Light touch initiating coverage cerus corp

Sutherland Research

Cerus Corporation $6.88 Neutral

52-Week Range Mkt Cap $* Enterprise Value $* Shares Outstanding* Avg Daily Vol * Net Cash Per Share * mln

5.11-10.29 211.17 173 32 0.3 1.2

FY Ends: December 2006A 2007E (0.04) (0.21)A (0.18) (0.56)A (0.06) (0.29)A 0.11 (0.28) (0.18) (1.05) NM NM 36 17 4.9 10.1

Prior

2008E

Prior

(0.81) NM 29 5.9

Capitalizing on Blood Safety Market Through IBS; Initiating Coverage with a Neutral Rating We are initiating coverage of CERS with a Neutral rating. Our proforma diluted EPS estimates for FY07 and FY08 are $(1.05) and $(0.81), respectively, on revenue of $17.1 mln and $29.1 mln. CERS is focused on commercializing its Intercept Blood System (IBS), which kills bacteria and viruses found in donated blood. The system is currently approved in Europe. Going forward, we believe CERS’s growth will be driven by increasing international acceptance of IBS as the new standard of care. The system addresses unmet medical needs in the field of blood transfusion by significantly reducing the risk of contamination when compared with the technology currently in place. Near term revenue growth will be heavily influenced by timing of nationwide adoption of IBS in France.

Growth drivers for the company include the establishment of further contracts with countries in the EU, Eastern Europe, and Russia, the growing acceptance of CERS’s superior technology, and the aging of the population. We are initiating on CERS with a Neutral rating on the basis of its in-line valuation and promising, but still unproven, growth prospects. We would like to see some further evidence of the near-term acceptance of the superiority of the IBS technology on a nationwide basis in France before we become more positive on the stock.

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CERS Rating

EPS ($) 1Q 2Q 3Q 4Q FY P/E FY Rev* CY EV/S * $ mln

Rating: Neutral

CERS: $6.88

Cerus Corporation

HIGHLIGHTS

• Blood safety segment – now a pure play. Following the spinoff of its immunotherapy business, CERS’s sole focus is IBS and the blood transfusion market. IBS reduces the risk of transfusion-related transmission of pathogens by inactivating blood-borne pathogens. IBS uses ultra violet A (UVA) illuminators and disposable kits for this purpose. To inactivate pathogens, Amotosalen (a compound used by IBS) is mixed with the blood sample and exposed to UVA light for approximately five minutes. This, in turn, activates Amotosalen, which combines with a pathogens’ nucleic acid and prevents the pathogen from replicating itself. CERS has three products in this segment – IBS for red blood cells, IBS for platelets, and IBS for plasma. Plasma is the liquid that is left when blood is centrifuged to remove all of its cellular components. CERS has completed a Phase III trial for its platelet and plasma systems, and is currently marketing them in Europe ($500 mln market). The total market potential for IBS for platelets and plasma in the U.S. and Europe is estimated at more than $1 bln. IBS for red blood cell is in a Phase I trial after reversion from Phase III, due to complications related to its use. It is currently not clear whether or not the FDA will accept CERS’s European studies on platelets and plasma, as well as data accumulated from patients exposed successfully to the system in Europe as sufficient evidence for approval in the U.S. Neutral Factor • Aging population to boost demand for pathogen-free blood. In general, the probability that a person will need a blood transfusion in a year is about 0.89%. This probability increases considerably with age. The number of people aged above 65 years in the U.S. is estimated to be at 20% of the total population by 2030, up from about 13% in 2006. Similarly, in the European Union, the number of people aged above 65 years is estimated at 25% of the total population, up from about 17% in 2005. Aging reduces immunity to pathogens; therefore, blood safety has become a large concern in countries such as the U.S. and Europe. Further, there is a growing concern in the U.S. and Europe regarding the narrowing gap between blood collected and blood transfused (blood collected is always more than the blood transfused), more so when a significant amount of blood is rejected as unsafe due to pathogen contamination. We believe CERS is well-positioned to capitalize on this opportunity with the help of IBS, which enhances the safety of donated blood components by inactivating viruses, bacteria, parasites, and other pathogens, including potentially harmful white blood cells. Positive Factor • CERS’s spinoff of its Immunotherapy business will lower costs. On November 20, 2007, CERS spun off its Immunotherapy business in order to concentrate its efforts exclusively on its blood safety technology. As part of the transaction, CERS holds a 15.5% stake in the new company with the potential to receive another $1.5 mln in cash if certain product milestones are achieved. The new company will continue to work on developing therapies that can selectively treat cancer cells and infectious diseases.

