more of our
products to a production-ready stage and commence the marketing process. For us to get to that stage, we expect to need A$10 million  A$15 million in proceeds from a single capital raising, exclusive of transaction costs. The actual amount of
funding required is difficult to forecast due to the nature of our research and development activities. In addition, up to a further A$18.9 million will be required to repay the face value of the convertible notes currently on issue if they are
unable to be restructured or refinanced through other methods.

Our ability to obtain additional financing will be subject to
a number of factors, including market conditions and our operating performance. These factors may render the timing, amount, terms and conditions of additional financing unattractive for us. The sale of additional equity or convertible debt
securities would result in dilution to our existing stockholders. Additional debt could result in increased expenses and could result in further covenants that would restrict our operations. We cannot be certain that we will be able to raise any
required funding or capital on favorable terms or at all. If we do not have reasonable grounds to believe that we will be successful in our efforts to obtain sufficient financing to continue to fund our operations, we will be required to appoint an
administrator.

We have incurred operating losses in each year since our inception. We had net losses of A$6.0 million, A$8.9
million and A$11.3 million for the years ended December 31, 2011, 2010 and 2009 respectively. We expect to incur additional operating losses over the next few years. Our profitability is dependent on our ability, alone or with others, to
complete the successful product engineering of our technology, obtain any required regulatory clearances, and commercialize our products. We cannot be certain if or when we will achieve profitability or positive cash flow.

Raising additional capital by issuing securities may cause dilution to existing shareholders.

Metal Storm will require additional capital in the near term to fund product development programs. In addition, we may seek to exploit
business opportunities that will require us to raise additional capital from equity or debt sources. If we raise additional funds by issuing equity or convertible debt securities, we will reduce the percentage ownership of our then-existing
shareholders, and these securities may have rights, preferences or privileges senior to those of our existing shareholders. The issuance of any additional ordinary shares, any additional American Depositary Shares, also referred to ADSs, or any
securities that are exercisable for or convertible into our ordinary shares, may have an adverse effect on the market price of our ordinary shares and ADSs and will have a dilutive effect on our shareholders. In addition, to the extent that options,
convertible notes or convertible securities that are currently outstanding are exercised or converted (as the case may be), this may also have an adverse effect on the market price of our ordinary shares and ADSs and will also have a dilutive effect
on our shareholders.



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##### Table of Contents

We are in the product engineering phase and do not yet have any product for sale based on our core
technology.

Most of our technology requires further research, development, testing and possibly regulatory approval prior
to any commercial sales. Metal Storm does not currently derive any revenue from the commercial sale of any applications of our technology. We cannot be sure of the extent to which the technology or any products we develop will be able to penetrate
the potential markets for defense or commercial applications or gain market acceptance.

We cannot be certain of market acceptance of our
technology or the rate of any market acceptance.

We plan to develop our technology for use in a range of military, law
enforcement, counter-terrorism and commercial applications. It is not yet known whether our technology will be accepted in the market for any of these applications or the rate of any market acceptance. The degree of market acceptance will depend on
a number of factors, including the receipt and timing of any regulatory approvals, the establishment and demonstration of the need, safety, efficacy and cost-effectiveness of our technology and products, and our technologys advantages over
existing technologies. It is not yet known whether we will be able to fully develop or commercialize our technology and products, even if they perform successfully in research and evaluation trials.

We are dependent on retaining key personnel.

There is competition among defense development companies for qualified technical employees and retaining and attracting qualified individuals is critical to our success. The responsibility of overseeing
day to day management and the strategic management of Metal Storm is concentrated amongst a small number of key people. The loss of the services of key personnel could have a material adverse effect upon Metal Storm, as we may not be able to recruit
replacements for the key personnel within a short timeframe.

Any catastrophic event involving our technology could adversely affect Metal
Storms reputation.

Any catastrophic accident involving the testing of our technology or the use of products that
are developed utilizing our technology could severely damage Metal Storms reputation, marketing ability and results of operations.

Changes in funding or export regulation by the U.S. or Australian governments could impact our ability to develop and sell our products.

Some of our technology applications progress in collaboration with U.S. and Australian government defense research and
development program support. We have obtained such support from both the U.S. and Australian governments. We have entered into agreements with the departments of defense of these countries that provide conditions to the funding of research and
development grants. For example, generally we are required to achieve certain milestones with respect to the development of our technology prior to receiving payment under the agreements. In addition, we have granted exclusive licensing rights under
certain agreements and we are also in some circumstances required to repay money received under the agreements. Further, although the Australian programs provided for funding contributions by consortium members, we have received no direct funds from
these programs. If Metal Storm is unable to continue existing research and development programs or to enter into new research and development programs, if there is a decrease of available funding in respect of such programs, or if the U.S. or
Australian governments choose to exercise powers available to them under export control regulations to control the export of Metal Storm technology or products developed from it, this could have a material adverse affect on us.

There are some design and performance limitations relating to our technology.

In its usual configuration, the Metal Storm technology stacks a number of projectiles in each barrel and a quantity of propellant or
gunpowder is located in a space that separates the projectiles. As a result, barrels may be longer and therefore heavier to hold the additional propellant that may be required to support our technology. For these reasons, the development risk of our
technology increases as the operating pressure of the system increases. Furthermore, unlike conventional gun systems, which are mechanical in operation, our technology is reliant on a 100% electronic fire control system. Electronic systems may be
adversely affected by electromagnetic interference. Failure to design the electronics systems to minimize susceptibility to natural or man-made electromagnetic interference may result in unplanned and potentially catastrophic failure of our
technology. The extent to which these factors will affect the development of and the practical applications of our technology is uncertain.

We may not have adequate protection for our intellectual property.

We principally rely upon patents, trade secret, copyright and contract law to protect our proprietary technology. We cannot be certain that any protective measures we have taken will be adequate to
protect our proprietary technology. Many of the laws of foreign countries treat the protection of proprietary rights differently from, and may not protect our proprietary rights to the same extent as do, laws in Australia, the United States and
Patent Co-operation Treaty countries. In addition, the laws of many countries, including Australia and the United States, provide governments with the ability to control or restrict the use of defense technologies.



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Patent matters involve complex legal and factual questions. Accordingly, we cannot predict
the availability and breadth of claims sought in relation to patents. Statutory differences in patentable subject matter may limit the protection we can obtain for some of our inventions, or prevent us from obtaining patent protection, which could
materially adversely affect our business, financial condition and results of operations.

Additionally, the enforceability of
a patent is dependent on a number of factors, which may vary between jurisdictions. These factors may include the novelty of the invention, the requirement that the invention not be obvious in light of prior art, including prior use or publication
of the invention, the utility of the invention and the extent to which the patent clearly describes the best method of working the invention.

While we have obtained and continue to seek patent protection for our technology, we cannot be certain that:



| |  |  | any of the pending or future patent applications filed by us or on our behalf will be approved;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | we will develop any additional proprietary products or processes that are patentable; or
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | third parties will not independently develop similar products or processes, duplicate any of the products or processes we have or are developing
relating to our technology, or design around the patents we own with competitive advantages.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Furthermore,
we cannot be certain that patents held by third parties will not prevent the commercialization of products incorporating our technology or that third parties will not challenge or seek to narrow, invalidate or circumvent any of our issued, pending,
or future patents.

Protecting our proprietary technology from infringement by others may affect our business.

We may need to engage in litigation to enforce patents or to determine the scope and validity of third party proprietary rights. This
could result in substantial costs to us and divert efforts from our business. We may have to participate in opposition proceedings before the Australian Patent Office or a foreign patent office, or in interference proceedings declared by the U.S.
Patent and Trademark Office, to determine priority of invention of patent applications filed by competitors. Any such litigation, interference or opposition proceeding, regardless of the outcome, could be expensive and time consuming and adverse
determinations in any such proceedings could prevent us from developing, manufacturing or commercializing our technology or products, which could have a material adverse effect on our business, financial condition and results of operations.

In addition to patent protection, we rely on unpatented trade secrets, know-how and proprietary technological innovation and
expertise, which are protected, in part, by confidentiality agreements with our employees, advisers and consultants. We cannot be certain that these agreements will not be breached, that we will have adequate remedies for any breach, or that our
unpatented proprietary intellectual property will not otherwise become known or independently discovered by competitors. We also cannot be certain that relevant inventions will not be developed by persons not bound by such agreements.

We may be subject to patent infringement claims from our competitors and other third parties.

Our commercial success may depend, in part, on our ability to avoid infringing on patents issued to others. Although we are not aware of
any action or threatened action alleging patent infringement or improper use of proprietary information by us, if we have to defend any such claims we could incur substantial costs and our management resources could be diverted. This could have a
material adverse effect on our business, financial condition and results of operations.

If we were found to be infringing any
third party patents, we could be required to pay damages, alter our products or processes, obtain licenses or cease certain activities. We cannot be certain that if we required licenses for patents held by third parties that they would be made
available on terms acceptable to us, if at all. To the extent that we required such licenses for the development of our technology and we were unable to obtain them, we could be foreclosed from the development, manufacture or commercialization of
technology or products requiring such licenses, or encounter delays in product introductions while attempting to design around such patents. This could have a material adverse effect on our business, financial condition and results of operations.

The Australian and U.S. governments may take action on patent applications and patents.

Under the provisions of the Australian Patents Act 1990 (Patents Act), the Commonwealth of Australia has the right to
exploit, or authorize others in writing to exploit, an invention for the services of the Commonwealth of Australia at any time after a patent application has been made. The remuneration and terms for exploitation are determined by agreement between
the person entitled to the benefit of the patent application, or the persons nominee, and the Commonwealth of Australia. If there is no agreement, the determination is made by a prescribed court.



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Under the provisions of the Patents Act, a patent or a patent application may also be
acquired by the Commonwealth of Australia. In that instance, all rights in the patent, or the patent application, vest in the Commonwealth of Australia. Compensation must be paid in an amount to be agreed between the person entitled to be
compensated, and the Commonwealth of Australia. If there is no agreement, the amount of compensation is determined by a prescribed court. As such an acquisition clearly involves an acquisition of property, the terms of that acquisition must be
just, within the meaning of the Australian Constitution.

The Patents Act also allows the Commissioner of Patents,
on the direction of the relevant Minister of the Commonwealth of Australia, to prohibit or restrict the publication of information about the subject matter of a patent application. While any such order is in force, the complete specification of the
application is not open to public inspection, acceptance must not be notified and a patent must not subsequently be granted. As a result, if the Commonwealth of Australia were to take action on one or more of our patents under the Patents Act, we
may not be able to exclusively commercially exploit such patents in the way we currently intend. Additionally, the compensation we receive in connection with such actions may be significantly less than what we would receive if we were to retain full
rights to the patent.

Under the U.S. Patent Act, the U.S. government may use an invention described in and covered by a U.S.
patent without license of the owner. Where this occurs, the owners only remedy is an action against the U.S. government for the recovery of reasonable and entire compensation for the use and manufacture of the invention.

Under the U.S. Patent, if one of the authorized offices of various government agencies identified under the U.S. Patent Act holds the
opinion that publication or disclosure of an invention described in a patent application would be detrimental to the national security, the Commissioner of Patents being so notified shall order that the invention be kept secret and also withhold the
publication of the application or the grant of a patent for such period as the national interest requires. The owner of an application that has been placed under a secrecy order shall have the right to appeal from the order to the Secretary of
Commerce. An applicant whose patent is withheld shall have the right to apply for compensation for the damage caused by the order of secrecy.

It is also possible that countries other than Australia or the United States could take action that may impact upon our patents and patent applications. Any actions on our patents by the governments of
Australia, the United States or other countries could affect our ability to protect our technology and our ability to effectively commercialize our technology. This could have a material adverse effect on our business, financial condition and
results of operations.

There are potential adverse effects from competition and technological changes.

The defense industry market is highly competitive and can be subject to significant technological change. Large, well-established defense
companies are engaged in research and development and have considerably greater resources than Metal Storm to develop applications for defense technology. We cannot be certain that our competitors will not succeed in developing technologies and
products that are more effective than any which we are developing, or which would render our technology and products obsolete or non-competitive. Much of the research being conducted on defense technology is funded principally by government agencies
in the United States. We compete with such other companies for government resources allocated to such research and development projects. There are existing defense companies that may have target markets similar to, if not the same as, ours. Such
companies may be developing their own technology and products, which may ultimately compete with ours. This could have a material adverse effect on our business, results of operations and financial condition.

The defense industry market is characterized by changing technology, evolving industry standards, introductions and enhancements and
changing customer demands. These market characteristics are exacerbated by the nature of the defense industry. Accordingly, Metal Storms success may depend on our ability to adapt to changing technologies, our ability to adapt our technology
to evolving industry standards, and to continually improve the performance, features and reliability of our technology, in response to both evolving demands of the marketplace and competitive product offerings. If we fail to adapt to such changes
and evolution, this could have a material adverse effect on our business, results of operations and financial condition.

There are existing companies that may have target markets similar to, if not the same as, ours. Such companies may be developing their
own technology and products, which may ultimately compete with ours. Our technology may be perceived by our competitors as threatening existing markets and therefore may be resisted. As a result, we cannot be certain that we will be successful in
commercializing our technology or that we will be able to penetrate the potential markets for our products.

There may be reductions or
changes in military and other government expenditures.

We anticipate that our primary customers will be the U.S. and
Australian governments, the agencies of the U.S. and Australian governments Departments of Defense, the U.S. Department of Justice, U.S. and Australian law enforcement agencies and the



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global defense industry. Our markets may be limited by U.S. and Australian government requirements pertaining to foreign markets. We also cannot predict future levels of defense and law
enforcement spending with certainty and declines in military or law enforcement expenditures could materially adversely affect our results of operations and financial condition. The impact of possible declines in the level of defense procurement or
law enforcement expenditure on our results of operations and financial condition will depend upon the timing and size of the changes and our ability to mitigate their impact with new business, business consolidations or cost reductions. The loss or
significant curtailment of a material program in which we participate could have a material adverse affect on our future results of operations and financial condition.

We are subject to government regulation.

We are developing products for
sale in the defense and law enforcement industries, which are subject to extensive regulation. This regulation may adversely affect our business. For example, products incorporating our technology are required to undergo rigorous testing as well as
extensive regulatory approval processes. These processes take significant time and require us to expend substantial resources. Delays in obtaining regulatory approvals could adversely affect the development and commercialization of our technology
and products and could have a material adverse effect on our business, financial condition or results of operations.

We will
need to obtain operating licenses and permits. Such licenses and permits may be difficult to obtain and retain depending on government policies, customs, changes in political leadership, and other factors. We cannot assure you that we will continue
to be in compliance with any such licenses or permits or any other governmental requirements. If we fail to comply with any such licenses or permits or any other governmental requirements it could have a material adverse effect on our business,
financial condition and results of operations.

Products to be manufactured using our technology may also be subject to
government regulation, including regulations governing use, specification, manufacture, handling, disposal, packaging, labeling, transport and import/export in Australia, the United States and in each of the countries into which such products are
intended to be exported. See Item 4B Information on Metal Storm  Business Overview  Regulation for a discussion of government regulations that we are subject to in Australia and the United States.

Compliance with government regulation requires us to allocate resources to monitoring compliance, training, security of goods, reporting
and reviewing legislative and other changes to ensure we are complying with the relevant regulations in the jurisdictions in which we operate. Failure to comply with government regulations could result in our inability to sell our products in those
jurisdictions.

There are risks inherent in U.S. government contracts.

We expect that a significant portion of our revenue will be associated with contracts and programs for the U.S. government in which there
are significant inherent risks, including risks particular to the defense industry. The primary risks relate to:



| |  |  | Contract Termination
| | - |  | --------------------

Any contracts we may enter into with the U.S. government may be subject to termination by it either for its convenience or in the event of a default by us as the contractor. Termination for convenience
provisions may only provide for the recovery by us of costs incurred or committed, settlement expenses and profit on work completed prior to termination. Termination for default provisions may render us liable for excess costs incurred by the U.S.
government in procuring undelivered items from another source.



| |  |  | Loss of Appropriations
| | - |  | ----------------------

U.S. government contracts are usually conditional upon the continuing availability of U.S. Congressional appropriations. Congress usually appropriates funds for a given program on a fiscal-year basis even
though contract performance may take more than one year. Consequently, at the outset of a major program, the contract is usually partially funded, and additional monies are normally committed to the contract by the procuring agency only as
appropriations are made by Congress for future fiscal years. In addition, most U.S. government contracts are subject to modification in the event of changes in funding. Any failure by Congress to appropriate additional funds to any program in which
we participate or any contract modification as a result of funding changes could materially delay or terminate such program and therefore have a material adverse effect on our business, results of operations or financial condition.



| |  |  | Procurement and Other Related Laws and Regulations
| | - |  | --------------------------------------------------

If we enter into contracts with the U.S. government we may be subject to extensive and complex U.S. government procurement laws and regulations. These laws and regulations provide for ongoing U.S.
government audits and reviews of



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contract procurement, performance and administration. Failure to comply, even inadvertently, with these laws and regulations and with laws governing the export of munitions and other controlled
products and commodities, and any significant violations of any other U.S. federal law, could subject us to potential contract termination, civil and criminal penalties, and under certain circumstances, suspension and debarment from future U.S.
government contracts for a specified period of time. Any such actions could have a material adverse effect on our business, results of operations or financial condition.



| |  |  | Protection of Proprietary Technology
| | - |  | ------------------------------------

If we enter into U.S. government contracts, and in particular contracts that involve modification or development of our technology or products, we may face a risk that the U.S. government would seek to
assert far-reaching rights to our inventions and technology. Such assertions could compromise our competitive position.



| |  |  | Changes and Adjustments
| | - |  | -----------------------

The U.S. government often directs changes in contract work, particularly in the case of products under development. Recovery of additional costs and profit attributable to the changed work may require a
protracted effort that could adversely affect our cash flow.



| |  |  | Competitive Bidding and Domestic Preferences
| | - |  | --------------------------------------------

We may need to obtain military contracts through either competitive bidding or sole-sourced procurement. We cannot be certain that we will be successful in having our bids accepted or, if accepted, that
awarded contracts will be profitable. We may be disadvantaged in competing for contracts by laws and regulations that give preference to firms that offer products manufactured in the United States or to small or minority-owned businesses. We may
also be disadvantaged by regulations limiting the access of non-U.S. citizens to classified information of the U.S. government or the use or storage of such information at facilities outside the United States. We have organized Metal Storm Inc., our
U.S. subsidiary, as a U.S. owned small business, as defined by applicable U.S. Department of Defense requirements, which allows Metal Storm Inc. to contract directly with U.S. government and defense agencies in accordance with U.S.
Department of Defense requirements. Our other U.S. subsidiary, Metal Storm U.S.A. Limited, is 100% owned by us and was formed to contract with both U.S. government agencies as well as non-government defense contractors.

Additionally, inherent in either procurement process is the risk that if a bid is submitted and a contract is subsequently awarded,
actual performance costs may exceed the projected costs upon which the submitted bid or contract price was based. To the extent that actual costs exceed the projected costs on which bids or contract prices were based, our potential profitability
could be materially adversely affected.

We may have product liability exposure in the future.

The testing, marketing and sale of our technology may result in products that are used in situations that may result in serious,
permanent bodily injury, or even death, to those involved. A person injured in connection with the use of our products may bring legal action against us to recover damages on the basis of claims including personal injury, wrongful death, negligent
design, dangerous product or inadequate warning. We may also be subject to lawsuits involving allegations of misuse of our products. If successful, personal injury, misuse and other claims could have a material adverse effect on our business,
operating results and financial condition. There can be no assurance that adequate or necessary insurance coverage will be available or will be obtained to limit our product liability exposure.

We may be dependent on third party manufacturers, suppliers and teaming partners.

We currently do not have any manufacturing capabilities. In the future, we may be required to enter into contracting arrangements with
third party manufacturers in order to manufacture our products for large-scale, later-stage testing. If we need to use a third party to manufacture all, or a portion of, our products we cannot be certain that we will be able to enter into
satisfactory arrangements with such contract manufacturers. If, at any time, we are unable to maintain or expand as necessary or contract for manufacturing on acceptable terms, our manufacturing capabilities and our ability to conduct tests with our
products will be adversely affected, resulting in delays in submissions for regulatory approvals.

We may also need to develop
manufacturing resources, enter into collaborative arrangements with other parties who have established manufacturing capabilities, or have third parties manufacture our products on a contractual basis. We cannot be certain that we will have access
on acceptable terms to the extensive additional financing, qualified personnel and relevant technologies that would be required in order for us to scale-up production and develop effective commercial manufacturing processes and technologies, or that
we will be able to enter into collaborative or contractual arrangements on acceptable terms with parties that will meet our requirements in respect of quality, quantity and time lines.



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In addition, we may be dependent upon suppliers of parts for our projectile launching
systems and teaming partners with whose weapons platforms our systems may be integrated. Any failure in delivery or performance by these third parties could cause a delay in the development or commercialization of our systems.

Our share price has been and will likely continue to be volatile.

The ordinary shares of Metal Storm are quoted on the ASX and our American Depositary Shares, also referred to as ADSs, are registered and trade on the over-the-counter (OTC) market in the United States.
As a result, our share price will be subject to the numerous influences that may affect both the broad trend in the local and international share market and the share prices of individual companies and sectors. Investors should recognize that the
price of ordinary shares and options in Metal Storm may fall as well as rise. Our share price has been and is likely to continue to be volatile, particularly due to our relatively limited trading volume. Our share price could fluctuate significantly
due to a number of factors, including:



| |  |  | variations in our anticipated or actual operating results;
| | - |  | ----------------------------------------------------------



| |  |  | sales of substantial amounts of our shares;
| | - |  | -------------------------------------------



| |  |  | announcements about us or about our competitors, including new products;
| | - |  | ------------------------------------------------------------------------



| |  |  | litigation and other developments relating to our patents or other proprietary rights or those of our competitors;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | governmental regulation and legislation;
| | - |  | ----------------------------------------



| |  |  | our available cash resources or the need to seek additional funding through public or private equity or debt financings; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in securities analysts estimates of our performance, or our failure to meet analysts expectations.
| | - |  | ------------------------------------------------------------------------------------------------------------

Many of these factors are beyond our control. The minimum trading price on the ASX is A$0.001. Metal Storm has frequently traded at
A$0.001 on the ASX during February and March 2011.

A substantial source of funding is the Dutchess Equity Line Facility. The
Dutchess Equity Line Facility allows us to initiate drawdowns at a frequency of up to one drawdown per five trading days and issue ordinary shares to Dutchess in consideration. Any sale by Dutchess of the ordinary shares we have issued to it
pursuant to the Dutchess Equity Line Facility could cause volatility in our share price. In addition, a significant number of shares could be issued upon conversion of the convertible notes, conversion of the convertible securities that we issued in
2011, and the exercise of options issued to Noteholders in September 2006. See Item 7A  Major Shareholders and Related Party Transactions  Major Shareholders.

We are not currently paying dividends and we may not pay dividends in the future.

Until we are in a net asset position, our directors will not be able to recommend that any dividends be paid to our shareholders. Our future profitability and cash flow will depend on future earnings, as
well as our working capital requirements. Our directors current intention is to reinvest our income in the continued development and operation of our business. We may continue to generate operating losses on research projects until such time
as our technology, or products resulting from research into our technology, are successfully commercialized. There are a number of factors beyond our control and our directors control, for example changes in technology, market competition,
exchange rate fluctuations and governmental policy, which may also impact on our profitability and ability to pay dividends.

We have been,
and may be again, classified as a passive foreign investment company for U.S. federal income tax purposes.

While we do
not believe Metal Storm was a passive foreign investment company (PFIC) for U.S. federal income tax purposes in 2011, we believe Metal Storm was a PFIC in 2000, 2002, 2003, 2004, 2005, 2006 and 2008. Based on the composition of our
assets and income and our current expectations, Metal Storm could be a PFIC again in 2012 or any future taxable year. The determination of our PFIC status is dependent upon the composition of our income and assets and, in addition, we must make a
separate determination at the close of each taxable year as to whether we are a PFIC. A non-U.S. corporation will be considered a PFIC for any taxable year if either (i) at least 75% of its gross income is passive income or (ii) at least
50% of the value of its assets is attributable to assets that produce or are held for the production of passive income. The market value of our assets may be determined based on the market price of our ADSs, which is likely to fluctuate.

For any U.S. holder that owns our ADSs or ordinary shares during any taxable year in which we qualify as a PFIC, our status as a PFIC
could, among other things, have a material effect on the timing and character of income and gain, for U.S. federal income tax purposes, with respect to the holders ADSs or ordinary shares. It could also have a material adverse effect on the
amount of U.S. federal income tax owed by the U.S. holder as a result of owning, receiving dividends on or disposing of ADSs or ordinary shares. See Item 10E Additional Information  Taxation  U.S. Federal Income Tax
Considerations  Passive Foreign Investment Company Status for a more detailed description of the U.S. tax consequences of owning stock in a PFIC.



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U.S. holders are encouraged to consult their tax advisors regarding the consequences of
owning and disposing of ADSs or ordinary shares, including the desirability of making, and the availability of, certain elections with respect to our ADSs or ordinary shares. Metal Storm provides no advice on your taxation matters. The above should
not be taken as advice by the reader of this document.

Our ADS holders are not shareholders and do not have shareholder rights.

The Bank of New York Mellon, as depositary, delivers our ADSs, on our behalf. Our ADS holders will not be treated as
shareholders and do not have the rights of shareholders. The depositary will be the holder of the shares underlying our ADSs. Holders of our ADSs will have ADS holder rights. A deposit agreement among us, the depositary and our ADS holders, and the
beneficial owners of ADSs, sets out ADS holder rights as well as the rights and obligations of the depositary. New York law governs the deposit agreement and the ADSs.

Our ADS holders do not have the same voting rights as our shareholders. Shareholders are entitled to our notices of general meetings and to attend and vote at our general meetings of shareholders. At a
general meeting, every shareholder present (in person or by proxy, attorney or representative) and entitled to vote has one vote on a show of hands. Every shareholder present (in person or by proxy, attorney or representative) and entitled to vote
has one vote per fully paid ordinary share on a poll. This is subject to any other rights or restrictions which may be attached to any shares. Our ADS holders may instruct the depositary to vote the ordinary shares underlying their ADSs, but only if
we ask the depositary to ask for their instructions. If we do not ask the depositary to ask for the instructions, our ADS holders are not entitled to receive our notices of general meeting or instruct the depositary how to vote. Our ADS holders will
not be entitled to attend and vote at a general meeting unless they withdraw the ordinary shares. However, our ADS holders may not know about the meeting enough in advance to withdraw the shares. If we ask for our ADS holders instructions, the
depositary will notify our ADS holders of the upcoming vote and arrange to deliver our voting materials and form of notice to them.

The depositary will try, as far as practical, subject to Australian law and the provisions of the depositary agreement, to vote the shares as our ADS holders instruct. The depositary will not vote or
attempt to exercise the right to vote other than in accordance with the instructions of the ADS holders. We cannot assure our ADS holders that they will receive the voting materials in time to ensure that they can instruct the depositary to vote
their shares. In addition, there may be other circumstances in which our ADS holders may not be able to exercise voting rights.

Item 4. Information on Metal Storm

A. History and Development of Metal Storm

Our legal and commercial name is Metal Storm Limited, which was incorporated under the laws of Australia on April 13, 1994. Our
principal office is located at 29 Sudbury Street Darra, Queensland 4076, Australia. Our telephone number is 011-61-7-3147-8600. Our website address is www.metalstorm.com. Information on our website and websites linked to it do not constitute part of
this annual report. In 2001, our subsidiary Metal Storm Inc. opened an office in Arlington, Virginia, which is close to the Pentagon. Our agent for service of process in the United States is Mr. Peter D. Faulkner, 4350 N. Fairfax Drive,
Suite 810, Arlington, VA 22203.

In 1994, we acquired patents and intellectual property from Mr. J.M. ODwyer. In
consideration for these patents, we issued to him 1,125,000 ordinary shares. Between May 1994 and March 1999, a total of 2,625,000 ordinary shares were issued to a variety of investors raising a total of A$1,993,875.

In anticipation of our initial public offering in Australia, we effected a 21.4 to 1 stock split in March 1999 that increased our issued
capital from 3,750,002 to 80,250,042 ordinary shares. In June 1999, we raised A$12 million in an initial public offering in Australia by offering and selling 4,000,000 ordinary shares at an issue price of A$3.00 per share. Our ordinary shares were
quoted on the ASX in July 1999 under the symbol MST. In May 2000, we effected a 5 to 1 stock split, thereby increasing our issued capital from 84,250,042 to 421,250,210 ordinary shares.

In 2000, we commenced a Level 1 American Depositary Receipts (ADR) program with The Bank of New York as depositary and our
ADRs traded on the over-the-counter market. In December 2001, we commenced a Level 2 ADR program and our ADRs commenced trading on the NASDAQ Capital Market under the ticker symbol MTSX. From 2001 through 2004, we raised A$27.3 million
through a share purchase plan that was available only to Australian residents and various private placements of ordinary shares in Australia.

In December 2003, we acquired Seattle-based ProCam Machine LLC (ProCam) in exchange for the issuance of 5,524,926 ordinary shares of Metal Storm Limited and US$189,739 cash. As part of this
acquisition, Metal Storm assumed US$2.2 million in debt. ProCam was a manufacturer of precision-machined parts for the defense, electronics, aircraft and space propulsion industries. In June 2005, Metal Storm sold the ProCam business.



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In May 2006, we raised A$2.7 million through a share purchase plan available only to
shareholders resident in Australia and New Zealand. In September 2006, we raised A$27.5 million under a rights offer of convertible notes available only to shareholders resident in Australia and New Zealand.

In July 2008, we delisted our ADSs from the NASDAQ Capital Market and moved trading of our ADSs back to the over-the-counter market under
the symbol MTSXY.

In July 2009, we raised A$2.6 million through a share purchase plan available only to
shareholders resident in Australia and New Zealand.

On 31 July 2009, prior to maturity on 1 September 2009,
shareholders and noteholders of the Company approved a modification to the terms of the notes and to the trust deed. The modification provided a further two year extension to the maturity date to 1 September 2011 of the convertible notes and
created a new class of note. The new note carried identical terms to the 10% coupon note except it bore no interest and instead offered a fixed and floating charge over the Company.

Noteholders were provided the opportunity to exchange their 10% coupon notes for the same number of new secured notes plus 5 options for
every 7 notes they exchanged. Refer note 20 for the option terms. 77% of noteholders elected to make the exchange. Refer note 16 for further information.

In December 2009, we entered into an agreement with GEM Global Yield Fund Ltd (GEM) for an equity line of credit facility for the sum of A$20.2 million (the GEM Equity Line
Facility). The GEM Equity Line Facility yielded significantly lower funding than anticipated due to a variety of issues, including a condition requiring us to enter into a share lending agreement with a third party share lender in respect of
each proposed drawdown. In June 2010 we agreed with GEM to terminate the GEM Equity Line Facility and it was formally terminated in September 2010. To replace the GEM Equity Line Facility Agreement, we entered into the Dutchess Equity Line Facility
Agreement in June 2010 for up to A$25.0 million, which is available over three years. See further information in section 10 C  Equity Line Facility Agreements.

During 2010 we raised a further A$6.8 million through equity financing, including A$2.4 million from a rights issue in September 2010, A$2.3 million from private placements and A$2.1 million from equity
line of credit facilities. A further $787,500 in stock was issued to repay outstanding loans having a carrying value of $787,500.

During 2011 we raised a further $4.3 million through equity financing, including A$1.5 million from a rights issue in November 2011, A$1.4 million from private placements and A$1.4 million from our
Dutchess Equity Line Facility.

We entered into a Subscription Agreement in April 2011 with one of our largest shareholders,
Andrew Doyle, pursuant to which we have the discretion to require Mr. Doyle to subscribe for up to A$400,000 worth of ordinary shares at an issue price of A$0.01 per share. Consistent with the terms of our 2010 rights issue, Mr. Doyle was
issued three unquoted options for no additional consideration for every share allotted under the Subscription Agreement. Mr. Doyle subscribed for A$932,000 worth of shares during 2011, including the $400,000 worth of ordinary shares pursuant to
the Subscription Agreement entered into in April 2011.

In June 2011, we received A$200,000 from a private placement of shares
to an investor. In October 2011 we received A$700,000 in short term debt funding. In December 2011, we repaid A$230,000 of this funding and applied the balance as consideration for the issue by Metal Storm of a new convertible security with a face
value of A$700,000 . In December 2011 we received A$200,000 for the issue of new convertible securities.

In April 2012, we
entered into two Subscription Agreements with Luxinvest Capital Advisors S.A., of Luxembourg (Luxinvest), pursuant to which Luxinvest agreed to invest in Metal Storm (i) A$350,000 in exchange for ordinary shares at an issue price of
A$0.0008 per share, and (ii) A$4.3 million in exchange for ordinary shares at an issue price of A$0.0008 per share, to be issued in two tranches. Both Subscription Agreement are subject to shareholder approval.

B. Business Overview

Metal Storm is a defense technology company with offices in Australia and the United States. We specialize in the research, design,
development and integration of projectile launching systems utilizing our electronically initiated / stacked projectile technology for use in the defense, homeland security, law enforcement and industrial markets.



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Strategy

We are focused on developing and qualifying two 40mm calibre weapons systems plus one 18mm calibre weapons system that together could offer substantial, differentiated benefits to military and law
enforcement users.

In addition, we pursue contracts with military customers and major defense contractors where our unique
stacked projectile launching technology and component weapon systems can be applied for specific end-user requirements and/or where these contracts may open up opportunities for Metal Storm weapon sales.

In recent years, we have seen a significant increase in U.S. military interest in less-lethal weapons technology. Giving the soldier the
option to respond to a threat with lethal or less-lethal force when placed in complex urban conflict or peacekeeping missions may reduce civilian casualties. Our multi-barrel stacked round weapons can provide instantly selectable lethal or
less-lethal munitions, giving a clear advantage to Metal Storm in this emerging market.

We have entered into a number of
strategic partnerships with major companies, including Singapore Technologies Kinetics (STK), iRobot, Electro Optic Systems, and Defence Technologies Inc., where partners provide capabilities such as manufacturing, complementary
technology, or access to markets in areas where Metal Storm is not currently active.

In particular, we signed a Joint
Collaboration Agreement with STK with the specific objective being to collaborate in the design, development, testing, qualification, manufacture of prototypes and demonstration weapons and munitions as well as the commercial production and
marketing of munitions and selected Metal Storm ballistic weapons. This agreement provides us with a well-qualified partner to bring our weapons and munitions though the remaining stages to product sale and delivery.

To help us achieve these goals, we have populated Metal Storm with highly qualified professional staff with specific skills and
experience in required areas, built a strong team of engineers and scientists to focus on the accelerated development of potential products and increased our business development activities in key U.S. defense and homeland security markets and
selected international markets.

Engineering

In parallel with our U.S. based engineering team, we continued to advance the MAUL, FireStorm, less lethal munitions
development and to a lesser extent, 3GL products during the year.

Business Development

Our business development strategy is focused primarily on winning commercial contracts for systems that employ Metal Storm technology,
greater emphasis is now being placed on creating and winning opportunities to sell quantities of 3GL, FireStorm and MAUL for trial and/or deployment.

The sales cycle for weapons acquisition can be short or long depending on the particular customer and their procurement processes. Larger volume orders tend to have longer lead times, which is why we are
focusing on trying to get Metal Storm systems into the early stages of the procurement processes, when requirements are defined.

The majority of our business development effort is in the United States, where there is a substantial defence research and development industry. In addition, opportunities are being sought in the Middle
East, Asia and Europe.

We have also expanded our market scope to include law enforcement and homeland security agencies,
particularly for the MAUL product and the less-lethal applications of FireStorm.

As a key element of our business
development approach, we regularly conduct live fire trials and demonstrations to showcase the technical and operational capabilities of our products.

During 2011, we continued to increase our exposure through conferences, trade shows and demonstrations, including a live firing demonstration for officers of the U.S. military in November 2011 and a
demonstration event for shareholders, also in November 2011.

In August 2011, Metal Storm was chosen as a technology partner
by seven major US defence contractors to bid for contracts totalling US$997.0 million to provide force protection systems for integrated base defence for the US Army. With Metal Storm as a partner, these companies were successful in winning nine of
the 21 awards granted. No contracts have been allocated budget at this stage and prime contractors must now bid on task orders to receive funding.



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Technology

Metal Storms core technology is an electronically initiated, stacked projectile launching system that removes the mechanisms and
shortens the time normally required to fire projectiles by conventional means. Effectively, the only parts that move in Metal Storms technology during firing are the projectiles contained within the barrels. Multiple projectiles are stacked
one behind the other in the barrel and the technology allows each projectile to be fired sequentially from the barrel by electronic initiation of the propellant load.

Metal Storms weapons can produce semi-automatic or automatic fire without the need for a traditional ammunition feed or ejection system. Barrels can be effectively grouped in multiple configurations
to meet a diversity of applications.

Metal Storms technology is ideally suited to the new generation of network
centric weapons that are designed to fully integrate with todays digitally controlled battlefield. Importantly, Metal Storm  enabled systems are capable of local or remote operation through computerized fire control systems and
integrate well with the control systems of Unmanned Vehicles.

Metal Storms technology achieves its performance by
enabling numerous projectiles to be stacked in a barrel. Each projectile has its own propellant load, and its patented design allows the leading projectile to be reliably fired without causing unplanned blow-by ignition of the subsequent
projectiles, and without collapse of the projectile column in the barrel.

Our technology has the following features and
benefits:



| |  |  | electronically programmable rates of fire from single shots to ultra-rapid rates;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | no moving parts, resulting in increased reliability and availability because there is less maintenance required and decreased possibility of
malfunction;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | increased firepower to weight ratio resulting in a lighter weapon system with greater firepower compared to conventional systems;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | modular pods that could operate as a complete weapons system in one container;
| | - |  | ------------------------------------------------------------------------------



| |  |  | digital electronic operation;
| | - |  | -----------------------------



| |  |  | ideally suited to mounting on robotic and remotely operated platforms
| | - |  | ---------------------------------------------------------------------



| |  |  | the potential of grouping multiple calibres and multiple lethalities in one gun system allowing the user to vary the use to a specific situation; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | numerous hybrid configurations and Special Forces applications.
| | - |  | ---------------------------------------------------------------

Joint Collaboration Agreement with Singapore Technologies Kinetics

In February 2008, Metal Storm entered into a Joint Collaboration Agreement with STK to take our 3GL and 40mm ammunition to the
manufacturing stage. Under the terms of the agreement, Metal Storm and STK have agreed to collaborate in the design, development, testing, qualification, manufacture of prototypes and demonstration weapons and munitions as well as the
commercial production and marketing of munitions and selected Metal Storm ballistic weapons that only use those munitions. STK is contributing funds toward completing the demonstration and trial 3GL weapons and munitions. The agreement is
expected to result in munitions that are compatible with all of Metal Storms 40mm weapons and would allow Metal Storm to expand its operationally-ready munitions to additional types. The incurrence of costs under this agreement is
discretionary. The amount incurred in 2011 was nil (2010: nil ; 2009: A$189,345). The agreement terminates in December 2020.

In addition to development and manufacture, STK may market, distribute and support other Metal Storm weapons and munitions.

In September 2005, Metal Storm entered into an exclusive Teaming Agreement with STK for the development, testing, manufacture and
marketing of munitions to be used in conjunction with Metal Storm projects. The agreement terminates in December 2012 unless terminated earlier by joint agreement of the parties or upon a default by one party. The agreement provides that
intellectual property that is developed solely by one party under the agreement will be owned solely by that party. Intellectual property that is developed through the collaboration of both parties will be owned solely or jointly by Metal Storm,
except for technology relating to the internal workings of the warheads, which will be owned by STK. Each party is responsible for its own development costs under the agreement. In February 2008, this Teaming Agreement was incorporated under the
Joint Collaboration Agreement.

Joint Collaboration Memorandum of Understanding with TASER and BREON

In July 2011 we entered into a Memorandum of Understanding with TASER International Inc. and BREON Defense Systems Pty Limited to develop
and market TASER® less-lethal ammunition for the MAUL weapon. Under the Memorandum of Understanding the parties are collaborating to develop, produce and market our MAUL ammunition that launches TASER® Extended Range Electronic
Projectile. BREON Defense Systems Pty Limited is the exclusive Asia Pacific Distributor for TASER products and has signed an exclusive distributorship agreement with us for MAUL for the law enforcement market in Australia and New Zealand.



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Internal Product Development

We are actively developing and/or are in the process of certifying the following products:



| |  |  | 3GL  semi-automatic three shot 40mm modular underbarrel grenade launcher;
| | - |  | --------------------------------------------------------------------------



| |  |  | FireStorm  four barrel 16 shot 40mm remotely operated weapon system;
| | - |  | ----------------------------------------------------------------------



| |  |  | FireStorm FURY  a configurable 40mm remotely operated weapon system, a typical configuration being 30 barrels, 90 shots before reload;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | MAUL  semi automatic 18mm (12 gauge) multi-shot accessory under-barrel launcher; and
| | - |  | --------------------------------------------------------------------------------------



| |  |  | A range of 40mm and 18mm lethal and less-lethal ammunition.
| | - |  | -----------------------------------------------------------

In conjunction with Electro Optic Systems Limited (EOS), we have also developed Redback, a fast four barrel 16-shot 40mm remotely operated weapons system. The Redback system
is particularly suited to convoy protection and is designed to be capable of defending against rocket-propelled grenade (RPG) attacks.

3GL

The 3GL was developed to overcome many of the deficiencies of existing
40mm shoulder fired grenade launchers. Most current 40mm underslung grenade launchers are single shot. Multi-shot grenade launchers are heavy, bulky and in practice do not permit the soldier to also carry an assault rifle.

Single shot 40mm grenade launchers have several significant and obvious operational drawbacks. In a firefight, the 40mm grenade is a
powerful weapon. It has a psychological as well as physical impact on the enemy. However, often one shot is not enough and, after the first round is fired, the enemy can re-position while the soldier is reloading. Being able to keep
eye-on-target and deliver a second and third round immediately onto a mobile enemy substantially increases the effectiveness of the weapon, and potentially alters the outcome of the firefight.

The 3GL is a semi-automatic three shot underslung grenade launcher that can be fitted to a soldiers assault weapon. It carries less
than one pound additional weight penalty over a single shot M203 grenade launcher, while providing three times the firepower before reloading. This cannot be achieved using conventional weapons technology, as the mechanical auto-reload system would
add many additional pounds and increase the size to the point where an underslung weapon would be impractical for the soldier on the battlefield.

FireStorm

FireStorm is a lightweight multi-barrel 40mm
remotely operated weapons system, which Metal Storm is currently developing to fulfil multiple roles in urban conflict, peacekeeping, convoy and asset protection and civil crowd control environments. By taking full advantage of Metal Storm
developments in both lethal and less-lethal munitions, FireStorm could provide a greater flexibility for military forces, law enforcement and security personnel.

The separation of a weapon from its crew is an increasing characteristic of military operations. Whether mounted on the top of a vehicle, on the corner of a building or boundary fence, or on a robotic
platform, it is more difficult and dangerous for people to physically attend to a remote weapon during an engagement.

FireStorm can be deployed on ground robots, placed on vantage points for fixed asset and perimeter protection, mounted on
lightweight vehicles and used in both lethal and less-lethal operations. FireStorm guns have no moving parts in the firing sequence, eliminating the potential for mechanical reload jamming. The barrels can be hermetically sealed, yet still be
available for immediate remote firing as needed. These, together with the ability to select the ammunition type remotely at the time of firing, reduce the likelihood of exposing personnel to potentially lethal enemy fire, giving a potential
competitive advantage to FireStorm in this market.

Another distinguishing characteristic of FireStorm is its
instantaneous firepower. FireStorm can deliver up to 16 high explosive grenades instantaneously onto the same target, multiplying the target damage potential of the weapon.

While FireStorm is currently configured as a four barrel 16 shot system, its major components are modular and could be reconfigured
for other purposes with, for example, more barrels, greater ammunition loads and even a combination of 40mm and 18mm calibres within the one weapon system.



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FireStorm FURY

FireStorm FURY was introduced in April 2011. It broadens the FireStorm configuration developed for the US Marines
Mission Payload Module  Non Lethal Weapon System (MPMNLWS) Technology Development Phase contract, to a configurable multi-barrel weapon system that can fire both non-lethal and lethal ammunition.

FireStorm FURY weapons are defined as remotely operated mounted weapon systems that consist of between four and 30 barrels built
into pods  each pod being incorporated into a one or two axes motorised mount that can be remotely operated. Each barrel can be loaded with up to six rounds, and can deliver burst fire-rates of up to 10,000 rounds per minute with 40mm
grenades.

Using modular Metal Storm weapons technology, Metal Storm will be able to configure FireStorm FURY weapons to
meet specific user requirements in terms of barrel numbers, calibres, total payload and mount control systems.

The intended
market for FireStorm FURY is the international military and law enforcement market. The focus, as with MPM-NLWS, is the provision of a non-lethal weapon system for crowd control, convoy, checkpoint and perimeter protection. However, the
emphasis is being placed on the potential for escalation of force, from a non-lethal first response where appropriate, up to an overwhelmingly lethal response where necessary. FireStorm FURY weapons are also being marketed as configurable to
deliver only non-lethal payloads if this restriction is deemed necessary for the particular organisation being supplied.

FireStorm FURY will have the potential to fulfil the growing need for large scale non-lethal response to civil unrest situations
across the world, plus provide non-lethal and escalation of force options for military forces operating in urban combat and peacekeeping roles.

The development of the FireStorm FURY has resulted from, and continues to be influenced by, Metal Storms involvement in the MPM-NLWS program.

MAUL

The MAUL is an extremely lightweight 12 gauge accessory shotgun designed to fulfil a range of combat and law enforcement roles including door breaching, lethal and non-lethal response, and specialty
payload delivery. Minimal size and weight are hallmarks of the MAUL. MAULTMis currently the lightest, smallest automatic fire under-barrel shotgun in the world.

12 gauge (18mm) shotguns are in widespread use throughout the military, law enforcement and other government agencies. Shotguns offer greater versatility than conventional assault weapons, and are
used to meet a range of special requirements including door breaching, short range operations, and engagements with less-lethal ammunition. This versatility is set to extend as new ammunition types become available.

