Form 10-Q

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10-Q 1 d10q.htm FORM 10-Q Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2011

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

Commission File Number: 0-21699

VIROPHARMA INCORPORATED

(Exact Name of Registrant as Specified in its Charter)

Delaware

23-2789550

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

730 Stockton Drive

Exton, Pennsylvania 19341

(Address of Principal Executive Offices and Zip Code)

610-458-7300

(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, “non-accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Number of shares outstanding of the issuer’s Common Stock, par value $.002 per share, as of July 18, 2011: 75,944,185 shares.

VIROPHARMA INCORPORATED

INDEX


		Page
PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets (unaudited) at June 30, 2011 and December 31, 2010		3

	Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2011 and 2010		4

	Consolidated Statement of Stockholders’ Equity (unaudited) for the six months ended June 30, 2011		5

	Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2011 and 2010		6

	Notes to the Consolidated Financial Statements (unaudited)		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		21

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		35

Item 4.	Controls and Procedures		36

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings		37

Item 1A.	Risk Factors		38

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		42

Item 6.	Exhibits		43

SIGNATURES			44

ViroPharma Incorporated

Condensed Consolidated Balance Sheets

(unaudited)


(in thousands, except share and per share data)	June 30, 2011			December 31, 2010
Assets
Current assets:
Cash and cash equivalents	$	390,395		$	426,732
Short-term investments		127,845			78,439
Accounts receivable, net		68,676			43,879
Inventory		61,283			54,388
Prepaid expenses and other current assets		7,998			13,959
Prepaid income taxes		8,691			2,000
Deferred income taxes		11,285			13,744

Total current assets		676,173			633,141
Intangible assets, net		611,476			619,712
Property, equipment and building improvements, net		12,998			11,468
Goodwill		6,448			6,228
Debt issue costs, net		2,203			2,397
Deferred income taxes		8,284			4,252
Other assets		11,199			10,376

Total assets	$	1,328,781		$	1,287,574


Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	13,521		$	10,215
Contingent consideration		13,853			10,973
Accrued expenses and other current liabilities		62,703			48,990
Income taxes payable		798			1,944

Total current liabilities		90,875			72,122
Other non-current liabilities		2,198			2,463
Deferred tax liability		173,567			176,111
Long-term debt		149,523			145,743

Total liabilities		416,163			396,439


Stockholders’ equity:
Preferred stock, par value $0.001 per share. 5,000,000 shares authorized; Series A convertible participating preferred stock; no shares issued and outstanding		—			—

Common stock, par value $0.002 per share. 175,000,000 shares authorized; issued and outstanding 75,893,066 shares at June 30, 2011 and 78,141,491 shares at December 31, 2010		157			156

Treasury shares, at cost. 2,668,744 shares at June 30, 2011 and 0 shares at December 31, 2010		(50,000	)		—

Additional paid-in capital		728,616			717,375
Accumulated other comprehensive income (loss)		741			(258	)
Retained earnings		233,104			173,862

Total stockholders’ equity		912,618			891,135

Total liabilities and stockholders’ equity	$	1,328,781		$	1,287,574

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Operations

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands, except per share data)	2011			2010			2011			2010
Revenues:

Net product sales	$	128,808		$	108,961		$	255,843		$	199,609

Costs and Expenses:
Cost of sales (excluding amortization of product rights)		21,309			13,641			40,179			27,598
Research and development		20,417			9,224			30,843			18,965
Selling, general and administrative		32,090			25,419			60,376			46,339
Intangible amortization		7,156			7,620			16,053			15,195
Other operating expenses		5,528			—			6,026			—

Total costs and expenses		86,500			55,904			153,477			108,097

Operating income		42,308			53,057			102,366			91,512

Other Income (Expense):

Interest income		189			87			394			118
Interest expense		(3,066	)		(2,902	)		(6,023	)		(5,741	)
Other income (expense), net		259			(3,281	)		3,353			(3,804	)

Income before income tax expense		39,690			46,961			100,090			82,085

Income tax expense		16,894			18,440			40,848			32,283

Net income	$	22,796		$	28,521		$	59,242		$	49,802


Net income per share:
Basic	$	0.30		$	0.37		$	0.77		$	0.64
Diluted	$	0.28		$	0.34		$	0.70		$	0.59

Shares used in computing net income per share:
Basic		76,000			77,825			76,919			77,666
Diluted		89,459			90,002			90,240			89,830

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Stockholders’ Equity

(unaudited)


(in thousands)	Preferred Stock				Common Stock					Treasury Shares					Additional paid-in capital		Accumulated other comprehensive income (loss)			Retained Earnings		Total stockholders’ equity
(in thousands)	Number of shares		Amount		Number of shares			Amount		Number of shares		Amount			Additional paid-in capital		Accumulated other comprehensive income (loss)			Retained Earnings		Total stockholders’ equity
Balance, December 31, 2010		—	$	—		78,141		$	156		—	$	—		$	717,375	$	(258	)	$	173,862	$	891,135
Exercise of common stock options		—		—		399			1		—		—			2,857		—			—		2,858
Employee stock purchase plan		—		—		21			—		—		—			194		—			—		194
Share-based compensation		—		—		—			—		—		—			7,163		—			—		7,163
Unrealized gains on available for sale securities, net		—		—		—			—		—		—			—		48			—		48
Cumulative translation adjustment, net		—		—		—			—		—		—			—		951			—		951
Repurchase of shares		—		—		(2,668	)		—		2,668		(50,000	)		—		—			—		(50,000	)
Stock option tax benefits		—		—		—			—		—		—			1,027		—			—		1,027
Net income		—		—		—			—		—		—			—		—			59,242		59,242

Balance, June 30, 2011		—	$	—		75,893		$	157		2,668	$	(50,000	)	$	728,616	$	741		$	233,104	$	912,618

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Cash Flows

(unaudited)


	Six Months Ended June 30,
(in thousands)	2011			2010
Cash flows from operating activities:
Net income	$	59,242		$	49,802
Adjustments to reconcile net income to net cash provided by operating activities:
Non-cash share-based compensation expense		7,163			5,408
Non-cash interest expense		3,974			3,688
Non-cash charge for contingent consideration		2,524			—
Deferred tax provision		(3,898	)		10,638
Depreciation and amortization expense		17,208			16,126
Other, net		569			3,464
Changes in assets and liabilities:
Accounts receivable		(24,383	)		(6,947	)
Inventory		(4,916	)		2,097
Prepaid expenses and other current assets		3,185			(414	)
Prepaid income taxes and taxes payable		(7,844	)		2,763
Other assets		(240	)		(2,774	)
Accounts payable		2,646			4,723
Accrued expenses and other current liabilities		13,501			3,890
Other non-current liabilities		(265	)		(222	)

Net cash provided by operating activities		68,466			92,242

Cash flows from investing activities:
Purchase of Auralis, net of cash acquired		—			(13,152	)
Purchase of Vancocin assets		(7,000	)		(3,764	)
Purchase of property, equipment and building improvements		(2,646	)		(1,246	)
Purchase of short-term investments		(94,975	)		(53,659	)
Maturities of short-term investments		45,058			—

Net cash used in investing activities		(59,563	)		(71,821	)

Cash flows from financing activities:
Payment for treasury shares acquired		(50,000	)		—
Repayment of debt		—			(1,575	)
Net proceeds from issuance of common stock		3,051			1,458
Excess tax benefits from share-based payment arrangements		1,027			1,237

Net cash (used in) provided by financing activities		(45,922	)		1,120

Effect of exchange rate changes on cash		682			(755	)

Net (decrease) increase in cash and cash equivalents		(36,337	)		20,786

Cash and cash equivalents at beginning of period		426,732			331,672

Cash and cash equivalents at end of period	$	390,395		$	352,458

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements

Note 1. Organization and Business Activities

ViroPharma Incorporated and subsidiaries is a global biotechnology company dedicated to the development and commercialization of products that address serious diseases, with a focus on products used by physician specialists or in hospital settings. We intend to grow through sales of our marketed products, through continued development of our product pipeline, expansion of sales into additional territories outside the United States and through potential acquisition or licensing of products or acquisition of companies. We expect future growth to be driven by sales of Cinryze, both domestically and internationally, and by our primary development programs, including C1 esterase inhibitor and a non-toxigenic strain of C. difficile (VP20621).

We market and sell Cinryze in the United States for routine prophylaxis against angioedema attacks in adolescent and adult patients with hereditary angioedema (HAE). Cinryze is a C1 esterase inhibitor therapy for routine prophylaxis against HAE, also known as C1 inhibitor (C1-INH) deficiency, a rare, severely debilitating, life-threatening genetic disorder. Cinryze was acquired in October 2008 and, in January 2010, we acquired expanded rights to commercialize Cinryze and future C1-INH derived products in certain European countries and other territories throughout the world as well as rights to develop future C1-INH derived products for additional indications. In June 2011, the European Commission granted us Centralized Marketing Authorization for Cinryze^® in adults and adolescents with HAE for routine prevention, pre-procedure prevention and acute treatment of angioedema attacks. The approval also includes a self administration option for appropriately trained patients. We have begun to commercialize Cinryze in Europe and continue to evaluate our commercialization plans in countries where we have distribution rights.

We also market and sell Vancocin HCl capsules, the oral capsule formulation of vancomycin hydrochloride, in the U.S. and its territories. Vancocin is a potent antibiotic approved by the U.S. Food and Drug Administration, or FDA, to treat antibiotic-associated pseudomembranous colitis caused by Clostridium difficile infection (CDI), or C. difficile, and enterocolitis caused by Staphylococcus aureus, including methicillin-resistant strains.

Our product development portfolio is primarily focused on two programs, C1 esterase inhibitor [human] and VP20621. We are working on developing further therapeutic uses, potential additional indications in other C1 mediated diseases, and alternative modes of administration for C1 esterase inhibitor.

We are currently undertaking studies on the viability of subcutaneous administration of Cinryze. We intend to conduct ViroPharma sponsored studies and investigator-initiated studies (IIS) to identify further therapeutic uses and potentially expand the labeled indication for Cinryze to include other C1 mediated diseases, such as Antibody-Mediated Rejection (AMR) and Delayed Graft Function (DGF). Additionally, in May 2011, Halozyme Therapeutics (Halozyme) granted us an exclusive worldwide license to use Halozyme’s proprietary Enhanze™ technology, a proprietary drug delivery platform using Halozyme’s recombinant human hyaluronidase enzyme (rHuPH20) technology in combination with a C1 esterase inhibitor. We intend to apply rHuPH20 initially to develop an alternative subcutaneous formulation of Cinryze for routine prophylaxis against attacks of HAE.

We are also developing VP20621 for the treatment and prevention of CDI. In May 2011, we initiated a Phase 2 dose-ranging clinical study to evaluate the safety, tolerability, and efficacy of VP 20621 for prevention of recurrence of CDI in adults previously treated for CDI. In May 2010, we acquired Auralis Limited, a UK based specialty pharmaceutical company. The acquisition of Auralis provides us with the opportunity to accelerate our European commercial systems for potential future product launches and additional business development acquisitions. In connection with the Auralis acquisition we acquired Buccolam® (Oromucosal Solution, Midazolam [as hydrochloride]), for which we are seeking a pediatric-use marketing authorization (PUMA) for treatment of pediatric epilepsy in Europe. In June of 2011, the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) has adopted a positive opinion recommending approval of a PUMA for Buccolam. The acquisition also provided us revenue from sales of Diamorphine (Diamorphine Hydrochloride BP Injection) for palliative care and acute pain relief in the United Kingdom.

In addition to these programs, we have several other assets that we may make additional investments in. These investments will be limited and dependent on our assessment of the potential future commercial success of or benefits from the asset. These assets include maribavir for CMV and other compounds, including those acquired from Auralis.

Basis of Presentation

The consolidated financial information at June 30, 2011 and for the three and six months ended June 30, 2011 and 2010, is unaudited but includes all adjustments (consisting only of normal recurring adjustments) which, in the opinion of management, are necessary to state fairly the consolidated financial information set forth therein in accordance with accounting principles generally accepted in the United States of America. The interim results are not necessarily indicative of results to be expected for the full fiscal year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements

year ended December 31, 2010 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. We have evaluated all subsequent events through the date the financial statements were issued, and have not identified any such events.

Use of Estimates

The preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Adoption of Standards

In September 2009, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This ASU amends certain disclosure requirements of Topic 820 to provide for additional disclosures for transfers in and out of Levels 1 and 2 and for activity in Level 3. The ASU also clarifies certain other disclosure requirements including level of disaggregation and disclosures around inputs and valuation techniques. We adopted this ASU on January 1, 2010. The new disclosures about the purchases, sales, issuances and settlements in the roll forward activity for Level 3 fair value measurements are effective for fiscal years beginning after December 15, 2010 and we adopted this provision on January 1, 2011. The adoption of this disclosure provision did not have a material impact on our results of operations, cash flows, and financial position.

In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements, or ASU 2009-13, formerly EITF Issue No. 08-1. ASU 2009-13, amends existing revenue recognition accounting pronouncements that are currently within the scope of FASB ASC Topic 605 and provides accounting principles and application guidance on how the arrangement should be separated, and the consideration allocated. This guidance changes how to determine the fair value of undelivered products and services for separate revenue recognition. Allocation of consideration is now based on management’s estimate of the selling price for an undelivered item where there is no other means to determine the fair value of that undelivered item. This new approach is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We adopted this ASU January 1, 2011. The adoption of the provisions of this guidance did not have a material impact on our results of operations, cash flows, and financial position.