The alternative immunotherapy platform is based on KBMA technology. CERS is using

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CERS Share Price (LTM)

indicates split

Source: Sutherland Research and company reports

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CONTRA CASE

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this platform to make vaccines for Hepatitis C, HIV, Tularemia, and Anthrax. All of these drugs, except CRS-100, are in the pre-clinical stage. CRS-100 is in Phase I and has shown good initial results. The new company will be headed by David Cook and Thomas Dubensky, who will hold the positions of chief executive and chief scientific officer. The equity consideration could be up to 20% of the planned entity. We believe the spin-off has reduced the company’s risk profile, as it is no longer involved in the investigation of early stage drugs. Positive Factor Increasing concerns about blood transfusion. In general, blood collected for transfusion is contaminated with pathogens, namely viruses (HIV, West Nile, SARS, and hepatitis B and C), bacteria, and harmful white blood cells. Wide adoption of nucleic testing (NAT) has considerably reduced the risk of contracting viruses through transfusion. In contrast, bacterial contamination has emerged as a significant threat, with blood components becoming increasingly vulnerable to bacterial contamination, particularly during storage, making patients that receive such products susceptible to severe complication and even death. In fact, bacterial contamination is considered to be the second largest cause of death from transfusion (after clerical errors such as mislabeling), with morbidity and mortality ranging from 100 to 150 patients each year, creating an urgent need to address the bacterial contamination of blood. Although we believe CERS has the requisite expertise to address the increasing concerns over blood transfusion, it may take time to convince advocates of a screening-based approach to adopt IBS as the primary safety measure. Neutral Factor Pathogen inactivation technology to gain over testing. In the area of pathogen contamination, there are two methods for ensuring blood safety: testing and inactivation. Testing is currently being used globally as the standard procedure for screening blood, but it suffers from certain major limitations, particularly relating to incremental cost and time required to test for every new pathogen. Further, it can be ineffective in cases of new and emerging viruses and bacteria. Inactivation, on the other hand, is expected to gain popularity in the coming years because it can treat both known and unknown pathogens, thus catering to a much broader spectrum. Because medical experts have a zero-risk tolerance approach to transfusions, we expect CERS, with its inactivation-based approach, to capture significant market share. Positive Factor Competitive edge in blood safety systems. Presently, CERS is permitted to market IBS for platelets and plasma in Europe. At this point, CERS has no direct competitors for its platelets system, as all the major competitive products are either in Phase I or in preclinical trials. As for the plasma system, there are at least two prime competitive products: one is the Mirosal system from Navigant, which is marketed by Gambro AG; and the other is Phenothiazine from DRK NSTOB and MacoPharma. Phenothiazine uses Methylene Blue, which is unsuitable for platelets and red blood corpuscles; therefore, we do not expect it to gain significant market share. However, Mirosal uses Riboflavin, which has one meaningful advantage over Amotosalen (used by IBS) balanced with one disadvantage.

Riboflavin does not need to be removed from the treated blood, but Riboflavin suffers from low efficacy. The delayed launch of Mirosal should help CERS’s product gain share as blood banks may be reluctant to change to a different technology. Combining these factors, we believe IBS is well-positioned to gain significant market share. Positive Factor Setback in the U.S. and shift in focus to Europe. After completing the Phase III trial of IBS for platelets and plasma, CERS filed a final review application with the FDA in 2005. In response, the FDA asked CERS to conduct another randomized, blinded clinical trial on a much larger scale. Due to the prohibitive cost of such a trial, CERS shifted its focus to Europe from the U.S. One strategy the company is considering is to secure a U.S. partner to help finance the trial in the U.S. In Europe, CERS has made significant progress in obtaining regulatory approval and selling IBS. It has entered into several contracts with large national players across Europe, including the Etablissement Francais du Sang (EFS, the national blood service in France). This was a significant development given that EFS controls nearly all of the blood supply in France. Adoption of IBS by EFS is expected to lead to significant adoption across Europe. Further, CERS hopes to be able to use the data collected through broad adoption of IBS in Europe as a proxy for the additional tests requested by the FDA. Neutral Factor Valuation. CERS’s current share price is trading roughly in-line with our DCF-predicted value. We have applied a WACC of 12.1% in our DCF valuation. We believe CERS’s share price performance will primarily be driven by the continuation of successful commercialization of IBS in Europe, as well as the execution of a strategy that will allow for launch in the U.S. by 2010. It is the combination of an in-line valuation with the risk of not getting near term nationwide adoption in France that drives our Neutral rating.

