MTSX Metal Storm Limited ADS (MM)

 

 

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 1934

OR

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

For the fiscal year ended December 31, 2007

OR

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

OR

o		SHELL COMPANY 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)

Building 4
848 Boundary Road
Richlands, Queensland 4077
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 in the form of American Depositary Shares, evidenced by American Depositary Receipts
(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None

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

598,680,579 Fully Paid Ordinary Shares

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o    No þ

     If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o    No þ

     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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o       Accelerated filer o       Non-accelerated filer þ

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

U.S. GAAP o		International Financial Reporting Standards as issued		Other o
		by the International Accounting Standards Board þ

     If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

o Item 17     o Item 18

     If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o    No þ

 

 

Table of Contents

Item 1.		Identity of Directors, Senior Management and Advisors			4
Item 2.		Offer Statistics and Expected Timetable			4
Item 3.		Key Information			4
Item 4.		Information on Metal Storm			14
Item 4A.		Unresolved Staff Comments			23
Item 5.		Operating and Financial Review and Prospects			23
Item 6.		Directors, Senior Management and Employees			29
Item 7.		Major Shareholders and Related Party Transactions			34
Item 8.		Financial Information			35
Item 9.		The Offer and Listing			35
Item 10.		Additional Information			38
Item 11.		Quantitative and Qualitative Disclosure about Market Risk			50
Item 12.		Description of Securities Other than Equity Securities			50
Item 13.		Defaults, Dividend Arrearages and Delinquencies			50
Item 14.		Material Modifications to the Rights of Security Holders and the Use of Proceeds			50
Item 15T.		Controls and Procedures			50
Item 16A.		Audit Committee Financial Expert			52
Item 16B.		Code of Ethics			52
Item 16C.		Principal Accountant Fees and Services			52
Item 16D.		Exemptions from the Listing Standards for Audit Committees			53
Item 16E.		Purchases of Equity Securities by the Issuer and Affiliated Purchasers			53
Item 17.		Financial Statements			53
Item 18.		Financial Statements			53
Item 19.		Exhibits			53
EX-4.6: EMPLOYMENT AGREEMENT
EX-8.0: SUBSIDIARIES
EX-12.1: CERTIFICATION
EX-12.2: CERTIFICATION
EX-13.1: CERTIFICATION
EX-13.2: CERTIFICATION

CURRENCY OF PRESENTATION AND EXCHANGE RATES

     All references herein to “A$” and “$” are to Australian dollars. All references herein to “US$” and “U.S. dollar” are to United States dollars. Except as otherwise stated, all monetary amounts in this annual report are presented in Australian dollars. When necessary, historic data were converted at the applicable rate for the date or year indicated. The exchange rate used to convert balance sheet accounts at December 31, 2007 was A$1.00 = US$0.8776.

     For your convenience, we have translated some Australian dollar amounts into U.S. dollar amounts at the noon buying rate in The City of New York for cable transfers in Australian dollars as certified for customs purposes by the Federal Reserve Bank of New York (the “noon buying rate”). On June 26, 2008, the noon buying rate for Australian dollars into U.S. dollars was A$1.00 =US$0.9573.

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

		At
		Period				Average
		End				Rate (1)				High				Low
Year ended December 31,
2003			0.7520				0.6589				0.7520				0.5629
2004			0.7805				0.7384				0.7979				0.6840
2005			0.7342				0.7620				0.7974				0.7261
2006			0.7884				0.7535				0.7914				0.7056
2007			0.8776				0.8389				0.9369				0.7724
Month
January 2008			0.8968				0.8823				0.8981				0.8654
February 2008			0.9370				0.9133				0.9463				0.8934
March 2008			0.9132				0.9221				0.9411				0.8958
April 2008			0.9419				0.9309				0.9488				0.9067
May 2008			0.9551				0.9492				0.9644				0.9338

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.

PART I

Item 1. Identity of Directors, Senior Management and Advisers

     Not applicable.

Item 2. Offer Statistics and Expected Timetable

     Not applicable.

Item 3. Key Information

A. Selected Financial Data

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

     Until 2005, we prepared financial statements in Australian dollars and in accordance with Australian generally accepted accounting principles that existed at the time (“historical Australian GAAP”) in order to comply with requirements of the Australian Securities Exchange, which is our primary listing. In addition, we voluntarily prepared financial statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for inclusion in our annual report on Form 20-F.

     Commencing with fiscal years beginning on or after January 1, 2005, Australian companies such as Metal Storm must comply with Australian equivalents to International Financial Reporting Standards (“A-IFRS”) as well as International Financial Reporting Standards (“IFRS”) and interpretations adopted by the International Accounting Standards Board. We believe that U.S. investors better understand IFRS than historical Australian GAAP and, as a result, we no longer prepare financial statements in accordance with U.S. GAAP.

     Our financial statements for 2007, 2006 and 2005 have been prepared in Australian dollars and in accordance with A-IFRS and also comply with IFRS as issued by the International Accounting Standards Board. For the purpose of comparability, the 2004 financial information included in this annual report has been prepared on a basis to comply with IFRS.

     Our selected financial data set forth below for 2007, 2006, 2005 and 2004 are presented in accordance with IFRS. Income statement data for the years ended December 31, 2007, 2006 and 2005 the balance sheet data as at December 31, 2007, 2006 and 2005 have been derived from our audited financial statements, which are included elsewhere in this annual report.

		As of and for the year ended December 31,
		2007				2006				2005				2004
		A$				A$				A$				A$
Income Statement data in accordance with IFRS:
Revenue			3,205,381				2,339,310				830,645				837,201
Expenses			(8,269,116	)			(15,454,051	)			(10,107,359	)			(12,382,001	)
Loss from continuing operations			(5,063,735	)			(13,114,741	)			(9,276,714	)			(11,544,800	)
Finance costs			(4,934,415	)			(2,183,013	)			(35,496	)			(43,568	)
Income tax benefit			—				—				—				—
Loss after tax from continuing operations			(9,998,150	)			(15,297,754	)			(9,312,210	)			(11,588,368	)
Loss after tax from discontinued operation			—				(39,256	)			(1,602,390	)			(1,515,759	)
Loss attributable to members of the parent			(9,998,150	)			(15,337,010	)			(10,914,600	)			(13,104,127	)
Basic and diluted loss per share(1)			(0.0169	)			(0.0285	)			(0.0209	)			(0.0262	)
Weighted average ordinary number of shares outstanding			590,721,934				537,796,067				521,970,978				500,886,725
Balance Sheet data in accordance with IFRS:
Total current assets			17,069,966				26,605,477				7,115,554				17,349,971
Total assets			18,788,277				27,856,081				7,429,721				20,327,317
Total current liabilities			21,812,546				26,424,955				1,564,696				3,507,365
Long term obligations (including finance leases)			283,301				333,794				85,163				619,959
Total liabilities			22,095,847				26,758,749				1,649,859				4,127,324
Contributed equity			65,428,400				59,985,634				56,559,039				56,559,039

		As of and for the year ended December 31,
		2007				2006				2005				2004
		A$				A$				A$				A$
Total equity			(3,307,570	)			1,097,332				5,779,862				16,199,993
Other Financial Data:
Dividends per share			—				—				—				—

     Our selected financial data set forth below for 2003 is presented in Australian dollars and in accordance with U.S. GAAP. Income statement data for the year ended December 31, 2003 and the balance sheet data as at December 31, 2003 have been derived from our audited financial statements.

		As of and for the year ended
		December 31, 2003
		(A$)
Amounts in accordance with U.S. GAAP
Income Statement data:
Total operating income			348,570
Total operating expenses			(8,153,088	)
Loss from operations			(7,804,518	)
Total other income			997,985
Loss after tax from discontinued operations			(373,244	)
Net loss			(7,179,777	)
Net loss per ordinary share — basic and diluted (1)			(0.016	)
Weighted average ordinary number of shares outstanding			442,525,034
Balance Sheet data:
Total current assets			9,451,860
Total current liabilities			4,100,085
Total assets			15,101,660
Ordinary share capital			31,506,515
Total shareholders’ equity			9,353,392
Other financial data:
Dividends per share			—

B. Capitalization and Indebtedness

     Not applicable.

C. Reasons for Offer and Use of Proceeds

     Not applicable.

D. Risk Factors

There is uncertainty regarding Metal Storm continuing as a going concern .

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

     Our directors believe that Metal Storm will succeed in securing additional funding in the near future. As discussed below, in September 2006, we raised A$27.5 million through the issuance of convertible notes that mature in September 2009. We are in discussions with the largest holder of our convertible notes, Harmony Investment Fund Limited (“Harmony”), to extend the maturity date of the convertible notes. Under the Convertible Note Trust Deed (“Trust Deed”) entered into with ANZ Executors & Trustee Company Limited (“Trustee”) on July 11, 2006 which governs the convertible notes, an affirmative vote of 75% of the holders of the outstanding convertible notes is required to effect an amendment extending the maturity date. As of June 2, 2008, Harmony held approximately 81% of the outstanding convertible notes. In addition, we are seeking to raise approximately A$6 million by way of a rights issue of new convertible notes to existing noteholders who reside outside the United States and a placement of new notes to Harmony. This proposal would require various consents and approvals, including existing noteholders and potentially shareholder approval, and could be subject to other conditions, including the sale by Harmony of some of its existing convertible notes. There can be no assurance that the maturity of the existing convertible notes will be extended or whether the proposed new issuance of convertible notes will occur or, if it does occur, what the terms would be.

     If such funding were to be unavailable, there would be significant uncertainty as to whether Metal Storm would continue as a going concern and, therefore we may not realize the value of our assets and settle our liabilities at amounts different from those stated in our financial statements. No adjustments have been made to the financial statements relating to the recoverability and classification of the assets carrying amounts or classification of liabilities that might be necessary should Metal Storm not continue as a going concern.

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

     In September 2006, we raised A$27.5 million under a rights offer of unsecured convertible notes (“Rights Offer”) in Australia and New Zealand. The convertible notes mature in September 2009 at which time Metal Storm must repay the face value of any convertible notes unless a holder of convertible notes (“Noteholder”) has elected to convert them into ordinary shares. As previously mentioned, we are in discussions with the largest holder of our convertible notes to extend the maturity date. In connection with the Rights Offer, Metal Storm entered into the Trust Deed. On the occurrence of a default event under the Trust Deed, Metal Storm must, if required by the Trustee, redeem all convertible notes outstanding by payment of the face value of the convertible note together with all accrued but unpaid interest.

     Under the terms of the Trust Deed, Metal Storm must maintain specific minimum cash balances for various periods through December 2008. Failure to satisfy this or other requirements could result in early redemption of the convertible notes. For further details of the Trust Deed, see Item 10C “Additional Information—Material Contracts—Terms of convertible notes—Trust Deed in connection with the Rights Offer”. In the event of early redemption of the convertible notes, Metal Storm would have to raise funds to meet such obligations. It is likely that it will not be able to do so in a timely manner, or at all, in which case Metal Storm could become insolvent.

We may need additional capital and may not be able to raise additional capital on favorable terms, if at all.

     We may not have commercialized our technology when existing funds have been fully expended. Metal Storm will require additional capital by mid-2009 to fund product development programs. In addition, we may seek to exploit business opportunities that will require us to raise additional capital from equity or debt sources. In particular, developing and commercializing new technology and products to develop our business could require a significant commitment of additional resources that could, in turn, require us to obtain additional funding. We may also require further funds to pursue regulatory clearances, prosecute and defend our intellectual property rights, develop marketing capabilities and fund operating expenses.