In March 2010, the FASB ratified EITF Issue No. 08-9, Milestone Method of Revenue Recognition, and as a result of this ratification the FASB issued ASU 2010-17 in April 2010, which states that the milestone method is a valid application of the proportional performance model for revenue recognition if the milestones are substantive and there is substantive uncertainty about whether the milestones will be achieved. The Task Force agreed that whether a milestone is substantive is a judgment that should be made at the inception of the arrangement. To meet the definition of a substantive milestone, the consideration earned by achieving the milestone (1) would have to be commensurate with either the level of effort required to achieve the milestone or the enhancement in the value of the item delivered, (2) would have to relate solely to past performance, and (3) should be reasonable relative to all deliverables and payment terms in the arrangement. No bifurcation of an individual milestone is allowed and there can be more than one milestone in an arrangement. The new guidance is effective for interim and annual periods beginning on or after June 15, 2010. We adopted this ASU January 1, 2011. The adoption of this guidance did not have a material impact on our results of operations, cash flows, and financial position.

In December 2010, the FASB issued ASU 2010-27, Fees Paid to the Federal Government by Pharmaceutical Manufactures (EITF Issue 10-D; ASC 720), which addresses how pharmaceutical manufacturers should recognize and classify in the income statement fees mandated by the Patient Protection and Affordable Care Act as amended by the Health Care Education Reconciliation Act. The ASU specifies that the liability for the fee be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to operating expense using a straight-line method of allocation unless another method better allocates the fee over the calendar year. The new guidance is effective for calendar years beginning after December 31, 2010. We adopted this ASU January 1, 2011. The adoption of this guidance does not have a material impact on our results of operations, cash flows, and financial position.

On May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, and the IASB issued IFRS 13, Fair Value Measurement. The new guidance results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and IFRS. The ASU is effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. The new guidance changes certain fair value measurement principles and disclosure requirements. We do not expect the amendments to U.S. GAAP to have a material impact on our results of operations, cash flows, and financial position.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements

On June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (Topic 220). This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. The standard is intended to enhance comparability between entities that report under US GAAP and those that report under IFRS, and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity. Under the ASU, an entity can elect to present items of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive, statements. Each component of net income and each component of other comprehensive income, together with totals for comprehensive income and its two parts, net income and other comprehensive income, would need to be displayed under either alternative. The statement(s) would need to be presented with equal prominence as the other primary financial statements. The ASU does not change items that constitute net income and other comprehensive income, when an item of other comprehensive income must be reclassified to net income or the earnings-per-share computation (which will continue to be based on net income). The new US GAAP requirements are effective for public entities as of the beginning of a fiscal year that begins after December 15, 2011 and interim and annual periods thereafter. Early adoption is permitted, but full retrospective application is required under the accounting standard. We do not expect the amendments to U.S. GAAP to have a material impact on our results of operations, cash flows, and financial position.

Note 2. Short-Term Investments

Short-term investments consist of fixed income securities with remaining maturities of greater than three months at the date of purchase, debt securities and equity securities. At June 30, 2011, all of our short-term investments are classified as available for sale investments and measured as level 1 instruments of the fair value measurements standard.

The following summarizes the Company’s available for sale investments at June 30, 2011:


(in thousands)	Cost		Gross unrealized gains		Gross unrealized losses		Fair value

June 30, 2011
Debt securities:
U.S. Treasury	$	83,595	$	52	$	—	$	83,647
Corporate		44,175		28		5		44,198

	$	127,770	$	80	$	5	$	127,845


Maturities of investments were as follows:
Less than one year		94,689		73		2		94,760
Greater than one year		33,081		7		3		33,085

Total	$	127,770	$	80	$	5	$	127,845

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

Note 3. Inventory

Inventory is stated at the lower of cost or market using actual cost.


(in thousands)	June 30, 2011		December 31, 2010
Raw Materials	$	49,017	$	37,994
Work In Process		8,055		10,570
Finished Goods		4,211		5,824

Total	$	61,283	$	54,388

Note 4. Intangible Assets

The following represents the balance of the intangible assets at June 30, 2011:


(in thousands)	Gross Intangible Assets		Accumulated Amortization		Net Intangible Assets
Cinryze Product rights	$	521,000	$	56,134	$	464,866
Vancocin Intangibles		168,099		44,724		123,375
Auralis Contract rights		12,802		1,156		11,646
Auralis IPR&D (1)		11,589		—		11,589

Total	$	713,490	$	102,014	$	611,476

(1)	non-amortizing

The following represents the balance of the intangible assets at December 31, 2010:


(in thousands)	Gross Intangible Assets		Accumulated Amortization		Net Intangible Assets
Cinryze Product rights	$	521,000	$	45,714	$	475,286
Vancocin Intangibles		161,099		39,629		121,470
Auralis Contract rights		12,365		601		11,764
Auralis IPR&D (1)		11,192		—		11,192

Total	$	705,656	$	85,944	$	619,712

(1)	non-amortizing

In December 2008, FDA changed OGD’s 2006 bioequivalence recommendation, which we have opposed since its original proposal in March 2006, by issuing draft guidance for establishing bioequivalence to Vancocin which would require generic products that have the same inactive ingredients in the same quantities as Vancocin (“Q1 and Q2 the same”) to demonstrate bioequivalence through comparative in-vitro dissolution testing. Under this latest proposed method, any generic product that is not Q1 and Q2 the same as Vancocin would need to conduct an in-vivo study with clinical endpoints to demonstrate bioequivalence with Vancocin.

On August 4, 2009 the FDA’s Pharmaceutical Science and Clinical Pharmacology Advisory Committee voted in favor of the component of OGD’s 2008 draft guidance on bioequivalence for Vancocin that permits bioequivalence to be demonstrated through comparable in vitro dissolution for potential vancomycin HC1 capsule generic products that contain the same active and inactive ingredients in the same amounts as Vancocin, among other requirements. If FDA’s proposed bioequivalence method for Vancocin becomes effective, the time period in which a generic competitor could be approved would be reduced and multiple generics may enter the market, which would materially impact our operating results, cash flows and possibly intangible asset valuations. This could also result in a reduction to the useful life of the Vancocin-related intangible assets. Management currently believes there are no indicators that would require a change in useful life as management believes that Vancocin will continue to be utilized along with generics that may enter the market, and the number of generics and the timing of their market entry is unknown.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

A reduction in the useful life, as well as the timing and number of generics, will impact our cash flow assumptions and estimate of fair value, perhaps to a level that could result in an impairment charge. We will continue to monitor the actions of the OGD and consider the effects of our opposition actions and the announcements by generic competitors or other adverse events for additional impairment indicators. We will reevaluate the expected cash flows and fair value of our Vancocin-related assets at such time as a triggering event occurs.

We were obligated to pay Eli Lilly and Company (Lilly) additional purchase price consideration based on net sales of Vancocin within a calendar year through 2011. We accounted for these additional payments as additional purchase price which requires that the additional purchase price consideration is recorded as an increase to the intangible asset of Vancocin and is amortized over the remaining estimated useful life of the intangible asset. In addition, at the time of recording the additional intangible assets, a cumulative adjustment is recorded to accumulated intangible amortization, in addition to ordinary amortization expense, in order to reflect amortization as if the additional purchase price had been paid in November 2004.

As of June 30, 2011, we have paid an aggregate of $51.1 million to Lilly in additional purchase price consideration, as our net sales of Vancocin surpassed the maximum obligation level of $65 million in 2005 through 2011. As of June 30, 2011, we have satisfied our obligations to Lilly to make additional purchase price consideration payments under the purchase agreement.

On May 28, 2010 we acquired Auralis Limited, a UK based specialty pharmaceutical company. With the acquisition of Auralis we have added one marketed product and several development assets to our portfolio. We recognized an intangible asset related to certain supply agreements for the marketed product and one of the development assets. Additionally, we have recognized in-process research and development (IPR&D) assets related to the development assets which are currently not approved. We determined that these assets meet the criterion for separate recognition as intangible assets and the fair value of these assets have been determined based upon discounted cash flow models. The supply agreements will be amortized over their useful life of 12 years. The IPR&D assets used in research and development activities are classified as indefinite-lived and will be subject to periodic impairment testing. The IPR&D assets will remain as indefinite-lived intangible assets until the projects are completed or abandoned. Upon completion of the projects, we will make a separate determination of the useful life of the asset and begin amortization.

Note 5. Long-Term Debt

Long-term debt as of June 30, 2011 and December 31, 2010 is summarized in the following table:


(in thousands)	June 30, 2011		December 31, 2010
Senior convertible notes	$	149,523	$	145,743
less: current portion		—		—

Total debt principal	$	149,523	$	145,743

As of June 30, 2011 senior convertible notes representing $205.0 million of principal debt are outstanding with a carrying value of $149.5 million.

On March 26, 2007, we issued $250.0 million of 2% senior convertible notes due March 2017 (senior convertible notes) in a public offering. Net proceeds from the issuance of the senior convertible notes were $241.8 million. The senior convertible notes are unsecured unsubordinated obligations and rank equally with any other unsecured and unsubordinated indebtedness. The senior convertible notes bear interest at a rate of 2% per annum, payable semi-annually in arrears on March 15 and September 15 of each year commencing on September 15, 2007.

The debt and equity components of our senior convertible debt securities are bifurcated and accounted for separately based on the value and related interest rate of a non-convertible debt security with the same terms. The fair value of a non-convertible debt instrument at the original issuance date was determined to be $148.1 million. The equity (conversion options) component of our convertible debt securities is included in Additional paid-in capital on our Condensed Consolidated Balance Sheets and, accordingly,

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

the initial carrying value of the debt securities was reduced by $101.9 million. Our net income for financial reporting purposes is reduced by recognizing the accretion of the reduced carrying values of our convertible debt securities to their face amount of $250.0 million as additional non-cash interest expense. Accordingly, the senior convertible debt securities will recognize interest expense at effective rates of 8.0% as they are accreted to par value.

On March 24, 2009 we repurchased, in a privately negotiated transaction, $45.0 million in principal amount of our senior convertible notes due March 2017 for total consideration of approximately $21.2 million. The repurchase represented 18% of our then outstanding debt and was executed at a price equal to 47% of par value. Additionally, in negotiated transactions, we sold approximately 2.38 million call options for approximately $1.8 million and repurchased approximately 2.38 million warrants for approximately $1.5 million which terminated the call options and warrants that were previously entered into by us in March 2007. We recognized a $9.1 million gain in the first quarter of 2009 as a result of this debt extinguishment. For tax purposes, the gain qualifies for deferral until 2014 in accordance with the provisions of the American Recovery and Reinvestment Act.

As of June 30, 2011, the Company has accrued $1.2 million in interest payable to holders of the senior convertible notes. Debt issuance costs of $4.8 million have been capitalized and are being amortized over the term of the senior convertible notes, with the balance to be amortized as of June 30, 2011 being $2.2 million.

The senior convertible notes are convertible into shares of our common stock at an initial conversion price of $18.87 per share. The senior convertible notes may only be converted: (i) anytime after December 15, 2016; (ii) during the five business-day period after any five consecutive trading day period (the “measurement period”) in which the price per note for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such day; (iii) during any calendar quarter (and only during such quarter) after the calendar quarter ending June 30, 2007, if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter; or (iv) upon the occurrence of specified corporate events. Upon conversion, holders of the senior convertible notes will receive shares of common stock, subject to ViroPharma’s option to irrevocably elect to settle all future conversions in cash up to the principal amount of the senior convertible notes, and shares for any excess. We can irrevocably elect this option at any time on or prior to the 35th scheduled trading day prior to the maturity date of the senior convertible notes. The senior convertible notes may be required to be repaid on the occurrence of certain fundamental changes, as defined in the senior convertible notes. As of June 30, 2011, the fair value of the principal of the $205.0 million convertible senior notes outstanding was approximately $251.7 million, based on the level 2 valuation hierarchy of the fair value measurements standard.

Concurrent with the issuance of the senior convertible notes, we entered into privately-negotiated transactions, comprised of purchased call options and warrants sold, to reduce the potential dilution of our common stock upon conversion of the senior convertible notes. The transactions, taken together, have the effect of increasing the initial conversion price to $24.92 per share. The net cost of the transactions was $23.3 million.

The call options allow ViroPharma to receive up to approximately 13.25 million shares of its common stock at $18.87 per share from the call option holders, equal to the number of shares of common stock that ViroPharma would issue to the holders of the senior convertible notes upon conversion. These call options will terminate upon the earlier of the maturity dates of the related senior convertible notes or the first day all of the related senior convertible notes are no longer outstanding due to conversion or otherwise. Concurrently, we sold warrants to the warrant holders to receive shares of its common stock at an exercise price of $24.92 per share. These warrants expire ratably over a 60-day trading period beginning on June 13, 2017 and will be net-share settled.

The purchased call options are expected to reduce the potential dilution upon conversion of the senior convertible notes in the event that the market value per share of ViroPharma common stock at the time of exercise is greater than $18.87, which corresponds to the initial conversion price of the senior convertible notes, but less than $24.92 (the warrant exercise price). The warrant exercise price is 75.0% higher than the price per share of $14.24 of our price on the pricing date. If the market price per share of ViroPharma common stock at the time of conversion of any senior convertible notes is above the strike price of the purchased call options ($18.87), the purchased call options will entitle us to receive from the counterparties in the aggregate the same number of shares of our common stock as we would be required to issue to the holder of the converted senior convertible notes. Additionally, if the market price of ViroPharma common stock at the time of exercise of the sold warrants exceeds the strike price of the sold warrants ($24.92), we will owe the counterparties an aggregate of approximately 13.25 million shares of ViroPharma common stock. If we have insufficient shares of common stock available for settlement of the warrants, we may issue shares of a newly created series of preferred stock in lieu of our obligation to deliver common stock. Any such preferred stock would be convertible into 10% more shares of our common stock than the amount of common stock we would otherwise have been obligated to deliver under the warrants. We are entitled to receive approximately 10.87 million shares of its common stock at $18.87 from the call option holders and if the market price of ViroPharma common stock at the time of exercise of the sold warrants exceeds the strike price of the sold warrants ($24.92), will owe the counterparties an aggregate of approximately 10.87 million shares of ViroPharma common stock.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

The purchased call options and sold warrants are separate transactions entered into by us with the counterparties, are not part of the terms of the senior convertible notes, and will not affect the holders’ rights under the senior convertible notes. Holders of the senior convertible notes will not have any rights with respect to the purchased call options or the sold warrants. The purchased call options and sold warrants meet the definition of derivatives. These instruments have been determined to be indexed to our own stock and have been recorded in stockholders’ equity in our Condensed Consolidated Balance Sheets. As long as the instruments are classified in stockholders’ equity they are not subject to the mark to market provisions.