Improved performance of CERS is based on the assumption that it will be successful in getting FDA approval in the U.S. Any significant delay in getting approval will negatively impact valuation, as we have assumed that revenue from the U.S. will start flowing in from FY10 following the successful completion of additional tests.

DISCUSSION Significant Developments CERS entered into a contract with Grifols S.A. to commercialize IBS in Spain and Portugal (07/23/2007). CERS entered into an agreement with Grifols S.A. to commercialize IBS for plasma and platelets in Spain and Portugal. The number of units of platelets and plasma collected in Spain and Portugal were 200,000 and 300,000, respectively. According to the contract, the two companies will sell, deploy, and support IBS in Spanish and Portuguese blood centers. In addition, Grifols will take care of servicing IBS’s illuminators and will manage the supply chain for IBS through its distribution centers.

CERS entered into an agreement with EFS to supply IBS for platelets (06/26/2007). CERS announced signing an initial two-year agreement with EFS to supply IBS for platelets in France. The terms of the agreement provide for IBS equipment and disposable purchases of up to $8 million. The negotiated price per kit is nearly $100 (€75).

IBS plasma received registration in French Official Journal (05/15/2007). CERS announced that the French regulatory agency for medical products, AFSSAPS, has published specifications for the IBS for plasma in the Official Journal. As a result of this publication, French blood centers are authorized to prepare and sell plasma treated with IBS. CERS looking for strategic alternatives for its Immunotherapy programs (04/26/2007). CERS announced plans to explore strategic alternatives for its immunotherapy programs. It is considering several possible business structures, including partnering some or all of the programs within its immunotherapy business with other companies having established programs in immunology or in cancer and infectious Sutherland Research

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Small-Cap Healthcare

disease indications, combining its immunotherapy business with another public or private company, or spinning out the business for an equity interest in a newly formed immunotherapy company.

Figure 1. DCF Valuation Company Ticker: CERS 0 2006

Free Cash Flow to the Firm Growth in FCF PV of Cash Flows Terminal Value PV of Future Cash Flows PV of terminal value Value of the firm Net debt Value for the common shareholders Shares outstanding (In mln) Implied Valuation per Share

(4.8)

2 2008E

(25.9) 39.5% 0.7 -15.3% (0.9) -42.6% (7.2)

(12.9) 49.9% 1.0 33.0% (1.1) -21.3% (7.0)

4.5 135.0% 1.1 13.4% (1.6) -55.5% (10.0)

22.8 402.8% 1.7 52.9% (1.9) -17.4% (8.9)

(8.3)

(48.1) -477.00%

(33.2) 30.84%

(20.0) 39.80%

(6.0) 69.9%

13.6 325.3%

(8.3)

(42.9)

(26.4)

(14.2)

(3.8)

7.7

(1.1)

(3.2)

505 (36) 202 167 (38) 205 32 6.43

Discounted Cash Flow Valuation 3 4 5 2009E 2010E 2011E

(42.7) -794.0% 0.9 21.4% (0.6) 44.7% (5.6)

0.7

Perpetual Growth Rate

Net Income [PAT + Int Expense(1-Tax)] % increase Plus: Depreciation & Amortiz. % increase Less: CapEx % increase Less: Incr. in working capital (non-cash)

1 2007E

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(In $ mln except per share data) FY: Dec 31

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Financial Analysis • Initiating estimates. We are initiating coverage of CERS with EPS estimates of $(1.05) and $(0.81) in FY07 and FY08, respectively, on revenue of $17.1 mln and $29.1 mln. Net loss in FY07 is expected to increase primarily due to higher SG&A expenses and the cost of product revenue. We believe greater acceptance of IBS for platelets across Europe will drive revenue growth. We estimate 4Q07 EPS at $(0.28), which includes fair value of stock-based compensation.

