Dov Moran

Mr. Moran: M-Systems was founded 15 years ago to develop flash data storage. In fact, we introduced the concept of the flash disk into the market, and we have been focused on applications with this technology throughout our history. During the year, we have made tremendous progress, bringing to market better technology, smaller size, enhanced features and greater functionality. It has developed from a small niche into a very attractive market; one that, especially as of late, is growing rapidly.Today, we focus primarily on two markets with two core product families. One is DiskOnKey, which we invented in 1999. This is a device that plugs into any computer using the USB port. On the surface, it is a floppy replacement, but it is actually much more than that. It allows users to easily and conveniently store large amounts of data on a portable, virtually error-proof device. With its strong processor, DiskOnKey offers many enhanced features beyond simple storage, including the ability to run applications directly from the device, security, bootability and read-only access. In addition, we have established two subsidiaries to further differentiate DiskOnKey from other products in the market; The first subsidiary, called Key Computing, is working with third party software vendors to encourage DiskOnKey-specific application development and to create devices based on the DiskOnKey Technology Platform that offer unique functionality based on resident applications targeting mainly corporations. Our second subsidiary, SmartCaps, is developing hardware add-ons that will allow adding different consumer electronics applications to the DiskOnKey. The first such Cap, which was announced not long ago, is an MP3 player and voice recorder that uses DiskOnKey as the storage medium. We have many other very exciting ideas and I expect great things from both of these initiatives. During its relatively short life, we have already had wonderful success with the DiskOnKey. Since the products introduction in 2000, we have had sales of $6 million in 2001; $27 million in 2002; and expect over $75 million this year.The second product line is DiskOnChip. This is a product that was originally introduced in 1996. When we brought it to market, the DiskOnChip was primarily designed as a storage medium for Set-top Boxes, Internet Appliances and other embedded systems. We succeeded nicely in these markets but when we recognized that these markets lacked the high growth potential that we sought for, we began to adapt the product to meet the needs of other, larger markets. It was with this in mind that we created the Mobile DiskOnChip as a local storage solution for mobile handsets and PDAs. This is an ideal solution for manufacturers of smart phones, which are gaining acceptance among users who need additional features and functions, color displays, the ability to load software and store data. As a result, we have seen / are starting to see great success with this product, almost doubling our sales of the product from quarter to quarter. In 2002, which was the first year we were active in this market, our sales were less than 2 million dollars; we expect to complete 2003 with about $15 million in sales and we expect to continue this rapid sales growth through 2004. We already have numerous design wins, with nearly every leading mobile handset manufacturer. We are gaining similar acceptance among PDA manufacturers including Sony, who selected the Mobile DiskOnChip for its CLI handheld.

TWST: Can you say a word or two on the underlying technology and benefits of DiskOnChip and why its well-suited to these developments in the handset and PDA products?

Mr. Moran: The DiskOnChip provides flash-based data storage that is embedded in the device. It allows for storage of both code and data in one chip, a feature that is unique to our product. It is a reliable, fast, and cost-effective solution that is based on NAND flash architecture, which enables higher performance at lower cost than alternative flash technologies.

TWST: What is the revenue model? Is there a licensing component to this?

Mr. Moran: This year, we hardly recognize any revenue from licensing. Our revenues in 2001 were about $45 million. In 2002, revenues were $65 million; for 2003, we anticipate revenues of over $120 million, and we expect to continue this revenue growth in 2004. Our current revenue projections for next year do not include the full upside that can come from royalties, as we recently began to license our technology.

TWST: How would you describe your position on the competitive landscape and what is your advantage? You mentioned innovation on a couple of occasions. Is that where you find an edge?

Mr. Moran: Innovation is certainly one of our greatest strengths, as is our ability to anticipate market trends and adapt quickly to capitalize on potential opportunities. In the flash data storage area, there is no single dominant application, but rather several smaller markets each with its own growth potential. One such market is embedded flash for mobile devices. We believe that we are the leader in this market and do not have a lot of competition today. The Mobile DiskOnChip is a unique solution that we brought to market, and no other company has a device similar to ours. To this point, the main competition has come from NOR flash, which has historically been the embedded storage technology used in cell phones and PDAs. Device manufacturers are quickly becoming aware of the benefits of NAND, and more specifically of our Mobile DiskOnChip, over traditional NOR flash, and are incorporating our Mobile DiskOnChip into their products at the expense of other solutions. We have recently seen a bit of competition from companies working to develop similar components, but we still believe that we have a major advantage over them given our patented Flash File System software, TrueFFS. In addition to the technical advantages, we have an important ally with Toshiba. They are our fab for the Mobile DiskOnChip and they also have the right to sell the solution, with royalties paid to us on all sales. In the keychain storage market, which we established with the introduction of the DiskOnKey, we saw many copycats from the Far East who violated our patents. We declared that we will defend out intellectual property and have done so, causing several smaller companies to either leave the market or to join our licensing program. Those who did not abandon the market as a result of our legal efforts have been faced recently with another severe problem, as the industry is experiencing a significant shortage of raw flash components. Those companies that dont have strong relationships with flash vendors were unable to compete, as they had to purchase components on the spot market at prices that made it nearly impossible for them to remain in business. We do, however, see competition coming from companies such as SanDisk and Lexar. Lexar is doing quite well in the retail market, while SanDisk has been trying to enter this market for the last year-and-a-half with limited success. They are both legitimate competitors and are well known in the retail markets for their other flash memory products. We have approached selling DiskOnKey differently than any other company in the space, and have had a great deal of success since the product was introduced. We have partnered with nearly all of the major PC OEMs, as well as several well-known consumer electronics and computer peripherals companies. This strategy has allowed us to develop strong channels through our partners and I believe that our strategy of selling through PC OEMs and retailers will allow us to maintain our leadership position in the long term.