A major issue with 12 gauge deployment is that it usually requires personnel to carry a separate additional weapon or sacrifice their
primary weapon. Attempts to create shotgun attachments for assault rifles have been constrained by the weight and bulk of the required magazine and mechanical reload system. Metal Storm has identified this as a unique opportunity for its technology
hence the development of the MAUL.

The MAUL incorporates unique Metal Storm stacked round technology, eliminating
the need for mechanical parts to reload the weapon between each shot. Its profile is slim, consisting primarily of a cartridge/barrel tube plus a trigger and small battery housing. It eliminates the bulky bolt action receiver and extended magazine
of legacy systems, and requires no manual action between shots. The MAUL was first conceived under a contract with the U.S. Marines Warfighting Laboratory.

In November 2011 three Australian police forces requested an opportunity to trial our MAUL 12 gauge weapon system. In November 2011 we also received a purchase order for the evaluation of the
MAUL from the East Marlborough Township Police Department in the United States.

Systems for Unmanned Vehicles

Metal Storm weapon systems are well suited to robotic vehicle applications as they are lightweight with all projectiles
pre-stacked in the barrel. Additionally, with the lack of mechanical parts associated with conventional reload systems, the weapons are expected to be reliable and suitable for tele-robotic applications.



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Metal Storm has already demonstrated such systems, including a series of live fire
demonstrations that were held at the U.S. Armys range facility at Picatinny Arsenal in New Jersey in March 2005. The demonstrations consisted of multiple live firings of a purpose-built version of the Metal Storm 40mm weapon system, mounted on
a TALON unmanned ground vehicle produced by Foster Miller.

We have also worked with Dragonfly Pictures Inc., a U.S.
designer/manufacturer of unmanned helicopters, to weaponize a version of its DP-4X Vertical Take Off and Landing Unmanned Aerial Vehicle. Demonstrations of this system were held in September 2006.

In October 2007 Metal Storm entered into a memorandum of understanding with iRobot, a worldwide leader in the supply of military robots.
The FireStorm weapon has been integrated with the iRobot Warrior robot. This was successfully demonstrated to both the U.S. Army and U.S. Navy proving its ability to deliver 40mm less-lethal and lethal rounds from a remote robotic platform.

Metal Storm continues to pursue opportunities for the application of its technology to unmanned robotic platforms.

Redback

The Redback weapons system is a multi-barrelled pod that is designed to detect a target, slew into position, and be fired at extremely high speeds. The system includes detection, acquisition and
tracking electronics that are ultimately aimed at protecting vehicles from incoming rocket-propelled grenade attacks. Unlike other anti-RPG systems, Redback could be used as a conventional weapon for engaging conventional targets.

Redback is being developed in a consortium with EOS, which will supply the gimbal, mount and acquisition and tracking electronics,
and ST Kinetics, which will provide the ammunition. The weapon components are being funded and developed by Metal Storm.

Ammunition

Ammunition for Metal Storm 40mm and 18mm systems are under development.

40mm
lethal ammunition

The low velocity 40mm lethal round program is designed for full integration of the ammunition with the
3GL and FireStorm weapon systems, and on completion will allow us to demonstrate the enhanced capability of 3 rounds of high explosive warheads being man fired from a 3GL.

40mm less-lethal ammunition

The challenge with less-lethal projectiles is to keep weight down to maintain a less than lethal outcome, while also incorporating the additional Metal Storm ignition and propellant systems within the
projectile itself. Three main types of less-lethal 40mm ammunition have been developed and are undergoing testing. Blunt impact sponge rounds were successfully test fired at the beginning of 2008 and continue to be developed. Frangible nose blunt
impact chemical dispersion rounds have also been adapted for Metal Storm launchers. These rounds combine single target blunt impact with an area dispersion of an irritant or marker dye. Finally a chemical payload round was adapted for delivering
tear gas or other payloads in stacked munition Metal Storm launchers. The latter two round types were delivered as ammunition with FireStorm for the Marine Corps Systems Command Market Research Demonstration, and all have been successfully
demonstrated at other test firings.

18mm (12 gauge) ammunition

Ammunition development for the MAUL is essential for the commercial success of the weapon. Metal Storm developed and tested
munitions technology to launch stacked FRAG 12 door breaching grenades from the MAUL. Additional 18mm MAUL munitions being developed include solid projectile, and blunt impact less lethal rounds. Several other projectile natures are
currently being evaluated for adaption to the MAUL.

Fireworks

Metal Storm holds a number of patents relating to the formation of aerial images. The fireworks research is intended to add value to this
intellectual property. Initial development has demonstrated the ability to launch, spin-stabilize and light the fuse of fireworks projectiles in a stacked configuration. There are currently no specific fireworks products under development.



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Handgun

After thorough analyses a number of years ago of the state of our handgun technology, the challenges of obtaining certification, likely production and marketing costs, the state of competition and market
sensitivities, and the time and funds required to successfully generate a product, it is clear that the handgun in either its basic or smartgun form, should not be our primary focus for internal investment at this time.

External Development Programs

In addition to our internal product development programs, we seek external funding from military and government agencies to develop products in collaboration with other parties.

Papua New Guinea Correctional Service  MAUL weapons

In August 2010 we were awarded a US$3.4 million contract by the Papua New Guinea Correctional Service for the delivery of 500 MAUL
weapons plus 50,000 rounds of non-lethal ammunition, training and ancillary services. The contract is subject to ratification through the normal Papua New Guinea government protocols. The ratification process is underway but, partly due to political
instability and two changes of government in Papua New Guinea, has not been concluded. We believe that the contract with the Papua New Guinea Correctional Service is still active and that the 500 MAUL weapons plus 50,000 rounds of non-lethal
ammunition are still required.

U.S. Marine Corps  Mission Payload Module  Non-lethal Weapon System

In April 2010, Metal Storm was awarded a US$1.5 million contract by the U.S. Marine Corps for its Mission Payload Module
 Non-lethal Weapon System, which is a new weapon system designed to provide the Marine Corps with improved counter-personnel capabilities. The weapon would launch a new non-lethal ammunition to incapacitate personnel through light, sound and
pressure stimuli. It would provide a longer range, greater area coverage, extended duration, and better scalability of effects than current non-lethal weapon systems. The weapon could be used for controlling crowds, denying/defending areas,
controlling access and engaging threats. It could incapacitate its targets and provide increased stand-off distance for the protection of friendly forces.

The initial award was a cost plus fixed fee contract for the technology development phase, which evaluated demonstrated payload effectiveness, munitions fusing/functioning and weapon platform capability.
The contract was completed in May 2011.

Competition

Until we commercialize a product using our technology, we continue to compete for technology research and development funding available through various areas that are administered by the U.S. Department
of Defense and other government agencies, including, for example, under the Small Business Innovation Research (SBIR) Program.

The commercial success of products that we develop will depend in part on competing products. Large, well-established defense companies and other entities with collaborative arrangements with the
government are also engaged in research and development and may have considerably greater resources than us to develop applications for defense technology. We cannot be certain that our competitors will not succeed in developing technologies and
products that are more effective than any which we are developing, or which would render our technology and products obsolete or non-competitive.

Regulation

Our research and development activities are, and the production
and marketing of the products that we are developing are likely to be, subject to regulation by governmental authorities in Australia, the United States and other countries where we may market our technology. Prior to marketing, our technology and
any product may be required to undergo rigorous testing as well as extensive regulatory approval processes.

Australia

We have authority under the Weapons Act 1990 (Queensland) (Weapons Act) to engage in scientific or
experimental work. In compliance with the Weapons Act and Australian Controls on the Export of Defense and Strategic Goods, we have a weapons movement procedure policy. We do not currently envisage manufacturing any products in Australia, however,
in the event that we do, we would be required to obtain a manufacturers license to enable us to manufacture and export our products. In addition, we would be regulated by the Australian Department of Defense Export Controls under which we
would be required to obtain an export distribution license. Licenses and permits may be difficult to obtain and retain depending on government policies, customs, changes in political leadership, and other factors. These processes and obtaining
licensing and permits may take many years and require the expenditure of substantial resources.



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To the extent our activities under Australian government contracts may require access to or
result in the development of information classified by the Australian government, such activities may become subject to Australian government regulations.

Products to be manufactured using our technology may also be subject to government regulation. These may include regulations governing use, specification, manufacture, handling, disposal, packaging,
labelling, transport and import and export in Australia and in each of the countries into which such products are intended to be exported.

United States

Sales to U.S. military and to federal law enforcement
agencies will be regulated by the U.S. Federal Acquisition Regulations and Defense Federal Acquisition Regulations. Sales to local and state law enforcement agencies will be subject to the procurement regulations of the jurisdictions involved, as
well as applicable federal regulations. We plan to be in compliance with all regulatory and licensing requirements.

To the
extent our activities under U.S. government contracts may require access to or result in the development of information classified by the U.S. government, such activities may become subject to U.S. government regulations, including the Defense
Industrial Security Regulations and the National Industrial Security Program Operating Manual, which impose restrictions on a foreign companys ability to control or to have access to information in the possession of a cleared U.S. company
performing classified contracts. The U.S. and Australian governments have entered into a Statement of Principles for Enhanced Cooperation in Matters of Defense Equipment and Industry that is intended to facilitate sharing classified information
between the governments and cleared companies.

Intellectual Property

We principally rely upon patents, trade secret, copyright and contract law to protect the intellectual property in our proprietary
technology. See Item 3D Key Information  Risk Factors for a discussion of risks associated with protecting our intellectual property.

We aggressively pursue patent applications for new inventions. Since our inception, we have filed many patent applications, including, but not limited to, applications relating to:



| |  |  | stacked projectile delivery systems and stacked projectile weapon systems, in particular the sealing, reload and ignition thereof;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | technology related to encoding weapons to permit authorized access only;
| | - |  | ------------------------------------------------------------------------



| |  |  | ammunition and projectiles;
| | - |  | ---------------------------



| |  |  | electronic firing technology;
| | - |  | -----------------------------



| |  |  | area denial;
| | - |  | ------------



| |  |  | fire fighting;
| | - |  | --------------



| |  |  | seismic testing;
| | - |  | ----------------



| |  |  | multi-barrel systems;
| | - |  | ---------------------



| |  |  | fireworks;
| | - |  | ----------



| |  |  | missile defense and target interception;
| | - |  | ----------------------------------------



| |  |  | directional control of missiles;
| | - |  | --------------------------------



| |  |  | unmanned aerial vehicle weaponization;
| | - |  | --------------------------------------



| |  |  | adapting conventional munitions to Metal Storm configuration; and
| | - |  | -----------------------------------------------------------------



| |  |  | selectable kinetic energy systems.
| | - |  | ----------------------------------

As of December 31, 2011, we were maintaining:



| |  |  | 36 granted U.S. patents and nine pending U.S. patent applications;
| | - |  | ------------------------------------------------------------------



| |  |  | 11 granted Australian patents and three pending Australian patent applications; and
| | - |  | -----------------------------------------------------------------------------------



| |  |  | 32 other patents granted outside the United States and Australia and 24 pending applications outside the United States and Australia, including three
European Patent Convention applications.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

These patents have expiry dates between 2013 and 2030, but the
majority expire between 2014 and 2027.



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Raw Materials

We use the following principal raw materials: aluminium, steel, steel alloys, graphite fiber, epoxy resins, adhesives, nitrates, propellants and general electronic materials. Such materials are easily
obtained from a variety of sources and are generally readily available in the market. With the exception of aluminium and steel, the prices of such materials have not been subject to large fluctuations.

Seasonality

Our
business is primarily research and development and is not subject to seasonality fluctuations. However, U.S. Department of Defense contracts are typically awarded on a cyclical basis, and many of our research and development programs will follow
this cycle.

C. Organizational Structure

Metal Storm Limited has a U.S. subsidiary, Metal Storm Inc., that has operations in Arlington, Virginia. Metal Storm also has three non-trading subsidiaries that are based in the United States: Metal
Storm USA Limited, Pro-Cam Machine LLC and Digigun LLC.

D. Property, Plant and Equipment

We lease 16,092 square feet of office and workshop space in Queensland, Australia. The annual gross rental payments are A$185,328 payable
in monthly instalments of A$15,444. The lease expires on November 30, 2015.

We lease 3,453 square feet of office space
in Arlington, Virginia. The annual gross rent effective July 2011 is US$136,946, payable in monthly instalments of US$11,412. The lease expires on June 30, 2013.

We also lease 2,000 square feet of warehouse space in Chantilly, Virginia. The lease commenced in March 2009 and the effective annual gross rental is US$24,000, payable in monthly instalments of US$2,000.
The lease expires on June 30, 2012.

Item 4A. Unresolved Staff Comments

Not applicable.

Item 5. Operating and Financial Review and Prospects

You should read the following discussion and analysis in
conjunction with Item 3A Key Information  Selected Financial Data and our consolidated financial statements, the notes to the consolidated financial statements and other financial information appearing elsewhere in this annual
report. The consolidated financial statements have been prepared in accordance with IFRS as issued by the IASB. In addition to historical information, the following discussion and other parts of this annual report contain forward-looking statements
that reflect our plans, estimates, intentions, expectations and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. See Item 3D Key Information  Risk Factors and other
forward-looking statements in this annual report for a discussion of some, but not all factors that could cause or contribute to such differences.

A. Operating Results

Overview

We are a defense technology company that is involved in the research, development and commercialization of projectile launching systems
that utilize electronically fired, stacked projectile technology. In 2011, we worked on three contracts with the U.S. military and Public Works and Government Services. One of the U.S. military contracts was completed in June 2011.

In order to meet Metal Storms objectives to develop, manufacture and market commercial products effectively, we expect
to require further funding until such time that product sales are of sufficient volume to generate positive cash flows from operations. This has taken longer and has cost more than originally anticipated. Based on the expected levels of operating
expenditures, in order to continue its operations, Metal Storm will require additional capital. While Metal Storm has previously been successful in raising additional capital, there can be no assurance that we will be able to raise sufficient
capital to continue our operations. If we are unsuccessful in our efforts to obtain sufficient financing to continue to fund our current operations, we will be required to significantly reduce or cease operations altogether.



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We intend to continue to devote substantial resources to research and development as we
transition our technology from proof of concept to product implementation. Most of our funding for our external development programs has come from capital raisings in Australia. We have also received revenue from grants and contracts under various
government programs. We fund our internal product development through our accumulated funds.

We have incurred net losses
since our inception. We recognized a net loss of A$6.0 million and A$8.9 million in the years ended December 31, 2011 and 2010, respectively. Our accumulated losses from inception in 1994 to December 31, 2011 are approximately A$114.7
million. We expect to incur further losses in the foreseeable future as we continue to invest in the research and development of our patented electronically initiated stacked projectile technology prior to entering into the
commercialization phase. We expect that losses will fluctuate from period to period and that such fluctuations may be substantial as a result of, among other things, the results of our research and development programs, the number of future
prototypes we produce and test and potential design changes required as a result of testing. We are approaching the latter stage of product development and do not expect any significant revenue from product sales until at least 2013. While there has
been significant interest in our proof-of-concept demonstrations, we cannot give assurance that we will manufacture or sell our products successfully or ever achieve or sustain profitability.

Where We Derive Our Revenue

In 2011 and 2010, our principal sources of
revenue were demonstration product construction contracts, a sales contract, government grants and interest income.

Critical Accounting
Policies

Our discussion and analysis of our operating and financial review and prospects are based upon our consolidated
financial statements, which have been prepared in accordance with IFRS as issued by the IASB. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of revenue, assets,
liabilities and expenses. We re-evaluate our estimates on an on-going basis. Our estimates are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from
these estimates under different assumptions or conditions.

We believe the following are our critical accounting policies that
affect our more significant judgments and estimates used in the preparation of our financial statements. Refer to footnote 4 to our financial statements for further information.

Convertible debt and conversion derivatives

Borrowings are initially recognised at fair value, net of transaction costs incurred. Borrowings are subsequently measured at amortised cost. Any difference between the proceeds (net of transaction costs)
and the redemption amount is recognised in the Statements of Comprehensive Income over the period of the borrowings using the effective interest method. Fees paid on the establishment of loan facilities, which are not an incremental cost relating to
the actual draw-down of the facility, are recognised as prepayments and amortised on a straight-line basis over the term of the facility.

Borrowings are removed from the statement of financial position when the obligation specified in the contract is discharged, cancelled or expired. The difference between the carrying amount of a financial
liability that has been extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, is recognised in the profit and loss.

An exchange of an existing debt instrument for a new instrument with the lender on substantially different terms is accounted for as an
extinguishment of the original financial liability and the recognition of a new financial liability. An assessment is made as to whether the terms are substantially different considering qualitative and quantitative characteristics. For example, if
the discounted present value calculated using the original effective interest rate of the cash flows under the new terms, including fees, is at least 10 per cent different from the discounted present value of the remaining cash flows of the
original financial liability, or if the qualitative assessment concludes that the nature and risk profile of the original financial liability is materially different from that of the new financial liability based on the terms of the instruments
including repayment terms, coupon terms and call options, the original financial liability is extinguished.

Borrowings are
classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least 12 months after the end of the reporting period.

Convertible notes are hybrid financial instruments, a note payable host contract and conversion feature. For the notes issued in 2006 and
2009, the conversion feature has been separated from its host contract because the conversion derivative is not closely related to the loan host. The conversion feature is accounted for as a derivative liability because the feature could require a
variable number of shares to be issued upon conversion of each note.



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Upon initial recognition, the proceeds from issuance are first allocated to the fair value
of the conversion derivative. The remaining proceeds are allocated to the note payable host contract. Subsequently, the conversion derivative is measured at fair value with changes recognised through profit and loss and presented as fair value
movement in derivative in the statement of comprehensive income. The note payable host contract is subsequently measured at amortised cost.

Revenue Recognition

For revenue recognised on a percentage of
completion basis, we must estimate the current stage to which each contract is complete. Depending on the type of contract, the stage of completion is measured by reference to labour hours incurred to date as a percentage of estimated total labour
hours, or as costs incurred as a percentage of estimated total costs for each contract.

Comparison of Annual Results of Operations

2011 compared with 2010

Revenue.Revenue decreased by A$2.0 million (61%) from A$3.3 million in 2010 to A$1.3 million in 2011. The decrease was due to a decrease in contract revenue earned from the U.S. Government
from A$1.5 million in 2010 to A$0.5 million in 2011. In 2011 there was no revenue from sale of good compared to $A0.8 million in 2010. In addition, no settlement proceeds were received in 2011, compared to 2010 where we received settlement proceeds
of A$0.4 million from one of our customers in settlement of a dispute in relation to the terms of a contract for the commercialisation of the customers vehicle tagging technology.

The A$0.4 million in revenue earned from contracts with the U.S. Government in 2011 relates to a US$1.5 million contract we were awarded
in April 2010 by the U.S. Marine Corps for its Mission Payload Module  Non-lethal Weapon System, which is a weapon system designed to provide the Marine Corps with improved counter-personnel capabilities. The contract was completed in May
2011.

Expenses.Total expenses decreased by A$4.9 million (40%) from A$12.3 million in 2010 to A$7.4 million in
2011. Significant movements in expenses were:



| |  |  | A decrease in consumables used of A$702,932 (95%) from A$0.7 million in 2010 to A$33,212 in 2011, which directly relates to the decreased contract
revenue.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We had a A$1.5 million (360%) increase in fair value movement gain on the embedded derivative from A$0.4 million in 2010 to A$1.9 million in 2011,
which reflects the movement in the fair value of the conversion option separated from the convertible notes issued in 2006 and accounted for as a conversion derivative liability.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Finance costs decreased by A$1.5 million (36%) from A$4.3 million in 2010 to A$2.8 million in 2011. This is due to reduced non-cash finance costs
in 2011 being a reduction in the accretion of the convertible notes expense and a reduction in share-based establishment fees.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Employee expenses decreased by A$0.8 million (19%) from A$4.2 million in 2010 to A$3.5 million in 2011. This is due to a reduction in staff
numbers in 2011, as well as a reduction in bonuses paid to employees in 2011.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Net Loss.As a result
of the foregoing, our net loss decreased A$2.9 million (33%) from approximately A$8.9 million in 2010 to A$6.0 million in 2011. No income tax benefit has been recognized.

2010 compared with 2009

Revenue.Revenue tripled from A$1.1 million in 2009 to A$3.3 million in 2010. The increase was due to an increase in revenue earned from contracts with the U.S. Government from A$964,272 in 2009 to
A$2.2 million in 2010, settlement proceeds of A$442,953 that were received in March 2010 from one of our customers in settlement of a dispute in relation to the terms of a contract for the commercialisation of the customers vehicle tagging
technology, and receipt of a research and development rebate of A$628,290. No research and development tax rebate was received in 2009.

The A$2.2 million in revenue earned from contracts with the U.S. Government in 2010 relates to the following contracts:



| |  |  | In April 2010, Metal Storm was awarded a US$1.5 million contract by the U.S. Marine Corps for its Mission Payload Module  Non-lethal Weapon
System, which is a new weapon system designed to provide the Marine Corps with improved counter-personnel capabilities. The contract was completed in May 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Directional Fragmentation and Advanced Fuzing project with the United States Army Joint Munitions and Lethality Contracting Center.This
contract was to develop and demonstrate new and innovative technologies capable of providing significant improvements in lethality over current inventory warheads by controlling the directionality of the fragmentation pattern. The project was
completed in August 2010.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In March 2010, Metal Storm was awarded a contract by the U.S. Marine Corps for the assembly and delivery of explosive ordnance disposal and
improvised explosive device training kitsto multiple U.S. Marine Corps training centers across the United States. The final kits were delivered in July 2010.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Expenses.Total expenses decreased by A$136,876 (1%) from A$12,420,145, in 2009 to A$12,283,269 in 2010. Significant
movements in expenses were:



| |  |  | Increase in consumables used of A$581,184 that directly relates to the increased contract revenue.
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | In 2010 we had a fair value movement gain on the embedded derivative of A$407,041 that reflects the movement in the fair value of the conversion option
included in the convertible notes issued in 2006. In 2009, we had a fair value loss of A$224,611.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In 2009 we had a fair value gain on the extinguishment of convertible note debt of A$2,467,609 due to the substantial changes we made to the
convertible note terms. In 2010 we had no such item recorded in the income statement.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Finance costs decreased by A$1,444,652 from A$5,749,555 in 2009 to A$4,304,903 in 2010. This is due to the decrease in accretion expense of the
convertible notes resulting from the substantial changes we made to the convertible note terms and conditions in 2009.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Net Loss.As a result of the foregoing, our net loss decreased from approximately A$11.3 million in 2009 to A$8.9 million in 2010. No income tax benefit has been recognized.

Effects of Currency Fluctuations

Our functional currency and reporting currency is the Australian dollar.

In
accordance with IFRS, costs not denominated in Australian dollars are re-measured in Australian dollars, when recorded, at the prevailing exchange rates for the purposes of our financial statements. Consequently, fluctuations in the rates of
exchange between the Australian dollar and U.S. dollar currencies will affect our results of operations. An increase in the value of a particular currency relative to the Australian dollar will increase the Australian dollar reporting value for
transactions in that particular currency, and a decrease in the value of that currency relative to the Australian dollar will decrease the Australian dollar reporting value for those transactions.

The effect of foreign currency translation is reported in note 22 to the financial statements as an accumulated translation reserve. At
December 31, 2011, the impact of the foreign currency translation was an accumulated reserve of (A$48,129), which is unchanged when compared to our accumulated reserve balance of (A$48,129) at December 31, 2010. The fluctuations are caused
by fluctuations in the exchange rate between the Australian dollar and the U.S. dollar. We have not entered into any hedging arrangements to mitigate the effects of currency fluctuations.

B. Liquidity and Capital Resources

Overview

We have incurred substantial losses since the formation of Metal Storm and anticipate incurring substantial additional losses over at
least the next few years as we continue our research and development activities and conduct further trials of our technology. Our operations have been financed primarily from capital contributions by investors, an equity line of credit expiring
22 June 2013, and grants from government agencies.

The following table sets forth our consolidated cash flows for the
past three years.



|                                                    |  |                        |            |   |        |  |            |        |  |  |            |  
|--------------------------------------------------- |  | ---------------------- | ---------- | - | ------ |  | ---------- | ------ |  |  | ---------- | -
|                                                    |  | Year ended December 31 |           
|                                                    |  | 2011A$                 |            |   | 2010A$ |  |            | 2009A$ | 
|Net cash used in operating activities               |  |                        | (5,343,182 | ) |        |  | (6,189,600 | )      |  |  | (8,704,228 | )
|Net cash provided by/(used in) investing activities |  |                        | (48,574    | ) |        |  | 6,726      |        |  |  | 197,606    |  
|Net cash provided by financing activities           |  |                        | 4,705,023  |   |        |  | 7,280,450  |        |  |  | 1,048,665  |  
|Effect of exchange rate changes on cash             |  |                        | 744        |   |        |  | 1,735      |        |  |  | (45,985    | )
|                                                    |  |                        |            |   |        |  |            |        |  |  |            |  
|Net movement in cash and cash equivalents           |  |                        | (686,733   | ) |        |  | 1,099,311  |        |  |  | (7,503,942 | )
|                                                    |  |                        |            |   |        |  |            |        |  |  |            |  



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Cash used in operating activities in each of the past three years consisted primarily of
losses incurred in operations.

Net cash provided by investing activities in 2010 and 2009 consisted predominantly of interest
income on deposits. In 2011, the net cash outflow provided by investing activities is as a result of the purchase of property, plant and equipment in 2011, related to our move into new premises.

In 2010 and 2009 financing activities consisted of stock issues and repayment of borrowings. As our cash reserves have declined we have
had to rely on an increased number of equity placements to provide funding for our operations. Financing activities in 2011 consisted of stock issues, the issue of convertible securities and the repayment of borrowings.

Refer to Item 3D Key Information  Risk Factors for further information on Metal Storms capital requirements
and substantial doubt over our ability to continue as a going concern.

Borrowings

In 2006, Metal Storm issued 203,703,704 convertible notes to existing shareholders in Australia and New Zealand at the rate of one
convertible note for every 2.674 existing ordinary shares held to raise gross proceeds of A$27.5 million. This Rights Offer was made concurrently with the offer of one new share option for every two convertible notes allotted, which resulted in
101,852,055 quoted options being granted. In addition, 10 million options were granted to Harmony Capital Partners Pte Ltd (Harmony) or its nominees in consideration for a short term working capital facility of A$5 million which was
never drawn on by Metal Storm. A further 65 million options were issued to Harmony as payment for Harmonys commitment to sub-underwrite the Rights Offer up to A$26.1 million. In July 2009, the term of the convertible notes was extended by
two years to September 2011. In addition, the notes were bifurcated into secured and interest bearing tranches.

The interest
bearing convertible notes bear interest at the rate of 10% per annum on the face value of A$0.135 per convertible note over the term. Interest is payable quarterly in arrears. The maturity date of the convertible notes was September 1,
2011, but as at meetings of our shareholders and Noteholders, both held on August 29, 2011, it was agreed to extend the maturity date of the convertible notes from September 1, 2011 to March 1, 2012. At another meeting of our
shareholders and Noteholders, both held on January 12, 2012, the maturity date of the convertible notes was extended to March 1, 2015 (the Maturity Date), at which time Metal Storm must repay the face value of A$0.135 per
convertible note to the Noteholders, unless Noteholders have elected to convert some or all of their convertible notes into ordinary shares. Noteholders can elect to convert some or all of their convertible notes into ordinary shares at the
beginning of each quarter, at the Maturity Date and at certain other times.

The secured convertible notes do not bear
interest but hold a fixed and floating charge over the assets of Metal Storm. All other terms and conditions are the same as the interest bearing convertible notes.

At a meeting of our shareholders and Noteholders, both held on January 12, 2012, the following changes to the convertible note terms were approved:



|(a) | the maturity date of the convertible notes was extended to March 1, 2015; and
|--- | -----------------------------------------------------------------------------



|(b) | the conversion price formula was amended so that:
|--- | -------------------------------------------------



| | (i) | it is more favorable to Noteholders and has the potential to result in more shares being issued to a Noteholder on conversion (particularly if the price per share
exceeds A$0.015); and
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (ii) | it is rounded down to four decimal places rather than to the nearest cent (two decimal places), thereby ensuring that noteholders are not disadvantaged if shares trade
below A$0.01 during the conversion price calculation period;
| | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iii) | the VWAP period was reduced from 30 Business Days to 20 Business Days;
| | ----- | ----------------------------------------------------------------------



| | (iv) | the maximum conversion price was significantly reduced from A$0.135 to A$0.0105 per share; and
| | ---- | ----------------------------------------------------------------------------------------------



| | (v) | a Noteholder can rely upon the five lowest daily VWAPs of shares rather than the VWAP of shares over the entire calculation period, which is likely to provide
Noteholders with a more favorable conversion price.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The convertible notes were issued under Trust Deed, the
details of which are discussed in Item 10-C Additional Information  Material Contracts of this Form 20-F. See Item 3D Key Information  Risk Factors  There is substantial doubt regarding Metal
Storms ability to continue as a going concern and  We may be required to redeem convertible notes before the Maturity Date, which redemption could cause us to become insolvent.



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In July 2011 we received confirmation from AusIndustry that we were eligible for the
Australian Commonwealth Governments Research and Development Tax Concession program. The R&D Tax Concession is the principal Australian Commonwealth initiative to increase the amount of research and development undertaken in Australia and
provides a tax offset for companies that meet certain criteria. We expected to receive a rebate in 2011 in the amount of A$550,000  A$650,000. To monetize the expected rebate we signed a short term loan agreement in July 2011 with one of our
shareholders, Andrew Doyle, for A$500,000. As consideration for providing the loan, we issued Mr. Doyle 1,400,000 options that have a life of two years and an exercise price of A$0.001. The principal was repaid to Mr. Doyle in September
2011, upon receipt of the tax rebate. As consideration for providing the loan and in lieu of interest upon the principal that was repaid in September 2011, Mr. Doyle was issued an additional 1,300,000 options that have a life of two years and
an exercise price of A$0.001.

In October 2011, Australian Special Opportunity Fund LP (ASOF), an investment
company managed by the New York based investment fund manager, The Lind Partners, LLC, entered into an agreement with Harmony under which ASOF agreed to purchase all of Harmonys secured convertible notes (subject to the satisfaction or waiver
of various conditions) (ASOF Note Acquisition). As a result of the ASOF Note Acquisition, ASOF controls approximately 91% of the secured convertible notes on issue (equivalent to approximately 70% of all of the convertible notes on
issue). Pursuant to a Deed of Debt Forgiveness between Metal Storm and ASOF, ASOF has also agreed to forgive approximately A$1.5 million of the face value of the secured notes it has purchased from Harmony under the ASOF Note Acquisition subject to
a number of conditions (the Debt Forgiveness), including that the ASOF Note Acquisition becomes effective and no insolvency event occurs in relation to Metal Storm. The Debt Forgiveness will only become effective once ASOF has converted
the balance of the secured notes it holds into shares or on the Maturity Date, whichever occurs first.

On October 17,
2011, Metal Storm entered into a Convertible Security Agreement (the ASOF Agreement) with ASOF. Under the ASOF Agreement, ASOF provided the Company with short term debt funding totalling A$700,000. At a meeting of our shareholders held
on December 8, 2011, our shareholders agreed to have the A$700,000 received from ASOF, together with a further payment by ASOF of A$200,000 cash (i.e., a total of A$900,000) applied as consideration for the issue of a new convertible
security to ASOF (the ASOF Convertible Security).

On December 12, 2011, we received correspondence from The
Lind Partners LLC, as manager of ASOF, under which ASOF alleged that Metal Storm had breached the ASOF Agreement. On December 28, 2011, Metal Storm and ASOF reached an agreement to resolve the matter, with the key details of the agreement being
as follows:



|(a) | the further payment of A$200,000 cash by ASOF under the ASOF Agreement is no longer required;
|--- | ---------------------------------------------------------------------------------------------



|(b) | Metal Storm made early repayment of A$230,000 of the A$700,000 received from ASOF;
|--- | ----------------------------------------------------------------------------------



|(c) | the remainder of the A$700,000 received from ASOF was exchanged for the ASOF Convertible Security, which has a face value of A$700,000, instead of the A$900,000 face
value initially expected;
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(d) | ASOF waived Metal Storms breaches of the ASOF Agreement and the impact of those breaches on any related agreements with ASOF (including the Debt Forgiveness); and
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(e) | Metal Storm paid ASOFs reasonable legal expenses in relation to this matter.
|--- | -----------------------------------------------------------------------------

The issue of the ASOF Convertible Security was approved by shareholders on December 8, 2011, and was issued on December 28,
2011. The ASOF Convertible Security is an unquoted convertible security issued to ASOF with a face value of A$700,000, which will mature on April 17, 2013, will not bear interest, is unsecured and will be convertible into ordinary shares of
Metal Storm at a variable conversion rate. Each conversion shall be in an amount of not less than A$25,000. As of February 29, 2012, A$525,000 of the ASOF Convertible Security had been converted into ordinary shares.

On December 2, 2011, the Company issued one of its largest shareholders, Andrew Doyle, 10,000,000 convertible securities at an issue
price of A$0.010 for a total consideration of A$100,000 (Doyle Convertible Securities), with such issue ratified by shareholders on January 12, 2012. The Company also issued Andrew Doyle 10,000,000 additional convertible securities
for a total consideration of A$100,000 on the same day. Each Doyle Convertible Security matures on November 30, 2016. As of February 29, 2012, A$50,000 of the Doyle Convertible Securities had been converted into ordinary shares.

Each Doyle Convertible Security:



|(a) | has a face value of A$0.010;
|--- | ----------------------------



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|(b) | matures on November 30, 2016;
|--- | -----------------------------



|(c) | does not bear interest;
|--- | -----------------------



|(d) | is a form of equity that, once converted into shares, will rank equally with shareholders upon a winding up; and
|--- | ----------------------------------------------------------------------------------------------------------------



|(e) | must be converted into shares using a conversion formula at any time but before maturity.
|--- | -----------------------------------------------------------------------------------------

In April 2012, we entered into an Umbrella Deed (the ASOF Umbrella Deed) with ASOF and Luxinvest Capital Advisors S.A., of
Luxembourg (Luxinvest), whereby Metal Storm will redeem A$9.0 million in secured convertible notes from ASOF in exchange for a cash payment of A$1.7 million, a further A$1.4 million of secured convertible notes will be converted to
ordinary shares at a fixed conversion price of A$0.0009 per share, and pursuant to the Debt Forgiveness, A$1.5 million of secured convertible notes will be forgiven by ASOF. The parties have varied the arrangements under the ASOF Umbrella Deed such
that the A$400,000 deposit payable to ASOF under the Umbrella Deed is due by 17 May 2012. The Company has obtained commitments from Luxinvest and other investors to fund the deposit commitment by the due date. Upon completion of the transactions
contemplated by the Umbrella Deed, the A$400,000 deposit provided by Luxinvest and other investors will be used by Luxinvest and other investors to pay Metal Storm the subscription price for an unsecured convertible note with a face value of
A$300,000 and A$100,000 will be used to obtain ordinary shares at an issue price of A$0.0008 per share. Subject to completion of the transactions contemplated by the Umbrella Deed, we have agreed to issue Luxinvest with A$200,000 worth of ordinary
shares at an issue price of A$0.0008 per share, as payment of Luxinvests fee for providing the deposit under the Umbrella Deed. Under the Umbrella Deed, ASOF has the right to appoint a director of Metal Storm and has also agreed to either
redeem or convert the remaining face value of its unsecured convertible securities. Completion of the transactions contemplated by the Umbrella Deed is subject to a number of conditions being satisfied prior to July 17, 2012, including
(i) shareholder and noteholder approval, (ii) Metal Storm not suffering an event of insolvency before completion of transactions contemplated by the Umbrella Deed and (iii) completion of the A$4.3 million Subscription Deed between
Metal Storm and Luxinvest that was entered into in April 2012.

In 2009 we borrowed A$326,714 from Backwell Lombard Capital
under a non-interest bearing unsecured short term loan that has no fixed repayment date but is payable upon demand. We repaid A$50,000 and then borrowed a further A$100,000 during the first few months of 2010. The loan was then split into amounts
owed to each of the principals of Backwell Lombard Capital. In December 2010 we repaid A$162,500 through the issuance of ordinary shares to one of the principals of Backwell Lombard Capital, which is affiliated with one of our directors. As of
December 31, 2011 we owe A$214,848 under this loan. See Item 7B.

Equity Line Facility Agreements

In December 2009, we entered into an equity line of credit facility agreement with GEM Global Yield Fund Ltd in the
amount of A$20.2 million. Under the GEM Equity Line Facility, we could initiate drawdowns at a frequency of up to one drawdown per 15 Australian business days and issue ordinary shares to GEM in consideration. Our first drawdown occurred in January
2010. As of June 30, 2010, we received A$1,012,226 from GEM and had issued 65,000,000 ordinary shares to GEM. We agreed with GEM to terminate the facility as it has yielded significantly lower funding than had been anticipated and in September
2010 the agreement was formally terminated.

In June 2010, we entered into an equity line of credit agreement with Dutchess
for an amount of up to A$25.0 million to replace the existing facility with GEM. The Dutchess Equity Line Facility allows us to initiate drawdowns at a frequency of up to one drawdown per five trading days of the ASX and issue ordinary shares to
Dutchess in consideration. As of December 31, 2011 we have received A$2.3 million from the Dutchess Equity Line Facility and have issued 373,610,640 ordinary shares to Dutchess.

See Item 10C Additional Information  Material Contracts for a summary of the agreements.

Placements of ordinary shares

In April 2012, we entered into two Subscription Agreements with Luxinvest, pursuant to which Luxinvest agreed to invest in Metal Storm (i) A$350,000 in exchange for ordinary shares at an issue price
of A$0.0008 per share, and (ii) A$4.3 million in exchange for ordinary shares at an issue price of A$0.0008 per share, to be issued in two tranches. Both Subscription Agreement are subject to shareholder approval. Tranche 1 under the A$4.3
million Subscription Agreement involves the issue of 437,500,000 ordinary shares in exchange for A$350,000, while tranche 2, which in addition to shareholder approval is also subject to completion of the transactions contemplated by the Umbrella
Deed as described above, involves the issue of 4,875,000,000 ordinary shares in exchange for A$3.9 million.

In November 2011
we raised A$1.5 million from a rights issue in Australia, issuing 509,732,686 ordinary shares.

In June 2011 we received
A$200,000 from a private placement of ordinary shares to an investor, issuing 40,000,000 ordinary shares.



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In September 2010 we raised A$2.4 million from a rights issue, issuing 240,894,961 ordinary
shares. In September 2010 we also entered into Subscription Agreements with two existing shareholders and one former shareholder (at the time) to subscribe for up to A$1.7 million in Metal Storm shares and options. The terms of these Subscription
Agreements allowed us, at our sole discretion, to require the investors to subscribe for up to a maximum of A$1.7 million worth of our ordinary shares at an issue price of A$0.01 per share, with Metal Storm to issue three options to an investor for
no additional consideration for every share allotted to that investor. We received A$647,000 in 2010 pursuant to these Subscription Agreements, which expired in 2010, issuing 64,727,372 ordinary shares.

In March 2010, we issued 27,900,794 ordinary shares at a price of A$0.0143 to Mr. Andrew Doyle, raising gross proceeds of A$400,000.

We issued 12,500,000 ordinary shares to an Asian investor in January 2010 at a price of A$0.016 per share, raising gross
proceeds of A$200,000 and issued a further 52,669,568 ordinary shares to that investor in March 2010 at a price of A$0.013 per share, raising gross proceeds of A$700,000. We issued 14,285,714 ordinary shares at a price of A$0.014 per share to that
investor again in April 2010, raising gross proceeds of A$200,000 which included the issue of options to purchase 3,571,429 ordinary shares at an exercise price of A$0.01 per share. We also issued 15,306,122 ordinary shares at a price of A$0.0079
per share to the Asian investor again in June 2010, raising gross proceeds of A$150,000 and, in connection with the issuance, the investor also received options to purchase 3,061,244 ordinary shares at an exercise price of A$0.01 per share.

No capital expenditure commitments

We had no material capital expenditures during the past three years and do not expect to incur any material capital expenditure in 2012. Refer to the table in Item 5-F Operating and Financial
Review and Prospects  Tabular disclosure of contractual obligations for further details on commitments.

Future Cash Needs

We expect that operating expenses will continue to be the principal use of our cash resources. The Dutchess Equity Line Facility is not expected to cover all expenses for the next 24 months and will need
to be supplemented with other sources of funding.

We will need to raise additional sources of funding to repay debt
obligations which mature on March 1, 2015, accelerate development and reduce the reliance on our current funding agreement and may seek it through equity or debt financings. The sale of additional equity or convertible debt could result in
dilution to our shareholders. Additional debt would result in additional expenses and could result in covenants that would restrict our operations.

We expect that a major capital raising will enable us to get one or more of our products to a production-ready stage and commence the marketing process. For us to get to that stage, we expect to need A$10
million  A$15 million in proceeds from a capital raising, exclusive of transaction costs. The actual amount of funding required is difficult to forecast due to the nature of our research and development activities. In addition, up to a further
A$18.9 million will be required to repay the face value of the convertible notes currently on issue if they are unable to be restructured or refinanced through other methods.

Refer to Item 3D Key Information  Risk Factors for further information on Metal Storms capital requirements and substantial doubt over our ability to continue as a going
concern.

C. Research and Development: Patents and Licenses

Our primary activity since incorporation in 1994 has been the research and development of our technology. Expenditure on this activity, exclusive of labor costs, was A$0.5 million, A$0.6 million and A$1.0
million for the years ended December 31, 2011, 2010 and 2009, respectively, exclusive of the government grant for research and development. Our policy is to focus our research on selected internal product development projects as well as
external development programs under which we work in collaboration with other parties. See Item 4B Information on Metal Storm  Business Overview.

D. Trend Information

Much of our technology requires further investment,
research, development, testing and possibly regulatory approval. We cannot be sure of the extent to which the technology, or any products we develop, will be able to penetrate the potential markets and generate revenue. We believe that our future
success depends on our ability to further commercialize our technology. See Item 3D Key Information  Risk Factors.



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E. Off-Balance sheet arrangements

Not applicable.

F. Tabular
disclosure of contractual obligations

The following table summarizes our contractual obligations and commitments as of
December 31, 2011:



|                                    |  |                        |            |  |                 |  |            |            |  |  |            |  |  |                  |         |  |  |  |   | 
|----------------------------------- |  | ---------------------- | ---------- |  | --------------- |  | ---------- | ---------- |  |  | ---------- |  |  | ---------------- | ------- |  |  |  | - | 
|                                    |  | Payments due by period |           
|                                    |  | TotalA$                |            |  | Less Than1 Year |  |            | 1  3Years |  |  | 3  5Years |  |  | More than5 Years |        
|Capital (finance) lease obligations |  |                        | 3,413      |  |                 |  | 3,413      |            |  |  |           |  |  |                  |        |  |  |  |  | 
|Operating lease obligations         |  |                        | 942,843    |  |                 |  | 336,369    |            |  |  | 467,495    |  |  |                  | 138,979 |  |  |  |  | 
|Loans                               |  |                        | 214,848    |  |                 |  | 214,848    |            |  |  |           |  |  |                  |        |  |  |  |  | 
|Convertible Notes                   |  |                        | 18,866,897 |  |                 |  | 18,866,897 |            |  |  |           |  |  |                  |        |  |  |  |  | 
|                                    |  |                        |            |  |                 |  |            |            |  |  |            |  |  |                  |         |  |  |  |   | 
|Total                               |  |                        | 20,028,001 |  |                 |  | 19,421,527 |            |  |  | 467,495    |  |  |                  | 138,979 |  |  |  |  | 
|                                    |  |                        |            |  |                 |  |            |            |  |  |            |  |  |                  |         |  |  |  |   | 



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Item 6. Directors, Senior Management and Employees

A. Directors and Senior Management

The following people comprise our board of directors and executive officers:



|                    |  |                                              
|------------------- |  | ---------------------------------------------
|Name                |  | Position                                     
|Terence J. ODwyer  |  | Chairman                                     
|John R. Nicholls    |  | Director                                     
|Trevor W. Tappenden |  | Director                                     
|William Henkel      |  | Director                                     
|Lee J. Finniear     |  | Chief Executive Officer and Managing Director
|Brett I. Farmer     |  | Chief Financial Officer and Company Secretary
|Peter D. Faulkner   |  | President  Metal Storm Inc.                 
|George A. Orrison   |  | Director of Sales  Metal Storm Inc.         

Terence J. ODwyer.Mr. ODwyer, a chartered accountant in Australia, has been a
director of Metal Storm since 1998. He was Executive Chairman between April 2006 and February 2007, when he assumed the day to day management of Metal Storm but, in line with our cost reduction strategy, did not receive any compensation for this
role. He is a past Chairman of BDO Kendalls, a large Queensland accountancy firm of which he had been a partner for 28 years until his retirement in 2005. He is also a director of Bendigo Bank Limited and Qld Theatre Co.

John R. Nicholls.Mr. Nicholls was appointed as a Director in September 2006 pursuant to an agreement with Harmony Capital
Partners Pte Limited who were sub-underwriters in connection with the Rights Offer. He has extensive experience in the Australian and international business communities with start-up and established companies, having held senior management positions
and directorships for several Australian and international companies in the manufacturing, distribution, trading and merchant banking industries. He was previously a director of two other ASX listed companies, Nylex Limited (from 2006 to 2011), and
Brandrill Limited (from 2004 to 2009).

Trevor Tappenden. Mr. Tappenden was appointed a Director in July 2008. He
was a Partner in the firm of Ernst & Young, Australia from 1982 until 2003, specialising in Entrepreneurial Growth Companies as well as being the Melbourne Managing Partner from 1997 to 2001 and a Member of the firms Board of
Partners. Mr. Tappenden is also a director of Bionomics Limited (an ASX-listed company) as well as several government and education bodies.

William Henkel.Mr. Henkel was appointed a Director in November 2010. He has been a Director of Metal Storm Inc. since 2007 and has acted as its Chairman since 2009. Earlier in his career he
assisted with creating the schedule and events to communicate the agenda, policies and programs, both at home and abroad, for U.S. Presidents Nixon, Ford and Reagan. Mr. Henkel was a senior executive at Merrill Lynch from 1987 to 2003,
with extensive experience formulating strategic direction, overseeing corporate governance, devising high impact communications and directing the Client Marketing and Strategy Group. From 2006 to 2008 he wrote for the Henry Thornton Blog on the Roy
Morgan website, authoring columns on U.S. politics, government, economics and finance. Mr. Henkel acts as a private consultant providing advice on mergers and acquisitions to clients.