• 3Q07 highlights. Revenue in 3Q07 decreased 53.6% Y/Y to $3.7 mln, primarily due to lower milestone payments and government grants. Product revenue for IBS during the quarter rose to $2.8 mln from the $0.8 mln recorded in the year-earlier period. SG&A expenses increased to $5.6 mln in 3Q07 from $3.3 mln in 3Q06 due to increased commercialization efforts in Europe. Net loss widened to $(9.2) mln or $(0.29) per diluted share from $(1.8) mln or $(0.06) per diluted share in the year-earlier period, on the back of a higher SG&A expenses.

• Revenue outlook. We estimate FY07 revenue at $17.1 mln, down from $35.6 mln in FY06, representing a Y/Y decline of 51.9%.

Milestone and development funding is not expected to occur in FY07, as there are no contractual milestones outstanding with BioOne. Government aid is expected to slow down as CERS no longer qualifies for funding as a small business. We believe product revenue will increase sharply to $9.0 mln in FY07 from $3 mln in FY06, primarily due to increased sales in Europe.

• Operating expense. We estimate operating expense for FY07 at $63.9 mln, or 373.1% of revenue, up from $45.1 mln or 126.6% of revenue in FY06, on the back of higher R&D spending, SG&A expenses, and cost of product revenue. Cost of product revenue is expected to dercrease as a percentage of IBS sales from 59.9% in FY07 to 47.1% in FY08. General and administrative expense is expected to increase from $22.5 mln in FY07 to $24.8 mln in FY08, mainly due to increased commercialization efforts in Europe. We expect R&D expenses to be $26.6 mln in FY07, lower than that of FY06, followed by a decrease to $18.9 mln in FY08. According to CERS business model, the company will give UVA illuminators to its customers for minimal or no charge, and will profit in future years from the sales of consumables.

• CERS expected to be profitable in FY10. High R&D spending and lower sales (due to which the fixed cost is distributed over a smaller revenue base) had impaired the profitability of CERS. We expect CERS to turn profitable in FY10, reflecting the improvement in revenue and margins. We estimate operating profit and net profit at $4.0 mln and $4.5 mln in FY10, respectively.

• Liquidity position. We expect a cash burn of $20.1 mln for FY07. CERS has cash and cash equivalents of $38 mln and short-term investments of $31 mln as of 3Q07, which we believe is sufficient to sustain its operations through to profitability.

1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5%

6 2012E

7 2013E

34.2 50.0% 1.8 5.0% (2.0) 2.0% (9.8) 10.0% 24.1 77.5%

44.4 30.0% 1.9 5.0% (2.0) 2.0% (10.6) 8.0% 33.6 39.4%

12.2

15.1

Sensitivity of DCF value to Discount rate and Perpetual Growth Rate Discount Rate 10.6% 11.1% 11.6% 12.1% 12.6% 13.1% 13.6% 6.72 7.14 7.61 8.14 8.74 9.43 10.24 11.19 12.33

6.13 6.49 6.89 7.35 7.86 8.44 9.12 9.90 10.82

WACC Perpetual Growth Rate Exit FCF multiple

12.1% 3.5% 12.0

WACC Calculation Risk free rate Risk premium Adjusted Beta Cost of Equity

4.67% US 20 yr Treasury 5.00% 1.49 12.1%

Cost of Debt Tax rate Implied cost of debt

6.37% Corporate Bonds Moody's Seasoned (Baa) 35% 4.14%

5.60 5.92 6.27 6.66 7.10 7.59 8.16 8.81 9.57

5.13 5.41 5.71 6.05 6.43 6.85 7.34 7.88 8.52

4.71 4.95 5.22 5.52 5.84 6.21 6.62 7.09 7.62

4.33 4.54 4.78 5.04 5.32 5.64 6.00 6.40 6.85

3.98 4.17 4.38 4.61 4.86 5.14 5.45 5.79 6.18

Shares outstanding Market price ($) Market Capitalization ($ mln) Long Term Debt WACC