Note 6. Stockholder’s Equity

Preferred Stock

The Company’s Board of Directors has the authority, without action by the holders of common stock, to issue up to 5,000,000 shares of preferred stock from time to time in such series and with such preference and rights as it may designate.

Share Repurchase Program

On March 9, 2011, our Board of Directors authorized the use of up to $150.0 million to repurchase shares of our common stock and/or our 2% Senior Convertible Notes due 2017. Purchases may be made by means of open market transactions, block transactions, privately negotiated purchase transactions or other techniques from time to time.

On March 14, 2011 we entered into a three month accelerated share repurchase (ASR) agreement with a large financial institution to repurchase $50.0 million of our common stock on an accelerated basis. We paid $50.0 million to the financial institution and received approximately 2.7 million shares under this arrangement at an average purchase price of $18.74 per share.

Note 7. Share-based Compensation

Beginning in 2011, our stock-based compensation program consisted of a combination of: time vesting stock options with graduated vesting over a four year period; performance and market vesting common stock units, or PSUs, tied to the achievement of pre-established company performance metrics and market based goals over a three-year performance period; and, time vesting restricted stock awards, or RSUs, granted to our non-employee directors vesting over a one year period. Grants under our former stock based compensation program consisted only of time vesting stock options.

The fair values of our share-based awards are determined as follows:

•

Stock option grants are estimated as of the date of grant using a Black-Scholes option valuation model and compensation expense is recognized over the applicable vesting period;

•

PSUs subject to company specific performance metrics, which include both performance and service conditions, are based on the market value of our stock on the date of grant. Compensation expense is based upon the number of shares expected to vest after assessing the probability that the performance criteria will be met. Compensation expense is recognized over the vesting period, adjusted for any changes in our probability assessment;

•

PSUs subject to our total shareholder return, or TSR, market metric relative to a peer group of companies, which includes both market and service conditions, are estimated using a Monte Carlo simulation. Compensation expense is based upon the number and value of shares expected to vest. Compensation expense is recognized over the applicable vesting period. All compensation cost for the award will be recognized if the requisite service period is fulfilled, even if the market condition is never satisfied; and,

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

•

Time vesting RSUs are based on the market value of our stock on the date of grant. Compensation expense for time vesting RSUs is recognized over the vesting period.

The vesting period for our stock awards is the requisite service period associated with each grant.

Our share-based compensation expense is comprised of the following:


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2011		2010		2011		2010
Stock options	$	3,073	$	2,746	$	6,034	$	5,348
Performance shares		480		—		886
Restricted shares		116		—		166
Employee Stock Purchase Plan		38				77		60

Total	$	3,707	$	2,746	$	7,163	$	5,408

Our share-based compensation expense is recorded as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2011		2010		2011		2010
Research and development	$	999	$	823	$	1,986	$	1,638
Selling, general and administrative		2,708		1,923		5,177		3,770

Total	$	3,707	$	2,746	$	7,163	$	5,408

We currently have three shared-based award plans in place: a 1995 Stock Option and Restricted Share Plan (1995 Plan), a 2001 Equity Incentive Plan (2001 Plan) and a 2005 Stock Option and Restricted Share Plan (2005 Plan) (collectively, the “Plans”).

The following table lists information about these equity plans at June 30, 2011:


	1995 Plan		2001 Plan		2005 Plan		Combined
Shares authorized for issuance		4,500,000		500,000		12,850,000		17,850,000
Shares outstanding		4,500,000		439,666		8,651,485		13,591,151

Shares available for grant		—		60,334		4,198,515		4,258,849

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

Employee Stock Option Plans

We issued 1,617,278 stock options during the first six months ended June 30, 2011. The weighted average fair value of the grants was estimated at $11.37 per share using the Black-Scholes option-pricing model using the following assumptions:


Expected dividend yield		—
Range of risk free interest rate		2.39% - 2.87%
Weighted-average volatility		68.22%
Range of volatility		64.74% - 69.32%
Range of expected option life (in years)		5.50 - 6.25

We have 9,655,198 option grants outstanding at June 30, 2011 with exercise prices ranging from $0.99 per share to $29.37 per share and a weighted average remaining contractual life of 6.96 years. The following table lists the outstanding and exercisable option grants as of June 30, 2011:


	Number of options		Weighted average exercise price		Weighted average remaining contractual term (years)		Aggregate intrinsic value (in thousands)
Outstanding		9,655,198	$	11.74		6.96	$	66,632
Exercisable		5,484,519	$	10.65		5.57	$	44,389

The following tables summarizes information regarding our stock option awards at June 30, 2011:


	Shares Under Option			Weighted Average Exercise Price
Balance at December 31, 2010		8,553,332		$	10.45
Granted		1,617,278		$	17.89
Exercised		(399,014	)	$	7.16
Forfeited and cancelled		(116,398	)	$	18.01

Balance at June 30, 2011		9,655,198		$	11.74

As of June 30, 2011, there was $31.3 million of total unrecognized compensation cost related to unvested share-based payments (including share options) granted under the Plans. That cost is expected to be recognized over a weighted-average period of 2.92 years.

Performance Awards

Beginning in 2011, employees receive annual grants of performance award units, or PSUs, in addition to stock options which give the recipient the right to receive common stock that is contingent upon achievement of specified pre-established company performance goals over a three year performance period. The performance goals for the PSUs granted in January 2011, which are accounted for as equity awards, are based upon the following performance measures: (i) our revenue growth over the performance period, (ii) our adjusted net income as a percent of sales at the end of the performance period, and (iii) our relative total shareholder return, or TSR, compared to a peer group of companies at the end of the performance period. Depending on the outcome of these performance goals, a recipient may ultimately earn a number of shares greater or less than their target number of shares granted, ranging from 0% to 200% of the PSUs granted. Shares of our common stock are issued on a one-for-one basis for each PSU earned. Participants vest in their PSUs at the end of the performance period.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

The fair value of the market condition PSUs was determined using a Monte Carlo simulation and utilized the following inputs and assumptions:


	Six Months Ended June 30,
(in thousands)	2011
Closing stock price on grant date	$	17.84

Performance period starting price	$	16.85

Term of award (in years)		2.99
Volatility		69.75	%
Risk-free interest rate		1.19	%
Expected dividend yield		0.00	%

Fair value per TSR PSU	$	24.38

The performance period starting price is measured as the average closing price over the last 30 trading days prior to the performance period start. The Monte Carlo simulation model also assumed correlations of returns of the prices of our common stock and the common stocks of the comparator group of companies and stock price volatilities of the comparator group of companies.

At June 30, 2011, for the purposes of determining stock based compensation we assumed 295,771 and 17,253 performance condition PSUs and TSR based PSUs outstanding, respectively, with weighted-average grant date fair values of $ 17.84 and $ 24.38, respectively.

At June 30, 2011, there was approximately $ 4.8 million of unrecognized compensation cost related to all PSUs that is expected to be recognized over a weighted-average period of approximately 2.52 years.

The following table summarizes select information regarding our PSUs as of June 30, 2011:


	Share Units (in thousands)			Weighted- average grant date fair value
Balance at December 31, 2010		—		$	—
Granted		173,107		$	18.50
Vested		—		$	—
Forfeited		(1000	)	$	18.49

Balance at June 30, 2011		172,107		$	18.50

Restricted Stock Awards

Beginning in 2011, we also grant our non-employee directors restricted stock awards that vest after one year of service. The fair value of a restricted stock award is equal to the closing price of our common stock on the grant date. The following summarizes select information regarding our restricted stock awards as of June 30, 2011:


	Share Units (in thousands)		Weighted- average grant date fair value
Balance at December 31, 2010		—	$	—
Granted		27,000	$	17.30
Vested		—	$	—
Forfeited		—	$	—

Balance at June 30, 2011		27,000	$	17.30

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

As of June 30, 2011, there was approximately $ 0.30 million of unrecognized compensation cost related to RSUs which is expected to be recognized over a weighted average period of 0.65 years.

Employee Stock Purchase Plan

During the first six months of 2011, 16,991 shares were sold to employees. During the year ended December 31, 2010, 48,909 shares were sold to employees. As of June 30, 2011 there are approximately 413,069 shares available for issuance under this plan.

Under this plan, there are two plan periods: January 1 through June 30 (Plan Period One) and July 1 through December 31 (Plan Period Two). For Plan Period One in 2011, the fair value of approximately $77,000 was estimated using the Type B model with a risk free interest rate of 0.19%, volatility of 37.8% and an expected option life of 0.5 years. This fair value is being amortized over the six month period ending June 30, 2011.

Note 8. Income Tax Expense

Our income tax expense was $16.9 million and $18.4 million for the quarters ended June 30, 2011 and 2010, respectively and $40.8 million and $32.3 million for the six months ended June 30, 2011 and June 30, 2010, respectively. Our income tax expense includes federal, state and foreign income taxes at statutory rates and the effects of various permanent differences.

Our effective tax rates for the quarters ended June 30, 2011 and 2010 were 42.6% and 39.3%, respectively. For the six months ended June 30, 2011 and June 30, 2010, our effective tax rates were 40.8% and 39.3%, respectively. Our effective tax rate is higher than the statutory U.S. tax rate in all periods primarily due to state income taxes and certain share-based compensation that is not tax deductible. In addition, the effective tax rates for the quarter and six months ended June 30, 2011 are higher than the statutory U.S. tax rate due to an increase in the fair value of contingent consideration that is not deductible for tax purposes.

During the six months ended June 30, 2011, we had no material changes to our liability for uncertain tax positions. The examination of our 2008 U.S. income tax return concluded during the quarter ended March 31, 2011 with no material adjustments. Various state income tax returns are currently under examination. At this time, we do not believe that the results of these examinations will have a material impact on our financial statements.

Note 9. Comprehensive Income

The following table reconciles net income to comprehensive income for the three and six months ended June 30, 2011 and 2010:


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2011		2010		2011		2010
Net income	$	22,796	$	28,521	$	59,242	$	49,802
Other comprehensive:
Unrealized gains on available for sale securities, net		54		26		48		4
Currency translation adjustments, net		886		916		951		(700	)

Comprehensive income	$	23,736	$	29,463	$	60,241	$	49,106

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

The unrealized gains are reported net of federal and state income taxes.

Note 10. Earnings per share


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands, except per share data)	2011		2010		2011		2010
Basic Earnings Per Share
Net income	$	22,796	$	28,521	$	59,242	$	49,802
Common stock outstanding (weighted average)		76,000		77,825		76,919		77,666

Basic net income per share	$	0.30	$	0.37	$	0.77	$	0.64


Diluted Earnings Per Share
Net income	$	22,796	$	28,521	$	59,242	$	49,802
Add interest expense on senior convertible notes, net of income tax		1,883		1,796		3,727		3,557

Diluted net income	$	24,679	$	30,317	$	62,969	$	53,359

Common stock outstanding (weighted average)		76,000		77,825		76,919		77,666
Add shares from senior convertible notes		10,864		10,864		10,864		10,864
Add “in-the-money” stock options and stock awards		2,595		1,313		2,457		1,300

Common stock equivalents		89,459		90,002		90,240		89,830

Diluted net income per share	$	0.28	$	0.34	$	0.70	$	0.59

The following common shares that are associated with stock options were excluded from the calculations as their effect would be anti-dilutive:

Three Months Ended
June 30,

Six Months Ended
June 30,

(in thousands)

2011

2010

2011

2010

“Out-of-the-money” stock options

1,749

5,554

1,613

5,516

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

Note 11. Fair Value Measurement

Valuation Hierarchy - GAAP establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of June 30, 2011:


				Fair Value Measurements at June 30, 2011
(in thousands)	Total Carrying Value at June 30, 2011			(Level 1)		(Level 2)		(Level 3)
Cash and cash equivalents	$	390,395		$	390,395	$	—	$	—
Short term investments	$	127,845		$	127,845	$	—	$	—
Contingent consideration	$	(13,853	)	$	—	$	—	$	(13,853	)

Valuation Techniques – Cash, cash equivalents and short-term investments are measured at fair value using quoted market prices and are classified within Level 1 of the valuation hierarchy. There were no changes in valuation techniques during the quarter ended June 30, 2011.

The fair value of the Contingent consideration is measured using significant inputs not observable in the market, which are referred to in the guidance as Level 3 inputs. This fair value is estimated by applying a discount rate based on an implied rate of return from the acquisition to the risk probability weighted asset cash flows and the expected approval date to the probability adjusted payment amount. There were no changes in the valuation technique from the acquisition date. The contractual amount of contingent consideration related to the Auralis acquisition is £10.0 million (or approximately $16.0 million based on exchange rates at June 30, 2011). The fair value at acquisition was approximately £6.2 million or approximately $9.0 million.

At June 30, 2011 the fair value is approximately £8.6 million or approximately $13.9 million. Of the total change in the carrying value, approximately $2.5 million and $3.9 million is attributable to the change in the fair value from December 31, 2010 and from the acquisition date, respectively, with the balance attributable to the change in the GBP/$US exchange rate during those periods.

There were no transfers into or out of Levels 1 and 2 and there was no activity in Level 3.

We believe that the fair values of our current assets and current liabilities approximate their reported carrying amounts.

Note 12. Acquisitions

On May 28, 2010 we acquired a 100% ownership interest in Auralis Limited, a UK based specialty pharmaceutical company for approximately $14.5 million in upfront consideration for the acquisition of the company and its existing pharmaceutical licenses and products. We have also agreed to pay an additional payment of £10 million Pounds Sterling (approximately $16.0 million based on the June 30, 2011 exchange rate) upon the first regulatory approval of Buccolam.