     Our ability to obtain additional financing will be subject to a number of factors, including market conditions and our operating performance. These factors may render the timing, amount, terms and conditions of additional financing unattractive for us. The sale of additional equity or convertible debt securities would result in dilution to our existing stockholders. Additional debt could result in increased expenses and could result in further covenants that would restrict our operations. We cannot be certain that we will be able to raise any required funding or capital on favorable terms or at all. If we 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 A$10.0 million and A$15.3 million for the years ended December 31, 2007 and 2006, respectively. We expect to incur additional operating losses over the next few years. Our profitability is dependent on our ability, alone or with others, to complete the successful product engineering of our technology,

obtain any required regulatory clearances, and commercialize our products. We cannot be certain if or when we will achieve profitability.

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

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

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

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

We are dependent on retaining key personnel.

     There is competition among defense development companies for qualified technical employees and retaining and attracting qualified individuals is critical to our success. The responsibility of overseeing day to day management and the strategic management of Metal Storm is concentrated amongst a small number of key people. In February 2008, our Chief Engineer resigned for personal reasons. The loss of the services of key personnel could have a material adverse effect upon Metal Storm, as we may not be able to recruit replacements for the key personnel within a short timeframe.

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

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

We work on research and development programs.

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

There are some limitations relating to our technology.

     In its usual configuration, the Metal Storm technology stacks a number of projectiles in each barrel, and a quantity of propellant or gunpowder is located in a space that separates the projectiles. As a result, to hold the additional propellant that may be required for barrels may be longer and therefore heavier. For these reasons, the development risk of our technology increases as the operating pressure of the system increases. The extent to which these factors will affect the development of and the practical applications of our technology is uncertain. 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.

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.

     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 Patents Act 1990 (Commonwealth of Australia) (“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 Patents Act, a patent or a patent application may also be acquired by the Commonwealth of Australia. In that instance, all rights in the patent, or the patent application, vest in the Commonwealth of Australia. Compensation must be paid in an amount to be agreed between the person entitled to be compensated, and the Commonwealth of Australia. If there is no agreement, the amount of compensation is determined by a prescribed court. As such an acquisition clearly involves an acquisition of property, the terms of that acquisition must be “just”, within the meaning of the Australian Constitution.

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

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

     Under the U.S. Patent 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.

We have contracted to perform some systems integration work at a fixed price, which could turn out to be less than our costs.

     We perform systems integration work for third parties under contracts. Several of our contracts are bid on a fixed price basis. As such, there is inherent risk that our actual costs to perform the contracted job could exceed the agreed upon fixed price, which could have a material adverse effect on our business, financial condition and results of operations.

There are potential adverse effects from competition and technological changes.

     The defense industry market is highly competitive and can be subject to significant technological change. Large, well-established defense companies are engaged in research and development and have considerably greater resources than Metal Storm to develop applications for defense technology. We cannot be certain that our competitors will not succeed in developing technologies and products that are more effective than any which we are developing, or which would render our technology and products obsolete or non-competitive. Much of the research being conducted on defense technology is funded principally by government agencies in the United States. We compete with such other companies for government resources allocated to such research and development projects.

There are existing defense companies that may have target markets similar to, if not the same as, ours. Such companies may be developing their own technology and products, which may ultimately compete with ours. This could have a material adverse effect on our business, results of operations and financial condition.

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

     There are existing companies 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, the U.S. Department of Justice and the global defense industry. Our markets may be limited by U.S. and Australian government requirements pertaining to foreign markets. We also cannot predict future levels of defense 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 example, products incorporating our technology are required to undergo rigorous testing as well as extensive regulatory approval processes. These processes take significant time and require us to expend substantial resources. Delays in obtaining regulatory approvals could adversely affect the development and commercialization of our technology and products and could have a material adverse effect on our business, financial condition or results of operations.

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

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

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

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

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

•

Contract Termination

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

•

Loss of Appropriations

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

•

Procurement and Other Related Laws and Regulations

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

•

Protection of Proprietary Technology

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

•

Changes and Adjustments

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

•

Competitive Bidding and Domestic Preferences

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

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

We may have product liability exposure in the future.

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

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

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

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

     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.

     As Metal Storm is a listed company in both Australia and in the United States, our share price will be subject to the numerous influences that may affect both the broad trend in the local and international share market and the share prices of individual companies and sectors. Investors should recognize that the price of ordinary shares and options in Metal Storm may fall as well as rise. Our share price has been and is likely to continue to be volatile, particularly due to our relatively limited trading volume. Our share price could fluctuate significantly due to a number of factors, including:

	•		variations in our anticipated or actual operating results;
	•		sales of substantial amounts of our shares;
	•		announcements about us or about our competitors, including new products;
	•		litigation and other developments relating to our patents or other proprietary rights or those of our competitors;
	•		governmental regulation and legislation;
	•		our available cash resources or the need to seek additional funding through public or private equity or debt financings; and
	•		changes in securities analysts’ estimates of our performance, or our failure to meet analysts’ expectations.

     Many of these factors are beyond our control.

     Our major shareholder, James Michael O’Dwyer, beneficially owns 31% of Metal Storm’s ordinary shares. He has sold some shares recently and, in the past, he has indicated an intention to sell approximately one-half of his shareholding to someone who would

likely be a long term investor. Any such sale and any significant subsequent resales may cause volatility in our share price. In addition, a significant number of shares could be issued upon conversion of the convertible notes and the exercise of options issued to Noteholders in September 2006. See Item 7A “Major Shareholders.”

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 shareholders. 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, 2004, 2005 and 2006 but not in 2001 and 2007. Metal Storm could become a PFIC again in the future.

     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.

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

     The Bank of New York, as depositary, executes and delivers our American Depositary Receipts, or ADRs, on our behalf. Each ADR is a certificate evidencing a specific number of American Depositary Shares, also referred to as ADSs. Our ADR holders will not be treated as shareholders and do not have the rights of shareholders. The depositary will be the holder of the shares underlying our ADRs. Holders of our ADRs will have ADR holder rights. A deposit agreement among us, the depositary and our ADR holders, and the beneficial owners of ADRs, sets out ADR holder rights as well as the rights and obligations of the depositary. New York law governs the deposit agreement and the ADRs.

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

     The depositary will try, as far as practical, subject to Australian law and the provisions of the depositary agreement, to vote the shares as our ADR holders instruct. The depositary will not vote or attempt to exercise the right to vote other than in accordance with the instructions of the ADR holders. We cannot assure our ADR holders that they will receive the voting materials in time to ensure

that they can instruct the depositary to vote their shares. In addition, there may be other circumstances in which our ADR holders may not be able to exercise voting rights.

Item 4. Information on Metal Storm

A. History and Development of Metal Storm

     Our legal and commercial name is Metal Storm Limited, which was incorporated under the laws of Australia on April 13, 1994. Our principal office is located at Building 4, 848 Boundary Road, Richlands, Queensland, Australia 4077. Our telephone number is 011-61-7-3123-4700. Our website address is www.metalstorm.com. Information on our website and websites linked to it do not constitute part of this annual report. In 2001, our subsidiary Metal Storm Inc. opened an office in Arlington, Virginia, which is close to the Pentagon. Our agent for service of process in the United States is Mr. Peter D. Faulkner, 4350 N. Fairfax Drive, Suite 810, Arlington, VA 22203.

     In 1994, we acquired patents and intellectual property from Mr. J.M. O’Dwyer. In consideration for these patents, we issued to 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.

     In anticipation of our initial public offering in Australia, we effected a 21.4 to 1 stock split in March 1999 that increased our issued capital from 3,750,002 to 80,250,042 ordinary shares. In June 1999, we raised A$12 million in an initial public offering in Australia by offering and selling 4,000,000 ordinary shares at an issue price of A$3.00 per share. Our ordinary shares were listed on the Australian Securities 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.

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

     In December 2003, we acquired Seattle-based ProCam Machine LLC (“ProCam”) in exchange for the issuance of 5,524,926 ordinary shares of Metal Storm Limited and US$189,739 (A$256,716) cash. As part of this acquisition, Metal Storm assumed US$2.2 million (A$2.9 million) in debt. ProCam is a manufacturer of precision-machined parts for the defense, electronics, aircraft and space propulsion industries. In June 2005, Metal Storm sold the ProCam business.

     In May 2006, we raised A$2.7 million, net of transactions costs, through a share purchase plan available only to shareholders resident in Australia and New Zealand. In September 2006, we raised A$25.6 million net of transaction costs, under a fully underwritten renounceable rights offer (“Rights Offer”) of convertible notes available only to shareholders resident in Australia and New Zealand. The Rights Offer was made concurrently with an offer of one new share option for every convertible note allotted.

B. Business Overview

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

Strategy

     The 40mm weapons system category has been chosen as our primary focus in the short to medium term because we believe it provides the quickest path to the initial commercialization of our technology. We believe that Metal Storm technology is ideally suited to the 40mm category because the market for 40mm weapons and munitions is worldwide and covers both military and law enforcement sectors and this market is growing due to the increased use of 40mm weapons in modern warfare.

     Most contracted research and development projects are for 40mm weapons systems or components so the development work required aligns to the strategy points discussed above. Contracted research and development projects provide a valuable source of market opportunities as well as generating revenue. Contracts are generally funded by potential customers and are a recognized channel to market, particularly in the U.S. defense industry, where they can lead to eventual purchase orders.

     Our focus over the past 18 months has been to continue with the commercialization strategy of 40mm weapons system. This has included meeting the performance requirements of the Trust Deed governing our convertible notes. Specifically these were to demonstrate to the satisfaction of Noteholders or an independent expert appointed by the Trustee by June 30, 2007:

     (i) two fully functional prototypes of stabilized remotely operable weapons systems, including an Electro Optic Systems Pty Limited (“Electro Optic Systems”) electronic fire control system (known as “Redback™”) and a Metal Storm Ballistic Weapon that are assembled and ready for inspection;

     (ii) two fully functional prototype units of the Three Shot Grenade Launcher (known as “3GL”) are assembled and ready for inspection; and

     (iii) a successful live test firing of low velocity air burst rounds and low velocity high explosive rounds suitable for Metal Storm Ballistic Weapons in conjunction with Singapore Technologies Kinetics Ltd (“ST Kinetics”).

     These performance requirements were aligned with Metal Storm’s commercialization strategy and were successfully achieved in June 2007.

     The majority of our current and ongoing work is focused on low velocity/low pressure systems with progression into some specific higher velocity applications planned to occur in the near future. Metal Storm’s current commercialization strategy has the following key elements:

	•		completing the engineering of current Metal Storm 40mm weapon system components to a standard suitable for certification by relevant government agencies;
	•		building and demonstrating new and selected existing weapon prototypes designed to attract demand for early adoption by end-users;
	•		producing weapon prototypes to customer specifications in funded programs;
	•		obtaining certification of components and product prototypes by relevant government agencies, particularly the U.S. Department of Defense;
	•		merging our technology into fully integrated weapons systems that are adaptable to a variety of applications in current demand by military customers;
	•		securing customer production orders for certified products; and
	•		using the successful commercialization of 40mm weapons systems as a platform from which we can then branch out into other weapons categories and other applications of our core technology.

     We have entered in to a Joint Collaboration Agreement with Singapore Technologies Kinetics to collaborate in the design, development, testing, qualification and manufacture of prototypes and demonstration weapons and munitions as well as the commercial production and marketing of munitions and selected Metal Storm ballistic weapons that use those munitions. This agreement is expected to provide appropriately-qualified munitions and 3-shot grenade launcher (“3GL”) weapons for soldiers to trial and prepare these weapons for full-scale production.

     We continue to submit proposals for funded contracts based on the Metal Storm 40mm weapons systems and other calibers as opportunities arise.