TWST: So, in some ways you have outsourced the capital intensive part of the business by bringing in fab partners.

Mr. Moran: Thats right. Our relationship with Toshiba is a perfect example of this and an important part of our overall strategy. We have very strong ideas and world-class technology, and our agreement with Toshiba includes cross licensing of IP in exchange for virtual ownership of part of their fab, giving us a consistent supply of raw materials at very attractive prices. This agreement is non-exclusive and we are negotiating similar deals with the other flash vendors, as we believe that partnerships are very important in terms of securing the levels of supply we believe will be necessary to meet the continued growth in demand for our products in the years to come. However, we believe in taking the concept of partnerships a step further, treating our customers very much as partners. Whether it is IBM, Apple, Iomega, I-O Data or any other customer, we always work with them as a partner rather than a customer. This philosophy has been effective in allowing us to develop the strong relationships that we have with our customers.

TWST: Which is your largest geographic market? Do you have a strong presence now in the U.S.? Do you have a good footprint in both Europe and the Asian markets as well?

Mr. Moran: From a geographic standpoint, we are a well-balanced company. While the majority of our sales come from the U.S., we have seen considerable success in the Southern Asian regions such as China, and we also have established presences in Japan and Europe. Currently, about 30% of our sales come from the U.S., about 30% from Taiwan and China; 20% from Japan and 20% from Europe.

TWST: Have you been adding people to the company and do you feel confident you have the infrastructure in place to manage that revenue growth youve seen over the last few years?

Mr. Moran: Yes, we are adding people to the company. We announced in the third-quarter, for example, that we increased our revenues 33% over the second quarter of 2003 and that at the same time we increased our expenses by 5%. Most of this increase in expenses was related to the addition of new employees. What we have tried to do is to continue to grow the company, while being extremely careful to monitor the pace at which we add employees and increase expenses. We feel confident that we have a solid foundation in place to manage the anticipated growth

TWST: What goals achieved and objectives accomplished will make the next one or two years a success for M-Systems?

Mr. Moran: A couple of years from today we would like to be in a position where annual revenues reach hundreds of millions of dollars. This is a goal that I know we can achieve, and one that we are getting closer to every quarter. We are very satisfied that we returned to profitability during the third quarter of 2003 and are working to increase profitability alongside revenues. We intend to continue to be the leaders in the USB flash drive market, which is growing very rapidly, according to all available market data and is expected to be over $1 billion in two or three years. We expect to maintain our leadership position with the mobile DiskOnChip in the embedded flash data storage market, especially for the Smart Phone and PDA markets. This market is also growing rapidly, as an increasing number of the new handsets being introduced are smart phones, or multimedia phones, which require additional features and storage capacity. We also plan to enter into and become a major player in the memory card business.

TWST: It sounds like you have some pretty favorable broad scale industry trends and drivers to go after.

Mr. Moran: Yes, we are very fortunate in that respect. We're in a market that is truly experiencing significant growth. I believe that today, flash data storage is among the fastest growing segments of the high tech industry

TWST: How will you measure your success and what metrics or milestones should investors be watching in order to get a fair indication of how you are progressing?

Mr. Moran: The Company has to be in a position where both the top line and the bottom line are growing. When we discussed the company several years ago, we talked about Mobile DiskOnChip and we mentioned measuring success in terms of design wins. We said that we needed to see a first design wins, then design wins from at lest five companies, then 10 companies, and so on. Given that we have achieved our initial goal of market acceptance for the Mobile DiskOnChip, the emphasis is now on financial success. While we have grown revenues steadily and expect the growth to continue going forward, our focus must be on the bottom line as well. With respect to DiskOnKey, we have about 20 customers today and we feel confident that our customers have the market very well covered. I do not expect to see a drastic increase in the number of DiskOnKey customers in the future. What would be more beneficial to M-Systems would be for these current customers to continue growing and buying greater quantities of USB flash drives. Like the Mobile DiskOnChip, our continued success in this arena will be measured by our ability to grow revenues and profits.