The acquisition provides us with the opportunity to accelerate our European commercial systems, which will be utilized in the commercial launch of Cinryze™ (C1 esterase inhibitor [human]) in Europe if approved, for future product launches and potential additional business development acquisitions. The acquisition also provides immediate revenue from sales of a marketed product in the UK.

The contingent consideration will be payable upon the first regulatory approval of Buccolam. The fair value of the contingent consideration recognized on the acquisition date ($9.0 million) was estimated by applying a discount rate based on an implied rate of return from the acquisition to the risk probability weighted asset cash flows and the expected approval date. This fair value is based on significant inputs not observable in the market, which are referred to in the guidance as Level 3 inputs. The contingent consideration is classified as a liability and is subject to the recognition of subsequent changes in fair value.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

The results of Auralis’s operations have been included in the Consolidated Statement of Operations beginning June 1, 2010.

Note 13. Supplemental Cash Flow Information


	Six Months Ended June 30,
(in thousands)	2011		2010
Supplemental disclosure of non-cash transactions:
Employee share-based compensation	$	7,163	$	5,408
Unrealized gains on available for sale securities, net		48		4
Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	53,274	$	17,432
Cash paid for interest		2,050		2,050
Cash received for stock option exercises		2,858		1,256
Cash received for employee stock purchase plan		248		158

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

We are also developing VP20621 for the treatment and prevention of CDI. In May 2011, we initiated a Phase 2 dose-ranging clinical study to evaluate the safety, tolerability, and efficacy of VP 20621 for prevention of recurrence of CDI in adults previously treated for CDI. In May 2010, we acquired Auralis Limited, a UK based specialty pharmaceutical company. The acquisition of Auralis provides us with the opportunity to accelerate our European commercial systems for potential future product launches and additional business development acquisitions. In connection with the Auralis acquisition we acquired Buccolam^® (Oromucosal Solution, Midazolam [as hydrochloride]), for which we are seeking a pediatric-use marketing authorization (PUMA) for treatment of pediatric epilepsy in Europe. In June of 2011, the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) has adopted a positive opinion recommending approval of a PUMA for Buccolam. The acquisition also provided us revenue from sales of Diamorphine (Diamorphine Hydrochloride BP Injection) for palliative care and acute pain relief in the United Kingdom.

Executive Summary

Since March 31, 2011, we experienced the following:

Business Activities

Cinryze:

•

Shipped approximately 16,000 doses of Cinryze to specialty pharmacy/specialty distributors (SP/SD’s);

•

The European Commission granted us Centralized Marketing Authorization for Cinryze in adults and adolescents with HAE for routine prevention, pre-procedure prevention and acute treatment of angioedema attacks; and,

•

Announced a collaboration with Halozyme for combination of Halozyme’s recombinant human hyaluronidase enzyme (rHuPH20) technology with a C1 esterase inhibitor;

Buccolam:

•

The Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) has adopted a positive opinion recommending approval of a PUMA for Buccolam;

C. difficile infection (CDI):

•

Initiated a Phase 2 dose-ranging clinical study to evaluate the safety, tolerability, and efficacy of VP 20621 for prevention of recurrence of CDI in adults previously treated for CDI; and,

•

Vancocin scripts decreased 8.7% in the second quarter of 2011 as compared to the second quarter of 2010;

Financial Results

•

Increased net sales of Cinryze to $62.5 million as compared to $40.3 million in the second quarter of 2010;

•

Net sales of Vancocin decreased to $65.2 million from $68.4 million in the second quarter of 2010; and,

•

Reported net income of $22.8 million in the second quarter of 2011 compared to $28.5 million in the same quarter of 2010;

Liquidity

•

Generated net cash from operations of $68.5 million; and,

•

Ended the second quarter of 2011 with working capital of $585.3 million, which includes cash and cash equivalents and short-term investments of $518.2 million.

During the remainder of 2011 and going forward, we expect to face a number of challenges, which include the following:

The commercial sale of approved pharmaceutical products is subject to risks and uncertainties. There can be no assurance that future Vancocin sales will meet or exceed the historical rate of sales for the product, for reasons that include, but are not limited to, generic and non-generic competition for Vancocin and/or changes in prescribing habits or disease incidence.

The FDA convened a meeting of its Advisory Committee for Pharmaceutical Science and Clinical Pharmacology to discuss bioequivalence recommendations for oral vancomycin hydrochloride capsule drug products on August 4, 2009. The Advisory Committee was asked if the proposed guidelines are sufficient for establishing bioequivalence for generic vancomycin oral capsules. The Advisory Committee voted unanimously in favor of the component of the proposed OGD recommendation that requires bioequivalence to be demonstrated through comparable dissolution in media of pH 1.2, 4.5 and 6.8 for potential vancomycin HCl capsule generic products that (a) contain the same active and inactive ingredients in the same amounts as Vancocin HCl capsules; (b) meet currently accepted standards for assay, potency, purity, and stability (equivalent to those in place for Vancocin HCl capsules); and (c) are manufactured according to cGMP. We have opposed both the substance of the FDA’s bioequivalence method and the manner in which it was developed. In the event the OGD’s revised bioequivalence recommendation for Vancocin remains in effect, the time period in which a generic competitor may enter the market would be reduced. There can be no assurance that the FDA will agree with the positions stated in our Vancocin related submissions or that our efforts to oppose the OGD’s March 2006 and December 2008 recommendation to determine bioequivalence to Vancocin through in-vitro dissolution testing will be successful. We cannot predict the timeframe in which the FDA will make a decision regarding either our citizen petition for Vancocin or the approval of generic versions of Vancocin. If we are unable to change the recommendation set forth by the OGD in March 2006 as revised in December 2008 and voted upon by the Advisory Committee for Pharmaceutical Science and Clinical Pharmacology, the threat of generic competition will be high.

The FDA approved Cinryze for routine prophylaxis against angioedema attacks in adolescent and adult patients with hereditary angioedema on October 10, 2008. Cinryze became commercially available for routine prophylaxis against HAE in December 2008. The commercial success of Cinryze depends on several factors, including: the number of patients with HAE that may be treated with Cinryze; acceptance by physicians and patients of Cinryze as a safe and effective treatment; our ability to effectively market and distribute Cinryze in the United States; cost effectiveness of HAE treatment using Cinryze; relative convenience and ease of administration of Cinryze; potential advantages of Cinryze over alternative treatments; the timing of the approval of competitive products including another C1 esterase inhibitor for the acute treatment of HAE; the market acceptance of competing approved products such as Berinert; patients’ ability to obtain sufficient coverage or reimbursement by third-party payors; variations in dosing arising from physician preferences and patient compliance; sufficient supply and reasonable pricing of raw materials necessary to manufacture Cinryze; manufacturing or supply interruptions and capacity which could impair our ability to acquire an adequate supply of Cinryze to meet demand for the product; and our ability to achieve expansion of manufacturing capabilities in the capacities and timeframes currently anticipated. In addition, our ability to develop life cycle management plans for Cinryze, including designing and commencing clinical studies for additional indications and pursuing regulatory approvals in additional indications or territories will impact our ability to generate future revenues from Cinryze. In Europe, the European Commission has granted us Centralized Marketing Authorization for Cinryze in adults and adolescents with HAE for routine prevention, pre-procedure prevention and acute treatment of angioedema attacks. The approval also includes a self administration option for appropriately trained patients. In addition, the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) has adopted a positive opinion recommending approval of a PUMA for Buccolam. The commercial success of each of these products in Europe will depend on a number of factors, including our ability to achieve a regulatory approval of Buccolam in the timeframe we anticipate, the scope of regulatory protection afforded by the PUMA for Buccolam, the impact of the loss of orphan designation on Cinryze, and market acceptance of each of the products.

In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act (PPACA), which was amended by the Health Care and Education Reconciliation Act of 2010. The PPACA, as amended, is a sweeping measure intended to expand healthcare coverage within the United States, primarily through the imposition of health insurance mandates on employers and individuals and expansion of the Medicaid program. Several provisions of the new law, which have varying effective dates, will affect us. These include new requirements on private insurance companies that prohibit coverage denials because of a pre-existing condition; prohibit the application of annual and lifetime benefits limits on health insurance policies; and prohibit coverage rescissions (except for fraud) and health-based insurance rating. In addition, the PPACA, as amended, funds an interim high risk pool that states can draw on; following the expiration of this high risk pool funding, it provides for the creation of state-run “exchanges” that will allow people without employer-provided coverage, or who cannot afford their employer’s plan, to buy health insurance; and provides federal subsidies to those who cannot afford premiums. Collectively, these factors may increase the availability of reimbursement for patients seeking the products that ViroPharma commercializes. However, the Act, as amended, will likely increase certain of our costs as well. For example, an increase in the Medicaid rebate rate from 15.1% to 23.1% was effective as of January 1, 2010, and the volume of rebated drugs has been expanded to include beneficiaries in Medicaid managed care organizations, effective as of March 23, 2010. In 2011, the PPACA also imposes a manufacturer’s fee on the sale of branded Pharmaceuticals (excluding orphan drugs) to specified government programs, expands the 340B drug discount program (excluding orphan drugs), and includes a 50% discount on brand name drugs for Medicare Part D participants in the coverage gap, or “doughnut hole”. We have determined that the manufacturing fee is immaterial relative to our anticipated 2011 operating income and cash flow. We have also estimated that our incremental cost associated with the Medicare Part D coverage gap will be approximately $7.8 million during 2011. Our evaluation of PPACA, as amended, will continue to enable us to determine not only the immediate effects on our business, but also the trends and changes that may be encouraged by the legislation that may potentially impact on our business over time.

We will face intense competition in acquiring additional products to further expand our product portfolio. Many of the companies and institutions that we will compete with in acquiring additional products to further expand our product portfolio have substantially greater capital resources, research and development staffs and facilities than we have, and greater resources to conduct business development activities. We may need additional financing in order to acquire new products in connection with our plans as described in this report.

The outcome of our clinical development programs is subject to considerable uncertainties. We are currently undertaking studies on the viability of subcutaneous administration of Cinryze, either alone or in combination with Halozyme’s recombinant human hyaluronidase enzyme (rHuPH20) technology, and to identify further therapeutic uses and potentially expand the labeled indication for Cinryze to include other C1 mediated diseases, such as AMR and DGF. In addition, we are also developing VP20621 for the treatment and prevention of CDI and in May 2011 we initiated a Phase 2 dose-ranging clinical study. There can be no assurance that that our clinical programs with Cinryze and VP20621 will yield positive results or support further development of Cinryze for additional routes of administration or for additional indications or of VP20621 for the treatment and prevention of CDI. We cannot be certain that we will be successful in developing and ultimately commercializing any of our product candidates, that the FDA or other regulatory authorities will not require additional or unanticipated studies or clinical trial outcomes before granting regulatory approval, or that we will be successful in obtaining regulatory approval of any of our product candidates in the timeframes that we expect, or at all.

We cannot assure you that our current cash and cash equivalents and investments or cash flows from product sales will be sufficient to fund all of our ongoing development and operational costs, as well as the interest payable on our outstanding senior convertible notes, over the next several years, that planned clinical trials can be initiated, or that planned or ongoing clinical trials can be successfully concluded or concluded in accordance with our anticipated schedule and costs. Moreover, the results of our business development efforts could require considerable investments.

Our actual results could differ materially from those results expressed in, or implied by, our expectations and assumptions described in this Quarterly Report on Form 10-Q. The risks described in this report, our Form 10-Q for the Quarter ended June 30, 2011, are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. Please also see our discussion of the “Risk Factors” as described in our Form 10-K for the year ended December 31, 2010 in Item 1A and in our Form 10-Q for the quarter ended March 31, 2011, which describe other important matters relating to our business.

Results of Operations

Three and Six Months Ended June 30, 2011 and 2010


(in thousands, except per share data)	For the three months ended June 30,				For the six months ended June 30,
	2011		2010		2011		2010
Net product sales	$	128,808	$	108,961	$	255,843	$	199,609
Cost of sales (excluding amortization of product rights)	$	21,309	$	13,641	$	40,179	$	27,598
Operating income	$	42,308	$	53,057	$	102,366	$	91,512
Net income	$	22,796	$	28,521	$	59,242	$	49,802
Net income per share:
Basic	$	0.30	$	0.37	$	0.77	$	0.64
Diluted	$	0.28	$	0.34	$	0.70	$	0.59

The $42.3 million in operating income for the three month period ended June 30, 2011 decreased $10.7 million as compared to the same period in 2010 as the increase in overall net sales of $19.8 million have been offset by increased cost of sales $7.7 million due to the higher mix of Cinryze volume, a $9.0 million upfront fee related to our license arrangement with Halozyme, increased selling, general and administrative expenses of $6.7 million are primarily related to our European expansion efforts and our Cinryze marketing programs, a $3.4 million charge associated with the funding of Cinryze manufacturing enhancements at Sanquin and the impact of marking-to-market the Auralis contingent consideration liability.

The $102.4 million in operating income for the six months ended June 30, 2011 increased $10.9 million compared to the same period in 2010. The primary drivers of this increase are higher net sales of $56.2 million partly offset by increased cost of sales $12.6 million due to increased Cinryze volume, a $9.0 million upfront fee related to our license arrangement with Halozyme, increased selling, general and administrative expenses of $14.0 million are primarily related to our European expansion efforts and our Cinryze marketing programs, a $3.4 million charge associated with the funding of Cinryze manufacturing enhancements at Sanquin the impact of marking-to-market the Auralis contingent consideration liability.

