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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 20-F (Mark one)o
    
    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE
SECURITIES EXCHANGE ACT OF 1934ORþ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2004ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   METAL STORM LIMITED (Exact Name of Registrant as Specified in its Charter)
 
 Australia
(Jurisdiction of Incorporation or Organization) Level 34, Central Plaza One
345 Queen Street
Brisbane, QLD, 4000
Australia
(Address of principal executive offices)   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
(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. 521,970,978 Ordinary Shares 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
þ     No o Indicate by check mark which financial statement item the registrant has elected to follow.
o Item 17     þ Item 18




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Table of Contents Item 1.
    
    Identity of Directors, Senior Management and Advisors
    
    
    4Item 2.
    
    Offer Statistics and Expected Timetable
    
    
    4Item 3.
    
    Key Information
    
    
    4Item 4.
    
    Information on Metal Storm
    
    
    13Item 5.
    
    Operating and Financial Review and Prospects
    
    
    22Item 6.
    
    Directors, Senior Management and Employees
    
    
    29Item 7.
    
    Major Shareholders and Related Party Transactions
    
    
    34Item 8.
    
    Financial Information
    
    
    35Item 9.
    
    The Offer and Listing
    
    
    36Item 10.
    
    Additional Information
    
    
    40Item 11.
    
    Quantitative and Qualitative Disclosure about Market Risk
    
    
    51Item 12.
    
    Description of Securities Other than Equity Securities
    
    
    51Item 13.
    
    Defaults, Dividend Arrearages and Delinquencies
    
    
    52Item 14.
    
    Material Modifications to the Rights of Security Holders and the Use of Proceeds
    
    
    52Item 15.
    
    Controls and Procedures
    
    
    52Item 16A.
    
    Audit Committee Financial Expert
    
    
    53Item 16B.
    
    Code of Ethics
    
    
    53Item 16C.
    
    Principal Accountant Fees and Services
    
    
    53Item 16D.
    
    Exemptions from the Listing Standards for Audit Committees.
    
    
    54Item 16E.
    
    Purchases of Equity Securities by the Issuer and Affiliated Purchasers
    
    
    54Item 17.
    
    Financial Statements
    
    
    55Item 18.
    
    Financial Statements
    
    
    55Item 19.
    
    Exhibits
    
    
    55EX-4.4: ASSET PURCHASE AGREEMENTEX-4.5: EMPLOYMENT AGREEMENT OF DAVID A. SMITHEX-4.6: SEPARATION AGREEMENTEX-4.8: EMPLOYMENT AGREEMENT OF JAMES D. MACDONALDEX-8.0: LIST OF SUBSIDIARIES OF METAL STORM LIMITEDEX-12.1: CERTIFICATIONEX-12.2: CERTIFICATIONEX-13.1: CERTIFICATIONEX-13.2: CERTIFICATION
  2




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All references to US$, U.S. dollar and $ are to United States dollars. All references to
A$ are to Australian dollars. Except as otherwise stated, all monetary amounts in this annual report are presented in U.S.
dollars. Historic data has been converted at the applicable rate for the date or year indicated.
The exchange rate used to convert balance sheet accounts at December 31, 2004 was A$1.00 =
US$0.7805. 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, 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. 3




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PART I 
 Item 1. Identity of Directors, Senior Management and Advisors 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 periods 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 notes thereto and other financial information appearing elsewhere in this annual
report. Our selected financial data set forth below are presented in accordance with accounting
principles generally accepted in the United States (U.S. GAAP). The statement of operations data
for the years ended December 31, 2004, 2003, 2002, 2001 and 2000 and the balance sheet data as at
December 31, 2004, 2003, 2002, 2001 and 2000 have been derived from our respective audited
financial statements. Our audited financial statements for the three years ended December 31, 2004
are included elsewhere in this annual report. As of and for theyear ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Statement of Operations Data:Total operating income
    
    $
    3,884,753
    
    
    $
    462,732
    
    
    $
    12,373
    
    
    $
    353,180
    
    
    $
    78,958Total operating expenses
    
    
    (14,194,684
    )
    
    
    (5,580,374
    )
    
    
    (5,420,444
    )
    
    
    (3,293,089
    )
    
    
    (1,588,889
    )Loss from operations
    
    
    (10,309,931
    )
    
    
    (5,117,642
    )
    
    
    (5,408,071
    )
    
    
    (2,939,909
    )
    
    
    (1,509,931
    )Total other income
    
    
    657,572
    
    
    
    386,887
    
    
    
    28,478
    
    
    
    289,555
    
    
    
    352,017Net loss
    
    
    (9,652,359
    )
    
    
    (4,730,755
    )
    
    
    (5,379,593
    )
    
    
    (2,650,354
    )
    
    
    (1,157,914
    )Net loss per ordinary share
basic and diluted (1)
    
    $
    (0.019
    )
    
    $
    (0.011
    )
    
    $
    (0.013
    )
    
    $
    (0.006
    )
    
    $
    (0.003
    )Weighted average ordinary number
of shares outstanding (2)
    
    
    500,775,685
    
    
    
    442,525,034
    
    
    
    428,974,260
    
    
    
    422,326,884
    
    
    
    421,250,210Balance Sheet Data:Total current assets
    
    $
    13,507,822
    
    
    $
    7,107,799
    
    
    $
    4,871,983
    
    
    $
    3,412,777
    
    
    $
    4,328,977Total current liabilities
    
    
    2,601,986
    
    
    
    3,083,264
    
    
    
    1,228,701
    
    
    
    232,352
    
    
    
    207,078Total assets
    
    
    16,095,641
    
    
    
    11,356,448
    
    
    
    4,964,375
    
    
    
    3,526,995
    
    
    
    4,367,525Ordinary share capital
    
    
    38,610,543
    
    
    
    23,692,899
    
    
    
    16,658,496
    
    
    
    11,667,773
    
    
    
    8,937,914Total stockholders equity (3)
    
    
    13,010,101
    
    
    
    7,033,751
    
    
    
    3,700,253
    
    
    
    3,263,653
    
    
    
    4,149,798Other Financial Data:
 4




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Dividends per share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
   (1)
    
    Net loss per ordinary share  basic and diluted is calculated as net loss for the period
divided by adjusted weighted average number of ordinary shares outstanding for the same
period.(2)
    
    Reflects 5 to 1 stock split on May 31, 2000.(3)
    
    See note 14 to our financial statements for the movement in stockholders equity. B. Capitalization and Indebtedness Not applicable. C. Reasons for Offer and Use of Proceeds Not applicable. D. Risk Factors We will likely need additional capital and may not be able to raise additional capital on favorable
terms, if at all. Metal Storm will likely require additional capital by June 2006 to fund our existing research
and development programs. In addition, we cannot be certain that we will not 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 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. 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 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 are unable to obtain such additional funding or capital when
needed, we may be required to reduce the scope of our anticipated plans, including our research and
development activities, which could materially adversely affect our business, financial condition
and results of operations. We have incurred operating losses in each year since our inception. We had net losses of $9.7
million, $4.7 million and $5.4 million for the years ended December 31, 2004, 2003 and 2002,
respectively. Such losses have resulted primarily from expenses incurred in connection with
operation of the public company, research and development activities and defense industry studies.
We expect to incur additional operating losses over the next several 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. 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 investment, research, development, testing and
possibly regulatory approval prior to any commercial sales. We do 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 expect that our principal
technology will begin commercialization in the latter half of 2006 but can give no assurance as to
how much, if any, revenue will be generated. We cannot be certain of market acceptance of our technology or the rate of any market acceptance. We expect to develop our technology for use in a range of military, law enforcement,
counter-terrorism and commercial applications. We cannot be certain that 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, 5




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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. We cannot be certain that we will be
able to fully develop or commercialize our technology and products, even if they perform
successfully in research and evaluation trials. Furthermore, we cannot be certain that the defense
industry, homeland security or law enforcement industries, or the community will accept and utilize
any products that we may develop. We are dependent on retaining key personnel. We are dependent on retaining key personnel. There is competition among defense development
companies for qualified employees, and retaining and attracting qualified individuals is critical
to our success. We cannot be certain that we will be able to attract and retain such qualified
individuals currently or in the future on acceptable terms, if at all, and the failure to do so
would have a material adverse effect on our business, financial condition and results of
operations. There also may be a limited number of people with the required knowledge of, and
experience in, the defense industry within Australia, the United States or the rest of the world.
The process of locating, training and successfully integrating such personnel into our operations
may be lengthy and expensive. 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
we develop could severely damage Metal Storms reputation. This, in turn, could adversely affect
our marketing ability and our results of operations. We work on research and development programs. Some of the applications of our technology progress in collaboration with 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 we
are unable to continue our existing research and development programs or to enter into new research
and development programs, or if there is a decrease of available funding in respect of such
programs, or if the respective governments of the countries in which we operate choose to exercise
powers available to them to control the sale or use of our technology, our business, financial
condition and results of operations could be materially adversely affected. There are some limitations relating to our technology. With our technology, we stack 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, to hold
the additional propellant, high-pressure barrels are longer and therefore, heavier. For these
reasons, the development risk of our technology increases as operating pressures rise. The extent
to which these factors will determine the practical operating pressure limits of the technology is
uncertain. The diameter of the propellant contained in a Metal Storm munition is the same diameter as the
barrel, and therefore the length of the propellant is greater than in conventional high pressure
gun systems. This may have a negative impact on the way the propellant burns, and consequently slow
the projectile. If we are not successful in developing propellants that can produce the designated
pressures from smaller volumes of propellant, it could impact the viability of some of the
applications of our technology and could adversely affect our business, financial condition and
results of operations. 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. 6




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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. 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. 7




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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, 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. Under the provisions of the Australian 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 Australian 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 Australian 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 Act, if one of the authorized offices of various government agencies
identified under the 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 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. In addition, 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 8




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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 in which we intend to compete 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, our future 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 who 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 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, and the U.S. Department of
Justice. We cannot predict future levels of defense spending with certainty and declines in
military expenditures could materially adversely affect our results of operations and financial
condition. The impact of possible declines in the level of defense procurement 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 instance,
prior to marketing, a product incorporating our technology may be required to undergo rigorous
testing as well as extensive regulatory approval processes. These processes may take many years 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 and 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. There are risks inherent in U.S. government contracts. Although we have not begun to commercialize our technology or to sell any products, in the
future we expect that a significant portion of our sales will be associated with long-term
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: 9




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
    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 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 10




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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.
Our products may cause or be associated with these injuries. 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. 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. 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. 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. Our major shareholder, James Michael ODwyer, beneficially owns approximately 38% of Metal
Storms ordinary shares and has indicated an intention to sell approximately one-half of his
shareholding before January 2006. Any such sale and any significant subsequent resales may cause
volatility in our share price. 11




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We are not currently paying dividends and we may not pay dividends in the future. Until we make a profit, our directors will not be able to recommend that any dividends be paid
to our stockholders. Our directors will not resolve a formal dividend policy for us until we
generate profits. Our future profitability 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 likely will be again, classified as a passive foreign investment company for U.S.
federal income tax purposes. We believe that we were a passive foreign investment company (PFIC) for U.S. federal income
tax purposes in 2000, 2002, 2003 and 2004 but not in 2001. We expect that Metal Storm will be a
PFIC again in 2005. For any U.S. holder that owns our American Depositary Shares 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 American Depositary Shares 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 American Depositary Shares 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. U.S. holders are urged to consult their tax advisors regarding the consequences of owning and
disposing of American Depositary Shares or ordinary shares, including the desirability of making,
and the availability of, certain elections with respect to our American Depositary Shares 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. 12




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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 Level 34, Central Plaza One, 345
Queen Street, Brisbane, Queensland, Australia, 4000. Our telephone number is 011-61-7-3221-9733.
Our website address is www.metalstorm.com. Information on our website and websites linked to it
does not constitute part of this annual report. In July 2001, our subsidiary Metal Storm Inc.
opened an office in Arlington, Virginia, which is close to the Pentagon. In March 2004, our
subsidiary Metal Storm U.S.A. Limited was formed and it shares an office with Metal Storm Inc. in
Arlington, Virginia. Our agent for service of process in the United States is David Smith, 4350 N.
Fairfax Drive, Suite 810, Arlington, VA 22203. In 1994, we acquired patents and intellectual property from Mr. J.M. ODwyer relating to our
technology. In consideration for these patents, we issued to Mr. J.M. ODwyer 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 ($1,456,646). 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 (approximately $7.7 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 ($1.94) per
share. Our ordinary shares were listed on the Australian Stock Exchange 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. From 2001 through May 2004, we raised $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 August 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 with The Bank of New York as depositary and our ADRs
commenced trading on the Nasdaq SmallCap Market under the ticker symbol MTSX. In December 2003, we acquired Seattle-based ProCam Machine LLC in exchange for the issuance of
5,524,926 ordinary shares of Metal Storm Limited and $189,739 cash. As part of this acquisition,
Metal Storm assumed $2.2 million in debt. ProCam is a manufacturer of precision-machined parts for
the defense, electronics, aircraft and space propulsion industries. On June 1, 2005, Metal Storm
sold the ProCam business to Monroe Machines Products, Inc. (MMP). MMP purchased the assets and
current order backlog of ProCam for $1.3 million, plus an additional amount to acquire accounts
receivable, inventory and assumed the accounts payable liabilities of ProCams precision machinery
facility. A sum of $50,000 has been retained in trust contingent on the satisfaction of the
conditions set forth in the Asset Purchase Agreement. Our liabilities at December 31, 2004, which
will not be assumed by MMP, total $1.5 million. We expect net proceeds of approximately $800,000 from the
sale. The sale enables Metal Storm to preserve cash
resources and better focus on commercializing its 40mm weapons
systems. Since January 2002, we have not made any material capital expenditures or divestitures. We
have no material capital expenditures or divestitures currently in progress. B. Business Overview Metal Storm is a defense technology company that develops projectile launching systems
utilizing its unique, electronically fired, stacked projectile technology. We are in a transition
phase as we transition our technology from proof of concept to product implementation. Strategy We are focusing on winning commercial contracts for the supply and integration of complete
weapon systems. In short, we seek to become a systems integrator, utilizing our unique technology
as the foundation for growing a wider business. To get there, we intend to develop progressively
more sophisticated versions of our core technologies and to turn them into saleable products. 13




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In order to achieve this outcome, we are working to generate a range of products that exploit
the unique selling points of our technology and that match market needs in areas where sustainable
long-term profit growth is possible. All of our analysis points to the 40mm Metal Storm weapons
system, with its variety of forms and applications, as the best opportunity for product
commercialization that we currently have. We have therefore dedicated our resources for the
immediate future to building a line of products based on our core 40mm technology. All other
projects take a lower priority and will only be given greater priority if an opportunity arises
where we believe there is a clear path to sustainable profit growth. Systems Integrator We are focusing on integrating our technologies into existing weapons systems. For years,
Metal Storm has been a developer of technologies and ideas. The challenge for Metal Storm in the
future will be to integrate the best of our technologies into actual systems that work in the field
and can be integrated into platforms currently in use by militaries around the world. The most
successful defense contractors sell systems, rather than technologies, and we believe our future
lies in being a systems integrator. Engineering Metal Storm is engaged in a focused period of engineering work that will include testing and
prototyping the various elements of our 40mm weapons system. Our next task is to develop a high
explosive round for the 40mm weapons system. This engineering effort is expected to continue
through the second half of 2005. We expect to conduct a full demonstration of the system using high
explosive rounds by the end of 2005. Our key engineering goal is to be able to put forth a final
design to commence certification of the 40mm weapons system to the U.S. military in the second half
of 2006. For the balance of 2005, our engineering team is expected to devote approximately 80% of
its capacity to further developing the 40mm weapons system and munitions, 10% on small caliber
systems and 10% on the technological development of a supersonic launch system for specialized
weapons application. Business Development Our strategy is to focus on winning commercial contracts for the supply and integration of
complete weapon systems that employ Metal Storms technology. Our business model is that of a
systems integrator, utilizing our unique technology as the foundation for growing a wider business.
We aim to generate a range of products that exploit the unique selling points of our technology and
which match current market needs in areas where sustainable long-term profit growth is possible.
Our business development effort is focused on building a customer base for a line of products based
on our 40mm weapons system technology. A key element of our business development strategy is the use of live-fire demonstrations to
showcase the technical and operational capabilities of our technology and prototype products. These
demonstrations serve a technical development and data gathering purpose, and a business development
purpose. Typically we would aim to conduct these demonstrations for a select audience of military
and defense industry decision-makers. Metal Storm also seeks business partners who are experts in key areas such as target
acquisition and aiming, turreting and recoil management systems, and communications protocols. In
the area of targeting, we are interested in all available technologies, including optical, laser,
radar and infrared functionalities. We are also seeking partners among software and communications
companies that can help Metal Storm further develop the essential command, control, communications
and computer capabilities needed for remotely controlled systems. As business development efforts
continue, we expect to receive contracts to produce prototypes and otherwise take our products
through the development and testing phases. Technology Metal Storms technology is an electronically initiated, stacked projectile system that
removes the mechanisms required to fire a conventional weapon. Effectively, the only parts that
move in Metal Storms technology are the projectiles contained within the barrels. Multiple
projectiles are stacked in a barrel. The technology allows each projectile to be fired sequentially
from the barrel. 14




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Metal Storms fully loaded barrel tubes are essentially serviceable weapons, without the
traditional ammunition feed or ejection system, breech opening or any other moving parts. Metal
Storm 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 connect with todays battlefield. Importantly, Metal Storm enabled systems are
capable of local or remote operation through a computerized fire control system. Our technology achieves its performance through the concept of numerous projectiles stacked in
a barrel, in which each projectile has its own propellant load, such that the leading propellant
can be reliably ignited to fire the projectile, without the resulting high pressure and temperature
causing unplanned blow-by ignition of the following propellant load, 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 with greater
firepower compared to conventional weapons;
    modular pods that could operate as a complete weapon system in one container;
    100% electronic operation;
    the potential of grouping multiple calibers and multiple lethalities in one gun
allowing the user to vary the use to a specific situation;
    numerous hybrid configurations and Special Forces applications that could result in
enhanced capabilities for use behind enemy lines; and
    fast second round strike capability before recoil effect. Internal Product Development Our internal product development program is principally focused on a weapon system for
unmanned systems. We are also working on other applications, including crew-served weapons systems
and individual combat systems. While our technology may be used across a wide range of calibers, we
are focusing on the 40mm caliber because it is used extensively in military applications and, thus,
offers the best potential for commercialization. Weapon system for Unmanned Ground Vehicle We are working with the U.S. Armys Armaments Research, Development and Engineering Center
(ARDEC) in integrating our 40mm weapon system with an unmanned ground vehicle. In March 2005, we
successfully completed a series of live fire demonstrations that were held at the U.S. Armys range
facility at Picatinny Arsenal in New Jersey. The demonstrations consisted of multiple live firings
of a purpose-built version of the Metal Storm 40mm weapon system, mounted on an unmanned ground
vehicle. During the demonstrations, the Metal Storm-equipped vehicle engaged a variety of targets,
including simulated personnel, an armored personnel carrier, and a bunker, with pyrotechnic rounds.
The purpose of the demonstration was to showcase the technical and operational capabilities of the
Metal Storm 40mm weapon system combined with a robotic platform currently in use by the U.S.
military. Weapon system for Unmanned Aerial Vehicle We are developing a weapon based on our 40mm ballistics system for mounting on unmanned aerial
vehicles to provide a combat capability. We are working with Dragonfly Pictures Inc., a U.S.
designer/manufacturer of unmanned 15




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helicopters, to create a weaponized version of its DP-4X Vertical Take Off and Landing
Unmanned Aerial Vehicle for demonstration of the capability. In May 2004, initial test firings of our weapon system from a DP-4X were conducted. The tests
included a firing of inert 40mm grenade rounds in rapid sequence four-shot bursts from two
lightweight grenade launchers mounted on a DP-4X. The firings successfully demonstrated the
integration of our generic 40mm ballistics system with the remotely operated DP-4X. This project remains firmly on foot. The next step is to conduct a set of full in-flight test
firings followed by planned live firing demonstrations to U.S. defense authorities, with
demonstrations anticipated to occur later in 2005. We expect that a successful demonstration will
provide data to determine the efficacy of potential applications. Fire Fighting System Metal Storm has been investigating a concept for a fire fighting capability in which
containers of fire retardant canisters are substituted for ammunition and placed into
multibarreled pods based on our 40mm ballistics system, sharing the same core components and
support systems. A fire-fighting system that is mounted on a fire truck and fired electronically
could use these pods to rapidly target and launch fire-retardant chemicals on to a fire or
hazardous chemical spill, or to quickly lay a fire-retarding belt. Market feedback on the
operational feasibility and likely take up of such a fire fighting product has, however, shown that
it is unlikely to generate the levels of income in the time frames previously envisaged.
Consequently, this project has been downgraded in our priority list and we have no fixed milestones
for its development. However, we continue our collaboration with Pyrogen Australia Pty Limited,
which is seeking a rapid delivery system for its halon fire-retardant alternative. Handgun We have been developing a production prototype smartgun version of the Metal Storm
electronically initiated handgun, which is based on our small caliber launching system in
conjunction with the New Jersey Institute of Technology (NJIT). Using the NJITs Dynamic Grip
Recognition authorizing technology, this product would be designed to meet the requirements
specified under legislation in the State of New Jersey that become effective in 2007, and then
other markets. There is currently a variety of gun locking systems designed to restrict access to
unauthorized users that can be added to existing handguns. Manufacturers have, however, experienced
difficulty in developing conventional mechanical handguns that operate effectively and practically
when the electronic or other authorizing systems are added. By contrast, because the Metal Storm
handgun is 100% electronic, it avoids the problems associated with most add-on electronic systems.
The electronically initiated handgun is designed with an ease of integration with a variety of
electronically controlled user and authorizing devices. After thorough analyses 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 a primary focus for internal
investment at this point. We will, however, continue to collaborate with and explore alternative
strategies with external parties for the commercial development of the handgun and we will continue
to add to our technical base in this area through work done on small caliber military systems. Individual Combat Weapon We are investigating the feasibility of applying our technology to an individual combat weapon
and, in particular, a single barrel, multi-round grenade launcher based on our 40mm ballistics
system. 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. 16




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Area Denial Weapon System In June 2000, the Commonwealth of Australia approved a program to develop a prototype mortar
box system for an area denial weapons system (ADWS) for use in minefield replacement. The
objective of this program was to develop and demonstrate the feasibility of a multi-barrel mortar
box capable of launching 40mm ammunition at electronically variable and ultra-rapid rates of fire. We have undertaken this program in collaboration with the Australian Defense Science &
Technology Organization (DSTO), the U.S. Defense Advanced Research Projects Agency and an
international consortium, of which Metal Storm is a major consortium member. The agreement to
formalize the consortium members rights and obligations was finalized in May 2002 and is due for
completion mid 2005. Under the program, each of the participants will retain ownership of the
intellectual property related to its own technology and any developments and improvements to that
technology. The ADWS consists of a system of individual Metal Storm multi-barrel stacked-projectile pods,
integrated into a networked array and linked to intrusion sensors and a fire control system. The
ADWS 40mm weapon system is part of Metal Storms primary platform for development. Live fire demonstrations were conducted in May 2005 during which the ADWS engaged simulated
targets based on information provided by a computerized sensor system. The demonstration system
comprised four weapon pods, each containing four barrels, networked and linked to a command and
control station. Each demonstrator pod has the capability to fire up to 20 projectiles in varying
user-selectable combinations including rates of fire, barrel selection and firing sequence. Firing
responses included a range of combinations from single shots through to a rapid-fire burst of 20
projectiles at 1,500 rounds per minute. The pods are able to fire at a maximum rate of 6,000
rounds per minute. More barrels can be added to each pod to increase payload as required. Australia is a signatory to the 1997 Ottawa Treaty that bans the use of Anti-Personnel Land
Mines (APLs). Due to the banning of APLs, the Australian Defense Force needed to identify a more
appropriate weapon system to deny access by a dismounted enemy to large areas of ground. The ADWS
project was established to produce a concept weapon system alternative to APLs that is complaint
with the Ottawa Treaty. The ADWS system aims to demonstrate area denial technology that can overcome the
indiscriminate nature of land mines by addressing the requirement for a human-in-the-loop to
initiate the weapon system. In addition to land mine replacement and area denial applications, the
ADWS may have potential for other uses such as airfield defense and defense of ships against
close-in terrorist attack. We are in the process of determining appropriate strategies and industry partnerships to take
the ADWS concept to a commercialization stage. Advanced Individual Combat Weapon In May 2001, the Australian Department of Defence approved a program to develop, in
conjunction with an international consortium consisting of international defense companies, a
concept technology demonstrator for a hybrid electronic/mechanical assault rifle, which has been
named the Advanced Individual Combat Weapon. We believe the Advanced Individual Combat Weapon has
the potential to replace the Australian Armys current assault rifle. The proposal plans to
integrate our technology with an individual combat weapon and a range of other technologies to fire
40 millimeter bursting munitions in addition to the North Atlantic Treaty Organizations standard
5.56 millimeter kinetic rounds. In November 2001, the Weapons System Division of DSTO announced
that it had successfully developed an early-stage prototype Advanced Individual Combat Weapon. This weapon is being developed under a program undertaken by DSTO in collaboration with us and
Tenix Defense Systems to produce three fully operational Advanced Individual Combat Weapon
prototypes for further military testing. The agreement to formalize the consortium members rights
and obligations was finalized in September 2002 and has a five-year term. Under the program, each
of the participants will retain ownership of the intellectual property related to its own
technology and any developments and improvements to that technology. This weapon will be a hybrid assault rifle with an additional barrel incorporating our
technology and providing the combat soldier with a range of enhanced weapon capabilities. It will
integrate commercial-off-the-shelf products for enhancing surveillance, communication, target
detection and target engagement with our ballistics technology. We 17




