Edgar Filing: VIROPHARMA INC

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 March 31, 2010

¨	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 ¨ No ¨

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


Large Accelerated Filer	¨	Accelerated Filer	x

Non-accelerated filer	¨	Smaller Reporting Company	¨

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 April 23, 2010: 77,818,983 shares.

VIROPHARMA INCORPORATED

INDEX


		Page
PART I FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets (unaudited) at March 31, 2010 and December 31, 2009	2

	Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2010 and 2009	3

	Consolidated Statements of Stockholders’ Equity (unaudited) for the three months ended March 31, 2010 and 2009	4

	Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2010 and 2009	5

	Notes to the Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27

Item 4.	Controls and Procedures	27

PART II OTHER INFORMATION

Item 1A.	Risk Factors	29

Item 5.	Other Information	29

Item 6.	Exhibits	30

SIGNATURES		31

ViroPharma Incorporated

Condensed Consolidated Balance Sheets

(unaudited)


(in thousands, except share and per share data)	March 31, 2010			December 31, 2009
Assets
Current assets:
Cash and cash equivalents	$	354,243		$	331,672
Short-term investments		17,544			—
Accounts receivable, net		47,246			41,243
Inventory		40,033			41,582
Prepaid expenses and other current assets		9,052			9,546
Prepaid income taxes		2,483			2,256
Deferred income taxes		18,805			20,065

Total current assets		489,406			446,364
Intangible assets, net		614,700			618,510
Property, equipment and building improvements, net		10,139			10,508
Debt issue costs, net		2,687			2,784
Other assets		8,871			6,285

Total assets	$	1,125,803		$	1,084,451

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	10,818		$	5,866
Accrued expenses and other current liabilities		35,986			33,354
Taxes payable		6,581			769

Total current liabilities		53,385			39,989
Other non-current liabilities		2,876			2,958
Deferred tax liability		154,204			152,503
Long-term debt		140,333			138,614

Total liabilities	$	350,798		$	334,064

Commitments and Contingencies

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 77,779,141 shares at March 31, 2010 and 77,442,716 shares at December 31, 2009		157			156

Additional paid-in capital		706,035			701,063
Accumulated other comprehensive (loss) income		(723	)		914
Retained earnings		69,536			48,254

Total stockholders’ equity		775,005			750,387

Total liabilities and stockholders’ equity	$	1,125,803		$	1,084,451

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Operations

(unaudited)


	Three Months Ended March 31,
(in thousands, except per share data)	2010			2009
Revenues:
Net product sales	$	90,647		$	60,190

Costs and Expenses:
Cost of sales (excluding amortization of product rights)		13,958			3,929
Research and development		9,741			19,798
Selling, general and administrative		20,921			24,264
Intangible amortization		7,573			7,257
Goodwill impairment		—			65,099

Total costs and expenses		52,193			120,347

Operating income (loss)		38,454			(60,157	)

Other Income (Expense):
Interest income		31			144
Interest expense		(2,838	)		(3,309	)
Other expense, net		(522	)		—
Gain on long-term debt repurchase		—			9,079

Income (loss) before income tax expense		35,125			(54,243	)

Income tax expense		13,843			4,972

Net income (loss)	$	21,282		$	(59,215	)

Net income (loss) per share:
Basic	$	0.27		$	(0.77	)
Diluted	$	0.26		$	(0.77	)

Shares used in computing net income (loss) per share:
Basic		77,506			77,405
Diluted		89,668			77,405

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Stockholders’ Equity

(unaudited)


	Preferred Stock			Common Stock			Additional paid-in capital		Accumulated other comprehensive loss			Retained Earnings		Total stockholders’ equity
(in thousands)	Number of shares	Amount		Number of shares	Amount		Additional paid-in capital		Accumulated other comprehensive loss			Retained Earnings		Total stockholders’ equity
Balance, December 31, 2009	—	$	—	77,443	$	156	$	701,063	$	914		$	48,254	$	750,387
Exercise of common stock options	—		—	336		1		1,074		—			—		1,075
Share-based compensation	—		—	—		—		2,661		—			—		2,661
Unrealized losses on available for sale securities, net	—		—	—		—		—		(22	)		—		(22	)
Cumulative translation adjustment	—		—	—		—		—		(1,615	)		—		(1,615	)
Stock option tax benefits	—		—	—		—		1,237		—			—		1,237
Net income	—		—	—		—		—		—			21,282		21,282

Balance, March 31, 2010	—	$	—	77,779	$	157	$	706,035	$	(723	)	$	69,536	$	775,005

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Cash Flows

(unaudited)