Revenues

Revenues consisted of the following:


	For the three months ended June 30,				For the six months ended June 30,
(in thousands)	2011		2010		2011		2010
Net product sales
Vancocin	$	65,191	$	68,350	$	134,474	$	124,104
Cinryze		62,459		40,331		119,048		75,224
Other		1,158		280		2,321		281

Total revenues	$	128,808	$	108,961	$	255,843	$	199,609

Revenue

We sell Vancocin only to wholesalers who then distribute the product to pharmacies, hospitals and long-term care facilities, among others. Our sales of Vancocin are influenced by wholesaler forecasts of prescription demand, wholesaler buying decisions related to their desired inventory levels, and, ultimately, end user prescriptions, all of which could be at different levels from period to period.

We sell Cinryze to specialty pharmacy/specialty distributors (SP/SD’s) who then distribute to physicians, hospitals and patients, among others. During 2010, we continued work to expand our manufacturing capacity to insure the availability of Cinryze to meet growing patient needs and believe our efforts will allow us to continue to meet this growing patient demand for the foreseeable future. In the second quarter of 2010, we introduced parallel chromatography produced Cinryze into the trade which increased our supply so that we were able to start new patients on Cinryze as needed without undue concern of any disruption of the availability of Cinryze to those already receiving it. In order to meet anticipated longer term demand, we submitted to the FDA a Prior Approval Supplement (PAS) in the second quarter of 2010. The PAS involves a larger scale manufacturing project to significantly increase the Cinryze production capabilities at Sanquin. In October 2010, the FDA issued a complete response letter regarding the Cinryze industrial scale manufacturing expansion activities. In the complete response letter the FDA has requested additional information related to observations from the pre-approval inspection and review of the technical processes. We anticipate filing a response to the complete response letter during 2011 and in parallel will continue advancing additional initiatives intended to increase our capacity.

During the three month period ended June 30, 2011, net sales of Vancocin decreased 4.6% compared to the same period in 2010 due to reduced volumes partly offset by the effect of price increases during the second half of 2010 and the first quarter of 2011. During the six months ended June 30, 2011, net sales of Vancocin increased 8.4% compared to the same period in 2010 primarily due to the price increases during the second half of 2010 and the first quarter of 2011, partly offset by volume declines. Also, during the three and six months ended June 30, 2011 Vancocin net sales were reduced by approximately $1.8 million and $3.9 million, respectively, by the Medicare Part D coverage gap discount enacted under the PPACA which did not impact net sales in 2010. We anticipate that this discount will impact full year net sales by approximately $7.8 million during 2011. Based upon data reported by IMS Health Incorporated, prescriptions during the three and six months ended June 30, 2011 decreased from the same periods in 2010 period by 8.7% and 9.3%, respectively, which we believe is due to a decrease in the severity of the disease state, improved aseptic technique and a suspected increase in compounding seen both in the hospital and long-term care marketplace. Our net sales of Cinryze during the three and six months ended June 30, 2011 increased 54.9% and 58.3%, respectively, over the same periods in the prior year due to the increase in the number of patients receiving commercial drug.

Vancocin product sales are driven by demand fluctuations in trade inventories which could be at different levels from period to period. Cinryze product sales are influenced by prescriptions and the rate at which new patients are placed on Cinryze. We receive inventory data from our three largest wholesalers through our fee for service agreements and our two SP/SD’s through service agreements. We do not independently verify this data. Based on this inventory data and our estimates, we believe that as of June 30, 2011, the wholesalers and SP/SD’s did not have excess channel inventory.

Cost of sales (excluding amortization of product rights)

Cost of sales increased for the three months ended June 30, 2011 as compared to the prior year quarter by $7.7 million and increased for the six months ended June 30, 2011 by $12.6 million compared to the prior year. These increases are primarily due to the increased Cinryze volume which are partly offset by the $1.5 million recorded in the first quarter of 2010 related to non-refundable start up costs paid to a new plasma supplier.

Vancocin and Cinryze cost of sales includes the cost of materials and distribution costs and excludes amortization of product rights. Since units are shipped based upon earliest expiration date, we would expect the cost of product sales of both Vancocin and Cinryze to fluctuate from quarter to quarter as we may experience fluctuations in quarterly manufacturing yields.

Research and development expenses

For each of our research and development programs, we incur both direct and indirect expenses. Direct expenses include third party costs related to these programs such as contract research, consulting, cost sharing payments or receipts and clinical and development costs. Indirect expenses include personnel, facility, stock compensation and other overhead costs. Due to advancements in our VP20621 clinical program, and our Cinryze life cycle management program as well as cost associated with our efforts to advance additional initiatives intended to increase our Cinryze capacity, we expect future costs in these programs to increase from historical levels.

Research and development expenses were divided between our research and development programs in the following manner:


(in thousands)	For the three months ended June 30,				For the six months ended June 30,
	2011		2010		2011		2010

*Direct – Core programs*
Non-toxigenic strains of C. difficle (VP20621)	$	2,269	$	1,659	$	4,169	$	3,893
Cinryze & C1 esterase inhibitor		11,123		2,670		13,344		4,480
Vancocin		49		847		50		1,144

*Direct – Other Assets*
CMV		80		217		261		536
New Initiatives		700		—		1,181		—
Other assets		221		—		317		—
*Indirect*
Development		5,975		3,831		11,521		8,912

Total	$	20,417	$	9,224	$	30,843	$	18,965

Direct Expenses—Core Development Programs

The increase in costs of VP20621 in the three and six months ended June 30, 2011 over the same period in 2010 relates to timing of costs associated with our Phase 1 clinical trial and the initiation of our Phase 2 clinical trial during the current quarter.

Our costs associated with our Cinryze program increased during the three and six months ended June 30, 2011, as we incurred costs related to the continuation of our Phase 4 clinical trial, development of our life cycle program and quality assurance efforts in conjunction with increasing our manufacturing capacity. In the same period in the prior year, we incurred costs related to the preparation of our Phase 4 clinical trial. Also, during the second quarter of 2011 we made a $9.0 million upfront payment related to our entering into a license with Halozyme for the development of an alternative subcutaneous formulation of Cinryze for routine prophylaxis against attacks of HAE which we will begin to develop concurrently with our existing formulation.

Direct Expenses—Other Assets

Our direct expenses related to our CMV program decreased in the three and six months ended June 30, 2011 as we wound down our stem cell and liver transplant studies during 2010. During 2011, we continue to evaluate any potential alternative development strategies for maribavir.

Our costs related to New Initiatives represent expenses associated with our evaluation of a recombinant C1-INH technology and spending under our collaboration agreement with Sanquin supporting their Early Stage Research Programs.

Anticipated fluctuations in future direct expenses are discussed under “Liquidity – Development Programs.”

Indirect Expenses

These costs primarily relate to the compensation of and overhead attributable to our development team.

Selling, general and administrative expenses

Selling, general and administrative expenses (SG&A) increased for the three months ended June 30, 2011 by $6.7 million compared to the same period in the prior year primarily due to increases in compensation expense and employee cost of $3.2 million, marketing activities of $2.9 million and increased corporate cost of $0.8 million. For the six months ended June 30, 2011, SG&A increased $14.0 million compared to the same period in 2010. The increase of $14.0 million for the six month period was driven by increased compensation expense and employee cost of $6.2 million, increased marketing expenses of $3.7 million and increased corporate cost of $1.6 million.

To a large extent the overall increase in SG&A in both periods is driven by our European commercialization efforts and new Cinryze marketing programs. We anticipate that our SG&A spending will continue to increase in future periods as we continue our commercialization and expansion efforts outside the United States.

Intangible amortization and acquisition of technology rights

Intangible amortization for the three and six months ended June 30, 2011 were $7.2 million and $16.1 million, respectively, as compared to $7.6 million and $15.2 million, respectively in 2010. The year over year increases are primarily due to the amortization of the Auralis intangible assets acquired in May of 2010.

On an ongoing periodic basis, we evaluate the useful life of our intangible assets and determine if any economic, governmental or regulatory event has modified their estimated useful lives. This evaluation did not result in a change in the life of the intangible assets during the quarter ended June 30, 2011. We will continue to monitor the actions of the FDA and OGD surrounding the bioequivalence recommendation for Vancocin and consider the effects of our opposition efforts, any announcements by generic competitors or other adverse events for additional impairment indicators. We will reevaluate the expected cash flows and fair value of our Vancocin-related assets, as well as estimated useful lives, at such time.

Other operating expenses

The re-measurement of the fair value of the contingent consideration given for the acquisition of Auralis resulted in a charge to income of approximately $2.1 million and $2.5 million during the three and six months ended June 30, 2011, respectively. There was no such charge during 2010. Also included in other operating expenses for the three and six month periods ended June 30, 2011 are approximately $3.4 million of costs associated with the funding of Cinryze manufacturing enhancements at Sanquin.

Other Income (Expense)

Interest Income

Interest income for three and six months ended June 30, 2011 and 2010 was $0.2 million and $0.1 million and $0.4 million and $0.1 million, respectively.

Interest Expense


	For the three months ended June 30,				For the six months ended June 30,
(in thousands)	2011		2010		2011		2010
Interest expense on 2% senior convertible notes	$	1,025	$	1,025	$	2,050	$	2,050
Amortization of debt discount		1,944		1,780		3,779		3,497
Amortization of finance costs		97		97		194		194

Total interest expense	$	3,066	$	2,902	$	6,023	$	5,741

Interest expense and amortization of finance costs in 2011 and 2010 relates entirely to the senior convertible notes issued on March 26, 2007.

Other income (expense), net

Our other income (expense), net is primarily due to our foreign exchange gains and losses.

Income Tax Expense

The examination of our 2008 U.S. income tax return concluded during the quarter ended March 31, 2011 with no material adjustments. Various state income tax returns are currently under examination. At this time, we do not believe that the results of these examinations will have a material impact on our financial statements.

Liquidity

We expect that our sources of revenue will continue to arise from Cinryze and Vancocin product sales. However, future sales of Vancocin will vary based on the number of generic competitors that could enter the market if approved by the FDA, the timing of entry into the market of those generic competitors and/or the sales we may generate from an authorized generic version of Vancocin. In addition, there are no assurances that demand for Cinryze will continue to grow or that demand for Vancocin will continue at historical or current levels.

Our ability to generate positive cash flow is also impacted by the timing of anticipated events in our Cinryze and VP20621 development programs, including the timing of our expansion as we intend to seek to commercialize Cinryze in Europe and certain other countries, the scope of the clinical trials required by regulatory authorities, results from clinical trials, the results of our product development efforts, and variations from our estimate of future direct and indirect expenses.

The cash flows we have used in operations historically have been applied to research and development activities, marketing and commercial efforts, business development activities, general and administrative expenses, debt service, and income tax payments. Bringing drugs from the preclinical research and development stage through phase 1, phase 2, and phase 3 clinical trials and FDA and/or EMA or regulatory approval is a time consuming and expensive process. Because we have product candidates that are currently in the clinical stage of development, there are a variety of events that could occur during the development process that will dictate the course we must take with our drug development efforts and the cost of these efforts. As a result, we cannot reasonably estimate the costs that we will incur through the commercialization of any product candidate. However, our future costs may exceed current costs as we anticipate we will continue to invest in our pipeline on our initiative to develop VP20621 (non-toxigenic strains of C. difficile), our phase 4 program for Cinryze, any additional studies to identify further therapeutic uses and expand the labeled indication for Cinryze to potentially include other C1 mediated diseases as well as new modes of administration for Cinryze. Also, we will incur additional costs as we intend to seek to commercialize Cinryze in Europe in countries where we have distribution rights and certain other countries beginning in 2011 as well as conduct studies to identify additional C1 mediated diseases, such as AMR and

DGF, which may be of interest for further clinical development, and to evaluate new forms of administration for Cinryze. In May 2011, Halozyme Therapeutics (Halozyme) granted us an exclusive worldwide license to use Halozyme’s proprietary Enhanze™ technology, a proprietary drug delivery platform using Halozyme’s recombinant human hyaluronidase enzyme (rHuPH20) technology in combination with a C1 esterase inhibitor. We intend to apply rHuPH20 initially to develop a novel subcutaneous formulation of Cinryze for routine prophylaxis against attacks. Under the terms of the license agreement, we paid Halozyme an initial upfront payment of $9 million. Additionally, we will pay an annual maintenance fee of $1 million to Halozyme until specified events have occurred. Pending successful completion of a series of clinical and regulatory milestones, anticipated to begin during 2011, we may make further milestone payments to Halozyme which could reach up to an additional $44 million related to HAE and up to $30 million of additional milestone payments for three additional indications. Upon regulatory approval, Halozyme will receive up to a 10% royalty on net sales of the combination product utilizing Cinryze and rHuPH20, depending on the existence of a valid patent claim in the country of sale.

The most significant of our near-term operating development cash outflows are as described under “Development Programs” as set forth below.

We are required to pay contingent consideration to Lev shareholders upon achievement of a commercial milestone related to Cinryze sales and additional consideration to Auralis shareholders upon achievement of a regulatory milestone. Additionally, our operating expenses will not decrease significantly if there is the introduction of a generic Vancocin.

In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act (PPACA). The PPACA, as amended, will likely increase certain of our costs as well. For example, an increase in the Medicaid rebate rate from 15.1% to 23.1% was effective as of January 1, 2010, and the volume of rebated drugs has been expanded to include beneficiaries in Medicaid managed care organizations, effective as of March 23, 2010. In 2011, the PPACA also imposes a manufacturer’s fee on the sale of branded Pharmaceuticals (excluding orphan drugs) to specified government programs, expands the 340B drug discount program (excluding orphan drugs), and includes a 50% discount on brand name drugs for Medicare Part D participants in the coverage gap, or “donut hole”. We have determined that the manufacturing fee is immaterial relative to our anticipated 2011 operating income and cash flow. We have also estimated that our incremental cost associated with the Medicare Part D coverage gap will be approximately $7.8 million during 2011. Our evaluation of PPACA, as amended, will continue to enable us to determine not only the immediate effects on our business, but also the trends and changes that may be encouraged by the legislation that may potentially impact on our business over time.