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anticipate that the fire power component of this weapon will include NATO standard 5.56
millimeter rounds, initiated mechanically or electrically, and also integrate our stacked rounds
technology to fire a variety of 40 millimeter munitions. This DSTO-led concept technology demonstrator program will continue to be developed in 2005
with a final demonstration expected in the second half of the year. Small Business Innovation Research Programs Our technology has led to the awards of Small Business Innovation Research (SBIR) programs
over the past few years. The U.S. Department of Defense SBIR program funds early stage research and
development projects that serve defense needs and have the potential for commercialization in
private sector or military markets. SBIR proposals pass through three phases. Phase I is a
six-month commercial feasibility concept stage. Success at this level can lead to an invitation to
participate in a Phase II award of up to $750,000 over two years to develop the proposal to
prototype stage. Phase III requires private sector funding to take the technology to
commercialization. In addition, the SBIR program provides for private funding into Phase II that
can fast-track approvals and attracts up to $4 from the U.S. Department of Defense for every $1 of
private contribution, thereby leveraging private sector investment. SBIR program awards for our technology include:  
    U.S. Navy.In August 2004, the U.S. Navy made a SBIR Phase I award to our U.S.
subsidiary Metal Storm Inc., which has taken the lead role in a U.S. Navy program to
develop a system to defeat incoming rocket propelled grenades (RPGs). We are the prime
contractor in this funded program designed to demonstrate the feasibility of producing a
RPG defense system that integrates Metal Storms technology with the sensor, mount and
fire control system of subcontractor Northrop Grumman. Phase I of the program was aimed
to develop the system concept. A Phase II proposal has been submitted and we are awaiting
a determination.
    U.S. Office of Naval Research.In January 2003, the U.S. Navys Office of Naval
Research made a SBIR Phase I award to our teaming partner Schappell Automation
Corporation Inc. This SBIR program utilizes our technology in an innovative weapon system
that can deliver a variety of projectiles against a number of different threats. The
system is designed for use on naval vessels for close-in threats and can also be used to
protect port facilities and berthed ships. A Phase II proposal has been submitted and we
are awaiting a determination.
    U.S. Army Research Office.In December 2002, the U.S. Army Research Office made a
SBIR Phase I award to our teaming partner Schappell Automation Corporation Inc. The
program provides for a lethal and less-than-lethal Metal Storm weapon pod system. The
objective of this SBIR program is to develop the use of our technology to deliver special
projectiles from a multi-barrel pod that can be either hand-held or mounted on a robot. A
Phase II proposal has been submitted and we are awaiting a determination. Munitions Development We are developing ammunition and single use, replaceable multi-shot cartridges in which the
ammunition will be supplied. We are specifically designing ammunition for use in weapons utilizing
our technology, particularly to support activities in the key caliber area of 40mm. We have
developed and fired kinetic and pyrotechnic munitions and are now working to produce a range of
lethal and less-than-lethal munitions calibers to support our weapon programs. In addition to our internal development efforts, we are working in collaboration with the US
Armys Armament Research Development and Engineering Center under a Cooperative Research and
Development Agreement that is currently in the process of being upgraded to broaden its scope. We
are also pursuing commercial teaming arrangements with other third parties. Research Agreements with Government Agencies DSTO Research Agreement In April 2001, we entered into a five-year research agreement, which was amended in September
2002, with the Commonwealth of Australia as represented by the Defense Science & Technology
Organization. Pursuant to this agreement, we have granted DSTO a non-exclusive, worldwide,
perpetual license to use our scientific and technical 18




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know-how and information in relation to their gun hardware and gun system technology for
defense use and international collaboration. This agreement also specifies our intellectual property ownership rights, and sets out the
terms and conditions under which we may commercialize the technology developed under it. In
particular, this agreement provides that any improvements to our gun hardware or gun system
technology, including the intellectual property, developed or acquired by or for DSTO from DSTOs
further research, will be owned by us. However, we must pay royalties to DSTO at agreed rates if
they commercialize such improvements. DSTO Technology License Agreement In April 2001, we entered into an agreement with the Commonwealth of Australia to license from
DSTO certain technology that DSTO has used as a design, evaluation or modeling tool in appraising
our gun system technology. We also have the right to improvements in the DSTO technology developed
during the term of the license agreement. This agreement is for five years or such further period as we agree with DSTO, but will in any
event terminate at the same time as the DSTO research agreement. This agreement provides that if we
commercialize any of the DSTO technology described above, we must pay DSTO a royalty calculated on
our gross revenues on manufacture, sales or licensing, after taking into account the proportion of
the value of DSTOs intellectual property incorporated into the products based on our technology. Competition Until we commercialize a product using our technology, we continue to compete for technology
research and development grants available through various areas that are administered by the U.S.
Department of Defense and other government agencies, including, for example, under the 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. We also compete with manufacturers of handguns in developing the technology for our handgun.
These companies are in the process of developing or have developed technology similar to ours that
may have some of the same or similar features to our handgun. 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) to engage in scientific or
experimental work. In compliance with the Australian 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 Defence 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. 19




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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, labeling, 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:  
    barrel technology;
    technology related to encoding weapons to permit authorized access only;
    ammunition and projectiles;
    electronic firing technology;
    area denial; and
    fire fighting. As of December 31, 2004, we had  
    14 granted U.S. patents and 26 pending U.S. patent applications;
    18 granted Australian patents and 21 pending Australian patent applications;
    4 pending international Patent Co-operation Treaty applications that designate the
United States and Australia as well as all other signatory countries; and
    81 other patents granted outside the United States and Australia and 258 pending
applications outside the United States and Australia. Raw Materials We use the following principal raw materials: aluminum, 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 aluminum and steel, the prices of such materials have not been subject to large
fluctuations. 20




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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 Not applicable. D. Property, Plant and Equipment We lease approximately 3,347 square feet of office space in Brisbane, Australia. The annual
gross rental payments are approximately $83,470 payable in monthly installments of approximately
$6,956. The lease expires on December 31, 2006. We lease approximately 6,149 square feet of office space in Arlington, Virginia. The annual
gross rental payments are $196,764, payable in monthly installments of approximately $16,397. The
lease was entered into on January 1, 2005 and expires on April 30, 2010. The previous lease for
office space in Arlington, Virginia, was for 2,451 square feet of office space and expired on
December 31, 2004. In connection with the ProCam business, we leased approximately 21,400 square feet of
warehouse space and approximately 3,600 square feet of office space in Mill Creek, Washington. The
annual gross rental payments are $226,640, plus an annual adjustment for inflation, payable in
monthly installments of approximately $18,886. The lease was entered into by ProCam on September 1,
2002 and expires on June 30, 2007. On June 1, 2005, we sold the ProCam business to Monroe Machine
Products, Inc. 21




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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 financial statements, the notes to the financial
statements and other financial information appearing elsewhere in this annual report. 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 the Key Information  Risk Factors section of Item 3D 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 develops projectile launching systems utilizing
electronically fired, stacked projectile technology. Since incorporation in 1994, we have incurred approximately $26.3 million in operating losses.
Our losses have resulted principally from costs incurred in research and development and from
general and administrative costs associated with our operations. 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 equity 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 expect to continue to incur losses as we expand our product development and
commercialization programs. 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 in the latter stage of product
development and do not expect any revenues from product sales until at least the second half of
2006. While there has been significant interest in our prototypes, we cannot give assurance that we
will manufacture or sell our products successfully or ever achieve or sustain profitability. In December 2003, we acquired ProCam Machine LLC, which manufactures precision-machined parts
for the defense, electronics, aircraft and space propulsion industries. The excess of purchase
price over the fair value of net assets was allocated to identified intangibles with the remainder
of the excess being allocated to goodwill. In December 2004, we wrote off the goodwill on the
acquisition of ProCam as we assessed it as being impaired and the likelihood of future benefits
being received was deemed to be minimal. There was no purchased R&D, no restructuring or exit costs
or contingencies related to the acquisition. ProCam was unprofitable and the goodwill on the
acquisition was fully written down in 2004. On June 1, 2005, we sold the ProCam business to Monroe
Machine Products, Inc. Where We Derive Our Revenue Until fiscal 2003, our principal source of revenue has been interest income earned on our cash
held on deposit and cash equivalents. From December 2003 through May 2005, we owned the ProCam business, which earned revenue from
the sale of its precision-engineered parts that are made to customer specifications. Revenue was
recognized on delivery of the goods to (and acceptance by) the customers. Critical Accounting Policies Our discussion and analysis of our operating and financial review and prospects are based upon
our financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of
these 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 22




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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. Revenue Recognition A sale is recorded when goods have been delivered to and accepted by the customer pursuant to
a fixed price sales order, collectibility of the selling price is reasonably assured and the
associated risks have passed to the customer. There are no further performance obligations once the
customer has accepted the goods. We receive non-refundable government grants that fund our efforts in specific research and
development projects. These grants generally provide for reimbursement of approved costs incurred
as defined in each agreement and are expected to fully cover our costs for the specific research
and development projects. We recognize grant income when key milestones set within each agreement
are achieved and accepted by all parties to the grant. At that point collectibility is reasonably
assured. Revenue for each milestone achieved is fixed up front. Once each milestone is reached and
approved, the grantor is obligated to pay us and we have no further significant obligations in
relation to that part of the milestone. We recognize interest income as it is earned and when collectibility is reasonably assured. Research and Development Expense Research and development expense, which includes personnel costs, manufacturing expenses and
outsourcing services, consists of expenditures for research we conduct and includes our share of
costs we incur under research arrangements, grants and contracts with governments. We expense
research and development expenses as they are incurred. We have not entered into any research and
development agreements that would require government grants and contracts to be recorded as an
offset to research and development expenses in accordance with the AICPA Audit and Accounting
Guide: Audits of Federal Government Contractors. In addition, although we believe that our patents and underlying technology have continuing
value, the future benefits to be derived are uncertain. We therefore include patent costs under
research and development expenses rather than capitalizing them. Non-Cash Stock Compensation We have elected to account for our stock option plan in accordance with Accounting Principles
Board Opinion No. 25: Accounting for Stock Issued to Employeesand related interpretations (APB
25) and adopt the disclosure-only provisions of SFAS No. 123: Accounting for Stock-Based
Compensation(SFAS 123). Under APB 25, we recognize compensation expense for stock option grants
to the extent that the fair value of the stock exceeds the exercise price of the option at the
measurement date. Unearned compensation expense is charged against operations ratably over the
vesting period of the options. For disclosure purposes under SFAS 123, stock options are valued at
the measurement date using the Black-Scholes option valuation model and compensation costs are
recognized ratably over the vesting period. Goodwill We recorded goodwill from the purchase of ProCam Machine LLC, which was effective December 1,
2003. In accordance with SFAS No. 142, Accounting for Goodwill and Intangible Assets, no
amortization has been recorded for goodwill. SFAS No. 142 requires that goodwill be assessed
annually for impairment. Goodwill represents the excess of the cost of businesses acquired over the fair value of the
identifiable net assets acquired. We test goodwill for impairment annually, and on an interim
basis if events or changes in circumstances between annual tests indicate that the asset might be
impaired, using the two-step process prescribed in SFAS 142. The first step is a comparison of the
fair value of the reporting unit with its carrying amount, including goodwill. If this step
reflects impairment, then the loss is measured as the excess of the recorded goodwill over its
implied fair value. Implied fair value is the excess of the fair value of the reporting unit over
the fair value of all identified assets and liabilities. 23




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Comparison of Annual Results of Operations 2004 compared with 2003 Operating income.Operating income increased from $462,732 in 2003 to $3,884,753 in 2004 due
to revenue generated from the ProCam business during 2004. As ProCam was acquired in December
2003, only one month of revenue from ProCam was reflected in operating income during 2003. Operating expenses.Total operating expenses increased $8,614,310 (154.4%) from $5,580,374 in
2003 to $14,194,684 in 2004. As described in more detail below, the increase was primarily due to
the acquisition of ProCam in December 2003. Significant movements in operating expenses were:  
    Cost of goods sold increased $923,789 (291.8%) from $316,590 in 2003 to $1,240,379
in 2004 as a result of cost of goods sold attributable to ProCam for a full fiscal year.
    Research and development expenses increased $1,089,876 (33.8%) from $3,224,112 in
2003 to $4,313,988 in 2004 principally because of higher research and development
activity in both the United States and Australia, including higher research and
development activity related to our core 40mm technology.
    Depreciation and amortization increased $372,586 (665.3%) from $56,000 in 2003 to
$428,586 in 2004 principally due to the depreciation expense associated with assets
acquired as part of the acquisition of ProCam.
    An impairment loss of $1,529,941 was recorded in 2004. We previously recorded
goodwill from the purchase of ProCam in December 2003. In accordance with SFAS No. 142,
Accounting for Goodwill and Intangible Assets, we conducted an annual impairment test for
goodwill in 2004 and determined that goodwill was impaired based on our assessment of the
fair value of the manufacturing segment and the allocation of fair value to the assets
and liabilities of that segment. Accordingly, consistent with SFAS No. 142, the goodwill
was written off.
    Rentals on operating leases increased $288,670 (244.7%) from $117,960 in 2003 to
$406,630 in 2004 primarily due to a $226,604 operating lease rental expense for ProCam,
as well as inflationary adjustments to existing operating lease rentals.
    General and administrative expenses increased $4,412,942 (239.3%) from $1,843,805
in 2003 to $6,256,747 in 2004 primarily due to the hiring of additional employees and
expenses associated with the acquisition of ProCam in December 2003 as well as an
increase in insurance premiums, travel and computer costs.
    Consulting fees-related party decreased $3,494 (15.9%) from $21,907 in 2003 to
$18,413 in 2004 primarily due to board members ceasing to provide consulting services in
2004. Other income.Total other income increased $270,685 (70%) from $386,887 in 2003 to $657,572 in
2004 primarily due to an additional $375,051 interest earned on a higher level of cash held as
deposits and cash equivalents in 2004 that resulted from the raising of $15.7 million in equity in
May 2004 partially offset by higher interest expenses relating to the bank loan and capital leases
of ProCam. Net Loss.As a result of the foregoing, our net loss increased from approximately $4.7 million
in 2003 to approximately $9.7 million in 2004. Our net loss in 2004 includes a loss of
approximately $1.2 million incurred by ProCam (excluding the impairment of goodwill), which was in
part due to low sales following a downturn in the key markets in which ProCam operates. Due to our
continuing losses, no income tax expense has been recognized. 2003 compared with 2002 Operating income.Operating income increased from $12,373 in 2002 to $462,732 in 2003 due to
sales of $235,293 generated from ProCam in December 2003 and higher grant income of $227,439
received under the NIJ SmartGun project. 24




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Operating expenses.Total operating expenses increased $159,930 (3%) from $5,420,444 in 2002
to $5,580,374 in 2003. As described in more detail below, the increase was primarily due to the
acquisition of ProCam in December 2003. Significant movements in operating expenses were:  
    Cost of goods sold was $316,590 in 2003 and related to sales made by ProCam in
December 2003. We had no sales or cost of goods sold in 2002. As a result of December
2003s low margin sales, gross margin was negative.
    Research and development expenses decreased $222,295 (6%) from $3,446,407 in 2002
to $3,224,112 in 2003 principally because we did not make payments to DSTO in 2003 as we
did in 2002.
    Depreciation and amortization increased slightly from $53,982 in 2002 to $56,000 in
2003 due to the inclusion of $3,333 for amortization of intangibles recognized on the
acquisition of ProCam.
    Rentals on operating leases decreased $6,331 (5%) from $124,291 in 2002 to $117,960
in 2003 primarily due to the impact of accounting for a rent free period at our premises
in Brisbane, Australia. These rentals are operating lease commitments primarily for the
rental of office premises in Brisbane, Australia; Arlington, Virginia and, since December
2003, Seattle, Washington.
    General and administrative expenses increased $344,861 (23%) from $1,498,944 in
2002 to $1,843,805 in 2003 primarily due to the hiring of additional employees and
expenses associated with the acquisition of ProCam in December 2003 and an increase in
the insurance premium and computer costs offset by a decrease in consulting fees.
    Legal fees-related party decreased from $120,996 in 2002 to none in 2003 because a
director associated with our Australian law firm resigned as a director in 2003.
    Consulting fees-related party decreased $153,917 from $175,824 in 2002 to $21,907
in 2003 primarily because our former Chairman, Admiral William Owens, ceased receiving
consultancy fees in 2003 and because a director who provided consulting services in 2002
resigned as a director in 2003. Other income.Total other income increased $358,409 from $28,478 in 2002 to $386,887 in 2003
primarily due to (1) higher net interest income of $108,105 that was mostly earned from the
investment of funds raised in 2003 under our Share Purchase Plan and (2) a $274,937 tax rebate
received from the Australian Taxation Office for research and development expenditures made in
2003. Net Loss.As a result of the foregoing, our net loss decreased from $5.4 million in 2002 to
$4.7 million in 2003. Due to our continuing losses, no income tax expense has been recognized. Effects of Currency Fluctuations Our functional currency is the Australian dollar. We note that the functional currency of our
subsidiaries Metal Storm Inc. and Metal Storm U.S.A. Limited
is the Australian dollar and the functional currency of ProCam
Machine LLC is the U.S. dollar. We
translate our financial statements denominated in foreign currency in accordance with SFAS No. 52,
Foreign Currency Translations. The reporting currency for all periods presented is the U.S. dollar.
We translate our balance sheet accounts at the end of period exchange rate and our statement of
operations accounts at the average exchange rate for the period. Costs not effectively denominated in U.S. dollars are re-measured in to U.S. dollars, when
recorded, at the prevailing exchange rates for the purposes of our financial statements.
Consequently, fluctuations in the rates of exchange between the U.S. dollar and non-dollar
currencies will affect our results of operations. An increase in the value of a particular currency
relative to the U.S. dollar will increase the U.S. dollar reporting value for transactions in that
particular currency, and a decrease in the value of that currency relative to the U.S. dollar will
decrease the U.S. dollar reporting value for those transactions. The effect of foreign currency translation for U.S. dollar reporting purposes is reflected in
our financial statements in the statements of changes in stockholders equity and is reported as
accumulated other comprehensive income (loss). At December 31, 2004, the impact of the foreign
currency translation was an accumulated other comprehensive income of $762,892 compared to
accumulated other comprehensive income of $80,353 at December 31, 2003. The fluctuations are 25




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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 several 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, interest income earned on
cash and cash equivalents, and grants from government agencies. The following table sets forth our consolidated cash flows for the past three years. Year ended December 31,2004
    
    
    2003
    
    
    2002Net cash used in operating activities
    
    $
    (7,703,543
    )
    
    $
    (4,311,892
    )
    
    $
    (3,989,210
    )Net cash used in investing activities
    
    
    (826,318
    )
    
    
    (210,284
    )
    
    
    (15,111
    )Net cash provided by financing activities
    
    
    13,670,226
    
    
    
    4,812,152
    
    
    
    5,131,291Effect of exchange rate changes on cash
    
    
    628,831
    
    
    
    1,217,643
    
    
    
    284,883Net increase in cash and cash equivalents
    
    $
    5,769,196
    
    
    $
    1,507,619
    
    
    $
    1,411,853
 Cash used in operating activities in each of the past three years consisted primarily of
losses incurred in operations. In 2004, approximately $1.2 million of the operating loss was
incurred by ProCam. See Item 5A Operating and Financial Review and Prospects  Operating Results. Our net cash used in investing activities primarily related to the acquisition of property and
equipment in 2002 and the acquisition of ProCam in 2003. In 2004, the net cash used in investing
activities related primarily to the acquisition of property and equipment as well as a $622,671
payment made in respect of a restricted deposit. Our net cash provided by financing activities in each of the past three years related
primarily to offerings of ordinary shares. In August 2002, we raised $5.0 million in a private
placement of ordinary shares. In October 2003, we raised $4.9 million through a Share Purchase Plan
that was only available to shareholders resident in Australia and New Zealand. In May 2004, we
raised approximately $15.8 million in a placement of ordinary shares to sophisticated and
institutional investors outside the United States. Borrowings We had no borrowings until we assumed indebtedness of ProCam in connection with the
acquisition of ProCam in December 2003. We had a short-term bank loan of $432,637 resulting from
this acquisition that expired in February 2004. In January 2004, a new line of credit was
established that will mature in January 2006, with an interest rate of 4.6% and offsetting interest
earned on deposits at 2.5%. As of December 31, 2004, we had outstanding bank loans equal to
$647,729 and capital lease obligations of $666,759 (net present value) that related to ProCam. See
Note 10 to our financial statements for detail on our capital lease obligations. Other Material Commitments We had no material capital expenditures during the past three years and do not expect to incur
any material capital expenditure in 2005. Future Cash Needs We expect that operating expenses will continue to be the principal use of our cash resources.
We believe that our cash and cash equivalents of $11.8 million as at December 31, 2004 will provide
us with sufficient capital to fund our operations until at least June 2006. We will likely need to
raise additional sources of funding and may seek it through public or private equity or debt
financings. The sale of additional equity or convertible debt could result in dilution to our 26




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stockholders. Additional debt would result in increased expenses and could result in covenants
that would restrict our operations. 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 was $4.3 million, $3.2 million and $3.4 million for the
years ended December 31, 2004, 2003 and 2002, respectively. 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 We are a development stage company. Most of our technology requires further investment,
research, development, testing and possibly regulatory approval prior to any commercial sales. We
do 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 and generate revenue. We believe that our future success depends
on our ability to commercialize our technology. See Item 3D Key Information  Risk Factors. Recent Pronouncements We account for stock-based compensation utilizing the intrinsic value method in accordance
with the provisions of Accounting Principles Board Opinion No. 25. Accounting for Stock Issued to
Employeesand related Interpretations (APB 25). Accordingly, no compensation expense is
recognized because the exercise prices of these employee stock options equal or exceed the
estimated fair market value of the underlying stock on the dates of grant. In December 2004, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123R, Share-Based Payment(SFAS 123R). SFAS 123R is a revision of SFAS
123, Accounting for Stock Based Compensation, and supersedes APB 25. Among other items, SFAS 123R
eliminates the use of APB 25 and the intrinsic value method of accounting, and requires companies
to recognize in the financial statements the cost of employee services received in exchange for
awards of equity instruments, based on the grant date fair value of those awards. The effective
date of SFAS 123R is the first reporting period beginning after June 15, 2005, although early
adoption is allowed. SFAS 123R requires companies to adopt its requirements using a modified
prospective method or a modified retrospective method. Under the modified prospective method,
compensation cost is recognized in the financial statements beginning with the effective date,
based on the requirements of SFAS 123R for all share-based payments granted after that date, and
based on the requirements of SFAS 123 for all unvested awards granted prior to the effective date
of SFAS 123R. The modified retrospective method also permits entities to restate financial
statements of previous periods based on pro forma disclosures made in accordance with SFAS 123. We currently utilize a standard option pricing model (i.e., Black-Scholes) to measure the fair
value of stock options granted to employees for pro forma purposes. While SFAS 123R permits
entities to continue to use such a model, the standard also permits the use of a lattice model.
We have not yet determined which model we will use to measure the fair value of employee stock
options upon the adoption of SFAS 123R. SFAS 123R also requires that the benefits associated with the tax deductions in excess of
recognized compensation cost be reported as a financing cash flow, rather than as an operating cash
flow as required under current literature. We have not yet determined what effect, if any, this
change will have on future periods. We currently expect to adopt SFAS 123R effective July 1, 2005; however, we have not yet
determined which of the aforementioned adoption methods we will use. Please see Note 1 to our financial statements for a discussion of other recent accounting
pronouncements. E. Off  Balance sheet arrangements Not applicable. 27




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F. Tabular disclosure of contractual obligations The following table summarizes our contractual obligations and commitments as of December 31,
2004: Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    1 year
    
    
    1-3 years
    
    
    4-5 years
    
    
    5 yearsOperating leases
    
    $
    1,979,889
    
    
    $
    556,741
    
    
    $
    1,128,755
    
    
    $
    219,273
    
    
    $
    75,120Capital leases for ProCam (a)
    
    
    750,365
    
    
    
    258,452
    
    
    
    444,636
    
    
    
    47,277
    
    
    
    Total
    
    
    2,730,254
    
    
    
    815,193
    
    
    
    1,573,391
    
    
    
    266,550
    
    
    
    75,120
   (a)
    
    Metal Storm sold the ProCam business to Monroe Machined Products, Inc. on June 1, 2005.
For a description of the agreement, see Item 10.C. Additional Information  Material Contracts. 28




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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 senior management: Name
    