Market price ($) as of 12/3/2007 Source: Sutherland Research and company reports

Sutherland Research

Discount (premium) to DCF value

8 2014E 53.3 20.0% 2.0 5.0% (2.1) 2.0% (11.3) 6.0% 41.9 24.66% 16.8

14.1% 3.67 3.84 4.03 4.23 4.45 4.70 4.96 5.26 5.60

31.9 6.63 211 0 211 12.1% -3%

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Small-Cap Healthcare Figure 2. Financial Results – Historical Comparison CERUS CORP (CERS) 3QFY07 Sequential 2QFY07

3QFY07

Revenue ($, mln) Total Revenue

3.7

Year-over-Year 3QFY06 % Chg

% Chg 4.5

-18.0%

8.0

-53.6% 348.5%

Cost of product revenue

1.7

1.1

56.8%

0.4

Research and development

6.9

6.8

1.8%

7.0

-2.1%

Selling general and administrative

5.6

6.2

-8.5%

3.3

72.0%

Operating Expenses Operating Income EBT Provision for income taxes Net earnings EPS - Proforma Diluted shares outstanding

14.2

14.0

1.5%

10.7

32.9%

(10.5)

(9.5)

10.8%

(2.7)

288.0%

(9.2)

(17.9)

-48.9%

(1.8)

412.1%

0.0

0.0

(9.2)

(17.9)

-48.9%

NM

(1.8)

0.0

412.1%

NM

($0.29) 31.85

($0.27) 31.8

8.0% 0.1%

($0.06) 27.8

347.0% 14.6%

Source: Sutherland Research and company reports

10.5 9.5

Prices in USD

8.5 7.5 6.5 5.5

Cerus spins off immunotherapy business; receives stake in new company

Announces 2Q FY07 results Revenue for the quarter at $4.5m

4.5 Oct-06

CERS Q3 FY07 LossWidens, but good sales progress

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CERS to Explore Strategic alternatives for its Immunotheraphy Programs

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Figure 3. Annotated Price Chart

Dec-06

Feb-07

Apr-07

Jun-07

Aug-07

Oct-07

Dec-07

Source: Sutherland Research and company reports

COMPANY DESCRIPTION

Cerus Corporation (CERS) is a California based developer and marketer of products and technologies, catering to unmet medical needs in the field of blood safety and immunotherapy. CERS operates through two business segments namely Blood Safety and Immunotherapy.

Blood Safety segment represents the primary product line of CERS, with INTERCEPT Blood System (IBS) being the only one earning revenue. IBS is designed to enhance safety of donated blood components by inactivating the potential harmful bodies. Immunotherapy segment caters to development of vaccines for the treatment of cancer, HIV, Anthrax, Tularemia and Hepatitis. All the products under this segment are in the development phase. Blood Safety and Immunotherapy contributed 85.2% and 14.8% to total revenue (which includes revenue from grants, milestone development funding and product sales) in FY06.

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FY06

1QFY07

2QFY07

3QFY07

4QFY07

FY07E

FY08E

FY09E

FY10E

35.6 22.8 9.8 3.0 45.1 1.5 14.0 29.5 0.0 (9.5) 3.0 (4.8) 0.0% 0.0 (4.8) (0.18) (0.18) (0.18) 26.9 26.9 (8.8)

4.7 0.0 3.5 1.2 12.6 0.8 5.3 6.4 0.0 (7.9) 1.1 (6.8) 0.0% 0.0 (6.8) (0.21) (0.21) (0.21) 31.8 31.8 (7.7)

4.5 0.1 2.7 1.7 23.4 1.1 6.2 6.8 9.5 (18.9) 1.0 (17.9) 0.0% 0.0 (17.9) (0.56) (0.56) (0.27) 31.8 31.8 (18.7)

3.7 0.0 0.9 2.8 14.2 1.7 5.6 6.9 0.0 (10.5) 1.3 (9.2) 0.0% 0.0 (9.2) (0.29) (0.29) (0.29) 31.9 31.9 (10.3)