Lee J. Finniear.Dr Finniear was appointed Chief Executive Officer in February 2007 and Managing Director in May 2007. He is
responsible for the overall management of the operations of Metal Storm as well as managing our investor relations and capital requirements and corporate affairs. Prior to joining Metal Storm, Dr. Finniear was Chief Executive Officer of Derceto
Ltd from May 2006 to January 2007. He was Vice President Asia Pacific with Intergraph Corporations largest division from 2003 to 2006. He has held senior executive roles in technology companies that service defense organizations worldwide and
has direct experience with defense industry acquisition procedures. Dr. Finniear holds a PhD in an engineering related field.

Brett I. Farmer.Mr. Farmer was appointed Chief Financial Officer in August 2007 and Company Secretary in September 2010. He is a CPA in Australia and previously worked in senior accounting
positions for a number of years, including as Financial Controller of Metal Storm from June 2005 until his appointment as Chief Financial Officer.

Peter D. Faulkner. Mr. Faulkner is President of our U.S. Operations. He is responsible for the management and administration of our U.S. operations and contracting activities and provides
oversight of the U.S. based engineering team. Mr. Faulkner has more than 25 years of experience as a Department of Defense contractor, focused on military weapons support systems. Prior to joining Metal Storm, he served as Vice President for
ManTech International Corporation, one of the U.S. governments leading providers of innovative technologies and solutions for mission-critical national security programs. Preceding his 21 years at ManTech, Mr. Faulkner worked at Aircraft
Armaments Incorporated.



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##### Table of Contents

George A. Orrison.Mr. Orrison was appointed Director of Sales of Metal Storm
Inc. in November 2010. He has substantial experience in defence industry sales and marketing. From 2004 to 2009 Mr. Orrison was Director of Marketing for Qinetiq North America.

B. Compensation

In 2011, the aggregate remuneration we paid and that
accrued to our directors and senior management was A$1,384,708.

The remuneration and benefits paid to our directors and
executive officers during 2011, on an individual basis, are set out in the table below.



|                                                          |                |                              |           |           |       |  |                     |                        |  |  |                    |  |  |             |   |  |                   |  |        |                    |  |  |   |  |  |   |   |  |  |  |           |  |  |  |     |  
|--------------------------------------------------------- | -------------- | ---------------------------- | --------- | --------- | ----- |  | ------------------- | ---------------------- |  |  | ------------------ |  |  | ----------- | - |  | ----------------- |  | ------ | ------------------ |  |  | - |  |  | - | - |  |  |  | --------- |  |  |  | --- | -
|Name and Position                                         |                | Short Term Employee Benefits |           |           | Other |  |                     | PostEmploymentBenefits |  |  | ShareBasedPayments |  |  | Termination |   |  | TotalRemuneration |  |        | PerformanceRelated | 
|                                                          | Salary andFees |                              |           | CashBonus |       |  | Non MonetaryBenefit |                        |  |  |                    |  |  |            
|                                                          |                | $                            |           |           | $     |  |                     | $                      |  |  | $                  |  |  | $           |   |  | $                 |  |        | $                  |  |  | $ |  |  | % |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|T J ODwyerChairman (Non-Executive)                       |                |                              | 80,000    |           |       |  |                    |                        |  |  |                   |  |  |             |  |  |                   |  |       |                    |  |  |  |  |  |   |  |  |  |  | 80,000    |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|J R NichollsDirector (Non-Executive)                      |                |                              | 50,000    |           |       |  |                    |                        |  |  |                   |  |  |             |  |  |                   |  |       |                    |  |  |  |  |  |   |  |  |  |  | 50,000    |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|T W TappendenDirector (Non-Executive)                     |                |                              | 60,000    |           |       |  |                    |                        |  |  |                   |  |  |             |  |  |                   |  |       |                    |  |  |  |  |  |   |  |  |  |  | 60,000    |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|W HenkelDirector (Non-Executive)                          |                |                              | 50,000    |           |       |  |                    |                        |  |  |                   |  |  |             |  |  |                   |  |       |                    |  |  |  |  |  |   |  |  |  |  | 50,000    |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        |  |  |                    |  |  |             |   |  |                   |  |        |                    |  |  |   |  |  |   |   |  |  |  |           |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|Total Non Executive Directors                             |                |                              | 240,000   |           |       |  |                    |                        |  |  |                   |  |  |             |  |  |                   |  |       |                    |  |  |  |  |  |   |  |  |  |  | 240,000   |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        |  |  |                    |  |  |             |   |  |                   |  |        |                    |  |  |   |  |  |   |   |  |  |  |           |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|L J FinniearManaging Director and Chief Executive Officer |                |                              | 293,525   |           |       |  | 28,000              |                        |  |  | 26,475             |  |  |             |  |  |                   |  | 28,770 |                    |  |  |  |  |  |   |  |  |  |  | 376,770   |  |  |  | 7.4 | %
|                                                          |                |                              |           |           |       |  |                     |                        |  |  |                    |  |  |             |   |  |                   |  |        |                    |  |  |   |  |  |   |   |  |  |  |           |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|Total Executive Directors                                 |                |                              | 293,525   |           |       |  | 28,000              |                        |  |  | 26,475             |  |  |             |  |  |                   |  | 28,770 |                    |  |  |  |  |  |   |  |  |  |  | 276,770   |  |  |  | 7.4 | %
|                                                          |                |                              |           |           |       |  |                     |                        |  |  |                    |  |  |             |   |  |                   |  |        |                    |  |  |   |  |  |   |   |  |  |  |           |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|B I FarmerChief Financial Officer and Company Secretary   |                |                              | 185,000   |           |       |  |                    |                        |  |  |                   |  |  |             |  |  |                   |  | 16,640 |                    |  |  |  |  |  |   |  |  |  |  | 201,640   |  |  |  |    |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|P D FaulknerPresident  Metal Storm Inc.                  |                |                              | 214,908   |           |       |  |                    |                        |  |  | 9,012              |  |  |             |  |  |                   |  | 7,050  |                    |  |  |  |  |  |   |  |  |  |  | 230,970   |  |  |  |    |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|N J PartridgeChief Engineer                               |                |                              | 150,000   |           |       |  |                    |                        |  |  |                   |  |  |             |  |  |                   |  | 13,481 |                    |  |  |  |  |  |   |  |  |  |  | 163,481   |  |  |  |    |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|G A Orrison Director of Sales, Metal Storm Inc           |                |                              | 120,822   |           |       |  |                    |                        |  |  | 9,547              |  |  |             |  |  |                   |  |       |                    |  |  |  |  |  |   |  |  |  |  | 130,369   |  |  |  |    |  
|                                                          |                |                              |           |           |       |  |                     |                        |  |  |                    |  |  |             |   |  |                   |  |        |                    |  |  |   |  |  |   |   |  |  |  |           |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|Total Other Key Management                                |                |                              | 670,730   |           |       |  |                    |                        |  |  | 18,559             |  |  |             |  |  |                   |  | 37,171 |                    |  |  |  |  |  |   |  |  |  |  | 726,460   |  |  |  |    |  
|                                                          |                |                              |           |           |       |  |                     |                        |  |  |                    |  |  |             |   |  |                   |  |        |                    |  |  |   |  |  |   |   |  |  |  |           |  |  |  |     |  
|                                                          |                |                              |           |           |       |  |                     |                        | 
|Total Remuneration of Key Management Personnel            |                |                              | 1,204,255 |           |       |  | 28,000              |                        |  |  | 45,034             |  |  |             |  |  |                   |  | 65,941 |                    |  |  |  |  |  |   |  |  |  |  | 1,343,230 |  |  |  | 2.1 | %
|                                                          |                |                              |           |           |       |  |                     |                        |  |  |                    |  |  |             |   |  |                   |  |        |                    |  |  |   |  |  |   |   |  |  |  |           |  |  |  |     |  

During the year ended December 31, 2011, no options over ordinary shares were granted as equity
remuneration benefits to directors and executives. No shares were granted to directors and executives as equity compensation for services performed in 2011.



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C. Board Practices

Under our constitution, our board of directors is required to be comprised of at least three directors. As of December 31, 2011, our board was comprised of five directors and is currently comprised
of five directors. Our directors are elected to the board of directors for a three-year term and one-third of the directors retire by rotation at each annual general meeting of shareholders. Our Directors do not have fixed terms.

Mr. John Nicholls was appointed as a Director in September 2006 pursuant to an agreement with Harmony in connection with the Rights
Offer.

The board of directors has established an Audit Committee that consists of three directors. Current members of our
Audit Committee are Mr. Trevor Tappenden (Chairman), Mr. John Nicholls and Mr. Terry ODwyer.

Under its
charter, the Audit Committee:



| |  |  | retains independent auditors and reviews and discusses the independence of the auditors;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | sets the engagement policies for the independent auditors;
| | - |  | ----------------------------------------------------------



| |  |  | reviews and discusses the audit plan, the conduct of the audit and the audit results;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | reviews and discusses financial statements and disclosures;
| | - |  | -----------------------------------------------------------



| |  |  | reviews and discusses the systems of internal accounting controls;
| | - |  | ------------------------------------------------------------------



| |  |  | reviews and discusses the recommendations of independent auditors;
| | - |  | ------------------------------------------------------------------



| |  |  | approves related party transactions; and
| | - |  | ----------------------------------------



| |  |  | establishes procedures for complaints regarding financial statements or accounting policies.
| | - |  | --------------------------------------------------------------------------------------------

The Audit Committee invites external auditors to attend Audit Committee meetings where appropriate. The Audit Committee also meets to
receive reports from the external auditors concerning any matters that arise in connection with the performance of their role, including the adequacy of internal controls.

The board of directors has also established a Nominations and Remuneration Committee, whose members are: Mr. Nicholls, Mr. Tappenden and Mr. Henkel. The board of directors
remuneration objective is to motivate directors and management to pursue the long-term growth and success of Metal Storm within an appropriate control network.

The Nominations and Remuneration Committee reviews the compensation arrangements of all directors and executive officers on an annual basis and makes recommendations to the board. The Nominations and
Remuneration Committee reviews and assesses the appropriateness of compensation arrangements of directors and executive officers by reference to relevant employment market conditions and with regard to performance based on set key performance
indicators. Executive bonuses are linked to the achievement of pre-determined key performance indicators, and can also be granted based on the discretion of the Nominations and Remuneration Committee. In order to retain and attract executives of
sufficient calibre to facilitate the efficient and effective management of our operations, the Nominations and Remuneration Committee seeks the advice of external advisers in connection with the structure of remuneration packages. It is the
Nominations and Remuneration Committees policy that employment agreements are entered into with all executives.

Remuneration packages contain the following key elements:



| |  |  | salary/fees;
| | - |  | ------------



| |  |  | benefits  including the provision of retirement and health benefits; and
| | - |  | -------------------------------------------------------------------------



| |  |  | incentive schemes  including performance-related bonuses and share options under the discretionary share option plan.
| | - |  | ----------------------------------------------------------------------------------------------------------------------

It is the Nominations and Remuneration Committees policy that payment of equity based remuneration to
executive and non-executive directors is subject to shareholder approval. Metal Storm operates a discretionary employee option plan to enable the board of directors to provide an incentive to and to reward, full time executives and employees for the
role that they play in the future success of Metal Storm. Invitations to participate in the discretionary employee option plan are at the absolute discretion of the board of directors. Invitations to participate in the employee option plan specify
the details of the invitation, such as maximum number of shares, date by which the application must be made by the invitee, the exercise price, any conditions attached to the exercise of the option and any disposal restrictions. The exercise price
is not less than the market value of Metal Storms shares on the date determined by the board of directors, and the aggregate number of shares subject to options cannot exceed 5% of Metal Storms shares then on issue. There are also
individual limits on the number of options that may be granted to employees and individual limits on the number of shares that may be allotted and issued to employees upon exercise of the options. The exercise period for the options granted under
the employee option plan is the earliest of (a) the third anniversary of the date of grant of the option; (b) the date on which any special circumstances including death, disability, redundancy, retirement or cessation of employment arise;
(c) a takeover, compulsory acquisition, reconstruction, amalgamation or liquidation; and ending on the earliest of (d) the date which is 2 days before the tenth anniversary of the date of grant; (e) the last day before the first
anniversary of the date on which any special circumstance arises; and (f) the expiry of specified time frames set out in the employee option plan in



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relation to the circumstances in (c) above. An option lapses upon expiry of the exercise period, termination of the option holders employment otherwise than in a special circumstance,
upon the option holder being adjudicated bankrupt, or any purported transfer, assignment or alienation of the options by the option holder. The board of directors may at any time cease making further offers or invitations, but the subsisting rights
of options are not affected in such circumstances. Non-executive directors do not have service contracts with Metal Storm.

D. Employees

We employed 21 staff as at December 31, 2011. The following table provides a breakdown of our employees by main
category of activity and geographic location.



|               |  |                     |  |            
|-------------- |  | ------------------- |  | -----------
|               |  | QueenslandAustralia |  | VirginiaUSA
|Administration |  | 4                   |  | 4          
|Engineering    |  | 8                   |  | 5          

At each of December 31, 2010, and December 31, 2009, we had 27 staff.

E. Share Ownership

As
of December 31, 2011, the number of outstanding shares was 2,782,478,264, there are 1,504,451,138 unquoted share options, 20,000,000 convertible securities, 107,399,299 secured convertible notes, 32,355,497 interest bearing convertible notes
and 1 convertible security with a face value of $700,000.

As of December 31, 2011, the beneficial interests of the
directors and executives in the ordinary shares and options of Metal Storm were:



|                    |  |                       |           |     |                               |  |           |    
|------------------- |  | --------------------- | --------- | --- | ----------------------------- |  | --------- | ---
|                    |  | Number of Shares Held |           |     | Number of Options Exercisable | 
|Terence J. ODwyer  |  |                       | 2,637,449 | (1) |                               |  | 839,546   | (2)
|John R. Nicholls(3) |  |                       |          |     |                               |  |          |    
|Trevor W. Tappenden |  |                       | 125,000   |     |                               |  | 75,000    | (4)
|William Henkel      |  |                       |          |     |                               |  |          |    
|Lee J. Finniear     |  |                       | 1,117,656 |     |                               |  | 1,335,298 | (5)
|Brett I. Farmer     |  |                       | 500,000   |     |                               |  | 544,407   | (4)
|Peter D. Faulkner   |  |                       |          |     |                               |  | 200,000   | (6)
|George A. Orrison   |  |                       |          |     |                               |  |          |    



|(1) | 1,345,738 shares are owned by Mr. ODwyer and Mrs. P.M. ODwyer and 1,291,711 shares are owned by Louclaben Pty Ltd in trust for the ODwyer
Family Account.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | 27,042 unquoted options with an exercise price of A$0.001 per share and an expiry date of September 24, 2012 and 403,722 unquoted options with an exercise price of
A$0.015 per share and an expiry date of September 13, 2013 are owned by Mr. Terence J. ODwyer and Mrs. P.M. ODwyer. 21,269 unquoted options with an exercise price of A$0.001 per share and an expiry date of
September 24, 2012 and 387,513 unquoted options with an exercise price of A$0.015 per share and an expiry date of September 13, 2013 are owned by Louclaben Pty Ltd in trust for the ODwyer Family Account.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Mr. Nicholls is a director of Metal Storm and a director and investment manager of Harmony Capital Partners Pte Limited (Harmony). Harmony Investment
Fund Limited (Harmony Investment) is an entity that is managed by Harmony and which owns securities in Metal Storm. As of December 31, 2011, Harmony Investment held 24,870,644 ordinary shares and 25,930,470 unquoted options.
Pursuant to an agreement dated October 17, 2011, between Harmony and ASOF, ASOF agreed to purchase all of Harmonys 97,902,659 secured convertible notes (subject to the satisfaction or waiver of various conditions). ASOF completed the
acquisition of Harmonys 97,902,659 secured convertible notes on March 30, 2012. Mr. Nicholls disclaims beneficial ownership of securities owned by Harmony Investment.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | These are unquoted options with an exercise price of A$0.015 per share and an expiry date of September 13, 2013.
|--- | ----------------------------------------------------------------------------------------------------------------

|(5) | 1,000,000 options held by Mr. Finniear have an exercise price of A$0.185 per share and expire in March 2012, and 335,298 options held by Mr. Finniear have an
exercise price of A$0.015 per share and an expiry date of September 13, 2013.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Options held by Mr. Faulkner have an exercise price of A$0.40 per share and expire between December 2010 and September 2012.
|--- | ----------------------------------------------------------------------------------------------------------------------------



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We can grant options to purchase our shares to our directors and employees under our
constitution and under our discretionary share option scheme and under various employment agreements. See Item 10B Additional Information  Our Constitution for a summary of the provisions of our constitution relating to the
issuance of options and Note 14 to the accompanying consolidated financial statements and Item 6B Directors, Senior Management and Employees  Compensation for a summary of the terms of our various option schemes.

Item 7. Major Shareholders and Related Party Transactions

A. Major Shareholders

As of December 31, 2011, there are no
beneficial owners of more than 5% of our ordinary shares based upon filings made by such persons with the ASX. Beneficial ownership is determined according to the rules of the Securities and Exchange Commission and generally means that a person has
beneficial ownership of a security if he or she possesses sole or shared voting or investment power of that security, and includes options that are exercisable within 60 days. Information with respect to beneficial ownership has been furnished to us
by each director, executive officer or 5% or more shareholder, as the case may be. Unless otherwise indicated, to our knowledge, each shareholder possesses sole voting and investment power over the shares listed, subject to community property laws
where applicable.

All holders of our ordinary shares have the same voting rights.

The applicable percentage ownership of shareholders discussed in the following paragraphs is based on 2,782,478,264 ordinary shares
outstanding as of December 31, 2011. Options to purchase our ordinary shares that are exercisable or convertible notes that can be converted into ordinary shares within 60 days of December 31, 2011 are deemed to be beneficially owned by
the persons holding these options for the purpose of computing percentage ownership of that person, but are not treated as outstanding for the purpose of computing any other persons ownership percentage.

As of December 31, 2011, Andrew Doyle was the beneficial owner of 109,375,824 ordinary shares, 598,244,541 options convertible to
598,244,541 ordinary shares within 60 days, 1,833,997 convertible notes that can be converted into 24,758,960 ordinary shares within 60 days and 20,000,000 convertible securities that can be converted into 100,000,000 ordinary shares within 60 days.
If all of the options and convertible notes were exercised or converted at that date and no other optionholder, Noteholder or securityholder converted their holdings, Mr Doyle would hold approximately 24% of the ordinary shares in Metal Storm
Limited. The diluting effect of this transaction would make Mr Doyle the largest shareholder. We note, however, that any conversion of notes that would result in ownership of more than 19.9% of Metal Storms ordinary shares would require
shareholder approval under ASX Listing Rules. Since November 29, 2011, Mr. Doyle has beneficially owned less than 5% of all of our ordinary shares.

As of December 31, 2011, PNG Ports Corporation Limited held 22,500,000 convertible notes. If all these convertible notes were exercised or converted at that date and no other optionholder or
Noteholder converted their holdings, PNG Ports Corporation Limited would hold approximately 10% of the ordinary shares in Metal Storm Limited.

As of December 31, 2011, Harmony Investment was the beneficial owner of 24,870,644 ordinary shares and 25,930,470 unquoted options. Pursuant to an agreement dated October 17, 2011, between
Harmony and ASOF, ASOF agreed to purchase all of the Harmonys 97,902,659 secured convertible notes (subject to the satisfaction or waiver of various conditions). ASOF completed the acquisition of Harmonys 97,902,659 secured convertible
notes on March 30, 2012. In July 2010 Harmony beneficially owned 29,453,097 ordinary shares, 97,902,659 quoted convertible notes and 25,930,470 unquoted options. In July 2009, Harmony beneficially owned 29,453,097 ordinary shares, 97,902,659
quoted convertible notes and 118,726,332 quoted options.

A former major shareholder, James Michael ODwyer, reduced his
beneficial ownership during the past few years. In June 2008 he beneficially owned 187,423,610 ordinary shares or 30.8% of all our ordinary shares. In April 2009 Mr. ODwyer beneficially owned 160,375,776 ordinary shares or 25.5% of all
our ordinary shares. In June 2010 he beneficially owned 80,699,059 ordinary shares or 7.5% of all our ordinary shares. Since September 29, 2010, Mr. ODwyer has beneficially owned less than 5% of all our ordinary shares.

As of December 31, 2011, 2.1% of our ordinary shares were held by 60 U.S. holders of record and 93% of our ordinary shares were held
by 9,327 Australian holders of record.

As of December 31, 2011, 9,245,543 American Depositary Shares, representing
184,910,860 ordinary shares, were outstanding.



33



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##### Table of Contents

B. Related Party Transactions

During 2009, Backwell Lombard Capital, a company of which Terry ODwyer is a principal, loaned the sum of A$326,714 to Metal Storm.
The loan is unsecured, has no fixed repayment dates, is at call and does not bear interest. We repaid A$50,000 and then borrowed a further A$100,000 during the first few months of 2010. The loan was then split into amounts owed to each of the
principals of Backwell Lombard Capital. In December 2010 we repaid A$162,500 through the issuance of ordinary shares at market rates to one of the principals. As of December 31, 2011 we owe A$214,848 under this loan.

In 2011, Peter Faulkner, President of Metal Storm Inc., loaned the sum of A$33,128 to Metal Storm. This loan was repaid in 2011 and no
amount was outstanding as of December 31, 2011. Interest of A$494 was paid on this loan in 2011 to Mr. Faulkner.

C. Interest of
Experts and Counsel

Not applicable.

Item 8. Financial Information

A. Consolidated Financial
Statements and Other Financial Information

Our financial statements are included in Item 17 Financial
Statements.

Legal Proceedings

None

Dividends

We have never declared or paid any cash dividends on our ordinary stock and we do not anticipate paying any cash dividends in the foreseeable future. Dividends may only be paid out of our profits. Payment
of cash dividends, if any, in the future will be at the discretion of our board of directors or, if our directors do not exercise their power to issue dividends, our shareholders in a general meeting may exercise the powers. See Item 10
Additional Information  B. Constitution  Right to Share in Our Profits. Our Directors current intention is to reinvest any income in the continued development and operation of our business.

B. Significant Changes

None.

Item 9. The Offer and Listing

A. Listing Details  Price History

Australian Securities Exchange

Our ordinary shares were initially quoted and admitted to trading on the ASX (symbol: MST) in 1999. The following table presents, for the periods indicated, the reported low and high market
prices for our ordinary shares as quoted on the ASX. All figures are in Australian dollars.



|                  |  |                         |       |  |     |   |       | 
|----------------- |  | ----------------------- | ----- |  | --- | - | ----- | 
|                  |  | Price
PerOrdinary Share |      
|                  |  | High                    |       |  | Low |  
|Year Ended        |  | A$                      |       |  | A$  |  
|December 31, 2011 |  |                         |       |  |     |   |       | 
|First Quarter     |  | $                       | 0.010 |  |     | $ | 0.006 | 
|Second Quarter    |  | $                       | 0.008 |  |     | $ | 0.004 | 
|Third Quarter     |  | $                       | 0.006 |  |     | $ | 0.003 | 
|Fourth Quarter    |  | $                       | 0.004 |  |     | $ | 0.002 | 
|December 31, 2010 |  |                         |       |  |     |   |       | 
|First Quarter     |  | $                       | 0.030 |  |     | $ | 0.013 | 
|Second Quarter    |  | $                       | 0.016 |  |     | $ | 0.006 | 



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##### Table of Contents

|                  |  |   |       |  |  |   |       | 
|----------------- |  | - | ----- |  |  | - | ----- | 
|Third Quarter     |  | $ | 0.014 |  |  | $ | 0.007 | 
|Fourth Quarter    |  | $ | 0.011 |  |  | $ | 0.007 | 
|December 31, 2009 |  |   |       |  |  |   |       | 
|Annual            |  | $ | 0.076 |  |  | $ | 0.018 | 
|December 31, 2008 |  |   |       |  |  |   |       | 
|Annual            |  | $ | 0.095 |  |  | $ | 0.029 | 
|December 31, 2007 |  |   |       |  |  |   |       | 
|Annual            |  | $ | 0.210 |  |  | $ | 0.080 | 



|              |  |                         |       |  |     |   |       | 
|------------- |  | ----------------------- | ----- |  | --- | - | ----- | 
|              |  | Price
PerOrdinary Share |      
|              |  | High                    |       |  | Low |  
|Month Ended   |  | A$                      |       |  | A$  |  
|March 2012    |  | $                       | 0.002 |  |     | $ | 0.001 | 
|February 2012 |  | $                       | 0.002 |  |     | $ | 0.001 | 
|January 2012  |  | $                       | 0.003 |  |     | $ | 0.001 | 
|December 2011 |  | $                       | 0.003 |  |     | $ | 0.002 | 
|November 2011 |  | $                       | 0.004 |  |     | $ | 0.002 | 
|October 2011  |  | $                       | 0.004 |  |     | $ | 0.002 | 

American Depositary Shares

Since December 2001, our ordinary shares, initially in the form of ADRs and subsequently in the form of ADSs, were traded on the NASDAQ
Capital Market (symbol: MTSX) until they were moved to the Over the Counter market (symbol: MTSXY) in July 2008. Each ADS represents 20 ordinary shares. The following table presents, for the periods indicated, the high and
low closing prices in U.S. dollars of our ADSs.



|                  |  |                         |      |  |     |   |      | 
|----------------- |  | ----------------------- | ---- |  | --- | - | ---- | 
|                  |  | Price PerOrdinary Share |     
|                  |  | High                    |      |  | Low |  
|Year Ended        |  | US$                     |      |  | US$ |  
|December 31, 2011 |  |                         |      |  |     |   |      | 
|First Quarter     |  | $                       | 0.21 |  |     | $ | 0.16 | 
|Second Quarter    |  | $                       | 0.18 |  |     | $ | 0.09 | 
|Third Quarter     |  | $                       | 0.15 |  |     | $ | 0.09 | 
|Fourth Quarter    |  | $                       | 0.13 |  |     | $ | 0.04 | 
|December 31, 2010 |  |                         |      |  |     |   |      | 
|First Quarter     |  | $                       | 0.52 |  |     | $ | 0.25 | 
|Second Quarter    |  | $                       | 0.31 |  |     | $ | 0.12 | 
|Third Quarter     |  | $                       | 0.48 |  |     | $ | 0.14 | 
|Fourth Quarter    |  | $                       | 0.33 |  |     | $ | 0.17 | 
|December 31, 2009 |  |                         |      |  |     |   |      | 
|Annual            |  | $                       | 0.90 |  |     | $ | 0.28 | 
|December 31, 2008 |  |                         |      |  |     |   |      | 
|Annual            |  | $                       | 1.57 |  |     | $ | 0.31 | 
|December 31, 2007 |  |                         |      |  |     |   |      | 
|Annual            |  | $                       | 3.38 |  |     | $ | 1.15 | 



|              |  |                         |      |  |     |   |      | 
|------------- |  | ----------------------- | ---- |  | --- | - | ---- | 
|              |  | Price PerOrdinary Share |     
|              |  | High                    |      |  | Low |  
|Month Ended   |  | US$                     |      |  | US$ |  
|March 2012    |  | $                       | 0.04 |  |     | $ | 0.03 | 
|February 2012 |  | $                       | 0.06 |  |     | $ | 0.03 | 
|January 2012  |  | $                       | 0.08 |  |     | $ | 0.04 | 
|December 2011 |  | $                       | 0.10 |  |     | $ | 0.04 | 
|November 2011 |  | $                       | 0.13 |  |     | $ | 0.04 | 
|October 2011  |  | $                       | 0.13 |  |     | $ | 0.08 | 

B. Plan of Distribution

Not applicable.



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##### Table of Contents

C. Markets

Our ordinary shares are traded on the ASX and were listed on the NASDAQ Capital Market until July 2008 and, since then, quoted on the OTC market, in the form of American Depositary Shares.

D. Selling Shareholders

Not applicable.

E. Dilution

Not applicable.

F. Expenses of the Issue

Not applicable.

Item 10. Additional Information

A. Share Capital

Not applicable.

B. Our Constitution

We are a public company limited by shares registered under the Australian Corporations Act 2001 (Corporations Act) by the
Australian Securities and Investments Commission (ASIC). We were registered as a private company in Queensland, Australia on April 13, 1994 and our registered company number is 064 270 006. Our constituent document is a constitution
which is similar in nature to the by-laws of a company incorporated under the laws of the U.S. Our constitution does not provide for or prescribe any specific objectives or purposes of Metal Storm. Our constitution is subject to the terms of the ASX
Listing Rules and the Corporations Act. Our constitution may be amended or repealed and replaced by special resolution of shareholders, which is a resolution passed by at least 75% of the votes cast by shareholders entitled to vote on the
resolution.

Our current constitution was adopted on May 14, 1999. Under Australian law, a company has the legal capacity
and powers of an individual both inside and outside Australia. The material provisions of our constitution are summarized below. This summary is not intended to be complete, nor to constitute a definitive statement of the rights and liabilities of
our shareholders and is qualified in its entirety by reference to the constitution, which is available on request.

Directors

Interested Directors

A director may not vote in respect of any contract or arrangement in which the director has, directly or indirectly, any material interest according to our constitution. Such director may not be counted
in the quorum present at the meeting and if the director does vote, such vote may not be counted. Either or both of these prohibitions may be relaxed or suspended to any extent by resolution passed at a general meeting of shareholders.

The Corporations Act prohibits directors of companies listed on the ASX from voting on matters in which they have a material personal
interest, requires disclosure of such interest to shareholders, and requires shareholders approval of any provision of related party benefits.

Directors Compensation

Our directors are paid remuneration
for their services as directors, which is determined in a general meeting of shareholders. The aggregate, fixed sum for directors remuneration is to be divided among the directors in such proportion as the directors themselves agree, and in
accordance with our constitution. The fixed sum remuneration for directors may not be increased except at a general meeting of shareholders and the particulars of the proposed increase are required to have been provided to shareholders in the notice
convening the meeting.



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##### Table of Contents

Pursuant to our constitution any director who devotes special attention to our business or
who otherwise performs services which in the opinion of our board of directors are outside the scope of the ordinary duties of a director, or who at the request of the board of directors engages in any journey related to our business, may be paid
extra remuneration which is determined by the board.

In addition to other remuneration provided in our constitution, all
directors are entitled to be paid by us for reasonable travel accommodation and other expenses incurred by the directors in attending company meetings, board meetings, committee meetings or while engaged on our business.

Additionally in accordance with our constitution, a director may be paid a retirement benefit as determined by the board of directors in
accordance with the Corporations Act and the ASX Listing Rules.

Borrowing Powers Exercisable by Directors

Pursuant to our constitution, the management and control of our business affairs are vested in our board of directors.
The board has the powers to raise or borrow money, guarantee the debts or obligations of any person and enter into any other financial arrangement, in each case in the manner and on the terms it thinks fit. The board may also charge any of our
property or business or any uncalled capital and may issue debentures or give any other security for any of our debts, liabilities or obligations or of any other person, in each case, in the manner and on terms it deems fit.

Retirement of directors

Pursuant to our constitution, one third of directors other than the director who is the managing director, must retire from office at every annual general meeting. If the number of directors is not a
multiple of three then the number nearest to but not less than one third must retire from office. The directors who retire in this manner are required to be the directors or director longest in office since last being elected. A director, other than
the director who is a managing director, must retire from office at the conclusion of the third annual general meeting after which the director was elected.

Share Qualifications

There are no requirements under our
constitution or elsewhere for directors to own our shares in order to qualify as directors.

Rights and Restrictions on Classes of Shares

Subject to the Corporations Act and the ASX Listing Rules, rights attaching to our shares are detailed in our
constitution. Our constitution provides that any of our shares may be issued with preferred, deferred or other special rights, whether in relation to dividends, voting, return of share capital, payment of calls or otherwise as the board of directors
may determine from time to time. Except as provided by contract or by our constitution to the contrary, all unissued shares are under the control of the board which may grant options on the shares, allot or otherwise dispose of the shares on the
terms and conditions and for the consideration it deems fit. Currently our outstanding share capital consists of only one class of ordinary shares.

Dividend Rights

The board may from time to time determine to pay
dividends to shareholders. All unclaimed dividends may be invested or otherwise made use of by the board for our benefit until claimed or otherwise disposed of in accordance with our constitution.

Voting Rights

Under our constitution, each shareholder has one vote determined by a show of hands at a meeting of the shareholders. On a poll vote each shareholder shall have one vote for each fully paid share and a
fractional vote for each share which is not fully paid, such fraction being equivalent to the proportion of the amount which has been paid to such date on that share. Under Australian law, shareholders of a public company are not permitted to
approve corporate matters by written consent. Our constitution does not provide for cumulative voting.



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##### Table of Contents

Right to Share in our Profits

Pursuant to our constitution, our shareholders are entitled to participate in our profits only by payment of dividends. The board may from
time to time determine to pay dividends to the shareholders, however no dividend is payable except out of our profits. A declaration by the board as to the amount of our profits is conclusive.

Rights to Share in the Surplus in the Event of Liquidation

Our constitution provides for the right of shareholders to participate in a surplus in the event of our liquidation. In certain
circumstances, any division may be otherwise than in accordance with the legal rights of the contributories, and in particular, any class may be given preferential or special rights or may be excluded altogether or in part from participation in a
surplus in the event of liquidation. In the case of any division otherwise than in accordance with the legal rights of the contributories, any contributory who would be prejudiced by the division has a right to dissent and has ancillary rights, as
if the determination were a special resolution passed pursuant to the Corporations Act relating to the sale or transfer of our assets by a liquidator or in a voluntary winding up.

Redemption Provisions

There are no redemption provisions in our constitution in relation to ordinary shares. Under our constitution and subject to the Corporations Act, any preference shares may be issued on the terms that
they are, or may at our option be, liable to be redeemed.

Sinking Fund Provisions

There are no sinking fund provisions in our constitution in relation to ordinary shares.

Liability for Further Capital Calls

According to our constitution, the board may make any calls from time to time upon shareholders in respect of all monies unpaid on shares, subject to the terms upon which any of the shares have been
issued. Each shareholder is liable to pay the amount of each call in the manner, at the time, and at the place specified by the board. Calls may be made payable by instalment.

Provisions Discriminating Against Holders of a Substantial Number of Shares

There are no provisions under our constitution discriminating against any existing or prospective holders of a substantial number of our shares.

Variation of Share Rights

Our constitution provides that, unless otherwise
provided by the terms of issue of the shares of such class, the rights attaching to any class of shares may, subject to the ASX Listing Rules, be varied with the consent in writing of members with at least 75% of the votes in the class or with the
sanction of a special resolution passed at a separate meeting of the holders of the shares of such class. Our constitution also provides that the rights conferred upon holders of shares of any class issued with preferred or other rights are, unless
otherwise expressly provided by the terms of issue of the shares of that class, deemed not to be varied by the creation or issue of further shares ranking equally with the first mentioned shares. These conditions are not more significant than
required by the Corporations Act.

General Meetings of Shareholders

General meetings of shareholders may be called by the board of directors. Except as permitted under the Corporations Act, shareholders may
not convene a meeting. Under the Corporations Act, shareholders with at least 5% of the votes which may be cast at a general meeting may call and arrange to hold a general meeting. The Corporations Act requires the directors to call and arrange to
hold a general meeting on the request of shareholders with at least 5% of the votes that may be cast at a general meeting or at least 100 shareholders who are entitled to vote at the general meeting. Twenty-eight days notice of the proposed
meeting of our shareholders is required under the Corporations Act.

According to our constitution, the chairman of the
general meeting may refuse admission to or exclude from the meeting, any person who is in possession of a picture recording or sound recording device, in possession of a placard or banner, in possession of an object considered by the chairman to be
dangerous, offensive or liable to cause disruption, any person who refuses to produce or permit examination of any object, any person who behaves or threatens to behave in a dangerous, offensive or destructive manner, or any person who is not a
director or one of our auditors, one of our shareholders or a proxy, attorney or representative of one of our shareholders.



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Foreign Ownership Regulation

There are no limitations on the rights to own securities imposed by our constitution. However, acquisitions and proposed acquisitions of shares in Australian companies may be subject to review and
approval by the Australian Federal Treasurer under the Australian Foreign Acquisitions and Takeovers Act 1975 (Foreign Acquisitions and Takeovers Act). Generally this Act applies to acquisitions or proposed acquisitions:

(a) by a foreign person, as defined in the Foreign Acquisitions and Takeovers Act, or associated foreign persons which would result in
such persons having an interest in 15% or more of the issued shares of, or control of 15% or more of the voting power in, an Australian company, and

(b) by a non-associated foreign person which would result in such foreign person having an interest in 40% or more of the issued shares of, or control of 40% or more of the voting power in, an Australian
company.

The Australian Federal Treasurer may prevent a proposed acquisition in the above categories or impose conditions on
such acquisition if the Treasurer is satisfied that the acquisition would be contrary to the national interest. If a foreign person acquires shares or an interest in shares in an Australian company in contravention of the Foreign Acquisitions and
Takeovers Act, the Australian Federal Treasurer may order the divestiture of such persons shares or interest in shares in the company. The Australian Federal Treasurer may order divestiture pursuant to the Foreign Acquisitions and Takeovers
Act if he determines that the acquisition has resulted in that foreign person, either alone or together with other non-associated or associated foreign persons, controlling the company and that such control is contrary to the national interest.

Merger, Acquisition or Restructure

Our constitution indicates that where offers to purchase our shares have been made under a proportional takeover scheme, we are prohibited from registering a transfer which would give effect to the
contract resulting from the acceptance of such an offer unless and until a resolution to approve the proportional takeover scheme is approved at a meeting by the persons entitled to vote on such resolution. The offeror or an associate of the offeror
is not entitled to vote on such resolution. A person, other than an offeror or associate of the offeror, who, as at the end of the day in which the first offer under the proportional takeover scheme was made, held shares in that class of shares, is
entitled to one vote for each of the shares held in that class.

Ownership Threshold

There are no provisions in our constitution that require a shareholder to disclose ownership above a certain threshold. The Corporations
Act, however, requires a substantial shareholder to notify us and the ASX once a 5% interest in our shares is obtained. Further, once a shareholder owns a 5% interest in us, such shareholder must notify us and the ASX of any increase or decrease of
1% or more in its holding of our shares.

Conditions for Change of Capital

There are no conditions imposed by our constitution relating to changes in our capital which are more stringent than are required by the
Corporations Act.

Stock Issues and Takeover Attempts

We are governed by the Corporations Act which provides shareholders with broad protection in relation to takeovers, including:



| |  |  | that the acquisition of control over voting shares takes place in a efficient, competitive and informed market;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | that shareholders have enough information to assess the merits of a proposal; and
| | - |  | ---------------------------------------------------------------------------------



| |  |  | that shareholders all have a reasonable and equal opportunity to participate in any benefits accruing to the shareholders through any proposal
under which a person would acquire a substantial interest.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Further, subject to certain limited exceptions
provided in the ASX Listing Rules, we must not issue or agree to issue shares, without the approval of holders of our ordinary shares, for three months after we are told in writing that a person is making or proposes to make, a takeover for our
shares.



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##### Table of Contents

The exceptions to the ASX Listing Rules are as follows:



| |  |  | an issuance or agreement to issue which we have notified the ASX of before we are told a person is making or proposes to make a takeover offer
for our shares;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an issuance to our ordinary shareholders on a pro-rata basis;
| | - |  | -------------------------------------------------------------



| |  |  | an issuance made due to an exercise of rights of conversion already in existence;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | an issuance by us as consideration for an off-market takeover bid made by us where we are required to comply with the provisions of the
Corporations Act;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an issuance under a dividend stock distribution plan that is in operation before we are told a person is making or proposes to make a takeover
for our shares; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if there is an agreement to issue shares and such agreement is conditional on ordinary shareholders approving the issuance before the issuance
is made.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------

Access to and Inspection of Documents

Inspection of our records is governed by the Corporations Act. Any member of the public has the right to inspect or obtain copies of our
company registers on the payment of a prescribed fee. Shareholders are not required to pay a fee for inspection of our registers or minute books of the meetings of shareholders. Other corporate records including minutes of directors meetings,
financial records and other documents are not open for inspection by shareholders. Where a shareholder is acting in good faith and an inspection is deemed to be made for a proper purpose, a shareholder may apply to the court to make an order for
inspection of our books.

CHESS

We participate in the Clearing House Electronic Sub-Register System, known as CHESS, which is maintained by the CHESS Securities Clearing House pursuant to the ASX Listing Rules and the Securities
Clearing House business rules. CHESS is an automated, electronic transfer and settlement system with no requirement for physical title or transfer documents. Accordingly, the legal registered record of holding balances for our CHESS-approved shares
are recorded on either of the electronic CHESS sub-register or the electronic issuer sponsored sub-register, which together form the complete company register. We do not issue share certificates to shareholders. Instead, we provide shareholders with
a holding statement (similar to a bank account statement) that sets out the number of ordinary shares registered in each shareholders name. This statement also advised shareholders of their holder identification number or shareholder reference
number and relevant particulars. If a shareholding changes during any month, shareholders will receive a statement after the end of that month. Shareholders may also request statements at any other time (subject to payment of a small administration
fee).

C. Material Contracts

Terms of convertible notes

The terms of the convertible notes were set out
in the Rights Offer prospectus that was approved by the Board of Metal Storm in July 2006 and amended in July 2009.

The
maturity date of the convertible notes was September 1, 2011, but at meetings of our shareholders and Noteholders held on August 29, 2011, it was agreed to extend the maturity date of the convertible notes from September 1, 2011 to
March 1, 2012. At another meeting of our shareholders and Noteholders held on January 12, 2012, the maturity date of the convertible notes was extended to March 1, 2015 (the Maturity Date), at which time Metal Storm must
repay the face value of A$0.135 per convertible note to the Noteholders, unless Noteholders have elected to convert some or all of their convertible notes into ordinary shares. Noteholders can elect to convert some or all of their convertible notes
into ordinary shares at the beginning of each quarter, at the Maturity Date and at certain other times.

The secured
convertible notes do not bear interest but hold a fixed and floating charge over the assets of Metal Storm. All other terms and conditions are the same as the interest bearing convertible notes.

At a meeting of our shareholders and Noteholders, both held on January 12, 2012, the following changes to the convertible note terms
were approved:



|(a) | the maturity date of the convertible notes was extended to March 1, 2015; and
|--- | -----------------------------------------------------------------------------



|(b) | the conversion price formula was amended so that:
|--- | -------------------------------------------------



| | (i) | it is more favorable to Noteholders and has the potential to result in more shares being issued to a Noteholder on conversion (particularly if the price per share
exceeds A$0.015); and
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| | (ii) | it is rounded down to four decimal places rather than to the nearest cent (two decimal places), thereby ensuring that noteholders are not disadvantaged if shares trade
below A$0.01 during the conversion price calculation period;
| | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iii) | the VWAP period was reduced from 30 Business Days to 20 Business Days;
| | ----- | ----------------------------------------------------------------------



| | (iv) | the maximum conversion price was significantly reduced from A$0.135 to A$0.0105 per share; and
| | ---- | ----------------------------------------------------------------------------------------------



| | (v) | a Noteholder can rely upon the five lowest daily VWAPs of shares rather than the VWAP of shares over the entire calculation period, which is likely to provide
Noteholders with a more favorable conversion price.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Metal Storm cannot redeem any convertible notes prior to
the Maturity Date. On the Maturity Date, the convertible notes must be redeemed by Metal Storm paying to the Noteholder the face value of the notes (unless the Noteholder has previously elected to convert their notes into ordinary shares). On the
occurrence of an event of default (examples of which are set out below), if required by ANZ Executors & Trustee Company Limited (Trustee), Metal Storm must redeem all the convertible notes on issue by paying to the Noteholders
the face value together with all accrued but unpaid interest at the date of redemption.

There are two types of convertible
notes outstanding, interest bearing convertible notes and secured convertible notes. Interest is payable on the face value of the interest bearing notes at a rate of 10% per annum. Interest is payable quarterly in arrears on the last day of
each quarter until the earlier of conversion or redemption of the convertible notes. Until conversion or redemption, the interest bearing convertible notes are unsecured debt obligations of Metal Storm and rank equally with other ordinary unsecured
creditors. The convertible notes rank behind any of our secured creditors but rank ahead of shares outstanding. Each share issued on conversion of the notes will rank equally with all existing shares then on issue.

The secured convertible notes do not bear interest but have a fixed and floating charge over the assets of Metal Storm. They rank ahead
of all other unsecured debt obligations. Each share issued on conversion of the notes will rank equally with all existing shares then on issue.

Neither of the two types of convertible notes carry any entitlement to participate in rights offers, any returns of capital, bonus issue or capital reconstruction.

Trust Deed in connection with the Rights Offer

Metal Storm entered into the Trust Deed with the Trustee in connection with the Rights Offer in July 2006, as amended and restated on July 30, 2009. Under the Trust Deed, the Trustee has agreed to
hold on trust for the Noteholders, the right to enforce Metal Storms obligation to repay the face value of the convertible notes, together with all accrued but unpaid interest.

The Trustee has covenanted that it will exercise reasonable diligence to ascertain whether Metal Storm has committed any breach of the
terms applicable to convertible notes, the Trust Deed or Chapter 2L of the Corporations Act.

Equity Line Facility
Agreements

In December 2009, we entered into an agreement with GEM Global Yield Fund Ltd for an equity line of credit in
the amount of A$20.2 million. Under the GEM Equity Line Facility, we could initiate drawdowns at a frequency of up to one drawdown per 15 Australian business days. The amount of each drawdown was limited based upon the trading volume of the shares
during the 15-day period.

Following the date that we issued a drawdown notice, we issued ordinary shares to GEM at 90% of the
15-day weighted average trading closing price of our shares, as quoted on the ASX. In addition, we issued GEM one option for every five ordinary shares issued.

For the term of the GEM Equity Line Facility, we were prohibited from entering into an equity line of credit with a third party without the prior written consent of GEM. The GEM Equity Line Facility
included customary covenants and events of default. If any event of default occurred and was continuing, the GEM Equity Line Facility could be terminated and any amounts owing became immediately due and payable.

In connection with the establishment of the GEM Equity Line Facility, Metal Storm paid A$303,000 in commitment and establishment fees to
an affiliate of GEM that advised it.