    PositionTerence J. ODwyer
    
    Interim ChairmanGeneral Wayne A. Downing
    
    DirectorDr. Daniel L. Alspach
    
    DirectorBruce S. McComish
    
    DirectorDavid A. Smith
    
    Chief Executive Officer and Managing DirectorJames D. MacDonald
    
    Chief Financial Officer and Company SecretaryIan A. Gillespie
    
    General ManagerGeorge L. Bergeron III
    
    Chief Technology Officer
 Terence J. ODwyer.Mr. ODwyer, a chartered accountant in Australia, has been a director of
Metal Storm since 1998. He is the Chairman of BDO Kendalls, a large Queensland public accountancy
firm of which he has been a partner for 27 years. He is also a director of Bendigo Bank Limited,
Qld Theatre Co and is the Chairman of MFS Limited and Brumbys Bakeries Holdings Limited. Mr.
ODwyers past Board and government authority appointments include Leutenegger Limited, the
Australian Financial Institutions Steering Committee, membership of the North Brisbane Regional
Hospitals Board, the Legal Aid Commission and CS Energy Limited. General Wayne A. Downing (U.S. Army (retired)).Appointed as a director of Metal Storm in
October 1999, General Downing resigned from the Board in October 2001 following his appointment as
U.S. National Director and Deputy National Security Advisor for Combating Terrorism. Following
completion of this service, he was re-appointed a director of Metal Storm in October 2002. General
Downing retired from active service in the military in 1996 after a distinguished 34-year career in
the U.S. Army. He served two combat tours in Vietnam as a junior infantry officer. His career
included commands in infantry, armored, airborne, special operation and joint units. He commanded
all U.S. special operations forces during the 1989 invasion of Panama and commanded a joint special
operations task force during the first Gulf War. General Downing culminated his career as
Commander in Chief of the U.S Special Operations Command, where he was responsible for all special
operations forces in the U.S. Army, Navy and Air Force. He is the Chair of West Points Combating
Terrorism Center and a director of the U.S. based technology company, Science Applications
International Corporation. Dr. Daniel L. Alspach.Dr Alspach was appointed a director of Metal Storm in August 2003.
Until mid-2003 Dr Alspach served as Chairman and Chief Executive Officer of ORINCON Corporation
International, the systems integration and information technology company he co-founded in 1973. Dr
Alspach led many of ORINCONs efforts, including contracts with DARPA, the U.S. Navy and other
government customers. Prior to co-founding ORINCON, he was a tenured Professor of Engineering at
Colorado State University and took a visiting Professorship in Engineering at the University of
California in San Diego. Dr Alspach holds a Bachelor and Master of Science Degree in Physics from
the University of Washington and a Ph.D. in Engineering Sciences from the University of California
in San Diego. Bruce S. McComish.Mr. McComish was appointed a director of Metal Storm in October 2004. From
April 2001 to April 2005, he served as Chairman of the Australian investment bank BBY Limited.
From 1998 to 2000, Mr. McComish was Chairman of the banking practice at the Australian law firm
Corrs Chambers Westgarth and, from 1994 to 1998, he was Chief Financial Officer at National
Australia Bank. He has also served as Executive General Manager of Corporate Affairs for the
Australian resources company North Limited. Mr. McComish also worked for 18 years in senior
financial positions around the world with Unilever Plc. Mr. McComish is a Fellow of the Australian
Society of CPAs and a Fellow of the Australian Institute of Chartered Accountants. He is a
director of New Prophet Investments Pty Ltd, New Prophet Capital Partners Pty Ltd, BBY Retired
Staff Holdings Pty Ltd, BBY Staff Holdings Pty Ltd and The Accountomist Pty Ltd, which are
businesses unrelated to Metal Storm. David A. Smith.Mr. Smith was appointed Chief Executive Officer of Metal Storm in February
2005 and Managing Director in May 2005. Upon graduating from the United States Naval Academy, Mr.
Smith went into Naval Aviation where he flew a number of Navy Tactical and Surveillance aircraft.
After leaving the Navy, Mr. Smith held various senior management positions at General Electric
Company, SENSIS Corporation, Amphenol and Quixote Corporation. Most 29




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##### Table of Contents



recently, Mr. Smith served as President and Chief Operating Officer of SenSyTech, Inc, a
publicly traded high technology defense corporation located in the Washington, D.C. metropolitan
area. Mr. Smith holds a Bachelor of Science Degree in Mechanical Engineering from the United
States Naval Academy and a Master of Business Administration from Syracuse University. James D. MacDonald.Mr. MacDonald was appointed Chief Financial Officer and Company Secretary
in October 2004. Prior to joining Metal Storm, Mr. MacDonald held similar positions with Endeavor
Foundation, a charitable organization that is one of the largest of its kind in Australia, from
2000 to 2004; Grow Force Australia Limited from 1996 to 2000; and Southern Cross Pumps and
Irrigation from 1993 to 1996. He has also worked with Arnotts Biscuits Limited and was Group
AccountantAustralian Operations for Spicers Paper Limited (now Paperlinx Limited) from 1986 to
1990. Mr. MacDonald is a Certified Practicing Accountant and a Fellow of the Australian Institute
of Company Directors and the CEO Institute of Australia. Ian A. Gillespie.Mr. Gillespie was appointed as Metal Storms General Manager in May 2003.
He is responsible for the overall management of the Australian operations of Metal Storm as well as
managing the companys investor relations and capital requirements, intellectual property
protection and corporate affairs. He is also responsible for business development in Australia,
Asia and Europe. Among his previous roles prior to joining Metal Storm, Mr. Gillespie held the
position of Managing Director and CEO of Grow Force Australia Limited. He has also held General
Manager positions with Incitec Limited, Atlas Steels Limited and Wormald International Limited.
Mr. Gillespie is Fellow of the CEO Institute of Australia and a Member of the Australia Institute
of Company Directors. He is a director and shareholder of Standfast Enterprises Pty Ltd, and a
director and shareholder of Rugby Resources International Pty Ltd, which are businesses unrelated
to Metal Storm. George L. Bergeron III.Mr. Bergeron was appointed Senior Vice PresidentProduct Development
in March 2004 and became Chief Technology Officer in September 2004. Based in the United States,
Mr. Bergeron leads Metal Storms team of engineers and scientific staff both in the United States
and Australia. Mr. Bergeron is responsible for directing Metal Storms research and development
and product development efforts as well as overseeing Metal Storms technical projects and
programs. Mr. Bergeron is a specialist in mechanical and electronic systems design, power
generation and material science, with more than 25 years as a highly experienced electromechanical
and electronics engineer, scientist and program manager. For the 14 years prior to joining Metal
Storm, Mr. Bergeron worked for SAIC, where he held several senior positions, most recently as
director of SAICs Technology Development Laboratory. B. Compensation In 2004, the aggregate remuneration we paid and that accrued to our directors and executive
officers was $1,719,269. In accordance with Australian superannuation legislation, we contributed
$80,597 to superannuation funds for our directors and executive officers for their pension,
retirement and other similar benefits in 2004. We employed approximately thirty-eight U.S.
residents during 2004. As disclosed in our Australian annual report for the year ended December 31, 2004, the
remuneration and benefits paid to our directors and executive officers during 2004, on an
individual basis, are set out in the table below. Year Ended December 31, 2004
    
    
    Options IssuedSalary/
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    ExerciseBoard
    
    
    
    
    
    
    
    
    
    
    Shares
    
    
    
    
    
    
    
    
    
    
    Price per
    
    
    ExpiryName
    
    Fees($)
    
    
    Benefits (1)
    
    
    Total($)
    
    
    Issued
    
    
    Listed
    
    
    Unlisted
    
    
    option(A$)
    
    
    DateJames M. ODwyer (2)
    
    
    234,718
    
    
    
    25,367
    
    
    
    260,085
    
    
    
    
    
    
    
    
    
    
    
    450,000
    
    
    
    A$0.40
    
    
    
    6/21/2009Wayne A. Downing
    
    
    33,143
    
    
    
    
    
    
    
    33,143
    
    
    
    
    
    
    
    
    
    
    
    450,000
    
    
    
    A$0.40
    
    
    
    6/21/2009Terence J. ODwyer
    
    
    64,563
    
    
    
    
    
    
    
    64,563
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    William A. Owens (3)
    
    
    11,048
    
    
    
    
    
    
    
    11,048
    
    
    
    
    
    
    
    
    
    
    
    450,000
    
    
    
    A$0.40
    
    
    
    6/21/2009Daniel W. Christman (3)
    
    
    45,571
    
    
    
    
    
    
    
    45,571
    
    
    
    
    
    
    
    
    
    
    
    675,000
    
    
    
    A$0.40
    
    
    
    6/21/2009
    
    
    
    
    
    
    
    200,000
    
    
    
    A$1.15
    
    
    
    6/21/2009
    
    
    
    
    
    
    
    40,000
    
    
    
    A$1.10
    
    
    
    6/21/2009Daniel L. Alspach
    
    
    49,714
    
    
    
    
    
    
    
    49,714
    
    
    
    
    
    
    
    
    
    
    
    675,000
    
    
    
    A$0.40
    
    
    
    6/21/2009Bruce S. McComish
    
    
    8,286
    
    
    
    
    
    
    
    8,286
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    J.D. Heipt (3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Charles A. Vehlow (4)
    
    
    247,082
    
    
    
    263,458
    (5)
    
    
    510,540
    
    
    
    
    
    
    
    
    
    
    
    225,000
    
    
    
    A$0.40
    
    
    
    6/21/2009
 30




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##### Table of Contents



Year Ended December 31, 2004
    
    
    Options IssuedSalary/
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    ExerciseBoard
    
    
    
    
    
    
    
    
    
    
    Shares
    
    
    
    
    
    
    
    
    
    
    Price per
    
    
    ExpiryName
    
    Fees($)
    
    
    Benefits (1)
    
    
    Total($)
    
    
    Issued
    
    
    Listed
    
    
    Unlisted
    
    
    option(A$)
    
    
    Date
    
    
    
    
    
    
    
    31,250
    
    
    
    A$1.16
    
    
    
    1/8/2006
    
    
    
    
    
    
    
    31,250
    
    
    
    A$1.16
    
    
    
    1/8/2006
    
    
    
    
    
    
    
    500,000
    
    
    
    A$0.40
    
    
    
    4/14/2009
    
    
    
    
    
    
    
    125,000
    
    
    
    A$0.40
    
    
    
    1/14/2009
    
    
    
    
    
    
    
    125,000
    
    
    
    A$0.40
    
    
    
    7/14/2009
    
    
    
    
    
    
    
    125,000
    
    
    
    A$0.40
    
    
    
    10/14/2009Ian A. Gillespie
    
    
    160,099
    
    
    
    20,302
    (6)
    
    
    180,401
    
    
    
    
    
    
    
    
    
    
    
    600,000
    
    
    
    A$0.40
    
    
    
    4/14/2009
    
    
    
    
    
    
    
    62,500
    
    
    
    A$0.40
    
    
    
    3/31/2009
    
    
    
    
    
    
    
    62,500
    
    
    
    A$0.40
    
    
    
    6/30/2009
    
    
    
    
    
    
    
    62,500
    
    
    
    A$0.40
    
    
    
    9/30/2009
    
    
    
    
    
    
    
    62,500
    
    
    
    A$0.40
    
    
    
    12/31/2009Sylvie Moser-Savage (4)
    
    
    50,702
    
    
    
    4,563
    
    
    
    55,265
    
    
    
    
    
    
    
    
    
    
    
    37,500
    
    
    
    A$0.40
    
    
    
    2/24/2009Arthur D. Schatz
    
    
    140,385
    
    
    
    7,279
    
    
    
    147,664
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    G. Russell Zink
    
    
    155,878
    
    
    
    7,656
    
    
    
    163,534
    
    
    
    
    
    
    
    
    
    
    
    12,500
    
    
    
    A$0.56
    
    
    
    12/31/2007
    
    
    
    
    
    
    
    12,500
    
    
    
    A$0.56
    
    
    
    12/31/2007
    
    
    
    
    
    
    
    12,500
    
    
    
    A$0.56
    
    
    
    9/14/2007
    
    
    
    
    
    
    
    12,500
    
    
    
    A$0.56
    
    
    
    12/14/2007James D. MacDonald
    
    
    35,692
    
    
    
    3,212
    
    
    
    38,904
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    George L. Bergeron III
    
    
    137,771
    
    
    
    12,780
    
    
    
    150,551
    
    
    
    
    
    
    
    
    
    
    
    31,250
    
    
    
    A$0.40
    
    
    
    9/4/2009
    
    
    
    
    
    
    
    31,250
    
    
    
    A$0.40
    
    
    
    12/4/2009
   (1)
    
    Benefits include provision of health benefits and statutory superannuation contributions.(2)
    
    Former director who resigned in 2005.(3)
    
    Former director who resigned in 2004.(4)
    
    Former officer who resigned in 2004.(5)
    
    Includes termination payment of $249,856.(6)
    
    Includes bonus of $7,365. Please see note 15 to our financial statements for further details on our share option plans. C. Board Practices Under our constitution, our board of directors is required to be comprised of at least three
directors. As of December 31, 2004, our board was comprised of six directors. Our board 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. The board of directors has established an Audit Committee that consists of independent
directors. Current members of our Audit Committee are Mr. B.S. McComish (Chairman of the Audit
Committee) and Mr. T. J. ODwyer. We expect to appoint a third independent director to the Audit
Committee by July 31, 2005. 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;
    determines and administers internal audit procedures;
    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. 31




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##### Table of Contents



Our board of directors has established a Finance Committee that is intended to be an oversight
body on capital raisings, mergers and acquisitions and the financial function of the companys
operations. Mr. McComish is Chairman and the sole member of the Finance Committee. The board of directors has also established a Remuneration Committee, which currently has one
member: General Wayne A. Downing. The board of directors expects to appoint an additional member to
this Committee. 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 Remuneration Committee reviews the compensation arrangements of all directors and
executive officers on an annual basis and makes recommendations to the board. The 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 Remuneration Committee. In order to retain and attract executives of sufficient
caliber to facilitate the efficient and effective management of our operations, the Remuneration
Committee seeks the advice of external advisers in connection with the structure of remuneration
packages. It is the Remuneration Committees policy that employment agreements are entered into
with all executives. The employment agreement with the Chief
Executive Officer provides for a separation benefit in the form of a payment of an amount equal to six months of the annual base salary
paid as a lump sum. 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 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 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. Pursuant to his employment agreement, David Smith was nominated to the Board of Directors in
2005. In the event of termination without cause, his employment agreement provides for a separation
payment equal to six months of base salary, which is currently $20,000 per month. D. Employees As at December 31, 2004, we had forty-nine full-time employees, including four executive
managers (two in Brisbane, Australia and two in Washington, D.C.), four senior managers, two
engineering managers, four engineers, five administrative personnel and thirty personnel at ProCam. 32




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##### Table of Contents



As at December 31, 2003, we had sixty full-time employees, including nine executive
managers (three in Washington D.C. and three in Seattle, Washington), one engineering manager, five
administrative personnel and 45 personnel at ProCam. E. Share Ownership The following table sets forth the beneficial ownership of our directors and executive
officers as of April 28, 2005: PercentageNumber of
    
    
    of
    
    
    Number ofShares
    
    
    Outstanding
    
    
    OptionsName
    
    Owned(1)
    
    
    Shares
    
    
    Owned(1)Terence James ODwyer
    
    
    63,611
    
    
    
    0.01
    %
    
    
    Daniel L. Alspach
    
    
    
    
    
    
    
    
    
    
    675,000
    (2)Wayne A. Downing
    
    
    500,000
    
    
    
    0.10
    %
    
    
    2,450,000
    (3)Bruce McComish
    
    
    
    
    
    
    
    
    
    
    David Smith
    
    
    
    
    
    
    
    
    
    
    Ian A. Gillespie
    
    
    
    
    
    
    
    
    
    
    850,000
    (4)James D. MacDonald
    
    
    
    
    
    
    
    
    
    
    George L. Bergeron III
    
    
    
    
    
    
    
    
    
    
    62,500
    (4)
   (1)
    
    At April 28, 2005 the number of outstanding shares was 521,970,978 and the number of
outstanding options (all unlisted) was 11,755,603, of which 2,239,688 were granted but not
issued.(2)
    
    Represents 675,000 unlisted options to purchase ordinary shares of Metal Storm on or before
June 21, 2009 at an exercise price of A$0.40 per share. The purchase price for the options
was A$0.10.(3)
    
    Represents: (a) 2,000,000 unlisted options to purchase ordinary shares of Metal Storm that
are exercisable only upon certain conditions on or before July 2, 2011 at an exercise price of
A$0.01 per share (the purchase price for the 2,000,000 unlisted options was nil); and (b)
450,000 unlisted options to purchase ordinary shares of Metal Storm on or before June 21, 2009
at an exercise price of A$0.40 per share (the purchase price for the 450,000 unlisted options
was A$0.10).(4)
    
    Due to capital restrictions, these options were not issued at fiscal year-end. 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 15 to our financial
statements and Item 6B Directors, Senior Management and Employees  Compensation for a summary of
the terms of our various option schemes. 33




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##### Table of Contents



Item 7. Major Shareholders and Related Party Transactions A. Major Stockholders The following table sets out details, as of April 28, 2005, of entities beneficially holding
more than five percent of the ordinary shares of Metal Storm. Ordinary SharesBeneficially Owned as atApril 28, 2005Number of
    
    
    PercentShares
    
    
    ofName
    
    owned
    
    
    ClassJames Michael ODwyer
    
    
    199,729,664
    (1)
    
    
    38.26
    %
   (1)
    
    131,517,059 shares are owned by Mr. J.M. ODwyer, 68,212,500 shares are owned by
ODwyer Investments Pty Ltd as trustee for the ODwyer Family Discretionary Trust and 105
shares owned by Rhonda Clare ODwyer in trust for Mr. J.M. ODwyer. Mr. J.M. ODwyer has
indicated an intention to sell approximately one-half of his shareholding before January
2006. A former major shareholder, Charter Pacific Corporation Limited, reduced its shareholding over
the past few years: it owned 26.9% of our ordinary shares at June 30, 2002, 9.65% at May 4, 2004
and, since October 20, 2004, less than 5%. As at April 28, 2005, there were 9,951 record holders of ordinary shares, of which 9,783
represented Australian record holders holding approximately 98% of our outstanding ordinary shares. B. Related Party Transactions In February 2005, Metal Storm entered into a Separation Agreement with its major shareholder
James M. ODwyer pursuant to which he was paid a retirement benefit of A$500,000 in recognition of
his services to Metal Storm as its founder, a director and chief executive officer during our early
years and, in more recent years, as an employee and consultant. In addition, Mr. ODwyer agreed to
assign to Metal Storm certain intellectual property rights and agreed to certain non-competition
arrangements. Since Bruce S. McComish became a director in October 2004, Metal Storm paid A$25,000 in fees
to investment bank BBY Ltd, where Mr. McComish was chairman until April 2005. In 2000, we entered into a consultancy agreement with Admiral William A. Owens, a former
director, to provide services to us in the United States in relation to the defense industry and
market, defense technology, military and customer requirements. Admiral Owens received fees for
these services of approximately $107,050 from January 1, 2002 through May 6, 2004, when Admiral
Owens resigned from our board of directors. C. Interest of Experts and Counsel Not applicable. 34




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##### Table of Contents



Item 8. Financial Information A. Consolidated Financial Statements and Other Financial Information Our financial statements are included in Item 18 Financial Statements. Export Sales Not applicable. Legal Proceedings We are not a party to any legal proceedings. Dividends Until we make a profit our directors will not be able to recommend that any dividends be paid
to our stockholders. Our directors will not resolve a formal dividend policy for us until we
generate profits. Our directors current intention is to reinvest our income in the continued
development and operation of our business. B. Significant Changes Not applicable. 35




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##### Table of Contents



Item 9. The Offer and Listing A. Listing Details Australian Stock Exchange Our ordinary shares were listed and posted for trading on the Australian Stock Exchange
(symbol MST) in 1999. The following table sets forth for the periods indicated the reported low
and high bid prices and the average daily trading volume for our ordinary shares as quoted on the
Australian Stock Exchange. All figures are in U.S. dollars. AveragePrice Per
    
    
    DailyOrdinary Share
    
    
    TradingYear Ended
    
    High
    
    
    Low
    
    
    VolumeDecember 31, 2004First Quarter
    
    $
    0.46
    
    
    $
    0.45
    
    
    $
    244,400Second Quarter
    
    $
    0.38
    
    
    $
    0.37
    
    
    $
    1,157,581Third Quarter
    
    $
    0.26
    
    
    $
    0.26
    
    
    $
    531,449Fourth Quarter
    
    $
    0.26
    
    
    $
    0.26
    
    
    $
    155,890December 31, 2003First Quarter
    
    $
    0.33
    
    
    $
    0.21
    
    
    $
    213,060Second Quarter
    
    $
    0.31
    
    
    $
    0.22
    
    
    $
    146,669Third Quarter
    
    $
    0.44
    
    
    $
    0.25
    
    
    $
    555,042Fourth Quarter
    
    $
    0.35
    
    
    $
    0.29
    
    
    $
    222,730December 31, 2002First Quarter
    
    $
    0.78
    
    
    $
    0.60
    
    
    $
    247,615Second Quarter
    
    $
    0.72
    
    
    $
    0.52
    
    
    $
    230,407Third Quarter
    
    $
    0.58
    
    
    $
    0.28
    
    
    $
    378,347Fourth Quarter
    
    $
    0.36
    
    
    $
    0.23
    
    
    $
    165,430December 31, 2001Annual
    
    $
    1.08
    
    
    $
    0.47
    
    
    
    December 31, 2000Annual (1)
    
    $
    2.10
    
    
    $
    0.27
    
    
    
    
 AveragePrice Per
    
    
    DailyOrdinary Share
    
    
    TradingMonth Ended
    
    High
    
    
    Low
    
    
    VolumeMay 31, 2005
    
    $
    0.15
    
    
    $
    0.14
    
    
    $
    516,667April 30, 2005
    
    $
    0.14
    
    
    $
    0.13
    
    
    $
    466,582March 31, 2005
    
    $
    0.18
    
    
    $
    0.17
    
    
    $
    1,038,232February 28, 2005
    
    $
    0.20
    
    
    $
    0.20
    
    
    $
    578,347January 31, 2005
    
    $
    0.23
    
    
    $
    0.22
    
    
    $
    773,132
   (1)
    
    Ordinary shares were subject to a 5 for 1 split on May 31, 2000. Prices and average daily
trading volumes prior to the split are expressed in equivalent new (post split) share prices. Nasdaq SmallCap Market Our ordinary shares in the form of ADRs were listed for trading on the Nasdaq SmallCap Market
(symbol MTSX) on December 12, 2001. Each ADR represents the right to receive 20 ordinary shares.
The following table sets forth for the periods indicated the high and low closing sales prices in
U.S. dollars and the average daily trading volume of our ADRs as reported on the Nasdaq SmallCap
Market. 36




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##### Table of Contents



AveragePrice Per
    
    
    DailyOrdinary Share
    
    
    TradingYear Ended
    
    High
    
    
    Low
    
    
    VolumeDecember 31, 2004First Quarter
    
    $
    0.39
    
    
    $
    0.32
    
    
    $
    7,719Second Quarter
    
    $
    0.48
    
    
    $
    0.26
    
    
    $
    628,388Third Quarter
    
    $
    0.26
    
    
    $
    0.18
    
    
    $
    90,947Fourth Quarter
    
    $
    0.25
    
    
    $
    0.15
    
    
    $
    250,148December 31, 2003First Quarter
    
    $
    0.33
    
    
    $
    0.21
    
    
    $
    213,060Second Quarter
    
    $
    0.31
    
    
    $
    0.22
    
    
    $
    146,669Third Quarter
    
    $
    0.44
    
    
    $
    0.25
    
    
    $
    555,042Fourth Quarter
    
    $
    0.35
    
    
    $
    0.29
    
    
    $
    222,730December 31, 2002First Quarter
    
    $
    0.78
    
    
    $
    0.60
    
    
    $
    247,615Second Quarter
    
    $
    0.72
    
    
    $
    0.52
    
    
    $
    230,407Third Quarter
    
    $
    0.58
    
    
    $
    0.28
    
    
    $
    378,347Fourth Quarter
    
    $
    0.36
    
    
    $
    0.23
    
    
    $
    165,430December 31, 2001Annual
    
    $
    1.08
    
    
    $
    0.47
    
    
    
    December 31, 2000Annual
    
    $
    2.10
    
    
    $
    0.27
    
    
    
    
 AverageDailyTradingMonth Ended:
    
    High
    
    
    Low
    
    
    VolumeMay 31, 2005
    
    $
    0.12
    
    
    $
    0.10
    
    
    $
    26,040April 30, 2005
    
    $
    0.14
    
    
    $
    0.10
    
    
    $
    66,615March 31, 2005
    
    $
    0.15
    
    
    $
    0.13
    
    
    $
    61,957February 28, 2005
    
    $
    0.17
    
    
    $
    0.14
    
    
    $
    134,383January 31, 2005
    
    $
    0.21
    
    
    $
    0.16
    
    
    $
    96,671
 B. Plan of Distribution Not applicable. C. Markets Our ordinary shares are listed on the Australian Stock Exchange under the symbol MST and on
the Nasdaq SmallCap Market in the form of American Depositary Receipts under the symbol MTSX. Exemptions from certain Nasdaq Corporate Governance Rules Exemptions from the Nasdaq corporate governance standards are available to foreign private
issuers such as Metal Storm when those standards are contrary to a law, rule or regulation of any
public authority exercising jurisdiction over such issuer or contrary to generally accepted
business practices in the issuers country of domicile. In connection with Metal Storms Nasdaq
SmallCap Market Listing Application, Nasdaq granted Metal Storm exemptions from certain corporate
governance standards that were contrary to the laws, rules, regulations or generally accepted
business practices in Australia. These exemptions and the practices followed by Metal Storm during
the fiscal year ended December 31, 2004 are described below. 37