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

Recent achievements

     Recent achievements, arising out of this strategic focus, include the successful completion of live firing trials and demonstrations of the 40mm weapons technology in several different configurations, including:

	•		the successful test firing of the Redback™ weapon system and munitions in collaboration with Electro Optic Systems and ST Kinetics in February 2006, March 2007, April 2007 and June 2007;
	•		the successful live fire demonstration of the FireStorm™ weapons system with non-lethal munitions for the U.S. Army in December 2007;
	•		the initial test firing and trials of a prototype high explosive 40mm grenade assembly developed in collaboration with ARDEC in March 2006;
	•		the successful live fire demonstrations of the MAUL 18mm grenade launcher to the U.S. Marine Corp in February 2008;
	•		successful live fire demonstration from an unmanned aerial vehicle in collaboration with Dragonfly Pictures Inc. in September 2006;
	•		ongoing development and firings of the 3GL weapons; and
	•		ongoing refinement and development of munitions for use in all Metal Storm 40mm weapons systems.

      Engineering

     Metal Storm has progressed from the rapid iteration stage of development to a longer development cycle as the product is refined beyond proof of concept to a commercial ready product. System and quality testing along with system safety are key elements of this phase. This involves the mutual development of the system and the munitions to provide a complete solution.

     Most of the above work is being carried out in our Australian office, while our U.S. office is focused on contract performance on customer-specified systems. The combined tactics of systems development and application insertion are designed to help assure customer interest in Metal Storm-enabled systems, while providing feedback to Metal Storm engineers.

     The current labor breakdown is that approximately 90% of the Australian engineering effort is focused on 3GL weapon systems and associated munitions with 10% focused on other 40mm systems. In the United States, approximately 90% of the engineering effort is concentrated on contracted systems development and 10% is on internal research and development for systems improvements.

      Business Development

     Our strategy is to focus on winning commercial contracts for the supply and integration of our weapon systems. Our business model is to integrate our unique technology into a range of military systems 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 predominately based on our 40mm weapons system technology.

     A key element of our business development strategy is 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 seek 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.

     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 designed to be capable of local or remote operation through a computerized fire control system. This is of particular value as combat becomes focused on remotely operated weapons and the use of robotic platforms.

     Our technology achieves its performance through the concept of numerous projectiles stacked in a barrel, in which each projectile, in most configurations, 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 capability for special applications; and
	•		fast second round strike capability before recoil effect.

Joint Collaboration Agreement with ST Kinetics

     In February 2008, Metal Storm entered into a Joint Collaboration Agreement with ST Kinetics that is designed to progress the 3GL and 40mm munitions to the manufacturing stage. Metal Storm and ST Kinetics have agreed to collaborate in the design, development, testing, qualification, manufacture of prototypes and demonstration weapons and munitions as well as the commercial production and marketing of munitions and selected Metal Storm ballistic weapons that only use those munitions. Both parties will contribute funds toward completing the demonstration and trial 3GL weapons and munitions. The agreement is expected to result in munitions that are compatible with all of Metal Storms’ 40mm weapons and could allow Metal Storm to expand its operationally-ready munitions to additional types. The agreement terminates in December 2020, unless terminated earlier pursuant to the terms of the agreement.

     In September 2005, Metal Storm entered into an exclusive Teaming Agreement with ST Kinetics for the development, testing, manufacture and marketing of munitions to be used in conjunction with Metal Storm projects. The agreement terminates in December 2012 unless terminated earlier by joint agreement of the parties or upon a default by one party. The agreement provides that intellectual property that is developed solely by one party under the agreement will be owned solely by that party. Intellectual property that is developed through the collaboration of both parties will be owned solely or jointly by Metal Storm, except for technology

relating to the internal workings of the warheads, which will be owned by ST Kinetics. Each party is responsible for its own development costs under the agreement.

Internal Product Development

     Currently, the two primary internally-funded development programs consist of Redback™, which is a four barrel pod for a rapid slewing weapons mount, and 3GL, which is a rifle-mounted or handheld three-shot grenade launcher. The research not only encompasses the weapons themselves, but also associated electronic fire control systems and projectile technology.

      3GL

     The 3GL is a modular semi-automatic grenade launcher that is being designed to attach to an existing assault rifle and be capable of being mounted to a separate stock for stand-alone use. The advantage of the system is that it would be able to fire three grenade rounds without reloading, enabling the soldier to maintain aim at the target. It is expected that, once developed, the 3GL would provide a higher probability of hitting a target than a conventional grenade launcher. This project is being developed entirely by Metal Storm with munitions potentially being supplied by ST Kinetics. Several 3GL proof-of-concept models have been built and successfully tested in Australia and in Singapore. Under the collaborative agreement with ST Kinetics, a commercialization program for the 3GL is underway with the goal of having the weapon qualified for firing by the end of 2008.

      Redback™

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

     Redback™ is being developed in a consortium with Electro Optic Systems, who will supply the gimbal, mount and acquisition and tracking electronics, and ST Kinetics, who will provide the ammunition. The weapon components are being funded and developed by Metal Storm. The Redback™ program commenced in November 2005. The project has already demonstrated the adaptation of existing ST Kinetics high explosive rounds to Metal Storm configuration for stacking ammunition in a barrel. Trials witnessed by an independent expert were conducted in Singapore in June 2007, proving it had reached fully functional prototype status. Electro Optic Systems is currently working on its targeting and sensor suite for anti-RPG Applications.

     Effective August 2005, Metal Storm entered into an exclusive Teaming Agreement with Electro Optic Systems for the joint development, manufacturing and marketing of a stabilized remote weapon system. The agreement terminates on December 31, 2012 unless terminated earlier by joint agreement of the parties or upon the occurrence of certain termination events. Each party is responsible for its own development costs under the agreement. The agreement provides that intellectual property which is developed solely by one party under the agreement will be owned solely by that party. Intellectual property that is developed through the collaboration of both parties will be owned by Electro Optic Systems except for technology that can only be utilized in connection with Metal Storm’s stacked-round systems, which will be owned by Metal Storm. If a weapon system developed under the agreement is ordered by a customer, Metal Storm will be paid for the components it provides under the terms of a separate purchase agreement.

      FireStorm

     FireStorm is a lightweight multi barrel 40mm electronic weapon system that is expected to provide solutions to the defense, security and law enforcement communities. The system can be mounted to fixed or mobile platforms to provide mission support for operations to include:

	•		military operations on urban terrain;
	•		reconnaissance patrol;
	•		border patrol;
	•		critical infrastructure protection; and
	•		crowd control.

     FireStorm has successfully demonstrated its capabilities under separate contracts for the U.S. Navy and U.S. Army. Recent demonstrations have proven the system capable of delivering high explosive and a range of less-lethal munitions.

      Fireworks

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

      Systems for Unmanned Vehicles

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

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

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

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

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

      MAUL

     The Metal Storm Multi-Shot Accessory Underbarrel Launcher (“MAUL”) is a lightweight 12-gauge gun system that attaches to the barrel of the M4 and M16 individual combat weapons. The MAUL uses Metal Storm’s stacked round firing system to allow four shots to be simultaneously loaded in a single chamber to maximize mission effectiveness.

     Traditionally soldiers have carried separate weapons to perform door-breaching and less-lethal force missions. The MAUL, which attaches to the primary weapons, allows both missions to be performed by a single weapon system with minimal weight overhead.

     Originally developed as a door-breaching capability, the MAUL is capable of firing both lethal and less-lethal munitions. It is bore sight aligned to the host gun sighting system.

     Constructed from carbon fibre with a steel barrel, the MAUL weighs only 2.75 pounds. Because there is no conventional mechanical action, the MAUL exhibits superior performance over other 12-gauge guns and operates over a wider range of climatic conditions. The MAUL is powered from a single, common stock, military grade lithium ion battery and will provide months of use from a single cell.

      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, and then other markets.

     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 our primary focus for internal investment at this time.

      Electronically Initiated Munitions Development — ST Kinetics

     This program involves the development of a range of electronically initiated munitions in collaboration with ST Kinetics, specifically for use with Metal Storm weapons. The range will be based on the existing ST Kinetics family of 40mm munition types, adapted to Metal Storm configuration. The program commenced in September 2005. High explosive and enhanced blast rounds plus air burst munitions were successfully test-fired in February 2006, June 2007 and March 2008.

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.

      U.S. Navy SBIR Contract — Metal Storm Active Protection System

     This contract was for the development of a remotely controlled Active Protection System for mounting on various types of unmanned ground vehicles. It was funded through a Phase II Small Business Innovation Research (“SBIR”) contract sponsored by the U.S. Navy’s Space and Naval Warfare Systems Command and the Office of Naval Research. Metal Storm provided an unattended remotely operated weapon system designed to operate in a networked environment for the protection of very high value assets. The contract, which commenced in January 2006, was completed in March 2008.

      U.S. Army SBIR Contract — Metal Storm Crowd Control System

     This contract was for the development and testing of a Crowd Control System using Metal Storm 40mm weapons technology and less-lethal munitions. It was funded through a U.S. Army Phase II SBIR contract sponsored by the U.S. Army ARDEC. The contract required Metal Storm to develop and fabricate specific less-lethal rounds capable of being fired from Metal Storm weapon systems in a variety of configurations as a means to control potentially hostile crowds from infringing upon or interrupting ongoing operations. This contract, which commenced in December 2005, was completed in January 2008.

      StarChase Contract — Pursuit Management System Phase II Lead System Integrator

     StarChase LLC engaged Metal Storm to act as the lead systems integrator on the commercialization of the patented StarChase vehicle tagging technology. The contract required Metal Storm to generate a production-ready configuration of the StarChase system, and to produce, implement, and provide support for a limited number of systems to be used for operational testing. The contract commenced in May 2006 and was completed in October 2007. Metal Storm is continuing to provide services to StarChase in support of the product commercialization.

      U.S. Marine Corps — 18mm Stacked Round Firing System

     This contract was for the design, fabrication and test of 18mm stacked round firing systems. Under the terms of the contract, Metal Storm explored the feasibility of employing 18mm fin stabilized high explosive projectiles from an accessory under-barrel weapon for the M-16A4 service rifle. The firing technology led to a test bed capability potentially leading to U.S. Marine Corps experimentation with larger diameter finned projectiles than are possible with shot gun-launched munitions. The contract was announced in July 2006 and was successfully completed in March 2008.

      U.S. Navy — 12-gauge Multi-shot Grenade Launcher

     In June 2008, the U.S. Office of Naval Research awarded a contract to further develop a 12-guage, multi-short grenade launcher. The contract was awarded on “cost plus fixed fee” basis and is valued at US$936,695. This project will extend work performed previously under a contract with the U.S. Marine Corps for a Multi-Shot Accessory Underbarrel Launcher. The MAUL is a lightweight grenade launcher and shotgun attachment that fits under the barrel of a combat weapon such as the M-16 or M-4.

      U.S. Army — Explosive Ordinance Disposal

     Under this contract with the U.S. Army, Metal Storm completed the preliminary design for a multiple shot disrupter to counter Improvised Explosive Devices (“IED”) and other explosive devises. This was received as a sole source, fixed price contract from the U.S. Army. The success of this preliminary design effort may lead to a follow on effort where design details will be finalized and proof guns and munitions will be fabricated. This contract was awarded in 2006 and was completed in June 2007.

      U.S. Navy — Weapons Pod Assembly and Spares

     Under this purchase order with the U.S. Naval Surface Warfare Center, Dahlgren Division, Metal Storm delivered a 4-barrel weapons pod, fire control unit, and 3-spare weapon assemblies for bench and field testing and evaluation. The purchase order was awarded July 2007 and completed in October 2007. Metal Storm is continuing to support the U.S. Navy in the integration of the Metal Storm weapons with its Cougar vehicle.

      Commercial Contract — Design Support Services

     Under this contract, Metal Storm is providing design support and participating in a series of tests for a major defense contractor. The contract was awarded in late December 2007 and is scheduled to be completed in September 2008.