Pursuant to the terms of the agreement, the GEM Equity Line Facility was scheduled to
terminate in December 2012. However, in June 2010 we agreed with GEM to terminate the GEM Equity Line Facility as it has not operated as effectively as desired. The GEM Equity Line Facility was formally terminated on September 13, 2010.



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In June 2010, we entered into an equity line of credit agreement with Dutchess Opportunity
Fund II LP for an amount of up to A$25.0 million to replace the previous facility with GEM. The Dutchess Equity Line Facility allows us to initiate drawdowns at a frequency of up to one drawdown per five ASX trading days and issue ordinary shares to
Dutchess in consideration.

In connection with the establishment of the Dutchess Equity Line Facility, Metal Storm issued
20,636,715 shares to Dutchess, totalling an issue price of A$200,000 equal to the first half of the commitment fee owing to Dutchess under the facility agreement. We obtained shareholder approval on August 19, 2010 to issue 21,978,022 shares
owed to Dutchess with respect to the remaining part of the commitment fee of A$200,000 and for the issue of future shares under the Dutchess Equity Line Facility for a three month period (the Shareholder Approval). We also obtained
shareholder approval on December 8, 2010, May 20, 2011, July 19, 2011, December 8, 2011, and January 12, 2012, for the issue of further shares to Dutchess pursuant to the Dutchess Equity Line Facility.

Prior to obtaining the Shareholder Approval, the amount of each drawdown was limited to the lesser of A$100,000 and half of
the commitment fee multiplied by the volume weighted average price of our ordinary shares on the ASX (the VWAP) over five trading days. After the Shareholder Approval, the drawdown limit was increased to the lesser of A$200,000 and the
full commitment fee multiplied by the VWAP over five trading days. Upon issuing a drawdown notice and subject to customary closing conditions, we must issue ordinary shares to Dutchess at a price per share equal to the lowest daily VWAP on the five
trading day period following delivery of the notice.

For the term of the Dutchess Equity Line Facility, we are prohibited
from entering into an equity line of credit with a third party without the prior written consent of Dutchess. The facility agreement includes customary covenants and events of default, including failure to obtain the Shareholder Approval. If any
event of default occurs and is continuing, Dutchess may terminate the Dutchess Equity Line Facility and any amounts owing to Dutchess become immediately due and payable.

The Dutchess Equity Line Facility terminates in June 2013.

Doyle Loan
Agreement

In July 2011 we received confirmation from AusIndustry that we were eligible for the Australian Commonwealth
Governments Research and Development Tax Concession program. The R&D Tax Concession is the principal Australian Commonwealth initiative to increase the amount of research and development undertaken in Australia and provides a tax offset
for companies that meet certain criteria. We expected to receive a rebate in 2011 in the amount of A$550,000  A$650,000. To monetize the expected rebate we signed a short term loan agreement in July 2011 with one of our shareholders, Andrew
Doyle, for A$500,000. As consideration for providing the loan, we issued Mr. Doyle 1,400,000 options that have a life of two years and an exercise price of A$0.001. The principal was repaid to Mr. Doyle in September 2011, upon receipt of
the tax rebate. As consideration for providing the loan and in lieu of interest upon the principal that was repaid in September 2011, Mr. Doyle was issued an additional 1,300,000 options that have a life of two years and an exercise price of
A$0.001.

Deed of Debt Forgiveness

In October 2011, Australian Special Opportunity Fund LP (ASOF), an investment company managed by the New York based investment fund manager, The Lind Partners, LLC, entered into an agreement
with Harmony under which ASOF agreed to purchase all of Harmonys secured convertible notes (subject to the satisfaction or waiver of various conditions) (ASOF Note Acquisition). As a result of the ASOF Note Acquisition, ASOF
controls approximately 91% of the secured convertible notes on issue (equivalent to approximately 70% of all of the convertible notes on issue). Pursuant to a Deed of Debt Forgiveness between Metal Storm and ASOF, ASOF has also agreed to forgive
approximately A$1.5 million of the face value of the secured notes it has purchased from Harmony under the ASOF Note Acquisition subject to a number of conditions (the Debt Forgiveness), including that the ASOF Note Acquisition becomes
effective and no insolvency event occurs in relation to Metal Storm. The Debt Forgiveness will only become effective once ASOF has converted the balance of the secured notes it holds into shares or on the Maturity Date, whichever occurs first, so
long as there has not been an insolvency event.

ASOF Convertible Security Agreement

On October 17, 2011, Metal Storm entered into a Convertible Security Agreement (the ASOF Agreement) with ASOF. Under the
ASOF Agreement, ASOF provided the Company with short term debt funding totalling A$700,000. At a meeting of our shareholders held on December 8, 2011, our shareholders agreed to have the A$700,000 received from ASOF, together with a further
payment by ASOF of A$200,000 cash (i.e. a total of A$900,000), applied as consideration for the issue of a new convertible security to ASOF (the ASOF Convertible Security).



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On December 12, 2011, we received correspondence from The Lind Partners, LLC, as
manager of ASOF, under which ASOF alleged that Metal Storm had breached the ASOF Agreement. On December 28, 2011, Metal Storm and ASOF reached an agreement to resolve the matter, with the key details of the agreement being as follows:



|(a) | the further payment of A$200,000 cash by ASOF under the ASOF Agreement is no longer required;
|--- | ---------------------------------------------------------------------------------------------



|(b) | Metal Storm made early repayment of A$230,000 of the A$700,000 received from ASOF;
|--- | ----------------------------------------------------------------------------------



|(c) | the remainder of the A$700,000 received from ASOF was exchanged for the ASOF Convertible Security, which has a face value of A$700,000, instead of the A$900,000 face
value initially expected;
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(d) | ASOF waived Metal Storms breaches of the ASOF Agreement and the impact of those breaches on any related agreements with ASOF (including the Debt Forgiveness); and
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(e) | Metal Storm paid ASOFs reasonable legal expenses in relation to this matter.
|--- | -----------------------------------------------------------------------------

The issue of the ASOF Convertible Security was approved by shareholders on December 8, 2011, and was issued on December 28,
2011. The ASOF Convertible Security is an unquoted convertible security issued to ASOF with a face value of A$700,000, which will mature on April 17, 2013, will not bear interest, is unsecured and will be convertible into ordinary shares of
Metal Storm at a variable conversion rate. Each conversion shall be in an amount of not less than A$25,000. As of February 29, 2012, A$525,000 of the ASOF Convertible Security had been converted into ordinary shares.

Doyle Convertible Securities

On December 2, 2011, the Company issued one of its largest shareholders, Andrew Doyle, 10,000,000 convertible securities at an issue price of A$0.010 for a total consideration of A$100,000
(Doyle Convertible Securities), with such issue ratified by shareholders on January 12, 2012. The Company also issued Andrew Doyle 10,000,000 additional Doyle Convertible Securities for a total consideration of A$100,000 on the same
day. Each Doyle Convertible Security matures on November 30, 2016. As of February 29, 2012, A$50,000 of the Doyle Convertible Securities had been converted into ordinary shares.

Each Doyle Convertible Security:



|(a) | has a face value of A$0.010;
|--- | ----------------------------



|(b) | matures on November 30, 2016;
|--- | -----------------------------



|(c) | does not bear interest;
|--- | -----------------------



|(d) | is a form of equity that, once converted into shares, will rank equally with shareholders upon a winding up; and
|--- | ----------------------------------------------------------------------------------------------------------------



|(e) | must be converted into shares using a conversion formula at any time but before maturity.
|--- | -----------------------------------------------------------------------------------------

Luxinvest Subscription Agreements

In April 2012, we entered into two Subscription Agreements with Luxinvest Capital Advisors S.A., of Luxembourg (Luxinvest), pursuant to which Luxinvest agreed to invest in Metal Storm
(i) A$350,000 in exchange for ordinary shares at an issue price of A$0.0008 per share, and (ii) A$4.3 million in exchange for ordinary shares at an issue price of A$0.0008 per share, to be issued in two tranches. Both Subscription
Agreement are subject to shareholder approval. Tranche 1 under the A$4.3 million Subscription Agreement involves the issue of 437,500,000 ordinary shares in exchange for A$350,000, while tranche 2, which in addition to shareholder approval is also
subject to completion of the transactions contemplated by the Umbrella Deed, involves the issue of 4,875,000,000 ordinary shares in exchange for A$3.9 million.

Umbrella Deed

In April 2012, we entered into an Umbrella Deed (the
ASOF Umbrella Deed) with ASOF and Luxinvest, whereby Metal Storm will redeem A$9.0 million in secured convertible notes from ASOF in exchange for a cash payment of A$1.7 million, a further A$1.4 million of secured convertible notes will
be converted to ordinary shares at A$0.0009 per share, and pursuant to the Debt Forgiveness, A$1.5 million of secured convertible notes will be forgiven by ASOF. The parties have varied the arrangements under the ASOF Umbrella Deed such that the
A$400,000 deposit payable to ASOF under the Umbrella Deed is due by 17 May 2012. The Company has obtained commitments from Luxinvest and other investors to fund the deposit commitment by the due date. Upon completion of the transactions contemplated
by the Umbrella Deed, the A$400,000 deposit provided by Luxinvest and other investors will be used by Luxinvest and other investors to pay Metal Storm the subscription price for an unsecured convertible note with a face value of A$300,000 and
A$100,000 will be used to obtain ordinary shares at an issue price of A$0.0008 per share. Subject to completion of the transactions contemplated by the Umbrella Deed, we have agreed



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to issue Luxinvest with A$200,000 worth of ordinary shares at an issue price of A$0.0008 per share, as payment of Luxinvests fee for providing the deposit under the Umbrella Deed. Under the
Umbrella Deed, ASOF has the right to appoint a director of Metal Storm and has also agreed to either redeem or convert the remaining face value of its unsecured convertible notes. Completion of the transactions contemplated by the Umbrella Deed is
subject to a number of conditions being satisfied prior to July 17, 2012, including (i) shareholder and noteholder approval, (ii) Metal Storm not suffering an event of insolvency before completion of transactions contemplated by the
Umbrella Deed and (iii) completion of the A$4.3 million Subscription Deed between Metal Storm and Luxinvest that was entered into in April 2012.

D. Exchange Controls

The Australian dollar is convertible into U.S.
dollars at freely floating rates. There are no legal restrictions on the flow of Australian dollars between Australia and the United States. The Commonwealth of Australia has, however enacted laws to make effective the United Nations Security
Council resolutions that impose a freeze on financial assets and foreign exchange dealings with certain persons and entities. In addition, transactions involving the transfer of funds or payments to, by the order of, or on behalf of prescribed
entities, or any undertaking owned or controlled directly or indirectly, by prescribed entities, are not permitted without the specific approval of the Reserve Bank of Australia.

E. Taxation

The following is a summary of certain material U.S. federal
income tax and Australian tax consequences to U.S. holders, as defined below, of the acquisition, ownership and disposition of American Depositary Shares (ADSs) or ordinary shares and is based on the laws in force as at the date of this
annual report. Holders are advised to consult their tax advisors concerning the overall tax consequences of the acquisition, ownership and disposition of ADSs or ordinary shares in their particular circumstances. This discussion is not intended, and
should not be construed, as legal or professional tax advice. This discussion relies in part on representations by the depositary in the deposit agreement and related documents and the assumption that each obligation in the deposit agreement and
related documents will be performed in accordance with their terms.

U.S. Federal Income Tax Considerations

To ensure compliance with U.S. Treasury Department Circular 230, investors are hereby notified that: (a) any discussion of U.S.
Federal tax issues in this document is not intended or written by Metal Storm to be relied upon, and cannot be relied upon by investors in the ADSs or ordinary shares, for the purpose of avoiding penalties that may be imposed on investors in the
ADSs or ordinary shares under the U.S. Internal Revenue Code of 1986, as amended (the Code), (b) such discussion is written in connection with the promotion or marketing of the transactions or matters addressed herein by Metal
Storm, and (c) investors in the ADSs or ordinary shares should seek advice based on their particular circumstances from their own independent tax advisors. U.S. counsel does not intend to be, and is not, engaged in the promotion or marketing of
the transactions or matters described in this offering memorandum, and no inference to the contrary shall be implied by reason of the U.S. tax discussion set forth herein.

In this section, we discuss certain material U.S. federal income tax considerations applicable to an investment in ADSs, which are
evidenced by American Depositary Receipts (ADRs), or ordinary shares by a U.S. holder, as defined below, that will hold the ADSs or ordinary shares as capital assets within the meaning of the Internal Revenue Code of 1986, as amended
(the Code). We do not discuss any tax considerations that may apply to holders subject to special tax rules, such as banks, insurance companies, dealers in securities or currencies, tax-exempt entities, persons subject to the alternative
minimum tax, persons that hold ADSs or ordinary shares as a position in a straddle or as part of a hedging, constructive sale or conversion transaction for U.S. federal income tax purposes, persons that have a functional currency other than the U.S.
dollar, persons that own 10% or more of our equity or persons that are not U.S. holders.

This section is based on the Code,
income tax regulations issued under the Code, and judicial and administrative interpretations of the Code and the income tax regulations, all as of the date of this annual report. All of the foregoing are subject to change at any time, and any
change could be retroactive.

In this section, a U.S. holder means a beneficial owner of ADSs or ordinary shares
that is, for U.S. federal income tax purposes:



| |  |  | an individual who is a citizen or resident of the United States for U.S. federal income tax purposes;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | a corporation, or other entity treated as a corporation for U.S. federal income tax purposes, created or organized in or under the laws of the
United States or any state thereof or the District of Columbia;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an estate the income of which is subject to U.S. federal income taxation regardless of its source; or
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | a trust the administration of which is subject to the primary supervision of a court in the United States and for which one or more U.S. persons
have the authority to control all substantial decisions.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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If a partnership holds ADSs or ordinary shares, the U.S. federal income tax treatment of a
partner generally will depend on the status of the partner and the activities of the partnership. Partners of partnerships that will hold ADSs or ordinary shares should consult their tax advisors.

You should consult your tax advisor with respect to the U.S. federal, as well as state, local and non-U.S., tax consequences to you
of an investment in ADSs or ordinary shares.

Ownership of ADSs in General

A beneficial owner of ADSs will be treated as the beneficial owner of the ordinary shares represented by such ADSs for U.S. federal income
tax purposes. Accordingly, no gain or loss will be recognized by a U.S. holder upon the exchange of ADSs for the ordinary shares represented by such ADSs. A U.S. holders tax basis in an ADS generally will equal the cost of such ADS to such
U.S. holder. A U.S. holders tax basis in the ordinary shares received upon an exchange of ADSs for ordinary shares will be the same as its tax basis in the surrendered ADSs and the holding period for ordinary shares received will include the
period during which the holder held such ADSs.

Dividends

Subject to the passive foreign investment company rules, discussed below, U.S. holders will include as dividend income gross amount of any
distributions of cash or property (without deduction for any withholding tax), other than certain pro ratadistributions of ordinary shares, with respect to ADSs or ordinary shares to the extent the distributions are made from our current or
accumulated earnings and profits, as determined for U.S. federal income tax purposes. A U.S. holder will include the dividend income at the time of receipt, which, for a holder of ADSs, generally will be the date of receipt by the depositary. To the
extent, if any, that the amount of any distribution by us exceeds our current and accumulated earnings and profits, as so determined, it will be treated first as a tax-free return of the U.S. holders tax basis in the ADSs or ordinary shares
and thereafter as capital gain. Dividends paid by us will not be eligible for the dividends-received deduction generally allowed to U.S. corporate shareholders.

For taxable years beginning before January 1, 2013, certain dividends received by an individual U.S. holder (as well as certain trusts and estates) from a qualified foreign corporation
are eligible for preferential rates of taxation. We believe that we are a qualified foreign corporation with respect to our ordinary shares because we should be eligible for benefits under the Double Taxation Convention between Australia and the
United States. A qualified foreign corporation generally does not include any foreign corporation that is a passive foreign investment company for the taxable year in which the dividend is paid or for the preceding taxable year. Even
though we likely were not a passive foreign investment company for 2011 (as discussed below), we would not be a qualified foreign corporation for a dividend paid in 2012 if we are a passive foreign investment company for 2012. If we are a qualified
foreign corporation with respect to ADSs or ordinary shares, then dividends with respect to such shares generally would be eligible for the preferential tax rates, except to the extent that the individual (1) holds the relevant share of stock
for 60 days or less during the 121-day period beginning 60 days before the ex-dividend date (or, in the case of certain preferred stock, 90 days or less during the 181-day period beginning 90 days before the ex-dividend date) as measured under
Section 246(c) of the Code, (2) is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property or (3) elects to treat the dividend
as investment income for purposes of determining the amount of deductible investment interest under Section 163(d)(4)(B) of the Code. Further, if an individual receives, with respect to any share of stock, an extraordinary dividend (within the
meaning of Section 1059(c) of the Code) eligible for the preferential tax rates, any loss on a subsequent sale of the stock is treated as a long-term capital loss to the extent of the extraordinary dividend.

Includible distributions paid in Australian dollars, including any Australian withholding taxes, will be included in the gross income of
a U.S. holder in a U.S. dollar amount calculated by reference to the exchange rate in effect on the date of receipt, regardless of whether the Australian dollars are converted into U.S. dollars at that time. If Australian dollars are converted into
U.S. dollars on the date of receipt, a U.S. holder generally should not be required to recognize any foreign exchange gain or loss.

If Australian dollars so received are not converted into U.S. dollars on the date of receipt, the U.S. holder will have a basis in the Australian dollars equal to their U.S. dollar value on the date of
receipt. Any gain or loss on a subsequent conversion or other disposition of the Australian dollars generally will be treated as ordinary income or loss to such U.S. holder and generally such gain or loss will be income or loss from sources within
the United States for foreign tax credit limitation purposes.

Dividends received by a U.S. holder with respect to ADSs or
ordinary shares will be treated as foreign source income, which may be relevant in calculating the holders foreign tax credit limitation. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific
classes of income. For these purposes, dividends will be categorized as passive category income, or in certain cases as general category income.



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Subject to certain complex limitations, a U.S. holder generally will be entitled to a credit
against its U.S. federal income tax liability or a deduction in computing its U.S. federal taxable income in respect of any Australian taxes withheld by us. A U.S. holder who elects a deduction for Australian taxes withheld by us must do so with
respect to all foreign taxes paid or accrued in such taxable year.

You should consult your tax advisor as to the consequences
of Australian withholding taxes and the availability of a foreign tax credit or deduction for U.S. federal income tax purposes. See Australian Tax Considerations  Taxation of Dividends.

Sale or Exchange of ADSs or Ordinary Shares

Subject to the passive foreign investment company rules, discussed below, a U.S. holder generally will recognize gain or loss on a disposition, including a sale, exchange or redemption, of ADSs or
ordinary shares equal to the difference between the amount realized on the disposition and the U.S. holders tax basis in the ADSs or ordinary shares. This gain or loss will generally be long-term capital gain or loss if the U.S. holder has
held the ADSs or ordinary shares for more than one year and otherwise will be short-term capital gain or loss. Long-term capital gains of individuals are eligible for preferential rates of taxation. For foreign tax credit limitation purposes, gain
or loss recognized upon a disposition generally will be treated as from sources within the United States. The deductibility of capital losses is subject to limitations for U.S. federal income tax purposes.

You should consult your tax advisor regarding the availability of a foreign tax credit or deduction in respect of any Australian tax
imposed on a sale or other disposition of ADSs or ordinary shares. See Australian Tax Considerations  Tax on Sales or other Dispositions of Shares.

Medicare Tax on Unearned Income

Newly enacted legislation requires
certain U.S. holders that are individuals, estates or trusts to pay an additional 3.8% tax on, among other things, dividends on and capital gains from the sale or other disposition of stock for taxable years beginning after December 31, 2012.
U.S. holders that are individuals, estates or trusts should consult their tax advisors regarding the effect, if any, of this legislation on their ownership and disposition of our common stock.

Passive Foreign Investment Company Status

The Code provides special anti-deferral rules regarding certain distributions received by U.S. shareholders with respect to, and sales and other dispositions, including pledges, of shares of stock of, a
passive foreign investment company (PFIC). A foreign corporation will be treated as a PFIC for any taxable year if 75% or more of its gross income for the taxable year is passive income or the average percentage of its assets, generally
by value, that produce or are held for the production of passive income is at least 50%. Passive income for this purpose generally includes, among other things, dividends, interest, rents, royalties, and gains from commodities and securities
transactions. In determining whether a foreign corporation is a PFIC, a pro-rata portion of the income and assets of each corporation in which it owns, at least a 25% interest (by value) is taken into account.

While we do not believe Metal Storm was a PFIC in 2011, we believe Metal Storm was a PFIC for U.S. federal income tax purposes in 2000,
2002, 2003, 2004, 2005, 2006 and 2008. Metal Storm could be a PFIC again in 2012.

As noted above, under  
Dividends, dividends received by an individual from a qualified foreign corporation are eligible for preferential rates of taxation. A qualified foreign corporation generally does not include any foreign corporation that is a PFIC
for the taxable year in which the dividend is paid or for the preceding taxable year.

A U.S. shareholder that holds stock in
a foreign corporation during any taxable year in which the corporation qualifies as a PFIC is subject to tax under the excess distribution rules unless the shareholder elects to treat the PFIC as a qualified electing fund
(QEF) or makes a mark-to-market election, each as discussed below. An excess distribution is a distribution with respect to PFIC stock that exceeds 125% of the average of such distributions over the preceding
three-year period or, if shorter, the shareholders holding period for its shares. Excess distributions are allocated ratably to each day of the U.S. shareholders holding period. Amounts allocated to the current taxable year and any years
before the corporation was a PFIC are currently included in gross income as ordinary income. Amounts allocated to other taxable years are taxed at the highest ordinary income tax rates in effect for those years, and the tax for each such prior year
is subject to an interest charge at the rate applicable to income tax deficiencies. In addition, the entire amount of any gain that a U.S. shareholder realizes upon a sale or other disposition of shares in a PFIC is considered an excess distribution
subject to tax and interest as described above. A U.S. shareholder that acquires shares in a PFIC from a decedent generally will not receive a stepped-up fair market value tax basis in such shares but, instead, will receive a tax basis
equal to the decedents basis, if lower. If a corporation is a PFIC for any taxable year during which a U.S. shareholder holds shares in the corporation, then the corporation generally will continue to be treated as a PFIC with respect to the
shareholders shares, even if the corporation no longer satisfies either the passive income or passive assets test described above, unless the U.S. shareholder terminates this deemed PFIC status by electing to recognize gain, which will be
taxed under the excess distribution rules as if such shares had been sold on the last day of the last taxable year for which the corporation was a PFIC.



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The excess distribution rules may be avoided if a U.S. shareholder makes a QEF election
effective beginning with the first taxable year in the shareholders holding period in which the corporation is a PFIC. A U.S. shareholder that makes a QEF election is required to include in income its pro ratashare of the PFICs
ordinary earnings and net capital gain as ordinary income and long-term capital gain, respectively, subject to a separate election to defer payment of taxes, which deferral is subject to an interest charge. A U.S. shareholder whose QEF election is
effective after the first taxable year during the shareholders holding period in which the corporation is a PFIC (an unpedigreed QEF election) will continue to be subject to the excess distribution rules for years beginning with
such first taxable year and prior to the year in which the QEF election first becomes effective, unless the shareholder elects to recognize as an excess distribution any gain that the shareholder would have recognized if the shares were sold on the
first day of the first taxable year for which the QEF election is effective. Although an option to acquire PFIC stock generally is treated as PFIC stock for purposes of the excess distribution rules, a QEF election with respect to a
shareholders shares will not apply to the shareholders options. If a shareholder that owns PFIC shares subject to a QEF election acquires additional shares pursuant to the exercise of an option, the additional shares will be subject to
the QEF election, but the election may be an unpedigreed QEF election with respect to those shares.

In general, a U.S.
shareholder makes a QEF election by attaching a completed Internal Revenue Service (IRS) Form 8621 to a timely filed (taking into account extensions) U.S. federal income tax return for the year beginning with which the QEF election is to
be effective. (A U.S. shareholder of a PFIC must file as directed by the Secretary of the Treasury an IRS Form 8621 annually regardless of whether or not it makes a QEF election.) In certain circumstances, a U.S. shareholder may be able to make a
retroactive QEF election. In order for a U.S. shareholder to make a valid QEF election, the corporation must annually provide or make available to the shareholder certain information. A QEF election can be revoked only with the consent of the IRS.
Metal Storm does not provide to U.S. holders the information required to make a valid QEF election, and makes no undertaking to provide such information in the future.

As an alternative to making a QEF election, a U.S. shareholder may make a mark-to-market election with respect to its PFIC shares if the shares meet certain minimum trading requirements. A
U.S. shareholder that makes a mark-to-market election will be required to include in income each year an amount equal to the excess of the fair market value of the shares that the shareholder owns as of the close of the taxable year over the
shareholders adjusted tax basis in the shares. The U.S. shareholder will be entitled to a deduction for the excess, if any, of the shareholders adjusted tax basis in the shares over the fair market value of the shares as of the close of
the taxable year; provided, however, that the deduction will be limited to the extent of any net mark-to-market gains with respect to the shares included by the U.S. shareholder under the election for prior taxable years. The U.S. shareholders
basis in the shares will be adjusted to reflect the amounts included or deducted pursuant to the election. Amounts included in income pursuant to a mark-to-market election, as well as gain on the sale or exchange of the shares, will be treated as
ordinary income. The deductible portion of any mark-to-market loss, as well as loss on a sale or exchange of shares to the extent that the amount of such loss does not exceed net mark-to-market gains previously included in income, will be treated as
ordinary loss.

The mark-to-market election applies to the taxable year for which the election is made and all subsequent
taxable years, unless the shares cease to meet applicable trading requirements or the IRS consents to its revocation. The excess distribution rules generally do not apply to a U.S. shareholder for tax years for which a mark-to-market election is in
effect. However, if a U.S. shareholder makes a mark-to-market election for PFIC stock after the beginning of the shareholders holding period for the stock, a coordination rule applies to ensure that the shareholder does not avoid the tax and
interest charge with respect to amounts attributable to periods before the election.

A mark-to-market election is available
to a U.S. holder only if the shares are considered marketable for these purposes. Shares will be considered marketable if they are regularly traded on certain U.S. stock exchanges or certain non-U.S. stock exchanges. For these purposes,
shares will be considered regularly traded during any calendar year during which they are traded, other than in negligible quantities, on at least 15 days during each calendar quarter. Any trades that have as their principal purpose, meeting these
requirements will be disregarded. It is not clear whether our ADSs or ordinary shares will meet the minimum trading requirements necessary to permit a U.S. holder to make a mark-to-market election with respect to them.

U.S. holders are urged to consult their tax advisors as to the effect on them of the PFIC rules and the desirability of making, and
the availability of, either a QEF election or a mark-to-market election with respect to our ADSs or ordinary shares. Metal Storm provides no advice on your taxation matters. The above should not be taken as advice by the reader of this document.



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Backup Withholding Tax and Information Reporting Requirements

U.S. backup withholding tax and information reporting requirements generally apply to payments to non-corporate holders of ADSs or
ordinary shares. Information reporting will apply to payments of dividends on, and to proceeds from the disposition of, ADSs or ordinary shares by a paying agent within the United States to a U.S. holder, other than an exempt recipient,
including a corporation and certain other persons that, when required, demonstrate their exempt status. A paying agent within the United States will be required to withhold at the applicable statutory rate, currently 28%, in respect of any payments
of dividends on, and the proceeds from the disposition of, ADSs or ordinary shares within the United States to a U.S. holder, other than an exempt recipient, if the holder fails to furnish its correct taxpayer identification number or
otherwise fails to comply with applicable backup withholding requirements. U.S. holders who are required to establish their exempt status generally must provide IRS Form W-9 (Request for Taxpayer Identification Number and Certification).

Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against a U.S. holders U.S.
federal income tax liability. A U.S. holder may obtain a refund of any amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the Internal Revenue Service in a timely manner and furnishing any required
information.

Under legislation signed into law on March 18, 2010, certain U.S. holders may be required to report
information with respect to such holders interest in specified foreign financial assets (as defined in Section 6038D of the Code), including stock of a non-U.S. corporation that is not held in an account maintained by a U.S.
financial institution, if the aggregate value of all such assets exceeds US$50,000. Persons who are required to report specified foreign financial assets and fail to do so may be subject to substantial penalties. U.S. holders are urged
to consult their own tax advisors regarding foreign financial asset reporting obligations and their possible application to the holding of our shares.

The discussion above is not intended to constitute a complete analysis of all tax considerations applicable to an investment in ADSs or ordinary shares. You should consult with your tax advisor
concerning the tax consequences to you in your particular situation.

Australian Tax Considerations

In this section we discuss the material Australian tax considerations related to the acquisition, ownership and disposal by the absolute
beneficial owners of ADSs which are evidenced by ADRs, or ordinary shares. This discussion is based upon existing Australian tax law as of the date of this annual report, which is subject to change, possibly retrospectively. This discussion does not
address all aspects of Australian income tax law which may be important to particular investors in light of their individual investment circumstances, such as ADSs or shares held by investors subject to special tax rules (for example, financial
institutions, insurance companies or tax exempt organizations). In addition, this summary does not discuss any foreign or state tax considerations, other than stamp duty. Prospective investors are urged to consult their tax advisors regarding the
Australian and foreign income and other tax considerations of the purchase, ownership and disposition of the ADSs or shares. This summary is based upon the premise that the holder is not an Australian tax resident.

Nature of ADRs for Australian Taxation Purposes

ADSs held by a U.S. holder will be treated for Australian taxation purposes as held under a bare trust for such holder. Consequently, the underlying ordinary shares will be regarded as owned
by the ADS holder for Australian income tax and capital gains tax purposes. Dividends paid on the underlying ordinary shares will also be treated as dividends paid to the ADS holder, as the person beneficially entitled to those dividends. Therefore,
in the following analysis we discuss the tax consequences to non-Australian resident holders of ordinary shares which, for Australian taxation purposes, will be the same as to U.S. holders of ADSs.

Taxation of Dividends

Australia operates a dividend imputation system under which dividends may be declared to be franked to the extent of tax paid on company profits. Fully franked dividends are not subject to
dividend withholding tax. Dividends payable by Metal Storm to non-Australian resident shareholders will be subject to dividend withholding tax, to the extent the dividends are unfranked. Dividend withholding tax will be imposed at 30%, unless a
shareholder is a resident of a country with which Australia has a double taxation agreement and qualifies for the benefit of that double tax agreement. Under the provisions of the current Double Taxation Convention between Australia and the United
States, the Australian tax withheld on unfranked dividends paid by us to which a resident of the United States is beneficially entitled is limited to 15%, unless the shares are effectively connected to a permanent establishment or fixed base in
Australia through which the shareholder carries on business or provides independent personal services, respectively.

If a
company that is a non-Australian resident shareholder owns a 10% or more interest, the Australian tax withheld on dividends paid by us to which a resident of the United States is beneficially entitled is limited to 5%.



48



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##### Table of Contents

Tax on Sales or other Dispositions of Shares  Capital gains tax

Non-Australian resident shareholders will not be subject to Australian capital gains tax on the gain made on a sale or
other disposal of our shares, unless they, together with associates, hold 10% or more of our issued capital at that time or throughout a 12 month period within the 24 months prior to disposal of the shares and more than 50% of our assets, by market
value, consist of Australian real property (which includes leaseholds interests) or mining, quarrying or prospecting rights located in Australia.

Australian capital gains tax applies to net capital gains at a taxpayers marginal tax rate but for certain shareholders a discount of the capital gain may apply if the shares have been held for 12
months or more prior to disposal. For individuals and trusts, this discount is 50%. Companies are not entitled to a capital gains tax discount. Net capital gains are calculated after reduction for capital losses, which may only be offset against
capital gains.

Tax on Sales or other Dispositions of Shares  Shareholders Holding Shares on Revenue Account

Some non-Australian resident shareholders may hold shares on revenue rather than on capital account, for example,
share traders. These shareholders may have the gains made on the sale or other disposal of the shares included in their assessable income under the ordinary income provisions of the income tax law, if the gains are sourced in Australia.

Non-Australian resident shareholders assessable under these ordinary income provisions in respect of gains made on shares held on revenue
account would be assessed for such gains at the Australian tax rates for non-Australian residents, which start at a marginal rate of 29%. Some relief from Australian income tax may be available to such non-Australian resident shareholders under the
Double Taxation Convention between the United States and Australia, for example, where the shareholder does not have a permanent establishment in Australia.

To the extent an amount would be included in a non-Australian resident shareholders assessable income under both the capital gains tax provisions and the ordinary income provisions, the capital gain
amount would generally be reduced, so that the shareholder would not be subject to double tax on any part of the income gain or capital gain.

Dual Residency

If a shareholder were a resident of both Australia
and the United States under those countries domestic taxation laws, that shareholder may be treated as an Australian resident for the purposes of the Double Taxation Convention between the United States and Australia. If, however, the
shareholder is determined to be a U.S. resident for the purposes of the Double Taxation Convention between the United States and Australia, the Australian tax would be subject to limitation by the Double Taxation Convention. Shareholders should
obtain specialist taxation advice in these circumstances.

Stamp Duty

A transfer of quoted shares in Metal Storm through trading on the ASX, whether by Australian residents or foreign residents, is not
subject to share transfer duty in any Australian jurisdiction. The acquisition, ownership and disposal by the absolute beneficial owners of ADSs should also not attract any Australian share transfer duty.

Australian Death Duty

Australia does not have estate or death duties. No capital gains tax liability is realized upon the inheritance of a deceased persons shares. The disposal of inherited shares by beneficiaries, may,
however, give rise to a capital gains tax liability.

Goods and Services Tax

The issue or transfer of shares or interests in ADSs will not incur Australian goods and services tax.

F. Dividends and Paying Agents

Not applicable.

G. Statements by Experts

Not applicable.



49



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##### Table of Contents

H. Documents on Display

We are subject to the periodic reporting and other informational requirements of the U.S. Securities Exchange Act of 1934 (Exchange Act). Under the Exchange Act, we are required to file
reports and other information with the SEC. Copies of reports and other information, when so filed, may be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the SEC at 100 F. Street,
N.E., Washington, D.C. 20549. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the SEC at 1-800-SEC-0330. The public may also view our annual reports and other documents filed with the SEC on the
internet at www.sec.gov. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and our officers, directors and principal shareholders
are exempt from the reporting and short-swing profit recovery provisions in Section 16 of the Exchange Act.

I. Subsidiary Information

Not applicable.

Item 11. Quantitative and Qualitative Disclosure about Market Risk

We invest excess cash in term deposits with financial institutions with investment grade credit ratings. Other than the conversion feature
in our convertible debt and convertible securities, we do not utilize derivative financial instruments, derivative commodity instruments, positions or transactions in any material manner. Accordingly, we believe that we are not subject to any
material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments. Since we do not invest in locations outside Australia, we
are not subject to cross-border risks, with the exceptions of risk set out immediately below.

We operate in Australia and the
United States and, as a result, are subject to certain foreign currency exposure. Historically, currency translation gains and losses have been reflected as adjustments to shareholders equity, while transaction gains and losses have been
reflected as components of income and loss. Transaction gains and losses could be material depending upon changes in the exchange rate relationships between the Australian dollar and the U.S. dollar. See Item 5A Operating and Financial
Review and Prospects  Operating Results  Effects of Currency Fluctuations above for a detailed description of the impact of foreign currency translation on our financial statements.

In addition, convertible notes and convertible securities issued by Metal Storm have embedded derivatives which are required to be fair
valued to market at each balance date. As such we are subject to fluctuations in our market price, interest rates and other market changes that affect market risk sensitive instruments.

See footnote 3 to our 2011 financial statements for further information.

Item 12. Description of Securities Other than Equity Securities

A. Debt Securities

Not applicable.

B. Warrants and Rights

Not applicable.

C. Other
Securities

Not applicable.

D. American Depositary Shares

The Bank of New York Mellon is the
depositary of our shares in accordance with the Deposit Agreement, dated July 31, 2000, as amended and restated as of December 12, 2001 and as further amended and restated as of March 24, 2008, among Metal Storm, The Bank of New York,
as depositary, and all owners and beneficial owners from time to time of ADSs (Deposit Agreement).



50



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##### Table of Contents

The depositary collects its fees for delivery and surrender of ADSs directly from investors
depositing shares or surrendering ADSs or from intermediaries acting for them. The depositary also collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable
property to pay the fees. Pursuant to the Deposit Agreement, holders of our ADSs may have to pay to The Bank of New York, either directly or indirectly, fees or charges up to the amounts set forth in the table below.



|                                                                                                                                                                                 |  |                   |  |                                                                                                                                                                         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Associated Fee                                                                                                                                                                   |  | Depositary Action
|$5.00 or less per 100 ADSs (or portion thereof)                                                                                                                                  |  |                  |  | Issuance of ADSs, including issuances resulting from a distribution of shares or rights or other property.                                                              
|                                                                                                                                                                                 |  |                  
|                                                                                                                                                                                 |  |                  |  | Cancellation of ADSs for the purpose of withdrawal, including in case of termination of the Deposit Agreement.                                                          
|                                                                                                                                                                                 |  |                  
|$.02 or less per ADS                                                                                                                                                             |  |                  |  | Any cash distribution to ADS registered holders made pursuant to the Deposit Agreement.                                                                                 
|                                                                                                                                                                                 |  |                  
|A fee equivalent to the fee that would be payable if securities distributed to you had been shares and the shares had been deposited for issuance of ADSs                        |  |                  |  | Distribution of securities distributed to holders of deposited securities which are distributed by the depositary to ADS registered holders.                            
|                                                                                                                                                                                 | 
|Taxes and other governmental charges                                                                                                                                             |  | As necessary     
|                                                                                                                                                                                 |  |                  
|Registration and transfer fees                                                                                                                                                   |  |                  |  | Transfer and registration of shares on our share register to or from the name of the depositary or its agent when you deposit or withdraw shares                        
|                                                                                                                                                                                 |  |                  
|A fee equivalent to the fee that would be payable for execution and delivery of ADSs as a result of the deposit of such securities, but which securities are instead
distributed |  |                  |  | Issuance of ADS or shares received in exercise of rights distributed, but whose securities or rights are instead sold by the depositary and the net proceeds
distributed
|                                                                                                                                                                                 | 
|Any charges incurred by the depositary or its agents for servicing the deposited securities                                                                                      |  | As necessary     
|                                                                                                                                                                                 |  |                  
|Expenses of the depositary                                                                                                                                                       |  |                  |  | Cable, telex and facsimile transmissions (when expressly provided in the deposit agreement)                                                                             
|                                                                                                                                                                                 |  |                  
|                                                                                                                                                                                 |  |                  |  | Expenses incurred converting foreign currency to U.S. dollars                                                                                                           

Subject to certain terms and conditions, the Bank of New York Mellon, has agreed to reimburse us for
certain expenses it incurs that are related to establishment and maintenance expenses of the ADR program, including the standard out-of-pocket maintenance costs for the ADSs, which consist of the expenses of postage and envelopes for mailing annual
and interim financial reports, printing and distributing dividend checks, electronic filing of U.S. Federal tax information, mailing required tax forms, stationery, postage, facsimile, and telephone calls. There are limits on the amount of expenses
for which the depositary will reimburse us, but the amount of reimbursement available to us is not necessarily tied to the amount of fees the depositary collects from investors.

PART II

Item 13. Defaults, Dividend Arrearages and Delinquencies

Not applicable.



51



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##### Table of Contents

Item 14. Material Modifications to the Rights of Security Holders and the
Use of Proceeds

Not applicable.

Item 15. Controls and Procedures

(a)
Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial
Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2011. Based upon this evaluation, our Chief Executive Officer
and Chief Financial Officer have concluded that the design and operation of our disclosure controls and procedures were effective as of that date.

Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports we file under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer, to allow timely discussions regarding required disclosure.

In designing and evaluating our disclosure controls and procedures, our management, including the Chief Executive Officer and
the Chief Financial Officer, recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Because of
the inherent limitations in all control systems, no evaluations of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Group have been detected.

(b) Managements Annual Report on Internal Control over Financial Reporting

The management of Metal Storm is responsible for establishing and maintaining adequate internal control over financial reporting (as
defined in Rule 13a-15(f) under the Exchange Act). Metal Storms internal control system is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with applicable accounting standards.

Metal Storms internal control over financial
reporting includes policies and procedures that:



| |  |  | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of its assets and its
consolidated entities;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of Metal Storm are being made only in accordance with authorizations of management and directors of Metal Storm and its consolidated entities; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the assets of Metal Storm and
its consolidated entities that could have a material effect on the financial statements.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Because of its
inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

With the
participation of Metal Storms Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of Metal Storms internal control over financial reporting based on the framework in Internal
Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

Based on
our evaluation, management has concluded that internal controls over financial reporting were effective as of December 31, 2011.

(c) Attestation Report of the Registered Public Accounting Firm

Not applicable.

(d) Changes in Internal Control over Financial Reporting



52



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##### Table of Contents

There have been no changes in our internal controls over financial reporting during the year
ended December 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Item 16A. Audit Committee Financial Expert

Mr. Trevor Tappenden is an audit committee financial expert (as defined in Item 16A of Form 20-F) and is
independent (as defined in the rules of The Nasdaq Stock Market Inc.). Please see Item 6A Directors, Senior Management and Employees  Directors and Senior Management for details of his background.

Item 16B. Code of Ethics

We have adopted a code of conduct to guide executives, management and employees in carrying out their duties and responsibilities. The code of conduct covers such matters as:



| |  |  | responsibilities to shareholders;
| | - |  | ---------------------------------



| |  |  | compliance with laws and regulations;
| | - |  | -------------------------------------



| |  |  | relations with customers and suppliers;
| | - |  | ---------------------------------------



| |  |  | ethical responsibilities;
| | - |  | -------------------------



| |  |  | employment practices; and
| | - |  | -------------------------



| |  |  | responsibilities to the environment and the community.
| | - |  | ------------------------------------------------------

We undertake to provide to any person without charge, upon request, a copy of our code of conduct. Please contact our Company Secretary
at 011- 61-7-3147-8600 to obtain a copy.

In 2011, we did not (expressly or implicitly) grant a waiver under our code of
conduct to our principal executive officer, our principal accounting officer or controller or persons performing similar functions.

Item 16C. Principal Accountant Fees and Services

PricewaterhouseCoopers



|                   |  |              |         |  |        |  |         |        |  |  |         | 
|------------------ |  | ------------ | ------- |  | ------ |  | ------- | ------ |  |  | ------- | 
|                   |  | December 31, |        
|                   |  | 2011A$       |         |  | 2010A$ |  |         | 2009A$ | 
|Audit fees         |  |              | 332,850 |  |        |  | 305,000 |        |  |  | 341,500 | 
|Audit related fees |  |              |        |  |        |  | 30,400  |        |  |  |        | 
|All other fees     |  |              |        |  |        |  |        |        |  |  | 69,000  | 
|                   |  |              |         |  |        |  |         |        |  |  |         | 
|Total              |  |              | 332,850 |  |        |  | 335,400 |        |  |  | 410,500 | 
|                   |  |              |         |  |        |  |         |        |  |  |         | 

Fees for audit services include fees associated with the annual audit of the consolidated financial
statements, including reviews of our half-year reports. Audit  related fees include review and consultation work and advice performed related to SEC compliance. All other fees principally include the performance of agreed-upon auditing
procedures.

The audit committee pre-approved the engagement of PricewaterhouseCoopers for all the services described in
Item 16C.

Item 16D. Exemptions from the Listing Standards for Audit Committees.

Not applicable.

Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers

Not applicable.



53



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##### Table of Contents

Item 16F. Changes in Registrants Certifying Accountant

Not applicable.

Item 16G. Corporate Governance

Not applicable.



54



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##### Table of Contents

PART III

Item 17. Financial Statements

The
financial statements are included as the F pages to this annual report.

Item 18. Financial
Statements

Not applicable.