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
    In March 2003, the Australian Stock Exchange Corporate Governance Council
published its Principles of Good Corporate Governance and Best Practice Recommendations
(Corporate Governance Principles). As Metal Storm was included in the top 300 of the S&P
All Ordinaries Index of the Australian Stock Exchange on January 1, 2004, it was obliged
under the Australian Stock Exchange Listing Rules to comply with the Corporate Governance
Principles in relation to the composition, operation and responsibility of the audit
committee during 2004. Metal Storm was therefore exempt from Nasdaqs audit committee
charter requirements. After August 27, 2004 this exemption was not required by Metal
Storm as it adopted an audit committee charter consistent with Nasdaq requirements.
    Metal Storm was exempt from Nasdaqs audit committee composition requirements. The
recommendations set forth in the Australian Stock Exchange Corporate Governance Principles
relating to composition of audit committees differ to Nasdaqs audit committee composition
requirements. For example, the Corporate Governance Principles recommend that an audit
committee comprise at least three members and that at least one member be independent,
whereas Nasdaq requires that all members of the committee be independent. In 2004, Metal
Storm had an audit committee consisting of two directors who were independent within the
meaning of the Nasdaq rules, and is seeking to appoint a third independent director. This
exemption will not be available after July 31, 2005 when all issuers listed on Nasdaq must
have an audit committee comprising at least three directors.
    Metal Storm was exempt from Nasdaqs independence requirements for a majority of the
board of directors. The Australian Stock Exchange Listing Rules did not require Metal
Storm to have a majority of independent directors on the board during 2004. During most
of the fiscal year ended December 31, 2004, Metal Storm did, however, have a majority of
directors who were independent as defined in the Australian Stock Exchange Corporate
Governance Principles, which definition differs from Nasdaqs definition. Accordingly,
because Australian law and generally accepted business practices in Australia regarding
director independence differ to Nasdaqs independence requirements, Metal Storm claimed
this exemption in 2004.
    Metal Storm was exempt from Nasdaqs requirement that related party transactions be
reviewed on an ongoing basis and be approved by an audit committee or other independent
body of the board of directors. Australian law and the Australian Stock Exchange Listing
Rules are the basis for generally accepted business practices in Australia followed by
Metal Storm with respect to related party transactions. Australian law provides that a
public company, such as Metal Storm, must not give a financial benefit to a related
party (each as defined in the Australian Corporations Act 2001) of the company unless it
obtains shareholder approval, or unless an exception applies. In addition, the Australian
Stock Exchange Listing Rules provide that a listed company must ensure that neither it nor
its subsidiaries acquires substantial assets from, or sells substantial assets to, a
related party without the approval of its security holders, unless an exception applies.
There is, however, no requirement under Australian law or the Australian Stock Exchange
Listing Rules for a review of related party transactions in the manner contemplated by the
Nasdaq requirements and, accordingly, Metal Storm claimed this exemption. On August 27,
2004, Metal Storm adopted an audit committee charter that contemplates review of related
party transactions by the audit committee. Metal Storm no longer claims this exemption.
    Metal Storm was exempt from Nasdaqs quorum requirements applicable to meetings of
shareholders. Consistent with Australian law, Metal Storms constitution provides that
five shareholders present shall constitute a quorum for a general meeting. Nasdaq
requires that an issuer provide for a quorum as specified in its by-laws for any meeting
of the holders of common stock, which quorum may not be less than 33 1/3 % of the
outstanding shares of an issuers voting common stock. Accordingly, because applicable
Australian law and rules governing quorums at shareholder meetings differ to Nasdaqs
quorum requirements, Metal Storm claimed this exemption in 2004.
    Metal Storm was exempt from the Nasdaq requirement that an issuers auditors be subject
to a peer review. Neither Australian law nor the Australian Stock Exchange Listing
Rules required peer review of independent public accountants during 2004. Accordingly,
Metal Storm claimed this exemption in 2004.
    Metal Storm was exempt from the Nasdaq requirement that issuers obtain shareholder
approval prior to the issuance of securities in connection with the establishment or
amendment of certain stock option, purchase or other compensation plans. Applicable
Australian law and rules differ to the Nasdaq requirements, with the Australian Stock
Exchange Listing Rules providing generally for prior shareholder approval in numerous
circumstances, including (i) issuance of equity securities exceeding 15% of the issued
share capital of the 38




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company in any 12 month period (but in determining the 15% limit,
securities issued under an exception to the rule or with shareholder approval are not
counted), (ii) issuance of equity securities to related parties (as defined in the
Australian Stock Exchange Listing Rules), and (iii) directors or their associates
acquiring securities under an employee incentive plan. Generally accepted business
practices in Australia also provide for plans involving
the issue of shares to directors and employees being capped at no more than 5% of the total
number of shares on issue. Metal Storms Discretionary Share Option Scheme applies this 5%
cap. Due to differences between Australian law and rules and the Nasdaq shareholder
approval requirements, Metal Storm claimed this exemption in 2004. D. Selling Stockholders Not applicable. E. Dilution Not applicable. F. Expenses of the Issue Not applicable. 39




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Item 10. Additional Information A. Share Capital Not applicable. B. Our Constitution We are a public company limited by shares registered by the Australian Securities and
Investments Commission (ASIC). We were registered on April 13, 1994 and our Australian company
number is 064 270 006. Subject to the Australian Stock Exchange Listing Rules and the Australian
Corporations Act, the rights that attach to our shares are detailed in our constitution. 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
stockholders 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 stockholders. The Australian Corporations Act prohibits directors of companies listed on the Australian
Stock Exchange from voting on matters in which they have a material personal interest, requires
disclosure of such interest to stockholders, and requires stockholders 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 stockholders. 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 stockholders and the particulars of the proposed increase are required to have
been provided to stockholders in the notice convening the meeting. 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 Australian Corporations Act and the
Australian Stock Exchange 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 40




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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. There are no requirements in our constitution regarding the retirement of directors at any
particular age. The Australian Corporations Act, however, requires that directors retire at the
conclusion of the first annual general meeting after a director reaches age 72. A person who has
reached age 72 may by special resolution of our stockholders be appointed or re-appointed as a
director, provided the notice of meeting and the resolution appointing such director states such
directors age. 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 Australian Corporations Act and the Australian Stock Exchange 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 from time to time determine. 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 stockholders. 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 stockholder has one vote determined by a show of hands at a
meeting of the stockholders. On a poll vote each stockholder 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, stockholders are not permitted to approve corporate matters by written consent. Our
constitution does not provide for cumulative voting. Right to Share in our Profits Pursuant to our constitution, our stockholders 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
stockholders, 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 stockholders 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 41




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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 Australian 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 Australian 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
stockholders in respect of all monies unpaid on shares, subject to the terms upon which any of the
shares have been issued. Each stockholder 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 installment. 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 Australian Stock
Exchange 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 Australian Corporations Act. General Meetings of Stockholders General meetings of stockholders may be called by the board of directors. Except as permitted
under the Australian Corporations Act, stockholders may not convene a meeting. Under the Australian
Corporations Act, stockholders 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 Australian Corporations Act requires the
directors to call and arrange to hold a general meeting on the request of stockholders with at
least 5% of the votes that may be cast at a general meeting or at least 100 stockholders who are
entitled to vote at the general meeting. Twenty-eight days notice of the proposed meeting of our
stockholders is required under the Australian 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 stockholders or a proxy, attorney or representative of one of our stockholders. 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 42




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Treasurer under the Foreign Acquisitions and Takeovers Act
of 1974. 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 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 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 take-over 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 stockholder to disclose ownership
above a certain threshold. The Corporations Act 2001, however, requires a substantial stockholder
to notify us and the Australian Stock Exchange once a 5% interest in our shares is obtained.
Further, once a stockholder owns a 5% interest in us, such stockholder must notify us and the
Australian Stock Exchange of any increase or decrease of 1% or more in its holding in 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 Australian Corporations Act. Stock Issues and Takeover Attempts We are governed by the Australian Corporations Act which provides stockholders 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 stockholders have enough information to assess the merits of a proposal; and
    that stockholders all have a reasonable and equal opportunity to participate in any
benefits accruing to the stockholders through any proposal under which a person would
acquire a substantial interest. Further, subject to limited exceptions provided in the Australian Stock Exchange 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. 43




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The exceptions to the listing rule are as follows:  
    an issuance or agreement to issue which we have notified the Australian Stock
Exchange of before we are told a person is making or proposes to make a takeover for our shares;
    an issuance to our ordinary stockholders 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 Australian 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 stockholders approving the issuance before the issuance is made. Access to and Inspection of Documents Inspection of our records is governed by the Australian Corporations Act. Any person has the
right to inspect our company registers on payment of a fee. Stockholders are not required to pay a
fee for inspection. Any person may obtain copies of a register or any part of the register upon
payment of a fee as prescribed by us. Further, we must ensure that the minute books for the
meetings of our stockholders are open for inspection to our stockholders free of charge. Other
corporate records including minutes of directors meetings, financial records and other documents
are not open for inspection by stockholders. However, a stockholder may apply to a court to make an
order for inspection of our books, if the applicant stockholder is acting in good faith and the
inspection is made for a proper purpose. 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 Australian Stock Exchange Listing
Rules and the Securities Clearing House business rules. CHESS is an electronic transfer and
settlement system, with no requirement for paper 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 stockholders. Instead, we
provide stockholders with a holding statement (similar to a bank account statement) that sets out
the number of ordinary shares registered in each stockholders name. This statement also advised
stockholders of their holder identification number or stockholder reference number and relevant
particulars. If a shareholding changes during any month, stockholders will receive a statement
after the end of that month. Stockholders may also request statements at any other time (subject to
payment of a small administration fee). C. Material Contracts Effective December 1, 2003, Metal Storm entered into a Membership Interest Purchase Agreement
with ProCam Machine LLC and William McAllister, Michael F. Bell, Bruce D. Campbell, Raymond J.
Prokorym and Michael J. Rubel (the Sellers). Under the agreement, Metal Storm agreed to issue
5,097,747 ordinary shares in consideration for the acquisition of all of the issued equity in
ProCam and promissory notes issued by ProCam in favor of one of the Sellers. Metal Storm agreed to
assume up to $3 million of outstanding debt of ProCam. The agreement contains representations and
warranties that are customary for an agreement of this nature. The Sellers agreed to certain
restrictions on the transfer or disposal of the shares issued to them under the agreement. In
addition, certain Sellers agreed to make a $200,000 operating credit line facility available to
Metal Storm through June 11, 2004. Metal Storm agreed to enter into employment agreements with two
of the Sellers who would continue to work at ProCam. Effective June 1, 2005, Metal Storm entered into an Asset Purchase Agreement with Monroe
Machined Products, Inc. (MMP) for the sale of the ProCam business to MMP. Under the agreement,
MMP purchased the assets and current order backlog of ProCam for $1.3 million, plus an additional
amount to acquire accounts receivable, inventory and assumed the accounts payable liabilities of
ProCams precision machinery facility. A sum of $50,000 has been retained in 44




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trust contingent on
the satisfaction of certain conditions set forth in the Asset Purchase Agreement. Our liabilities
at December 31, 2004, which will not be assumed by MMP, total
$1.5 million. The Asset Purchase
Agreement also provides that most ProCam staff will be offered
positions with MMP. We expect net proceeds of approximately $800,000
from the sale. 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 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 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;
    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. 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. 45




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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. Dividends Subject to the passive foreign investment company rules, discussed below, U.S. holders will
include as dividend income any distributions of cash or property, other than certain pro rata
distributions 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
stockholders. For taxable years beginning before January 1, 2009, 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 passive foreign
investment company for the taxable year in which the dividend is paid or for the preceding taxable
year. Accordingly, because we will likely be a passive foreign investment company for 2005 (as
discussed below), we likely will not be a qualified foreign corporation for 2005 or 2006. If in
subsequent taxable years we were eligible to be a qualified foreign corporation, then our dividends
generally would be eligible for the preferential tax rates, except to the extent that the
individual (1) holds a share of stock for 60 days or less during the 120-day period
beginning 60 days before the ex-dividend date (or, in the case of certain preferred stock, 90
days or less during the 180-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. 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 this purpose, dividends paid with respect to ADSs or
ordinary shares will generally constitute passive income or financial services income for
taxable years beginning on or before December 31, 2006, and as passive category income, or in
certain cases general category income, for taxable years beginning after December 31, 2006. 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. You should consult your tax advisor as to the consequences of Australian withholding taxes and
the availability of a foreign tax credit or deduction. 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 46




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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, which have been reduced for long-term
capital gains recognized on or after May 6, 2003, and before January 1, 2009. Short-term capital
gains are taxed at the rates applicable to ordinary income, which, for gains recognized on or after
May 6, 2003, and before January 1, 2009, are higher than the rates applicable to dividends. 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. Passive Foreign Investment Company Status The Code provides special anti-deferral rules regarding certain distributions received by U.S.
stockholders 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%. We believe that we were a PFIC for U.S. federal income tax purposes in 2000, 2002, 2003 and
2004, but not in 2001. We expect that Metal Storm will be a PFIC again in 2005 due to the asset
test described above. As noted above, 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. stockholder 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 stockholder 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 stockholders holding period for its shares. Excess
distributions are allocated ratably to each day of the U.S. stockholder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. stockholder 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. stockholder 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. stockholder holds shares in the corporation, then the corporation generally
will continue to be treated as a PFIC with respect to the stockholders shares, even if the
corporation no longer satisfies either the passive income or passive assets test described above,
unless the U.S. stockholder 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. The excess distribution rules may be avoided if a U.S. stockholder makes a QEF election
effective beginning with the first taxable year in the stockholders holding period in which the
corporation is a PFIC. A U.S. stockholder 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. stockholder whose QEF election is effective
after the first taxable year during the stockholder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 stockholder elects to recognize as an excess distribution any
gain that the stockholder 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 stockholders shares will not apply to the stockholders options. If a
stockholder that owns PFIC shares subject to a QEF election acquires additional shares pursuant to
the exercise of an 47




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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. stockholder 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.
stockholder of a PFIC must file an IRS Form 8621 annually regardless of whether or not it makes a
QEF election.) In certain circumstances, a U.S. stockholder may be able to make a retroactive QEF
election. In order for a U.S. stockholder to make a valid QEF election, the corporation must
annually provide or make available to the stockholder certain information. For any year that we are
a PFIC, we will provide to U.S. holders the information necessary to report income and gain in
accordance with a QEF election upon their written request to our Company Secretary. However, in the
case of a U.S. holder that is a calendar year taxpayer, the information is not expected to be
provided until after the due date for filing a U.S. federal income tax return without an extension.
A QEF election can be revoked only with the consent of the IRS. As an alternative to making a QEF election, a U.S. stockholder may make a mark-to-market
election with respect to its PFIC shares if the shares meet certain minimum trading requirements. A
U.S. stockholder 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 stockholder owns
as of the close of the taxable year over the stockholders adjusted tax basis in the shares. The
U.S. stockholder will be entitled to a deduction for the excess, if any, of the stockholder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. stockholder under the election
for prior taxable years. The U.S. stockholder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.
stockholder for tax years for which a mark-to-market election is in effect. However, if a U.S.
stockholder makes a mark-to-market election for PFIC stock after the beginning of the stockholders
holding period for the stock, a coordination rule applies to ensure that the stockholder does
not avoid the tax and interest charge with respect to amounts attributable to periods before the
election. 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. 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. 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
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. 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. 48




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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 the company to non-Australian resident stockholders
will be subject to dividend withholding tax, to the extent the dividends are unfranked. Dividend
withholding tax will be imposed at 30%, unless a stockholder is a resident of a country with which
Australia has a double taxation 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 stockholder carries on business or provides independent personal
services, respectively. If a company that is a non-Australian resident stockholder 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%. Tax on Sales or other Dispositions of SharesCapital gains tax Non-Australian resident stockholders 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 any time during the five years before the disposal of the
shares. There are proposed changes to the current legislation, which would exempt holdings of 10%
or more of issued capital from Australian capital gains tax. At the present time it is uncertain
when these proposed changes might take effect. Currently, a non-Australian resident stockholder who owns a 10% or more interest would be
subject to Australian capital gains tax to the same extent as Australian resident stockholders. The
Australian Taxation Office maintains the view that Australian capital gains tax is not limited by
the Double Taxation Convention between the United States and Australia. Australian capital gains
tax applies to net capital gains at a taxpayers marginal tax rate but for certain stockholders a
discount of the capital gain may apply if the shares have been held for 12 months or more. For
individuals, this discount is 50%. 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Stockholders Holding Shares on Revenue Account Some non-Australian resident stockholders may hold shares on revenue rather than on capital
account, for example, share traders. These stockholders 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. 49




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Non-Australian resident stockholders 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 stockholders under the Double Taxation Convention between the United
States and Australia, for example, because the stockholder does not have a permanent establishment
in Australia. To the extent an amount would be included in a non-Australian resident stockholder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 stockholder would not be subject to
double tax on any part of the income gain or capital gain. Dual Residency If a stockholder were a resident of both Australia and the United States under those
countries domestic taxation laws, that stockholder may be subject to tax as an Australian
resident. If, however, the stockholder 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. Stockholders should obtain specialist
taxation advice in these circumstances. Stamp Duty From July 1, 2001, any transfer of shares through trading on the Australian Stock Exchange,
whether by Australian residents or foreign residents, are not subject to Queensland stamp 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 will not incur Australian goods and services tax and does not
require a stockholder to register for Australian goods and services tax purposes. F. Dividends and Paying Agents Not applicable. G. Statements by Experts Not applicable. H. Documents on Display We are subject to the periodic reporting and other informational requirements of the 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 Judiciary
Plaza, 450 Fifth Street, N.W., 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. 50




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Item 11. Quantitative and Qualitative Disclosure about Market Risk We invest excess cash in term deposits with high-quality financial institutions. 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 stockholders equity, while transaction gains and losses have been reflected as
components of income and loss. Translation 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. 
 Item 12. Description of Securities Other than Equity Securities Not applicable. 51




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PART II 
 Item 13. Defaults, Dividend Arrearages and Delinquencies Not applicable. 
 Item 14. Material Modifications to the Rights of Security Holders and the Use of Proceeds Not applicable. 
 Item 15. Controls and Procedures Our management have evaluated the effectiveness of Metal Storms disclosure controls and
procedures as of the end of the period covered by this report. Based on that evaluation, the
principal executive officer and principal financial officer became aware of the weaknesses related
to internal control over financial reporting described below. In connection with their audit of our 2004 consolidated financial statements our independent
auditors, Ernst & Young, advised our Audit Committee that they had identified material weaknesses
relating to our internal control environment involving our systems and processes, our financial
close process and segregation of duties. In particular, our auditors observed, as a result of our
size and the limited resources available to us, that duties and functions were not segregated to
adequately safeguard our assets and ensure proper financial reporting. Most accounting processes,
including updating of journals, reconciliation preparation, processing of payments, writing checks
and banking tasks, were being performed by a contract financial controller with little review
processes in place and, where there were review processes in place, they were not necessarily being
performed. Our auditors noted that the lack of a segregation of duties is a common problem for
companies the size of Metal Storm and recommended various measures to establish such a control,
including (i) the segregation of duties between employees, (ii) scrutinizing monthly receipts and
payments by someone other than the processor of journal entries, (iii) review and sign off of
month-end reconciliations by someone other than the preparer, and (iv) requiring a second signatory
for all checks issued. Our auditors also advised our Audit Committee that our financial close
process, and in particular, our ability to prepare financial statements under both Australian and
U.S. GAAP, need improvement. We have taken measures to establish internal controls over financial reporting related to the
segregation of duties by implementing the recommendations of our auditors. We employed a new Chief
Financial Officer in October 2004 who independently reviews the processes performed by an
experienced financial controller who was recruited by us in June 2005. We believe that the
segregation of duties between the financial controller and the Chief Financial Officer, the
periodic review by the Chief Financial Officer of the processes performed by the financial
controller, and the introduction of the other measures recommended by our auditors will improve our
internal controls over financial reporting. Our Audit Committee will continually assess the
progress and effectiveness of these initiatives and make adjustments as and when necessary. As of
the date of this report, we believe that the implementation of the measures outlined above, when
completed, will eliminate the weakness related to internal control over financial reporting
described above. Nonetheless, a control system, no matter how well designed and operated, cannot
provide absolute assurance that the objectives of the control system are met, and no evaluation of
controls can provide absolute assurance that all control issues have been detected. In order to improve our knowledge of U.S. GAAP, our senior finance staff are committed to
attending targeted U.S. GAAP and SEC reporting courses and to subscribing to additional information
publications and updates of SEC and U.S. GAAP releases, rule changes and information related to
internal controls in accordance with standards established by the Public Company Accounting
Oversight Board, to the extent that such standards are applicable to us. We will also continue to
mitigate this weakness by conferring with and/or hiring outside accounting advisors with respect to
the technical requirements applicable to our financial statements. There were no significant changes in our internal controls or in other factors that could
significantly affect internal controls subsequent to the date of their evaluation. 52




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Item 16A. Audit Committee Financial Expert Terence J. ODwyer 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). 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 011-61-7-3221-9733 to obtain a copy. In 2004, 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 December 31,2004
    
    
    2003Audit
feesAudit of U.S. financial statements
    
    $
    121,552
    
    
    $
    34,588Audit of Australian financial statements
    
    
    101,260
    
    
    
    25,336Review of half-year Australian financial statements
    
    
    18,965
    
    
    
    13,441241,777
    
    
    
    73,365Audit-related
feesInternal control review
    
    
    
    
    
    
    23,242Tax fees
    
    
    
    
    
    
    All other
feesQuarterly review of U.S. press releases
    
    
    4,625
    
    
    
    8,665Total
    
    $
    246,402
    
    
    $
    105,272
 The audit committee pre-approved the engagement of Ernst & Young for all the services
described in Item 16C. 53




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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. 54




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PART III 
 Item 17. Financial Statements Not applicable. 
 Item 18. Financial Statements The financial statements are included as the F pages to this annual report. 
 Item 19. Exhibits ExhibitNumber
    
    Description of Exhibit1.1
    
    Constitution of Metal Storm*4.1
    
    DSTO Research Agreement dated April 20, 2001*4.2
    
    Deed of Amendment to the DSTO
Research Agreement dated September 13, 2002 (portions omitted pursuant to a request for confidential treatment; non-public information has been filed with the SEC)**4.3
    
    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)*4.4
    
    Asset Purchase Agreement, dated May 24, 2005, with Monroe Machined Products, Inc. (MMP) for the
sale of the ProCam business to MMP.4.5
    
    Employment Agreement of David A. Smith4.6
    
    Separation Agreement, dated February 8, 2005, of J.M. ODwyer4.7
    
    Employment Agreement of A. Schatz*4.8
    
    Employment Agreement of James D. MacDonald4.9
    
    Employment Agreement of G. Bergeron***4.10
    
    [Not used]4.11
    
    Discretionary Share Option Scheme*4.12
    
    [Not used]4.13
    
    Employment Agreement of G. R. Zink**4.14
    
    Employment Agreement of Ian A. Gillespie***4.15
    
    Membership Interest Purchase Agreement dated December 1, 2003 with ProCam Machine LLC and members of
ProCam***8.0
    
    List of Subsidiaries of Metal Storm Limited12.1
    
    Certification by the Chief Executive Officer of Metal Storm Limited in accordance with Section 302
of the Sarbanes-Oxley Act12.2
    
    Certification by the Chief Financial Officer of Metal Storm Limited in accordance with Section 302
of the Sarbanes-Oxley Act13.1
    
    Certification by the Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act13.2
    
    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 July 14, 2003.***
    
    Incorporated by reference from our Annual Report on Form 20-F filed on July 15, 2004. 55




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INDEX TO FINANCIAL STATEMENTS  
 PageMetal Storm LimitedReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Balance Sheets as of December 31, 2004 and 2003
    
    
    F-3Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2004 and the period
from April 13, 1994 (inception) to December 31, 2004
    
    
    F-4Consolidated Statements of Changes in Stockholders Equity
and Comprehensive Income (Loss) for each of the three years
in the period ended December 31, 2004 and the period from
April 13, 1994 (inception) to December 31, 2004
    
    
    F-5Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2004 and the period
from April 13, 1994 (inception) to December 31, 2004
    
    
    F-10Notes to Consolidated Financial Statements
    
    
    F-11
 F-1




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Metal Storm Limited We have audited the accompanying consolidated balance sheets of Metal Storm Limited (a
development stage enterprise) (the Company) as of December 31, 2004 and 2003, and the related
consolidated statements of operations, changes in stockholders equity and comprehensive income
(loss) and cash flows for each of the three years in the period ended December 31, 2004. These
financial statements are the responsibility of the Companys management. Our responsibility is to
express an opinion on these financial statements based on our audits. We conducted our audits in accordance with 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. We were not engaged to perform an audit of the Companys internal control over
financial reporting. Our audits included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the Companys internal control
over financial reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Metal Storm Limited at December 31, 2004 and 2003,
and the consolidated results of its operations and its cash flows for each of the three years in
the period ended December 31, 2004 in conformity with U.S. generally accepted accounting
principles. /s/ Ernst & Young Brisbane, Queensland, Australia
June 1, 2005 F-2




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METAL STORM LIMITED
(a development stage enterprise) 
 CONSOLIDATED BALANCE SHEETS
 (U.S. DOLLARS)
 As of December 312004
    
    
    2003ASSETS:Current assets:Cash and cash equivalents
    
    $
    11,818,445
    
    
    $
    6,049,249Restricted cash
    
    
    659,871
    
    
    
    Receivables-trade
    
    
    260,407
    
    
    
    352,392Receivables-other
    
    
    141,000
    
    
    
    98,754Inventory
    
    
    195,891
    
    
    
    149,925Prepaid expenses
    
    
    415,039
    
    
    
    440,318Other
    
    
    17,169
    
    
    
    17,161Total current assets
    
    
    13,507,822
    
    
    
    7,107,799Property and equipment, net
    
    
    1,447,890
    
    
    
    824,556Property and equipment under capital leases, net
    
    
    1,045,394
    
    
    
    1,717,866Other non-current receivables
    
    
    2,651
    
    
    
    8,730Intangible assets, net
    
    
    91,884
    
    
    
    1,697,497TOTAL ASSETS
    
    $
    16,095,641
    
    
    $
    11,356,448LIABILITIES AND STOCKHOLDERS EQUITY:Current liabilities:Accounts payable
    
    $
    690,962
    
    
    $
    972,726Accounts payable-severance
    
    
    265,782
    
    
    
    Accounts payable-R&D contracts
    
    
    
    
    
    
    411,400Accounts payable-related party
    
    
    209,272
    
    
    
    160,820Bank loan
    
    
    647,729
    
    
    
    432,637Note payable
    
    
    290,998
    
    
    
    333,518Obligations under capital leases
    
    
    215,505
    
    
    
    453,522Accruals for employee entitlements
    
    
    281,738
    
    
    
    318,641Total current liabilities
    
    
    2,601,986
    
    
    
    3,083,264Non-current liabilities:Accounts payable
    
    
    
    
    
    
    6,359Accruals for employee entitlements, non-current
    
    
    
    
    
    
    51,790Obligations under capital leases
    
    
    451,254
    
    
    
    1,156,664Other provisions
    
    
    32,300
    
    
    
    24,620Total non-current liabilities
    
    
    483,554
    
    
    
    1,239,433TOTAL LIABILITIES
    
    
    3,085,540
    
    
    
    4,322,697Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity:Ordinary shares issued-no par value;
521,970,978 and 460,245,890 shares issued and
outstanding in 2004 and 2003, respectively
    
    
    38,610,543
    
    
    
    23,692,899Deficit accumulated during development stage
    
    
    (26,286,742
    )
    
    
    (16,634,383
    )Unearned compensation
    
    
    (76,592
    )
    
    
    (105,118
    )Accumulated other comprehensive income
    
    
    762,892
    
    
    
    80,353Total stockholders equity
    
    
    13,010,101
    
    
    
    7,033,751TOTAL LIABILITIES AND STOCKHOLDERS EQUITY:
    