Research Agreements with Government Agencies

     We currently have no active agreement with Australian government agencies for the development of our technology.

Competition

     Until we commercialize a product using our technology, we continue to compete for technology research and development funding available through various areas that are administered by the U.S. Department of Defense and other government agencies, including, for example, under the 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 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 Defense Export Controls under which we would be required to obtain an export distribution license. Licenses and permits may be difficult to obtain and retain depending on government policies, customs, changes in political leadership, and other factors. These processes and obtaining licensing and permits may take many years and require the expenditure of substantial resources.

     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:

	•		stacked projectile delivery systems and stacked projectile weapon systems, in particular the sealing, reload and ignition thereof;
	•		technology related to encoding weapons to permit authorized access only;
	•		ammunition and projectiles;
	•		electronic firing technology;
	•		area denial;
	•		fire fighting;
	•		seismic testing;
	•		increased first shot kill probability;
	•		multi-barrel systems;
	•		fireworks;
	•		missile defense and target interception;
	•		directional control of missiles;
	•		unmanned aerial vehicle weaponization;
	•		adapting conventional munitions to Metal Storm configuration; and
	•		selectable kinetic energy systems.

     As of December 31, 2007, we were maintaining:

	•		25 granted U.S. patents and 15 pending U.S. patents;
	•		24 granted Australian patents and 13 pending Australian patent applications including one allowed application; and
	•		158 other patents granted outside the United States and Australia and 152 pending applications outside the United States and Australia, including 10 allowed applications (including 16 pending European Patent Convention and 3 PCT applications).

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.

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 16,194 square feet of office and workshop space in Richlands, Australia. The annual gross rental payments are approximately A$130,716 payable in monthly installments of approximately A$10,893. The lease expires on June 30, 2009.

     We lease approximately 6,149 square feet of office space in Arlington, Virginia. The annual gross rent effective March 2007 is US$213,432 (A$233,724), payable in monthly installments of approximately US$17,786 (A$19,477). The lease expires on June 30, 2010.

Item 4A. Unresolved Staff Comments

     Not applicable.

Item 5. Operating and Financial Review and Prospects

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

A. Operating Results

Overview

     Metal Storm Limited was incorporated as a private company in Australia in April 1994. We are a defense technology company that is involved in the research, development and commercialization of projectile launching systems that utilize electronically fired, “stacked projectile” technology. In 2007, we worked on several contracts with various U.S. government departments and private companies.

     In order to meet Metal Storm’s objectives to develop, manufacture and market commercial products effectively, we may require further funding until such time that product sales are of sufficient volume to generate positive cash flows from operations. This has taken longer and has cost more than originally anticipated. Based on the expected levels of operating expenditures, in order to continue its operations past mid-2009, Metal Storm may require additional sources of capital. While Metal Storm has previously been successful in raising additional capital, there can be no assurance that we will be able to raise sufficient capital to continue our operations. If we are unsuccessful in our efforts to obtain sufficient financing to continue to fund our current operations, we will be required to significantly reduce or cease operations altogether.

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

     We have incurred net losses since our inception. We recognized a net loss of A$10.9 million, A$15.3 million and A$10.0 million in the years ended December 31, 2005, 2006 and 2007, respectively. Our accumulated losses from inception to December 31, 2007 are A$77.8 million. We expect to incur increasing losses in the foreseeable future as we continue to invest in the research and development of our patented electronically initiated “stacked projectile” technology prior to entering into commercialization phase. We expect that losses will fluctuate from period to period and that such fluctuations may be substantial as a result of, among other things, the results of our research and development programs, the number of future prototypes we produce and test and potential design changes required as a result of testing. We are approaching the latter stage of product development and do not expect any revenues from product sales until at least the second half of 2009. While there has been significant interest in our proof-of-concept demonstrations, we cannot give assurance that we will manufacture or sell our products successfully or ever achieve or sustain profitability.

Where We Derive Our Revenue

     In 2007 and 2006, our principal sources of revenue were systems integration work and interest income.

Critical Accounting Policies

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

     We believe the following are our critical accounting policies that affect our more significant judgments and estimates used in the preparation of our financial statements.

      Revenue Recognition

     Revenue is recognized and measured at the fair value of the consideration received or receivable to the extent that it is probable that the economic benefits will flow to Metal Storm and the revenue can be reliably measured. The following specific recognition criteria must also be met before revenue is recognized:

      Sale of goods

     Revenue is recognized when the significant risks and rewards of ownership of the goods have passed to the buyer and the costs incurred or to be incurred in respect of the transaction can be measured reliably. Risks and rewards of ownership are considered passed to the buyer at the time of delivery of the goods to and acceptance by the customer, and collectibility of the selling price is reasonably assured.

      Rendering of services

     Revenue is recognized when key milestones or deliverables specified within each agreement are achieved and accepted by all parties to the agreement, no performance obligation with respect to the milestone or deliverables remains, the arrangement fee is fixed, and collectibility is reasonably assured. For most of our contract service revenue arrangements, revenue is recognized upon delivery of a report summarizing the findings of specified research activities requested by our customers. For those contracts requiring acceptance of the delivery of our report by our customers, we recognize revenue upon receipt of written acceptance or payment in lieu of written acceptance.

      Construction contracts

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

     For fixed price contracts, the stage of completion is measured by reference to labor hours incurred to date as a percentage of estimated total labor hours for each contract. Revenue from cost-plus contracts is recognized by reference to the recoverable costs incurred during the reporting period plus the percentage of fees earned.

     The percentage of fees earned is measured by the proportion that costs incurred to date bear to the estimated total costs of the contract. Where the outcome of a contract cannot be reliably estimated, contract costs are recognized as an expense as incurred, and where it is probable that the costs will be recovered, revenue is recognized to the extent of costs incurred.

      Share-based payment transactions

     We provide benefits to employees (including directors) of Metal Storm in the form of share-based payment transactions, whereby employees render services in exchange for shares or rights over shares (“equity-settled transactions”). We currently provide these benefits through (i) options issued to executives and employees as part of a remuneration package issued in accordance with the power contained in our constitution and (ii) the Employee Share Option Plan (“ESOP”).

     The cost of these equity-settled transactions with employees is measured by reference to the fair value at the date at which they are granted. The fair value is determined using a Black-Scholes model. In valuing equity-settled transactions, no account is taken of any performance conditions, other than conditions linked to the price of the shares of Metal Storm (‘market conditions’). The cost of equity-settled transactions is recognized, together with a corresponding increase in equity, over the period in which the performance conditions are fulfilled, ending on the date on which the relevant employees become fully entitled to the award (‘vesting date’).

     The cumulative expense recognized for equity-settled transactions at each reporting date until vesting date reflects (i) the extent to which the vesting period has expired and (ii) the number of awards that, in the opinion of the Directors of Metal Storm, will ultimately vest. This opinion is formed based on the best available information at balance date. No adjustment is made for the likelihood of market performance conditions being met as the effect of these conditions is included in the determination of fair value at grant date.

Comparison of Annual Results of Operations

      2007 compared with 2006

      Revenue. Revenue increased by A$866,071 from A$2,339,310 in 2006 to A$3,205,381 in 2007 due to higher fees earned from systems integration work carried out by our U.S. office and higher interest income, which increased by A$595,768 to A$1,354,048 as a result of higher average cash balances.

     Contract revenue was generated from six contracts during 2007. In addition, we completed a long-term contract with StarChase LLC valued at US$1.2 million. While some revenue relating to this contract had been recognized in 2006, no revenue was recognized in 2007 because the terms of the contract provided for the delay of payment until 2008, which is when we expect to recognize the balance of revenue from this contract.

      Expenses. Total expenses decreased A$4.5 million (25%) from A$17.7 million in 2006 to A$13.2 million in 2007. Significant movements in expenses were:

	•		Employee expenses decreased A$1,133,346 (20.7%) from A$5,481,934 in 2006 to A$4,348,588 in 2007 due to a reduction in share based payments, termination payments and staff restructuring.
	•		Research and development expenses increased A$681,035 (68.8%) due to the increased costs of test firings associated with the performance milestones of the Trust Deed.
	•		Professional fees decreased A$410,227 (23.7%) primarily due to a non recurring expense in 2006 of A$399,141 associated with a proposed capital raising that was terminated in 2006.
	•		In 2007, we had a fair value movement gain of A$2,421,388 on the embedded derivative that reflects the movement in the fair value of the conversion option embedded in the convertible notes issued in 2006. In 2006, we had a fair value loss of A$4,469,042.

•

Finance expenses increased A$2,751,402 in 2007. Finance expenses primarily relate to the convertible notes that we issued in September 2006. Accordingly, interest and accretion expenses for 2006 reflect the period from September to December whereas finance expenses in 2007 reflect the full year.

      Net Loss. As a result of the foregoing, our net loss decreased from approximately A$15.3 million in 2006 to A$10.0 million in 2007. Due to our continuing losses, no income tax expense has been recognized.

      2006 compared with 2005

      Revenue. Revenue increased by A$1,508,665 from A$830,645 in 2005 to A$2,339,310 in 2006 principally due to higher fees earned from systems integration work carried out by our U.S. office on four contracts. This increase is also due in part to higher interest revenue, which increased by A$158,378 to A$758,280 due to additional interest earned which resulted from the increase in cash from the proceeds of the Rights Offer.

      Expenses. Total expenses, excluding finance costs, increased A$4.1 million (41%) from A$10.1 million in 2005 to A$15.5 million in 2006. Significant movements in operating expenses were:

	•		Employee expenses increased A$873,708 (19.6%) from A$4,468,640 in 2005 to A$5,342,348 in 2006, primarily due to the costs of additional staff employed throughout the year and executive bonuses.
	•		Professional fees decreased A$42,456 (2.4%) from A$1,774,369 in 2005 to A$1,731,913 in 2006 due to cost savings achieved through performing more work in-house rather than using external consultants. These savings were off-set by professional fees of A$399,141 associated with a proposed capital raising that commenced in 2005 and was terminated in 2006.
	•		Research and development expenses decreased A$156,342 (13.6%) from A$1,146,364 in 2005 to A$990,022 in 2006 reflecting the change in focus of the U.S. office from research and development on our internal programs to contract performance.
	•		Administrative expenses decreased A$97,284 (10.5%) from A$928,931 in 2005 to A$831,647 in 2006 primarily due to a aggressive cost saving activities.
	•		Facilities and equipment expenses increased A$218,950 (41.9%) from A$522,693 in 2005 to A$741,643 in 2006 primarily due to higher costs required to maintain two facilities in Brisbane for six months while a new engineering facility was being established plus higher depreciation costs resulting from the purchase of new plant and equipment.
	•		Travel and entertainment expenses increased A$89,573 (20.6%) from A$433,859 in 2005 to A$523,432 in 2006 primarily due to an increase in travel costs associated with research and development activities and A$65,200 of travel costs relating to a proposed capital raising that commenced in 2005 and was terminated in 2006.
	•		Public relations and compliance expenses decreased A$155,580 (31.4%) from A$494,786 in 2005 to A$339,206 primarily due to savings achieved through more work performed in-house rather than using external consultants.
	•		In 2006, we had an A$4,469,042 embedded derivative expense that reflects the movement in the fair value of the conversion option embedded in the convertible notes issued in 2006. The fair value of the liability component of convertible notes is carried as a current liability on an amortized cost basis until extinguished on conversion or redemption.

      Finance Cost. Our finance costs increased A$2,260,351 from A$35,496 in 2005 to A$2,183,013 in 2006 due to the issue of unsecured convertible notes in connection with the Rights Offer in September 2006. These finance costs include the accretion of the convertible note liability of A$753,262 and the quarterly interest payable on the convertible notes of A$897,327. The finance costs also include A$467,000 which represents the fair value of options issued to Harmony Investment Fund Limited (“Harmony”) in accordance with a facilitation agreement dated July 20, 2006. Harmony was sub-underwriter of the Rights Offer.