While we anticipate that cash flows from Cinryze and Vancocin, as well as our current cash, cash equivalents and short-term investments, should allow us to fund our ongoing development and operating costs, as well as the interest payments on our senior convertible notes, we may need additional financing in order to expand our product portfolio. At June 30, 2011, we had cash, cash equivalents and short-term investments of $518.2 million. Short-term investments consist of high quality fixed income securities with remaining maturities of greater than three months at the date of purchase and high quality debt securities or obligation of departments or agencies of the United States. At June 30, 2011, the annualized weighted average nominal interest rate on our short-term investments was 0.29% and the weighted average length to maturity was 10.9 months.

From time to time, we may seek approval from our board of directors to evaluate additional opportunities to repurchase our common stock or convertible notes, including through open market purchases or individually negotiated transactions.

Overall Cash Flows

During the six months ended June 30, 2011, we generated $68.5 million of net cash from operating activities, primarily from our net income after adjustments for non-cash items partly offset by our net increase in working capital. We used $59.6 million of cash from investing activities mainly in the purchase of short-term investments, net of investment maturities. Our net cash used in financing activities for the six months ended June 30, 2011 was $45.9 million which relates to the common stock repurchase arrangement entered into during the quarter under our share repurchase program net of proceeds from stock option exercises. For the prior year period ended June 30, 2010, we generated $92.2 million of net cash from operating activities, primarily from our net income plus non-cash items and the change in accounts payable. We used $71.8 million of cash from investing activities mainly in the purchase of short-term investments, as well as in the purchase of Auralis and Vancocin assets and our net cash provided by financing activities for the six months ended June 30, 2010 was $1.1 million which relates to stock option exercises.

Development Programs

For each of our development programs, we incur both direct and indirect expenses. Direct expenses include third party costs related to these programs such as contract research, consulting, cost sharing payments or receipts, and preclinical and clinical development costs. Indirect expenses include personnel, facility and other overhead costs. Additionally, for some of our development programs, we have cash inflows and outflows upon achieving certain milestones.

Core Development Programs

Cinryze—We acquired Cinryze in October 2008 and through June 30, 2011 have spent approximately $32.8 million in direct research and development costs related to Cinryze since acquisition. During the remainder of 2011, we continue to expect research and development costs related to Cinryze to increase as we complete our Phase 4 commitment and initiate our Phase 2 study to evaluate Cinryze for treatment of acute HAE in children. Additionally, we will incur costs related to evaluating additional indications, formulations and territories as we develop our life cycle program related to Cinryze such as our efforts on both our own and the C1 esterase inhibitor/rHuPH20 combination sub-subcutaneous formulations, AMR and DGF. We are solely responsible for the costs of Cinryze development.

VP20621—We acquired VP20621 in February 2006 and through June 30, 2011 have spent approximately $28.1 million in direct research and development costs. For the remainder of 2011, we expect our research and development activities related to VP20621 to increase as we continue our development program and in May 2011 we initiated a Phase 2 dose-ranging clinical study to evaluate the safety, tolerability, and efficacy of VP 20621 for prevention of recurrence of CDI in adults previously treated for CDI. We are solely responsible for the costs of VP20621 development.

Vancocin—We acquired Vancocin in November 2004 and through June 30, 2011 have spent approximately $2.9 million in direct research and development costs related to Vancocin activities since acquisition.

Other Assets

In addition to the programs described above, we have several other assets that we may make additional investments in. These investments will be dependent on our assessment of the potential future commercial success of or benefits from the asset. These assets include maribavir for CMV, and other compounds. We will continue to incur costs associated with our other development assets for direct research and development costs for medicinal products which will address unmet medical needs such as our current evaluation of a recombinant C1-INH technology which may be included in future clinical studies.

Business development activities

On October 21, 2008, we completed our acquisition under which ViroPharma acquired Lev Pharmaceuticals, Inc. (Lev). Lev is a biopharmaceutical company focused on developing and commercializing therapeutic products for the treatment of inflammatory diseases. The terms of the merger agreement provided for the conversion of each share of Lev common stock into upfront consideration of $453.1 million, or $2.75 per Lev share, comprised of $2.25 per share in cash and $0.50 per share in ViroPharma common stock, and contingent consideration of up to $1.00 per share which may be paid on achievement of certain regulatory and commercial milestones. The target for the first CVR payment of $0.50 per share (or $87.5 million) will not be paid as a third party’s human C1 inhibitor product was approved for the acute treatment of HAE and granted orphan exclusivity. The second CVR payment of $0.50 per share ($87.5 million) becomes payable if Cinryze reaches at least $600 million in cumulative net product sales by October 2018 and we anticipate achieving this milestone in 2012.

We intend to continue to seek to acquire additional products or product candidates. The costs associated with evaluating or acquiring any additional product or product candidate can vary substantially based upon market size of the product, the commercial effort required for the product, the product’s current stage of development, and actual and potential generic and non-generic competition for the product, among other factors. Due to the variability of the cost of evaluating or acquiring business development candidates, it is not feasible to predict what our actual evaluation or acquisition costs would be, if any, however, the costs could be substantial.

Share Repurchase Program

On March 9, 2011 our Board of Directors authorized the use of up to $150.0 million to repurchase shares of our common stock and/or our 2% Senior Convertible Notes due 2017. Purchases may be made by means of open market transactions, block transactions, privately negotiated purchase transactions or other techniques from time to time. The sources of cash for this repurchase program are expected to be a combination of our available liquid assets and/or our anticipated cash flows from operations, and we anticipate executing under this authorization from time to time until fully utilized.

Senior Convertible Notes

As of January 1, 2009 we account for the debt and equity components of our convertible debt securities as bifurcated instruments which are accounted for separately. Accordingly, the convertible debt securities will recognize interest expense at effective rates of 8.0% as they are accreted to par value.

The call options allowed ViroPharma to receive up to approximately 13.25 million shares of its common stock at $18.87 per share from the call option holders, equal to the number of shares of common stock that ViroPharma would issue to the holders of the senior convertible notes upon conversion. These call options will terminate upon the earlier of the maturity dates of the related senior convertible notes or the first day all of the related senior convertible notes are no longer outstanding due to conversion or otherwise. Concurrently, we sold warrants to the warrant holders to receive shares of its common stock at an exercise price of $24.92 per share. These warrants expire ratably over a 60-day trading period beginning on June 13, 2017 and will be net-share settled.

The purchased call options are expected to reduce the potential dilution upon conversion of the senior convertible notes in the event that the market value per share of our common stock at the time of exercise is greater than $18.87, which corresponds to the initial conversion price of the senior convertible notes, but less than $24.92 (the warrant exercise price). The warrant exercise price is 75.0% higher than the price per share of $14.24 of our stock price on the pricing date. If the market price per share of our common stock at the time of conversion of any senior convertible notes is above the strike price of the purchased call options ($18.87), the purchased call options will entitle us to receive from the counterparties in the aggregate the same number of shares of our common stock as we would be required to issue to the holder of the converted senior convertible notes. Additionally, if the market price of our common stock at the time of exercise of the sold warrants exceeds the strike price of the sold warrants ($24.92), we will owe the counterparties an aggregate of approximately 13.25 million shares of our common stock. If we have insufficient shares of common stock available for settlement of the warrants, we may issue shares of a newly created series of preferred stock in lieu of our obligation to deliver common stock. Any such preferred stock would be convertible into 10% more shares of our common stock than the amount of common stock we would otherwise have been obligated to deliver under the warrants. We are entitled to receive approximately 10.87 million shares of its common stock at $18.87 from the call option holders and if the market price of our common stock at the time of exercise of the sold warrants exceeds the strike price of the sold warrants ($24.92), will owe the counterparties an aggregate of approximately 10.87 million shares of our common stock.

and sold warrants meet the definition of derivatives. These instruments have been determined to be indexed to our own stock and have been recorded in stockholders’ equity in our unaudited Condensed Consolidated Balance Sheets. As long as the instruments are classified in stockholders’ equity they are not subject to the mark to market requirements of US GAAP.

Capital Resources

While we anticipate that cash flows from Cinryze and Vancocin, as well as our current cash, cash equivalents and short-term investments, should allow us to fund our ongoing development and operating costs, as well as the interest payments on our senior convertible notes, we may need additional financing in order to expand our product portfolio. At June 30, 2011, we had cash, cash equivalents and short-term investments of $518.2 million. Our investments consist of high quality fixed income securities and high quality debt securities or obligation of departments or agencies of the United States. We generally invest in financial instruments with maturities of less than one year. At June 30, 2011, the annualized weighted average nominal interest rate on our investment portfolio was 0.29% and the weighted average length to maturity was 10.9 months.

Should we need financing, we would seek to access the public or private equity or debt markets, enter into additional arrangements with corporate collaborators to whom we may issue equity or debt securities or enter into other alternative financing arrangements that may become available to us.

Financing

If we raise additional capital by issuing equity securities, the terms and prices for these financings may be much more favorable to the new investors than the terms obtained by our existing stockholders. These financings also may significantly dilute the ownership of existing stockholders.

If we raise additional capital by accessing debt markets, the terms and pricing for these financings may be much more favorable to the new lenders than the terms obtained from our prior lenders. These financings also may require liens on certain of our assets that may limit our flexibility.

Additional equity or debt financing, however, may not be available on acceptable terms from any source as a result of, among other factors, our operating results, our inability to achieve regulatory approval of any of our product candidates, and our inability to file, prosecute, defend and enforce patent claims and or other intellectual property rights. If sufficient additional financing is not available, we may need to delay, reduce or eliminate current development programs, or reduce or eliminate other aspects of our business.

We may seek additional authorization from our board of directors to evaluate additional opportunities to repurchase our common stock or convertible notes, including through open market purchases or individually negotiated transactions.

Critical Accounting Policies

Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America. Preparing consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and contingent assets and liabilities. Actual results could differ from such estimates. These estimates and assumptions are affected by the application of our accounting policies. Critical policies and practices are both most important to the portrayal of a company’s financial condition and results of operations, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

Our summary of significant accounting policies is described in Note 2 to our Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2010. However, we consider the following policies and estimates to be the most critical in understanding the more complex judgments that are involved in preparing our consolidated financial statements and that could impact our results of operations, financial position, and cash flows:

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Product Sales—Our net sales consist of revenue from sales of our products, Vancocin, Cinryze and Diamorphine, less estimates for chargebacks, rebates, distribution service fees, returns and losses. We recognize revenue for product sales when title and risk of loss has passed to the customer, which is typically upon delivery to the customer, when estimated provisions for chargebacks, rebates, distribution service fees, returns and losses are reasonably determinable, and when collectability is reasonably assured. Revenue from the launch of a new or significantly unique product may be deferred until estimates can be made for chargebacks, rebates and losses and all of the above conditions are met and when the product has achieved market acceptance, which is typically based on dispensed prescription data and other information obtained during the period following launch.

At the end of each reporting period we analyze our estimated channel inventory and we would defer recognition of revenue on product that has been delivered if we believe that channel inventory at a period end is in excess of ordinary business needs. Further, if we believe channel inventory levels are increasing without a reasonably correlating increase in prescription demand, we proactively delay the processing of wholesaler orders until these levels are reduced.

We establish accruals for chargebacks and rebates, sales discounts and product returns. These accruals are primarily based upon the history of Vancocin and for Cinryze they are based on information on payee’s obtained from our SP/SD’s and CinryzeSolutions. We also consider the volume and price of our products in the channel, trends in wholesaler inventory, conditions that might impact patient demand for our product (such as incidence of disease and the threat of generics) and other factors.

In addition to internal information, such as unit sales, we use information from external resources, which we do not verify, to estimate the Vancocin channel inventory. Our external resources include prescription data reported by IMS Health Incorporated and written and verbal information obtained from our three largest wholesaler customers with respect to their inventory levels. Based upon this information, we believe that inventory held at these warehouses are within normal levels.

Chargebacks and rebates are the most subjective sales related accruals. While we currently have no contracts with private third party payors, such as HMO’s, we do have contractual arrangements with governmental agencies, including Medicaid. We establish accruals for chargebacks and rebates related to these contracts in the period in which we record the sale as revenue. These accruals are based upon historical experience of government agencies’ market share, governmental contractual prices, our current pricing and then-current laws, regulations and interpretations. We analyze the accrual at least quarterly and adjust the balance as needed. These analyses have been adjusted to reflect the U.S. healthcare reform acts and their affect on governmental contractual prices and rebates. We believe that a 10% change in our estimate of the actual rate of sales subject to governmental rebates would affect our operating income and accruals by approximately $2.1 million in the period of adjustment.

Annually, as part of our process, we performed an analysis on the share of Vancocin and Cinryze sales that ultimately go to Medicaid recipients and result in a Medicaid rebate. As part of that analysis, we considered our actual Medicaid historical rebates processed, total units sold and fluctuations in channel inventory. We also consider our payee mix for Cinryze based on information obtained at the time of prescription.

Under the PPACA we are required to fund 50% of the Medicare Part D insurance coverage gap for prescription drugs sold to eligible patients staring on January 1, 2011. For Vancocin sales subject to this discount we recognize this cost using an effective rebate percentage for all sales to Medicare patients throughout the year. For applicable Cinryze sales we recognize this cost at the time of sale for product expected to be purchased by a Medicare Part D insured patient when we estimate they are within the coverage gap.

Product return accruals are estimated based on Vancocin’s history of damage and product expiration returns and are recorded in the period in which we record the sale of revenue. Cinryze has a no returns policy.

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Impairment of Long-lived Assets—We review our fixed and long-lived intangible assets for possible impairment annually and whenever events occur or circumstances indicate that the carrying amount of an asset may not be recoverable. The impairment test is a two-step test. Under step one we assess the recoverability of an asset (or asset group). The carrying amount of an asset (or asset group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected from the use and eventual disposition of the asset (or asset group). The impairment loss is measured in step two as the difference between the carrying value of the asset (or asset group) and its fair value. Assumptions and estimates used in the evaluation of impairment may affect the carrying value of long-lived assets, which could result in impairment charges in future periods. Such assumptions include, for example, projections of future cash flows and the timing and number of generic/competitive entries into the market, in determining the undiscounted cash flows, and if necessary, the fair value of the asset and whether impairment exists. These assumptions are subjective and could result in a material impact on operating results in the period of impairment.