    $
    16,095,641
    
    
    $
    11,356,448
 See accompanying notes to financial statements F-3




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise) 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (U.S. DOLLARS)
 For the Periodfrom April 13,1994(inception) toFor the years ending December 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2002
    
    
    2004(unaudited)Operating income:Sales income
    
    $
    3,853,371
    
    
    $
    235,293
    
    
    $
    
    
    
    $
    4,088,664Grant income
    
    
    31,382
    
    
    
    227,439
    
    
    
    12,373
    
    
    
    942,353Total operating income
    
    
    3,884,753
    
    
    
    462,732
    
    
    
    12,373
    
    
    
    5,031,017Operating expenses:Cost of goods sold
    
    
    1,240,379
    
    
    
    316,590
    
    
    
    
    
    
    
    1,556,969Research and development
    
    
    4,313,988
    
    
    
    3,224,112
    
    
    
    3,446,407
    
    
    
    15,451,069Depreciation
    
    
    380,339
    
    
    
    52,667
    
    
    
    53,982
    
    
    
    559,230Amortization
    
    
    48,247
    
    
    
    3,333
    
    
    
    
    
    
    
    51,580Impairment loss
    
    
    1,529,941
    
    
    
    
    
    
    
    
    
    
    
    1,529,941Rentals on operating leases
    
    
    406,630
    
    
    
    117,960
    
    
    
    124,291
    
    
    
    855,566General and administrative
    
    
    6,256,747
    
    
    
    1,843,805
    
    
    
    1,498,944
    
    
    
    11,916,704Legal fees-related party
    
    
    
    
    
    
    
    
    
    
    120,996
    
    
    
    444,618Consulting fees-related party
    
    
    18,413
    
    
    
    21,907
    
    
    
    175,824
    
    
    
    846,496Total operating expenses
    
    
    14,194,684
    
    
    
    5,580,374
    
    
    
    5,420,444
    
    
    
    33,212,173Loss from operations
    
    
    (10,309,931
    )
    
    
    (5,117,642
    )
    
    
    (5,408,071
    )
    
    
    (28,181,156
    )Other income (expense):Interest income
    
    
    596,787
    
    
    
    221,736
    
    
    
    101,893
    
    
    
    1,623,277Research and development rebate received
    
    
    245,066
    
    
    
    274,937
    
    
    
    
    
    
    
    520,003Interest expense
    
    
    (196,519
    )
    
    
    (12,639
    )
    
    
    (901
    )
    
    
    (214,800
    )Other income

    
    
    10,403
    
    
    
    
    
    
    
    384
    
    
    
    10,787Foreign exchange
    
    
    1,835
    
    
    
    (97,147
    )
    
    
    (72,898
    )
    
    
    (44,853
    )Total other income
    
    
    657,572
    
    
    
    386,887
    
    
    
    28,478
    
    
    
    1,894,414Net loss
    
    $
    (9,652,359
    )
    
    $
    (4,730,755
    )
    
    $
    (5,379,593
    )
    
    $
    (26,286,742
    )Net loss per ordinary share (basic and diluted)
    
    $
    (0.019
    )
    
    $
    (0.011
    )
    
    $
    (0.013
    )Weighted average ordinary shares outstanding
    
    
    500,775,685
    
    
    
    442,525,034
    
    
    
    428,974,260
 See accompanying notes to financial statements F-4




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise) 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME
 (LOSS)
 (U.S. DOLLARS)
 AccumulatedNumber of
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    
    OtherOrdinary
    
    
    
    
    
    
    Accumulated
    
    
    Unearned
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Deficit
    
    
    Compensation
    
    
    Income (Loss)
    
    
    TotalBalance at April 13, 1994
(inception)
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,679
    
    
    
    12,679Net loss
    
    
    
    
    
    
    
    
    
    
    (740,991
    )
    
    
    
    
    
    
    
    
    
    
    (740,991
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (728,312
    )Issuance of ordinary shares
in exchange for patents and
intellectual property (May 4,
1994)
    
    
    1,125,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of ordinary shares (May
4, 1994)
    
    
    500,002
    
    
    
    365,951
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    365,951Compensation expense
    
    
    
    
    
    
    465,588
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    465,588Balance-June 30, 1995
    
    
    1,625,002
    
    
    
    831,539
    
    
    
    (740,991
    )
    
    
    
    
    
    
    12,679
    
    
    
    103,227Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,618
    
    
    
    21,618Net loss
    
    
    
    
    
    
    
    
    
    
    (178,748
    )
    
    
    
    
    
    
    
    
    
    
    (178,748
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (157,130
    )Issuance of ordinary shares
(100,000 November 3, 1995; 562,500
December 15, 1995; 5,000 May 20,
1996)
    
    
    667,500
    
    
    
    506,766
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    506,766Balance-June 30, 1996
    
    
    2,292,502
    
    
    
    1,338,305
    
    
    
    (919,739
    )
    
    
    
    
    
    
    34,297
    
    
    
    452,863Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,622
    )
    
    
    (14,622
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (208,962
    )
    
    
    
    
    
    
    
    
    
    
    (208,962
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (223,584
    )Balance-June 30, 1997
    
    
    2,292,502
    
    
    
    1,338,305
    
    
    
    (1,128,701
    )
    
    
    
    
    
    
    19,675
    
    
    
    229,279Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (62,120
    )
    
    
    (62,120
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (272,032
    )
    
    
    
    
    
    
    
    
    
    
    (272,032
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (334,152
    )Issuance of ordinary shares
(March 30, 1998)
    
    
    820,000
    
    
    
    554,977
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    554,977Share options exercised (March 30,
1998)
    
    
    637,500
    
    
    
    4,314
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,314Balance-June 30, 1998
    
    
    3,750,002
    
    
    
    1,897,596
    
    
    
    (1,400,733
    )
    
    
    
    
    
    
    (42,445
    )
    
    
    454,418
 F-5




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME
 (LOSS)
 (U.S. DOLLARS)
 AccumulatedNumber of
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    
    OtherOrdinary
    
    
    
    
    
    
    Accumulated
    
    
    Unearned
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Deficit
    
    
    Compensation
    
    
    Income (Loss)
    
    
    TotalBalance-June 30, 1998
    
    
    3,750,002
    
    
    
    1,897,596
    
    
    
    (1,400,733
    )
    
    
    
    
    
    
    (42,445
    )
    
    
    454,418Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,615
    )
    
    
    (6,615
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (184,463
    )
    
    
    
    
    
    
    
    
    
    
    (184,463
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (191,078
    )Balance-December 31, 1998
    
    
    3,750,002
    
    
    
    1,897,596
    
    
    
    (1,585,196
    )
    
    
    
    
    
    
    (49,060
    )
    
    
    263,340Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    131,537
    
    
    
    131,537Net loss
    
    
    
    
    
    
    
    
    
    
    (1,130,571
    )
    
    
    
    
    
    
    
    
    
    
    (1,130,571
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (999,034
    )Share split
    
    
    76,500,040
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of ordinary shares (June 9, 1999)
    
    
    4,000,000
    
    
    
    7,745,070
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,745,070Share issue costs
    
    
    
    
    
    
    (773,850
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (773,850
    )Balance-December 31, 1999
    
    
    84,250,042
    
    
    
    8,868,816
    
    
    
    (2,715,767
    )
    
    
    
    
    
    
    82,477
    
    
    
    6,235,526Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (945,371
    )
    
    
    (945,371
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (1,157,914
    )
    
    
    
    
    
    
    
    
    
    
    (1,157,914
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,103,285
    )Share split
    
    
    337,000,168
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unearned compensation
    
    
    
    
    
    
    69,098
    
    
    
    
    
    
    
    (69,098
    )
    
    
    
    
    
    
    Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,557
    
    
    
    
    
    
    
    17,557Balance-December 31, 2000
    
    
    421,250,210
    
    
    
    8,937,914
    
    
    
    (3,873,681
    )
    
    
    (51,541
    )
    
    
    (862,894
    )
    
    
    4,149,798Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (370,601
    )
    
    
    (370,601
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (2,650,354
    )
    
    
    
    
    
    
    
    
    
    
    (2,650,354
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,020,955
    )Options issued to employee fully vested
    
    
    
    
    
    
    56,616
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,616Unearned compensation
    
    
    
    
    
    
    746,237
    
    
    
    
    
    
    
    (746,237
    )
    
    
    
    
    
    
    Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    151,188
    
    
    
    
    
    
    
    151,188Options issued to non-employee fully vested
    
    
    
    
    
    
    303,159
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    303,159Issuance of ordinary shares (1,390,154
March 19, 2001; 658,194 May 29, 2001)
    
    
    2,048,348
    
    
    
    1,553,770
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,553,770Issuance of ordinary shares (June 1, 2001)
    
    
    100,000
    
    
    
    68,677
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    68,677Share options exercised (June 28, 2001)
    
    
    5,000
    
    
    
    1,400
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,400Balance-December 31, 2001
    
    
    423,403,558
    
    
    
    11,667,773
    
    
    
    (6,524,035
    )
    
    
    (646,590
    )
    
    
    (1,233,495
    )
    
    
    3,263,653
 F-6




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME
 (LOSS)
 (U.S. DOLLARS)
 AccumulatedNumber of
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    
    OtherOrdinary
    
    
    
    
    
    
    Accumulated
    
    
    Unearned
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Deficit
    
    
    Compensation
    
    
    Income (Loss)
    
    
    TotalBalance-December 31, 2001
    
    
    423,403,558
    
    
    $
    11,667,773
    
    
    $
    (6,524,035
    )
    
    $
    (646,590
    )
    
    $
    (1,233,495
    )
    
    $
    3,263,653Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    335,320
    
    
    
    335,320Net loss
    
    
    
    
    
    
    
    
    
    
    (5,379,593
    )
    
    
    
    
    
    
    
    
    
    
    (5,379,593
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,044,273
    )Unearned compensation
    
    
    
    
    
    
    (495,933
    )
    
    
    
    
    
    
    495,933
    
    
    
    
    
    
    
    Amortization of unearned
compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,783
    )
    
    
    
    
    
    
    (5,783
    )Share options exercised (May 31,
2002)
    
    
    500,000
    
    
    
    132,319
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    132,319Issuance of ordinary shares
(August 27, 2002)
    
    
    14,142,700
    
    
    
    5,009,132
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,009,132Share issue costs
    
    
    
    
    
    
    (15,777
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,777
    )Share options exercised (6,958
September 24, 2002; 8,844 October
17, 2002)
    
    
    15,802
    
    
    
    5,617
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,617Issuance of ordinary shares for
services (September 24, 2002)
    
    
    766,488
    
    
    
    216,824
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    216,824Issuance of ordinary shares to
employees (September 24, 2002)
    
    
    50,000
    
    
    
    14,416
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,416Options issued to non-employees -
fully vested (50,000 June 26,
2002; 766,488 September 24, 2002;
16,665 October 17, 2002)
    
    
    
    
    
    
    124,125
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    124,125Balance-December 31, 2002
    
    
    438,878,548
    
    
    
    16,658,496
    
    
    
    (11,903,628
    )
    
    
    (156,440
    )
    
    
    (898,175
    )
    
    
    3,700,253
 F-7




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME
 (LOSS)
 (U.S. DOLLARS)
 AccumulatedNumber of
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    
    OtherOrdinary
    
    
    
    
    
    
    Accumulated
    
    
    Unearned
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Deficit
    
    
    Compensation
    
    
    Income (Loss)
    
    
    TotalBalance-December 31, 2002
    
    
    438,878,548
    
    
    
    16,658,496
    
    
    
    (11,903,628
    )
    
    
    (156,440
    )
    
    
    (898,175
    )
    
    
    3,700,253Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    978,528
    
    
    
    978,528Net loss
    
    
    
    
    
    
    
    
    
    
    (4,730,755
    )
    
    
    
    
    
    
    
    
    
    
    (4,730,755
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,752,227
    )Unearned compensation
    
    
    
    
    
    
    30,267
    
    
    
    
    
    
    
    (30,267
    )
    
    
    
    
    
    
    Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    81,589
    
    
    
    
    
    
    
    81,589Issuance of ordinary shares to third
parties (February 24, 2003)
    
    
    59,472
    
    
    
    15,635
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,635Share options exercised (January 28,
2003)
    
    
    1,008
    
    
    
    387
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    387Share options exercised (February 24,
2003)
    
    
    475
    
    
    
    185
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    185Share options exercised (June 4, 2003)
    
    
    125
    
    
    
    54
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    54Share options exercised (October 16,
2003)
    
    
    455
    
    
    
    204
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    

    204Share options exercised (December 4,
2003)
    
    
    250
    
    
    
    120
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    120Issuance of ordinary shares to
employees (September 3, 2003)
    
    
    50,000
    
    
    
    16,440
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,440Issuance of ordinary shares under the
Share Purchase Plan (October 2003)
    
    
    15,730,631
    
    
    
    4,872,327
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,872,327Share issue costs
    
    
    
    
    
    
    (23,964
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,964
    )Issuance of shares for purchase of
ProCam Machine LLC (December 11,
2003)
    
    
    3,913,033
    
    
    
    1,416,374
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,416,374Issuance of shares for settlement of
promissory note as part of the
purchase of ProCam Machine LLC
(December 11, 2003)
    
    
    1,184,713
    
    
    
    407,999
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    407,999Issuance of shares for services
rendered as part of the purchase of
ProCam Machine LLC (December 11,
2003)
    
    
    427,180
    
    
    
    153,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    153,000Issuance of options in settlement of
cash bonus payable (500,000 September
3, 2003; 118,000 November 19, 2003)
    
    
    
    
    
    
    140,138
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    140,138Issuance of options under employee
share option plan  fully vested
(5,000 on June 4, 2003 and 80,000 on
September 3, 2003)
    
    
    
    
    
    
    5,237
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,237Balance-December 31, 2003
    
    
    460,245,890
    
    
    
    23,692,899
    
    
    
    (16,634,383
    )
    
    
    (105,118
    )
    
    
    80,353
    
    
    
    7,033,751
 F-8




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME
(LOSS)
(U.S. DOLLARS) AccumulatedNumber of
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    
    OtherOrdinary
    
    
    
    
    
    
    Accumulated
    
    
    Unearned
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Deficit
    
    
    Compensation
    
    
    Income (Loss)
    
    
    TotalBalance-December 31, 2003
    
    
    460,245,890
    
    
    
    23,692,899
    
    
    
    (16,634,383
    )
    
    
    (105,118
    )
    
    
    80,353
    
    
    
    7,033,751Other comprehensive income:Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    682,539
    
    
    
    682,539Net loss
    
    
    
    
    
    
    
    
    
    
    (9,652,359
    )
    
    
    
    
    
    
    
    
    
    
    (9,652,359
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,936,069
    )Unearned compensation
    
    
    
    
    
    
    (96,446
    )
    
    
    
    
    
    
    96,446
    
    
    
    
    
    
    
    Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (67,920
    )
    
    
    
    
    
    
    (67,920
    )Issuance of shares under a private
equity raising (May 5, 2004)
    
    
    61,461,194
    
    
    
    15,782,927
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,782,927Share issue costs
    
    
    
    
    
    
    (1,251,037
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,251,037
    )Issuance of shares to a former employee
of ProCam Machine LLC as part of his
exit agreement (February 6, 2004)
    
    
    242,069
    
    
    
    80,609
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    80,609Issuance of shares for employment
services rendered (July 9, 2004)
    
    
    17,200
    
    
    
    4,784
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,784Share options exercised (March 24, 2004)
    
    
    60
    
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29Share options exercised (April 16, 2004)
    
    
    75
    
    
    
    37
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    37Share options exercised (April 23, 2004)
    
    
    100
    
    
    
    47
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    47Share options exercised (August 13,
2004)
    
    
    50
    
    
    
    24
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24Share options exercised (September 7,
2004)
    
    
    4,340
    
    
    
    1,956
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,956Issuance of options to Directors in
lieu of cash payment (3,465,000 on June
21, 2004)
    
    
    
    
    
    
    247,428
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    247,428Grant of options in settlement of
consultants fees (100,000 on February
2, 2004; 14,438 on February 16, 2004;
8,250 on March 10, 2004; 29,500 on
April 5, 2004; 25,000 on May 10, 2004;
25,000 on June 8, 2004 and 75,000 on
July 5, 2004)
    
    
    
    
    
    
    58,357
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    58,357Issuance of options in settlement
of cash bonus payable (500,000 on
April 14, 2004)
    
    
    
    
    
    
    63,299
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    63,299Grant of options to employees under
employment contracts (125,000 on
January 14, 2004, 81,250 on February
24, 2004, 62,500 on March 31, 2004 and
600,000 on April 14, 2004)
    
    
    
    
    
    
    25,630
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,630Balance-December 31, 2004
    
    
    521,970,978
    
    
    $
    38,610,543
    
    
    $
    (26,286,742
    )
    
    $
    (76,592
    )
    
    $
    762,892
    
    
    $
    13,010,101
 The functional currency for the Companys operations is Australian dollars (A$). The
translation from Australian dollars into U.S. dollars is performed for balance sheet accounts using
current exchange rates in effect at balance sheet date and for revenue and expense accounts using
the average exchange rate during the period. The gains or losses resulting from such translation
are included in other comprehensive income (loss). See accompanying notes to financial statements F-9




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise) 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (U.S. DOLLARS)
 For the Periodfrom April 13,1994(inception) toFor the years ending December 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2002
    
    
    2004(unaudited)Operating ActivitiesNet loss
    
    $
    (9,652,359
    )
    
    $
    (4,730,755
    )
    
    $
    (5,379,593
    )
    
    $
    (26,286,742
    )Depreciation and amortization
    
    
    428,586
    
    
    
    56,000
    
    
    
    53,982
    
    
    
    610,810Stock based compensation-employee
    
    
    (42,290
    )
    
    
    86,826
    
    
    
    8,633
    
    
    
    278,610Shares issued to employees
    
    
    4,784
    
    
    
    16,440
    
    
    
    
    
    
    
    21,224Stock based compensation-non-employees
    
    
    58,357
    
    
    
    15,635
    
    
    
    340,949
    
    
    
    786,777Foreign exchange (gain) loss
    
    
    1,835
    
    
    
    (22,750
    )
    
    
    72,898
    
    
    
    81,031Movement in inventory provision
    
    
    69,994
    
    
    
    
    
    
    
    
    
    
    
    69,994Impairment loss
    
    
    1,529,941
    
    
    
    
    
    
    
    
    
    
    
    1,529,941Movement in deferred rent
    
    
    48,697
    
    
    
    
    
    
    
    
    
    
    
    48,697Write-off of loan receivable
    
    
    34,248
    
    
    
    
    
    
    
    
    
    
    
    34,248Accretion expense-Asset retirement obligation
    
    
    8,704
    
    
    
    
    
    
    
    
    
    
    
    8,704Net change in operating assets and liabilities:(Increase) decrease in assets:Receivables and other current assets
    
    
    110,438
    
    
    
    40,252
    
    
    
    171,810
    
    
    
    123,245Prepaid expenses
    
    
    8,525
    
    
    
    26,931
    
    
    
    (185,402
    )
    
    
    (224,620
    )Inventory
    
    
    (113,418
    )
    
    
    85,813
    
    
    
    
    
    
    
    (27,605
    )Increase (decrease) in liabilities:Accounts payables
    
    
    (115,678
    )
    
    
    97,555
    
    
    
    734,545
    
    
    
    977,573Accruals for employee entitlements
    
    
    (32,913
    )
    
    
    29,159
    
    
    
    179,374
    
    
    
    139,465Accruals for employee entitlements, non-current
    
    
    (50,994
    )
    
    
    (12,998
    )
    
    
    13,594
    
    
    
    (19,295
    )Net cash used in operating activities
    
    
    (7,703,543
    )
    
    
    (4,311,892
    )
    
    
    (3,989,210
    )
    
    
    (21,847,943
    )Investing activitiesPurchase of controlled entity, net of cash received
    
    
    
    
    
    
    (144,110
    )
    
    
    
    
    
    
    (144,110
    )Payment for property and equipment
    
    
    (203,647
    )
    
    
    (66,174
    )
    
    
    (15,111
    )
    
    
    (486,807
    )Restricted cash
    
    
    (622,671
    )
    
    
    
    
    
    
    
    
    
    
    (622,671
    )Net cash used in investing activities
    
    
    (826,318
    )
    
    
    (210,284
    )
    
    
    (15,111
    )
    
    
    (1,253,588
    )Financing ActivitiesProceeds from share options exercised
    
    
    2,093
    
    
    
    950
    
    
    
    137,936
    
    
    
    146,693Proceeds from share issue
    
    
    15,782,927
    
    
    
    4,872,327
    
    
    
    5,009,132
    
    
    
    36,390,921Share issue costs
    
    
    (1,251,037
    )
    
    
    (23,964
    )
    
    
    (15,777
    )
    
    
    (2,064,628
    )Repayment of borrowings
    
    
    (1,750,001
    )
    
    
    (37,161
    )
    
    
    
    
    
    
    (1,787,162
    )Proceeds from borrowings
    
    
    886,244
    
    
    
    
    
    
    
    
    
    
    
    886,244Net cash provided by financing activities
    
    
    13,670,226
    
    
    
    4,812,152
    
    
    
    5,131,291
    
    
    
    33,572,068Effect of exchange rate changes on cash
    
    
    628,831
    
    
    
    1,217,643
    
    
    
    284,883
    
    
    
    1,347,908Net increase in cash and cash equivalents
    
    
    5,769,196
    
    
    
    1,507,619
    
    
    
    1,411,853
    
    
    
    11,818,445Cash and cash equivalents, beginning of year
    
    
    6,049,249
    
    
    
    4,541,630
    
    
    
    3,129,777
    
    
    
    Cash and cash equivalents, end of year
    
    $
    11,818,445
    
    
    $
    6,049,249
    
    
    $
    4,541,630
    
    
    $
    11,818,445Supplemental disclosure of cash flow information:Cash paid during the period for interest
    
    $
    187,815
    
    
    $
    12,639
    
    
    $
    901
    
    
    $
    205,828
 See accompanying notes to financial statements F-10




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise) 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (U.S. DOLLARS)
 1. Summary of Significant Accounting Policies Organization and Nature of Operations Metal Storm Limited was incorporated in Queensland, Australia on April 13, 1994 and listed on
the Australian Stock Exchange on July 8, 1999. On March 14, 2001, Metal Storm Limited formed a
wholly-owned subsidiary, Metal Storm, Inc., incorporated in the state of Virginia, United States
(U.S.) on March 31, 2004, Metal Storm Limited formed another wholly-owned subsidiary, Metal Storm
U.S.A. Limited incorporated in the state of Delaware, U.S. and on December 11, 2003, Metal Storm
Limited acquired 100% of ProCam Machine LLC, based in Seattle, Washington, U.S. (collectively
referred to as Metal Storm or the Company). Metal Storm is a development stage enterprise engaged in the research and development of
electronic ballistics technology. The Company continues to establish the viability of this
technology with government agencies in the U.S. and Australia. The technology has no known
equivalent and incorporates a 100% electronic firing system. The technology has many potential
applications, including applications in the military and law enforcement industries, firearms and
the commercial environment. ProCam Machine LLC specializes in the manufacture and sale of precision engineered parts to
the defense, electronics, aircraft and space propulsion industries. Principles of Consolidation The financial statements include the accounts of Metal Storm Limited and its wholly-owned
subsidiaries, Metal Storm Inc (comprising the Rabbi Trust), Metal Storm U.S.A. Limited and ProCam
Machine LLC. All inter-company balances and transactions have been eliminated on consolidation. Basis of Presentation The Companys principal activities to date have included technology development, obtaining
research and funding grants, securing of patents and intellectual property rights and securing
finance for working capital and capital expenditure. Accordingly, these financial statements are
presented as those of a development stage enterprise, as prescribed by Statement of Financial
Accounting Standards (SFAS) No. 7 Accounting and Reporting by Development Stage Enterprises. The
financial statements have been prepared in accordance with accounting principles generally accepted
in the United States of America (U.S. GAAP) and are presented in U.S. dollars. Development StageRisks As a development stage enterprise, the Companys prospects are subject to the risks, expenses
and uncertainties frequently encountered by companies which have not yet commercialized any
applications of their technology, particularly in new and evolving markets. The Companys operating
results may fluctuate significantly in the future as a result of a variety of factors, including
capital expenditure and other costs relating to establishing, maintaining and expanding the
operations, the number and mix of potential customers, potential pricing of future products by the
Company and its competitors, new technology introduced by the Company and its competitors, delays
or expense in obtaining necessary equipment, economic and social conditions in the defense and
ballistics industries and general economic conditions. The Company will continue to review the need to seek additional funding through public and
private financing and/or through collaboration or other arrangements with corporate partners. The
Company cannot be certain that it will be able to raise any required funding or capital, on
favorable terms or at all, or that they will be able to establish corporate collaborations on
acceptable terms, if at all. If the Company is unable to obtain such additional funding or capital,
they may be required to reduce the scope of their development plans. The Companys experience in exploiting their technology is limited. The Company cannot be certain
that their operations will be profitable in the short-term, or at all. If the Company fails in any
of their efforts to establish or expand their business, the results of operations and financial
condition could be materially adversely affected. The Company cannot be certain that they will be
able to obtain or retain any permits required by the Company to market, sell and deliver its
technology. Any of these factors could result in cessation of the Companys operations. F-11