Item 19. Exhibits



|               |  |                                                                                                                                                                                                     
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
Number |  | Description of Exhibit                                                                                                                                                                              
|               | 
|1.1            |  | Constitution of Metal Storm*                                                                                                                                                                        
|               | 
|4.1            |  | Convertible Notes Trust Deed, dated July 30, 2009****                                                                                                                                               
|               | 
|4.2            |  | GEM Equity Line Facility Agreement, dated December 30, 2009, among GEM Global Yield Fund Ltd, GEM Investment Advisors, Inc. and Metal Storm Limited ****                                            
|               | 
|4.3            |  | Line Agreement, dated June 22, 2010, between Dutchess Opportunity Fund II LP and Metal Storm Limited****                                                                                            
|               | 
|4.4            |  | DSTO Technology License Agreement dated April 20, 2001, as amended (portions omitted pursuant to a request for confidential treatment; non-public information has been filed with the
SEC)*         
|               | 
|4.5            |  | Employment Agreement of Dr. Lee Finniear**                                                                                                                                                          
|               | 
|4.6            |  | Letter of Offer to Peter D. Faulkner**                                                                                                                                                              
|               | 
|4.7            |  | Employment Agreement of Brett Farmer***                                                                                                                                                             
|               | 
|4.8            |  | Letter of Offer to George A. Orrison*****                                                                                                                                                           
|               | 
|4.9            |  | Subscription Agreement, dated April 8, 2011 between Andrew Doyle and Metal Storm Limited*****                                                                                                       
|               | 
|4.10           |  | Discretionary Share Option Scheme*                                                                                                                                                                  
|               | 
|4.11           |  | Loan Agreement, dated July 20, 2011, between Metal Storm Limited and Andrew Winston Doyle                                                                                                           
|               | 
|4.12           |  | Convertible Security Agreement , dated October 17, 2011, between Metal Storm Limited and Australian Special Opportunity Fund LP                                                                     
|               | 
|4.13           |  | Deed of Debt Forgiveness, dated November 3, 2011, between Metal Storm Limited and Australian Special Opportunity Fund LP                                                                            
|               | 
|4.14           |  | Convertible Security Subscription Agreement, dated December 2, 2011, between Metal Storm Limited and Andrew Doyle                                                                                   
|               | 
|4.15           |  | Second Amendment and Restatement of Convertible Security Agreement , dated December 24, 2011, between Metal Storm Limited and Australian Special Opportunity Fund LP                                
|               | 
|4.16           |  | Luxinvest Subscription Agreement, dated March 12, 2012, between Metal Storm Limited and Luxinvest Capital Advisors S.A.                                                                             
|               | 
|4.17           |  | Umbrella Deed  Secured Notes and Convertible Security, dated April 18, 2012, between Metal Storm Limited, Australian Special Opportunity Fund LP, Luxinvest Capital Advisors
S.A. and Hopgood Ganim



55



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##### Table of Contents

|     |  |                                                                                                                             
|---- |  | ----------------------------------------------------------------------------------------------------------------------------
|     | 
|8.0  |  | List of Subsidiaries of Metal Storm Limited                                                                                 
|     | 
|12.1 |  | Certification by the Chief Executive Officer of Metal Storm Limited in accordance with Section 302 of the Sarbanes-Oxley Act
|     | 
|12.2 |  | Certification by the Chief Financial Officer of Metal Storm Limited in accordance with Section 302 of the Sarbanes-Oxley Act
|     | 
|13.1 |  | Certification by the Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act                       
|     | 
|13.2 |  | Certification by the Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act                       



|* | Incorporated by reference from our Registration Statement on Form 20-F filed on December 12, 2001, File No. 000-31212.
|- | ----------------------------------------------------------------------------------------------------------------------

|** | Incorporated by reference from our annual report on Form 20-F filed on May 18, 2007.
|-- | ------------------------------------------------------------------------------------

|*** | Incorporated by reference from our annual report on Form 20-F filed on July 15, 2009.
|--- | -------------------------------------------------------------------------------------

|**** | Incorporated by reference from our annual report on Form 20-F filed on July 15, 2010.
|---- | -------------------------------------------------------------------------------------

|***** | Incorporated by reference from our annual report on Form 20-F filed on July 20, 2011.
|----- | -------------------------------------------------------------------------------------



56



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##### Table of Contents

Index to Financial Statements



|                                                        |  |  |     | 
|------------------------------------------------------- |  |  | --- | 
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM |  |  | F-2 | 
|                                                        | 
|CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME          |  |  | F-3 | 
|                                                        | 
|CONSOLIDATED STATEMENT OF FINANCIAL POSITION            |  |  | F-4 | 
|                                                        | 
|CONSOLIDATED STATEMENT OF CASH FLOW                     |  |  | F-5 | 
|                                                        | 
|CONSOLIDATED STATEMENT OF CHANGES IN EQUITY             |  |  | F-6 | 
|                                                        | 
|NOTES TO THE FINANCIAL STATEMENTS                       |  |  | F-7 | 



F - 1



---

##### Table of Contents

Report of Independent Registered Public Accounting firm

To the Board of Directors and Shareholders

In
our opinion, the accompanying consolidated statements of financial position and the related consolidated statements of comprehensive income, changes in equity and cash flows present fairly, in all material respects, the financial position of Metal
Storm Limited and its subsidiaries at 31 December 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended 31 December 2011 in conformity with International Financial Reporting Standards
as issued by the International Accounting Standards Board. 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 of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring
losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Managements plans in regard to these matters are also described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

/s/ PricewaterhouseCoopers

PricewaterhouseCoopers

Brisbane, Australia

May 15, 2012





PricewaterhouseCoopers, ABN 52
780 433 757

Riverside Centre, 123 Eagle Street, GPO BOX 150, BRISBANE QLD 4001

DX 77 Brisbane, Australia

T +61 7
3257 5000, F +61 7 3257 5999, www.pwc.com.au





F - 2



---

##### Table of Contents

Consolidated Statement of Comprehensive Income

For the year ended 31 December 2011



|                                                                                           |  |      |  |       |            |   |       |  |            |       |  |  |             |  
|------------------------------------------------------------------------------------------ |  | ---- |  | ----- | ---------- | - | ----- |  | ---------- | ----- |  |  | ----------- | -
|                                                                                           |  | Note |  | 2011$ |            |   | 2010$ |  |            | 2009$ | 
|                                                                                           |  |      |  |      
|Revenue                                                                                    |  | 6    |  |       | 1,318,082  |   |       |  | 3,345,016  |       |  |  | 1,112,481   |  
|                                                                                           |  |      |  |      
|Gain on extinguishment of debt                                                             |  |      |  |       |           |   |       |  |           |       |  |  | 2,467,609   |  
|Fair value movement in derivative                                                          |  | 15   |  |       | 1,867,873  |   |       |  | 407,041    |       |  |  | (224,611    | )
|Consumables used                                                                           |  |      |  |       | (33,212    | ) |       |  | (736,144   | )     |  |  | (154,960    | )
|Finance costs                                                                              |  | 7    |  |       | (2,761,748 | ) |       |  | (4,304,903 | )     |  |  | (5,749,555  | )
|Employee expenses                                                                          |  | 7    |  |       | (3,450,533 | ) |       |  | (4,237,269 | )     |  |  | (4,491,565  | )
|Professional fees                                                                          |  |      |  |       | (874,922   | ) |       |  | (991,581   | )     |  |  | (1,187,842  | )
|Research and development                                                                   |  |      |  |       | (476,014   | ) |       |  | (603,413   | )     |  |  | (976,994    | )
|Facilities and equipment                                                                   |  |      |  |       | (614,833   | ) |       |  | (465,073   | )     |  |  | (755,798    | )
|Administrative expenses                                                                    |  |      |  |       | (302,581   | ) |       |  | (480,752   | )     |  |  | (515,215    | )
|Public relations and compliance                                                            |  |      |  |       | (472,074   | ) |       |  | (563,762   | )     |  |  | (403,830    | )
|Travel expenses                                                                            |  |      |  |       | (82,630    | ) |       |  | (127,602   | )     |  |  | (246,809    | )
|Communication and technology                                                               |  |      |  |       | (106,674   | ) |       |  | (159,139   | )     |  |  | (234,022    | )
|Impairment of available-for-sale financial assets                                          |  |      |  |       |           |   |       |  |           |       |  |  | 75,000      |  
|Net foreign exchange differences                                                           |  |      |  |       | (43,952    | ) |       |  | (20,672    | )     |  |  | (21,553     | )
|                                                                                           |  |      |  |       |            |   |       |  |            |       |  |  |             |  
|Loss before Income tax                                                                     |  |      |  |       | (6,033,218 | ) |       |  | (8,938,253 | )     |  |  | (11,307,664 | )
|                                                                                           |  |      |  |      
|Income tax expense                                                                         |  | 8    |  |       |           |   |       |  |           |       |  |  |            |  
|                                                                                           |  |      |  |       |            |   |       |  |            |       |  |  |             |  
|                                                                                           |  |      |  |      
|Loss for the year                                                                          |  |      |  |       | (6,033,218 | ) |       |  | (8,938,253 | )     |  |  | (11,307,664 | )
|                                                                                           |  |      |  |       |            |   |       |  |            |       |  |  |             |  
|                                                                                           |  |      |  |      
|Other comprehensive income                                                                 |  |      |  |       |            |   |       |  |            |       |  |  |             |  
|-        Currency translation difference                                                   |  |      |  |       |           |   |       |  | 17,149     |       |  |  | 41,523      |  
|                                                                                           |  |      |  |       |            |   |       |  |            |       |  |  |             |  
|-        Other comprehensive income for the year                                           |  |      |  |       |           |   |       |  | 17,149     |       |  |  | 41,523      |  
|                                                                                           |  |      |  |       |            |   |       |  |            |       |  |  |             |  
|                                                                                           |  |      |  |      
|Total comprehensive income for the year                                                    |  |      |  |       | (6,033,218 | ) |       |  | (8,921,104 | )     |  |  | (11,266,141 | )
|Earnings per share (cents per share)                                                       |  |      |  |       |            |   |       |  |            |       |  |  |             |  
|-        Basic and diluted loss for the year attributable to ordinary owners of the
parent |  | 30   |  |       | (0.3       | ) |       |  | (0.6       | )     |  |  | (1.2        | )

The above consolidated statement of comprehensive income should be read in conjunction with the accompanying notes.



F - 3



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##### Table of Contents

Consolidated Statement of Financial Position

As at 31 December 2011



|                                          |  |      |  |       |              |   |       |  |              |  
|----------------------------------------- |  | ---- |  | ----- | ------------ | - | ----- |  | ------------ | -
|                                          |  | Note |  | 2011$ |              |   | 2010$ | 
|Assets                                    |  |      |  |       |              |   |       |  |              |  
|Current assets                            |  |      |  |       |              |   |       |  |              |  
|Cash and cash equivalents                 |  | 9    |  |       | 480,672      |   |       |  | 1,166,661    |  
|Trade and other receivables               |  | 10   |  |       | 236,998      |   |       |  | 555,866      |  
|                                          |  |      |  |       |              |   |       |  |              |  
|Total current assets                      |  |      |  |       | 717,670      |   |       |  | 1,722,527    |  
|                                          |  |      | 
|Non-current assets                        |  |      |  |       |              |   |       |  |              |  
|Other assets                              |  | 11   |  |       | 78,452       |   |       |  | 78,210       |  
|Property, plant and equipment             |  | 12   |  |       | 284,295      |   |       |  | 346,219      |  
|Intangible assets and goodwill            |  | 13   |  |       |             |   |       |  |             |  
|                                          |  |      |  |       |              |   |       |  |              |  
|Total non-current assets                  |  |      |  |       | 362,747      |   |       |  | 424,429      |  
|                                          |  |      | 
|Total assets                              |  |      |  |       | 1,080,417    |   |       |  | 2,146,956    |  
|                                          |  |      | 
|Liabilities                               |  |      |  |       |              |   |       |  |              |  
|Current liabilities                       |  |      |  |       |              |   |       |  |              |  
|Trade and other payables                  |  | 14   |  |       | 1,072,109    |   |       |  | 1,187,070    |  
|Conversion derivative                     |  | 15   |  |       | 18,867       |   |       |  | 1,888,067    |  
|Non-interest bearing loans and borrowings |  | 16   |  |       | 14,701,159   |   |       |  | 13,339,952   |  
|Interest-bearing loans and borrowings     |  | 17   |  |       | 4,364,860    |   |       |  | 4,198,777    |  
|Provisions                                |  | 18   |  |       |             |   |       |  | 22,475       |  
|                                          |  |      |  |       |              |   |       |  |              |  
|Total current liabilities                 |  |      |  |       | 20,156,995   |   |       |  | 20,636,341   |  
|                                          |  |      | 
|Non-current liabilities                   |  |      |  |       |              |   |       |  |              |  
|Convertible securities                    |  | 19   |  |       | 900,000      |   |       |  |             |  
|Other                                     |  |      |  |       | 15,109       |   |       |  |             |  
|                                          |  |      |  |       |              |   |       |  |              |  
|Total non-current liabilities             |  |      |  |       | 915,109      |   |       |  |             |  
|                                          |  |      | 
|Total liabilities                         |  |      |  |       | 21,072,104   |   |       |  | 20,636,341   |  
|                                          |  |      |  |       |              |   |       |  |              |  
|Net assets (liabilities)                  |  |      |  |       | (19,991,687  | ) |       |  | (18,489,385  | )
|                                          |  |      |  |       |              |   |       |  |              |  
|                                          |  |      | 
|Equity                                    |  |      |  |       |              |   |       |  |              |  
|Contributed equity                        |  | 20   |  |       | 81,926,463   |   |       |  | 77,683,753   |  
|Reserves                                  |  | 21   |  |       | 12,799,382   |   |       |  | 12,511,176   |  
|Accumulated losses                        |  | 22   |  |       | (114,717,532 | ) |       |  | (108,684,314 | )
|                                          |  |      |  |       |              |   |       |  |              |  
|Total equity (deficiency)                 |  |      |  |       | (19,991,687  | ) |       |  | (18,489,385  | )
|                                          |  |      |  |       |              |   |       |  |              |  

The above Consolidated Statement of Financial Position should be read in conjunction with the accompanying notes.



F - 4



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##### Table of Contents

Consolidated Statement of Cash Flow

For the year ended 31 December 2011



|                                                           |  |      |  |       |            |   |       |  |            |       |  |  |            |  
|---------------------------------------------------------- |  | ---- |  | ----- | ---------- | - | ----- |  | ---------- | ----- |  |  | ---------- | -
|                                                           |  | Note |  | 2011$ |            |   | 2010$ |  |            | 2009$ | 
|Cash Flows From Operating Activities                       |  |      |  |       |            |   |       |  |            |       |  |  |            |  
|Receipts from customers (inclusive of GST)                 |  |      |  |       | 766,087    |   |       |  | 2,550,535  |       |  |  | 1,576,199  |  
|Payments to suppliers and employees (inclusive of GST)     |  |      |  |       | (6,440,186 | ) |       |  | (8,888,703 | )     |  |  | (8,693,671 | )
|Interest and other costs of finance paid                   |  |      |  |       | (434,755   | ) |       |  | (479,722   | )     |  |  | (1,586,756 | )
|Research and development tax rebate                        |  | 6    |  |       | 765,672    |   |       |  | 628,290    |       |  |  |           |  
|                                                           |  |      |  |       |            |   |       |  |            |       |  |  |            |  
|Net cash outflow from operating activities                 |  | 29   |  |       | (5,343,182 | ) |       |  | (6,189,600 | )     |  |  | (8,704,228 | )
|                                                           |  |      |  |      
|Cash Flows From Investing Activities                       |  |      |  |       |            |   |       |  |            |       |  |  |            |  
|Purchase of property, plant and equipment                  |  |      |  |       | (87,637    | ) |       |  | (16,732    | )     |  |  | (77,426    | )
|Proceeds from the disposal of property plant and equipment |  |      |  |       | 30,040     |   |       |  |           |       |  |  |           |  
|Interest received                                          |  |      |  |       | 9,023      |   |       |  | 23,458     |       |  |  | 190,032    |  
|Proceeds from sale of available-for-sale financial assets  |  |      |  |       |           |   |       |  |           |       |  |  | 85,000     |  
|                                                           |  |      |  |       |            |   |       |  |            |       |  |  |            |  
|Net cash inflow/(outflow) from investing activities        |  |      |  |       | (48,574    | ) |       |  | 6,726      |       |  |  | 197,606    |  
|                                                           |  |      |  |      
|Cash Flows From Financing Activities                       |  |      |  |       |            |   |       |  |            |       |  |  |            |  
|Proceeds from issues of shares                             |  |      |  |       | 4,111,435  |   |       |  | 7,071,247  |       |  |  | 3,326,194  |  
|Share issue costs                                          |  |      |  |       | (76,412    | ) |       |  | (203,683   | )     |  |  | (160,701   | )
|Proceeds from issue of convertible securities              |  |      |  |       | 200,000    |   |       |  |           |       |  |  |           |  
|Proceeds from borrowings                                   |  |      |  |       | 1,233,128  |   |       |  | 884,024    |       |  |  | 426,714    |  
|Repayment of borrowings                                    |  |      |  |       | (763,128   | ) |       |  | (471,138   | )     |  |  | (2,543,542 | )
|                                                           |  |      |  |       |            |   |       |  |            |       |  |  |            |  
|Net cash inflow from financing activities                  |  |      |  |       | 4,705,023  |   |       |  | 7,280,450  |       |  |  | 1,048,665  |  
|                                                           |  |      |  |      
|Net movement in cash and cash equivalents                  |  |      |  |       | (686,733   | ) |       |  | 1,097,576  |       |  |  | (7,457,957 | )
|Net foreign exchange differences                           |  |      |  |       | 744        |   |       |  | 1,735      |       |  |  | (45,985    | )
|Cash and cash equivalents at beginning of period           |  |      |  |       | 1,166,661  |   |       |  | 67,350     |       |  |  | 7,571,292  |  
|                                                           |  |      |  |       |            |   |       |  |            |       |  |  |            |  
|Cash and cash equivalents at year end                      |  | 9    |  |       | 480,672    |   |       |  | 1,166,661  |       |  |  | 67,350     |  
|                                                           |  |      |  |       |            |   |       |  |            |       |  |  |            |  

The above Consolidated Statement of Cash Flow should be read in conjunction with the accompanying notes.



F - 5



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##### Table of Contents

Consolidated Statement of Changes in Equity

For the year ended 31 December 2011



|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|-------------------------------------------------------- |  | --------------- | ---------- | - | --------- |  | ---------- | ------------------ |  |  | ------------- | - |  |  | ----------- | -
|                                                         |  | Issued capital$ |            |   | Reserves$ |  |            | Accumulatedlosses$ |  |  | Total equity$ |  
|At 1 January 2009                                        |  |                 | 66,209,718 |   |           |  | 9,035,414  |                    |  |  | (88,438,397   | ) |  |  | (13,193,265 | )
|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|Loss for the year                                        |  |                 |           |   |           |  |           |                    |  |  | (11,307,664   | ) |  |  | (11,307,664 | )
|Other comprehensive income                               |  |                 |           |   |           |  | 41,523     |                    |  |  |              |   |  |  | 41,523      |  
|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|Total comprehensive income for the year                  |  |                 |           |   |           |  | 41,523     |                    |  |  | (11,307,664   | ) |  |  | (11,266,141 | )
|Transactions with the owners in their capacity as owners |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|Net increase in option and share reserves                |  |                 |           |   |           |  | 1,393,087  |                    |  |  |              |   |  |  | 1,393,087   |  
|Exercise of options                                      |  |                 | 1,294      |   |           |  |           |                    |  |  |              |   |  |  | 1,294       |  
|Conversion of notes                                      |  |                 | 662,772    |   |           |  |           |                    |  |  |              |   |  |  | 662,772     |  
|Issue of share capital                                   |  |                 | 3,361,950  |   |           |  |           |                    |  |  |              |   |  |  | 3,361,950   |  
|Share issue cost                                         |  |                 | (160,701   | ) |           |  |           |                    |  |  |              |   |  |  | (160,701    | )
|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|At 1 January 2010                                        |  |                 | 70,075,033 |   |           |  | 10,470,024 |                    |  |  | (99,746,061   | ) |  |  | (19,201,004 | )
|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|Loss for the year                                        |  |                 |           |   |           |  |           |                    |  |  | (8,938,253    | ) |  |  | (8,938,253  | )
|Other comprehensive income                               |  |                 |           |   |           |  | 17,149     |                    |  |  |              |   |  |  | 17,149      |  
|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|Total comprehensive income for the year                  |  |                 |           |   |           |  | 17,149     |                    |  |  | (8,938,253    | ) |  |  | (8,921,104  | )
|Transactions with the owners in their capacity as owners |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|Net increase in option and share reserves                |  |                 |           |   |           |  | 2,024,003  |                    |  |  |              |   |  |  | 2,024,003   |  
|Exercise of options                                      |  |                 | 55,541     |   |           |  |           |                    |  |  |              |   |  |  | 55,541      |  
|Conversion of notes                                      |  |                 | 342,790    |   |           |  |           |                    |  |  |              |   |  |  | 342,790     |  
|Issue of share capital                                   |  |                 | 7,260,692  |   |           |  |           |                    |  |  |              |   |  |  | 7,260,692   |  
|Share issue costs                                        |  |                 | (50,303    | ) |           |  |           |                    |  |  |              |   |  |  | (50,303     | )
|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|At 1 January 2011                                        |  |                 | 77,683,753 |   |           |  | 12,511,176 |                    |  |  | (108,684,314  | ) |  |  | (18,489,385 | )
|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|Loss for the year                                        |  |                 |           |   |           |  |           |                    |  |  | (6,033,218    | ) |  |  | (6,033,218  | )
|Other comprehensive income                               |  |                 |           |   |           |  |           |                    |  |  |              |   |  |  |            |  
|Total comprehensive income for the year                  |  |                 |           |   |           |  |           |                    |  |  | (6,033,218    | ) |  |  | (6,033,218  | )
|Transactions with the owners in their capacity as owners |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|Net increase in option and share reserves                |  |                 |           |   |           |  | 288,206    |                    |  |  |              |   |  |  | 288,206     |  
|Exercise of options                                      |  |                 | 7          |   |           |  |           |                    |  |  |              |   |  |  | 7           |  
|Conversion of notes                                      |  |                 | 14,054     |   |           |  |           |                    |  |  |              |   |  |  | 14,054      |  
|Issue of share capital                                   |  |                 | 4,305,061  |   |           |  |           |                    |  |  |              |   |  |  | 4,305,061   |  
|Share issue cost                                         |  |                 | (76,412    | ) |           |  |           |                    |  |  |              |   |  |  | (76,412     | )
|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  
|At 31 December 2011                                      |  |                 | 81,926,463 |   |           |  | 12,799,382 |                    |  |  | (114,717,532  | ) |  |  | (19,991,687 | )
|                                                         |  |                 |            |   |           |  |            |                    |  |  |               |   |  |  |             |  

The above Consolidated Statement of Changes in Equity should be read in conjunction with the accompanying notes.



F - 6



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##### Table of Contents

Notes to the financial statements

For the year ended 31 December 2011

Contents



|    |  |                                                                                      |  |  |    | 
|--- |  | ------------------------------------------------------------------------------------ |  |  | -- | 
|1.  |  | GOING CONCERN                                                                        |  |  | 8  | 
|    |  |                                                                                     
|2.  |  | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES                                           |  |  | 9  | 
|    |  |                                                                                     
|3.  |  | FINANCIAL RISK MANAGEMENT                                                            |  |  | 19 | 
|    |  |                                                                                     
|4.  |  | CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS                                         |  |  | 23 | 
|    |  |                                                                                     
|5.  |  | SEGMENT INFORMATION                                                                  |  |  | 24 | 
|    |  |                                                                                     
|6.  |  | REVENUE                                                                              |  |  | 26 | 
|    |  |                                                                                     
|7.  |  | EXPENSES                                                                             |  |  | 26 | 
|    |  |                                                                                     
|8.  |  | INCOME TAX                                                                           |  |  | 27 | 
|    |  |                                                                                     
|9.  |  | CURRENT ASSETS  CASH AND CASH EQUIVALENTS                                           |  |  | 28 | 
|    |  |                                                                                     
|10. |  | CURRENT ASSETS  TRADE AND OTHER RECEIVABLES                                         |  |  | 28 | 
|    |  |                                                                                     
|11. |  | NON-CURRENT ASSETS  OTHER ASSETS                                                    |  |  | 29 | 
|    |  |                                                                                     
|12. |  | NON-CURRENT ASSETS  PROPERTY, PLANT AND EQUIPMENT                                   |  |  | 29 | 
|    |  |                                                                                     
|13. |  | NON-CURRENT ASSETS  INTANGIBLE ASSETS AND GOODWILL                                  |  |  | 30 | 
|    |  |                                                                                     
|14. |  | CURRENT LIABILITIES  TRADE AND OTHER PAYABLES                                       |  |  | 30 | 
|    |  |                                                                                     
|15. |  | CURRENT LIABILITIES  CONVERSION DERIVATIVE                                          |  |  | 31 | 
|    |  |                                                                                     
|16. |  | CURRENT LIABILITIES  NON-INTEREST BEARING LOANS AND BORROWINGS                      |  |  | 31 | 
|    |  |                                                                                     
|17. |  | CURRENT LIABILITIES  INTEREST BEARING LOANS AND BORROWINGS                          |  |  | 32 | 
|    |  |                                                                                     
|18. |  | CURRENT LIABILITIES  PROVISIONS                                                     |  |  | 33 | 
|    |  |                                                                                     
|19. |  | NON-CURRENT LIABILITIES  CONVERTIBLE SECURITIES                                     |  |  | 33 | 
|    |  |                                                                                     
|20. |  | CONTRIBUTED EQUITY                                                                   |  |  | 34 | 
|    |  |                                                                                     
|21. |  | RESERVES                                                                             |  |  | 36 | 
|    |  |                                                                                     
|22. |  | ACCUMULATED LOSSES                                                                   |  |  | 38 | 
|    |  |                                                                                     
|23. |  | KEY MANAGEMENT PERSONNEL DISCLOSURES                                                 |  |  | 38 | 
|    |  |                                                                                     
|24. |  | REMUNERATION OF AUDITORS                                                             |  |  | 40 | 
|    |  |                                                                                     
|25. |  | COMMITMENTS                                                                          |  |  | 41 | 
|    |  |                                                                                     
|26. |  | RELATED PARTY TRANSACTIONS                                                           |  |  | 42 | 
|    |  |                                                                                     
|27. |  | SUBSIDIARIES                                                                         |  |  | 42 | 
|    |  |                                                                                     
|28. |  | EVENTS OCCURRING AFTER THE END OF THE REPORTING PERIOD                               |  |  | 42 | 
|    |  |                                                                                     
|29. |  | RECONCILIATION OF LOSS AFTER INCOME TAX TO NET CASH INFLOW FROM OPERATING
ACTIVITIES |  |  | 43 | 
|    |  |                                                                                     
|30. |  | EARNINGS PER SHARE                                                                   |  |  | 45 | 
|    |  |                                                                                     
|31. |  | SHARE-BASED PAYMENTS                                                                 |  |  | 45 | 
|    |  |                                                                                     
|32. |  | PARENT ENTITY DISCLOSURES                                                            |  |  | 46 | 



F - 7



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##### Table of Contents

|1. | Going concern
|-- | -------------

The financial statements
have been prepared on the basis of going concern which contemplates continuity of normal business activities and the realisation of assets and settlement of liabilities in the ordinary course of business.

Key financial data for the Group for the financial year ended 31 December 2011, 2010 and 2009 is disclosed below:



|                                           |  |       |             |   |       |  |             |       |  |  |             |  
|------------------------------------------ |  | ----- | ----------- | - | ----- |  | ----------- | ----- |  |  | ----------- | -
|                                           |  | 2011$ |             |   | 2010$ |  |             | 2009$ | 
|Cash at Bank                               |  |       | 480,672     |   |       |  | 1,166,661   |       |  |  | 67,350      |  
|Loss for the Year                          |  |       | (6,033,218  | ) |       |  | (8,938,253  | )     |  |  | (11,307,664 | )
|Net cash outflow from operating activities |  |       | (5,343,182  | ) |       |  | (6,189,600  | )     |  |  | (8,704,228  | )
|Net liabilities                            |  |       | (19,991,687 | ) |       |  | (18,489,385 | )     |  |  | (19,201,004 | )

Metal Storm relies on continually raising additional capital to fund its operations. Over the past 12 months more than
$4 million was received in exchange for shares and options. These funds were received through a Rights Issue to existing shareholders, various subscription agreements and an equity line of credit facility.

The equity line of credit facility (Line Agreement) is with Dutchess Opportunity Fund. The level of funding provided for by the Line Agreement is
variable which creates uncertainty over the cash inflows the Group may receive over the next 12 months. Funding is received under the Line Agreement in tranches as frequent as up to every 5 business days and each tranche can be up to
$200,000. The level of funding available under the Line Agreement includes the possibility of certain adjustment events. Adjustment events may reduce the level of funding received in a particular tranche by 1/5th for every day an adjustment event
occurs. Additionally, the level of funds likely to be provided under the Line Agreement may be less than the Groups historical cash requirements and managements forecasts for business operations. To date, the Line Agreement has been
supplemented by equity placements, however, the availability of such placements in the future is uncertain.

For some time the Company has
been seeking a substantial cornerstone investor. At present the Company is in negotiations with a number of parties with the objective of securing sufficient funds to enable the Group to continue operations and commercialise its technology. There is
no guarantee that these negotiations will be completed, provide sufficient funding or funding on terms acceptable to the Group.

The Group
also has agreements that impose a number of restrictions on the operations of the Company. A breach of any of these restrictions could trigger a significant cash payment that the Group may not be able to meet.

Therefore, there is substantial doubt with regards to the Groups ability to continue as a going concern and, therefore whether the Group will
realise its assets and settle its liabilities at amounts different from those stated in the financial statements.

In order to reduce or
eliminate this doubt and continue operating, the Group will continue to seek new or additional sources of funding. The Company has successfully conducted a number of small equity placements during 2011 and is actively working to secure a more
substantial capital investment. The Company entered into an equity subscription agreement with Luxinvest Capital Advisors S.A. for $350,000 on April 2, 2012. In addition the Company signed an equity subscription agreement with Luxinvest for a
further $4.3 million on April 18, 2012. On the same date the Company entered into an Unmbrella Deed whereby the Company will pay $1.7 million to the majority notholder to redeem $9 million of secured convertible notes and require the majority
noteholder to convert a further $1.4 million of secured convertible notes to shares. Under the terms of a debt forgiveness deed entered into in October 2011, a further $1.5 million of secured conververtible notes will be forgiven upon completion of
the umbrella deed. The umbrella deed and Luxinvest subscription agreement for $4.3 million are interdependent upon each other completing and are both subject to shareholder and noteholder approval. The conditions and the status of the conditions are
set out in Note 28. Whilst the deposit has yet to be made, the Directors believe that the Agreements will be completed as anticipated.

The
Directors have a responsibility to prepare the financial statements in accordance with accounting standards. IAS 1 requires entities to prepare financial statements on a going concern basis unless they intend to liquidate, cease trading or have no
alternative but to do so.

The Directors believe that the Group has reasonable prospects of securing sufficient funding to fund its operations
for the foreseeable future and as a consequence they have no intention to liquidate or cease trading. The Directors believe they have reasonable grounds to expect that they can raise additional capital in the timeframes required in order to meet
their debts as and when they fall due.

No adjustments have been made to the financial statements relating to the recoverability and
classification of the asset carrying amounts or classification of liabilities that might be necessary should the Group not continue as a going concern.



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|2. | Summary of significant accounting policies
|-- | ------------------------------------------

The principal accounting policies adopted in the preparation of the financial statements are set out below. These policies have been consistently applied
to all the years presented, unless otherwise stated. The financial statements are for the consolidated entity consisting of Metal Storm Limited and its subsidiaries. These consolidated financial statements have been approved for issue by the Board
of Directors on 2 April 2012.



|a. | Basis of preparation
|-- | --------------------

These general
purpose financial statements have been prepared in accordance with Australian Accounting Standards, other authoritative pronouncements of the Australian Accounting Standards Board, Urgent Issues Group Interpretations and the Corporations Act 2001.



| | i. | Compliance with IFRS
| | -- | --------------------

The consolidated
financial statements and notes of Metal Storm Limited also comply with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB).



| | ii. | Historical cost convention
| | --- | --------------------------

These
financial statements have been prepared under the historical cost convention, except for available-for-sale financial assets, which are at fair value through equity on the statement of financial position, and embedded derivative, which is at fair
value through profit and loss.



| | iii. | Critical accounting estimates
| | ---- | -----------------------------

The
preparation of financial statements in conformity with AIFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Groups accounting policies. The areas
involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the financial statements are disclosed in note 4.



|b. | Principles of consolidation
|-- | ---------------------------

The
consolidated financial statements incorporate the assets and liabilities of all subsidiaries of Metal Storm Limited as at 31 December 2011 and 2010 and the results of all subsidiaries for the years ended 31 December 2011, 2010 and 2009.
Metal Storm Limited and its subsidiaries together are referred to in these financial statements as the Group.

Subsidiaries are all those
entities (including special purpose entities) over which the Group has the power to govern the financial and operating policies. Subsidiaries are fully consolidated from the date on which control is transferred to the Group. They are de-consolidated
from the date that control ceases.

The purchase method of accounting is used to account for the acquisition of subsidiaries by the Group
(refer to note2 (j).

Intercompany transactions, balances and gains on transactions between Group companies are eliminated.
Losses are also eliminated unless the transaction provides evidence of the impairment of the asset transferred. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Group.

The Group applies a policy of treating transactions with minority interests as transaction with parties external to the Group. Disposals to
minority interests result in gains or losses for the Group that are recorded in the Statements of Comprehensive Income. Purchases from minority interests result in goodwill, being the difference any consideration paid and the relevant share acquired
of the carrying value of identifiable net assets of the subsidiary.



|c. | Segment reporting
|-- | -----------------

Operating segments are
reported in a manner consistent with the internal reporting provided to the chief operating decision maker. The chief operating decision maker, who is responsible for allocating resources and assessing performance of the operating segments, has been
identified as the Chief Executive Officer and Chief Financial Officer.



|d. | Foreign currency translation
|-- | ----------------------------



| | i. | Functional and presentation currency
| | -- | ------------------------------------

Items included in the financial statements for Metal Storm Limited and Metal Storm Inc are presented in their functional currencies, which is the
Australian Dollar. The functional currency is assessed at each reporting date.



| | ii. | Transactions and balances
| | --- | -------------------------

Foreign
currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at
year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognized in profit or loss.



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Translation differences on non-monetary financial assets and liabilities are reported as part of the fair
value gain or loss. Translation differences on non-monetary financial assets and liabilities such as equities held at fair value through profit or loss are recognized in profit or loss as part of the fair value gain or loss. Translation differences
on non-monetary financial assets such as equities classified as available-for-sale financial assets are included in the fair value reserve in equity.



| | iii. | Group companies
| | ---- | ---------------

The results and
financial position of all the Group entities (none of which has the currency of a hyperinflationary economy) that have a functional currency different from the presentation currency are translated into the presentation currency as follows:



| |  | assets and liabilities for each statement of financial position presented are translated at the closing rate at the date of that statement of financial
position;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | income and expenses for each Statement of Comprehensive Income are translated at average exchange rates (unless this is not a reasonable approximation
of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | all resulting exchange differences are recognized in other comprehensive income.
|- |  | --------------------------------------------------------------------------------



|e. | Revenue recognition
|-- | -------------------

Revenue is measured
at the fair value of the consideration received or receivable.

The Group recognises revenue when the amount of revenue can be reliably
measured, it is probable that future economic benefits will flow to the entity and specific criteria have been met for each of the Groups activities as described below. The amount of revenue is not considered to be reliably measurable until
all contingencies relating to the sale have been resolved. The Group bases its estimates on historical results, taking into consideration the type of customer, the type of transaction and the specifics of each arrangement.

Revenue is recognized for the major business activities as follows:



| | i. | Contract Revenue
| | -- | ----------------

Contract revenue and
expenses are recognized in accordance with the percentage of completion method unless the outcome of the contract cannot be reliably estimated. Where it is probable that a loss will arise from a contract the excess of total expected contract costs
over total expected contract revenue is recognized as an expense immediately.

Where the outcome of a contract cannot be reliably estimated,
contract costs are recognized as an expense when incurred, and where it is probable that the costs will be recovered, revenue is recognized to the extent of costs incurred.

Depending on the type of the contract, the stage of completion is measured by reference to labour hours incurred to date as a percentage of estimated total labour hours or by costs incurred to date as a
percentage of estimated total costs for each contract. Revenue from cost plus contracts is recognized by reference to the recoverable costs incurred during the reporting period plus the percentage of fees earned.

The percentage of fees earned is measured by the proportion that costs incurred to date bear to the estimated total costs of the contract.



| | ii. | Interest income
| | --- | ---------------

Interest income is
recognized on a time proportion basis using the effective interest method. When a receivable is impaired, the Group reduces the carrying amount to its recoverable amount, being the estimated future cash flow discounted at the original effective
interest rate of the instrument, and continues unwinding the discount as interest income. Interest income on impaired loans is recognized using the original effective interest rate.



| | iii. | Sale of goods
| | ---- | -------------

Revenue from the sale of
goods is recognized when a group entity sells a product to the customer. Sales are recorded based on the price specified in the sales contracts. Sales of goods are recognized when a group entity has delivered products to the customer. Delivery does
not occur until the products have been shipped to the specified location and the risks of ownership have been transferred to the customer.



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|f. | Government grants
|-- | -----------------

Grants from the
government, including Australian Research and Development Tax Rebates, are recognized at their fair value where there is a reasonable assurance that the grant will be received and the group will comply with all attached conditions.

Government grants relating to costs are recognized in the Statements of Comprehensive Income as revenue.

Government grants relating to the purchase of property, plant and equipment are included in non-current liabilities as deferred income and are credited
to the Statements of Comprehensive Income on a straight-line basis over the expected lives of the related assets.



|g. | Research and development
|-- | ------------------------

Research
expenditure is recognized as an expense as incurred. Costs incurred on development projects (relating to the design and testing of new or improved products) are recognized as intangible assets when it is probable that the project will, after
considering its commercial and technical feasibility, be completed and generate future economic benefits and its costs can be measured reliably. The expenditure capitalised comprises all directly attributable costs, including costs of materials,
services, direct labour and an appropriate proportion of overheads. Other development expenditures that do not meet these criteria are recognized as an expense as incurred. Development costs previously recognized as an expense are not recognized as
an asset in a subsequent period. Capitalised development costs are recorded as intangible assets and amortised from the point at which the asset is ready for use on a straight-line basis over its useful life.



|h. | Income tax
|-- | ----------

The income tax expense or
revenue for the period is the tax payable on the current periods taxable income based on the national income tax rate for each jurisdiction adjusted by changes in deferred tax assets and liabilities attributable to temporary differences and to
unused tax losses.

Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax
bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, the deferred income tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a
business combination that at the time of the transaction affects neither accounting nor taxable profit nor loss.

Deferred income tax is
determined using tax rates (and laws) that have been enacted or substantially enacted by the end of the reporting period and are expected to apply when the related deferred income tax asset is realised or the deferred income tax liability is
settled.

Deferred tax assets are recognized for deductible temporary differences and unused tax losses only if it is probable that future
taxable amounts will be available to utilise those temporary differences and losses.

Deferred tax liabilities and assets are not recognized
for temporary differences between the carrying amount and tax bases of investments in controlled entities where the Company is able to control the timing of the reversal of the temporary differences and it is probable that the differences will not
reverse in the foreseeable future.

Deferred tax assets and liabilities are offset when there is a legally enforceable right to offset current
tax assets and liabilities and when the deferred tax balances relate to the same taxation authority. Current tax assets and tax liabilities are offset where the entity has a legally enforceable right to offset and intends either to settle on a net
basis, or to realise the asset and settle the liability simultaneously.

Current and deferred tax is recognized in profit or loss, except to
the extent that it relates to items recognized in other comprehensive income or directly in equity. In this case, the tax is also recognized in other comprehensive income or directly in equity, respectively.



|i. | Leases
|-- | ------

Leases of property, plant and
equipment where the Group, as lessee, has substantially all the risks and rewards of ownership are classified as finance leases (note 25 (b)). Finance leases are capitalised at the leases inception at the fair value of the leased property or,
if lower, the present value of the minimum lease payments. The corresponding rental obligations, net of finance charges, are included in other short-term and long-term payables. Each lease payment is allocated between the liability and finance cost.
The finance cost is charged to the Statements of Comprehensive Income over the lease period so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period. The property, plant and equipment acquired
under finance leases is depreciated over the shorter of the assets useful life and the lease term.

Leases in which a significant
portion of the risks and rewards of ownership are not transferred to the Group as lessee are classified as operating leases (note 25 (a)). Payments made under operating leases (net of any incentives received from the lessor) are charged to the
Statements of Comprehensive Income on a straight-line basis over the period of the lease.



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|j. | Business combinations
|-- | ---------------------

The acquisition
method of accounting is used to account for all business combinations, regardless of whether equity instruments or other assets are acquired. The consideration transferred for the acquisition of a subsidiary comprises the fair values of the assets
transferred, the liabilities incurred and the equity interests issued by the group. The consideration transferred also includes the fair value of any asset or liability resulting from a contingent consideration arrangement and the fair value of any
pre-existing equity interest in the subsidiary. Acquisition-related costs are expensed as incurred.

Identifiable assets acquired and
liabilities and contingent liabilities assumed in a business combination are, with limited exceptions, measured initially at their fair values at the acquisition date. On an acquisition by acquisition basis, the group recognises any non-controlling
interest in the acquiree either at fair value or at the non-controlling interests proportionate share of the acquires net identifiable assets.

The excess of the consideration transferred and the amount of any non-controlling interest in the acquiree over the fair value of the net identifiable assets acquired is recorded as goodwill. If those
amounts are less than the fair value of the net identifiable assets of the subsidiary acquired and the measurement of all amounts has been reviewed, the difference is recognised directly in profit or loss as a bargain purchase.

Where settlement of any part of cash consideration is deferred, the amounts payable in the future are discounted to their present value as at the date of
exchange. The discount rate used is the entitys incremental borrowing rate, being the rate at which a similar borrowing could be obtained from an independent financier under comparable terms and conditions.

Contingent consideration is classified either as equity or a financial liability. Amounts classified as a financial liability are subsequently remeasured
to fair value with changes in fair value recognised in profit or loss.



|k. | Impairment of assets
|-- | --------------------

Goodwill and
intangible assets that have an indefinite useful life are not subject to amortisation and are tested annually for impairment or more frequently if events or changes in circumstances indicate that they might be impaired. Other assets are reviewed for
impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized for the amount by which the assets carrying amount exceeds its recoverable amount. The
recoverable amount is the higher of an assets fair value less costs to sell and value in use. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash inflows which are
largely independent of the cash inflows from other assets or groups of assets (cash-generating units). Non-financial assets other than goodwill that suffered impairment are reviewed for possible reversal of the impairment at the end of each
reporting period.



|l. | Cash and cash equivalents
|-- | -------------------------

For statement
of cash flows presentation purposes, cash and cash equivalents includes cash on hand, deposits held at call with financial institutions, other short-term, highly liquid investments with original maturities of three months or less that are readily
convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.



|m. | Trade receivables
|-- | -----------------

Trade receivables are
initially recognized at fair value and are stated net of any provisions for impairment. Trade receivables are generally due for settlement within 30 days.

Collectability of trade receivables is reviewed on an ongoing basis. Debts which are known to be uncollectible are written off. A provision for impairment of trade receivables is established when there is
objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables. Significant financial difficulties of the debtor, probability that the debtor will enter bankruptcy or financial
reorganisation, and default or delinquency in payments (more than 30 days overdue) are considered indicators that the trade receivable is impaired. The amount of the provision is the difference between the assets carrying amount and the
present value of estimated future cash flows, discounted at the original effective interest rate. Cash flows relating to short-term receivables are not discounted if the effect of discounting is immaterial. The amount of the provision is recognized
in the Statements of Comprehensive Income in administrative expenditure.

The carrying amount of the asset is reduced through the use of an
allowance account and the amount of the loss is recognized in the Statements of Comprehensive Income within administrative expenditure. When a trade receivable is uncollectible, it is written off against the allowance account for trade
receivables. Subsequent recoveries of amounts previously written off are credited against administrative expenditure in the Statements of Comprehensive Income.



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|n. | Investments and other financial assets
|-- | --------------------------------------



| | i. | Classification
| | -- | --------------

The Group classifies its
investments in the following categories: financial assets at fair value through profit or loss, loans and receivables, held-to-maturity investments and available-for-sale financial assets. The classification depends on the purpose for which the
investments were acquired. Management determines the classification of its investments at initial recognition and, in the case of assets classified as held-to-maturity, re-evaluates this designation at the end of each reporting period.



| |  |  | Financial assets at fair value through profit or loss
| | - |  | -----------------------------------------------------

Financial assets at fair value through profit or loss are financial assets held for trading. A financial asset is classified in this category if acquired principally for the purpose of selling in the
short term. Derivatives are classified as held for trading unless they are designated as hedges. Assets in this category are classified as current assets.



| |  |  | Loans and receivables
| | - |  | ---------------------

Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They are included
in current assets, except for those with maturities greater than 12 months after the end of the reporting period which are classified as non-current assets. Loans and receivables are included in trade and other receivables in the statement of
financial position (note 10).



| |  |  | Held-to-maturity investments
| | - |  | ----------------------------

Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Groups management has the positive intention and ability to hold to
maturity. If the Group were to sell other than an insignificant amount of held-to-maturity financial assets, the whole category would be tainted and reclassified as available-for-sale. Held-to-maturity financial assets are included in non-current
assets, except for those with maturities less than 12 months from the end of the reporting period, which are classified as current assets.



| |  |  | Available-for-sale investments
| | - |  | ------------------------------

Available-for-sale financial instruments are non-derivatives that are either designated in this category or not classified in any of the other categories. They are included in non-current assets unless
the investment matures or management intends to dispose of the investment within 12 months of the end of the reporting period. Investments are designated as available-for-sale if they do not have fixed maturities and fixed or determinable payments
and management intends to hold them for the medium to long term.



| | ii. | Recognition and derecognition
| | --- | -----------------------------

Regular
purchases and sales of financial assets are recognized on trade date  the date on which the Group commits to purchase or sell the asset. Investments are initially recognized at fair value plus transaction costs for all financial assets not
carried at fair value through profit or loss. Financial assets carried at fair value through profit or loss are initially recognized at fair value and transaction costs are expensed in the Statements of Comprehensive Income. Financial assets are
derecognized when the rights to receive cash flows from the financial assets have expired or have been transferred and the Group has transferred substantially all the risks and rewards of ownership.

When securities classified as available-for-sale are sold, the accumulated fair value adjustments recognized in equity are included in the Statements of
Comprehensive Income as gains and losses from investment securities.



| | iii. | Subsequent measurement
| | ---- | ----------------------

Loans and
receivables and held-to-maturity investments are carried at amortised cost using the effective interest method.

Available-for-sale financial
investments and financial assets at fair value through profit and loss are subsequently carried at fair value. Gains or losses arising from changes in the fair value of the financial assets at fair value through profit or loss category
are presented in the Statements of Comprehensive Income within other income or other expenses in the period in which they arise. Dividend income from financial assets at fair value through profit and loss is recognized in the Statements of
Comprehensive Income as part of revenue when the Groups right to receive payments is established.

Changes in the fair value of monetary
securities denominated in a foreign currency and classified as available-for-sale are analysed between translation differences resulting from changes in amortised cost of the security and other changes in the carrying amount of the security. The
translation differences related to changes in the amortised cost are recognized in profit or loss, and other changes in carrying amount are recognized in other comprehensive income. Changes in the fair value of other monetary and non-monetary
securities classified as available-for-sale are recognized in other comprehensive income.



| | iv. | Fair value
| | --- | ----------

The fair values of quoted
investments are based on current bid prices. If the market for a financial asset is not active (and for unlisted securities), the Group establishes fair value by using valuation techniques. These include the use of



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recent arms length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, and option pricing models making maximum use of market inputs
and relying as little as possible on entity-specific inputs.



| | v. | Impairment
| | -- | ----------

The Group assesses at the end
of each reporting period whether there is objective evidence that a financial asset or group of financial assets is impaired. In the case of financial instruments classified as available-for-sale, a significant or prolonged decline in the fair value
of a security below its cost is considered as an indicator that the securities are impaired. If any such evidence exists for available-for-sale financial assets, the cumulative loss  measured as the difference between the acquisition cost and
the current fair value, less any impairment loss on that financial asset previously recognized in profit or loss  is removed from equity and recognized in the Statements of Comprehensive Income. Impairment losses recognized in the Statements
of Comprehensive Income on instruments classified as available-for-sale are not reversed through the Statements of Comprehensive Income.



|o. | Derivatives
|-- | -----------

Derivatives are initially
recognized at fair value on the date a derivative contract is entered into and are subsequently remeasured to their fair value at the end of each reporting period.



|p. | Fair value estimation
|-- | ---------------------

The fair value of
financial assets and financial liabilities must be estimated for recognition and measurement or for disclosure purposes.