4.2 0.0 0.9 3.3 13.7 1.8 5.4 6.5 0.0 (9.5) 0.6 (8.9) 0.0% 0.0 (8.9) (0.28) (0.28) (0.28) 31.9 31.9 (9.2)

17.1 0.1 8.0 9.0 63.9 5.4 22.5 26.6 9.5 (46.8) 4.0 (42.7) 0.0% 0.0 (42.7) (1.34) (1.34) (1.05) 31.8 31.8 (45.9)

29.1 0.0 1.6 27.5 56.6 13.0 24.8 18.9 0.0 (27.5) 1.7 (25.9) 0.0% 0.0 (25.9) (0.81) (0.81) (0.81) 31.9 31.9 (26.8)

66.2 0.0 1.1 65.1 80.2 28.7 21.7 29.8 0.0 (13.9) 1.0 (12.9) 0.0% 0.0 (12.9) (0.41) (0.41) (0.41) 31.9 31.9 (13.0)

117.7 0.0 1.1 116.6 113.7 49.6 25.9 38.3 0.0 4.0 0.5 4.5 0.0% 0.0 4.5 0.14 0.14 0.14 31.9 32.7 5.1

Margin Analysis SG&A (as % of sales) R&D (as % of sales) Operating Margin EBITDA Margin Net Margin

39.4% 82.9% NM NM NM

113.3% 137.2% NM NM NM

136.3% 149.7% NM NM NM

152.2% 186.0% NM NM NM

128.0% 154.0% NM NM NM

131.4% 155.2% NM NM NM

85.0% 65.0% NM NM NM

32.8% 45.0% NM NM NM

22.0% 32.5% 3.4% 4.3% 3.8%

46.0% (201.5%) (200.9%) (136.6%) (132.6%) (147.2%)

(32.9%) (364.7%) (372.5%) (832.0%) (631.1%) (667.7%)

(30.1%) (418.4%) (424.7%) (453.2%) (408.4%) (245.7%)

(53.6%) (488.0%) (509.5%) (612.1%) (547.0%) (547.0%)

(70.3%) (541.2%) (493.5%) (394.1%) (348.1%) (717.1%)

(51.9%) (593.2%) (623.6%) (994.0%) (855.0%) (688.0%)

93.4 115.8 0.0 101.0 115.8 NM

79.6 106.2 0.0 95.0 106.2 NM

74.4 91.8 0.0 77.6 91.8 NM

Balance Sheet Metrics Cash and marketable securities Total assets Long term debt Stockholder's equity Total liabilities ROE Cash Flow Statement Free cash flow Free cash flow per share

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Growth Analysis Total Revenue Operating profit (loss) EBITDA Income (Loss) from continuing operations Diluted EPS from continuing operations Diluted EPS from continuing operations

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CERUS CORP (CERS) Fiscal year ends Dec (In $ mln except per share data) Total Revenue Milestone development funding Government grants and cooperative aggr.

Product revenue (not breaking out b/w platele Operating Expenses Cost of product revenue Selling general and administrative Research and development Other Operating profit (loss) Interest expense, net Earning (loss) before tax Tax rate Income tax (expense) benefit Net income Diluted EPS (incl. Stock Comp.)

Diluted EPS (excl. Stock Comp.)

Pro-forma EPS (diluted) Weighted average basic shares (in mln) Weighted average diluted shares (in mln) EBITDA

(15.8) (0.59)

(14.1) (0.44)

(5.2) (0.16)

69.0 85.0 0.0 69.2 85.0 NM (5.8) (0.18)

Source: Sutherland Research and company reports

Sutherland Research

57.2 76.5 0.0 60.8 76.5 NM (11.8) (0.37)

57.2 76.5 0.0 60.8 76.5 NM (36.8) (1.16)

70.1% 41.1% 41.6% 39.5% 39.5% 39.5%

127.5% 49.3% 51.6% 49.9% 49.9% 49.9%

77.7% 128.6% 139.3% 135.0% 134.1% 134.1%

26.1 62.0 0.0 37.1 62.0 NM

10.0 59.4 0.0 26.2 59.4 NM

6.1 81.1 0.0 32.8 81.1 15.3%

(31.1) (0.98)

(17.9) (0.56)

(3.9) (0.12)