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) Revenue Recognition A sale is recorded when goods have been delivered to and accepted by the customer pursuant to
a fixed price sales order, collectibility of the selling price is reasonably assured and the
associated risks have passed to the customer. The Company receives non-refundable government grants which fund the Companys efforts in
specific research and development projects. These grants generally provide for reimbursement of
approved costs incurred as defined in the various agreements and are expected to fully cover the
Companys costs for the specific research and development projects. Government grants are recorded
as revenue when key milestones set within each agreement are achieved and accepted by all parties
to the grant, no performance obligation remains and collectibility is reasonably assured. Interest income is recognized as earned and when collectibility is assured. Research and Development Research and development expense, which includes personnel costs, manufacturing expenses and
outsourcing services, consists of expenditures for research the Company conducts and includes the
Companys share of costs incurred under research arrangements, grants and contracts with the U.S.
government. The Company expenses research and development expenses as they are incurred. The
Company has not entered into any research and development agreements that would require government
grants and contracts to be recorded as an offset to research and development expenses in accordance
with the AICPA Audit and Accounting Guide: Audits of Federal Government Contractors. Although the Company believes that its patents and underlying technology have continuing
value, the future benefits to be derived there from are uncertain. Patent costs are therefore
included under research and development expenses rather than capitalized. Foreign Currency Transactions The Australian dollar is the functional currency for the parent entity, Metal Storm Limited.
The functional currency of the Companys subsidiaries Metal
Storm Inc. and Metal Storm U.S.A. Limited is the Australian dollar
and the functional currency of ProCam Machine LLC is the U.S. dollar. Balance sheet amounts
denominated in Australian dollars have been translated into U.S. dollars using the year end rate of
exchange. Operating results denominated in Australian dollars have been translated into U.S.
dollars using the average rate of exchange. Capital accounts are translated at historical exchange
rates. Gains or losses resulting from such translation are included as a component of stockholders
equity. Foreign currency transaction gains or losses are recognized in the period incurred and are
included in other income (expense) in the consolidated statements of operations. Commitments,
contingencies and option exercise prices detailed in the notes have been translated into U.S.
currency at the rate of exchange at December 31, 2004 and 2003 of A$1.00 = $0.7805 and A$1.000 =
$0.748, respectively. Cash and Cash Equivalents Cash equivalents are comprised of short-term, highly liquid investments that are both: (i)
readily convertible to known amounts of cash, and (ii) so near their maturity that they present
insignificant risk of changes in value because of changes in interest rates. Investments with
maturities less than 90 days are classified as cash equivalents. Accounts Receivable Trade receivables are carried at amounts due. The collectibility of debts is assessed at the
balance date and specific provision is made for any doubtful accounts. Property and Equipment Property and equipment are stated at cost, net of accumulated depreciation. Property and
equipment are depreciated on a straight line basis over the estimated useful lives of the assets. F-12




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) Classes of property and equipment and related useful lives are as follows: EstimatedUseful LifeAsset
    
    YearsMachinery and equipment
    
    
    2.5-5Leasehold improvements
    
    Lease termMachinery and equipment under capital leases
    
    Lease term
 Inventory Inventory is stated at the lower of cost or market value. Costs are assigned to individual
items of inventory mainly on the basis of average costs. Goodwill The Company recorded goodwill from the purchase of ProCam Machine, LLC which was effective
December 1, 2003. In accordance with SFAS No. 142, Accounting for Goodwill and Intangible Assets,
no amortization has been recorded for goodwill. SFAS No. 142 requires that goodwill be assessed
annually for impairment. Goodwill represents the excess of the cost of businesses acquired over the fair value of the
identifiable net assets acquired. The Company tests goodwill for impairment annually, and on an
interim basis if events or changes in circumstances between annual tests indicate that the asset
might be impaired, using the two-step process prescribed in SFAS 142. The first step is a
comparison of the fair value of the reporting unit with its carrying amount, including goodwill. If
this step reflects impairment, then the loss is measured as the excess of the recorded goodwill
over its implied fair value. Implied fair value is the excess of the fair value of the reporting
unit over the fair value of all identified assets and liabilities. Intangible Assets The Company amortizes finite life intangible assets over their estimated useful life using the
straight line method as follows: Non-compete agreements  3 years The Company periodically evaluates the recoverability of intangible assets when necessary and
takes into account events or circumstances that warrant revised estimates of useful lives or that
indicate that impairment exists. Stock-Based Compensation The Company has elected to account for its stock option plans in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employeesand related
interpretations (APB 25) and adopt the disclosure-only provisions of SFAS No. 123, Accounting for
Stock-Based Compensation(SFAS 123). Under APB 25, the Company recognizes compensation expense
for stock option grants to the extent that the fair value of the stock exceeds the exercise price
of the option at the measurement date. Unearned compensation expense is charged against operations
ratably over the vesting period of the options. For disclosure purposes under SFAS 123, stock
options are valued at the measurement date using the Black-Scholes option valuation model and
compensation costs are recognized ratably over the vesting period. Options granted to consultants and other non-employees are accounted for in accordance with
Emerging Issues Task Force Consensus No. 96-18, Accounting for Equity Instruments That Are Issued
to Other Than Employees for Acquiring, or In Conjunction with Selling, Goods or Services, and
valued using the Black-Scholes option valuation model. F-13




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) The Companys pro forma information with respect to employee stock-based compensation is as
follows: 2004
    
    
    2003
    
    
    2002Net loss as reported
    
    $
    (9,652,359
    )
    
    $
    (4,730,755
    )
    
    $
    (5,379,593
    )Basic and diluted net loss per ordinary share as reported
    
    $
    (0.019
    )
    
    $
    (0.011
    )
    
    $
    (0.013
    )Employee stock based compensation, net of taxes, as
calculated under APB 25 included in net loss as reported
    
    $
    (37,506
    )
    
    $
    103,266
    
    
    $
    8,633Employee stock based compensation, net of taxes, as
calculated under FAS 123
    
    $
    (325,674
    )
    
    $
    (229,170
    )
    
    $
    (145,691
    )Pro forma net loss
    
    $
    (10,015,539
    )
    
    $
    (4,856,659
    )
    
    $
    (5,516,651
    )Pro forma basic and diluted net loss per ordinary share
    
    $
    (0.020
    )
    
    $
    (0.011
    )
    
    $
    (0.013
    )
 Refer to Note 15 for further details regarding the Companys stock option plans. Net Loss Per Share Basic and diluted net loss per share has been calculated by dividing net loss by the weighted
average ordinary shares outstanding during the periods. Stock options have not been included in the computation of net loss per share in the periods
presented, as their effect is anti-dilutive. For additional disclosures regarding stock options see
Note 15. Accounting Estimates The preparation of financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported results of operations during
the reporting period. Actual results could differ from those estimates. Accounting estimates have
been applied to calculate accruals for employee entitlements. Income Taxes Income taxes have been provided using the liability method of accounting in accordance with
Statement of Financial Accounting Standards No 109 (SFAS 109) Accounting for Income Taxes. Accruals for Employee Entitlements The Company accrues compensated absences and related benefits as current charges to earnings
when the following criteria are met: (i) the employees right to receive compensation for the
future absences is attributable to services already performed by the employee; (ii) the employees
right to receive the compensation for the future absences is vested, or accumulates; (iii) it is
probable that the compensation will be paid; and (iv) the amount of compensation is reasonably
estimable. F-14




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) Impairment Pursuant to guidance established in SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets,the Company evaluates the recoverability of its long lived assets when events
and circumstances warrant such a review or at least annually. An impairment review is based on an
undiscounted cash flow analysis. Impairment occurs if the carrying value exceeds the future
undiscounted cash flows from related operations. If impairment is deemed to exist, the asset will
be written down to fair value, generally determined based on projected discounted cash flows.
Management also re-evaluates the periods of amortization to determine whether subsequent events and
circumstances warrant revised estimates of useful lives. The Company did not deem any of its
identifiable assets to be impaired, and no impairment adjustment (other than for goodwill) was
recorded. Financial Instruments The fair values of financial instruments, including cash and cash equivalents, accounts
receivable, investments, accounts payable, bank loan and other loan, approximate their carrying
value due to their short term nature. Refer to Note 17 for further details. Reclassifications Certain reclassifications have been made to prior periods to conform to the current period
presentation. Rabbi Trust On September 1, 2003, in order for the Company to meet the requirements of the Small Business
Innovation Research Program (SBIR), a U.S. Government program that funds research and development
activities aimed at the defense industry, the Company divested 51% of its interest in Metal Storm
Inc. to a trust established to hold shares of common stock for the benefit of U.S. citizens
identified by the Board and pursuant to a compensation plan, which has yet to be adopted. The
trust qualifies as a rabbi trust for U.S. legal and tax purposes and per guidance in EITF 97-14
Accounting for Deferred Compensation Agreements Where Amounts Are Held in a Rabbi Trust and
Investedshould be consolidated with the financial statements of the employer, being Metal Storm
Inc. At December 31, 2004 no shares or options were issued by the trust. Software development cost: Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed, requires software development costs to be
capitalized upon the establishment of technological feasibility. The establishment of technical
feasibility and the ongoing assessment of the recoverability of these costs requires considerable
judgment by management with respect to certain external factors, such as anticipated future
revenue, estimated economic life, and changes in software and hardware technologies. Capitalizable
software development expenses have not been significant and have been expensed as incurred. Accounting Standards In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment. SFAS No. 123R is a revision
of SFAS No. 123, Accounting for Stock Based Compensation, and supersedes APB 25. Among other items,
SFAS 123R eliminates the use of APB 25 and the intrinsic value method of accounting, and requires
companies to recognize in the financial statements the cost of employee services received in
exchange for awards of equity instruments, based on the grant date fair value of those awards. The
effective date of SFAS 123R is the first reporting period beginning after June 15, 2005, although
early adoption is allowed. SFAS 123R requires companies to adopt its requirements using a modified
prospective method or a modified retrospective method. Under the modified prospective method,
compensation cost is recognized in the financial statements beginning with the effective date,
based on the requirements of SFAS 123R for all share-based payments granted after that date, and
based on the requirements of SFAS 123 for all unvested awards granted prior to the effective date
of SFAS 123R. The modified retrospective method also permits entities to restate financial
statements of previous periods based on proforma disclosures made in accordance with SFAS 123. F-15




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) The Company currently utilizes a standard option pricing model (i.e., Black-Scholes) to
measure the fair value of stock options granted to employees for proforma purposes. While SFAS 123R
permits entities to continue to use such a model, the standard also permits the use of a lattice
model. The Company has not yet determined which model it will use to measure the fair value of
employee stock options upon the adoption of SFAS 123R. SFAS 123R also requires that the benefits associated with the tax deductions in excess of
recognized compensation cost be reported as a financing cash flow, rather than as an operating cash
flow as required under current literature. The Company has not yet determined what effect, if any,
this change will have on future periods. The Company will adopt SFAS 123R effective July 1, 2005; however, it has not yet determined
which of the aforementioned adoption methods it will use. In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151,
Inventory Costs  an amendment to ARB No. 43. This statement provides guidance to clarify the
accounting for abnormal amounts of idle facility expense, freight handling costs, and wasted
material (spoilage), among other production costs. Provisions of ARB No. 43 stated that under some
circumstances, items such as idle facility expense, excessive spoilage and other costs may be so
abnormal as to require treatment as current period charges. This statement requires that those
items to be recognized as current period charges regardless of whether they meet the criterion of
so abnormal. In addition, SFAS No. 151 requires that allocation of fixed production overheads to
the costs of conversion be based on the normal capacity of the production facilities. The
provisions of this statement will be applied prospectively during the fiscal year beginning January
1, 2006. Adoption of the statement is not expected to have a material impact on the Companys
financial statements. In November 2004, the FASB issued SFAS No. 152 Accounting for Real Estate Time-Sharing
Transactions  an amendment of SFAS No. 66 and 67. This Statement amends SFAS No. 66. Accounting
for Sales of Real Estate, to reference the financial accounting and reporting guidance for real
estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2,
Accounting for Real Estate Time-Sharing Transactions. This Statement also amends SFAS No. 67,
Accounting for Costs and Initial Rental Operations of Real Estate Projects, to state the guidance
for (a) incidental costs and (b) costs incurred to sell real estate projects does not apply to real
estate time-sharing transactions. The accounting for those operations and costs is subject to
guidance in SOP 04-2. SFAS No. 152 is effective for financial statements for fiscal years
beginning after June 15, 2005. Adoption of this statement is not expected to have a material
impact on the Companys financial statements. In November 2004, the FASB issued SFAS No. 153, Exchange of Non-monetary Assets  an amendment
to Accounting Principles Board (APB) Opinion No. 29. This Statement amends APB Opinion No. 29
Accounting for Non-monetary Transactions to eliminate the exception for non-monetary exchanges of
similar productive assets and replaces it with a general exception for exchanges of non-monetary
assets that do not have commercial substance. A non-monetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly as a result of the
exchange. This is effective for the Companys fiscal year beginning January 1, 2006. Adoption of
this statement is not expected to have a material impact on the Companys financial statements. 2. Concentrations of Credit Risk Financial instruments, which potentially subject the Company to concentrations of credit risk,
consist principally of cash, cash equivalents and accounts receivable. The Company invests cash and
cash equivalents, which are not required for immediate operating needs with various high credit
quality financial institutions located in Australia. Concentrations of credit risk with respect to
accounts receivable are limited due to the number and quality of entities comprising the Companys
customer base. The Company performs credit evaluations of its customers financial conditions and
does not require collateral for accounts receivable. Included in accounts receivable at December 31, 2003 is $211,880 receivable from three
customers representing 47% of the receivable balance. Sales to each of these customers exceeded 10%
of the Companies total sales in 2003. At December 31, 2004 no individual customer had outstanding
balances greater than 10% of accounts receivable and no sales to customers exceeded 10% of 2004
sales. Refer to Note 16 for further details. At December 31, 2004, and 2003 the Company had $177,941 and $250,356 respectively of cash on
deposit with a financial institution. The Company believes no significant risk of loss exists with
respect to these amounts. F-16




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) 3. Acquisition of Controlled Entity In December 2003, Metal Storm Limited acquired 100% of the outstanding common stock of ProCam
Machine LLC (ProCam). The results of ProCams operations have been included in the consolidated
financial statements since December 1, 2003. ProCam specialize in the manufacturing of defense
products, which provides the Company with an established business in the U.S. defense and aerospace
sector as well as the ability to produce the Companys prototype weapon systems for demonstration
in the U.S. The aggregate purchase price for the acquisition of ProCam was 5,524,926 shares of Metal Storm
Limited and $189,739 cash comprising of: 3,913,033 shares for the acquisition, 1,184,713 shares for
settlement of a promissory note, and 427,180 shares and $189,739 cash as payment for direct costs
related to the acquisition. The fair value of the shares was calculated based on the average market
price of the securities two days before and two days after the terms of the acquisition were agreed
and announced, giving a total purchase price of $2,167,112. The following table summarized the estimated fair values of the assets acquired and the
liabilities assumed at the date of acquisition. Cash
    
    $
    45,629Receivables
    
    
    442,707Inventories
    
    
    242,004Prepayments & deposits
    
    
    50,998Property and
equipment (net)
    
    
    2,413,352Intangibles
    
    
    147,000Goodwill
    
    
    1,553,830Total assets acquired
    
    
    4,895,520Payables
    
    
    (249,424
    )Interest bearing liabilities (current)
    
    
    (955,460
    )Interest bearing liabilities (long term)
    
    
    (1,237,890
    )Provisions
    
    
    (77,248
    )Other accruals
    
    
    (208,386
    )Total liabilities assumed
    
    
    (2,728,408
    )Net assets acquired
    
    $
    2,167,112
 Identifiable intangibles consist of non-compete agreements having a fair value of
$147,000 with a remaining life of three years. This intangible was assigned to the manufacturing
segment. The goodwill balance was assigned to the manufacturing segment. The following unaudited pro forma financial information summarizes the Companys consolidated
results of operations as if the ProCam acquisition had occurred on the first day of the fiscal
years 2003 and 2002. December 31,Pro-forma financial information (unaudited)
    
    2003
    
    
    2002Net revenues
    
    $
    4,294,853
    
    
    $
    1,252,195Loss before income taxes
    
    
    (5,096,327
    )
    
    
    (5,411,249
    )Net loss
    
    
    (5,096,327
    )
    
    
    (5,411,249
    )Earnings per shareBasic and Diluted
    
    
    (0.012
    )
    
    
    (0.013
    )
 F-17




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) 4. Cash and Cash Equivalents December 31,2004
    
    
    2003Cash at bank
    
    $
    891,445
    
    
    $
    484,412Cash on deposit at floating rate
    
    
    10,927,000
    
    
    
    5,564,837$
    11,818,445
    
    
    $
    6,049,249
 Deposits or withdrawals from cash on deposit may be made at any time without prior notice
or penalty. 5. Restricted Cash Restricted cash of $659,871 at December 31, 2004 represents deposits held as security for the
ProCam Machine line of credit facility. These amounts become available for use upon the
termination of this credit facility; the credit facility expires in January 2006. 6. Inventory December 31,2004
    
    
    2003Inventory consists of the following:Raw materials and supplies at cost
    
    $
    37,720
    
    
    $
    38,202Work in progress at cost
    
    
    132,847
    
    
    
    111,723Finished goods at cost
    
    
    95,318
    
    
    
    Less: Provision for obsolescence
    
    
    (69,994
    )
    
    
    $
    195,891
    
    
    $
    149,925
 Movements in provision for obsolescence for the fiscal year 2004 and 2003 are shown
below. 2004
    
    
    2003Balance at beginning of the year
    
    $
    
    
    
    $
    Provision
    
    
    101,000
    
    
    
    Write off
    
    
    (10,009
    )
    
    
    Reversal
    
    
    (20,997
    )
    
    
    Balance at end of the year
    
    $
    69,994
    
    
    $
    
 F-18




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) 7. Property and Equipment Property and equipment consist of the following: December 31,2004
    
    
    2003Machinery and equipment
    
    $
    2,111,026
    
    
    $
    1,032,827Accumulated depreciation and amortization
    
    
    (672,512
    )
    
    
    (208,271
    )1,438,514
    
    
    
    824,556Leasehold improvements
    
    
    23,596
    
    
    
    Accumulated depreciation and amortization
    
    
    (14,220
    )
    
    
    9,376
    
    
    
    Property and equipment, net
    
    $
    1,447,890
    
    
    $
    824,556Machinery and equipment under capital leases
    
    $
    1,303,864
    
    
    $
    1,733,769Accumulated depreciation and amortization
    
    
    (258,470
    )
    
    
    (15,903
    )Property and equipment under capital leases, net
    
    $
    1,045,394
    
    
    $
    1,717,866Total property and equipment, net
    
    $
    2,493,284
    
    
    $
    2,542,422
 Depreciation expense relating to property and equipment, including amounts recorded for items
under capital leases, amounted to $366,119, $52,667 and $53,982 for the years ended 2004, 2003 and
2002 respectively. 8. Intangible Assets Intangible assets consist of the following: December 31,2004
    
    
    2003Non-compete agreements  gross
    
    $
    147,000
    
    
    $
    147,000Less accumulated amortization
    
    
    (55,116
    )
    
    
    (3,333
    )Non-compete agreements  net
    
    $
    91,884
    
    
    $
    143,667Goodwill  opening
    
    $
    1,553,830
    
    
    $
    1,553,830Change in opening balance due to
movement in exchange rate
    
    
    (23,889
    )
    
    
    1,529,941
    
    
    
    1,553,830Impairment loss
    
    
    (1,529,941
    )
    
    
    Goodwill  net
    
    $
    
    
    
    $
    1,553,830Total intangible assets  net
    
    $
    91,884
    
    
    $
    1,697,497
 For further information with regard to the acquisition of the non-compete agreements and
goodwill refer to Note 3. The amortization expense of amortizable intangible assets for the years
ended December 31, 2004, 2003 and 2002 was $48,247, $3,333 and nil respectively. F-19




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) At
December 31, 2004 the Company determined an impairment loss on
goodwill of $1,529,941 was
appropriate (2003: nil). The goodwill balance arose on the acquisition of the Companys subsidiary,
ProCam Machine LLC (ProCam) in December 2003. It was deemed impaired because of the significant
underperformance of ProCam relative to expected historical and projected future operating results.
Through a detailed cash flow analysis management determined that the goodwill was impaired and
written down to its fair value. Goodwill is disclosed as part of the manufacturing segment. 9. Income Taxes At December 31, 2004 the Company has net operating loss carryforwards of approximately
$19,284,344 which are indefinite as to use under Australian tax law, and $6,789,752 in the United
States which expires at various dates through 2024. The Company has not yet assessed the impact of the reorganization of ownership in its US
subsidiary, Metal Storm, Inc. on the ability of the Company to utilize net operating losses. The gross tax loss carryforward can be reconciled as follows: Year Ended December 31,2004
    
    
    2003Opening tax loss carryforward- Australian
    
    $
    14,525,918
    
    
    $
    9,459,000- US
    
    
    2,290,102
    
    
    
    1,054,000Current year tax loss
    
    
    8,626,937
    
    
    
    4,548,375Effect of foreign currency translation
    
    
    631,139
    
    
    
    1,754,645Gross tax loss:- Australian
    
    
    19,284,344
    
    
    
    14,525,918- US
    
    
    6,789,752
    
    
    
    2,290,102Total
    
    $
    26,074,096
    
    
    $
    16,816,020
 The tax effects of temporary differences that give rise to significant portions of deferred
tax assets and liabilities at December 31, 2004, 2003 and 2002 are presented below: Year Ended December 31,Deferred tax assets
    
    2004
    
    
    2003
    
    
    2002Patent costs
    
    
    748,520
    
    
    
    517,957
    
    
    
    226,060Capital raising costs
    
    
    406,511
    
    
    
    105,351
    
    
    
    13,352Amortization
    
    
    16,535
    
    
    
    1,000
    
    
    
    Employee entitlements
    
    
    84,521
    
    
    
    111,129
    
    
    
    79,866Other
    
    
    
    
    
    
    7,386
    
    
    
    Loss carryforward (net)
    
    
    8,093,818
    
    
    
    5,229,565
    
    
    
    3,153,900Net deferred tax assets
    
    
    9,349,905
    
    
    
    5,972,388
    
    
    
    3,473,178Valuation allowance
    
    
    (9,349,905
    )
    
    
    (5,972,388
    )
    
    
    (3,473,178
    )
    
    
    
    
    
    
    
    
 The change in the valuation allowance and the corresponding change in the deferred tax
asset amounted to $3,377,517, $2,499,210 and $1,797,262 for the years ended December 31, 2004, 2003
and 2002, respectively. F-20




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) In assessing the realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generating of future taxable income during
the periods in which those temporary differences become deductible. Management considers the
projected future taxable income over the periods in which
the deferred tax assets are deductible. At this time, management has concluded that it is not
likely that the Company will realize the benefits of these deductible differences, as there can be
no assurance that the Company will generate the necessary taxable income in any future periods. The reconciliation of income tax computed at the Australian statutory rate to income tax
expense is as follows: Year Ended December 31,2004
    
    
    2003
    
    
    2002Tax at Australian statutory tax rate
    
    
    (30.00
    )%
    
    
    (30.00
    )%
    
    
    (30.00
    )%Effect of difference between the
Australian tax rate and the U.S. tax
rate
    
    
    (1.11
    )%
    
    
    (0.98
    )%
    
    
    (0.78
    )%Non deductible items
    
    
    2.04
    %
    
    
    2.35
    %
    
    
    2.06
    %Change in valuation allowance
    
    
    29.07
    %
    
    
    28.63
    %
    
    
    28.72
    %
    %
    
    
    
    %
    
    
    
    %
 For financial reporting purposes, loss before income taxes includes the following components: Year Ended December 31,2004
    
    
    2003
    
    
    2002Pre tax (loss):Domestic operations (Australia)
    
    $
    (6,103,968
    )
    
    $
    (3,377,749
    )
    
    $
    (4,325,460
    )Foreign operations (United States)
    
    $
    (3,548,391
    )
    
    $
    (1,353,006
    )
    
    $
    (1,054,133
    )
 10. Capital leases During the year, the Company has prepaid balances totaling $388,620 on capital leases. As a
result, the expiry date of lease commitments has been reduced from 2021 to 2009. The Company leases machinery and equipment under capital leases expiring at various dates
through to 2009. The assets and liabilities under capital leases are recorded at the lower of the
present value of the minimum lease payments or the fair value of the assets. The assets are
amortized over the lesser of their related lease terms or their estimated productive lives.
Amortization of assets under capital leases is included in depreciation expense. Following is a summary of machinery and equipment held under capital leases as of December 31,
2004 and 2003. December 31,2004
    
    
    2003Machinery and equipment
    
    $
    1,303,864
    
    
    $
    1,733,769Less: accumulated depreciation
    
    
    (258,470
    )
    
    
    (15,903
    )Total
    
    $
    1,045,394
    
    
    $
    1,717,866
 F-21




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) At December 31, 2004 minimum future lease payments under capital leases for each year
through 2009 and thereafter is as follows: 20042005
    
    $
    258,4522006
    
    
    222,8202007
    
    
    115,0302008
    
    
    106,7862009
    
    
    47,277Thereafter
    
    
    Total minimum lease payments
    
    
    750,365Less: amount representing interest
    
    
    (83,606
    )Present value of net minimum lease payments
    
    $
    666,759Obligations under capital leasesCurrent liability
    
    $
    215,505Non-current liability
    
    
    451,254Total obligations under capital leases
    
    $
    666,759
 11. Borrowings Borrowings consist of the following: December 31,2004
    
    
    2003CurrentBank loan
    
    $
    647,729
    
    
    $
    432,637Note payable
    
    
    290,998
    
    
    
    333,518$
    938,727
    
    
    $
    766,155
 Terms and conditions of borrowings Current Bank loan: The bank loan was assumed on the acquisition of ProCam and represents a line of
credit with an interest rate of prime of 4.0% plus 1.5% that expired in February 2004, the weighted
average interest rate was 5.5%. On January 27, 2004 a new line of credit was established which will
expire on January 27, 2006, with an interest rate of 4.6%. At December 31, 2004 there was an
available balance of $2,271. These borrowings are denominated in U.S. Dollars. Note
payable: The note payable is with a financial institution, which will
expire in July 2005 and has an interest rate of 4.2%. The note
payable is denominated in Australian Dollars. The weighted average interest rate on short-term borrowings outstanding at December 31, 2004
and 2003 was 6.1% and 7.4%, respectively. F-22