      Net Loss. As a result of the foregoing, our net loss increased from approximately A$10.9 million in 2005 to A$15.3 million in 2006. Due to our continuing losses, no income tax expense has been recognized.

Effects of Currency Fluctuations

     Our functional currency and reporting currency is the Australian dollar.

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

     The effect of foreign currency translation is reflected in our financial statements in the statements of changes in shareholders’ equity and is reported as accumulated translation reserve. At December 31, 2007, the impact of the foreign currency translation was an accumulated reserve of (A$68,559) compared to accumulated reserve balance of (A$84,572) at December 31, 2006. The fluctuations are caused by fluctuations in the exchange rate between the Australian dollar and the U.S. dollar. We have not entered into any hedging arrangements to mitigate the effects of currency fluctuations.

B. Liquidity and Capital Resources

      Overview

     We have incurred substantial losses since the formation of Metal Storm and anticipate incurring substantial additional losses over at least the next few years as we continue our research and development activities and conduct further trials of our technology. Our operations have been financed primarily from capital contributions by investors, 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 two years.

		Year ended December 31
		2007				2006
		A$				A$
Net cash used in operating activities			(11,255,896	)			(7,456,339	)
Net cash provided by investing activities			2,214,431				2,603,896
Net cash provided by (used in) financing activities			(59,772	)			28,046,849
Effect of exchange rate changes on cash			(1.482	)			—
Net movement in cash and cash equivalents			(9,102,719	)			23,194,406

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

     In 2006, net cash provided by investing activities was a result of the sale of some of our fixed interest securities and the purchase of property, plant, and equipment. In 2007, net cash provided by investing activities consisted of interest income on deposits and the sale of financial investments.

     In 2006, financing activities were the result of a A$2.7 million, net of transaction costs, capital raising from shareholders resident in Australia and New Zealand through a share purchase plan conducted in May. In addition, we raised A$25.6 million net of costs in September 2006 through the Rights Offer. In 2007, financing activities consisted of the repayment of borrowings from short term loans.

      Borrowings

     In 2006, Metal Storm issued 203,703,704 convertible notes to existing shareholders in Australia and New Zealand at the rate of one convertible note for every 2.674 existing ordinary shares held to raise gross proceeds of A$27.5 million on September 1, 2006 under the Rights Offer. The Rights Offer was made concurrently with the offer of one new share option for every two convertible notes allotted, which resulted in 101,852,055 listed options being granted. In addition, 10 million options were granted to Harmony or its nominees in consideration for a short term working capital facility of A$5 million which was never drawn on by Metal Storm. A further 65 million options were issued to Harmony as payment for Harmony’s commitment to sub-underwrite the Rights Offer up to A$26.1 million.

     Convertible notes bear interest at the rate of 10% per annum on the face value of A$0.135 per convertible note over the term. Interest is payable quarterly in arrears, however, Metal Storm may elect to defer payment of some or all of the interest for the first year. The term of the convertible notes is three years from the date of issue unless converted into ordinary shares. The maturity date of the convertible notes is September 1, 2009, at which time Metal Storm must repay the face value of A$0.135 per convertible note to the Noteholders, unless Noteholders have elected to convert some or all of their convertible notes into ordinary shares at a conversion price which is the lesser of A$0.135 or 90% of the volume weighted average price of Metal Storm’s ordinary shares during the 30 business days immediately preceding the conversion date. Noteholders can elect to convert some or all of their convertible notes into ordinary shares at the beginning of each quarter, at the maturity date and at certain other times.

     The convertible notes were issued under Trust Deed, the details of which are discussed in Item 10.C of this Form 20-F. It is possible that the convertible notes could become due and payable in 2008 if certain default events were to occur, most notably a breach of particular minimum cash levels. See Item 3D “Key Information— Risk Factors —We may be required to redeem convertible notes before maturity, which redemption could cause us to become insolvent.”

     Metal Storm has finance leases for workshop equipment and demountable buildings with a carrying amount of A$306,180. These leases expire within three years with no option to renew the leases or purchase the assets at the completion of the lease term. These finance leases are secured through a bank guarantee deposit.

     In addition, our annual insurance premiums are paid by a third party financier to whom we make monthly repayments with interest. In 2007, the amount of this insurance premium was A$419,703 of which A$36,465 (including interest) is payable per month.

      Other Material Commitments

     We had no material capital expenditures during the past two years and do not expect to incur any material capital expenditure in 2008.

      Future Cash Needs

     We expect that operating expenses will continue to be the principal use of our cash resources. Available cash resources are expected to provide us with sufficient capital to fund our operations through mid-2009. We will need to raise additional sources of funding before then and may seek it through equity or debt financings. The sale of additional equity or convertible debt could result in dilution to our shareholders. Additional debt would result in additional expenses and could result in covenants that would restrict our operations.

     Our convertible notes mature in September 2009. We are in discussions with our largest holder of our convertible notes, Harmony, to seek to extend the maturity date of the convertible notes. Under the Trust Deed entered into with the Trustee which governs the convertible notes, an affirmative vote of 75% of the holders of the outstanding convertible notes is required to effect an amendment extending the maturity date. As of June 2, 2008, Harmony held approximately 81% of the outstanding convertible notes. In addition, we are seeking to raise approximately A$6 million by way of a rights issue of new convertible notes to existing noteholders who reside outside the United States and a placement of new notes to Harmony. This proposal would require various consents and approvals, including existing noteholders and potentially shareholder approval, and could be subject to other conditions, including the sale by Harmony of some of its existing convertible notes. There can be no assurance that the maturity of the existing convertible notes will be extended or whether the proposed new issuance of convertible notes will occur or, if it does occur, what the terms would be.

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 A$1.7 million and A$1.0 million for the years ended December 31, 2007 and 2006, respectively inclusive of the tax concession for research and development. Our policy is to focus our research on selected internal product development projects as well as external development programs under which we work in collaboration with other parties. See Item 4B “Information on Metal Storm — Business Overview”.

D. Trend Information

     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”.

E. Off-Balance sheet arrangements

     Not applicable.

F. Tabular disclosure of contractual obligations

     The following table summarizes our contractual obligations and commitments as of December 31, 2007:

		Payments due by period
		Total				Less Than												More than
		A$				1 Year				1 — 3 Years				4 — 5 Years				5 Years
Capital (finance) lease obligations			278,943				63,907				215,036				—				—
Operating lease obligations			919,951				443,858				476,093				—				—
Convertible Notes			24,041,577				2,060,868				21,980,709				—				—
Total			25,240,471				2,568,633				22,671,838				—				—

Item 6. Directors, Senior Management and Employees

A. Directors and Senior Management

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

Name		Position
Terence J. O’Dwyer		Chairman
Dr. Peter D. Jonson		Director
John R. Nicholls		Director
Dr. Lee J. Finniear		Chief Executive Officer
Brett I. Farmer		Chief Financial Officer
Peter D. Faulkner		General Manager – MS Inc
Peter R. Wetzig		Company Secretary

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

      Dr. Peter D. Jonson. Dr. Jonson was appointed as a Director in February 2006. He has had government and commercial experience in leadership positions. He is a professional director and economist and spends a considerable part of his time directly or indirectly helping scientists and technologists produce commercial outcomes from their research. Dr. Jonson is a director of Pro Medicus Limited and Village Roadshow Limited and is chairman of Bionomics Ltd. Dr. Jonson is also Chairman of Australian Institute for Commercialisation, Australian Aerospace and Defense Innovations Ltd and the Australian Government’s Cooperative Research Centers Committee. He is Chairman Emeritus of the Melbourne Institute Advisory Board. He also held a number of senior positions as an economist with the Reserve Bank of Australia from 1972 to 1988.

      John R. Nicholls. Mr. Nicholls was appointed as a Director in September 2006 pursuant to an agreement with Harmony Capital Partners Pte Limited, which was a sub-underwriter for the Rights Offer. Mr. Nicholls has extensive experience with start-up and established companies, having held senior management positions and directorships for several Australian and international companies in the manufacturing, distribution, trading and merchant banking industries. He is a director of Nylex Limited and Brandrill Limited, each of which is listed on the Australian Securities Exchange.

      Dr. Lee J. Finniear. Dr. Finniear was appointed Chief Executive Officer in February 2007 and Managing Director in May 2007. He is responsible for the overall management of the operations of Metal Storm as well as managing our investor relations and capital requirements and corporate affairs. Prior to joining Metal Storm, Dr. Finniear was Chief Executive Officer of Derceto Ltd from May 2006 to January 2007. He was Vice President Asia Pacific with Intergraph Corporation’s largest division from 2003 to 2006. He has

held senior executive roles in technology companies that service defense organizations worldwide and has direct experience with defense industry acquisition procedures. Dr. Finniear holds a PhD in an engineering related field.

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

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

      Peter R. Wetzig. Mr. Wetzig was General Manager — Commercial of Metal Storm from August 1999 to December 2002 and re-joined Metal Storm in May 2007 as Company Secretary. He has been a professional corporate governance consultant to public and private company groups for the past four years. Mr. Wetzig is a Fellow of both the Chartered Institute of Company Secretaries and the Institute of Chartered Accountants in Australia.

B. Compensation

     In 2007, the aggregate remuneration we paid and that accrued to our directors and senior management was A$1,805,158.

     The remuneration and benefits paid to our directors and executive officers during 2007, on an individual basis, are set out in the table below.

												Non																Total				Perfor-
				Salary &				Cash				Monetary																Remuner				mance
Name		Position		Fees				Bonus				Benefit				Other				Super				Options				-ation				Related
				A$				A$				A$				A$				A$				A$				A$				%
T. J O'Dwyer		Chairman (Non-Executive)			80,000				—				—				—				—				—				80,000				—
B. S. McComish		Director (Non-Executive) - resigned March 2007			12,333				—				—				—				—				—				12,333				—
J. M. Crunk		Director (Non-Executive) - resigned May 2008			85,248				—				—				—				—				—				85,248				—
P. D. Jonson		Director (Non-Executive)			60,000				—				—				—				—				—				60,000				—
J. R. Nicholls		Director (Non-Executive)			50,000				—				—				—				—				—				50,000				—
L. J. Finniear		Managing Director & Chief Executive Officer - appointed February 2007			214,361				40,000				—				—				21,597				89,700				365,658				10.9	%
P. R. Wetzig		Company Secretary - appointed April 2007			50,720				—				—				—				—				—				50,720				—
B. I. Farmer		Chief Financial Officer - appointed August 2007			50,365				—				—				—				4,533				—				54,898				—
P. D. Faulkner		General Manager-MS Inc			227,929				19,709				10,279				2,937				—				10,223				271,077				7.3	%
J. Cronin		Managing Engineer - resigned effective Feb. 2008			177,368				19,500				17,632				—				19,364				—				233,864				8.3	%
J. D. MacDonald		Chief Financial Officer-resigned April 2007			142,905				22,750				—				—				10,712				—				176,366				12.9	%
S. T. Rolander		Vice President - Corporate Services-MS Inc			144,339				13,076				7,730				2,021				—				—				167,166				7.8	%
A. D. Schatz		Vice President - Business Development - MS Inc			174,484				—				—				2,334				—				—				176,818				—
G. L. Bergeron		Chief Technical Officer - resigned January 2007			19,475				—				1,318				216				—				—				21,009				—
Total Remuneration					1,489,527				115,035				36,959				7,508				56,205				99,923				1,805,158				6.4	%

     During the year ended December 31, 2007, the following options over ordinary shares were granted as equity remuneration benefits to directors and executives. Options issued to executives were granted as equity compensation for services performed in the 2007 year in accordance with employment contracts and letters of offer. These options were not issued as part of an incentive plan.