The fair value of
financial instruments traded in active markets (such as publicly traded derivatives, and trading and available-for-sale securities) is based on quoted market prices at the end of the reporting period. The quoted market price used for financial
assets held by the Group is the current bid price.

The fair value of financial instruments that are not traded in an active market (for
example, over-the-counter derivatives) is determined using valuation techniques. The Group uses a variety of methods and makes assumptions that are based on market conditions existing at the end of each reporting period. Quoted market prices or
dealer quotes for similar instruments are used for long-term debt instruments held.

The carrying value less impairment provision of trade
receivables and payables are assumed to approximate their fair values due to their short-term nature. The fair value of financial liabilities for disclosure purposes is estimated by discounting the future contractual cash flows at the current market
interest rate that is available to the Group for similar financial instruments.



|q. | Property, plant and equipment
|-- | -----------------------------

Property,
plant and equipment is stated at historical cost less accumulated depreciation. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Subsequent costs are included in the assets carrying amount or
recognized as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the cost of the item can be measured reliably. The carrying amount of the replaced part is
derecognized. All other repairs and maintenance are charged to the Statements of Comprehensive Income during the reporting period in which they are incurred.

Land is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate their cost or revalued amounts, net of their residual values, over their estimated useful
lives, as follows:



|                                  |  |              |  |                            |  |            
|--------------------------------- |  | ------------ |  | -------------------------- |  | -----------
|Machinery                         |  | 5 - 10 years |  | Leasehold improvements     |  | 5 years    
|Furniture, fittings and equipment |  | 2 - 5 years  |  | Leased plant and equipment |  | 1 - 5 years

The assets residual values and useful lives are reviewed, and adjusted if appropriate, at the end of each reporting
period.

An assets carrying amount is written down immediately to its recoverable amount if the assets carrying amount is greater
than its estimated recoverable amount (note 2 (k)).

Gains and losses on disposals are determined by comparing proceeds with carrying amount.
These are included in the Statements of Comprehensive Income. When revalued assets are sold, it is Group policy to transfer the amounts included in other reserves in respect of those assets to retained earnings.



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|r. | Intangible assets
|-- | -----------------



| | i. | Goodwill
| | -- | --------

Goodwill represents the excess
of the cost of an acquisition over the fair value of the Groups share of the net identifiable assets of the acquired subsidiary/associate at the date of acquisition. Goodwill on acquisitions of subsidiaries is included in intangible assets.
Goodwill on acquisitions of associates is included in investments in associates. Goodwill is not amortised. Instead, goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be
impaired, and is carried at cost less accumulated impairment losses. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold.

Goodwill is allocated to cash-generating units for the purpose of impairment testing. Each of those cash-generating units represents the Groups investment in each country of operation by each
reporting segment.



| | ii. | Software
| | --- | --------

Purchased computer software
licences are capitalised as intangible non-current assets where they have a useful economic life of more than one year. They are amortised on a straight line basis over the shorter of the term of the license and their useful economic life.
Impairment testing is carried out annually where an indicator of impairment exists.

Gains or losses arising from derecognition of an
intangible asset are measured as the difference between the net disposal proceeds and the carrying amount of the asset and are recognized in profit or loss when the asset is derecognized. No gains or losses arising from derecognition of intangible
assets were recognized in 2011 or 2010.



|s. | Trade and other payables
|-- | ------------------------

These amounts
represent liabilities for goods and services provided to the Group prior to the end of financial year which are unpaid. The amounts are unsecured and are usually paid within 30 days of recognition.



|t. | Convertible Securities
|-- | ----------------------

The Company
elects on a security by security basis to bifurcate embedded derivatives or fair value the entire security. Convertible securities issued in 2011 which convert into common shares of the Company at a variable conversion rate are hybrid financial
instruments. Rather than bifurcate the hybrid financial instrument into a host contract and embedded derivative, the Company has elected to classify the entire convertible security as a financial liability at fair value through profit or loss.
Convertible securities are initially recorded at fair value and subsequent changes in value are recognised through profit or loss. Transaction costs associated with redeemable preference shares recorded at fair value through the profit or loss are
immediately expensed. Refer to note 19 for further disclosure.



|u. | Borrowings
|-- | ----------

Borrowings are initially
recognized at fair value, net of transaction costs incurred. Borrowings are subsequently measured at amortised cost. Any difference between the proceeds (net of transaction costs) and the redemption amount is recognized in the Statements of
Comprehensive Income over the period of the borrowings using the effective interest method. Fees paid on the establishment of loan facilities, which are not an incremental cost relating to the actual draw-down of the facility, are recognized as
prepayments and amortised on a straight-line basis over the term of the facility.

Borrowings are removed from the statement of financial
position when the obligation specified in the contract is discharged, cancelled or expired. The difference between the carrying amount of a financial liability that has been extinguished or transferred to another party and the consideration paid,
including any non-cash assets transferred or liabilities assumed, is recognized in the profit and loss.

An exchange of an existing debt
instrument for a new instrument with the lender on substantially different terms is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. An assessment is made as to whether the
terms are substantially different considering qualitative and quantitative characteristics. For example, if the discounted present value calculated using the original effective interest rate of the cash flows under the new terms, including fees, is
at least 10 per cent different from the discounted present value of the remaining cash flows of the original financial liability, or if the qualitative assessment concludes that the nature and risk profile of the original financial liability is
materially different from that of the new financial liability based on the terms of the instruments including repayment terms, coupon terms and call options, the original financial liability is extinguished.

Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least 12 months
after the end of the reporting period.

Convertible notes are hybrid financial instruments, a note payable host contract and conversion
feature. The conversion feature has been separated from its host contract because the conversion derivative is not closely related to the loan host. The conversion feature is accounted for as a derivative liability because the feature could require
a variable number of shares to be issued upon conversion of each note.



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Upon initial recognition, the proceeds from issuance are first allocated to the fair value of the conversion
derivative. The remaining proceeds are allocated to the note payable host contract. Subsequently, the conversion derivative is measured at fair value with changes recognised through profit and loss and presented as fair value movement in derivative
in the statement of comprehensive income. The note payable host contract is subsequently measured at amortised cost.



|v. | Borrowing costs
|-- | ---------------

Borrowing costs incurred
for the construction of any qualifying asset are capitalised during the period of time that is required to complete and prepare the asset for its intended use or sale.

Other borrowing costs are expensed as incurred.



|w. | Provisions
|-- | ----------

Provisions for legal claims,
onerous lease and make good obligations are recognized when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation and the amount has
been reliably estimated. Provisions are not recognized for future operating losses. Where there are a number of similar obligations, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations
as a whole. A provision is recognized even if the likelihood of an outflow with respect to any one item included in the same class of obligations may be small.

Provisions are measured at the present value of managements best estimate of the expenditure required to settle the present obligation at the end of the reporting period. The discount rate used to
determine the present value reflects current market assessments of the time value of money and the risks specific to the liability. The increase in the provision due to the passage of time is recognized as interest expense.

Where the events and or items being provided for resolve themselves without the need to utilise the provision, the provision will be derecognized.



|x. | Employee benefits
|-- | -----------------



| | i. | Wages and salaries, annual leave and sick leave
| | -- | -----------------------------------------------

Liabilities for wages and salaries, including non-monetary benefits, annual leave and accumulating sick leave expected to be settled within 12 months of the end of the reporting period are recognized in
provisions in respect of employees services up to the end of the reporting period and are measured at the amounts expected to be paid when the liabilities are settled.



| | ii. | Long service leave
| | --- | ------------------

The liability for
long service leave is recognized in the provision for employee benefits and measured as the present value of expected future payments to be made in respect of services provided by employees up to the end of the reporting period using the projected
unit credit method. Consideration is given to expected future wage and salary levels, experience of employee departures and periods of service. Expected future payments are discounted using market yields at the end of the reporting period on
national government bonds with terms to maturity and currency that match, as closely as possible, the estimated future cash outflows.



| | iii. | Share-based payments
| | ---- | --------------------

Share-based
compensation benefits are provided to employees at the absolute discretion of the Board or via the Metal Storm Limited Employee Share Option Plan. Information relating to these schemes is set out in note 31.

The fair value of options or shares granted is recognized as an employee benefit expense with a corresponding increase in equity. The fair value is
measured at grant date and recognized over the period during which the employees become unconditionally entitled to the options.

The fair
value is determined based on grant date. For options, a Black-Scholes option pricing model is used that takes into account the exercise price, the term of the option, the impact of dilution, the share price at grant date and expected price
volatility of the underlying share, the expected dividend yield and the risk free interest rate for the term of the option.



| | iv. | Post employment benefits
| | --- | ------------------------

Superannuation
is paid in Australia at a rate of 9% on the employees gross wage. All 401k contributions are paid in the United States with matching contribution equal to 50% on the first 6% of the participants compensation.



| | v. | Bonus plans
| | -- | -----------

The group recognises a
provision where contractually obliged or where there is a past practice that has created a constructive obligation.



F - 16



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##### Table of Contents

|y. | Share-based payments
|-- | --------------------

Share-based
payments are recognized as expenses when the goods or services received in return for the share-based payment are received. Share-based payments are recognized as assets when the goods or services received in the transaction qualify for recognition
as assets.

Share-based payments are measured at the value of the goods or services received. Where the goods or services received cannot be
reliably measured the share-based payment is measured at fair value at grant date.



|z. | Contributed equity
|-- | ------------------

Ordinary shares are
classified as equity.

Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net
of tax, from the proceeds. Incremental costs directly attributable to the issue of new shares or options for the acquisition of a business are not included in the cost of the acquisition as part of the purchase consideration, they are expensed.



|aa. | Goods and services tax (GST)
|--- | ----------------------------

Revenues,
expenses and assets are recognized net of the amount of associated GST, unless the GST incurred is not recoverable from the taxation authority. In this case it is recognized as part of the cost of acquisition of the asset or as part of the expense.

Receivables and payables are stated inclusive of the amount of GST receivable or payable. The net amount of GST recoverable from, or payable
to, the taxation authority is included with other receivables or payables in the statement of financial position.

Cash flows are presented on
a gross basis. The GST components of cash flows arising from investing or financing activities which are recoverable from, or payable to the taxation authority, are presented as operating cash flow.



|bb. | Earnings per share
|--- | ------------------



| | i. | Basic earnings per share
| | -- | ------------------------

Basic earnings
per share is calculated by dividing the profit attributable to owners of the Company, excluding any costs of servicing equity other than ordinary shares, by the weighted average number of ordinary shares outstanding during the financial year.



| | ii. | Diluted earnings per shares
| | --- | ---------------------------

Diluted
earnings per share adjusts the figures used in determination of basic earnings per share to take into account the after income tax effect of interest and other financing costs associated with dilutive potential ordinary shares and the weighted
average number of additional ordinary shares that would have been outstanding assuming the conversion of all dilutive potential ordinary shares.



|cc. | Parent entity financial information
|--- | -----------------------------------

The
financial information for the parent entity, Metal Storm Limited, disclosed in note 32 has been prepared on the same basis as the consolidated financial statements, except as set out below.



| | i. | Investments in subsidiaries
| | -- | ---------------------------

Investments
in subsidiaries are accounted for at cost in the financial statements of Metal Storm Limited. Dividends received from associates are recognized in the parent entitys profit or loss, rather than being deducted from the carrying amount of these
investments.



|dd. | New accounting standards and interpretations
|--- | --------------------------------------------

Certain new Australian accounting standards have been published that are not mandatory for 31 December 2011 reporting periods. The Groups assessment of the impact of these new Australian
accounting standards is set out below.



| | i. | Revised IFRS 9 Financial Instruments (addressing accounting for financial liabilities and the derecognition of financial assets and financial liabilities) (effective
for annual reporting periods beginning on or after 1 January 2013)
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

IFRS 9 Financial Instruments addresses the
classification, measurement and derecognition of financial assets and financial liabilities. The standard is not applicable until 1 January 2013 but is available for early adoption. There will be no impact on the Groups accounting for
financial instruments.

The derecognition rules have been transferred from IAS 39 Financial Instruments: Recognition and Measurement and have
not been changed. The group has not yet decided when to adopt IFRS 9.



F - 17



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##### Table of Contents

| | ii. | IFRS 13 Fair Value Measurement (effective 1 January 2013)
| | --- | ---------------------------------------------------------

IFRS 13 was released in September 2011. It explains how to measure fair value and aims to enhance fair value disclosures. The group has yet to determine which, if any, of its current measurement
techniques will have to change as a result of the new guidance. It is therefore not possible to state the impact, if any, of the new rules on any of the amounts recognized in the financial statements. However, application of the new standard will
impact the type of information disclosed in the notes to the financial statements. The group does not intend to adopt the new standard before its operative date, which means that it would be first applied in the annual reporting period ending
31 December 2014.



| | iii. | IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IFRS 12 Disclosure of Interests in Other Entities, IAS 28 Investments in Associates and Joint
Ventures (effective 1 January 2013)
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In August 2011, the IASB issued a suite of five new and amended standards which
address the accounting for joint arrangements, consolidated financial statements and associated disclosures.

IFRS 10 replaces all of the
guidance on control and consolidation in IAS 27 Consolidated and Separate Financial Statements, and IFRIC 12 Consolidation  Special Purpose Entities. The core principle that a consolidated entity presents a parent and its subsidiaries as if
they are a single economic entity remains unchanged, as do the mechanics of consolidation. However the standard introduces a single definition of control that applies to all entities. It focuses on the need to have both power and rights or exposure
to variable returns before control is present.

Power is the current ability to direct the activities that significantly influence returns.
Returns must vary and can be positive, negative or both.

There is also new guidance on participating and protective rights and on
agent/principal relationships. While the group does not expect the new standard to have a significant impact on its composition, it has yet to perform a detailed analysis of the new guidance in the context of its various investees that may or may
not be controlled under the new rules.

IFRS 11 introduces a principles based approach to accounting for joint arrangements. The focus is no
longer on the legal structure of joint arrangements, but rather on how rights and obligations are shared by the parties to the joint arrangement. Based on the assessment of rights and obligations, a joint arrangement will be classified as either a
joint operation or joint venture. Joint ventures are accounted for using the equity method, and the choice to proportionately consolidate will no longer be permitted. Parties to a joint operation will account their share of revenues, expenses,
assets and liabilities in much the same way as under the previous standard. IFRS 11 also provides guidance for parties that participate in joint arrangements but do not share joint control. As the group is not party to any joint arrangements, this
standard will not have any impact on its financial statements.

IFRS 12 sets out the required disclosures for entities reporting under the two
new standards, IFRS 10 and IFRS 11, and replaces the disclosure requirements currently found in IAS 28. Application of this standard by the group will not affect any of the amounts recognised in the financial statements, but will impact the type of
information disclosed in relation to the groups investments.

Amendments to IAS 28 provide clarification that an entity continues to
apply the equity method and does not remeasure its retained interest as part of ownership changes where a joint venture becomes an associate, and vice versa. The amendments also introduce a partial disposal concept. The group is still
assessing the impact of these amendments.

The group does not expect to adopt the new standards before their operative date. They would
therefore be first applied in the financial statements for the annual reporting period ending 31 December 2014.



F - 18



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##### Table of Contents

|3. | Financial risk management
|-- | -------------------------

The
Groups activities expose it to a variety of financial risks: market risk, credit risk and liquidity risk. The Groups overall risk management program focuses on the unpredictability of financial markets and seeks to minimise potential
adverse effects on the financial performance of the Group.

The Groups principal financial instruments comprise cash, short-term
deposits, finance leases, convertible notes and related embedded derivatives. It is, and has been throughout the period under review, the Companys policy that no trading in financial instruments shall be undertaken.



|a. | Market risk
|-- | -----------



| | i. | Foreign exchange risk
| | -- | ---------------------

The Group operates
internationally and is exposed to foreign exchange risk arising from various currency exposures, primarily with respect to the US dollar.

The
Groups objective is to minimise the exposure to fluctuations in the foreign exchange rate on the Groups monetary assets and liabilities. It is the Groups policy to maintain minimum operating cash balances denominated in foreign
currencies. Where practicable the Group will denominate its loans and receivables in Australian dollars.

At the end of the reporting period
the Group had cash balances equivalent to $9,771 (2010: $101,886), receivables equivalent to $22,039 (2010: $235,926) and payables equivalent $47,357 (2010: $265,595,) denominated in foreign currencies.

At the end of the reporting period had the Australian dollar been weaker/stronger by 10% against the US dollar with all other variables remaining
constant, the Groups net loss and equity would have been lower/higher by $1,582 (2010: $7,107).



| | ii. | Fair value interest rate risk
| | --- | -----------------------------

The Group
has interest bearing assets and liabilities which exposes it to interest rate risk. The Groups objective is to minimise its exposure to interest rate risk. It is the Groups policy to invest surplus funds in the short term market and source
funds at fixed interest rates wherever possible.

At the end of the reporting period the Group held deposits with a face value of $590,422
(2010: $1,273,769) and interest bearing loans of $4,352,266 (2010: $4,198,551).

All interest bearing deposits are at market rates current at
the time of the deposit and have the interest rate revised periodically every 1 to 3 months. All interest bearing loans are at fixed rates.

During 2011, had interest rates risen/fallen proportionately by 10% on their actual 2011 levels with all other variables remaining constant, the
Groups net loss and equity would have been higher/lower by $902 (2010: $2,346).



|                                                                                      |  |                            |             |   |                            |  |             |  
|------------------------------------------------------------------------------------- |  | -------------------------- | ----------- | - | -------------------------- |  | ----------- | -
|Sensitivity of loss to market risk (2011)                                             |  | Increase inGroupLoss       |             |   | Decrease inGroupLoss       | 
|                                                                                      |  | $                          |             |   | $                          | 
|Risk Factor                                                                           |  |                            |             |   |                            |  |             |  
|2011 actual loss                                                                      |  |                            | (6,033,218  | ) |                            |  | (6,033,218  | )
|(i) Australian Dollar stronger/(weaker) by 10% against the US Dollar                  |  |                            | (1,582      | ) |                            |  | 1,582       |  
|(ii) Interest rate increase/(decrease) by 10%                                         |  |                            | (902        | ) |                            |  | 902         |  
|                                                                                      |  |                            |             |   |                            |  |             |  
|2011 loss after adjusting for market risk sensitivity factors                         |  |                            | (6,035,702  | ) |                            |  | (6,030,734  | )
|                                                                                      |  |                            |             |   |                            |  |             |  
|                                                                                      |  |                           
|Sensitivity of shareholders deficiency to market risk (2011)                          |  | Increase inGroupDeficiency |             |   | Decrease inGroupDeficiency | 
|                                                                                      |  | $                          |             |   | $                          | 
|Risk Factor                                                                           |  |                            |             |   |                            |  |             |  
|2011 actual shareholders deficiency                                                   |  |                            | (19,991,687 | ) |                            |  | (19,991,687 | )
|(i) Australian Dollar stronger/(weaker) by 10% against the US Dollar                  |  |                            | (1,582      | ) |                            |  | 1,582       |  
|(ii) Interest rate increase/(decrease) by 10%                                         |  |                            | (902        | ) |                            |  | 902         |  
|                                                                                      |  |                            |             |   |                            |  |             |  
|2011 total shareholder deficiency after adjusting for market risk sensitivity factors |  |                            | (19,994,171 | ) |                            |  | (19,989,203 | )
|                                                                                      |  |                            |             |   |                            |  |             |  



F - 19



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##### Table of Contents

|                                                                                      |  |                            |             |   |                            |  |             |  
|------------------------------------------------------------------------------------- |  | -------------------------- | ----------- | - | -------------------------- |  | ----------- | -
|Sensitivity of loss to market risk (2010)                                             |  | Increase inGroupLoss       |             |   | Decrease inGroupLoss       | 
|                                                                                      |  | $                          |             |   | $                          | 
|Risk Factor                                                                           |  |                            |             |   |                            |  |             |  
|2010 actual loss                                                                      |  |                            | (8,938,253  | ) |                            |  | (8,938,253  | )
|(i) Australian Dollar stronger/(weaker) by 10% against the US Dollar                  |  |                            | (7,107      | ) |                            |  | 7,107       |  
|(ii) Interest rate increase/(decrease) by 10%                                         |  |                            | (2,346      | ) |                            |  | 2,346       |  
|                                                                                      |  |                            |             |   |                            |  |             |  
|2010 loss after adjusting for market risk sensitivity factors                         |  |                            | (8,947,706  | ) |                            |  | (8,928,800  | )
|                                                                                      |  |                            |             |   |                            |  |             |  
|                                                                                      |  |                           
|Sensitivity of shareholders deficiency to market risk (2010)                          |  | Increase inGroupDeficiency |             |   | Decrease inGroupDeficiency | 
|                                                                                      |  | $                          |             |   | $                          | 
|Risk Factor                                                                           |  |                            |             |   |                            |  |             |  
|2010 actual shareholders deficiency                                                   |  |                            | (18,489,385 | ) |                            |  | (18,489,385 | )
|(i) Australian Dollar stronger/(weaker) by 10% against the US Dollar                  |  |                            | (7,107      | ) |                            |  | 7,107       |  
|(ii) Interest rate increase/(decrease) by 10%                                         |  |                            | (2,346      | ) |                            |  | 2,346       |  
|                                                                                      |  |                            |             |   |                            |  |             |  
|2010 total shareholder deficiency after adjusting for market risk sensitivity factors |  |                            | (18,498,838 | ) |                            |  | (18,479,932 | )
|                                                                                      |  |                            |             |   |                            |  |             |  



|b. | Credit risk
|-- | -----------

Credit risk is managed on a
Group basis. Credit risk arises from deposits with banks and financial institutions as well as credit exposure to customers, including outstanding receivables and committed transactions.

At the end of the reporting period the Group had deposits of $590,568 (2010: $1,273,769) and receivables of $210,264 (2010: $524,394).

Credit risk on deposits is limited to the carrying value. The majority of the Groups funds are held by the Company in deposits with Australian Financial Institutions with investment grade credit
ratings.

Customers are assessed individually on the credit quality of the customer, taking into account its financial position, past
experience and other factors. At 31 December 2011 no debtors were outside the credit terms.



F - 20



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##### Table of Contents

|c. | Liquidity risk
|-- | --------------

The Group has a number of
short term payment commitments that present a liquidity risk. The Group has procedures in place that forecast cash requirements and age deposit maturity dates to correlate to cash out flow obligations. It is the Groups policy to maintain
flexibility in its investment decisions to enable it to close out positions as needed and meet credit requirements. Refer Note 1.

Management
reviews cash flow forecasts in light of the operating requirements of the Group and its obligations under the Convertible Note terms.

The
following contractual maturity analysis of financial liabilities has the value of each liability presented as undiscounted.



|                    |  |                         |         |  |                                                   |  |            |                                                 |  |  |                                                |  |  |                         |       |  |                 |  |            |  |  |  |            | 
|------------------- |  | ----------------------- | ------- |  | ------------------------------------------------- |  | ---------- | ----------------------------------------------- |  |  | ---------------------------------------------- |  |  | ----------------------- | ----- |  | --------------- |  | ---------- |  |  |  | ---------- | 
|Financial liability |  | Not laterthan
onemonth$ |         |  | Later thanone monthand not laterthan threemonths$ |  |            | Later thanthreemonths andnot laterthan oneyear$ |  |  | Later thanone
yearand not laterthan
fiveyears$ |  |  | TotalContractCashFlows$ |       |  | CarryingAmount$ | 
|Group  2011        |  |                         |         |  |                                                   |  |            |                                                 |  |  |                                                |  |  |                         |       |  |                 |  |            |  |  |  |            | 
|Payables            |  |                         | 274,736 |  |                                                   |  | 45,411     |                                                 |  |  |                                               |  |  |                         |      |  |                 |  | 320,147    |  |  |  | 320,147    | 
|Finance Leases      |  |                         | 341     |  |                                                   |  | 683        |                                                 |  |  | 2,389                                          |  |  |                         |      |  |                 |  | 3,413      |  |  |  | 662        | 
|Convertible Notes   |  |                         |        |  |                                                   |  | 18,866,897 | 1                                               |  |  |                                               |  |  |                         |      |  |                 |  | 18,866,897 |  |  |  | 18,850,509 | 
|Loan                |  |                         |        |  |                                                   |  | 214,848    |                                                 |  |  |                                               |  |  |                         |      |  |                 |  | 214,848    |  |  |  | 214,848    | 
|                    |  |                         |         |  |                                                   |  |            |                                                 |  |  |                                                |  |  |                         |       |  |                 |  |            |  |  |  |            | 
|Total               |  |                         | 275,077 |  |                                                   |  | 19,127,839 |                                                 |  |  | 2,389                                          |  |  |                         |      |  |                 |  | 19,405,305 |  |  |  | 19,386,166 | 
|                    |  |                         |         |  |                                                   |  |            |                                                 |  |  |                                                |  |  |                         |       |  |                 |  |            |  |  |  |            | 
|Group  2010        |  |                         |         |  |                                                   |  |            |                                                 |  |  |                                                |  |  |                         |       |  |                 |  |            |  |  |  |            | 
|Payables            |  |                         | 187,238 |  |                                                   |  | 122,337    |                                                 |  |  |                                               |  |  |                         |      |  |                 |  | 309,575    |  |  |  | 309,575    | 
|Finance Leases      |  |                         | 353     |  |                                                   |  | 706        |                                                 |  |  | 3,176                                          |  |  |                         | 3,417 |  |                 |  | 7,652      |  |  |  | 226        | 
|Convertible Notes   |  |                         |        |  |                                                   |  |           |                                                 |  |  | 18,880,675                                     |  |  |                         |      |  |                 |  | 18,880,675 |  |  |  | 17,323,655 | 
|Loan                |  |                         |        |  |                                                   |  | 214,848    |                                                 |  |  |                                               |  |  |                         |      |  |                 |  | 214,848    |  |  |  | 214,848    | 
|                    |  |                         |         |  |                                                   |  |            |                                                 |  |  |                                                |  |  |                         |       |  |                 |  |            |  |  |  |            | 
|Total               |  |                         | 187,591 |  |                                                   |  | 337,891    |                                                 |  |  | 18,883,851                                     |  |  |                         | 3,417 |  |                 |  | 19,412,750 |  |  |  | 17,848,304 | 
|                    |  |                         |         |  |                                                   |  |            |                                                 |  |  |                                                |  |  |                         |       |  |                 |  |            |  |  |  |            | 



|d. | Fair value estimation
|-- | ---------------------

The fair value of
financial assets and financial liabilities must be estimated for recognition and measurement or for disclosure purposes.

As of 1 January
2009 the Group has adopted the amendments to IFRS 7 Financial Instruments: Disclosures which requires disclosure of fair value measurements by level of the following fair value measurement hierarchy:



| | a) | Quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1);
| | -- | -------------------------------------------------------------------------------------------



| | b) | Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices)
(Level 2); and
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) | Inputs for the asset or liability that are not based on observable market data (unobservable inputs) (Level 3).
| | -- | ---------------------------------------------------------------------------------------------------------------

The following table presents the Groups assets and liabilities measured and recognized at fair value at 31 December 2011.



|1 | Terms of convertible notes have been extended (refer note 28)
|- | -------------------------------------------------------------



F - 21



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##### Table of Contents

2011



|                       |  |           |   |  |           |  |   |           |  |  |         |  |  |  |         | 
|---------------------- |  | --------- | - |  | --------- |  | - | --------- |  |  | ------- |  |  |  | ------- | 
|Liabilities            |  | Level 1 $ |   |  | Level 2 $ |  |   | Level 3 $ |  |  | Total $ | 
|Conversion derivative  |  |           |  |  |           |  |  |           |  |  | 18,867  |  |  |  | 18,867  | 
|Convertible securities |  |           |  |  |           |  |  |           |  |  | 900,000 |  |  |  | 900,000 | 
|                       |  |           |   |  |           |  |   |           |  |  |         |  |  |  |         | 
|Total Liabilities      |  |           |  |  |           |  |  |           |  |  | 918,867 |  |  |  | 918,867 | 
|                       |  |           |   |  |           |  |   |           |  |  |         |  |  |  |         | 

2010



|                      |  |           |   |  |           |  |   |           |  |  |           |  |  |  |           | 
|--------------------- |  | --------- | - |  | --------- |  | - | --------- |  |  | --------- |  |  |  | --------- | 
|Liabilities           |  | Level 1
$ |   |  | Level 2
$ |  |   | Level 3
$ |  |  | Total $   | 
|Conversion derivative |  |           |  |  |           |  |  |           |  |  | 1,888,067 |  |  |  | 1,888,067 | 
|                      |  |           |   |  |           |  |   |           |  |  |           |  |  |  |           | 
|Total Liabilities     |  |           |  |  |           |  |  |           |  |  | 1,888,067 |  |  |  | 1,888,067 | 
|                      |  |           |   |  |           |  |   |           |  |  |           |  |  |  |           | 

The fair value of financial instruments traded in active markets (such as publicly traded derivatives, and trading and
available-for-sale securities) is based on quoted market prices at the end of the reporting period. The quoted market price used for financial assets held by the group is the current bid price. These instruments are included in level 1. The fair
value of financial instruments that are not traded in an active market (for example, over-the-counter derivatives) is determined using valuation techniques. The group uses a variety of methods and makes assumptions that are based on market
conditions existing at the end of each reporting period. Quoted market prices or dealer quotes for similar instruments are used to estimate fair value for long-term debt for disclosure purposes for debt that is carried at fair value. Other
techniques, such as estimated discounted cash flows, are used to determine fair value for the remaining financial instruments. The fair value of interest rate swaps is calculated as the present value of the estimated future cash flows. The fair
value of forward exchange contracts is determined using forward exchange market rates at the end of the reporting period. These instruments are included in level 2 and comprise debt investments and derivative financial instruments. In the
circumstances where a valuation technique for these instruments is based on significant unobservable inputs, such instruments are included in level 3. Refer to Note 15 and 19 for detail of the level 3 instrument and refer to Note 4 for estimates and
judgements in the instrument.

The following tables present the changes in the level 3 instruments for the past two years:



|                                             |  |                       |            |   |                       |  |           |  
|-------------------------------------------- |  | --------------------- | ---------- | - | --------------------- |  | --------- | -
|                                             |  | 2011                  |            |   | 2010                  | 
|Consolidated                                 |  | Conversionderivative$ |            |   | Conversionderivative$ | 
|Opening balance                              |  |                       | 1,888,067  |   |                       |  | 2,337,200 |  
|Conversions                                  |  |                       | (1,327     | ) |                       |  | (42,092   | )
|Losses /(Gains) recognized in profit or loss |  |                       | (1,867,873 | ) |                       |  | (407,041  | )
|                                             |  |                       |            |   |                       |  |           |  
|Closing Balance                              |  |                       | 18,867     |   |                       |  | 1,888,067 |  
|                                             |  |                       |            |   |                       |  |           |  



|                                             |  |                      |         |  |                      |  |   | 
|-------------------------------------------- |  | -------------------- | ------- |  | -------------------- |  | - | 
|                                             |  | 2011                 |         |  | 2010                 | 
|Consolidated                                 |  | ConvertibleSecurity$ |         |  | ConvertibleSecurity$ | 
|Opening balance                              |  |                      |        |  |                      |  |  | 
|New issues                                   |  |                      | 900,000 |  |                      |  |  | 
|Conversions                                  |  |                      |        |  |                      |  |  | 
|Losses /(Gains) recognized in profit or loss |  |                      |        |  |                      |  |  | 
|                                             |  |                      |         |  |                      |  |   | 
|Closing Balance                              |  |                      | 900,000 |  |                      |  |  | 
|                                             |  |                      |         |  |                      |  |   | 



|e. | Capital risk management
|-- | -----------------------

The Group
manages its capital risk to ensure that the Group will be able to continue as a going concern while maximising the return to stakeholders through optimisation of the debt and equity balance.

In order to maintain or adjust the capital structure, the Group may elect not to pay dividends to shareholders, issue new shares or sell assets to reduce debt.

The Groups overall strategy remains unchanged from 2010 and 2009.

The capital structure of the Group consists of debt, which includes borrowings disclosed in note 16 and 17, convertible securities disclosed in note 19, cash and cash equivalents disclosed in note 9 and
equity attributable to owners of the parent, comprising contributed equity, reserves and accumulated losses as disclosed in notes 20, 21 and 22.



F - 22



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##### Table of Contents

|4. | Critical accounting estimates and judgements
|-- | --------------------------------------------



|a. | Conversion derivatives
|-- | ----------------------

The fair value of
financial instruments that are not traded in an active market is determined by using valuation techniques. The fair value is determined using a Black-Scholes options pricing model and taking into account the inherent benefits to the Noteholder
outlined in the Convertible Note terms as well as scenario based Monte Carlo simulations and binomial tree simulations with weightings according to Pascals Triangle, using the assumptions detailed below:



|                       |  |      |        |   |      |   |       |      |  |   |        |   |  |                                                                                                                                                             
|---------------------- |  | ---- | ------ | - | ---- | - | ----- | ---- |  | - | ------ | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|                       |  | 2011 |        |   | 2010 |   |       | 2009 |  |   | Detail
|Share Price            |  | $    | 0.002  |   |      | $ | 0.01  |      |  | $ | 0.02   |   |  | Determined as the closing share price on the ASX at year end.                                                                                               
|Exercise Price         |  | $    | 0.15   |   |      | $ | 0.15  |      |  | $ | 0.15   |   |  | As per the terms and conditions of the contract. Exercise price of the convertible notes option should shares trade above $0.15 (or 10% higher than $0.135).
|Share Price Volatility |  |      | 109.43 | % |      |   | 90.17 | %    |  |   | 118.76 | % |  | Determined having regard to a number of factors including recent Metal Storm market trading prices.                                                         
|Risk Free Rate         |  |      | 3.13   | % |      |   | 4.7   | %    |  |   | 4.4    | % |  | Yield as at year end for a commonwealth security with a maturity that approximates the remaining life of the instrument.                                    

A weighting is applied to the Black-Scholes pricing model used to determining the value of the conversion derivative.
This is incorporated to allow for the circumstances that a conversion of notes could result in a premium upon conversion. The Company estimated a 1% probability that the share price would trade above $0.01 between 1 January 2012 and
29 February 2012.



|b. | Convertible securities
|-- | ----------------------

The non-current
converitble securities were valued with consideration given to the transaction price and what the transaction price would have been in an arms length transaction that was not forced. This included the share price volatility, liquidity, market
discount rates for this type of financial instrument, the conversion terms and the maturity date of the convertible securities. Refer note 19.



|                       |  |      |        |   |        |                                                                                                                                    
|---------------------- |  | ---- | ------ | - | ------ | -----------------------------------------------------------------------------------------------------------------------------------
|                       |  | 2011 |        |   | Detail
|Share Price            |  | $    | 0.002  |   |        | Determined as the closing share price on the ASX at year end.                                                                      
|Exercise Price         |  | $    | 0.0018 |   |        | As per the terms and conditions of the contract. Exercise price of the convertible securities should they be converted at year end.
|Share Price Volatility |  |      | 109.43 | % |        | Determined having regard to a number of factors including recent Metal Storm market trading prices.                                
|Risk Free Rate         |  |      | 3.14   | % |        | Yield as at year end for a commonwealth security with a maturity that approximates the remaining life of the instrument.           



|c. | Unlisted options
|-- | ----------------



|                       |  |      |       |   |      |                  |        |                                                                                                                         
|---------------------- |  | ---- | ----- | - | ---- | ---------------- | ------ | ------------------------------------------------------------------------------------------------------------------------
|                       |  | 2011 |       |   | 2010 |                  | Detail
|Share Price            |  | $    | 0.005 |   |      | $0.008 - $0.0012 |        | Determined as the closing share price on the ASX at grant date.                                                         
|Exercise Price         |  | $    | 0.001 |   |      | $0.018 - $0.035  |        | As per the terms and conditions of agreement.                                                                           
|Share Price Volatility |  |      | 90    | % |      | 104% - 127%      |        | Determined having regard to a number of factors including historical Metal Storm market trading prices.                 
|Risk Free Rate         |  |      | 5.0   | % |      | 3.5% - 4.5%      |        | Yield as at year end for a commonwealth security with a maturity that approximates the remaining life of the instrument.



F - 23



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##### Table of Contents

|d. | Revenue recognition
|-- | -------------------

For revenue
recognized on a percentage of completion basis the Company must estimate the current stage to which each contract is complete. Depending on the type of the contract, the stage of completion is measured by reference to labour hours incurred to date
as a percentage of estimated total labour hours or as costs incurred as a percentage of estimated total costs for each contract.



|5. | Segment information
|-- | -------------------



|a. | Description of segments
|-- | -----------------------

Management has
determined the operating segments based on reports reviewed by the Chief Executive Officer and the Chief Financial Officer (Executive) that are used to make strategic decisions.

The Executive considers the business from a geographic perspective and has identified two reportable segments, Australia and the United States. The Executive monitors the performance in these two regions
separately. Due to the current financial constraints, the primary focus of the Executive is monitoring of cash inflows and outflows.

Revenue
in the United States is generated through research and development contracts for the provision of services or products.

Metal Storm has 1
customer whose transaction amount to more than 10% of the Groups revenues. In 2011 $511,152 was recognized from the US Government in the United States segment. (2010: $2,224,289, 2009: $964,272).



|b. | Segment information provided to the Chief Executive Officer and Chief Financial Officer
|-- | ---------------------------------------------------------------------------------------



|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|----------------------------------------- |  | --------- | ----------- | - | ------------- |  | ----------- | ------------------------- |  |  | ------------ | - |  |  | ----------- | -
|                                          |  | Australia |             |   | United States |  |             | Inter-segmenteliminations |  |  | Consolidated |  
|2011                                      |  | $         |             |   | $             |  |             | $                         |  |  | $            |  
|                                          |  |           |             |  
|Revenue                                   |  |           | 805,878     |   |               |  | 512,204     |                           |  |  |             |   |  |  | 1,318,082   |  
|Expenses                                  |  |           | (6,743,177  | ) |               |  | (1,884,072  | )                         |  |  | 1,266,949    |   |  |  | (7,351,300  | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|Segment loss                              |  |           | (5,928,299  | ) |               |  | (1,371,868  | )                         |  |  | 1,266,949    |   |  |  | (6,033,218  | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|                                          |  |           |             |  
|Current assets                            |  |           | 698,972     |   |               |  | 18,698      |                           |  |  |             |   |  |  | 717,670     |  
|Current liabilities                       |  |           | (20,108,975 | ) |               |  | (23,754,042 | )                         |  |  | 23,706,022   |   |  |  | (20,156,995 | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|Net current assets/(liabilities)          |  |           | (19,410,003 | ) |               |  | (23,735,344 | )                         |  |  | 23,706,022   |   |  |  | (19,439,325 |  
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|                                          |  |           |             |  
|Net operating cash flows                  |  |           | (3,994,766  | ) |               |  | (1,348,416  | )                         |  |  |             |   |  |  | (5,343,182  | )
|Net investing cash flows                  |  |           | (1,304,875  | ) |               |  | 7           |                           |  |  | 1,256,294    |   |  |  | (48,574     | )
|Net financing cash flows                  |  |           | 4,705,023   |   |               |  | 1,256,294   |                           |  |  | (1,256,294   | ) |  |  | 4,705,023   |  
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|Net movement in cash and cash equivalents |  |           | (594,618    | ) |               |  | (92,115     | )                         |  |  |             |   |  |  | (686,733    | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  



F - 24



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##### Table of Contents

|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|----------------------------------------- |  | --------- | ----------- | - | ------------- |  | ----------- | ------------------------- |  |  | ------------ | - |  |  | ----------- | -
|                                          |  | Australia |             |   | United States |  |             | Inter-segmenteliminations |  |  | Consolidated |  
|2010                                      |  | $         |             |   | $             |  |             | $                         |  |  | $            |  
|                                          |  |           |             |  
|Revenue                                   |  |           | 35,106      |   |               |  | 2,681,620   |                           |  |  |             |   |  |  | 2,716,726   |  
|Expenses                                  |  |           | (9,466,786  | ) |               |  | (3,000,942  | )                         |  |  | 812,749      |   |  |  | (11,654,979 | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|Segment loss                              |  |           | (9,431,680  | ) |               |  | (319,322    | )                         |  |  | 812,749      |   |  |  | (8,938,253  | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|                                          |  |           |             |  
|Current assets                            |  |           | 1,397,367   |   |               |  | 325,160     |                           |  |  |             |   |  |  | 1,722,527   |  
|Current liabilities                       |  |           | (20,370,520 | ) |               |  | (22,343,178 | )                         |  |  | 22,077,357   |   |  |  | (20,636,341 | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|Net current assets/(liabilities)          |  |           | (18,973,153 | ) |               |  | (22,018,018 | )                         |  |  | 22,077,357   |   |  |  | (18,913,814 | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|                                          |  |           |             |  
|Net operating cash flows                  |  |           | (5,533,625  | ) |               |  | (655,975    | )                         |  |  |             |   |  |  | (6,189,600  | )
|Net investing cash flows                  |  |           | (748,838    | ) |               |  | (1,252      | )                         |  |  | 756,816      |   |  |  | 6,726       |  
|Net financing cash flows                  |  |           | 7,293,200   |   |               |  | 744,066     |                           |  |  | (756,816     | ) |  |  | 7,280,450   |  
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|Net movement in cash and cash equivalents |  |           | 1,010,737   |   |               |  | 86,839      |                           |  |  |             |   |  |  | 1,097,576   |  
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  



|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|----------------------------------------- |  | --------- | ----------- | - | ------------- |  | ----------- | ------------------------- |  |  | ------------ | - |  |  | ----------- | -
|                                          |  | Australia |             |   | United States |  |             | Inter-segmenteliminations |  |  | Consolidated |  
|2009                                      |  | $         |             |   | $             |  |             | $                         |  |  | $            |  
|Revenue                                   |  |           | 136,708     |   |               |  | 975,773     |                           |  |  |             |   |  |  | 1,112,481   |  
|Expenses                                  |  |           | (10,882,739 | ) |               |  | (2,972,831  | )                         |  |  | 1,435,425    |   |  |  | (12,420,145 | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|Segment loss                              |  |           | (10,746,031 | ) |               |  | (1,997,058  | )                         |  |  | 1,435,425    |   |  |  | (11,307,664 | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|                                          |  |           |             |  
|Current assets                            |  |           | 168,690     |   |               |  | 207,944     |                           |  |  |             |   |  |  | 376,634     |  
|Current liabilities                       |  |           | (19,344,629 | ) |               |  | (22,269,498 | )                         |  |  | 21,607,169   |   |  |  | (20,006,958 | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|Net current assets/(liabilities)          |  |           | (19,175,939 | ) |               |  | (22,061,554 | )                         |  |  | 21,607,169   |   |  |  | (19,630,324 | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|                                          |  |           |             |  
|Net operating cash flows                  |  |           | (7,153,819  | ) |               |  | (1,550,409  | )                         |  |  |             |   |  |  | (8,704,228  | )
|Net investing cash flows                  |  |           | (1,221,021  | ) |               |  | (16,798     | )                         |  |  | 1,435,425    |   |  |  | 197,606     |  
|Net financing cash flows                  |  |           | 1,060,196   |   |               |  | 1,423,894   |                           |  |  | (1,435,425   | ) |  |  | 1,048,665   |  
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  
|Net movement in cash and cash equivalents |  |           | (7,314,644  | ) |               |  | (143,313    | )                         |  |  |             |   |  |  | (7,457,957  | )
|                                          |  |           |             |   |               |  |             |                           |  |  |              |   |  |  |             |  



|c. | Notes to and forming part of the segment information
|-- | ----------------------------------------------------



| | i. | Accounting policies
| | -- | -------------------

Segment information
is prepared in conformity with the accounting policies of the entity and IFRS 8 Segment Reporting. Segment revenues, expenses, assets, liabilities and net cash flows are those that are directly attributable to a segment and the relevant
portion that can be allocated to the segment on a reasonable basis.

Segment assets include all assets used by a segment and consist primarily
of operating cash, receivables, property, plant and equipment and goodwill and other intangible assets, net of related provisions. Segment liabilities consist primarily of trade and other creditors, employee benefits and provisions. Segment assets
and liabilities do not include income taxes.



| | ii. | Inter-segment transfers
| | --- | -----------------------

Segment
revenues, expenses, results and cash flows include transfers between segments. Such transfers are priced on an arms-length basis and are eliminated on consolidation.