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) 12. Related Parties On May 25, 1999 Mr. J.M. ODwyer entered into a voting rights agreement with Charter Pacific
Corporation Limited pursuant to which Charter Pacific Corporation agreed to appoint Mr. J.M.
ODwyer as the Charter Pacific Corporations proxy with respect to 4,287,503 of the Companys
shares to vote in respect of all matters put before the stockholders, with certain limited
exceptions. The voting rights agreement expired on July 7, 2001. In consideration for the voting
rights agreement, Mr. J.M. ODwyer entered into a relationship deed with Charter Pacific
Corporation dated May 25, 1999 where he agreed, (a) that he will use or procure the voting rights
attached to the shares registered in his name or that he controls, to vote in favor of the election
or re-election, as the case may be, of the person nominated by Charter Pacific Corporation to be a
director of Metal Storm; (b) that he will not use the voting rights attached to the shares
registered in his name that he controls, to vote to remove the person nominated by Charter Pacific
Corporation to be a director of Metal Storm as a director; and (c) that while he is a director of
Metal Storm, and if requested so to do by Charter Pacific Corporation, he will seek to procure the
appointment of a person nominated by Charter Pacific Corporation to be appointed as a director of
Metal Storm to fill any casual vacancy caused by the death, retirement, resignation or removal of
the then existing Charter Pacific Corporation representative. Mr J.M. ODwyer resigned as director
on February 8, 2005. The relationship deed expires on the later of two years after the date of the issuance of the
Companys securities in Australia under its May 1999 prospectus or Charter Pacific Corporations
shareholding in the Company is reduced to 5% of the Companys issued capital. This relationship
deed expired October 20, 2004. During 2004, legal services totaling $nil (2003: $nil; 2002: $120,996) were performed by
McCullough Robertson Lawyers of which Mr. J.B.L. Heading, a former director (resigned March 26,
2003), is a partner. At December 31, 2004, $nil was outstanding and payable (2003: $nil). The
amounts owing were repaid in full under the Companys normal trading terms of credit. During 2004, accounting and consulting services totaling $nil (2003: $3,993; 2002: $29,449)
were performed by BDO Kendalls, of which Mr. T.J. ODwyer, a director, is a partner. At December
31, 2004 $nil was outstanding and payable (2003: $nil). The amounts owing were repaid in full under
the Companys normal trading terms of credit. During 2004, consultancy fees were paid to Admiral W.A. Owens (US Navy retired), a director,
totaling $nil (2003: $24,147; 2002: $82,903) pursuant to a consultancy agreement with the Company.
At December 31, 2004, $nil was outstanding and payable (2003: $nil). The amounts owing were
non-interest bearing and were repaid in full generally under 30 day terms. During 2004, consultancy services totaling $nil (2003: $24,586; 2002: $63,472) were performed
by Clarity Business Consulting, of which Mr. P.L.G. Pursey, a former director of the Company
(resigned March 26, 2003), is a director and shareholder. At December 31, 2004, $nil was
outstanding and payable (2003: $nil). The amounts owing were non-interest bearing and were repaid
in full generally under 30 day terms. During 2004, corporate advisory services totaling $18,413 were performed by BBY Ltd of which
Mr B.S. McComish, a director (appointed October 12, 2004) is a director. At December 31, 2004 $nil
was outstanding and payable. The amounts owing were non-interest bearing and repayable under the
Companys normal trading terms of credit. At December 31, 2004 severance payments of $265,782 were due to Mr. C.A. Vehlow pursuant to
his termination agreement. In addition, directors fees were payable to the following directors at December 31, 2004 and
2003: December 31,2004
    
    
    2003Admiral W.A. Owens
    
    $
    11,708
    
    
    $
    48,620Mr. J.M. ODwyer
    
    
    35,123
    
    
    
    33,660General W.A. Downing
    
    
    35,123
    
    
    
    33,660Lieutenant General D.W. Christman
    
    
    48,293
    
    
    
    33,660Dr. D.L. Alspach
    
    
    52,684
    
    
    
    11,220Mr. B.S. McComish
    
    
    8,781
    
    
    
    Mr. C.A. Vehlow
    
    
    17,560
    
    
    
    $
    209,272
    
    
    $
    160,820
 F-23




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) 13. Commitments and Contingencies Operating Leases The operating lease commitments primarily consist of the rental of office premises. The Company is obligated under various operating leases for office premises and other
equipment for periods expiring through 2010. Future payments under non-cancelable operating lease arrangements at December 31, 2004 are as
follows: Years ending December 312005
    
    $
    556,7412006
    
    
    568,2092007
    
    
    347,1152008
    
    
    213,4312009
    
    
    219,2732010
    
    
    75,120Total minimum rental commitments
    
    $
    1,979,889
 The rentals under the office premises operating leases are subject to annual increases of
2% to 4.5% and/or CPI increases. 14. Stockholders Equity On May 31, 2002 500,000 executive options were exercised at an exercise price of A$0.48
(approximately $0.26) per option. On June 26, 2002 the Company issued 50,000 options as payment for consultancy services
provided by an unrelated party. The payment of these services and of the options issued have been
recorded in the financial statements at the fair value of the options as of June 26, 2002, the date
at which the options were issued and the services were completed. The fair value of $13,508 was
calculated by using the Black Scholes valuation model. On August 27, 2002 the Company issued 14,142,700 ordinary shares in the Company and received
proceeds of $5,009,132. Costs incurred relating to the issue totaled $15,777. On September 24, 2002 the Company issued 766,488 ordinary shares in the Company at market
value as partial payment for consultancy services provided by an unrelated party. The partial
payment of these services and the ordinary shares issued have been recorded in the financial
statements at the fair value of the ordinary shares as of September 24, 2002 the date the services
were completed. The fair value of $216,824 was calculated by using the market value of the shares
on the date of issue. On September 24, 2002 the Company issued 766,488 listed options as partial payment for
consultancy services provided by an unrelated party. The partial payment of these services and the
options issued have been recorded in the financial statements at the fair value of the options as
of September 24, 2002, the date at which the options were issued and the services were completed.
The fair value of $109,153 was calculated by using the Black Scholes valuation model. On September 24, 2002 the Company issued 50,000 ordinary shares in the Company at market value
to an employee under the terms of the employment contract. The employee related expense and the
ordinary shares issued have been recorded in the financial statements at the fair value of the
ordinary shares as of September 24, 2002. The fair value of $14,416 was calculated by using the
market value of the shares on the date of issue. On September 24, 2002, 6,958 listed options were exercised at an exercise price of A$0.65
(approximately $0.35) per option. On October 17, 2002, 8,844 listed options were exercised at an exercise price of A$0.65
(approximately $0.36) per option. (Listed options have a fixed exercise price of A$0.65. Exercised
options were translated at the rate of exchange on the date of conversion being $0.5385 and $0.5538
respectively for the above transactions.) F-24




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) On October 17, 2002 the Company issued 16,655 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of October 17, 2002,
the date at which the options were issued and the services were completed. The fair value of $1,464
was calculated by using the Black Scholes valuation model. On January 28, 2003, 1,008 listed options were exercised at an exercise price of A$0.65
(approximately $0.38) per option. On February 24,2003 the Company issued 59,472 ordinary shares in the Company at
market value as payment for consultancy services provided by an unrelated party. The payment of
these services and the ordinary shares have been recorded in the financial statements at the fair
value of the ordinary shares as of February 24, 2003. The fair value of $15,635 was calculated by
using the market value of the shares on the date of issue. On February 24, 2003, 475 listed options were exercised at an exercise price of A$0.65
(approximately $0.40) per option. On June 4, 2003, 125 listed options were exercised at an exercise
price of A$0.65 (approximately $0.43) per option. On October 16, 2003, 455 listed options were
exercised at an exercise price of A$0.65 (approximately $0.45) per option. On December 4, 2003, 250 listed options were exercised at an exercise price of A$0.65
(approximately $0.48) per option. On September 3, 2003 the Company issued 50,000 ordinary shares in the Company at market value
to an employee under the terms of the employment contract. The employee related expense and the
ordinary shares issued have been recorded in the financial statements at the fair value of the
ordinary shares as of September 3, 2003. The fair value of $16,440 was calculated by using the
market value of the shares on the date of issue. In October 2003 the Company raised an additional A$7,078,784 (approximately $5 million) in
working capital through a Share Purchase Plan to those shareholders of record on October 3, 2003.
This offer was only available to those shareholders resident of Australia and New Zealand. The
placement comprised the issue of 15,730,631 ordinary shares at A$0.45 ($0.31) per share. The total
capital raising costs attributable to this placement was A$34,816 ($23,964). On December 11, 2003 the Company issued 5,524,926 shares of Metal Storm Limited for the
purchase of ProCam Machine LLC comprising of 3,913,033 shares for the acquisition, 1,184,713 shares
for settlement of a promissory note, and 427,180 shares as payment for direct costs related to the
acquisition. The fair value of the shares was calculated based on the average market price of the
securities two days before and two days after the terms of the acquisition were agreed and
announced. The fair value of shares issued was $1,977,373. For further details refer to Note 3. On February 2, 2004 the Company granted 100,000 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of February 2, 2004,
the date at which the options were granted and the services completed. The fair value of $20,784
was calculated by using the Black Scholes valuation model. On February 6, 2004 the Company issued 242,069 shares in the Company to a former employee of
ProCam Machine LLC as part of his exit agreement. The employee related expense and ordinary shares
issued were recorded in the financial statements at the fair value of the ordinary shares as of
February 6, 2004. The fair value of $80,609 was calculated by using the market value of the shares
on the date of issue. On February 16, 2004 the Company granted 14,438 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of February 16, 2004,
the date at which the options were granted and the services completed. The fair value of $5,116
was calculated by using the Black Scholes valuation model. On March 10, 2004 the Company granted 8,250 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of March 10, 2004,
the date at which the options were granted and the services completed. The fair value of $2,780
was calculated by using the Black Scholes valuation model. On March 24, 2004 60 listed options were exercised at an exercise price of A$0.65
(approximately $0.49) per option. F-25




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) On April 5, 2004 the Company granted 29,500 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of April 5, 2004, the
date at which the options were granted and the services completed. The fair value of $6,940 was
calculated by using the Black Scholes valuation model. On April 16, 2004 75 listed options were exercised at an exercise price of A$0.65
(approximately $0.49) per option. On April 23, 2004 100 listed options were exercised at an exercise price of A$0.65
(approximately $0.47) per option. On May 5, 2004 the Company issued 61,461,194 shares in a private equity raising and received
proceeds of $15,782,927. Costs incurred relating to the issue totaled $1,251,037. On May 10, 2004 the Company granted 25,000 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of May 10, 2004, the
date at which the options were granted and the services completed. The fair value of $4,091 was
calculated by using the Black Scholes valuation model. On June 8, 2004 the Company granted 25,000 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of June 8, 2004, the
date at which the options were granted and the services completed. The fair value of $4,218 was
calculated by using the Black Scholes valuation model. On July 5, 2004 the Company granted 75,000 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of July 5, 2004, the
date at which the options were granted and the services completed. The fair value of $14,428 was
calculated by using the Black Scholes valuation model. On July 9, 2004 the Company issued 17,200 ordinary shares in the Company at market value to
employees of ProCam Machine LLC for services rendered. The employee related expense and the
ordinary shares issued have been recorded in the financial statements at the fair value of the
ordinary shares as of July 9, 2004. The fair value of $4,784 was calculated by using the market
value of the shares on the date of issue. On August 13, 2004 50 listed options were exercised at an exercise price of A$0.65
(approximately $0.47) per option. On September 7, 2004 4,340 listed options were exercised at an exercise price of A$0.65
(approximately $0.45) per option. F-26




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) 15. Stock Options Unlisted Options Discretionary Options issued to
Executives and Employees Options issued to executives
and employees are
issued at the discretion of the Board under the Companys constitution to provide incentive and to reward full time executives and
employees for the role they play in the Company. The exercise price of the options issued shall not be less than the market price of the Companys shares on the date
determined by the Board and the aggregate number of options issued shall not exceed 5% of the
Companys shares then on issue. A summary of the terms of the options
issued and outstanding at December 31, 2004 are as follows: 5,000 options were granted on June 4, 2003. These options vested immediately, have an
exercise price of A$0.39 and expire on the fifth anniversary of the grant date. 25,000 options were granted on September 3, 2003. These options vested in full one year after
the grant date and had no performance hurdles attached to it. The options have an exercise price
of A$0.40 and expire on the second anniversary of the grant date. 55,000 options were granted on September 3, 2003. These options vested immediately, have an
exercise price of A$0.40 and expire on the third anniversary of the grant date. Information with
respect to the number of options granted to executives and employees
at the discretion of the Board are as follows: Number of
    
    
    Weighted
    
    
    Number of
    
    
    Weightedoptions
    
    
    average exercise
    
    
    options
    
    
    average exerciseoutstanding
    
    
    price (i)
    
    
    exercisable
    
    
    price (i)Options outstanding, December 31, 2000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    - granted
    
    
    575,000
    
    
    
    
    
    
    
    A$1.16- forfeited
    
    
    
    
    
    
    
    
    
    
    - expired
    
    
    
    
    
    
    
    
    
    
    - exercised
    
    
    
    
    
    
    
    
    
    
    Options outstanding, December 31, 2001
    
    
    575,000
    
    
    
    
    
    
    
    A$1.16
    
    
    
    575,000
    
    
    
    
    
    
    
    A$1.16- granted
    
    
    
    
    
    
    
    
    
    
    - forfeited
    
    
    
    
    
    
    
    
    
    
    - expired
    
    
    
    
    
    
    
    
    
    
    - exercised
    
    
    
    
    
    
    
    
    
    
    Options outstanding, December 31, 2002
    
    
    575,000
    
    
    
    
    
    
    
    A$1.16
    
    
    
    575,000
    
    
    
    
    
    
    
    A$1.16- granted
    
    
    85,000
    
    
    
    
    
    
    
    A$0.40- forfeited
    
    
    
    
    
    
    
    
    
    
    - expired
    
    
    
    
    
    
    
    
    
    
    - exercised
    
    
    
    
    
    
    
    
    
    
    Options outstanding, December 31, 2003
    
    
    660,000
    
    
    
    
    
    
    
    A$1.06
    
    
    
    635,000
    
    
    
    
    
    
    
    A$0.94- granted
    
    
    
    
    
    
    
    
    
    
    - forfeited
    
    
    
    
    
    
    
    
    
    
    - expired
    
    
    (575,000
    )
    
    
    
    
    
    
    A$1.16- exercised
    
    
    
    
    
    
    
    
    
    
    Options outstanding, December 31, 2004
    
    
    85,000
    
    
    
    
    
    
    
    A$0.40
    
    
    
    85,000
    
    
    
    
    
    
    
    A$0.40Shares reserved for future issuance as at December
31, 2004
    
    
    85,000
   (i)
    
    Options were issued in Australian dollars (the functional currency for the Company). F-27




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) There were a total of nil options granted during 2004 (2003: 85,000; and 2002: nil). The
equivalent market price per share at grant date for options granted during 2003 was A$0.43-A$0.49. On July 2, 2004 575,000 options expired. The
following table summarizes information about options outstanding at
December 31, 2004, which were issued at the discretion of the Board: Outstanding
    
    
    ExercisableWeighted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Weightedaverage
    
    
    Weighted
    
    
    
    
    
    
    averageremaining
    
    
    average
    
    
    Number of
    
    
    exerciseExercise price (i)
    
    Options
    
    
    contractual life
    
    
    exercise price
    
    
    options
    
    
    priceA$0.39
    
    
    5,000
    
    
    3.4 years
    
    
    
    A$
    0.39
    
    
    
    
    
    5,000
    
    
    
    
    A$
    0.39A$0.40
    
    
    25,000
    
    
    0.7 years
    
    
    
    A$
    0.40
    
    
    
    
    
    25,000
    
    
    
    
    A$
    0.40A$0.40
    
    
    55,000
    
    
    1.7 years
    
    
    
    A$
    0.40
    
    
    
    
    
    55,000
    
    
    
    
    A$
    0.40Total
    
    
    85,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    85,000
   (i)
    
    Options were issued in Australian dollars (the functional currency for the Company). Options
issued under the Companys Constitution Information with respect to options issued in line with the powers contained in the Companys constitution, is as
follows: Number of
    
    
    Weighted
    
    
    Number of
    
    
    Weightedoptions
    
    
    average exercise
    
    
    options
    
    
    average exerciseoutstanding
    
    
    price (i)
    
    
    exercisable
    
    
    price (i)Options outstanding, December 31, 2000
    
    
    1,375,000
    
    
    
    
    A$
    0.50
    
    
    
    
    
    1,375,000
    
    
    
    
    A$
    0.50- granted
    
    
    5,600,000
    
    
    
    
    A$
    0.16- forfeited
    
    
    
    
    
    
    
    
    - expired
    
    
    
    
    
    
    
    
    - exercised
    
    
    (5,000
    )
    
    
    
    
    Options outstanding, December 31, 2001
    
    
    6,970,000
    
    
    
    
    A$
    0.23
    
    
    
    
    
    1,970,000
    
    
    
    
    A$
    0.77- granted
    
    
    129,165
    
    
    
    
    A$
    1.09- forfeited
    
    
    
    
    
    
    
    
    - expired
    
    
    
    
    
    
    
    
    - exercised
    
    
    (500,000
    )
    
    
    
    A$
    0.48Options outstanding, December 31, 2002
    
    
    6,599,165
    
    
    
    
    A$
    0.22
    
    
    
    
    
    1,599,165
    
    
    
    
    A$
    0.89- granted
    
    
    793,000
    
    
    
    
    A$
    0.53- forfeited
    
    
    (870,000
    )
    
    
    
    A$
    0.51- expired
    
    
    
    
    
    
    
    
    - exercised
    
    
    
    
    
    
    
    
    Options outstanding, December 31, 2003
    
    
    6,522,165
    
    
    
    
    A$
    0.21
    
    
    
    
    
    1,522,165
    
    
    
    
    A$
    0.98- granted (ii)
    
    
    5,748,438
    
    
    
    
    A$
    0.44- forfeited
    
    
    
    
    
    
    
    
    - expired
    
    
    (600,000
    )
    
    
    
    A$
    1.40- exercised
    
    
    
    
    
    
    
    
    Options outstanding, December 31, 2004
    
    
    11,670,603
    
    
    
    
    A$
    0.27
    
    
    
    
    
    4,430,915
    
    
    
    
    A$
    0.49Shares reserved for future issuance as at December 31, 2004
    
    
    11,670,603
   (i)
    
    Options were issued in Australian dollars (the functional currency for the Company). F-28




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS)  (ii)
    
    Of the 5,748,438 options granted during 2004, option certificates for 2,239,688 were not
issued by the Company because during the year the Company had reached its annual limit of
issuing equity securities under Australian Stock Exchange Listing Rules. These option
certificates have not yet been issued. 277,188 of the options were granted to external
consultants for services rendered and 1,962,500 were granted to employees under the terms of
their service contracts or in lieu of cash bonuses. The value of the options granted to
employees recognized in the statement of operations is $25,630. The value of options granted
to consultants recognized in the statement of operations in 2004 is $58,357. The employees
and consultants were entitled to these options at grant date and the Company was obliged to
issue those options, therefore a measurement date has occurred. At December 31, 2004 the
recipients had received notification of their entitlement to these awards. No further service
is required and the options are fully vested. The unissued options have been valued and have
been recognized as an expense where appropriate. There were 5,748,438 options granted during 2004 (2003: 793,000, 2002: 129,165). The
equivalent market price per share at grant date for options granted during 2004 was A$0.22-A$0.47
(2003: A$0.43-A$0.49; 2002: A$0.55-A$0.99). On January 14, 2004 the Company granted 125,000 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $3,890. On February 2, 2004 the Company granted 100,000 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of February 2, 2004,
the date at which the options were granted and the services completed. The fair value of $20,784
was calculated by using the Black Scholes valuation model. On February 6, 2004 the Company issued 43,750 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at the intrinsic value being $nil. On February 16, 2004 the Company granted 14,438 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of February 16, 2004,
the date at which the options were granted and the services completed. The fair value of $5,116
was calculated by using the Black Scholes valuation model. On February 24, 2004 the Company granted 81,250 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $1,269. On March 10, 2004 the Company granted 8,250 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of March 10, 2004,
the date at which the options were granted and the services completed. The fair value of $2,780
was calculated by using the Black Scholes valuation model. On March 31, 2004 the Company granted 62,500 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $2,858. On April 5, 2004 the Company granted 29,500 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of April 5, 2004, the
date at which the options were granted and the services completed. The fair value of $6,940 was
calculated by using the Black Scholes valuation model. On April 14, 2004 the Company granted 600,000 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $17,613. The Company also granted 500,000 options in
lieu of cash bonus valued at cash liability settled of $63,299. On April 14, 2004 the Company granted 43,750 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. F-29




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) On May 10, 2004 the Company granted 25,000 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of May 10, 2004, the
date at which the options were granted and the services completed. The fair value of $4,091 was
calculated by using the Black Scholes valuation model. On June 8, 2004 the Company granted 25,000 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of June 8, 2004, the
date at which the options were granted and the services completed. The fair value of $4,218 was
calculated by using the Black Scholes valuation model. On June 21, 2004 the Company issued 3,465,000 options to the Directors of the Company in lieu
of cash payment. The options issued have been recorded in the financial statements at the cash
liability value settled of $247,428. On June 30, 2004 the Company granted 62,500 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On July 5, 2004 the Company granted 75,000 unlisted options as payment for consultancy
services provided by an unrelated party. The payment of these services and the options issued have
been recorded in the financial statements at the fair value of the options as of July 5, 2004, the
date at which the options were granted and the services completed. The fair value of $14,428 was
calculated by using the Black Scholes valuation model. On July 14, 2004 the Company granted 125,000 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On September 4, 2004 the Company granted 31,250 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On September 14, 2004 the Company granted 12,500 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On September 30, 2004 the Company granted 62,500 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On October 14, 2004 the Company granted 125,000 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On November 24, 2004 the Company granted 6,250 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On December 4, 2004 the Company granted 31,250 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On December 7, 2004 the Company granted 12,500 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On December 14, 2004 the Company granted 12,500 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. On December 31, 2004 the Company granted 68,750 options to employees under their employment
contracts. The employee related expense and options issued have been recorded in the financial
statements at their intrinsic value being $nil. F-30




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) The following table summarizes information about options outstanding at December 31, 2004, which
were issued under the Company's constitution: Outstanding
    
    
    ExercisableWeighted average
    
    
    Weightedremaining
    
    
    average
    
    
    Number of
    
    
    Weighted averageExercise price (i)
    
    Options
    
    
    contractual life
    
    
    exercise price
    
    
    options
    
    
    exercise priceA$0.57
    
    
    16,665
    
    
    0.8 years
    
    
    
    A$
    0.57
    
    
    
    
    
    16,665
    
    
    
    
    A$
    0.57A$1.16
    
    
    31,250
    
    
    0.27 years
    
    
    
    A$
    1.16
    
    
    
    
    
    31,250
    
    
    
    
    A$
    1.16A$1.16
    
    
    50,000
    
    
    0.48 years
    
    
    
    A$
    1.16
    
    
    
    
    
    50,000
    
    
    
    
    A$
    1.16A$1.16
    
    
    31,250
    
    
    0.77 years
    
    
    
    A$
    1.16
    
    
    
    
    
    31,250
    
    
    
    
    A$
    1.16A$1.16
    
    
    62,500
    
    
    1.42 years
    
    
    
    A$
    1.16
    
    
    
    
    
    62,500
    
    
    
    
    A$
    1.16A$1.16
    
    
    31,250
    
    
    1.67 years
    
    
    
    A$
    1.16
    
    
    
    
    
    31,250
    
    
    
    
    A$
    1.16A$0.40
    
    
    500,000
    
    
    1.67 years
    
    
    
    A$
    0.40
    
    
    
    
    
    500,000
    
    
    
    
    A$
    0.40A$1.16
    
    
    31,250
    
    
    1.83 years
    
    
    
    A$
    1.16
    
    
    
    
    
    31,250
    
    
    
    
    A$
    1.16A$0.56
    
    
    12,500
    
    
    2.00 years
    
    
    
    A$
    0.56
    
    
    
    
    
    12,500
    
    
    
    
    A$
    0.56A$0.40
    
    
    118,000
    
    
    2.00 years
    
    
    
    A$
    0.40
    
    
    
    
    
    118,000
    
    
    
    
    A$
    0.40A$0.56
    
    
    25,000
    
    
    2.00 years
    
    
    
    A$
    0.56
    
    
    
    
    
    25,000
    
    
    
    
    A$
    0.56A$0.56
    
    
    12,500
    
    
    2.00 years
    
    
    
    A$
    0.56
    
    
    
    
    
    12,500
    
    
    
    
    A$
    0.56A$0.01 (iii)
    
    
    5,000,000
    
    
    6.50 years
    
    
    
    A$
    0.01
    
    
    
    
    
    
    
    
    
    
    
    A$1.16
    
    
    31,250
    
    
    1.02 years
    
    
    
    A$
    1.16
    
    
    
    
    
    31,250
    
    
    
    
    A$
    1.16A$0.56
    
    
    12,500
    
    
    3.00 years
    
    
    
    A$
    0.56
    
    
    
    
    
    12,500
    
    
    
    
    A$
    0.56A$0.40
    
    
    3,225,000
    
    
    4.47 years
    
    
    
    A$
    0.40
    
    
    
    
    
    3,225,000
    
    
    
    
    A$
    0.40A$1.15
    
    
    200,000
    
    
    4.47 years
    
    
    
    A$
    1.15
    
    
    
    
    
    200,000
    
    
    
    
    A$
    1.15A$1.10
    
    
    40,000
    
    
    4.47 years
    
    
    
    A$
    1.10
    
    
    
    
    
    40,000
    
    
    
    
    A$
    1.10A$0.40 (ii)
    
    
    2,170,938
    
    
    4.37 years
    
    
    
    A$
    0.40
    
    
    
    
    
    2,170,938
    
    
    
    
    A$
    0.40A$0.56 (ii)
    
    
    37,500
    
    
    2.89 years
    
    
    
    A$
    0.56
    
    
    
    
    
    37,500
    
    
    
    
    A$
    0.56A$1.16 (ii)
    
    
    31,250
    
    
    1.02 years
    
    
    
    A$
    1.16
    
    
    
    
    
    31,250
    
    
    
    
    A$
    1.16Total
    
    
    11,670,603
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,670,603
   (i)
    
    Options were issued in Australian dollars (the functional currency for the Company).(ii)
    