On an ongoing periodic basis, we evaluate the useful life of intangible assets and determine if any economic, governmental or regulatory event has modified their estimated useful lives.

On August 4, 2009 the FDA’s Pharmaceutical Science and Clinical Pharmacology Advisory Committee voted in favor of the component of the OGD’s 2008 draft guidelines on bioequivalence for Vancocin that permits bioequivalence to be demonstrated through comparable in vitro dissolution for potential vancomycin HCl capsule generic products that contain the same active and inactive ingredients in the same amounts as Vancocin, among other requirements. If FDA’s proposed bioequivalence method for Vancocin becomes effective, the time period in which a generic competitor could be approved would be reduced and multiple generics may enter the market, which would materially impact our operating results, cash flows and possibly intangible asset valuations. This could also result in a reduction to the useful life of the Vancocin-related intangible assets. Management currently believes there are no indicators that would require a change in useful life as management believes that Vancocin will continue to be utilized along with generics that may enter the market, and the number of generics and the timing of their market entry is unknown.

A reduction in the useful life, as well as the timing and number of generics, will impact our cash flow assumptions and estimate of fair value, perhaps to a level that could result in an impairment charge. We will continue to monitor the actions of the OGD and consider the effects of our opposition actions and any announcements by generic competitors or other adverse events for additional impairment indicators. We will reevaluate the expected cash flows and fair value of our Vancocin-related assets at such time a triggering event occurs.

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Impairment of Goodwill and Indefinite-lived Intangible Assets – We review the carrying value of goodwill and indefinite-lived intangible assets, to determine whether impairment may exist. The goodwill impairment test consists of two steps. The first step compares a reporting unit’s fair value to its carrying amount to identify potential goodwill impairment. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the second step of the impairment test must be completed to measure the amount of the reporting unit’s goodwill impairment loss, if any. Step two requires an assignment of the reporting unit’s fair value to the reporting unit’s assets and liabilities to determine the implied fair value of the reporting unit’s goodwill. The implied fair value of the reporting unit’s goodwill is then compared with the carrying amount of the reporting unit’s goodwill to determine the goodwill impairment loss to be recognized, if any. The impairment test for indefinite-lived intangible assets is a one-step test, which compares the fair value of the intangible asset to its carrying value. If the carrying value exceeds its fair value, an impairment loss is recognized in an amount equal to the excess. Based on accounting standards, it is required that these assets be assessed annually for impairment unless a triggering event occurs between annual assessments which would then require an assessment in the period which a triggering event occurred.

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Share-Based Payments—We record the estimated grant date fair value of awards granted as stock-based compensation expense in our consolidated statements of operations over the requisite service period, which is generally the vesting period.

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Income Taxes—Our annual effective tax rate is based on projected pre-tax earnings, enacted statutory tax rates, limitations on the use of tax credits and net operating loss carryforwards, evaluation of qualified expenses related to the orphan drug credit and tax planning opportunities available in the jurisdictions in which we operate. Significant judgment is required in determining our annual effective tax rate.

We calculate our quarterly effective tax rate based on projected income, permanent differences and credits by jurisdiction, enacted statutory tax rates, and other items. Discrete tax impacts are recorded in the quarter in which they occur.

On a periodic basis, we evaluate the realizability of our deferred tax assets and will adjust such amounts in light of changing facts and circumstances, including but not limited to projections of future taxable income, the reversal of deferred tax liabilities, tax legislation, rulings by relevant tax authorities, tax planning strategies and the progress of ongoing tax examinations. As part of this evaluation, we consider whether it is more likely than not that all or some portion of the deferred tax asset will not be realized. The ultimate realization of a deferred tax asset is dependent upon the generation of future taxable income during the period in which the related temporary difference becomes deductible or the NOL and credit carryforwards can be utilized. With respect to the reversal of valuation allowances, we consider the level of past and future taxable income, the existence and nature of reversing deferred tax liabilities, the utilization of carryforwards and other factors. Revisions to the estimated net realizable value of the deferred tax asset could cause our provision for income taxes to vary significantly from period to period.

We recognize the benefit of tax positions that we have taken or expect to take on the income tax returns we file if such tax position is more likely than not of being sustained. Settlement of filing positions that may be challenged by tax authorities could impact our income tax expense in the year of resolution.

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Acquisition Accounting — The application of the purchase accounting requires certain estimates and assumptions especially concerning the determination of the fair values of the acquired intangible assets and property, plant and equipment as well as the liabilities assumed at the date of the acquisition. Moreover, the useful lives of the acquired intangible assets, property, plant and equipment have to be determined.

The total purchase price of businesses acquired will be allocated to the net tangible assets and identifiable intangible assets based on their fair values as of the date of the acquisition and the fair value of any contingent consideration. Changes in the fair value of contingent consideration will be expensed in the period in which the change in fair value occurs. Additionally, acquired IPR&D projects will initially be capitalized and considered indefinite-lived assets subject to annual impairment reviews or more often upon the occurrence of certain events. For those compounds that reach commercialization, the assets are amortized over the expected useful lives.

Measurement of fair value and useful lives are based to a large extent on anticipated cash flows. If actual cash flows vary from those used in calculating fair values, this may significantly affect our future results of operations. In particular, the estimation of discounted cash flows of intangible assets of newly developed products is subject to assumptions closely related to the nature of the acquired products. Factors that may affect the assumptions regarding future cash flows:

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long-term sales forecasts,

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anticipation of selling price erosion after the end of orphan exclusivity due to follow-on biologic competition in the market,

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behavior of competitors (launch of competing products, marketing initiatives etc.).

For significant acquisitions, the purchase price allocation is carried out with assistance from independent third-party valuation specialists. The valuations are based on information available at the acquisition date.

As our business evolves, we may face additional issues that will require increased levels of management estimation and complex judgments.

Recently Issued Accounting Pronouncements

In March 2010, the FASB ratified EITF Issue No. 08-9, Milestone Method of Revenue Recognition and as a result of this ratification the FASB issued ASU 2010-17 in April 2010, which states that the milestone method is a valid application of the proportional performance model for revenue recognition if the milestones are substantive and there is substantive uncertainty about whether the milestones will be achieved. The Task Force agreed that whether a milestone is substantive is a judgment that should be made at the inception of the arrangement. To meet the definition of a substantive milestone, the consideration earned by achieving the milestone (1) would have to be commensurate with either the level of effort required to achieve the milestone or the enhancement in the value of the item delivered, (2) would have to relate solely to past performance, and (3) should be reasonable relative to all deliverables and payment terms in the arrangement. No bifurcation of an individual milestone is allowed and there can be more than one milestone in an arrangement. The new guidance is effective for interim and annual periods beginning on or after June 15, 2010. We adopted this ASU January 1, 2011. The adoption of this guidance did not have a material impact on our results of operations, cash flows, and financial position.

In December 2010, the FASB issued ASU 2010-27, Fees Paid to the Federal Government by Pharmaceutical Manufactures (EITF Issue 10-D; ASC 720), which addresses how pharmaceutical manufacturers should recognize and classify in the income statements fees mandated by the patient protection and Affordable Care Act as amended by the Health Care Education Reconciliation Act. The ASU specifies that the liability for the fee be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to operating expense using a straight-line method of allocation unless another method better allocates the fee over the calendar year. The new guidance is effective for calendar years beginning after December 31, 2010. We adopted this ASU January 1, 2011. The adoption of this guidance does not have a material impact on our results of operations, cash flows, and financial position.

On June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (Topic 220). This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. The standard is intended to enhance comparability between entities that report under US GAAP and those that report under IFRS, and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity. Under the ASU, an entity can elect to present items of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive, statements. Each component of net income and each component of other comprehensive income, together with totals for comprehensive income and its two parts, net income and other comprehensive income, would need to be displayed under either alternative. The statement(s) would need to be presented with equal prominence as the other primary financial statements. The ASU does not change items that constitute net income and other comprehensive income, when an item of other comprehensive income must be reclassified to net income or the earnings-per-share computation (which will continue to be based on net income). The new US GAAP requirements are effective for public entities as of the beginning of a fiscal year that begins after December 15, 2011 and interim and annual periods thereafter. Early adoption is permitted, but full retrospective application is required under the accounting standards. We do not expect the amendments to U.S. GAAP to have a material impact on our results of operations, cash flows, and financial position.

Contractual Obligations

We have committed to purchase a minimum number of liters of plasma per year through 2015 from our supplier. Additionally, we are required to purchase a minimum number of units from our third party toll manufacturers. The total minimum purchase commitments for these continuing arrangements as of June 30, 2011 are approximately $335.2 million.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Our holdings of financial instruments are primarily comprised of money market funds holding only U.S. government securities and fixed income securities, including a mix of corporate debt and government securities. All such instruments are classified as securities available for sale. Our debt security portfolio represents funds held temporarily pending use in our business and operations. We manage these funds accordingly. Our primary investment objective is the preservation of principal, while at the same time optimizing the generation of investment income. We seek reasonable assuredness of the safety of principal and market liquidity by investing in cash equivalents (such as Treasury bills and money market funds) and fixed income securities (such as U.S. government and agency securities, municipal securities, taxable municipals, and corporate notes) while at the same time seeking to achieve a favorable rate of return. Our market risk exposure consists principally of exposure to changes in interest rates. Our holdings are also exposed to the risks of changes in the credit quality of issuers. We generally invest in financial instruments with maturities of less than one year. The carrying amount, which approximates fair value based on the level 1 valuation hierarchy of the fair value measurement standard, and the annualized weighted average nominal interest rate of our investment portfolio at June 30, 2011, was approximately $127.8 million and 0.29%, respectively. The weighted average length to maturity was 10.9 months. A one percent change in the interest rate would have resulted in a $0.3 million impact to interest income for the quarter ended June 30, 2011.

At June 30, 2011, we had principal outstanding of $205.0 million of our senior convertible notes. The senior convertible notes bear interest at a rate of 2% per annum, payable semi-annually in arrears on March 15 and September 15 of each year commencing on September 15, 2007. The senior convertible notes are convertible into shares of our common stock at an initial conversion price of $18.87 per share. The senior convertible notes may only be converted: (i) anytime after December 15, 2016; (ii) during the five business-day period after any five consecutive trading day period (the “measurement period”) in which the price per note for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such day; (iii) during any calendar quarter (and only during such quarter) after the calendar quarter ending June 30, 2007, if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter; or (iv) upon the occurrence of specified corporate events. Upon conversion, holders of the senior convertible notes will receive shares of common stock, subject to our option to irrevocably elect to settle all future conversions in cash up to the principal amount of the senior convertible notes, and shares for any excess. We can irrevocably elect this option at any time on or prior to the 35th scheduled trading day prior to the maturity date of the senior convertible notes. The senior convertible notes may be required to be repaid on the occurrence of certain fundamental changes, as defined in the senior convertible notes. As of June 30, 2011, the fair value of the principal of the $205.0 million convertible senior notes outstanding was approximately $251.7 million, based on the level 2 valuation hierarchy of the fair value measurements standard. The carrying value of the debt at June 30, 2011 is $149.5 million.

In connection with the issuance of the senior convertible senior notes, we have entered into privately-negotiated transactions with two counterparties (the “counterparties”), comprised of purchased call options and warrants sold. These transactions are expected to generally reduce the potential equity dilution of our common stock upon conversion of the senior convertible notes. These transactions expose us to counterparty credit risk for nonperformance. We manage our exposure to counterparty credit risk through specific minimum credit standards, and diversification of counterparties.

ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer, or CEO, and our Chief Financial Officer, or CFO, of the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of June 30, 2011. Based on that evaluation, our management, including our CEO and CFO, concluded that as of June 30, 2011 our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to the Company’s management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

During the second quarter of 2011 there were no significant changes in our internal control over financial reporting identified in connection with the evaluation of such controls that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

On May 26, 2011, we filed a notice of appeal to the United States Court of Appeals for the District of Columbia Circuit from the final order granting a motion to dismiss the Company’s motion for declaratory relief (the “Complaint”) against the Food and Drug Administration, Margaret A. Hamburg, M.D., in her official capacity as Commissioner of Food and Drug Administration, the United States Department of Health and Human Services (“HHS”), and Kathleen Sebelius, in her official capacity as Secretary of HHS, (collectively “FDA”) entered in the United States District Court for the District of Columbia (the “District Court”) on April 15, 2011. Pursuant to the Complaint, we sought review under the Administrative Procedure Act (“APA”) of the FDA’s decision to change its regulations to abandon its longstanding rule that an applicant for an Abbreviated New Drug Application (“ANDA”) seeking to demonstrate bioequivalence must do so through in vivo evidence unless the applicant obtains a waiver pursuant to the enumerated waiver criteria set forth in 21 C.F.R. § 320.22. We had requested that the Court determine that (i) the plain reading of FDA’s regulations requires in vivo bioequivalence testing unless one of the criteria set forth in 21 C.F.R. § 320.22 is satisfied, and (ii) FDA’s amendment of its regulations governing waiver of submission of in vivo bioequivalence evidence, without notice-and-comment rulemaking, violates 5 U.S.C. § 553 of the APA and was therefore invalid. The District Court did not address these arguments but instead granted the motion to dismiss brought by the defendants on a basis of a lack of standing. Our future filings with the United States Court of Appeals for the District of Columbia Circuit will specify the basis for the appeal.

From time to time we are a party to litigation in the ordinary course of our business. We do not believe these matters, even if adversely adjudicated or settled, would have a material adverse effect on our financial condition, results of operations or cash flows.

ITEM 1A.