	Three Months Ended March 31,
(in thousands)	2010			2009
Cash flows from operating activities:
Net income (loss)	$	21,282		$	(59,215	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Non-cash share-based compensation expense		2,661			4,296
Non-cash interest expense		1,816			2,059
Gain on long-term debt repurchase		—			(9,079	)
Non-cash goodwill impairment		—			65,099
Deferred tax provision		2,892			3,700
Depreciation and amortization expense		8,019			7,637
Changes in assets and liabilities:
Accounts receivable		(6,236	)		(12,344	)
Inventory		497			(3,414	)
Prepaid expenses and other current assets		260			473
Prepaid income taxes/ taxes payable		5,585			1,142
Other assets		(2,636	)		223
Due to partners		—			(484	)
Accounts payable		5,244			(2,229	)
Accrued expenses and other current liabilities		(1,028	)		(7,061	)
Other non-current liabilities		(9	)		—

Net cash provided by (used in) operating activities		38,347			(9,197	)

Cash flows from investing activities:
Purchase of property, plant and equipment		(114	)		(757	)
Purchase of short-term investments		(17,577	)		—

Net cash used in investing activities		(17,691	)		(757	)

Cash flows from financing activities:
Long-term debt repurchase		—			(21,150	)
Termination of call spread options, net		—			274
Net proceeds from issuance of common stock		1,075			13
Excess tax benefits from share-based payment arrangements		1,237			—

Net cash provided by (used in) financing activities		2,312			(20,863	)

Effect of exchange rate changes on cash		(397	)		185

Net increase (decrease) in cash and cash equivalents		22,571			(30,632	)

Cash and cash equivalents at beginning of period		331,672			275,839

Cash and cash equivalents at end of period	$	354,243		$	245,207

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 have two marketed products and two development programs. We intend to grow through sales of our marketed products, Cinryze ^TM and Vancocin^®, through continued development of our product pipeline, expansion of sales of Cinryze into additional territories and through potential acquisition or licensing of products or acquisition of companies.

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 obtained in October 2008, when we completed our acquisition of Lev Pharmaceuticals, Inc. (Lev). 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 March 2010, our Marketing Authorization Application (MAA) for Cinryze for acute treatment and prophylaxis against HAE was accepted by the European Medicines Agency (EMA). We intend to seek to commercialize Cinryze in Europe in 2011 in countries which we have distribution rights. We are currently evaluating our commercialization plans in additional territories. We also 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), as well as new modes of administration.

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.

We currently have two core development programs. 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 also developing a non-toxigenic strain of C. difficile (NTCD) for the treatment and prevention of CDI. On August 6, 2009 we announced that dosing had begun in the Phase 1 clinical trial for NTCD. The Phase 1 study will determine the safety and tolerability of NTCD dosed orally as a single and as repeat escalating doses in healthy young and older adults. In addition to our core programs, we have a non-core program for Cytomegalovirus (CMV) disease. We are currently evaluating our maribavir program in light of the Phase 3 clinical trial results. On February 9, 2009, we announced that our Phase 3 trial evaluating maribavir used as prophylaxis in allogeneic stem cell, or bone marrow, transplant (SCT) patients did not achieve its primary endpoint. In the primary analysis, there was no statistically significant difference between maribavir and placebo in reducing the rate of CMV disease. Additionally, on February 13, 2009, we announced that enrollment in our Phase 3 trial evaluating maribavir in liver transplant patients was discontinued and that all patients on study drug were moved to the current standard of care.

Basis of Presentation

The consolidated financial information at March 31, 2010 and for the three months ended March 31, 2010 and 2009, 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 year ended December 31, 2009 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.

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 March 2010, the Financial Accounting Standards Board (FASB) amended the disclosure requirements so that SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. This revised guidance is effective immediately and we adopted this pronouncement on March 31, 2010 and have revised the disclosures as required.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements—(Continued)

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 March 31, 2010, all of our fixed income securities were 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 March 31, 2010:


(in thousands)	Cost		Gross unrealized gains		Gross unrealized losses		Fair value
March 31, 2010
Debt securities:
U.S. Treasury	$	12,508	$	—	$	20	$	12,488
Corporate		5,069		—		13		5,056

	$	17,577	$	—	$	33	$	17,544

Maturities of investments were as follows:
Less than one year	$	17,577	$	—	$	33	$	17,544

Note 3. Inventory

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


(in thousands)	March 31, 2010		December 31, 2009
Raw Materials	$	23,623	$	26,780
Work In Process		8,040		8,533
Finished Goods		8,370		6,269

Total	$	40,033	$	41,582

Approximately $2.8 million of WIP inventory is currently not available for commercial use as it represents product produced as part of our effort to receive FDA approval for a larger scale manufacturing line. Upon FDA approval, this amount will be available for sale commercially as Cinryze.