		Granted								Terms and Conditions for each Grant																				Vested
										Fair
										Value
										per												First				Last
						Grant				Option				Exercise				Expiry				Exercise				Exercise
		No.				Date				(1)				Price				Date				Date				Date				No.				%
Directors
T. J O’Dwyer			—				—				—				—				—				—				—				—				—
L. J. Finniear			500,000				2/26/07			$	0.09			$	0.19				3/08/12				8/18/07				3/08/12				500,000				100.0
L. J. Finniear (2)			500,000				2/26/07			$	0.09			$	0.19				3/08/12				2/18/08				3/08/12				500,000				100.0
J. M. Crunk			—				—				—				—				—				—				—				—				—
P. D. Jonson			—				—				—				—				—				—				—				—				—
J. R. Nicholls			—				—				—				—				—				—				—				—				—
B. S. McComish			—				—				—				—				—				—				—				—				—
Other Key Management Personnel
P. R. Wetzig			—				—				—				—				—				—				—				—				—
B. I. Farmer			—				—				—				—				—				—				—				—				—
P. D. Faulkner			25,000				2/06/06			$	0.10			$	0.40				3/31/12				3/31/07				3/31/12				25,000				100.0
P. D. Faulkner			25,000				2/06/06			$	0.10			$	0.40				6/30/12				6/30/07				6/30/12				25,000				100.0
P. D. Faulkner			25,000				2/06/06			$	0.11			$	0.40				9/30/12				9/30/07				9/30/12				25,000				100.0
J. Cronin			—				—				—				—				—				—				—				—				—
J. D. MacDonald			—				—				—				—				—				—				—				—				—
S. T. Rolander			—				—				—				—				—				—				—				—				—
A. D. Schatz			—				—				—				—				—				—				—				—				—
G. L. Bergeron			—				—				—				—				—				—				—				—				—
Total			1,075,000																												1,075,000

C. Board Practices

     Under our constitution, our board of directors is required to be comprised of at least three directors. As of December 31, 2007, our board was comprised of five directors and is currently comprised of four 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. Mr. John Nicholls was appointed as a Director in September 2006 pursuant to an agreement with Harmony in connection with the Rights Offer.

     The board of directors has established an Audit Committee that consists of three directors. Current members of our Audit Committee are Dr. Peter Jonson, Mr. John Nicholls and Mr. Terry O’Dwyer.

     Under its charter, the Audit Committee:

	•		retains independent auditors and reviews and discusses the independence of the auditors;
	•		sets the engagement policies for the independent auditors;

	•		reviews and discusses the audit plan, the conduct of the audit and the audit results;
	•		reviews and discusses financial statements and disclosures;
	•		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.

     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 Metal Storm’s operations. The Board disbanded this committee in March 2008.

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

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

     Remuneration packages contain the following key elements:

	•		salary/fees;
	•		benefits — including the provision of retirement and health benefits; and
	•		incentive schemes — including performance-related bonuses and share options under the discretionary share option plan.

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

compulsory acquisition, reconstruction, amalgamation or liquidation; and ending on the earliest of (d) the date which is 2 days before the tenth anniversary of the date of grant; (e) the last day before the first anniversary of the date on which any special circumstance arises; and (f) the expiry of specified time frames set out in the employee option plan in relation to the circumstances in (c) above. An option lapses upon expiry of the exercise period, termination of the option holder’s employment otherwise than in a special circumstance, upon the option holder being adjudicated bankrupt, or any purported transfer, assignment or alienation of the options by the option holder. The board of directors may at any time cease making further offers or invitations, but the subsisting rights of options are not affected in such circumstances. Non-executive directors do not have service contracts with Metal Storm.

D. Employees

     We employed 30 staff as at December 31, 2007.

E. Share Ownership

At June 2, 2008, the beneficial interests of the directors and executives in the ordinary shares and options of Metal Storm were:

						Number of Options
		Number of Shares Held				Exercisable
T. J O’Dwyer			180,855	(2)			33,819	(3)
P. D. Jonson			680,000				—
J. R. Nicholls(4)			—				—
L. J. Finniear			—				1,000,000
P. D. Faulkner			—				200,000
J. Cronin			—				200,000
P. R. Wetzig			400				—

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

Item 7. Major Shareholders and Related Party Transactions

A. Major Shareholders

     The following table presents certain information regarding the beneficial ownership of our ordinary shares as of June 2, 2008 by each person known by us to be the beneficial owner of more than 5% of our ordinary shares, based upon a review of our share registry and filings made by shareholders with the Australian Securities Exchange. Beneficial ownership is determined according to the rules of the Securities and Exchange Commission and generally means that a person has beneficial ownership of a security if he or she possesses sole or shared voting or investment power of that security, and includes options that are exercisable within 60 days.

Information with respect to beneficial ownership has been furnished to us by each director, executive officer or 5% or more shareholder, as the case may be. Unless otherwise indicated, to our knowledge, each shareholder possesses sole voting and investment power over the shares listed, subject to community property laws where applicable.

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

     The below table lists applicable percentage ownership based on 608,443,049 ordinary shares outstanding as of June 2, 2008. Options to purchase our ordinary shares that are exercisable or convertible notes that can be converted into ordinary shares within 60 days of June 2, 2008 are deemed to be beneficially owned by the persons holding these options for the purpose of computing percentage ownership of that person, but are not treated as outstanding for the purpose of computing any other person’s ownership percentage.

		Number of Ordinary
Name of Shareholder		Shares (2)				Percentage of Class
James Michael O’Dwyer(1)			187,423,610				30.8	%

     As of June 2, 2008, Harmony Investment Fund Limited was the beneficial owner of 29,476,097 ordinary shares, 106,097,590 convertible notes and 123,226,332 options. If all these options and convertible notes were exercised or converted and no other optionholder or Noteholder converted their holdings, Harmony would hold in excess of 40% of the ordinary shares in Metal Storm Limited. The diluting effect of this transaction would make Harmony the largest shareholder. Harmony has indicated an interest in selling some of its convertible notes on the Port Moresby Stock Exchange, where the convertible notes were recently listed.

     As of June 2, 2008, 1.1% of our ordinary shares were held by 59 U.S. holders of record and 97.9% of our ordinary shares were held by 8,753 Australian holders of record.

     As of June 2, 2008, 6,621,855 American Depositary Shares, representing 132,437,100 ordinary shares, were outstanding.

B. Related Party Transactions

     During 2007, Backwell Lombard Capital Ptd Ltd, of which our Director Terence O’Dwyer is a principal, was appointed to undertake consultancy work for Metal Storm. As at December 31, 2007, no fees were paid or payable to Backwell Lombard Capital Pty Ltd. Subsequent to that date, services have been performed resulting in a fee payable of A$30,000.

C. Interest of Experts and Counsel

     Not applicable.

Item 8. Financial Information

A. Consolidated Financial Statements and Other Financial Information

     Our financial statements are included as the “F” pages to this annual report.

Legal Proceedings

     None.

Dividends

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

B. Significant Changes

     None.

Item 9. The Offer and Listing

A. Listing Details — Price History

      Australian Securities Exchange

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

		Price Per
		Ordinary Share
		High				Low
Year Ended		A$				A$
December 31, 2007
First Quarter		$	0.21			$	0.16
Second Quarter		$	0.17			$	0.12
Third Quarter		$	0.15			$	0.09
Fourth Quarter		$	0.12			$	0.08
December 31, 2006
First Quarter		$	0.28			$	0.18
Second Quarter		$	0.21			$	0.12
Third Quarter		$	0.16			$	0.10
Fourth Quarter		$	0.17			$	0.13
December 31, 2005
Annual		$	0.31			$	0.10
December 31, 2004
Annual		$	0.66			$	0.20
December 31, 2003
Annual		$	0.68			$	0.32

		Price Per
		Ordinary Share
		High				Low
Month Ended		A$				A$
May 2008		$	0.07			$	0.06
April 2008		$	0.08			$	0.05
March 2008		$	0.08			$	0.06
February 2008		$	0.08			$	0.07
January 2008		$	0.09			$	0.06
December 2007		$	0.11			$	0.08

      NASDAQ Capital Market — American Depositary Receipts

     Our ordinary shares in the form of ADRs were listed for trading on the NASDAQ Capital Market (symbol: “MTSX”) in December 2001. Each ADR represents 20 ordinary shares. The following table presents, for the periods indicated, the high and low closing prices in U.S. dollars of our ADRs as reported on the NASDAQ Capital Market.

		Price Per
		Ordinary Share
		High				Low
Year Ended		US$				US$
December 31, 2007
First Quarter		$	3.38			$	2.15
Second Quarter		$	2.87			$	2.00
Third Quarter		$	2.53			$	1.81
Fourth Quarter		$	2.25			$	1.15
December 31, 2006
First Quarter		$	4.04			$	2.32
Second Quarter		$	3.05			$	1.75
Third Quarter		$	2.40			$	1.80
Fourth Quarter		$	3.20			$	2.00
December 31, 2005
Annual		$	4.84			$	1.75
December 31, 2004
Annual		$	14.47			$	2.95
December 31, 2003
Annual		$	8.53			$	3.97

		Price Per
		Ordinary Share
		High				Low
Month Ended		US$				US$
May 2008		$	1.25			$	1.00
April 2008		$	1.25			$	0.81
March 2008		$	2.90			$	0.91
February 2008		$	1.50			$	1.30
January 2008		$	1.57			$	1.00
December 2007		$	1.78			$	1.15

B. Plan of Distribution

     Not applicable.

C. Markets

     Our ordinary shares are traded on the Australian Securities Exchange under the symbol “MST” and on the NASDAQ Capital Market in the form of American Depositary Receipts under the symbol “MTSX”.

Exemptions from certain Nasdaq Corporate Governance Rules

     Exemptions from the corporate governance standards of The Nasdaq Stock Market Inc. (“Nasdaq”) 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 Capital 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, 2007 are described below.

•

Metal Storm was exempt from Nasdaq’s independence requirements for a majority of the board of directors. The Australian Securities Exchange Listing Rules did not require Metal Storm to have a majority of independent directors on the board during 2007. During most of the fiscal year ended December 31, 2007, Metal Storm did, however, have a majority of directors who were “independent” as defined in the Australian Securities 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 2007.

•		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 2007.
•		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 Securities Exchange Listing Rules required “peer review” of independent public accountants during 2007. Accordingly, Metal Storm claimed this exemption in 2007.
•		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 Securities 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 Metal Storm 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 Securities 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 2007.

D. Selling Shareholders

     Not applicable.

E. Dilution

     Not applicable.

F. Expenses of the Issue

     Not applicable.

Item 10. Additional Information

A. Share Capital

     Not applicable.

B. Our Constitution

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

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

Directors

      Interested Directors

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

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

      Directors’ Compensation

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

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

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

     Additionally in accordance with our constitution, a director may be paid a retirement benefit as determined by the board of directors in accordance with the Corporations Act and the Australian Securities 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 any of our property or business or any uncalled capital and may issue debentures or give any other security for any of our debts, liabilities or obligations or of any other person, in each case, in the manner and on terms it deems fit.

      Retirement of directors

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

      Share Qualifications

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

Rights and Restrictions on Classes of Shares

     Subject to the Corporations Act and the Australian Securities 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 determine

from time to time. Except as provided by contract or by our constitution to the contrary, all unissued shares are under the control of the board which may grant options on the shares, allot or otherwise dispose of the shares on the terms and conditions and for the consideration it deems fit. Currently our outstanding share capital consists of only one class of ordinary shares.