Risk Factors

We are providing the following information regarding changes that have occurred to previously disclosed risk factors from our Annual Report on Form 10-K for the year ended December 31, 2010 and 10-Q for the quarter ended March 31, 2011. In addition to the other information set forth below and elsewhere in this report, you should carefully consider the factors discussed under the heading “Risk Factors” in our Form 10-K for the year ended December 31, 2010 and 10-Q for the quarter ended March 31, 2011. The risks described in our Quarterly Report on Form 10-Q are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

We currently depend, and will in the future continue to depend, on third parties to manufacture raw, intermediate and finished goods for Vancocin, Cinryze and our product candidates. If these manufacturers fail to meet our requirements and the requirements of regulatory authorities, our future revenues may be materially adversely affected.

We do not have the internal capability to manufacture quantities of pharmaceutical products to supply our clinical or commercial needs under the current Good Manufacturing Practice regulations, or cGMPs, required by the FDA and other regulatory agencies. In order to continue to develop products, apply for regulatory approvals and commercialize our products, we will need to contract with third parties that have, or otherwise develop, the necessary manufacturing capabilities.

There are a limited number of manufacturers that operate under cGMPs that are capable of manufacturing our products and product candidates. As such, if we are unable to enter into supply and processing contracts with any of these manufacturers or processors for our development stage product candidates, there may be additional costs and delays in the development and commercialization of these product candidates. For example, Cinryze is a biologic which requires processing steps that are more difficult than those required for most chemical pharmaceuticals and therefore the third party contracts must have additional technical skills and multiple steps to attempt to control the manufacturing processes.

Problems with these manufacturing processes such as equipment malfunctions, facility contamination, labor problems, raw material shortages or contamination, natural disasters, power outages, terrorist activities, or disruptions in the operations of our suppliers and even minor deviations from the normal process, could result in product defects or manufacturing failures that result in lot failures, product recalls, product liability claims and insufficient inventory.

If we are required to find an additional or alternative source of supply, there may be additional costs and delays in the development or commercialization of our product candidates. Additionally, the FDA and other regulatory agencies routinely inspect manufacturing facilities before approving a new drug application, or NDA, or biologic application, or BLA, for a drug or biologic manufactured at those sites. If any of our manufacturers or processors fails to satisfy regulatory requirements, the approval and eventual commercialization of our products and product candidates may be delayed. For example, in addition to FDA, Sanquin is also subject to the requirements of the European health authorities which may impose on Sanquin obligations relating to facility maintenance and/or equipment modifications that could cause delays in Cinryze production.

In addition, regulatory agencies subject a marketed therapy, its manufacturer and the manufacturer’s facilities to continual review and periodic inspections. The discovery of

previously unknown problems with a therapy or the facility or process used to produce the therapy could prompt a regulatory authority to impose restrictions on us or delay approvals for new products or could cause us to voluntarily adopt restrictions, including withdrawal of one or more of our products or services from the market.

In September 2010, in connection with an FDA pre-approval inspection of the larger scale manufacturing line under development by Sanquin, our contract manufacturer for Cinryze, FDA issued a notice of observations at the close of the inspection on FDA Form 483. The FDA also issued a complete response letter regarding Cinryze™ (C1 Esterase Inhibitor [Human]) industrial scale manufacturing expansion activities. The FDA requested additional information related to observations from the pre-approval inspection and review of the technical processes. In addition, during 2009, FDA inspected two sites maintained by our contract manufacturer for Cinryze and issued a notice of observations at the close of the inspection on FDA Form 483 for each site. The observations at one site were subsequently remedied and a notice to this effect was issued by the FDA. Responses to the observations made at the second site have been provided to the FDA, however, several of the responses remain the subject of continuing corrective and preventive action procedures. Also, at the close of the pre-approval inspection of the facility at which the Cinryze industrial scale manufacturing expansion activities will occur, the FDA issued a notice of observations on FDA Form 483. In May 2011, the FDA conducted a biennial inspection of one of the sites maintained by our contract manufacturer for Cinryze and issued a notice of observations at the close of the inspection on FDA Form 483 for such site. Responses to the observations made at this site have been provided to the FDA. Several of the responses remain the subject of continuing corrective and preventive action procedures. If any of our manufacturers or processors fails to satisfy regulatory requirements, operations at such facility may be halted which could result in our inability to supply product to patients and reduce our revenues.

All of our contract manufacturers must comply with the applicable cGMPs, which include quality control and quality assurance requirements as well as the corresponding maintenance of records and documentation. If our contract manufacturers do not comply with the applicable cGMPs and other FDA regulatory requirements, we may be subject to product liability claims, the availability of marketed products for sale could be reduced, our product commercialization could be delayed or subject to restrictions, we may be unable to meet demand for our products and may lose potential revenue and we could suffer delays in the progress of clinical trials for products under development. We do not have control over our third-party manufacturers’ compliance with these regulations and standards. Moreover, while we may choose to manufacture products in the future, we have no experience in the manufacture of pharmaceutical products for clinical trials or commercial purposes. If we decide to manufacture products, we would be subject to the regulatory requirements described above. In addition, we would require substantial additional capital and would be subject to delays or difficulties encountered in manufacturing pharmaceutical products. No matter who manufactures the product, we will be subject to continuing obligations regarding the submission of safety reports and other post-market information.

We depend on single manufacturers for certain components used in Vancocin and Cinryze and the loss of either of these suppliers or any supplier in general would have a negative impact on our operations.

We rely on a single supplier of vancomycin, the active pharmaceutical ingredient (API) of Vancocin, and also rely on a single manufacturer of Vancocin capsules. Our third party API supplier and finished product supplier are the only manufacturers qualified by the FDA to manufacture API and Vancocin capsule finished product for distribution and sale in the United States. We are therefore dependent upon these suppliers and attempt to maintain Vancocin inventory levels to meet our current projections, plus a reasonable stock in excess of those projections.

We rely on a single manufacturer of Cinryze. Pursuant to our distribution agreement, Sanquin Blood Supply Foundation will supply us with certain annual minimum and maximum amounts of CINRYZE. In the event that certain events occur which result in Sanquin permanently ceasing to manufacture Cinryze, Sanquin will grant us a perpetual license under its intellectual property related to the Product and assign to us each of the agreements with such third party manufacturers. In consideration thereof, we will pay a one-time fee to Sanquin as well as a royalty on future sales of products. In the event demand for Cinryze is greater than the amount supplied by Sanquin, we will not be able to meet such demand as there are no other sources of supply of Cinryze available to us. In the event Sanquin permanently ceases to manufacture Cinryze, we will need to find an alternate manufacturer of Cinryze. Currently, to our knowledge, there is only one other commercial supplier of C1 esterase inhibitor and that supplier has recently received marketing approval for their product in the United States. Accordingly, in the event Sanquin permanently ceases to manufacture Cinryze, we cannot be certain that we would be able to locate another willing supplier for our product on the terms we require.

There are numerous factors that could cause interruptions in the supply of our products, including regulatory reviews; changes in our sources for manufacturing; or disputes with a manufacturer. Our failure to timely locate and obtain replacement manufacturers as needed and conditions affecting the cost and availability of raw materials are magnified when the suppliers are limited in number. Any interruption in the supply of finished products could hinder our ability to timely distribute our products and satisfy customer demand. If we are unable to obtain adequate product supplies to satisfy our customers’ orders, we may lose those orders, our customers may cancel other orders, and they may choose instead to stock and purchase competing products. Supply interruptions may occur, and our inventory may not always be adequate. This in turn could cause a loss of our market share and negatively affect our revenues. We maintain limited property insurance which would only protect us from physical damage to our assets caused by certain types of occurrences to the extent of the value of the property damaged and would not cover lost revenue.

We are taking steps to increase manufacturing capacity for Cinryze, and a failure to increase timely such capacity could limit the rate at which additional new patients will receive Cinryze and will limit the number of doses provided to patients. This would result in a reduction of potential future revenues.

Pursuant to our distribution agreement, Sanquin Blood Supply Foundation supplies us with certain annual minimum and maximum amounts of C1 INH. We and Sanquin are undertaking process improvements and facility expansions to increase the capacity of the facilities involved in manufacturing Cinryze. Our efforts to increase manufacturing capacity have included several approaches. First, using the current processing scale equipment, an additional chromatography

unit (PCP, or parallel chromatography process) was added which enabled the addition of production shifts to increase manufacturing output. Second, an additional small scale processing line is currently being installed and requires Sanquin to recruit and train a number of additional employees. When this second processing line is fully staffed and registered with FDA, it will provide additional output. This work is still ongoing and no filings have yet been made with FDA related to it. There can be no assurance that the personnel and regulatory review issues associated with this effort can be accomplished in a timely manner.

Third, we also are working on industrial scale manufacturing expansion activities. Sanquin must obtain the requisite regulatory approvals for this expansion in order to manufacture Cinryze for us at an increased capacity. On October 21, 2010, the United States Food and Drug Administration (FDA) issued a complete response letter regarding the facility to be utilized for the Cinryze industrial scale manufacturing expansion activities. The FDA requested additional information related to both (i) observations at the close of the pre-approval inspection and (ii) review of the technical processes. In order to manufacture Cinryze at the industrial scale we must respond to all FDA questions and satisfactorily complete the FDA review. We are finalizing our responses to FDA’s questions regarding the industrial scale process and will re-submit for this expansion as additional process information is established. While we believe that the data collected from our industrial scale manufacturing process demonstrates equivalence with the existing manufacturing process, we cannot guarantee that the FDA will agree with us in the timeframes we anticipate or at all as biologics such as Cinryze require processing steps that are more complex than those required for most chemical pharmaceuticals. When the industrial scale processing line is fully staffed and registered with FDA, it will provide additional output. This work is still ongoing and there can be no assurance that the personnel and regulatory review issues associated with this effort can be accomplished in a timely manner.

The FDA may view the data regarding equivalence of the industrial scale manufacturing process as insufficient or inconclusive, request additional data, require additional conformance batches, delay any decision past the time frames anticipated by us, or deny the approval of the industrial scale manufacturing process. In addition, our plans to increase manufacturing capacity through the construction of another small scale manufacturing line may not be completed in the time frame we anticipate or may not yield the volume of Cinryze we anticipate. In both cases, delays could arise as a result of many factors, including but not limited to, the availability of necessary equipment, validation of such equipment, the timing of regulatory reviews and approvals.

The number of patients enrolling into our treatment support service for patients with HAE and their healthcare providers, CinryzeSolutions, has periodically exceeded our expectations. For example, in 2010 we began to temporarily limit the rate at which additional patients are started on drug to ensure that those already receiving commercial product continue with a supply of Cinryze until capacity increases. If one or more of the manufacturing capacity expansion projects at Sanquin are delayed, or do not result in the capacity we anticipate, or if Sanquin cannot obtain necessary regulatory approvals for the contemplated facility expansions in the time frames we anticipate, or if we are not able to manufacture the anticipated volume of product at the existing scale, we may not be able to satisfy patient demand. Our inability to obtain adequate product supplies to satisfy our patient demand may create opportunities for our competitors and we will suffer a loss of potential future revenues.

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

Below is a summary of stock repurchases for the three months ended June 30, 2011:


Month	Total Number of Shares Purchased⁽¹⁾		Average Price Paid per Share⁽²⁾		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs (in thousands)
April 1 – April 30		—	$	—		—	$	100,000,000

May 1 – May 31		—	$	—		—	$	100,000,000

June 1 – June 30		249,389	$	20.05		249,389	$	100,000,000


Total		249,389	$	20.05		249,389

(1)

In March 2011, our Board of Directors authorized up to $150.0 million in funds for repurchases of ViroPharma Incorporated’s outstanding shares of common stock and 2% senior convertible notes due 2017. The $150.0 million authorization excludes fees and expenses and authorizes management to repurchase shares opportunistically in the open market, in block transactions, in private transactions or other techniques from time to time, depending on market conditions. All shares repurchased in the first quarter of 2011 were purchased pursuant to an accelerated share repurchase agreement that we entered into on March 14, 2011 with a large financial institution, pursuant to which we paid $50.0 million to the financial institution and received an initial delivery of 2.4 million shares of our common stock, representing approximately 90% of the shares that could have been purchased, based on the closing price of our common stock on March 14, 2011. In June 2011, we received an additional 249,389 shares in June 2011 upon termination of the share repurchase program in accordance with the terms of the agreement. In total, we received approximately 2.7 million shares under this arrangement at an average purchase price of $18.74 per share.

(2)	The Average Price Paid per Share is based on the price paid per share in the open market. The average price was determined at the completion of the accelerated share repurchase agreement based on the volume weighted-average-price of our stock during the term of the agreement.

During the period covered by this report, we did not sell any of our equity shares that were not registered under the Securities Act of 1933, as amended.

ITEM 6. Exhibits

List of Exhibits:


10.1*†		Collaboration and License Agreement between ViroPharma SPRL and Halozyme Inc. dated May 10, 2011.

10.2*†		Second Amendment to Project Agreement No. 2 between ViroPharma Incorporated and Norwich Pharmaceuticals, Inc. dated May 25, 2011.

31.1*		Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*		Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101		The following financial information from this Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2011, formatted in XBRL (Extensible Business Reporting Language) and furnished electronically herewith: (i) the Condensed Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Stockholders’ Equity; (iv) the Consolidated Statements of Cash Flows; and, (v) the Notes to the Consolidated Financial Statements.

*	Filed herewith.

†	Portions of this exhibit were omitted and filed separately with the Secretary of the Commission pursuant to an application for confidential treatment filed with the Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	VIROPHARMA INCORPORATED

Date: July 28, 2011	By:	/s/ Vincent J. Milano
		Vincent J. Milano
		President and Chief Executive Officer (Principal Executive Officer)

	By:	/s/ Charles A. Rowland, Jr.
		Charles A. Rowland, Jr.
		Vice President, Chief Financial Officer (Principal Financial Officer)

	By:	/s/ Richard S. Morris
		Richard S. Morris
		Vice President, Chief Accounting Officer (Principal Accounting Officer)