Note 4. Intangible Assets

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


(in thousands)	Gross Intangible Assets		Accumulated Amortization		Net Intangible Assets
Cinryze Product rights	$	521,000	$	30,084	$	490,916
Vancocin Intangibles		157,863		34,079		123,784

Total	$	678,863	$	64,163	$	614,700

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements—(Continued)

The following represents the balance of the intangible assets at December 31, 2009:


(in thousands)	Gross Intangible Assets		Accumulated Amortization		Net Intangible Assets
Cinryze Product rights	$	521,000	$	24,873	$	496,127
Vancocin Intangibles		154,099		31,716		122,383

Total	$	675,099	$	56,589	$	618,510

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 OGD’s 2008 draft guidelines on bioequivalence for Vancocin. 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 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 are obligated to pay Eli Lilly and Company (Lilly) additional purchase price consideration based on net sales of Vancocin within a calendar year. The additional purchase price consideration is determined by the annual net sales of Vancocin, is paid quarterly and is due each year through 2011. We account 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 March 31, 2010, we have paid an aggregate of $37.1 million to Lilly in additional purchase price consideration, as our net sales of Vancocin surpassed the maximum obligation level of $65 million in 2009, 2008, 2007, 2006 and 2005. The $37.1 million paid to Lilly was based upon 35% of $20 million in 2009 and 2008, 35% of $17 million in 2007, 35% of $19 million in 2006 and 50% of $21 million in 2005. The Company is obligated to pay Lilly additional amounts based on 35% of annual net sales between $45 and $65 million of Vancocin during 2010 and 2011.

Based on net sales through the first quarter of 2010, $3.8 million is due to Lilly on net sales of Vancocin above the net sales levels reflected above.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements—(Continued)

Note 5. Goodwill Impairment

During the first quarter of 2009 and as of March 31, 2009, the market capitalization of ViroPharma fell below the carrying value of our net assets due to the results of our Phase 3 clinical trial evaluating maribavir used as prophylaxis in allogeneic stem cell transplant patients and our decision to discontinue dosing in our Phase 3 trial of maribavir in solid organ (liver) transplant patients. The fact that our market capitalization fell below our carrying value required us to test for impairment of our goodwill and other intangible assets. We conducted this analysis at March 31, 2009 and concluded that our goodwill was impaired due to our market capitalization being below the carrying value of our net assets for an extended period of time. We incurred a $65.1 million charge in the first quarter of 2009 related to this goodwill impairment.

Note 6. Property, Equipment and Building Improvements

During 2009, we reclassified property and a building that was previously held for sale to a held and use long term asset. This was due to the Company’s decision to lease our previous corporate headquarters and take the building off the market. In accordance with the applicable accounting pronouncements, we adjusted the carrying value of the building to fair value at the time of the reclassification and incurred a $3.4 million impairment to the building in the fourth quarter of 2009.

The useful life for the major categories of property and equipment are 30 years for the building, 3 to 5 years for computers and equipment and 15 years for building improvements.

Note 7. Long-Term Debt

Long-term debt as of March 31, 2010 and December 31, 2009 is summarized in the following table:


(in thousands)	March 31, 2010		December 31, 2009
Senior convertible notes	$	140,333	$	138,614
less: current portion		—		—

Total debt principal	$	140,333	$	138,614

As of March 31, 2010 senior convertible notes representing $205.0 million of principal debt are outstanding with a carrying value of $140.3 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.

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.

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 March 31, 2010, the Company has accrued $0.2 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 March 31, 2010 being $2.7 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

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements—(Continued)

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 March 31, 2010, the fair value of the principal of the $205.0 million convertible senior notes outstanding was approximately $194.9 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.

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 Consolidated Balance Sheets. As long as the instruments are classified in stockholders’ equity they are not subject to the mark to market provisions.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements—(Continued)

Note 8. Share-based Compensation

We recorded share-based compensation expense as follows:


	Three Months Ended March 31,
(in thousands)	2010		2009
Research and development	$	815	$	968
Selling, general and administrative		1,846		3,328

Total	$	2,661	$	4,296

Employee Stock Option Plans

We currently have three option 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 the balances available by Plan at March 31, 2010:


	1995 Plan		2001 Plan		2005 Plan		Combined
Number of shares authorized	4,500,000		500,000		7,850,000		12,850,000
Number of options granted since inception	(6,997,515	)	(1,255,472	)	(6,680,337	)	(14,933,324	)
Number of options cancelled since inception	3,059,608		821,302		548,083		4,428,993
Number of shares expired	(562,093	)	(7,751	)	(39,328	)	(609,172	)

Number of shares available for grant	—		58,079		1,678,418		1,736,497

The Company issued stock options in the first three-months of 2010. The weighted average fair value of each option grant was estimated at $6.00 per share using the Black-Scholes option-pricing model using the following assumptions:


Expected dividend yield			—
Range of risk free interest rate	3.05	%	—	3.39	%
Weighted-average volatility	71.61%
Range of volatility	71.54	%	—	72.42	%
Range of expected option life (in years)	5.50		—	6.25

The Company has 8,713,624 option grants outstanding at March 31, 2010 with exercise prices ranging from $0.99 per share to $38.70 per share and a weighted average remaining contractual life of 6.86 years. The following table lists the outstanding and exercisable option grants as of March 31, 2010:


	Number of options	Weighted average exercise price		Weighted average remaining contractual term (years)	Aggregate intrinsic value (in thousands)
	Number of options	Weighted average exercise price		Weighted average remaining contractual term (years)	Aggregate intrinsic value (in thousands)
Outstanding	8,713,624	$	10.35	6.86	$	36,811
Exercisable	4,710,695	$	10.55	5.24	$	22,347

As of March 31, 2010, there was $22.3 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 2.60 years.