TWST: Are there any opportunities for either large or in-fill type acquisitions in this strategy?

Mr. Moran: We believe in organic growth. All of the growth that we have had from 2001 through today has come from within. The last acquisition we made was in 2000, when we purchased a small security company that gave us technology and know-how, which adds value of our products but almost no direct revenues. It was a very good acquisition for us, but we don't expect many others in the future. We will always look at opportunities and we would be interested in adding new technology if it fits with our strategy, but we feel there are sufficient growth opportunities available to M-Systems under the current structure.

TWST: Are you comfortable with your financial position at this point? Is cash flow or capital a limitation to a degree?

Mr. Moran: Our balance sheet is very strong. We have about $93 million in the bank with no debt. We are also in the process of raising additional capital through a secondary offering. We expect that the majority of proceeds from this offering will be used to secure the flash supply that we need for 2005 and on. With the agreement that we have with Toshiba and a similar agreement that we are negotiating with another supplier, we should be very well covered for 2004 and maybe the first half of 2005. But looking at what our needs will be going forward, we believe that in 2006 we will require additional fab capacity, which we are planning to secure through an investment. We will need more money than we currently have to do this, so we are doing a secondary

TWST: When will the shares float?

Mr. Moran: It is not finalized yet, but we anticipate that the offering will be in the beginning of 2004.

TWST: It is a good segue into the investment community. Do you feel your message has effectively reached investors or is there more work to be done on that front?

Mr. Moran: The story is not so well-known to the investment community, as we have not put a lot of effort into disseminating the story. But we have just now moved from a loss to profit and our feeling is that once we get out and begin to tell the story and meet with potential investors again, the story will be more known and understood. It is good opportunity for many investors.

TWST: You'll be coming over to the U.S., presumably.

Mr. Moran: Yes, we expect to meet with U.S. investors in conjunction with the offering.

TWST: Can you provide a snapshot of your management team and a quick overview of the skills and experience that will help you execute on these opportunities?

Mr. Moran: Many of the people in this company have a background in the Israeli Navy. Our core team has remained stable for years, and includes Aryeh Mergi co-founder of the Company; Dana Gross, our Chief Marketing Officer, who has been with the Company for about ten years; and Ronit Maor, the Chief Financial Officer. She has been with the Company for seven years, and has been CFO for the last six. We are by no means new to M-Systems. We have worked together for many years and everyone knows the industry and our target markets very well.The Company itself is structured around business units, with each business unit run by an experienced team. One of the co-managers of the DiskOnChip division, for example, was CEO of an Israeli company called Simtech. The other was VP of Sales for two prominent Israeli technology companies; DSP Group and NICE Systems. They are both highly ambitious and they are doing an excellent job.

TWST: Is the team in place?

Mr. Moran: Yes, this is the team that will take us forward.

TWST: What's the key challenge from your perspective at this point?

Mr. Moran: The key challenge is first of all to monitor our growth. This is not easy, but we are highly motivated and we have the benefit of a very good infrastructure that enables us to meet these goals. I'm very, very proud of what M-Systems have accomplished so far. We have excellent IP, a great team and wonderful logistics infrastructure that allows us to work with top players in the market. Nevertheless, the greatest challenge we are facing is to maintain and build upon the high levels of growth that we have achieved. We need, for example, to secure enough flash components to meet our needs. We are in an enviable position in that the level of demand for our products is even higher than our ability to supply. As you would imagine, we're doing a lot in order to increase the supply, but this is a major challenge for us.

TWST: You do have some manufacturing capability, dont you?

Mr. Moran: In-house, we have a small manufacturing facility, while most of our manufacturing is done by contract manufacturers. We are manufacturing DiskOnKey in three different places - Taiwan, China, and just recently we added Celestica in the Czech Republic. And, as we discussed, the mobile DiskOnChip is manufactured for us by Toshiba with their fab in Japan.

TWST: Will there be any major capex requirements over the next year?

Mr. Moran: We do have a plan to invest in flash capacity. It doesn't mean that we'll invest directly in a fab. It might be through an agreement of prepayment or other means to guarantee capacity.

TWST: As a summary, what are the three compelling reasons for investors to take a position in your company?

Mr. Moran: We have had tremendous growth in a very strong and rapidly growing market. We have leading-edge, innovative technology. We have good partners. And there is great potential for this growth to continue and for us to become a key player in a very large field.

TWST: Thank you. (DG)

M-Systems Flash Disk Pioneers Ltd.
Dov Moran
Chairman, President & CEO 
7 Atir Yeda St.
Kfar Saba 44425, Israel
Tel: +972-9-764-5000
Fax: +972-3-548-8666
info@m-sys.com