    These options were granted during 2004 but option certificates have not yet been issued. See
further discussion at Note 15 (ii).(iii)
    
    The options are exercisable for a period of 10 years from the date of grant based on share
price levels of the Companys shares being achieved and maintained for a period of 30 days, as
follows: Share Price LevelUSD
    
    Options Exercisable$1.00
    
    
    1,000,000$2.00
    
    
    2,000,000$4.00
    
    
    1,000,000$5.00
    
    
    1,000,000
 In 2001, management assessed that the share price reaching $1.00 was probable and estimated
that this would occur in 2003. Compensation expense of $99,647 was recorded in 2001 based on
the intrinsic value of 1,000,000 options at December 31, 2001, amortized over a two year
period. In 2002, management reassessed the date at which the $1.00 share price would be
achieved to 2005; previously recognized expense in the amount of $5,783 was reversed in 2002.
In 2004, management believes the share price will reach $1.00 in 2007. The intrinsic value of
these options at December 31, 2004 was $184,125 (2003: $280,571; 2002: $250,304). Compensation
expense of $(67,920) (2003: 81,589; 2002: (5,783)) was recorded in 2004 bringing the
cumulative compensation expense to $107,533 (2003: $175,453; 2002: 93,864).  (iv)
    
    Other than as disclosed in (iii) above, all options vest on date of grant. There is no limit
to the number of shares authorized for the grant of options under the
Companys constitution, as this is at the Companys discretion along with the term of each
option granted. The contractual lives of the options range from two to ten years. F-31




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) The weighted average grant date fair value of options granted during the year, by range of
exercise prices is as follows: Weighted average exerciseRange of Exercise prices
    
    Number of Options
    
    
    price
    
    
    Weighted average fair valueYear ended December 31, 2004:Exercise price equal to
market on grant date
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise price less than market
on grant date
    
    
    1,520,938
    
    
    
    
    
    
    
    A$0.40
    
    
    
    
    
    
    
    A$0.44Exercise price greater than
market on grant date
    
    
    4,227,500
    
    
    

    
    
    
    

    A$0.46
    
    
    

    
    
    
    
    A$0.37Year ended December 31, 2003:Exercise price equal to
market on grant date
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise price less than market
on grant date
    
    
    618,000
    
    
    
    
    
    
    
    A$0.40
    
    
    
    
    
    
    
    A$0.48Exercise price greater than
market on grant date
    
    
    175,000
    
    
    
    
    
    
    
    A$0.99
    
    
    
    
    
    
    
    A$0.46Year ended December 31, 2002:Exercise price equal to
market on grant date
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise price less than market
on grant date
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise price greater than
market on grant date
    
    
    129,165
    
    
    
    
    
    
    
    A$1.09
    
    
    
    
    
    
    
    A$0.75
 Given the wide range of exercise prices, the following table provides additional information
on all options outstanding at December 31, 2004 by ranges of exercise prices. Weighted average exercise
    
    
    Weighted average remainingRange of Exercise Prices
    
    Number of Options
    
    
    price(i)
    
    
    contractual life value (years)A$0.01A$0.10
    
    
    5,000,000
    
    
    
    
    
    
    
    A$0.01
    
    
    
    6.5A$0.40A$0.57 (ii)
    
    
    6,130,603
    
    
    
    
    
    
    
    A$0.40
    
    
    
    4.12A$1.10A$1.64 (ii)
    
    
    540,000
    
    
    
    
    
    
    
    A$1.15
    
    
    
    2.58
   (i)
    
    Options were issued in Australian dollars (the functional currency for the Company).(ii)
    
    Includes options granted during 2004 but not issued. Compensation cost for stock options granted to non-employees is measured as the fair value of
stock options as calculated using an option pricing model, and is expensed over the period in which
the options vest. 277,188 options issued in 2004 (2003: nil; 2002: 66,665) to non-employees as
payment for consulting services rendered were valued at 58,357 (2003: nil; 2002: $14,972) using the
Black-Scholes option valuation model. These options vested upon grant and were fully expensed in
the year they were granted. The fair value of options granted in 2004, 2003 and 2002 (employee, director and consultant
options) were estimated at the date of grant using the Black Scholes method, assuming no dividends,
an expected life in 2004 of 1.2 and 5 years (2003: 1.75 and 4 years and 2002: 2 years), volatility
in 2004 of between 51.1% and 97.2% (2003 between 42.7%% and 79.2%; 2002: between 84.5% and 124%)
and a risk free rate of between 5.07% and 5.73% in 2004 (2003: between 4.39% and 5.39%; 2002:
between 4.46% and 5.53%). The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Because the Companys employee stock
options have characteristics significantly different from those of traded options, and because
changes in the subjective input assumptions can materially affect the fair value estimate, in
managements opinion, the existing models do not necessarily provide a reliable single measure of
the fair value of its employee stock options. F-32




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) Listed Options During the year ended December 31, 2004 the Company issued nil options (2003: nil; 2002:
36,811,761) that were listed on the Australian Stock Exchange as follows: December 31,
    
    
    December 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2002Balance at beginning of year
    
    
    36,793,646
    
    
    
    36,795,959
    
    
    
    - placement under a private equity raising
    
    
    
    
    
    
    
    
    
    
    14,142,700- rights issue (1 bonus option per 20 ordinary shares held)
    
    
    
    
    
    
    
    
    
    
    21,902,573- issued as partial payment for consultancy services
    
    
    
    
    
    
    
    
    
    
    766,488
    (i)- lapsed
    
    
    (36,789,021
    )
    
    
    
    
    
    
    (15,802
    )- exercised
    
    
    (4,625
    )
    
    
    (2,313
    )
    
    
    Balance at end of year
    
    
    
    
    
    
    36,793,646
    
    
    
    36,795,959Shares reserved for future issuance as at December 31, 2004
    
    
    
    
    
    
    
    
    
    
    
   (i)
    
    The 766,488 listed options issued as partial payment for consultancy services were valued
at the market value of the listed options on date of grant and were fully expensed in the year
ended December 31, 2002. All listed options were fully vested and were exercisable at any time. All listed options had
a fixed exercise price of A$0.65 (approximately $0.49). Each listed option is exercisable to one
ordinary share at any time on or before September 6, 2004 and lapsed on that date. During the year ended December 31, 2004, 4,625 (2003: 2,313; 2002: 15,802) listed options were
exercised. As a result at December 31, 2004 there remains nil (2003: 36,793,646; 2002: 36,795,959)
unexercised listed options. Summary of total shares reserved for future issuance as at December 31, 2004: Unlisted
options  Discretionary options issued to executives and
employees
    
    
    85,000Unlisted
options  Issued under the Companys constitution
    
    
    11,670,60311,755,603
 2000 Discretionary Share Option Scheme During the year ended December 31, 2000 the stockholders in Annual General Meeting approved
the establishment of a Discretionary Share Option Scheme (Scheme) to enable the board to provide
an incentive to and to reward full time executives and employees for the key role that they will
play in the future success of the Company. A summary of the terms of the Scheme is as follows: Invitations to participate in the Scheme are at the absolute discretion of the board. Any
invitation shall specify the precise details of the invitation, such as maximum number of shares,
date by which application must be made by the invitee, the exercise price and any conditions
attached to the exercise of the option. The exercise price shall not be less than the market price
of the Companys shares on the date determined by the board. The aggregate number of shares subject
to options shall not exceed 5% of the Companys shares then on issue. There are also individual
limits on the number of options which may be granted to employees. The exercise period is the earlier 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; (f) the expiry of specific time
frames set out in the Scheme in relation to the circumstances in (c) above. An option shall lapse upon expiry of the exercise period, termination of the option holders
employment otherwise than in a special circumstance, upon the option holders being adjudicated
bankrupt or any purported alienation of the options by the option holder. F-33




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) Upon the variation of the share capital of the Company, the number of shares subject to
the option and the exercise price shall be adjusted in such manner to be fair and reasonable and
consistent with any relevant requirements of the Corporations Act in Australia and the Listing
Rules of the Australian Stock Exchange. The board may, at any time, cease making further offers or invitations but the subsisting
rights of option holders shall not be affected. At
December 31, 2004, there were no options issued or outstanding
under this scheme (2003: nil; 2002: nil). 16. Segment Disclosures Following the acquisition of ProCam in 2003, the Company is organized based on the products
and services that it offers. Under this organizational structure, there are two reportable
segments: (i) research and development and (ii) manufacturing. The research and development segment
derives its revenues from funding received to assist with the development of its ballistics
technology for markets in Australia and the United States. The manufacturing segment derives
revenue from the sale of precision-machined parts for the defense, electronics, aircraft and space
propulsion industries based in the United States. As stated, Metal Storm Limited sees itself as
predominately a research and development company with its primary focus on the development of its
ballistics technology for markets in Australia and the United States. The Company views certain expenses, particularly some general and administration costs, as not
belonging to any one reportable segment. As a result, the Company has aggregated these items into
an Unallocated expenses non-segment line, as permitted by Statement of Financial Accounting
Standards No. 131 Disclosures about Segments of an Enterprise and Related Information. R&D
    
    
    Manufacturing
    
    
    
    
    
    
    Consolidated2004
    
    
    2004
    
    
    Eliminations
    
    
    2004$
    
    
    $
    
    
    
    
    
    $Sales to customers outside the economic entity
    
    
    
    
    
    
    3,910,298
    
    
    
    (56,927
    )
    
    
    3,853,371Interest revenue
    
    
    585,197
    
    
    
    11,590
    
    
    
    
    
    
    
    596,787Grant revenue
    
    
    31,382
    
    
    
    
    
    
    
    
    
    
    
    31,382Other revenue
    
    
    
    
    
    
    10,403
    
    
    
    
    
    
    
    10,403Total revenue
    
    
    616,579
    
    
    
    3,932,291
    
    
    
    
    
    
    
    4,491,943Interest expense
    
    
    7,990
    
    
    
    188,529
    
    
    
    
    
    
    
    196,519Segment result
    
    
    (13,813,336
    )
    
    
    (1,356,529
    )
    
    
    5,875,706
    
    
    
    (9,294,159
    )Unallocated expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (358,200
    )Consolidated operating loss from ordinary activities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,652,359
    )AssetsSegment assets
    
    
    8,998,459
    
    
    
    3,893,683
    
    
    
    3,203,499Total assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,095,641LiabilitiesSegment liabilities
    
    
    1,388,704
    
    
    
    4,928,131
    
    
    
    (3,231,295
    )Total liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,085,540Acquisition of property, plant and equipment,
intangibles, goodwill and other non-current assets
    
    
    93,228
    
    
    
    110,419
    
    
    
    
    
    
    
    203,647Depreciation
    
    
    93,736
    
    
    
    286,603
    
    
    
    
    
    
    
    380,339Amortization
    
    
    
    
    
    
    48,247
    
    
    
    
    
    
    
    48,247Non-cash expenses other than depreciation, issue of
options, shares in lieu of cash payments
    
    
    
    
    
    
    4,311,972
    
    
    
    (2,782,031
    )
    
    
    1,529,941
 No single customer exceeded 10% of total sales in 2004. F-34




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) Geographic information Revenues (1)
    
    
    Long-lived assets2004
    
    
    2004$
    
    
    $Australia
    
    
    
    
    
    
    124,779United States
    
    
    3,853,371
    
    
    
    2,451,013Total
    
    
    3,853,371
    
    
    
    2,575,792
   (1)
    
    Revenues to external customers are attributed to countries based on the location of the
customer. R&D
    
    
    Manufacturing
    
    
    
    
    
    
    Consolidated2003
    
    
    2003
    
    
    Eliminations
    
    
    2003$
    
    
    $
    
    
    
    
    
    $Sales to customers outside the economic entity
    
    
    
    
    
    
    235,293
    
    
    
    
    
    
    
    235,293Interest revenue
    
    
    221,736
    
    
    
    
    
    
    
    
    
    
    
    221,736Grant revenue
    
    
    227,439
    
    
    
    
    
    
    
    
    
    
    
    227,439Total revenue
    
    
    449,175
    
    
    
    235,293
    
    
    
    
    
    
    
    684,468Interest expense
    
    
    1,073
    
    
    
    11,566
    
    
    
    
    
    
    
    12,639Segment result
    
    
    (4,350,042
    )
    
    
    (186,560
    )
    
    
    
    
    
    
    (4,536,602
    )Unallocated expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (194,153
    )Consolidated operating loss from ordinary
activities before income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,730,755
    )AssetsSegment assets
    
    
    8,520,609
    
    
    
    4,722,228
    
    
    
    (1,886,389
    )Total assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,356,448LiabilitiesSegment liabilities
    
    
    1,619,353
    
    
    
    3,153,344
    
    
    
    (450,000
    )Total liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,322,697Acquisition of property, plant and equipment,
intangibles, goodwill and other non-current assets
    
    
    62,720
    
    
    
    4,195,183
    
    
    
    
    
    
    
    4,257,903Depreciation
    
    
    33,575
    
    
    
    19,092
    
    
    
    
    
    
    
    52,667Amortization
    
    
    
    
    
    
    3,333
    
    
    
    
    
    
    
    3,333Non-cash expenses other than depreciation, issue
of options, shares in lieu of cash payments
    
    
    118,901
    
    
    
    
    
    
    
    
    
    
    
    118,901
 In the manufacturing business segment, sales to individual customers exceed 10% of total sales
for three different customers. The amount of sales to these customers equals $89,399, $44,429 and
$40,642 respectively. The three customers are: Aerojet  General Corporation, General Dynamics AES
and General Dynamics OTS. The loss of these three customers would not have had a material effect on
the 31 December 2003 operations. F-35




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) Geographic information Revenues (1)
    
    
    Long-lived assets2003
    
    
    2003$
    
    
    $Australia
    
    
    
    
    
    
    1,667,702United States
    
    
    235,293
    
    
    
    2,572,217Total
    
    
    235,293
    
    
    
    4,239,919
   (1)
    
    Revenues to external customers are attributed to countries based on the location of the
customer. In 2002, prior to the acquisition of ProCam, the Company was organized based on the
geographical areas in which it operated, being Australia and North America. For this reason, no
business segment information has been disclosed for this year. Australia
    
    
    North America
    
    
    
    
    
    
    Consolidated2002
    
    
    2002
    
    
    Eliminations
    
    
    2002$
    
    
    $
    
    
    
    
    
    $Sales to customers outside the economic entity
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Interest revenue
    
    
    99,555
    
    
    
    2,338
    
    
    
    
    
    
    
    101,893Grant revenue
    
    
    5,172
    
    
    
    7,201
    
    
    
    
    
    
    
    12,373Other revenue
    
    
    384
    
    
    
    
    
    
    
    
    
    
    
    384Total revenue
    
    
    105,111
    
    
    
    9,539
    
    
    
    
    
    
    
    114,650Interest expense
    
    
    396
    
    
    
    505
    
    
    
    
    
    
    
    901Segment result
    
    
    (4,154,377
    )
    
    
    (1,053,630
    )
    
    
    
    
    
    
    (5,208,007
    )Unallocated expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (171,586
    )Consolidated operating loss from ordinary
activities before income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,379,593
    )AssetsSegment assets
    
    
    5,985,701
    
    
    
    367,803
    
    
    
    (1,389,129
    )Total assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,964,375LiabilitiesSegment liabilities
    
    
    1,050,681
    
    
    
    1,602,570
    
    
    
    (1,389,129
    )Total liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,264,122Acquisition of property, plant and equipment,
intangible assets and other non-current assets
    
    
    9,758
    
    
    
    5,353
    
    
    
    
    
    
    
    15,111Depreciation and amortization
    
    
    43,454
    
    
    
    10,528
    
    
    
    
    
    
    
    53,982Non-cash expenses other than depreciation
    
    
    411,319
    
    
    
    11,161
    
    
    
    
    
    
    
    422,480
 F-36




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. DOLLARS) 17. Fair Value of Financial Instruments December 31,2004
    
    
    2004
    
    
    2003
    
    
    2003Carrying
    
    
    Estimated
    
    
    Carrying
    
    
    EstimatedAmount
    
    
    fair value
    
    
    Amount
    
    
    fair valueASSETSCash and cash equivalents
    
    $
    11,818,445
    
    
    $
    11,818,445
    
    
    $
    6,049,249
    
    
    $
    6,049,249Restricted cash
    
    
    659,871
    
    
    
    659,871
    
    
    
    
    
    
    
    LIABILITIESAccounts payable
    
    
    956,744
    
    
    
    956,744
    
    
    
    1,384,126
    
    
    
    1,384,126Accounts payable  related party
    
    
    209,272
    
    
    
    209,272
    
    
    
    160,820
    
    
    
    160,820Bank loan and other loan
    
    
    938,727
    
    
    
    938,727
    
    
    
    766,155
    
    
    
    766,155Accounts payable  non-current
    
    
    
    
    
    
    
    
    
    
    6,359
    
    
    
    6,359
 The Company has reviewed the fair value of all financial instruments and based on their
analysis of current market conditions and the nature of the financial instrument, the Company has
concluded that the carrying amounts approximate fair value. Limitations: Fair value estimates are made at a specific point in time, and are based on
relevant market information about the financial instrument. These estimates are subjective in
nature and involve uncertainties and matters of significant judgment and therefore cannot be
determined with precision. Changes in assumptions could significantly affect the estimates. 18. Significant Research and Development Agreements Area Denial Weapon System In June 2000, the Commonwealth of Australia approved a program to develop a prototype mortar
box system for an area denial weapons system (ADWS) for use in minefield replacement. The
objective of this program was to develop and demonstrate the feasibility of a multi-barrel mortar
box capable of launching 40mm ammunition at electronically variable and ultra-rapid rates of fire.
There were no amounts received under this agreement during the course of the 2004 financial year.
At December 31, 2004 there were no balances outstanding under this agreement. Advanced Individual Combat Weapon In May 2001, the Australian Department of Defence approved a program to develop, in
conjunction with an international consortium consisting of international defense companies, a
concept technology demonstrator for a hybrid electronic/mechanical assault rifle, which has been
named the Advanced Individual Combat Weapon. There were no amounts received under this agreement
during the course of the 2004 financial year. At December 31, 2004 there were no balances
outstanding under this agreement. Small Business Innovation Research Programs The U.S. Department of Defense Small Business Innovation Research (SBIR) program funds early
stage research and development projects that serve defense needs and have the potential for
commercialization in private sector or military markets. SBIR proposals pass through three phases.
Phase I is a six-month commercial feasibility concept stage. Success at this level can lead to an
invitation to participate in a Phase II award of up to $750,000 over two years to develop the
proposal to prototype stage. Phase III requires private sector funding to take the technology to
commercialization. In addition, the SBIR program provides for private funding into Phase II that
can fast-track approvals and attracts up to $4 from the U.S. Department of Defense for every $1 of
private contribution, thereby leveraging private sector investment. SBIR program awards for the Companys technology include: U.S. Navy.In August 2004, the U.S. Navy made a SBIR Phase I award to the Companys U.S.
subsidiary Metal Storm Inc., which has taken the lead role in a U.S. Navy program to develop a
system to defeat incoming rocket propelled grenades (RPGs). The Company is the prime
contractor in this funded program designed to demonstrate the feasibility of producing a RPG
defense system that integrates Metal Storms technology with the sensor, mount and fire control
system of subcontractor Northrop Grumman. F-37




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) During the 2004 financial year, $31,382 was received under this agreement. At December 31,
2004 there were no balances outstanding under this agreement. U.S. Office of Naval Research.In January 2003, the U.S. Navys Office of Naval Research made
a SBIR Phase I award to the Companys teaming partner Schappell Automation Corporation Inc.
This SBIR program utilizes the Companys technology in an innovative weapon system that can
deliver a variety of projectiles against a number of different threats. The system is designed
for use on naval vessels for close-in threats and can also be used to protect port facilities
and berthed ships. There were no amounts received under this agreement during the course of the
2004 financial year. At December 31, 2004 there were no balances outstanding under this
agreement. U.S. Army Research Office.In December 2002, the U.S. Army Research Office made a SBIR Phase
I award to the Companys teaming partner Schappell Automation Corporation Inc. The program
provides for a lethal and less-than-lethal Metal Storm weapon pod system. The objective of this
SBIR program is to develop the use of the Companys technology to deliver special projectiles
from a multi-barrel pod that can be either hand-held or mounted on a robot. There were no
amounts received under this agreement during the course of the 2004 financial year. At
December 31, 2004 there were no balances outstanding under this agreement. Research Agreements with Government Agencies DSTO Research Agreement In April 2001, the Company entered into a five-year research agreement, which was amended in
September 2002, with the Commonwealth of Australia as represented by Defence Science & Technology
Organization (DSTO). Pursuant to this agreement, the Company has granted DSTO a non-exclusive,
worldwide, perpetual license to use their scientific and technical know-how and information in
relation to their gun hardware and gun system technology for defense use and international
collaboration. This agreement also specifies the Companys intellectual property ownership rights, and sets
out the terms and conditions under which the Company may commercialize the technology developed
under it. In particular, this agreement provides that any improvements of the Companys gun
hardware or gun system technology, including the intellectual property, developed or acquired by or
for DSTO from DSTOs further research, will be owned by the Company. However, the Company must pay
royalties to DSTO at agreed rates if they commercialize such improvements. There were no amounts received under this agreement during the course of the 2004 financial
year. At December 31, 2004 there were no balances outstanding under this agreement. DSTO Technology License Agreement In April 2001, the Company entered into an agreement with the Commonwealth of Australia to
license from DSTO certain technology that DSTO has used as a design, evaluation or modeling tool in
appraising the Companys gun system technology. The Company also have the right to improvements in
the DSTO technology developed during the term of the license agreement. This agreement is for five years or such further period as the Company agree with DSTO, but
will in any event terminate at the same time as the DSTO Research Agreement. This agreement
provides that if the Company commercializes any of the DSTO technology described above, the Company
must pay DSTO a royalty calculated on the Companys gross revenues on manufacture, sales or
licensing, after taking into account the proportion of the value of DSTOs intellectual property
incorporated into the products based on the Companys technology. There were no amounts received under this agreement during the course of the 2004 financial
year. At December 31, 2004 there were no balances outstanding under this agreement. 19. Employee Superannuation As required by Australian superannuation legislation, the Company contributes 9% (2003: 9%;
2002 8%) of all Australian employees salary to an approved superannuation fund nominated by the
employee for their retirement benefit. The Company contributed $80,597 to superannuation funds for
the year ended December 31, 2004 (2003: $68,888; 2002: $30,442). F-38




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##### Table of Contents



METAL STORM LIMITED
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  continued
(U.S. DOLLARS) 20. Subsequent Events Effective June 1, 2005, Metal Storm entered into an Asset Purchase Agreement with Monroe
Machined Products, Inc. (MMP) for the sale of the ProCam business to MMP. Under the agreement,
MMP purchased the assets and current order backlog of ProCam for $1.3 million, plus an additional
amount to acquire accounts receivable, inventory and assume the accounts payable liabilities of
ProCams precision machinery facility. A sum of $50,000 has been retained in trust contingent on
the satisfaction of the conditions of the agreement. Other liabilities at December 31, 2004 which
will not be assumed by MMP total $1.5 million. The agreement also provides that most staff will be
offered positions with MMP. The carrying value of the assets and liabilities to be disposed of are as follows: At December 31,2004Receivables  trade
    
    $
    260,330Inventory
    
    
    218,184Property and equipment
    
    
    2,145,321Accounts payable
    
    
    (177,400
    )
 On May 25, 2005, the shareholders approved the granting of 2,641,250 options to the directors
of the Company. 2,601,250 of the options were issued in lieu of cash payment, have an exercise
price of A$0.40 and an exercise period of 5 years from date of issue. 40,000 of the options were
issued in consideration of becoming a director, have an exercise price of A$1.10 and an exercise
period of 5 years from date of issue. In April 2005, a former employee of ProCam filed a Demand for Arbitration against the Company
relating to the employees termination and severance. The Company is unable to determine the
probability of whether this claim will be successful, however based on legal advice note that any
settlement is not expected to exceed a range of $20,000 to $119,000. F-39




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the
registrant certifies that it meets all of the requirements for filing on Form 20-F and has duly
caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized. METAL STORM LIMITEDBy:
    
    /s/ James MacDonaldName

Title:
    
    James MacDonald

Chief Financial OfficerDate:
June 15, 2005




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##### Table of Contents



EXHIBIT INDEX ExhibitNumber
    
    Description of Exhibit1.1
    
    Constitution of Metal Storm*4.1
    
    DSTO Research Agreement dated April 20, 2001*4.2
    
    Deed of Amendment to the DSTO Research Agreement dated September 13, 2002 (portions omitted pursuantto a request for confidential treatment; non-public information has been filed with the SEC)**4.3
    
    DSTO Technology License Agreement dated April 20, 2001, as amended (portions omitted pursuant to arequest for confidential treatment; non-public information has been filed with the SEC)*4.4
    
    Asset Purchase Agreement, dated
May 24, 2005, with Monroe Machined Products, Inc. ("MMP") for thesale of the ProCam business to MMP.4.5
    
    Employment Agreement of David A. Smith4.6
    
    Separation Agreement, dated
February 8, 2005, of J.M. ODwyer4.7
    
    Employment Agreement of A. Schatz*4.8
    
    Employment Agreement of James D. MacDonald4.9
    
    Employment Agreement of G. Bergeron***4.10
    
    [Not used]4.11
    
    Discretionary Share Option Scheme*4.12
    
    [Not used]4.13
    
    Employment Agreement of G. R. Zink**4.14
    
    Employment Agreement of Ian A. Gillespie***4.15
    
    Membership Interest Purchase Agreement dated December 1, 2003 with ProCam Machine LLC and members ofProCam***8.0
    
    List of Subsidiaries of Metal Storm Limited12.1
    
    Certification by the Chief Executive Officer of Metal Storm Limited in accordance with Section 302of the Sarbanes-Oxley Act12.2
    
    Certification by the Chief Financial Officer of Metal Storm Limited in accordance with Section 302of the Sarbanes-Oxley Act13.1
    
    Certification by the Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act13.2
    
    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 July 14, 2003.***
    
    Incorporated by reference from our Annual Report on Form 20-F filed on July 15, 2004.