F - 25



---

##### Table of Contents

|6. | Revenue
|-- | -------



|                                               |  |     |  |       |           |  |       |  |           |       |  |  |           | 
|---------------------------------------------- |  | --- |  | ----- | --------- |  | ----- |  | --------- | ----- |  |  | --------- | 
|                                               |  |     |  | 2011$ |           |  | 2010$ |  |           | 2009$ | 
|Contract revenue                               |  |     |  |       | 511,152   |  |       |  | 1,452,481 |       |  |  | 964,272   | 
|Sale of goods                                  |  |     |  |       |          |  |       |  | 785,078   |       |  |  |          | 
|Interest revenue                               |  |     |  |       | 9,023     |  |       |  | 23,458    |       |  |  | 136,833   | 
|Australian Research and Development Tax Rebate |  |     |  |       | 765,672   |  |       |  | 628,290   |       |  |  |          | 
|Other                                          |  | (i) |  |       | 32,235    |  |       |  | 455,709   |       |  |  | 11,376    | 
|                                               |  |     |  |       |           |  |       |  |           |       |  |  |           | 
|                                               |  |     |  |       | 1,318,082 |  |       |  | 3,345,016 |       |  |  | 1,112,481 | 
|                                               |  |     |  |       |           |  |       |  |           |       |  |  |           | 



|(i) | 2010 other revenue represents settlement proceeds, refer note 10 for further detail.
|--- | ------------------------------------------------------------------------------------



|7. | Expenses
|-- | --------

Net loss attributable to
members of the parent includes the following expenses:



|                                            |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|------------------------------------------- |  | ----- |  | ----- | ---------- | - | ----- |  | ---------- | ----- |  |  | ---------- | -
|                                            |  | Note  |  | 2011$ |            |   | 2010$ |  |            | 2009$ | 
|Employee expenses                           |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|Wages and salaries                          |  |       |  |       | (2,901,940 | ) |       |  | (3,627,702 | )     |  |  | (3,901,523 | )
|Post employment                             |  |       |  |       | (168,996   | ) |       |  | (208,110   | )     |  |  | (229,408   | )
|Share-based payments                        |  | 31(d) |  |       | (40,000    | ) |       |  | (50,303    | )     |  |  | (22,230    | )
|Directors fees                              |  |       |  |       | (240,352   | ) |       |  | (218,514   | )     |  |  | (197,499   | )
|Other                                       |  |       |  |       | (99,245    | ) |       |  | (132,640   | )     |  |  | (140,905   | )
|                                            |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|Total employee expenses                     |  |       |  |       | (3,450,533 | ) |       |  | (4,237,269 | )     |  |  | (4,491,565 | )
|                                            |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|                                            |  |       |  |      
|Finance costs                               |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|Interest expense                            |  |       |  |       | (434,755   | ) |       |  | (479,723   | )     |  |  | (1,586,756 | )
|Accretion expense                           |  | (i)   |  |       | (1,555,968 | ) |       |  | (2,062,867 | )     |  |  | (3,184,692 | )
|Transaction cost amortisation               |  |       |  |       | (32,777    | ) |       |  |           |       |  |  | (876,393   | )
|Transaction cost                            |  |       |  |       | (738,248   | ) |       |  | (1,762,313 | )     |  |  | (101,714   | )
|                                            |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|Total finance costs                         |  |       |  |       | (2,761,748 | ) |       |  | (4,304,903 | )     |  |  | (5,749,555 | )
|                                            |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|                                            |  |       |  |      
|Depreciation and Amortisation               |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|Depreciation                                |  |       |  |       | (94,218    | ) |       |  | (94,227    | )     |  |  | (162,065   | )
|Amortisation                                |  |       |  |       |            |   |       |  | (612       | )     |  |  | (22,472    | )
|                                            |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|Total depreciation and amortisation         |  |       |  |       | (94,218    | ) |       |  | (94,839    | )     |  |  | (184,537   | )
|                                            |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|                                            |  |       |  |      
|Rental expense relating to operating leases |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|Operating lease payments                    |  |       |  |       | (337,475   | ) |       |  | (220,654   | )     |  |  | (589,793   | )
|                                            |  |       |  |       |            |   |       |  |            |       |  |  |            |  
|Total lease payments                        |  |       |  |       | (337,475   | ) |       |  | (220,654   | )     |  |  | (589,793   | )
|                                            |  |       |  |       |            |   |       |  |            |       |  |  |            |  



|(i) | Accretion expense is the recognition in the financial statements of the difference in value between the fair value at initial recognition and the face value. The
expense is recognized using an effective interest rate method over the life of the convertible notes.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F - 26



---

##### Table of Contents

|8. | Income tax
|-- | ----------



|a. | Income tax expense
|-- | ------------------



|                                   |  |       |            |   |       |  |            |       |  |  |            |  
|---------------------------------- |  | ----- | ---------- | - | ----- |  | ---------- | ----- |  |  | ---------- | -
|                                   |  | 2011$ |            |   | 2010$ |  |            | 2009$ | 
|Current tax (benefit)              |  |       |           |   |       |  |           |       |  |  | (2,724,940 | )
|Deferred tax (benefit)             |  |       | (2,091,417 | ) |       |  | (2,305,718 | )     |  |  | (218,219   | )
|Adjustment for prior years         |  |       |           |   |       |  |           |       |  |  | 68,233     |  
|Deferred tax assets not recognized |  |       | 2,091,417  |   |       |  | 2,305,718  |       |  |  | 2,874,926  |  
|                                   |  |       |            |   |       |  |            |       |  |  |            |  
|Income tax expense                 |  |       |           |   |       |  |           |       |  |  |           |  
|                                   |  |       |            |   |       |  |            |       |  |  |            |  



|b. | Numerical reconciliation of income tax expense to prima facie tax payable
|-- | -------------------------------------------------------------------------



|                                                                                        |  |       |            |   |       |  |            |       |  |  |             |  
|--------------------------------------------------------------------------------------- |  | ----- | ---------- | - | ----- |  | ---------- | ----- |  |  | ----------- | -
|                                                                                        |  | 2011$ |            |   | 2010$ |  |            | 2009$ | 
|Loss before income tax                                                                  |  |       | (6,033,218 | ) |       |  | (8,938,253 | )     |  |  | (11,307,664 | )
|                                                                                        |  |       |            |   |       |  |            |       |  |  |             |  
|                                                                                        |  |       |           
|Tax at the Australia tax rate of 30% (2010 and 2009: 30%)                               |  |       | (1,809,965 | ) |       |  | (2,681,476 | )     |  |  | (3,392,299  | )
|                                                                                        |  |       |           
|Tax effect of amounts which are not deductible (taxable) in calculating taxable income: |  |       |            |   |       |  |            |       |  |  |             |  
|Research and development tax concession received                                        |  |       | (229,701   | ) |       |  | (188,487   | )     |  |  |            |  
|Entertainment                                                                           |  |       | 763        |   |       |  | 1,257      |       |  |  | 1,530       |  
|Fair value movement in conversion derivative                                            |  |       | (560,362   | ) |       |  | (122,112   | )     |  |  | 67,383      |  
|Fair value of convertible security                                                      |  |       | 69,000     |   |       |  |           |       |  |  |            |  
|Fines and penalties                                                                     |  |       | 1,063      |   |       |  |           |       |  |  |            |  
|Gain on extinguishment                                                                  |  |       |           |   |       |  |           |       |  |  | (733,614    | )
|Non-deductible interest expense                                                         |  |       | 29,604     |   |       |  | 25,973     |       |  |  | 80,492      |  
|Option costs expensed  employees                                                       |  |       | 12,000     |   |       |  | 77,921     |       |  |  |            |  
|Borrowing costs accretion                                                               |  |       | 466,790    |   |       |  | 618,860    |       |  |  | 1,044,872   |  
|Other                                                                                   |  |       | (70,609    | ) |       |  | (37,654    | )     |  |  | (11,523     | )
|                                                                                        |  |       |            |   |       |  |            |       |  |  |             |  
|                                                                                        |  |       | (2,091,417 | ) |       |  | (2,305,718 | )     |  |  | (2,943,159  | )
|                                                                                        |  |       |           
|Adjustment for prior years                                                              |  |       |           |   |       |  |           |       |  |  | 68,233      |  
|Deferred tax assets not recognized                                                      |  |       | (2,091,417 | ) |       |  | (2,305,718 | )     |  |  | (2,874,926  | )
|                                                                                        |  |       |            |   |       |  |            |       |  |  |             |  
|Income tax expense                                                                      |  |       |           |   |       |  |           |       |  |  |            |  
|                                                                                        |  |       |            |   |       |  |            |       |  |  |             |  



|c. | Unrecognized temporary differences
|-- | ----------------------------------



| | i. | Temporary differences for which deferred tax assets or deferred tax liabilities have not been recognized.
| | -- | ---------------------------------------------------------------------------------------------------------



|                                                          |  |       |            |  |       |  |            |       |  |  |            | 
|--------------------------------------------------------- |  | ----- | ---------- |  | ----- |  | ---------- | ----- |  |  | ---------- | 
|                                                          |  | 2011$ |            |  | 2010$ |  |            | 2009$ | 
|Sundry creditors and accruals                             |  |       | 37,949     |  |       |  | 41,971     |       |  |  | 48,797     | 
|General accruals                                          |  |       | 503,397    |  |       |  | 572,589    |       |  |  | 626,083    | 
|Provision for doubtful debts                              |  |       |           |  |       |  |           |       |  |  | 958,885    | 
|Employee entitlements                                     |  |       | 204,321    |  |       |  | 198,515    |       |  |  | 175,905    | 
|Asset retirement obligation                               |  |       |           |  |       |  | 22,475     |       |  |  | 31,932     | 
|Lease make good                                           |  |       |           |  |       |  | 16,165     |       |  |  | 16,165     | 
|Deferred rent                                             |  |       | 15,109     |  |       |  |           |       |  |  | 16,056     | 
|Transaction cost amortisation (S40-880)                   |  |       | 240,893    |  |       |  | 132,358    |       |  |  | 234,095    | 
|Patent costs                                              |  |       | 3,339,706  |  |       |  | 3,541,605  |       |  |  | 3,796,804  | 
|Unrealised foreign exchange difference                    |  |       | 43,952     |  |       |  | 20,672     |       |  |  | 829,410    | 
|Losses available for offset against future income         |  |       | 93,525,557 |  |       |  | 86,393,145 |       |  |  | 76,519,638 | 
|Capital losses available for offset against future income |  |       | 915,000    |  |       |  | 915,000    |       |  |  | 915,000    | 
|                                                          |  |       |            |  |       |  |            |       |  |  |            | 
|Gross deferred income tax assets                          |  |       | 98,825,884 |  |       |  | 91,854,495 |       |  |  | 84,168,770 | 
|                                                          |  |       |            |  |       |  |            |       |  |  |            | 
|                                                          |  |       |            |  |       |  |            |       |  |  |            | 
|                                                          |  |       |            |  |       |  |            |       |  |  |            | 
|Potential tax benefit @ 30%                               |  |       | 29,647,765 |  |       |  | 27,556,349 |       |  |  | 25,250,631 | 
|                                                          |  |       |            |  |       |  |            |       |  |  |            | 



F - 27



---

##### Table of Contents

|d. | Tax losses
|-- | ----------

The Group has the following
tax losses arising in Australia and United States federal and state net operating loss carry-forwards:



|                                                        |  |       |            |  |       |  |            |       |  |  |            | 
|------------------------------------------------------- |  | ----- | ---------- |  | ----- |  | ---------- | ----- |  |  | ---------- | 
|                                                        |  | 2011$ |            |  | 2010$ |  |            | 2009$ | 
|Australian tax losses                                   |  |       | 71,950,256 |  |       |  | 65,638,347 |       |  |  | 56,836,046 | 
|United States federal net operating loss carry-forwards |  |       | 17,150,417 |  |       |  | 19,443,248 |       |  |  | 18,286,837 | 
|United States state net operating loss carry-forwards   |  |       | 14,043,854 |  |       |  | 13,638,689 |       |  |  | 12,482,278 | 

Australian tax losses are available indefinitely for offset against future taxable profits subject to the Companys
ability to satisfy the continuity of ownership test or same business test tax loss carry forward rules.

The U.S. State and Federal net
operating loss carry-forwards expire at various dates through 2013 and 2029, respectively.



|9. | Current assets  Cash and cash equivalents
|-- | ------------------------------------------



|                         |  |       |         |  |       |  |           | 
|------------------------ |  | ----- | ------- |  | ----- |  | --------- | 
|                         |  | 2011$ |         |  | 2010$ | 
|Cash at bank and on hand |  |       | 480,672 |  |       |  | 1,166,661 | 
|                         |  |       |         |  |       |  |           | 
|                         |  |       | 480,672 |  |       |  | 1,166,661 | 
|                         |  |       |         |  |       |  |           | 

These accounts earn interest at standard business banking operating account rates with a weighted average interest rate
at 31 December of 1.4% (2010: 2.5%).



|10. | Current assets  Trade and other receivables
|--- | --------------------------------------------



|                                   |  |       |  |       |         |  |       |  |         | 
|---------------------------------- |  | ----- |  | ----- | ------- |  | ----- |  | ------- | 
|                                   |  | Notes |  | 2011$ |         |  | 2010$ | 
|Trade receivables                  |  |       |  |       | 7,287   |  |       |  | 261,969 | 
|Other receivables                  |  |       |  |       | 801     |  |       |  | 4,230   | 
|Security deposits                  |  | (i)   |  |       | 44,910  |  |       |  | 44,910  | 
|Goods and services tax recoverable |  |       |  |       | 50,879  |  |       |  | 55,728  | 
|Prepayments                        |  |       |  |       | 133,121 |  |       |  | 189,029 | 
|                                   |  |       |  |       |         |  |       |  |         | 
|                                   |  |       |  |       | 236,998 |  |       |  | 555,866 | 
|                                   |  |       |  |       |         |  |       |  |         | 



|(i) | Represents restricted cash deposits held as security for operating and finance lease commitments.
|--- | -------------------------------------------------------------------------------------------------

The other categories within trade and other receivables do not contain impaired assets and are not past due. Based on the credit history of these other
classes, it is expected that these amounts will be received when due.

Other receivables generally arise from transactions outside the usual
operating activities of the Group. Interest may be charged at commercial rates where the terms of repayment exceed six months. Collateral is not normally obtained.\

Movements in provision for doubtful debts:



|                    |  |       |   |  |       |  |          |  
|------------------- |  | ----- | - |  | ----- |  | -------- | -
|                    |  | 2011$ |   |  | 2010$ | 
|Opening balance     |  |       |  |  |       |  | (958,885 | )
|Provision reduction |  |       |  |  |       |  | 958,885  |  
|                    |  |       |   |  |       |  |          |  
|Closing balance     |  |       |  |  |       |  |         |  
|                    |  |       |   |  |       |  |          |  

The provision created relates to a single customer of the Group who was significantly outside terms. The full balance of
the debt was not outside terms however in discussions with the customer, they had provided strong indications of their intention not to pay as well as an inability to repay all debts to the Group.

The Group initiated legal action against the customer in accordance with the provisions provided for dispute resolution contained in the contract. The
matter was settled in March 2010, the provision removed and any proceeds recognized in other revenue.



F - 28



---

##### Table of Contents

|11. | Non-current assets  Other assets
|--- | ---------------------------------



|                  |  |     |  |       |        |  |       |  |        | 
|----------------- |  | --- |  | ----- | ------ |  | ----- |  | ------ | 
|                  |  |     |  | 2011$ |        |  | 2010$ | 
|Security deposits |  | (i) |  |       | 78,452 |  |       |  | 78,210 | 
|                  |  |     |  |       |        |  |       |  |        | 
|                  |  |     |  |       | 78,452 |  |       |  | 78,210 | 
|                  |  |     |  |       |        |  |       |  |        | 



|(i) | Represents restricted cash deposits held as security for operating and finance lease commitments.
|--- | -------------------------------------------------------------------------------------------------



|12. | Non-current assets  Property, plant and equipment
|--- | --------------------------------------------------



|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|--------------------------- |  | --------------------- | -------- | - | ------------------ |  | -------- | ------------------------ |  |  | ------- | - |  |  | --------- | -
|                            |  | Leaseholdimprovements |          |   | Plant andequipment |  |          | Leased plantandequipment |  |  | Total   |  
|                            |  | $                     |          |   | $                  |  |          | $                        |  |  | $       |  
|At 1 January 2010           |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Cost                        |  |                       | 188,536  |   |                    |  | 889,437  |                          |  |  | 27,393  |   |  |  | 1,105,366 |  
|Accumulated depreciation    |  |                       | (160,279 | ) |                    |  | (499,361 | )                        |  |  | (22,011 | ) |  |  | (681,651  | )
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Net book amount             |  |                       | 28,257   |   |                    |  | 390,076  |                          |  |  | 5,382   |   |  |  | 423,715   |  
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|                            |  |                       |          |  
|Year ended 31 December 2010 |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Opening net book amount     |  |                       | 28,257   |   |                    |  | 390,076  |                          |  |  | 5,382   |   |  |  | 423,715   |  
|Additions                   |  |                       | 15,392   |   |                    |  | 1,339    |                          |  |  |        |   |  |  | 16,731    |  
|Transfers in / (out)        |  |                       |         |   |                    |  |         |                          |  |  |        |   |  |  |          |  
|Disposals                   |  |                       |         |   |                    |  |         |                          |  |  |        |   |  |  |          |  
|Depreciation charge         |  |                       | (19,644  | ) |                    |  | (69,201  | )                        |  |  | (5,382  | ) |  |  | (94,227   | )
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Closing net book amount     |  |                       | 24,005   |   |                    |  | 322,214  |                          |  |  |        |   |  |  | 346,219   |  
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|                            |  |                       |          |  
|At 1 January 2011           |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Cost                        |  |                       | 203,928  |   |                    |  | 890,776  |                          |  |  | 27,393  |   |  |  | 1,122,097 |  
|Accumulated depreciation    |  |                       | (179,923 | ) |                    |  | (568,562 | )                        |  |  | (27,393 | ) |  |  | (775,878  | )
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Net book amount             |  |                       | 24,005   |   |                    |  | 322,214  |                          |  |  |        |   |  |  | 346,219   |  
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|                            |  |                       |          |  
|Year ended 31 December 2011 |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Opening net book amount     |  |                       | 24,005   |   |                    |  | 322,214  |                          |  |  |        |   |  |  | 346,219   |  
|Additions                   |  |                       | 38,570   |   |                    |  | 49,068   |                          |  |  |        |   |  |  | 87,637    |  
|Disposals                   |  |                       |         |   |                    |  | (55,344  | )                        |  |  |        |   |  |  | (55,343   | )
|Depreciation charge         |  |                       | (18,846  | ) |                    |  | (75,373  | )                        |  |  |        |   |  |  | (94,218   | )
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Closing net book amount     |  |                       | 43,729   |   |                    |  | 240,566  |                          |  |  |        |   |  |  | 284,295   |  
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|                            |  |                       |          |  
|At 31 December 2011         |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Cost                        |  |                       | 193,100  |   |                    |  | 880,097  |                          |  |  | 27,393  |   |  |  | 1,100,590 |  
|Accumulated depreciation    |  |                       | (149,371 | ) |                    |  | (639,531 | )                        |  |  | (27,393 | ) |  |  | (816,295  | )
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  
|Net book amount             |  |                       | 43,729   |   |                    |  | 240,566  |                          |  |  |        |   |  |  | 284,295   |  
|                            |  |                       |          |   |                    |  |          |                          |  |  |         |   |  |  |           |  



F - 29



---

##### Table of Contents

|13. | Non-current assets  Intangible assets and goodwill
|--- | ---------------------------------------------------



|                              |  |          |         |   |          |  |            |       |  |  |            |  
|----------------------------- |  | -------- | ------- | - | -------- |  | ---------- | ----- |  |  | ---------- | -
|                              |  | Software |         |   | Goodwill |  |            | Total | 
|                              |  | $        |         |   | $        |  |            | $     | 
|At 1 January 2010             |  |          |         |   |          |  |            |       |  |  |            |  
|Cost                          |  |          | 89,291  |   |          |  | 1,861,726  |       |  |  | 1,951,017  |  
|Accumulated amortisation      |  |          | (88,679 | ) |          |  | (27,574    | )     |  |  | (116,253   | )
|Accumulated impairment losses |  |          |        |   |          |  | (1,834,152 | )     |  |  | (1,834,152 | )
|                              |  |          |         |   |          |  |            |       |  |  |            |  
|Net book amount               |  |          | 612     |   |          |  |           |       |  |  | 612        |  
|                              |  |          |         |   |          |  |            |       |  |  |            |  
|                              |  |          |        
|Year ended 31 December 2010   |  |          |         |   |          |  |            |       |  |  |            |  
|Opening net book amount       |  |          | 612     |   |          |  |           |       |  |  | 612        |  
|Additions                     |  |          |        |   |          |  |           |       |  |  |           |  
|Disposals                     |  |          |        |   |          |  |           |       |  |  |           |  
|Amortisation charge           |  |          | (612    | ) |          |  |           |       |  |  | (612       | )
|                              |  |          |         |   |          |  |            |       |  |  |            |  
|Closing net book amount       |  |          |        |   |          |  |           |       |  |  |           |  
|                              |  |          |         |   |          |  |            |       |  |  |            |  
|                              |  |          |        
|At 1 January 2011             |  |          |         |   |          |  |            |       |  |  |            |  
|Cost                          |  |          | 89,291  |   |          |  |           |       |  |  | 89,291     |  
|Accumulated amortisation      |  |          | (89,291 | ) |          |  |           |       |  |  | (89,291    | )
|Accumulated impairment losses |  |          |        |   |          |  |           |       |  |  |           |  
|                              |  |          |         |   |          |  |            |       |  |  |            |  
|Net book amount               |  |          |        |   |          |  |           |       |  |  |           |  
|                              |  |          |         |   |          |  |            |       |  |  |            |  
|                              |  |          |        
|Year ended 31 December 2011   |  |          |         |   |          |  |            |       |  |  |            |  
|Opening net book amount       |  |          |        |   |          |  |           |       |  |  |           |  
|Additions                     |  |          |        |   |          |  |           |       |  |  |           |  
|Disposals                     |  |          |        |   |          |  |           |       |  |  |           |  
|Amortisation charge           |  |          |        |   |          |  |           |       |  |  |           |  
|                              |  |          |         |   |          |  |            |       |  |  |            |  
|Closing net book amount       |  |          |        |   |          |  |           |       |  |  |           |  
|                              |  |          |         |   |          |  |            |       |  |  |            |  
|                              |  |          |        
|At 31 December 2011           |  |          |         |   |          |  |            |       |  |  |            |  
|Cost                          |  |          | 89,291  |   |          |  |           |       |  |  | 89,291     |  
|Accumulated amortisation      |  |          | (89,291 | ) |          |  |           |       |  |  | (89,291    | )
|Accumulated impairment loss   |  |          |        |   |          |  |           |       |  |  |           |  
|                              |  |          |         |   |          |  |            |       |  |  |            |  
|Net book amount               |  |          |        |   |          |  |           |       |  |  |           |  
|                              |  |          |         |   |          |  |            |       |  |  |            |  

All capitalised software represents externally acquired software with a useful life of between 2 and 5 years amortised on
a straight line basis.

No research and development costs have been capitalised as product maturation is still within the research stage.



|14. | Current liabilities  Trade and other payables
|--- | ----------------------------------------------



|                        |  |     |  |       |           |  |       |  |           | 
|----------------------- |  | --- |  | ----- | --------- |  | ----- |  | --------- | 
|                        |  |     |  | 2011$ |           |  | 2010$ | 
|Trade payables          |  |     |  |       | 152,621   |  |       |  | 225,837   | 
|Deferred revenue        |  |     |  |       | 23,072    |  |       |  | 54,928    | 
|Accrued payables        |  |     |  |       | 812,250   |  |       |  | 897,972   | 
|                        |  |     |  |       |           |  |       |  |           | 
|                        |  |     |  |       | 987,943   |  |       |  | 1,178,737 | 
|                        |  |     | 
|Related party payables: |  |     |  |       |           |  |       |  |           | 
|Directors fees payable  |  | (i) |  |       | 84,166    |  |       |  | 8,333     | 
|                        |  |     |  |       |           |  |       |  |           | 
|                        |  |     |  |       | 1,072,109 |  |       |  | 1,187,070 | 
|                        |  |     |  |       |           |  |       |  |           | 



|(i) | Refer to note 23 (d) for further detail.
|--- | ----------------------------------------



F - 30



---

##### Table of Contents

|15. | Current liabilities  Conversion derivative
|--- | -------------------------------------------



|                                          |  |       |            |   |       |  |           |  
|----------------------------------------- |  | ----- | ---------- | - | ----- |  | --------- | -
|                                          |  | 2011$ |            |   | 2010$ | 
|Balance at beginning of year              |  |       | 1,888,067  |   |       |  | 2,337,200 |  
|Conversion of convertible notes to shares |  |       | (1,327     | ) |       |  | (42,092   | )
|Fair value movement                       |  |       | (1,867,873 | ) |       |  | (407,041  | )
|                                          |  |       |            |   |       |  |           |  
|Balance at end of year                    |  |       | 18,867     |   |       |  | 1,888,067 |  
|                                          |  |       |            |   |       |  |           |  

The fair value movement represents the movement in the fair value of the liability arising from the ability of
noteholders to convert their notes to shares. Refer to note 4 (a) for further information on fair value.

Refer to note 16 for details of
the underlying financial instrument.



|16. | Current liabilities  Non-interest bearing loans and borrowings
|--- | ---------------------------------------------------------------



|                  |  |      |  |       |            |  |       |  |            | 
|----------------- |  | ---- |  | ----- | ---------- |  | ----- |  | ---------- | 
|                  |  |      |  | 2011$ |            |  | 2010$ | 
|Convertible notes |  | (i)  |  |       | 14,486,311 |  |       |  | 13,125,104 | 
|Short term loan   |  | (ii) |  |       | 214,848    |  |       |  | 214,848    | 
|                  |  |      |  |       |            |  |       |  |            | 
|                  |  |      |  |       | 14,701,159 |  |       |  | 13,339,952 | 
|                  |  |      |  |       |            |  |       |  |            | 



|(i) | Secured by fixed and floating charge over the Companys assets, matures on 1 March 2012. The maturity date has subsequently been extended, refer to note 28.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|(ii) | Related party loan, refer note 26 (b) for further details
|---- | ---------------------------------------------------------



|a. | Convertible Notes
|-- | -----------------

Background

On 1 September 2006, the Company raised $27.5 million dollars under a non renounceable rights issue from existing shareholders by
issuing 203,703,704 convertible notes with a three year maturity paying a 10% coupon.

On 31 July 2009, prior to maturity on
1 September 2009, shareholders and noteholders of the Company approved a modification to the terms of the notes and to the trust deed. The modification provided a further two year extension to the maturity date to 1 September 2011 of the
convertible notes and created a new class of note. The new note carried identical terms to the 10% coupon note except it bore no interest and instead offered a fixed and floating charge over the Company.

Noteholders were provided the opportunity to exchange their 10% coupon notes for the same number of new secured notes plus 5 options for every 7 notes
they exchanged. Refer note 20 for the option terms. 77% of noteholders elected to make the exchange.

On 29 August 2011, prior to
maturity, shareholders and noteholders approved a further extension of the interest bearing and secured convertible notes to 1 March 2012.

Subsequent to year end the maturity date of both classes of convertible notes have been further extended, refer note 28 for further details.

Terms

At 31 December 2011, both
classes of convertible notes have the following terms and features:



| |  |  | Face value of $0.135 per Note.
| | - |  | ------------------------------



| |  |  | Mature on 1 March 2012.
| | - |  | -----------------------



| |  |  | Convertible to ordinary shares on the first business day of each quarter prior to maturity date or at maturity date except for any note holders who
hold more than 5% of notes on issuance may convert at any time.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Convertible at a conversion price equal to the lesser of $0.135 and 90% of the volume weighted average price per share for the preceding 30 business
days prior to conversion date rounded to the nearest cent.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The 10% coupon convertible notes also:



| |  |  | bear interest at 10%pa payable quarterly in arrears,
| | - |  | ----------------------------------------------------

While the secured convertible notes have:



| |  |  | a fixed and floating charge over any interest of the Company
| | - |  | ------------------------------------------------------------



F - 31



---

##### Table of Contents

Convertible Note Accounting

Both classes of convertible notes are hybrid financial instruments, a note payable host contract and conversion feature. The conversion feature has been separated from its host contract because the
conversion derivative is not closely related to the loan host. The conversion feature is accounted for as a derivative liability because the feature could require a variable number of shares to be issued upon conversion of each note.

Upon initial recognition, the proceeds from issuance are first allocated to the fair value of the conversion derivative. The remaining proceeds are
allocated to the note payable host contract. Subsequently, the conversion derivative is measured at fair value with changes recognised through profit and loss and presented as fair value movement in derivative in the statement of comprehensive
income. The note payable host contract is subsequently measured at amortised cost.

The exchange from 10% coupon notes to secured notes in
2009 along with the extension to the maturity date were accounted for as an extinguishment and reissue of debt in accordance with the Companys accounting policy, refer note 2 (t). The extension to the notes term on 29 August 2011 has been
recorded as a modification in the terms of the notes.



|                                          |  |            |             |   |            |  |             |  
|----------------------------------------- |  | ---------- | ----------- | - | ---------- |  | ----------- | -
|                                          |  | 2011$      |             |   | 2010$      | 
|Balance at beginning of year              |  |            | 13,125,104  |   |            |  | 11,496,248  |  
|Transaction costs                         |  |            | (37,782     | ) |            |  |            |  
|Accretion expense                         |  |            | 1,384,949   |   |            |  | 1,845,539   |  
|Transaction costs amortisation            |  |            | 25,188      |   |            |  |            |  
|Conversion of convertible notes to shares |  |            | (11,148     | ) |            |  | (216,683    | )
|                                          |  |            |             |   |            |  |             |  
|Balance at end of year                    |  |            | 14,486,311  |   |            |  | 13,125,104  |  
|                                          |  |            |             |   |            |  |             |  
|                                          |  |           
|                                          |  | 2011Number |             |   | 2010Number | 
|Balance at beginning of year              |  |            | 107,489,131 |   |            |  | 109,471,371 |  
|Conversions                               |  |            | (89,832     | ) |            |  | (1,982,240  | )
|                                          |  |            |             |   |            |  |             |  
|Balance at end of year                    |  |            | 107,399,299 |   |            |  | 107,489,131 |  
|                                          |  |            |             |   |            |  |             |  



|17. | Current liabilities  Interest bearing loans and borrowings
|--- | -----------------------------------------------------------



|                                 |  |     |  |       |           |  |       |  |           | 
|-------------------------------- |  | --- |  | ----- | --------- |  | ----- |  | --------- | 
|                                 |  |     |  | 2011$ |           |  | 2010$ | 
|Obligations under finance leases |  |     |  |       | 662       |  |       |  | 226       | 
|Convertible notes                |  | (a) |  |       | 4,364,198 |  |       |  | 4,198,551 | 
|                                 |  |     |  |       |           |  |       |  |           | 
|                                 |  |     |  |       | 4,364,860 |  |       |  | 4,198,777 | 
|                                 |  |     |  |       |           |  |       |  |           | 



|a. | Convertible notes
|-- | -----------------

Refer to note 16 for
further information on convertible note terms



|                                          |  |            |            |   |            |  |            |  
|----------------------------------------- |  | ---------- | ---------- | - | ---------- |  | ---------- | -
|                                          |  | 2011$      |            |   | 2010$      | 
|Balance at beginning of year              |  |            | 4,198,551  |   |            |  | 4,065,240  |  
|Transaction costs                         |  |            | (11,381    | ) |            |  |           |  
|Accretion expense                         |  |            | 171,019    |   |            |  | 217,328    |  
|Transaction costs amortisation            |  |            | 7,588      |   |            |  |           |  
|Conversion of convertible notes to shares |  |            | (1,579     | ) |            |  | (84,017    | )
|                                          |  |            |            |   |            |  |            |  
|Balance at end of year                    |  |            | 4,364,198  |   |            |  | 4,198,551  |  
|                                          |  |            |            |   |            |  |            |  
|                                          |  |           
|                                          |  | 2011Number |            |   | 2010Number | 
|Balance at beginning of year              |  |            | 32,367,720 |   |            |  | 33,040,799 |  
|Conversions                               |  |            | (12,223    | ) |            |  | (673,079   | )
|                                          |  |            |            |   |            |  |            |  
|Balance at end of year                    |  |            | 32,355,497 |   |            |  | 32,367,720 |  
|                                          |  |            |            |   |            |  |            |  



F - 32



---

##### Table of Contents

|18. | Current liabilities  Provisions
|--- | --------------------------------



|                                    |  |            |         |   |        |  |         |  
|----------------------------------- |  | ---------- | ------- | - | ------ |  | ------- | -
|                                    |  | Make Good$ |         |   | Total$ | 
|Carrying amount at 1 January 2011   |  |            | 22,475  |   |        |  | 22,475  |  
|Additional provisions recognized    |  |            |        |   |        |  |        |  
|Amounts used during the year        |  |            | (20,008 | ) |        |  | (20,008 | )
|Derecognition                       |  |            | (2,467  | ) |        |  | (2,467  | )
|                                    |  |            |         |   |        |  |         |  
|Carrying amount at 31 December 2011 |  |            |        |   |        |  |        |  
|                                    |  |            |         |   |        |  |         |  



|19. | Non-current liabilities  Convertible securities
|--- | ------------------------------------------------

During the year, the Company issued two classes of convertible securities.



|a. | Convertible security 1
|-- | ----------------------

The first
convertible security has the following terms and features:



| |  |  | 20,000,000 securities issued for cash consideration of $200,000.
| | - |  | ----------------------------------------------------------------



| |  |  | Face value of $0.01 per convertible security.
| | - |  | ---------------------------------------------



| |  |  | Issued on 2 December 2011.
| | - |  | --------------------------



| |  |  | Maturity date of 30 November 2016.
| | - |  | ----------------------------------



| |  |  | Convertible at the lower of:
| | - |  | ----------------------------



| |  |  | The average of the lowest five daily VWAPs from the twenty consecutive trading days immediately prior to conversion multiplied by 90% rounded to four
decimal places,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 90% of the closing bid price for shares on the date immediately prior to conversion rounded to four decimal places,
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | $0.0025,
| | - |  | --------



| |  |  | Convertible by holder to shares at any time or mandatorily convertible at the maturity date.
| | - |  | --------------------------------------------------------------------------------------------

At year end there were 20,000,000 of these convertible securities on issue and they had a fair value of $200,000. Refer note 4.



|b. | Convertible security 2
|-- | ----------------------

In December 2011,
we received correspondence from the Lind Partners LLC, as manager of ASOF, under which ASOF allege that Metal Storm had breached the ASOF Agreement. As a result Metal Storm issued a security with a face value $700,000 as consideration for repayment
of a $470,000 loan. Consequently we recognised a $230,000 finance cost in the statement of comprehensive income.

The second convertible
security has the following terms and features:



| |  |  | Face value of $700,000.
| | - |  | -----------------------



| |  |  | Issued on 28 December 2011 in exchange for short term debt having a carrying value of $470,000.
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | Maturity Date of 17 April 2013.
| | - |  | -------------------------------



| |  |  | Convertible at the lower of:
| | - |  | ----------------------------



| |  |  | The average of the lowest five daily VWAPs from the twenty consecutive trading days immediately prior to conversion multiplied by 90% rounded to four
decimal places,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 90% of the closing bid price for shares on the date immediately prior to conversion rounded to four decimal places.
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | Convertible by holder to shares at any time in minimum amounts of $25,000 or mandatorily convertible at the maturity date.
| | - |  | --------------------------------------------------------------------------------------------------------------------------

At year end this security had a fair value of $700,000. Refer note 4. This convertible security has arisen through
conversion of short term borrowings as approved by the shareholders on 8 December 2011.



F - 33



---

##### Table of Contents

|                       |  |        |         |  |        |  |   | 
|---------------------- |  | ------ | ------- |  | ------ |  | - | 
|                       |  | 2011 $ |         |  | 2010 $ | 
|Convertible security 1 |  |        | 200,000 |  |        |  |  | 
|Convertible security 2 |  |        | 700,000 |  |        |  |  | 
|                       |  |        |         |  |        |  |   | 
|                       |  |        | 900,000 |  |        |  |  | 
|                       |  |        |         |  |        |  |   | 



|20. | Contributed equity
|--- | ------------------



|                                              |  |     |  |  |               |  |       |   |            |       |  |  |            |  
|--------------------------------------------- |  | --- |  |  | ------------- |  | ----- | - | ---------- | ----- |  |  | ---------- | -
|                                              |  |     |  |  |               |  | 2011$ |   |            | 2010$ | 
|Ordinary shares  issued and fully paid       |  |     |  |  |               |  |       |   | 81,926,463 |       |  |  | 77,683,753 |  
|                                              |  |     |  |  |               |  |       |   |            |       |  |  |            |  
|At 1 January 2009                             |  |     |  |  | 613,555,252   |  |       |   |            |       |  |  | 66,209,718 |  
|Conversion of notes first quarter             |  |     |  |  | 7,287,985     |  |       | $ | 0.0400     |       |  |  | 269,982    |  
|Conversion of notes second quarter            |  |     |  |  | 7,278,292     |  |       | $ | 0.0400     |       |  |  | 287,738    |  
|Conversion of notes third quarter             |  |     |  |  | 1,786,500     |  |       | $ | 0.0400     |       |  |  | 56,200     |  
|Conversion of notes fourth quarter            |  |     |  |  | 2,423,417     |  |       | $ | 0.0200     |       |  |  | 48,851     |  
|Shares issued in accordance with SPP          |  |     |  |  | 114,724,259   |  |       | $ | 0.0229     |       |  |  | 2,464,199  |  
|Exercise of Options                           |  |     |  |  | 1,293,758     |  |       | $ | 0.0010     |       |  |  | 1,295      |  
|Issue of Shares                               |  |     |  |  | 6,666,666     |  |       | $ | 0.0150     |       |  |  | 100,000    |  
|Issue of Shares                               |  |     |  |  | 17,142,857    |  |       | $ | 0.0175     |       |  |  | 300,000    |  
|Issue of Shares                               |  |     |  |  | 18,750,000    |  |       | $ | 0.0160     |       |  |  | 300,000    |  
|Issue of Shares                               |  |     |  |  | 950,000       |  |       | $ | 0.0039     |       |  |  | 37,050     |  
|                                              |  |     |  |  |               |  |       |   |            |       |  |  |            |  
|At 1 January 2010                             |  |     |  |  | 791,858,986   |  |       |   |            |       |  |  | 70,075,033 |  
|Conversion of notes first quarter             |  | (i) |  |  | 2,201,216     |  |       | $ | 0.0200     |       |  |  | 43,920     |  
|Conversion of notes second quarter            |  | (i) |  |  | 24,664,175    |  |       | $ | 0.0093     |       |  |  | 229,740    |  
|Conversion of notes third quarter             |  | (i) |  |  | 5,246,262     |  |       | $ | 0.0100     |       |  |  | 54,240     |  
|Conversion of notes fourth quarter            |  | (i) |  |  | 1,533,937     |  |       | $ | 0.0097     |       |  |  | 14,890     |  
|Shares issued in accordance with Rights Issue |  |     |  |  | 305,622,333   |  |       | $ | 0.0049     |       |  |  | 1,509,259  |  
|Exercise of Unlisted Options                  |  |     |  |  | 52,707,495    |  |       | $ | 0.0010     |       |  |  | 52,708     |  
|Exercise of Listed Options                    |  |     |  |  | 18,888        |  |       | $ | 0.1500     |       |  |  | 2,833      |  
|Issue of Shares                               |  |     |  |  | 7,946,273     |  |       | $ | 0.0010     |       |  |  | 7,946      |  
|Issue of Shares                               |  |     |  |  | 25,510,203    |  |       | $ | 0.0079     |       |  |  | 202,687    |  
|Issue of Shares                               |  |     |  |  | 51,178,022    |  |       | $ | 0.0080     |       |  |  | 409,424    |  
|Issue of Shares                               |  |     |  |  | 41,333,333    |  |       | $ | 0.0081     |       |  |  | 334,010    |  
|Issue of Shares                               |  |     |  |  | 39,655,678    |  |       | $ | 0.0090     |       |  |  | 358,000    |  
|Issue of Shares                               |  |     |  |  | 21,978,022    |  |       | $ | 0.0091     |       |  |  | 200,000    |  
|Issue of Shares                               |  |     |  |  | 20,636,715    |  |       | $ | 0.0097     |       |  |  | 200,000    |  
|Issue of Shares                               |  |     |  |  | 26,250,000    |  |       | $ | 0.0052     |       |  |  | 136,500    |  
|Issue of Shares                               |  |     |  |  | 40,724,658    |  |       | $ | 0.0056     |       |  |  | 227,247    |  
|Issue of Shares                               |  |     |  |  | 1,931,152     |  |       | $ | 0.0115     |       |  |  | 22,159     |  
|Issue of Shares                               |  |     |  |  | 25,000,000    |  |       | $ | 0.0126     |       |  |  | 315,000    |  
|Issue of Shares                               |  |     |  |  | 52,669,568    |  |       | $ | 0.0133     |       |  |  | 700,000    |  
|Issue of Shares                               |  |     |  |  | 2,022,592     |  |       | $ | 0.0139     |       |  |  | 28,144     |  
|Issue of Shares                               |  |     |  |  | 14,285,714    |  |       | $ | 0.0140     |       |  |  | 159,787    |  
|Issue of Shares                               |  |     |  |  | 27,900,794    |  |       | $ | 0.0143     |       |  |  | 400,000    |  
|Issue of Shares                               |  |     |  |  | 12,500,000    |  |       | $ | 0.0160     |       |  |  | 200,000    |  
|Issue of Shares                               |  |     |  |  | 49,444,444    |  |       | $ | 0.0162     |       |  |  | 800,000    |  
|Issue of Shares                               |  |     |  |  | 17,719,298    |  |       | $ | 0.0171     |       |  |  | 303,000    |  
|Issue of Shares                               |  |     |  |  | 40,000,000    |  |       | $ | 0.0174     |       |  |  | 697,226    |  
|                                              |  |     |  |  |               |  |       |   |            |       |  |  |            |  
|At 1 January 2011                             |  |     |  |  | 1,702,539,758 |  |       |   |            |       |  |  | 77,683,753 |  
|Conversion of notes first quarter             |  | (i) |  |  | 416,933       |  |       | $ | 0.0100     |       |  |  | 4,094      |  
|Conversion of notes second quarter            |  | (i) |  |  | 910,318       |  |       | $ | 0.0100     |       |  |  | 9,455      |  
|Conversion of notes third quarter             |  | (i) |  |  |              |  |       |   |           |       |  |  |           |  
|Conversion of notes fourth quarter            |  | (i) |  |  | 50,490        |  |       | $ | 0.0100     |       |  |  | 505        |  
|Shares issued in accordance with Rights Issue |  |     |  |  | 509,732,686   |  |       | $ | 0.0030     |       |  |  | 1,529,197  |  
|Rights Issue costs                            |  |     |  |  |              |  |       |   |           |       |  |  | (76,412    | )
|Exercise of options                           |  |     |  |  | 7,212         |  |       | $ | 0.0010     |       |  |  | 7          |  
|Issue of Shares                               |  |     |  |  | 135,166,667   |  |       | $ | 0.0030     |       |  |  | 405,500    |  
|Issue of Shares                               |  |     |  |  | 75,444,302    |  |       | $ | 0.0040     |       |  |  | 301,777    |  
|Issue of Shares                               |  |     |  |  | 172,766,209   |  |       | $ | 0.0050     |       |  |  | 863,844    |  
|Issue of Shares                               |  |     |  |  | 48,177,723    |  |       | $ | 0.0052     |       |  |  | 250,293    |  
|Issue of Shares                               |  |     |  |  | 5,888,944     |  |       | $ | 0.0060     |       |  |  | 35,334     |  
|Issue of Shares                               |  |     |  |  | 81,000,000    |  |       | $ | 0.0067     |       |  |  | 542,700    |  
|Issue of Shares                               |  |     |  |  | 31,600,000    |  |       | $ | 0.0070     |       |  |  | 221,200    |  
|Issue of Shares                               |  |     |  |  | 13,777,022    |  |       | $ | 0.0080     |       |  |  | 110,216    |  
|Issue of Shares                               |  |     |  |  | 5,000,000     |  |       | $ | 0.0090     |       |  |  | 45,000     |  
|                                              |  |     |  |  |               |  |       |   |            |       |  |  |            |  
|At 31 December 2011                           |  |     |  |  | 2,782,478,264 |  |       |   |            |       |  |  | 81,926,463 |  
|                                              |  |     |  |  |               |  |       |   |            |       |  |  |            |  



F - 34



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##### Table of Contents

|i | Issue price is based on calculation in accordance with Convertible Note terms. Value is based on the amortised cost of the notes converted.
|- | -------------------------------------------------------------------------------------------------------------------------------------------



|a. | Movement in listed options
|-- | --------------------------

The
following table illustrates the number and weighted average exercise price (WAEP) of share options granted during the year under the constitution.



|                                     |  |            |             |   |          |  |       |            |  |  |            |   |  |  |       | 
|------------------------------------ |  | ---------- | ----------- | - | -------- |  | ----- | ---------- |  |  | ---------- | - |  |  | ----- | 
|                                     |  | Number2011 |             |   | WAEP2011 |  |       | Number2010 |  |  | WAEP2010   |  
|Outstanding at beginning of the year |  |            | 27,856,846  |   |          |  | 0.150 |            |  |  |           |   |  |  |      | 
|Granted during the year              |  |            |            |   |          |  |      |            |  |  | 27,875,734 |   |  |  | 0.150 | 
|Exercised during the year            |  |            |            |   |          |  |      |            |  |  | (18,888    | ) |  |  | 0.150 | 
|Expired during the year              |  |            | (27,856,846 | ) |          |  | 0.150 |            |  |  |           |   |  |  |      | 
|                                     |  |            |             |   |          |  |       |            |  |  |            |   |  |  |       | 
|Outstanding at the end of the year   |  |            |            |   |          |  |      |            |  |  | 27,856,846 |   |  |  | 0.150 | 
|                                     |  |            |             |   |          |  |       |            |  |  |            |   |  |  |       | 
|                                     |  |            |             |  
|Exercisable at the end of the year   |  |            |            |   |          |  |      |            |  |  | 27,856,846 |   |  |  | 0.150 | 



|b. | Movement in unlisted options
|-- | ----------------------------

During the
year the Company issued unlisted options to participants in the rights and under certain subscription agreements.



|                                     |  |            |               |   |          |  |       |            |  |  |               |   |  |  |       | 
|------------------------------------ |  | ---------- | ------------- | - | -------- |  | ----- | ---------- |  |  | ------------- | - |  |  | ----- | 
|                                     |  | Number2011 |               |   | WAEP2011 |  |       | Number2010 |  |  | WAEP2010      |  
|Outstanding at beginning of the year |  |            | 1,264,202,517 |   |          |  | 0.016 |            |  |  | 90,195,809    |   |  |  | 0.036 | 
|Granted during the year              |  |            | 248,033,333   |   |          |  | 0.015 |            |  |  | 1,238,067,976 |   |  |  | 0.015 | 
|Exercised during the year            |  |            | (7,212        | ) |          |  | 0.001 |            |  |  | (60,653,768   | ) |  |  | 0.001 | 
|Expired during the year              |  |            | (7,777,500    | ) |          |  | 0.149 |            |  |  | (3,407,500    | ) |  |  | 0.400 | 
|                                     |  |            |               |   |          |  |       |            |  |  |               |   |  |  |       | 
|Outstanding at the end of the year   |  |            | 1,504,451,138 |   |          |  | 0.015 |            |  |  | 1,264,202,517 |   |  |  | 0.016 | 
|                                     |  |            |               |   |          |  |       |            |  |  |               |   |  |  |       | 
|                                     |  |            |               |   |          |  |       |            |  |  |               |   |  |  |       | 
|                                     |  |            |               |   |          |  |       |            |  |  |               |   |  |  |       | 
|Exercisable at the end of the year   |  |            | 1,504,451,138 |   |          |  | 0.015 |            |  |  | 1,259,202,517 |   |  |  | 0.016 | 

Refer note 31 for further details.