      Dividend Rights

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

      Voting Rights

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

      Right to Share in our Profits

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

      Rights to Share in the Surplus in the Event of Liquidation

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

      Redemption Provisions

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

      Sinking Fund Provisions

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

      Liability for Further Capital Calls

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

General Meetings of Shareholders

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

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

Foreign Ownership Regulation

     There are no limitations on the rights to own securities imposed by our constitution. However, acquisitions and proposed acquisitions of shares in Australian companies may be subject to review and approval by the Australian Federal Treasurer under the Foreign Acquisitions and Takeovers Act 1975 (Commonwealth of Australia). 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 takeover scheme, we are prohibited from registering a transfer which would give effect to the contract resulting from the acceptance of such an offer unless and until a resolution to approve the proportional takeover scheme is approved at a meeting by the persons entitled to vote on such resolution. The offeror or an associate of the offeror is not entitled to vote on such resolution. A person, other than an offeror or associate of the offeror, who, as at the end of the day in which the first offer under the proportional takeover scheme was made, held shares in that class of shares, is entitled to one vote for each of the shares held in that class.

Ownership Threshold

     There are no provisions in our constitution that require a shareholder to disclose ownership above a certain threshold. The Corporations Act, however, requires a substantial shareholder to notify us and the Australian Securities Exchange once a 5% interest

in our shares is obtained. Further, once a shareholder owns a 5% interest in us, such shareholder must notify us and the Australian Securities Exchange of any increase or decrease of 1% or more in its holding of our shares.

Conditions for Change of Capital

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

Stock Issues and Takeover Attempts

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

	•		that the acquisition of control over voting shares takes place in an efficient, competitive and informed market;
	•		that shareholders have enough information to assess the merits of a proposal; and
	•		that shareholders all have a reasonable and equal opportunity to participate in any benefits accruing to the shareholders through any proposal under which a person would acquire a substantial interest.

     Further, subject to certain limited exceptions provided in the Australian Securities 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.

     The exceptions to the Australian Securities Exchange Listing Rules are as follows:

	•		an issuance or agreement to issue which we have notified the Australian Securities Exchange of before we are told a person is making or proposes to make a takeover offer for our shares;
	•		an issuance to our ordinary shareholders on a pro-rata basis;
	•		an issuance made due to an exercise of rights of conversion already in existence;
	•		an issuance by us as consideration for an off-market takeover bid made by us where we are required to comply with the provisions of the Corporations Act;
	•		an issuance under a dividend stock distribution plan that is in operation before we are told a person is making or proposes to make a takeover for our shares; and
	•		if there is an agreement to issue shares and such agreement is conditional on ordinary shareholders approving the issuance before the issuance is made.

Access to and Inspection of Documents

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

CHESS

     We participate in the Clearing House Electronic Sub-Register System, known as CHESS, which is maintained by the CHESS Securities Clearing House pursuant to the Australian Securities Exchange Listing Rules and the Securities Clearing House business rules. CHESS is an automated, electronic transfer and settlement system with no requirement for physical title or transfer documents. Accordingly, the legal registered record of holding balances for our CHESS-approved shares are recorded on either of the electronic CHESS sub-register or the electronic issuer sponsored sub-register, which together form the complete company register. We do not

issue share certificates to shareholders. Instead, we provide shareholders with a holding statement (similar to a bank account statement) that sets out the number of ordinary shares registered in each shareholder’s name. This statement also advised shareholders of their holder identification number or shareholder reference number and relevant particulars. If a shareholding changes during any month, shareholders will receive a statement after the end of that month. Shareholders may also request statements at any other time (subject to payment of a small administration fee).

C. Material Contracts

      Terms of convertible notes

     The terms of the convertible notes were set out in the Rights Offer prospectus that was approved by the Board of Metal Storm in July 2006. At the maturity date of September 1, 2009 (“Maturity Date”), Metal Storm must repay the face value of A$0.135 to the holders of convertible notes (“Noteholders”), unless the Noteholders have elected to convert some or all of their convertible notes into ordinary shares at a conversion price which is the lesser of A$0.135 per share and 90% of the volume weighted average closing price of ordinary shares during the 30 business days immediately preceding the conversion date. Noteholders can elect to convert some or all of their convertible notes into ordinary shares at the beginning of each quarter, at the Maturity Date and at certain other times.

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

     Interest is payable on the face value at a rate of 10% per annum. Interest is payable quarterly in arrears on the last day of each quarter until the earlier of conversion or redemption of the convertible notes. Until conversion or redemption, the convertible notes are unsecured debt obligations of Metal Storm and rank equally with other ordinary unsecured creditors. The convertible notes rank behind any of our secured creditors but rank ahead of shares outstanding. Each share issued on conversion of the notes will rank equally with all existing shares then on issue. The convertible notes do not carry any entitlement to participate in rights offers, any returns of capital, bonus issue or capital reconstruction.

      Trust Deed in connection with the Rights Offer

     On July 11, 2006, Metal Storm entered into a trust deed with ANZ the Trustee in connection with the Rights Offer. Under the agreement, the Trustee has agreed to hold on trust for the Noteholders, the right to enforce Metal Storm’s obligation to repay the face value of the convertible notes.

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

     An event of default under the terms of the Trust Deed includes, but is not limited to, if Metal Storm:

	•		fails to pay principal or interest in respect of any convertible note within 5 business days after it becomes due and payable;
	•		if, without the prior approval of Noteholders by way of ordinary resolution, the total amount of cash held in Metal Storm’s bank accounts and in marketable securities falls below the following minimum cash levels:

Period		Minimum Cash Balance
September 1, 2006 to December 31, 2006		A$22.5 million
January 1, 2007 to June 30, 2007		A$19.5 million
July 1, 2007 to December 31, 2007		A$15.0 million
January 1, 2008 to June 30, 2008		A$12.5 million
July 1, 2008 to December 31, 2008		A$  7.5 million

•

if the process of commercialization of the key technology of Metal Storm fails to achieve the following milestones to the satisfaction of Noteholders (resolved by way of ordinary resolution) or an independent expert appointed by the Trustee:

     (i) two fully functional prototypes of stabilized remotely operable weapons systems, including an Electro Optic Systems electronic fire control system and a Metal Storm Ballistic Weapon, as defined in the Teaming Agreement between Electro Optic Systems Pty Limited and Metal Storm dated August 2, 2005 (subsequently named the Redback™ System) are assembled and ready for inspection by representatives of Harmony and customers before June 30, 2007;

     (ii) two fully functional prototype units of the Three Shot Grenade Launcher (known as “3GL”) are assembled and ready for inspection by representatives of Harmony and customers before June 30, 2007; and

     (iii) a successful live test firing of low velocity air burst rounds and low velocity high explosive rounds suitable for Metal Storm Ballistic Weapons in conjunction with ST Kinetics (as defined in the Teaming Agreement between the Metal Storm and ST Kinetics dated September 28, 2005) before June 30, 2007.

      Cash Advance Facility Agreement

     In June 2006, Metal Storm signed a Cash Advance Facility Agreement with Harmony Investment Fund Limited (an affiliate of Harmony Capital Partners Pte Limited) to establish a A$5 million short-term working capital secured loan facility. The working capital facility was never drawn on by Metal Storm and all security has since been discharged by Harmony. Metal Storm granted 10,000,000 options to purchase ordinary shares to Harmony Investment Fund Limited on completion of the Rights Offer as consideration for the working capital facility.

D. Exchange Controls

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

E. Taxation

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

U.S. Federal Income Tax Considerations

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

     In this section, we discuss certain material U.S. federal income tax considerations applicable to an investment in ADSs, which are evidenced by American Depositary Receipts (“ADRs”), or ordinary shares by a U.S. holder, as defined below, that will hold the ADSs or ordinary shares as capital assets within the meaning of the Internal Revenue Code of 1986, as amended (the “Code”). We do not discuss any tax considerations that may apply to holders subject to special tax rules, such as banks, insurance companies, dealers in securities or currencies, tax-exempt entities, persons subject to the alternative minimum tax, persons that hold ADSs or ordinary

shares as a position in a straddle or as part of a hedging, constructive sale or conversion transaction for U.S. federal income tax purposes, persons that have a functional currency other than the U.S. dollar, persons that own 10% or more of our equity or persons that are not U.S. holders.

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

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

	•		an individual who is a citizen or resident of the United States for U.S. federal income tax purposes;
	•		a corporation, or other entity treated as a corporation for U.S. federal income tax purposes, created or organized in or under the laws of the United States or any state thereof or the District of Columbia;
	•		an estate the income of which is subject to U.S. federal income taxation regardless of its source; or
	•		a trust the administration of which is subject to the primary supervision of a court in the United States and for which one or more U.S. persons have the authority to control all substantial decisions.

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

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

      Ownership of ADSs in General

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

      Dividends

     Subject to the passive foreign investment company rules, discussed below, U.S. holders will include as dividend income gross amount of any distributions of cash or property (without deduction for any withholding tax), other than certain pro 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 shareholders.

     For taxable years beginning before January 1, 2011, certain dividends received by an individual U.S. holder (as well as certain trusts and estates) from a “qualified foreign corporation” are eligible for preferential rates of taxation. We are considered to be a “qualified foreign corporation” with respect to the ADSs because our ADSs are listed on the NASDAQ Capital Market. Furthermore, we believe that we are a qualified foreign corporation with respect to our ordinary shares because we should be eligible for benefits under the Double Taxation Convention between Australia and the United States. The U.S. Treasury Department has announced its intention to promulgate rules pursuant to which U.S. Holders of the ordinary shares or ADSs and intermediaries through whom such ordinary shares or ADSs are held will be permitted to rely on certifications from issuers to establish that dividends are treated as qualified dividends. Because such rules have not yet been issued, it is not clear whether we will be in a position to comply with them. 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. Because we likely were not a passive foreign

investment company for 2007 (as discussed below), we should be a qualified foreign corporation for 2008 unless we are a passive foreign investment company for 2008. If we are a qualified foreign corporation with respect to ADSs or ordinary shares, then dividends with respect to such shares generally would be eligible for the preferential tax rates, except to the extent that the individual (1) holds the relevant share of stock for 60 days or less during the 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.

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

     Dividends received by a U.S. holder with respect to ADSs or ordinary shares will be treated as foreign source income, which may be relevant in calculating the holder’s foreign tax credit limitation. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For 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, 2007, and as “passive category income”, or in certain cases “general category income”, for taxable years beginning after December 31, 2007.

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

     You should consult your tax advisor as to the consequences of Australian withholding taxes and the availability of a foreign tax credit or deduction. See “Australian Tax Considerations—Taxation of Dividends.”

      Sale or Exchange of ADSs or Ordinary Shares

     Subject to the passive foreign investment company rules, discussed below, a U.S. holder generally will recognize gain or loss on a disposition, including a sale, exchange or redemption, of ADSs or ordinary shares equal to the difference between the amount realized on the disposition and the U.S. holder’s tax basis in the ADSs or ordinary shares. This gain or loss will generally be long-term capital gain or loss if the U.S. holder has held the ADSs or ordinary shares for more than one year and otherwise will be short-term capital gain or loss. Long-term capital gains of individuals are eligible for preferential rates of taxation, which have been reduced for long-term capital gains recognized on or after May 6, 2003, and before January 1, 2011. 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, 2011, 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. shareholders with respect to, and sales and other dispositions, including pledges, of shares of stock of, a passive foreign investment company (“PFIC”). A foreign

corporation will be treated as a PFIC for any taxable year if 75% or more of its gross income for the taxable year is passive income or the average percentage of its assets, generally by value, that produce or are held for the production of passive income is at least 50%. Passive income for this purpose generally includes, among other things, dividends, interest, rents, royalties, and gains from commodities and securities transactions. In determining whether a foreign corporation is a PFIC, a pro-rata portion of the income and assets of each corporation in which it owns, at least a 25% interest (by value) is taken into account.