F - 35



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##### Table of Contents

|21. | Reserves
|--- | --------



|                                 |  |  |    |  |       |  |            |       |  |  |            |  
|-------------------------------- |  |  | -- |  | ----- |  | ---------- | ----- |  |  | ---------- | -
|                                 |  |  |    |  | 2011$ |  |            | 2010$ | 
|Unlisted option reserve          |  |  |    |  |       |  | 5,926,065  |       |  |  | 5,637,859  |  
|Listed option reserve            |  |  |    |  |       |  | 6,921,446  |       |  |  | 6,921,446  |  
|Accumulated translation reserve  |  |  |    |  |       |  | (48,129    | )     |  |  | (48,129    | )
|                                 |  |  |    |  |       |  |            |       |  |  |            |  
|                                 |  |  |    |  |       |  | 12,799,382 |       |  |  | 12,511,176 |  
|                                 |  |  |    |  |       |  |            |       |  |  |            |  
|                                 |  |  |   
|Movements:                       |  |  |    |  |       |  |            |       |  |  |            |  
|                                 |  |  |   
|Unlisted option reserve          |  |  |    |  |       |  |            |       |  |  |            |  
|Balance at 1 January             |  |  |    |  |       |  | 5,637,859  |       |  |  | 3,641,736  |  
|New Issues                       |  |  |    |  |       |  | 276,866    |       |  |  | 1,996,123  |  
|Expenses recognized              |  |  | 31 |  |       |  | 11,340     |       |  |  |           |  
|                                 |  |  |    |  |       |  |            |       |  |  |            |  
|Balance at 31 December           |  |  |    |  |       |  | 5,926,065  |       |  |  | 5,637,859  |  
|                                 |  |  |    |  |       |  |            |       |  |  |            |  
|                                 |  |  |   
|Listed option reserve            |  |  |    |  |       |  |            |       |  |  |            |  
|Balance at 1 January             |  |  |    |  |       |  | 6,921,446  |       |  |  | 6,893,566  |  
|Issue of options                 |  |  |    |  |       |  |           |       |  |  | 27,880     |  
|                                 |  |  |    |  |       |  |            |       |  |  |            |  
|Balance at 31 December           |  |  |    |  |       |  | 6,921,446  |       |  |  | 6,921,446  |  
|                                 |  |  |    |  |       |  |            |       |  |  |            |  
|                                 |  |  |   
|Accumulated translation reserve  |  |  |    |  |       |  |            |       |  |  |            |  
|Balance at 1 January             |  |  |    |  |       |  | (48,129    | )     |  |  | (65,278    | )
|Currency translation differences |  |  |    |  |       |  |           |       |  |  | 17,149     |  
|                                 |  |  |    |  |       |  |            |       |  |  |            |  
|Balance at 31 December           |  |  |    |  |       |  | (48,129    | )     |  |  | (48,129    | )
|                                 |  |  |    |  |       |  |            |       |  |  |            |  

Nature and purpose of reserves



| | i. | Unlisted options reserve
| | -- | ------------------------

The options
reserve is used to record the share options issued to Directors, employees, consultants and owners.



| | ii. | Listed options reserve
| | --- | ----------------------

The listed
options reserve is used to record the receipt on allotment of listed options issued under the renounceable rights issue.



| | iii. | Accumulated translation reserve
| | ---- | -------------------------------

The
accumulated translation reserve is used to record the exchange differences arising from the translation of the financial statements of foreign subsidiaries whose functional currencies are different from the parent.



|a. | Listed option issues
|-- | --------------------

On
24 September 2009, 78,217,067 options were issued in connection with the secured convertible notes and are accounted for separately because they may be transferred independently from the secured notes. Refer note 16.

The options had the following terms and features:



| |  |  | Each Option entitles the holder to subscribe for one ordinary share upon exercise
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Fixed exercise price of $0.15
| | - |  | -----------------------------



| |  |  | Exercisable anytime between issuance and 1 September 2011
| | - |  | ---------------------------------------------------------

Upon issue of the secured notes, 5 unlisted options were issued to secured noteholders for every 7 secured notes issued.



F - 36



---

##### Table of Contents

|b. | Unlisted option issues
|-- | ----------------------

During 2011,
243,000,000 options were issued as part of equity placements. The options have an exercise price of $0.015 and are exercisable anytime between grant date and 13 September 2013.

A further 2,333,333 options were issued with an exercise price of $0.001 with an exercise price of $0.001 and are exercisable anytime between grant date and 12 September 2013.

2,700,000 options were issued with an expercise price of $0.001 and are exercisable anytime between grant date and 12 September 2013.

In 2010, 1,108,116,999 options were issued with an expercise price of $0.015 and are exercisable anytime between grant date and 13 September 2013.

101,062,425 options were issued with an expercise price of $0.018 and are exercisable anytime between grant date and 23 February 2011.

16,619,741 options were issued with an expercise price of $0.001 and are exercisable anytime between grant date and 24 February 2012.

8,000,000 options were issued with an expercise price of $0.035 and are exercisable anytime between grant date and 11 February 2013.

4,268,811 options were issued with an expercise price of $0.035 and are exercisable anytime between grant date and 16 April 2013.



|c. | Unlisted options issued
|-- | -----------------------

At
31 December the following unlisted options were on issue:



|                  |  |                |       |  |            |  |               |            |  |  |               |  |  |  |            | 
|----------------- |  | -------------- | ----- |  | ---------- |  | ------------- | ---------- |  |  | ------------- |  |  |  | ---------- | 
|Expiry Date       |  | ExercisePrice$ |       |  | 2011Number |  |               | 2010Number |  |  | 2009Number    | 
|18 March 2010     |  |                | 0.400 |  |            |  |              |            |  |  |              |  |  |  | 20,000     | 
|31 March 2010     |  |                | 0.400 |  |            |  |              |            |  |  |              |  |  |  | 200,000    | 
|21 June 2010      |  |                | 0.400 |  |            |  |              |            |  |  |              |  |  |  | 578,750    | 
|24 June 2010      |  |                | 0.400 |  |            |  |              |            |  |  |              |  |  |  | 1,990,000  | 
|30 June 2010      |  |                | 0.400 |  |            |  |              |            |  |  |              |  |  |  | 200,000    | 
|30 September 2010 |  |                | 0.400 |  |            |  |              |            |  |  |              |  |  |  | 200,000    | 
|31 December 2010  |  |                | 0.400 |  |            |  |              |            |  |  |              |  |  |  | 218,750    | 
|31 March 2011     |  |                | 0.400 |  |            |  |              |            |  |  | 193,750       |  |  |  | 193,750    | 
|28 April 2011     |  |                | 0.400 |  |            |  |              |            |  |  | 940,000       |  |  |  | 940,000    | 
|30 June 2011      |  |                | 0.400 |  |            |  |              |            |  |  | 818,750       |  |  |  | 818,750    | 
|02 July 2011      |  |                | 0.010 |  |            |  |              |            |  |  | 5,000,000     |  |  |  | 5,000,000  | 
|30 September 2011 |  |                | 0.400 |  |            |  |              |            |  |  | 125,000       |  |  |  | 125,000    | 
|27 October 2011   |  |                | 0.400 |  |            |  |              |            |  |  | 506,250       |  |  |  | 506,250    | 
|31 December 2011  |  |                | 0.400 |  |            |  |              |            |  |  | 193,750       |  |  |  | 193,750    | 
|23 February 2012  |  |                | 0.018 |  |            |  | 101,062,425   |            |  |  | 101,062,425   |  |  |  |           | 
|08 March 2012     |  |                | 0.180 |  |            |  | 1,000,000     |            |  |  | 1,000,000     |  |  |  | 1,000,000  | 
|31 March 2012     |  |                | 0.400 |  |            |  | 193,750       |            |  |  | 193,750       |  |  |  | 193,750    | 
|30 June 2012      |  |                | 0.400 |  |            |  | 193,750       |            |  |  | 193,750       |  |  |  | 193,750    | 
|24 September 2012 |  |                | 0.001 |  |            |  | 35,215,403    |            |  |  | 32,889,282    |  |  |  | 76,923,309 | 
|30 September 2012 |  |                | 0.400 |  |            |  | 193,750       |            |  |  | 193,750       |  |  |  | 193,750    | 
|31 December 2012  |  |                | 0.400 |  |            |  | 168,750       |            |  |  | 168,750       |  |  |  | 168,750    | 
|11 February 2013  |  |                | 0.035 |  |            |  | 8,000,000     |            |  |  | 8,000,000     |  |  |  |           | 
|31 March 2013     |  |                | 0.400 |  |            |  | 168,750       |            |  |  | 168,750       |  |  |  | 168,750    | 
|16 April 2013     |  |                | 0.035 |  |            |  | 4,268,811     |            |  |  | 4,268,811     |  |  |  |           | 
|30 June 2013      |  |                | 0.400 |  |            |  | 168,750       |            |  |  | 168,750       |  |  |  | 168,750    | 
|12 September 2013 |  |                | 0.001 |  |            |  | 2,700,000     |            |  |  |              |  |  |  |           | 
|13 September 2013 |  |                | 0.015 |  |            |  | 1,351,116,999 |            |  |  | 1,108,116,999 |  |  |  |           | 
|                  |  |                |       |  |            |  |               |            |  |  |               |  |  |  |            | 
|                  |  |                |       |  |            |  | 1,504,451,138 |            |  |  | 1,264,202,517 |  |  |  | 90,195,809 | 
|                  |  |                |       |  |            |  |               |            |  |  |               |  |  |  |            | 



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|22. | Accumulated losses
|--- | ------------------



|                       |  |       |              |   |       |  |              |  
|---------------------- |  | ----- | ------------ | - | ----- |  | ------------ | -
|                       |  | 2011$ |              |   | 2010$ | 
|Balance at 1 January   |  |       | (108,684,314 | ) |       |  | (99,746,061  | )
|Net loss               |  |       | (5,764,889   | ) |       |  | (8,938,253   | )
|                       |  |       |              |   |       |  |              |  
|Balance at 31 December |  |       | (114,449,203 | ) |       |  | (108,684,314 | )
|                       |  |       |              |   |       |  |              |  



|23. | Key management personnel disclosures
|--- | ------------------------------------



|a. | Key management personnel compensation
|-- | -------------------------------------



|                             |  |       |           |  |       |  |           |       |  |  |           | 
|---------------------------- |  | ----- | --------- |  | ----- |  | --------- | ----- |  |  | --------- | 
|                             |  | 2011$ |           |  | 2010$ |  |           | 2009$ | 
|Short-term employee benefits |  |       | 1,277,289 |  |       |  | 1,556,288 |       |  |  | 1,564,097 | 
|Post-employment benefits     |  |       | 65,941    |  |       |  | 86,672    |       |  |  | 86,139    | 
|Share-based payments         |  |       | 40,000    |  |       |  | 15,000    |       |  |  | 4,680     | 
|                             |  |       |           |  |       |  |           |       |  |  |           | 
|                             |  |       | 1,384,708 |  |       |  | 1,657,960 |       |  |  | 1,654,916 | 
|                             |  |       |           |  |       |  |           |       |  |  |           | 



|b. | Equity instrument disclosures relating to key management personnel
|-- | ------------------------------------------------------------------



| | i. | Options provided as remuneration and shares issued on exercise of such options
| | -- | ------------------------------------------------------------------------------

During the financial year no options were granted to key management personnel in respect of remuneration for the 2011 financial year (2010: nil). No key management personnel exercised any options during
the year.



| | ii. | Option holdings
| | --- | ---------------

The numbers of options
over ordinary shares in the Company held during the financial year by each director of Metal Storm Limited and other key management personnel of the Group, including their personally related parties, are set out below.



|                                            |  |                            |           |  |                        |  |   |           |  |  |         |  |  |                           |         |  |                       |  |           |          |  |  |           |  |  |  |   | 
|------------------------------------------- |  | -------------------------- | --------- |  | ---------------------- |  | - | --------- |  |  | ------- |  |  | ------------------------- | ------- |  | --------------------- |  | --------- | -------- |  |  | --------- |  |  |  | - | 
|2011                                        |  |                            |           |  |                        |  |   |           |  |  |         |  |  |                           |         |  |                       |  |           |          | 
|                                            |  |                            |           |  |                        |  |  
|Name                                        |  | Balance atstart of theyear |           |  | Granted ascompensation |  |   | Exercised |  |  | Expired |  |  | Balance at endof the year |         |  | Vested andexercisable |  |           | Unvested | 
|                                            |  |                            |           |  |                        | 
|Directors                                   |  |                            |           |  |                        |  |   |           |  |  |         |  |  |                           |         |  |                       |  |           |          |  |  |           |  |  |  |   | 
|TJ ODwyer                                  |  |                            | 839,546   |  |                        |  |  |           |  |  |        |  |  |                           |        |  |                       |  | 839,546   |          |  |  | 839,546   |  |  |  |  | 
|L J Finniear                                |  |                            | 1,335,298 |  |                        |  |  |           |  |  |        |  |  |                           |        |  |                       |  | 1,335,298 |          |  |  | 1,335,298 |  |  |  |  | 
|J R Nicholls                                |  |                            |          |  |                        |  |  |           |  |  |        |  |  |                           |        |  |                       |  |          |          |  |  |          |  |  |  |  | 
|T W Tappenden                               |  |                            | 75,000    |  |                        |  |  |           |  |  |        |  |  |                           |        |  |                       |  | 75,000    |          |  |  | 75,000    |  |  |  |  | 
|W Henkel                                    |  |                            |          |  |                        |  |  |           |  |  |        |  |  |                           |        |  |                       |  |          |          |  |  |          |  |  |  |  | 
|                                            |  |                            |           |  |                        |  |  
|Other key management personnel of the group |  |                            |           |  |                        |  |   |           |  |  |         |  |  |                           |         |  |                       |  |           |          |  |  |           |  |  |  |   | 
|B I Farmer                                  |  |                            | 544,407   |  |                        |  |  |           |  |  |        |  |  |                           |        |  |                       |  | 544,407   |          |  |  | 544,407   |  |  |  |  | 
|P D Faulkner                                |  |                            | 200,000   |  |                        |  |  |           |  |  |        |  |  |                           | 100,000 |  |                       |  | 100,000   |          |  |  | 100,000   |  |  |  |  | 
|N J Partridge                               |  |                            |          |  |                        |  |  |           |  |  |        |  |  |                           |        |  |                       |  |          |          |  |  |          |  |  |  |  | 
|G A Orrison                                 |  |                            |          |  |                        |  |  |           |  |  |        |  |  |                           |        |  |                       |  |          |          |  |  |          |  |  |  |  | 
|                                            |  |                            |           |  |                        |  |   |           |  |  |         |  |  |                           |         |  |                       |  |           |          |  |  |           |  |  |  |   | 
|                                            |  |                            | 2,994,251 |  |                        |  |  |           |  |  |        |  |  |                           | 100,000 |  |                       |  | 2,894,251 |          |  |  | 2,894,251 |  |  |  |  | 
|                                            |  |                            |           |  |                        |  |   |           |  |  |         |  |  |                           |         |  |                       |  |           |          |  |  |           |  |  |  |   | 



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|                                            |  |                            |           |  |                        |  |   |                                   |  |  |           |  |  |         |   |  |                           |  |   |                       |  |  |           |  |  |  |           |  |  |  |   | 
|------------------------------------------- |  | -------------------------- | --------- |  | ---------------------- |  | - | --------------------------------- |  |  | --------- |  |  | ------- | - |  | ------------------------- |  | - | --------------------- |  |  | --------- |  |  |  | --------- |  |  |  | - | 
|2010                                        |  |                            |           |  |                        |  |   |                                   |  |  |           |  |  |         |   |  |                           |  |   |                       |  |  |           | 
|                                            |  |                            |           |  |                        |  |   |                                  
|Name                                        |  | Balance atstart of theyear |           |  | Granted ascompensation |  |   | Optionspurchasedunder RightsIssue |  |  | Exercised |  |  | Expired |   |  | Balance at endof the year |  |   | Vested andexercisable |  |  | Unvested  | 
|Directors                                   |  |                            |           |  |                        |  |   |                                   |  |  |           |  |  |         |   |  |                           |  |   |                       |  |  |           |  |  |  |           |  |  |  |   | 
|TJ ODwyer                                  |  |                            | 48,311    |  |                        |  |  |                                   |  |  | 791,235   |  |  |         |  |  |                           |  |  |                       |  |  | 839,546   |  |  |  | 839,546   |  |  |  |  | 
|L J Finniear                                |  |                            | 1,000,000 |  |                        |  |  |                                   |  |  | 335,298   |  |  |         |  |  |                           |  |  |                       |  |  | 1,335,298 |  |  |  | 1,335,298 |  |  |  |  | 
|J R Nicholls                                |  |                            |          |  |                        |  |  |                                   |  |  |          |  |  |         |  |  |                           |  |  |                       |  |  |          |  |  |  |          |  |  |  |  | 
|T W Tappenden                               |  |                            |          |  |                        |  |  |                                   |  |  | 75,000    |  |  |         |  |  |                           |  |  |                       |  |  | 75,000    |  |  |  | 75,000    |  |  |  |  | 
|W Henkel                                    |  |                            |          |  |                        |  |  |                                   |  |  |          |  |  |         |  |  |                           |  |  |                       |  |  |          |  |  |  |          |  |  |  |  | 
|                                            |  |                            |           |  |                        |  |   |                                  
|Other key management personnel of the group |  |                            |           |  |                        |  |   |                                   |  |  |           |  |  |         |   |  |                           |  |   |                       |  |  |           |  |  |  |           |  |  |  |   | 
|P R Wetzig                                  |  |                            |          |  |                        |  |  |                                   |  |  | 120,000   |  |  |         |  |  |                           |  |  |                       |  |  | 120,000   |  |  |  | 120,000   |  |  |  |  | 
|B I Farmer                                  |  |                            |          |  |                        |  |  |                                   |  |  | 544,407   |  |  |         |  |  |                           |  |  |                       |  |  | 544,407   |  |  |  | 544,407   |  |  |  |  | 
|P D Faulkner                                |  |                            | 200,000   |  |                        |  |  |                                   |  |  |          |  |  |         |   |  |                           |  |   |                       |  |  | 200,000   |  |  |  | 200,000   |  |  |  |  | 
|D M Pashen                                  |  |                            |          |  |                        |  |  |                                   |  |  | 2,400,000 |  |  |         |  |  |                           |  |  |                       |  |  | 2,400,000 |  |  |  | 2,400,000 |  |  |  |  | 
|N J Partridge                               |  |                            |          |  |                        |  |  |                                   |  |  |          |  |  |         |  |  |                           |  |  |                       |  |  |          |  |  |  |          |  |  |  |  | 
|G A Orrison                                 |  |                            |          |  |                        |  |  |                                   |  |  |          |  |  |         |  |  |                           |  |  |                       |  |  |          |  |  |  |          |  |  |  |  | 
|                                            |  |                            |           |  |                        |  |   |                                   |  |  |           |  |  |         |   |  |                           |  |   |                       |  |  |           |  |  |  |           |  |  |  |   | 
|                                            |  |                            | 1,248,311 |  |                        |  |  |                                   |  |  | 4,265,940 |  |  |         |  |  |                           |  |  |                       |  |  | 5,514,251 |  |  |  | 5,514,251 |  |  |  |  | 
|                                            |  |                            |           |  |                        |  |   |                                   |  |  |           |  |  |         |   |  |                           |  |   |                       |  |  |           |  |  |  |           |  |  |  |   | 

All vested options are exercisable at the end of the year.



| | iii. | Share holdings
| | ---- | --------------

The numbers of shares in
the Company held during the financial year by each director of Metal Storm Limited and other key management personnel of the Group, including their personally related parties, are set out below.



|                                            |  |                            |           |  |                       |  |           |                          |  |  |           | 
|------------------------------------------- |  | -------------------------- | --------- |  | --------------------- |  | --------- | ------------------------ |  |  | --------- | 
|2011                                        |  | Balance atstart of theyear |           |  | Changesduring theyear |  |           | Balance atend of theyear | 
|Directors                                   |  |                            |           |  |                       |  |           |                          |  |  |           | 
|T J ODwyer                                 |  |                            | 1,318,724 |  |                       |  | 1,318,725 |                          |  |  | 2,637,449 | 
|L J Finniear                                |  |                            | 558,828   |  |                       |  | 558,828   |                          |  |  | 1,117,656 | 
|J R Nicholls                                |  |                            |          |  |                       |  |          |                          |  |  |          | 
|T W Tappenden                               |  |                            | 125,000   |  |                       |  |          |                          |  |  | 125,000   | 
|W Henkel                                    |  |                            |          |  |                       |  |          |                          |  |  |          | 
|                                            |  |                            |          
|Other key management personnel of the group |  |                            |           |  |                       |  |           |                          |  |  |           | 
|B I Farmer                                  |  |                            | 500,000   |  |                       |  | 500,000   |                          |  |  | 1,000,000 | 
|P D Faulkner                                |  |                            |          |  |                       |  |          |                          |  |  |          | 
|N J Partridge                               |  |                            |          |  |                       |  |          |                          |  |  |          | 
|G A Orrison                                 |  |                            |          |  |                       |  |          |                          |  |  |          | 
|                                            |  |                            |           |  |                       |  |           |                          |  |  |           | 
|                                            |  |                            | 2,502,552 |  |                       |  | 2,377,553 |                          |  |  | 4,880,105 | 
|                                            |  |                            |           |  |                       |  |           |                          |  |  |           | 



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|                                            |  |                            |           |  |                       |  |           |                          |  |  |           | 
|------------------------------------------- |  | -------------------------- | --------- |  | --------------------- |  | --------- | ------------------------ |  |  | --------- | 
|2010                                        |  | Balance atstart of theyear |           |  | Changesduring theyear |  |           | Balance atend of theyear | 
|Directors                                   |  |                            |           |  |                       |  |           |                          |  |  |           | 
|T J ODwyer                                 |  |                            | 1,054,979 |  |                       |  | 263,745   |                          |  |  | 1,318,724 | 
|L J Finniear                                |  |                            | 447,062   |  |                       |  | 111,766   |                          |  |  | 558,828   | 
|J R Nicholls                                |  |                            |          |  |                       |  |          |                          |  |  |          | 
|T W Tappenden                               |  |                            | 100,000   |  |                       |  | 25,000    |                          |  |  | 125,000   | 
|W Henkel                                    |  |                            |          |  |                       |  |          |                          |  |  |          | 
|                                            |  |                            |          
|Other key management personnel of the group |  |                            |           |  |                       |  |           |                          |  |  |           | 
|B I Farmer                                  |  |                            | 318,531   |  |                       |  | 181,469   |                          |  |  | 500,000   | 
|P D Faulkner                                |  |                            |          |  |                       |  |          |                          |  |  |          | 
|N J Partridge                               |  |                            |          |  |                       |  |          |                          |  |  |          | 
|G A Orrison                                 |  |                            |          |  |                       |  |          |                          |  |  |          | 
|P R Wetzig                                  |  |                            | 44,106    |  |                       |  | 40,000    |                          |  |  | 84,106    | 
|D M Pashen                                  |  |                            | 209,265   |  |                       |  | 800,000   |                          |  |  | 1,009,265 | 
|                                            |  |                            |           |  |                       |  |           |                          |  |  |           | 
|                                            |  |                            | 2,173,943 |  |                       |  | 1,421,980 |                          |  |  | 3,595,923 | 
|                                            |  |                            |           |  |                       |  |           |                          |  |  |           | 



|c. | Loans to key management personnel
|-- | ---------------------------------

There
were no loans to key management at 31 December 2011 or 31 December 2010.



|d. | Other transactions and balances with key management personnel
|-- | -------------------------------------------------------------

At 31 December the following Directors fees were payable to directors in relation to the financial year then ended:



|              |  |       |        |  |       |  |       | 
|------------- |  | ----- | ------ |  | ----- |  | ----- | 
|              |  | 2011$ |        |  | 2010$ | 
|T J ODwyer   |  |       | 26,667 |  |       |  |      | 
|J R Nicholls  |  |       | 16,666 |  |       |  |      | 
|T W Tappenden |  |       | 20,000 |  |       |  |      | 
|W Henkel      |  |       | 20,833 |  |       |  | 8,333 | 
|              |  |       |        |  |       |  |       | 
|              |  |       | 84,166 |  |       |  | 8,333 | 
|              |  |       |        |  |       |  |       | 



|24. | Remuneration of auditors
|--- | ------------------------

During the year
the following fees were paid or payable for services provided by the auditor of the Company, its related practises and non-related firms:



|a. | Audit Services
|-- | --------------



|                                         |  |       |         |  |       |  |         |       |  |  |         | 
|---------------------------------------- |  | ----- | ------- |  | ----- |  | ------- | ----- |  |  | ------- | 
|                                         |  | 2011$ |         |  | 2010$ |  |         | 2009$ | 
|PricewaterhouseCoopers                   |  |       |         |  |       |  |         |       |  |  |         | 
|Audit and review of financial statements |  |       | 332,850 |  |       |  | 305,000 |       |  |  | 341,500 | 
|Other assurance services                 |  |       |        |  |       |  | 30,400  |       |  |  |        | 
|Non-PricewaterhouseCoopers               |  |       |         |  |       |  |         |       |  |  |         | 
|Audit and review of financial statements |  |       |        |  |       |  |        |       |  |  |        | 
|                                         |  |       |         |  |       |  |         |       |  |  |         | 
|                                         |  |       | 332,850 |  |       |  | 335,400 |       |  |  | 341,500 | 
|                                         |  |       |         |  |       |  |         |       |  |  |         | 



|b. | Non-audit Services
|-- | ------------------



|                       |  |       |   |  |       |  |   |       |  |  |        | 
|---------------------- |  | ----- | - |  | ----- |  | - | ----- |  |  | ------ | 
|                       |  | 2011$ |   |  | 2010$ |  |   | 2009$ | 
|PricewaterhouseCoopers |  |       |   |  |       |  |   |       |  |  |        | 
|Non-audit services     |  |       |  |  |       |  |  |       |  |  | 69,000 | 
|                       |  |       |   |  |       |  |   |       |  |  |        | 



40



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|25. | Commitments
|--- | -----------



|a. | Operating leases
|-- | ----------------

Future minimum rental
payments under non-cancellable operating leases as at 31 December are as follows:



|                                         |  |       |         |  |       |  |           |       |  |  |         | 
|---------------------------------------- |  | ----- | ------- |  | ----- |  | --------- | ----- |  |  | ------- | 
|                                         |  | 2011$ |         |  | 2010$ |  |           | 2009$ | 
|Within one year                          |  |       | 336,369 |  |       |  | 312,820   |       |  |  | 138,494 | 
|After one year but not more than 5 years |  |       | 606,474 |  |       |  | 966,505   |       |  |  |        | 
|More than 5 years                        |  |       |        |  |       |  |          |       |  |  |        | 
|                                         |  |       |         |  |       |  |           |       |  |  |         | 
|Total minimum lease payments             |  |       | 942,843 |  |       |  | 1,279,325 |       |  |  | 138,494 | 
|                                         |  |       |         |  |       |  |           |       |  |  |         | 



|b. | Finance leases
|-- | --------------

Future minimum lease
payments under finance leases together with the present value of the net minimum lease payments are as follows:



|                                          |  |                      |        |   |                               |  |        | 
|----------------------------------------- |  | -------------------- | ------ | - | ----------------------------- |  | ------ | 
|                                          |  | Minimumleasepayments |        |   | Present valueof leasepayments | 
|                                          |  | 2011                 |       
|                                          |  | $                    |        |   | $                             | 
|Within one year                           |  |                      | 3,413  |   |                               |  | 3,229  | 
|After one year but not more than 5 years  |  |                      |       |   |                               |  |       | 
|                                          |  |                      |        |   |                               |  |        | 
|Total minimum lease payments              |  |                      | 3,413  |   |                               |  | 3,229  | 
|Less amounts representing finance charges |  |                      | (184   | ) |                               |  |       | 
|                                          |  |                      |        |   |                               |  |        | 
|                                          |  |                      | 3,229  |   |                               |  | 3,229  | 
|                                          |  |                      |        |   |                               |  |        | 
|                                          | 
|                                          |  | 2010                 |       
|                                          |  | $                    |        |   | $                             | 
|Within one year                           |  |                      | 4,235  |   |                               |  | 3,471  | 
|After one year but not more than 5 years  |  |                      | 3,417  |   |                               |  | 3,234  | 
|                                          |  |                      |        |   |                               |  |        | 
|Total minimum lease payments              |  |                      | 7,652  |   |                               |  | 6,705  | 
|Less amounts representing finance charges |  |                      | (947   | ) |                               |  |       | 
|                                          |  |                      |        |   |                               |  |        | 
|                                          |  |                      | 6,705  |   |                               |  | 6,705  | 
|                                          |  |                      |        |   |                               |  |        | 
|                                          | 
|                                          |  | 2009                 |       
|                                          |  | $                    |        |   | $                             | 
|Within one year                           |  |                      | 6,590  |   |                               |  | 5,344  | 
|After one year but not more than 5 years  |  |                      | 8,556  |   |                               |  | 7,630  | 
|                                          |  |                      |        |   |                               |  |        | 
|Total minimum lease payments              |  |                      | 15,146 |   |                               |  | 12,974 | 
|Less amounts representing finance charges |  |                      | (2,172 | ) |                               |  |       | 
|                                          |  |                      |        |   |                               |  |        | 
|                                          |  |                      | 12,974 |   |                               |  | 12,974 | 
|                                          |  |                      |        |   |                               |  |        | 



F - 41



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|26. | Related party transactions
|--- | --------------------------



|a. | Loans to/from related parties
|-- | -----------------------------

Loans made
to controlled entities, including wholly owned subsidiaries, outstanding at 31 December 2011 totalled $23,209,998. At 31 December 2010 these totalled $21,869,451. These amounts are eliminated upon consolidation. The loans are interest
bearing and have no set repayment terms. At year end a provision for diminution in value has been taken up to the amount of $23,209,998 (2010: $21,869,451).



|b. | Transactions with related parties
|-- | ---------------------------------

At
year end, Backwell Lombard Capital, a company of which Mr T ODwyer is a principal, had an outstanding loan of $214,848 owned by Metal Storm (2010: $214,848; 2009: $326,714). The loan was unsecured, has no fixed repayment dates, is at call and
does not bear interest.

During the year, Mr Faulkner, an executive of the Group, loaned the Group $33,128 (2010: $97,725; 2009: nil). This
amount has been subsequently repaid. No amount was outstanding at year end. Interest of $494 was paid on this loan (2010: $5,727; 2009: nil).

There have been no other related party transactions between the Group and its Directors, Key Management Personnel, or close members of their
family, or any entities that they control, jointly control or significantly influence that require disclosure in the financial statements under accounting standard AASB 124.



|27. | Subsidiaries
|--- | ------------



|                        |  |                         |  |                                       |     |   |            |  |     |      |  |  |       |  |  |  |       | 
|----------------------- |  | ----------------------- |  | ------------------------------------- | --- | - | ---------- |  | --- | ---- |  |  | ----- |  |  |  | ----- | 
|                        |  | Country ofIncorporation |  | Percentage of equity held bythe Group |     |   | Investment | 
|                        |  |                         |  | 2011                                  |     |   | 2010       |  |     | 2011 |  |  | 2010  | 
|Metal Storm Inc.        |  | USA                     |  |                                       | 49  | % |            |  | 49  | %    |  |  | 2,920 |  |  |  | 2,920 | 
|ProCam Machine LLC      |  | USA                     |  |                                       | 100 | % |            |  | 100 | %    |  |  |      |  |  |  |      | 
|Metal Storm USA Limited |  | USA                     |  |                                       | 100 | % |            |  | 100 | %    |  |  |      |  |  |  |      | 
|Digigun LLC             |  | USA                     |  |                                       | 100 | % |            |  | 100 | %    |  |  |      |  |  |  |      | 

The structure of Metal Storm Inc. allows the Group to bid directly on US defence projects such as the Small Business
Innovation Research (SBIR) program as the prime contractor, thus enabling revenue flows directly into the Group. Metal Storm Limited controls the operating and financial policies of Metal Storm Inc. and therefore consolidates 100%.



|28. | Events occurring after the end of the reporting period
|--- | ------------------------------------------------------

On 12 January 2012, Shareholders and Noteholders resolved to extend the maturity date of the interest bearing convertible notes issued in September 2006 and secured convertible notes issued in
September 2009 and change some of the key terms of the Notes.

The Notes have been amended to have the following terms and features:



| |  | Mature on 1 March 2015.
|- |  | -----------------------



| |  | Convertible at a conversion price equal to the lesser of $0.0105 or 90% of the average of the five lowest daily VWAPs during the 20 Business Days
immediately preceding the Conversion Date, with the resultant number being rounded down to four decimal places.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

All other
terms and conditions remain the same.

These changes represent a significant change to the terms and conditions of the Convertible Notes and
materially affect the cash flows associated with the notes. In that respect the change to the Notes terms will be treated an extinguishment and re-issue of debt on 12 January 2012.

This will require the notes to be recorded at their fair value in financial statements. The difference between their carrying value at January 2012 and their fair value is recognized in the income
statement as gain on extinguishment. At 12 January 2012, the convertible notes had a fair value of $7,071,593 resulting in a gain on extinguishment of $11,795,305. This will be recognized in the year ending 31 December 2012.

The conversion derivative is also revalued at 12 January 2012 and a change in its fair value is recognized in the statement of comprehensive income
as a fair value movement in the conversion derivative. The fair value movement to be recognized in the year ending 31 December 2012 is ($4,089,791).

On 2 April 2012, the Company announced it had entered in to a Subscription Agreement with Luxinvest Capital Advisors S.A. for $350,000.



F - 42



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##### Table of Contents

On 18 April 2012, the Company announced it had entered into a Subscription Agreement with Luxinvest
Capital Advisors S.A. for $4.3 million.

On 18 April 2012, we entered into an Umbrella Deed (the ASOF Umbrella Deed) with
ASOF and Luxinvest Capital Advisors S.A., whereby Metal Storm will redeem A$9.0 million in secured convertible notes from ASOF in exchange for a cash payment of A$1.7 million, a further A$1.4 million of secured convertible notes will be converted to
ordinary shares at a fixed conversion price of A$0.0009 per share, and pursuant to the Debt Forgiveness, A$1.5 million of secured convertible notes will be forgiven by ASOF. The parties have varied the arrangements under the ASOF Umbrella Deed such
that the A$400,000 deposit payable to ASOF under the Umbrella Deed is due by 17 May 2012. The Company has obtained commitments from Luxinvest and other investors to fund the deposit commitment by the due date. Upon completion of the transactions
contemplated by the Umbrella Deed, the A$400,000 deposit provided by Luxinvest and other investors will be used by Luxinvest and other investors to pay Metal Storm the subscription price for an unsecured convertible note with a face value of
A$300,000 and A$100,000 will be used to obtain ordinary shares at an issue price of A$0.0008 per share. Subject to completion of the transactions contemplated by the Umbrella Deed, we have agreed to issue Luxinvest with A$200,000 worth of ordinary
shares at an issue price of A$0.0008 per share, as payment of Luxinvests fee for providing the deposit under the Umbrella Deed. Under the Umbrella Deed, ASOF has the right to appoint a director of Metal Storm and has also agreed to either
redeem or convert the remaining face value of its unsecured convertible securities. Completion of the transactions contemplated by the Umbrella Deed is subject to a number of conditions being satisfied prior to July 17, 2012, including
(i) shareholder and noteholder approval, (ii) Metal Storm not suffering an event of insolvency before completion of transactions contemplated by the Umbrella Deed and (iii) completion of the A$4.3 million Subscription Deed between
Metal Storm and Luxinvest that was entered into in April 2012.



|29. | Reconciliation of loss after income tax to net cash inflow from operating activities
|--- | ------------------------------------------------------------------------------------



|                                                        |  |       |            |   |       |  |            |       |  |  |             |  
|------------------------------------------------------- |  | ----- | ---------- | - | ----- |  | ---------- | ----- |  |  | ----------- | -
|                                                        |  | 2011$ |            |   | 2010$ |  |            | 2009$ | 
|Net Loss                                                |  |       | (6,033,218 | ) |       |  | (8,938,253 | )     |  |  | (11,307,664 | )
|Adjustments for:                                        |  |       |            |   |       |  |            |       |  |  |             |  
|Depreciation and amortisation                           |  |       | 94,218     |   |       |  | 94,839     |       |  |  | 184,537     |  
|Accretion expense                                       |  |       | 1,555,968  |   |       |  | 2,062,867  |       |  |  | 3,183,491   |  
|Amortisation of transaction costs                       |  |       | (16,388    | ) |       |  | 1,552,878  |       |  |  | 576,976     |  
|Net loss of disposal of plant and equipment             |  |       | 25,303     |   |       |  |           |       |  |  |            |  
|Foreign exchange differences                            |  |       | (744       | ) |       |  | 15,414     |       |  |  | 87,508      |  
|Fair value of services paid for via issue of options    |  |       | 11,340     |   |       |  | 209,435    |       |  |  | 22,230      |  
|Fair value of services paid for via issue of shares     |  |       | 470,500    |   |       |  | 82,553     |       |  |  |            |  
|Fair value adjustment to conversion derivative          |  |       | (1,867,873 | ) |       |  | (407,041   | )     |  |  | 224,611     |  
|Gain on extinguishment of debt                          |  |       |           |   |       |  |           |       |  |  | (2,467,609  | )
|Gain on sale of available-for-sale financial assets     |  |       |           |   |       |  |           |       |  |  | (75,000     | )
|Impairment loss on available-for-sales financial assets |  |       |           |   |       |  |           |       |  |  |            |  
|Interest received                                       |  |       | (9,023     | ) |       |  | (23,458    | )     |  |  | (136,833    | )
|                                                        |  |       |           
|Changes in assets and liabilities:                      |  |       |            |   |       |  |            |       |  |  |             |  
|(Increase) / decrease in trade and other receivables    |  |       | 262,718    |   |       |  | (51,937    | )     |  |  | 461,352     |  
|(Increase) / decrease in prepayments                    |  |       | 55,908     |   |       |  | (140,071   | )     |  |  | 302,279     |  
|(Decrease) / increase in trade and other payables       |  |       | (114,961   | ) |       |  | (478,162   | )     |  |  | 287,751     |  
|(Decrease) / increase in provisions                     |  |       | (22,475    | ) |       |  | (138,034   | )     |  |  | (17,558     | )
|(Decrease) / increase in other liabilities              |  |       | 245,545    |   |       |  | (30,630    | )     |  |  | (30,299     | )
|                                                        |  |       |            |   |       |  |            |       |  |  |             |  
|Net cash used in operating activities                   |  |       | (5,343,182 | ) |       |  | (6,189,600 | )     |  |  | (8,704,228  | )
|                                                        |  |       |            |   |       |  |            |       |  |  |             |  



|a. | Non-cash financing and investing activities
|-- | -------------------------------------------

During 2011, 102,055 convertible notes were converted to 1,377,741 shares (2010: 2,655,319 notes to 43,944,374 shares; 2009: 5,071,959 notes to 18,776,194 shares).



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##### Table of Contents

In December 2011, a $470,000 loan was exchanged for 1 convertible security with a face value of $700,000
(2010: nil; 2009: nil).



F - 44



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|30. | Earnings per share
|--- | ------------------



|a. | Basic and diluted earnings per share
|-- | ------------------------------------



|                                                       |  |       |            |   |       |  |            |       |  |  |             |  
|------------------------------------------------------ |  | ----- | ---------- | - | ----- |  | ---------- | ----- |  |  | ----------- | -
|                                                       |  | 2011$ |            |   | 2010$ |  |            | 2009$ | 
|Loss for the year                                      |  |       | (6,033,218 | ) |       |  | (8,938,253 | )     |  |  | (11,307,664 | )
|                                                       |  |       |           
|Basic and diluted earnings per share (cents per share) |  |       | (0.3       | ) |       |  | (0.6       | )     |  |  | (1.2        | )



|b. | Weighted average number of shares used as the denominator
|-- | ---------------------------------------------------------



|                                                                                    |  |            |               |  |            |  |               |            |  |  |             | 
|----------------------------------------------------------------------------------- |  | ---------- | ------------- |  | ---------- |  | ------------- | ---------- |  |  | ----------- | 
|                                                                                    |  | 2011Number |               |  | 2010Number |  |               | 2009Number | 
|Weighted average number of ordinary shares for basic and diluted earnings per share |  |            | 2,030,705,830 |  |            |  | 1,380,734,227 |            |  |  | 930,322,973 | 

Earnings per share has been restated to incorporate the effect of bonus issues of shares. The weighted average number of
shares has been increased by the inclusion of shares issued subsequent to the end of the financial period which were issued for consideration at less than market value.



|c. | Information concerning other notes and options issued
|-- | -----------------------------------------------------

The following table summarizes the convertible notes, listed options and unlisted options that were not included in the calculation of weighted average number of ordinary shares because they are
anti-dilutive for the periods presented.



|                                     |  |            |               |  |            |  |               | 
|------------------------------------ |  | ---------- | ------------- |  | ---------- |  | ------------- | 
|                                     |  | 2011Number |               |  | 2010Number | 
|Interest bearing convertible notes   |  |            | 436,799,209   |  |            |  | 436,964,220   | 
|Secured convertible notes            |  |            | 1,449,890,536 |  |            |  | 1,451,103,268 | 
|Listed options                       |  |            |              |  |            |  | 27,856,846    | 
|Unlisted convertible securities      |  |            | 100,000,000   |  |            |  |              | 
|Unlisted convertible securities(i)i) |  |            | 777,777,778   |  |            |  |              | 
|Unlisted options                     |  |            | 1,504,451,138 |  |            |  | 1,264,202,517 | 



|31. | Share-based payments
|--- | --------------------



|a. | Securities issued at the discretion of the Board
|-- | ------------------------------------------------

The Board issues shares and options at their absolute discretion to employees as part of executive and employee remuneration packages and to third parties as part of capital raising transactions.

The fair value of share issues are estimated at grant date based on the Companys share price on that day.

The fair value of option issues are estimated at the date of grant using the Black-Scholes option pricing model. The following inputs were used in
determining the value of options.

Expected volatility  calculated using historical information for a period equivalent to the expected
life of the option dated back from the grant date of the options.

Risk-free interest rate  based on the implied yield on zero coupon
Australian Government bonds with a maturity equal to the expected life of the option.

Expected life of the option  range from four to
eight years determined by the terms of the option agreement and managements assessment of when the option will be exercised.

Option
exercise price  as per option terms.

Share price  share price at grant date of the option.



|b. | Expenses arising from share based payment transactions
|-- | ------------------------------------------------------



|                                            |  |       |        |  |       |  |         |       |  |  |        | 
|------------------------------------------- |  | ----- | ------ |  | ----- |  | ------- | ----- |  |  | ------ | 
|                                            |  | 2011$ |        |  | 2010$ |  |         | 2009$ | 
|Options granted during finance transactions |  |       | 11,340 |  |       |  | 209,435 |       |  |  |       | 
|Options granted and issued to employees     |  |       |       |  |       |  |        |       |  |  | 22,230 | 
|Shares granted and issued to employees      |  |       | 40,000 |  |       |  | 50,303  |       |  |  |       | 
|                                            |  |       |        |  |       |  |         |       |  |  |        | 
|                                            |  |       | 51,340 |  |       |  | 259,738 |       |  |  | 22,230 | 
|                                            |  |       |        |  |       |  |         |       |  |  |        | 



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|32. | Parent Entity Disclosures
|--- | -------------------------



|a. | Summary of financial information
|-- | --------------------------------

The
individual financial statements for the parent entity show the following aggregate amounts:



|                        |  |      |              |   |      |  |              |  
|----------------------- |  | ---- | ------------ | - | ---- |  | ------------ | -
|                        |  | 2011 |              |   | 2010 | 
|Balance Sheet           |  |      |              |   |      |  |              |  
|Current assets          |  |      | 698,972      |   |      |  | 1,397,367    |  
|Non-current assets      |  |      | 342,681      |   |      |  | 399,169      |  
|                        |  |      |              |   |      |  |              |  
|Total assets            |  |      | 1,041,653    |   |      |  | 1,796,536    |  
|                        |  |     
|Current liabilities     |  |      | 20,108,975   |   |      |  | 20,370,520   |  
|Non-current liabilities |  |      | 904,046      |   |      |  |             |  
|                        |  |      |              |   |      |  |              |  
|Total liabilities       |  |      | 21,013,021   |   |      |  | 20,370,520   |  
|                        |  |      |              |   |      |  |              |  
|Net Liabilities         |  |      | (19,971,368  | ) |      |  | (18,573,984  | )
|                        |  |      |              |   |      |  |              |  
|                        |  |     
|Contributed equity      |  |      | 81,926,463   |   |      |  | 77,683,754   |  
|Reserves                |  |      | 12,847,511   |   |      |  | 12,559,305   |  
|Retained earnings       |  |      | (114,745,342 | ) |      |  | (108,817,043 | )
|                        |  |      |              |   |      |  |              |  
|Total Equity            |  |      | (19,971,368  | ) |      |  | (18,573,984  | )
|                        |  |      |              |   |      |  |              |  



|                            |  |      |            |   |      |  |            |      |  |  |             |  
|--------------------------- |  | ---- | ---------- | - | ---- |  | ---------- | ---- |  |  | ----------- | -
|                            |  | 2011 |            |   | 2010 |  |            | 2009 | 
|Profit or loss for the year |  |      | (5,928,299 | ) |      |  | (9,431,680 | )    |  |  | (10,746,031 | )
|Total comprehensive income  |  |      | (5,928,299 | ) |      |  | (9,431,680 | )    |  |  | (10,746,031 | )



|b. | Contingent liabilities of the parent entity
|-- | -------------------------------------------

The parent entity did not have any contingent liabilities as at 31 December 2011 or 31 December 2010.



|c. | Contractual commitments
|-- | -----------------------

The parent
entity had no contractual commitments for the acquisition of property, plant or equipment as at 31 December 2011.



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SIGNATURES

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.



METAL STORM LIMITEDBy:

/s/ Lee FinniearName:

Lee J. FinniearTitle:

Chief Executive Officer


Date: May 15, 2012



1