     We believe that we were a PFIC for U.S. federal income tax purposes in 2000, 2002, 2003, 2004, 2005 and 2006, but not in 2001 and 2007. Metal Storm could become a PFIC again in the future.

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

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

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

     As an alternative to making a QEF election, a U.S. shareholder may make a “mark-to-market” election with respect to its PFIC shares if the shares meet certain minimum trading requirements. A U.S. shareholder that makes a mark-to-market election will be required to include in income each year an amount equal to the excess of the fair market value of the shares that the shareholder owns as of the close of the taxable year over the shareholder’s adjusted tax basis in the shares. The U.S. shareholder will be entitled to a

deduction for the excess, if any, of the shareholder’s adjusted tax basis in the shares over the fair market value of the shares as of the close of the taxable year; provided, however, that the deduction will be limited to the extent of any net mark-to-market gains with respect to the shares included by the U.S. shareholder under the election for prior taxable years. The U.S. shareholder’s basis in the shares will be adjusted to reflect the amounts included or deducted pursuant to the election. Amounts included in income pursuant to a mark-to-market election, as well as gain on the sale or exchange of the shares, will be treated as ordinary income. The deductible portion of any mark-to-market loss, as well as loss on a sale or exchange of shares to the extent that the amount of such loss does not exceed net mark-to-market gains previously included in income, will be treated as ordinary loss.

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

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

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

Backup Withholding Tax and Information Reporting Requirements

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

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

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

      Australian Tax Considerations

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

considerations of the purchase, ownership and disposition of the ADSs or shares. This summary is based upon the premise that the holder is not an Australian tax resident.

      Nature of ADRs for Australian Taxation Purposes

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

      Taxation of Dividends

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

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

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

     Non-Australian resident shareholders will not be subject to Australian capital gains tax on the gain made on a sale or other disposal of our shares, unless they, together with associates, hold 10% or more of our issued capital at 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 shareholder who owns a 10% or more interest would be subject to Australian capital gains tax to the same extent as Australian resident shareholders. 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 shareholders 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—Shareholders Holding Shares on Revenue Account

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

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

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

      Dual Residency

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

      Stamp Duty

     A transfer of shares through trading on the Australian Securities Exchange, whether by Australian residents or foreign residents, is 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.

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.

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 shareholders’ equity, while transaction gains and losses have been reflected as components of income and loss. Transaction gains and losses could be material depending upon changes in the exchange rate relationships between the Australian dollar and the U.S. dollar. See Item 5A “Operating and Financial Review and Prospects — Operating Results—Effects of Currency Fluctuations” above for a detailed description of the impact of foreign currency translation on our financial statements.

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

     Refer footnote 3 on page F-21 for further information.

Item 12. Description of Securities Other than Equity Securities

     Not applicable.

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 15T. Controls and Procedures

(a) Disclosure Controls and Procedures

     An evaluation as of December 31, 2007 was carried out under the supervision and with the participation of Metal Storm’s management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operations of Metal Storm’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended.

     Based on that evaluation, Metal Storm’s Chief Executive officer and Chief Financial officer concluded that the design and operation of the company’s disclosure controls and procedures are not effective as of December 31, 2007, to ensure that information required to be disclosed in the reports that Metal Storm files and submits under the Exchange Act is (i) recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

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

     The management of Metal Storm is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended). Metal Storm’s internal control system is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with applicable accounting standards.

     Metal Storm’s internal control over financial reporting includes policies and procedures that: pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of Metal Storm and its consolidated entities; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of Metal Storm are being made only in accordance with authorizations of management and directors of Metal Storm and its consolidated entities; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the assets of Metal Storm and its consolidated entities that could have a material effect on the financial statements.

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

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

     Based on our evaluation, management has concluded that internal controls over financial reporting were not effective as of December 31, 2007. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of Metal Storm’s annual or interim financial statements will not be prevented or detected on a timely basis.

     We did not maintain effective controls over derivative activities and the related accounts. Specifically, controls were not in place to ensure that embedded derivatives were valued accurately. This control deficiency resulted in an audit adjustment to Metal Storm’s liabilities and operating expenses account. Additionally, this control deficiency could result in misstatements to the aforementioned accounts and disclosures that would result in a material misstatement of the consolidated financial statements that would not be prevented and detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness.

     This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit Metal Storm to provide only management’s report in this annual report.

(c) Changes in Internal Control over Financial Reporting

     During the year ended December 31, 2007, we made the following material changes that have materially affected, or are reasonably likely to materially affect to our internal control over financial reporting:

     In January 2007, we implemented a new accounting system. This allowed us to introduce automated controls at an operational level to mitigate some of the segregation of duties weaknesses we had previously reported and also facilitate the reporting and review processes to help mitigate our financial statement close process weakness.

     In March 2007, our Chief Financial Officer resigned and had not been replaced at the date of filing our 2006 Form 20-F. In August 2007, this position was filled and appropriate support staff hired, restoring the previous staff structure.

     The prior period weaknesses relating to segregation of duties and financial statement close process were remediated with the introduction of a new accounting system that allowed the introduction of automated controls over approvals and management review of input data. Reporting processes were also redesigned to incorporate regular independent review of financial statements. Financial statement close process was documented to incorporate operational checklists and subscription based disclosure checklists. Reconciliation processes were formalized and documented based on best practice guidelines provided by a professional accounting membership organization in Australia.

     The prior period material weakness relating to the design and operation of Metal Storm’s process for reporting in accordance with US GAAP was remediated with the Securities and Exchange Commission (“SEC”) adopted rules on December 21, 2007 to allow foreign private issuers that file on Form 20-F and other eligible entities (as defined below) to file financial statements with the SEC in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) without reconciliation to US GAAP. Metal Storm’s financial statements are in compliance with IFRS as issued by the IASB and the report of our registered public accounting firms will provide an unqualified auditor’s report that opines on that compliance. Accordingly, we will no longer be required to report under US GAAP.

Item 16A. Audit Committee Financial Expert

     Terence 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 Inc.). Please see Item 6A “Directors, Senior Management and Employees — Directors and Senior Management” for details of his background.

     During 2007 and until his retirement from our Board of Directors at the annual meeting of shareholders in May 2008, James M. Crunk was an “audit committee financial expert” and was independent. He had been chief financial officer of a privately-held government contractor, the controller of a division of a large defense contractor and the chief financial officer of various start-up companies.

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- 61-7-3123-4700 to obtain a copy.

     In 2007, we did not (expressly or implicitly) grant a waiver under our code of conduct to our principal executive officer, our principal accounting officer or controller or persons performing similar functions.

Item 16C. Principal Accountant Fees and Services

PricewaterhouseCoopers

		December 31,
		2007				2006
		A$				A$
Audit fees			45,000				—
Audit-related fees			287,000				—
Tax fees			—				—
All other fees			—				—
Total			332,000

Ernst & Young

		December 31,
		2007				2006
		A$				A$
Audit fees			353,458				387,550
Audit-related fees			—				41,926
Tax fees			—				—
All other fees			—				—
Total			353,458				429,476

     Fees for audit services include fees associated with the annual audit of the consolidated financial statements, including reviews of our half-year reports. Audit —related fees principally include the performance of agreed-upon procedures in connection with capital raising activities and accounting consultation. Tax fees include tax compliance services. All other fees include reading press releases.

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

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

     Not applicable.

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

     Not applicable.

PART III

Item 17. Financial Statements

     Not applicable.

Item 18. Financial Statements

     Not applicable.

Item 19. Exhibits

Exhibit
Number		Description of Exhibit
1.1		Constitution of Metal Storm*
4.1		[not used]
4.2		[not used]
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		Employment Agreement of Dr. Lee Finniear***
4.5		Letter of Offer to P. D. Faulkner***
4.6		Employment Agreement of Brett Farmer
4.7		[not used]
4.8		Employment Agreement of Dr. Joe Cronin***
4.9		Cash Advance Facility Agreement, dated June 16, 2006, between Metal Storm and Harmony Investment Fund Limited**
4.10		Discretionary Share Option Scheme*
4.11		Convertible Note Trust Deed dated July 11, 2006***
8.0		List of Subsidiaries of Metal Storm Limited
12.1		Certification by the Chief Executive Officer of Metal Storm Limited in accordance with Section 302 of the Sarbanes-Oxley Act
12.2		Certification by the Chief Financial Officer of Metal Storm Limited in accordance with Section 302 of the Sarbanes-Oxley Act
13.1		Certification by the Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act
13.2		Certification by the Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act

Index to the Financial Statements

Report of Independent Registered Public Accounting Firm		F-2
Income Statements for the years ended 31 December 2007, 2006 and 2005		F-3
Balance Sheets as at 31 December 2007, 2006 and 2005		F-4
Cash Flow Statements for the years ended 31 December 2007, 2006 and 2005		F-5
Statement of Changes in Equity for the years ended 31 December 2007, 2006 and 2005		F-6
Notes to the Financial Statements		F-7

 

		PricewaterhouseCoopers Riverside Centre 123 Eagle Street BRISBANE QLD 4000 GPO Box 150 BRISBANE QLD 4001 DX 77 Brisbane Australia www.pwc.com/au Telephone +61 7 3257 5000 Facsimile +61 7 3257 5999

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders:

In our opinion, the accompanying consolidated balance sheets and the related consolidated Income Statements, Statements of Cash flows, Statements of Changes in Equity and notes to the financial statements present fairly, in all material respects, the financial position of Metal Storm Limited and its subsidiaries at December 31, 2007, 2006 and 2005 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

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

PricewaterhouseCoopers

/s/ Robert Roach

Robert Roach

Brisbane, Australia
June 30, 2008

Metal Storm Limited

Income Statements
For the years ended 31 December 2007, 2006 and 2005

						2007				2006				2005
		Note				A$				A$				A$
Continuing operations
Revenue			6				3,205,381				2,339,310				830,645
Expenses
Fair value movement in embedded derivative			17				2,421,388				(4,469,042	)			—
Consumables used							(469,579	)			(152,471	)			(4,360	)
Employee expenses			7				(4,348,588	)			(5,342,348	)			(4,468,640	)
Finance costs			7				(4,934,415	)			(2,183,013	)			(35,496	)
Professional fees							(1,321,686	)			(1,731,913	)			(1,774,369	)
Research and development							(1,671,057	)			(990,022	)			(1,146,364	)
Administrative expenditure							(576,387	)			(831,647	)			(928,931	)
Facility expenses							(790,874	)			(741,643	)			(522,693	)
Travel and entertainment							(468,868	)			(523,432	)			(433,859	)
Communication and technology							(360,501	)			(348,191	)			(306,335	)
Public relations and compliance							(393,967	)			(339,206	)			(494,786	)
Foreign exchange differences							(68,197	)			15,864				(27,022	)
Impairment expense			7				(220,800	)			—				—
Loss from continuing operations before Income tax							(9,998,150	)			(15,297,754	)			(9,312,210	)
Income tax benefit			8				—				—				—
Loss after tax from continuing operations							(9,998,150	)			(15,297,754	)			(9,312,210	)
Discontinued Operation
Loss after tax from discontinued operation			9				—				(39,256	)			(1,602,390	)
Loss for the year							(9,998,150	)			(15,337,010	)			(10,914,600	)
Earnings per share (cents per share)
- Basic and diluted loss for the year attributable to ordinary equity holders of the parent			31				(1.69	)			(2.85	)			(2.09	)
Earnings per share (cents per share)
- Basic and diluted loss for the year from continuing operations attributable to ordinary equity holders of the parent			31				(1.69	)			(2.84	)			(1.78	)