Employee Stock Purchase Plan

Under this plan, no shares were sold to employees during the first three months of 2010. During the year ended December 31, 2009, 69,806 shares were sold to employees. As of March 31, 2010 there are approximately 478,969 shares available for issuance under this plan.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements—(Continued)

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 2010, the fair value of approximately $60,000 was estimated using the Type B model, with a risk free interest rate of 0.20%, volatility of 54.9% and an expected option life of 0.5 years. This fair value is being amortized over the six month period ending June 30, 2010.

Note 9. Income Tax Expense

Our income tax expense was $13.8 million and $5.0 million for the quarters ended March 31, 2010 and 2009, respectively. Our income tax expense includes federal, state and foreign income taxes at statutory rates and the effects of various permanent differences. The income tax expense in the first quarter of 2009 reflects the full impact of our gain on the repurchase of a portion of our senior convertible notes and our estimate of orphan drug credits for maribavir, which will be significantly reduced in 2010 from 2009 levels.

During the three months ended March 31, 2010, we had no material changes to our liability for uncertain tax positions. We currently have various state returns under examination. The final outcomes of these examinations are not yet determinable at this time.

Note 10. Comprehensive Income (loss)

The following table reconciles net income (loss) to comprehensive income (loss) for the three months ended March 31, 2010 and 2009:


	Three Months Ended March 31,
(in thousands)	2010			2009
Net income (loss)	$	21,282		$	(59,215	)
Other comprehensive:
Unrealized losses on available for sale securities, net		(22	)		—
Currency translation adjustments		(1,615	)		185

Comprehensive income (loss)	$	19,645		$	(59,030	)

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

Note 11. Earnings (Loss) per share


	Three Months Ended March 31,
(in thousands, except per share data)	2010		2009
Basic Earnings (Loss) Per Share
Net income (loss)	$	21,282	$	(59,215	)
Common stock outstanding (weighted average)		77,506		77,405

Basic net income (loss) per share	$	0.27	$	(0.77	)

Diluted Earnings (Loss) Per Share
Net income (loss)	$	21,282	$	(59,215	)
Add interest expense on senior convertible notes, net of income tax		1,761		—

Diluted net income (loss)	$	23,043	$	(59,215	)

Common stock outstanding (weighted average)		77,506		77,405
Add shares from senior convertible notes		10,864		—
Add “in-the-money” stock options		1,298		—

Common stock assuming conversion and stock option exercises		89,668		77,405

Diluted net income (loss) per share	$	0.26	$	(0.77	)

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements—(Continued)

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 March 31,
(in thousands)	2010	2009
“Out-of-the-money” stock options	5,557	5,201
Shares from senior convertible notes	—	10,864
“In-the-money” stock options	—	912

Shares from senior convertible notes and in-the-money stock options are included in the diluted earnings per share calculation above for the period ended March 31, 2010.

Note 12. 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 March 31, 2010:


	Total Carrying Value at March 31, 2010		Fair Value Measurements at March 31, 2010 Using
(in millions of dollars)	Total Carrying Value at March 31, 2010		(Level 1)		(Level 2)		(Level 3)
Cash and cash equivalents	$	354,243	$	354,243	$	—	$	—
Short term investments		17,544		17,544		—		—

Total	$	371,787	$	371,787	$	—	$	—

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 March 31, 2010.

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

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements—(Continued)

Note 13. Collaborations

In January 2010, we entered into a collaboration agreement with Stichting Sanquin Bloedvoorziening (Sanquin Blood Supply Foundation) (Sanquin) which established a Joint Steering Committee related to the development and commercialization of C1-INH products. The Joint Steering Committee shall serve as a forum to establish and discuss progress under, among others, (i) a Global Commercialization Plan; (ii) clinical development programs of ViroPharma and the Sanquin early stage research programs; (iii) manufacturing Capacity Schedules; (iv) pharmacovigilence matters; (v) quality matters; (vi) manufacturing improvement programs; and (vii) regulatory matters.

Sanquin may conduct certain early stage research programs and we will provide to Sanquin €1,000,000 (approximately $1.3 million) per year for a period of five years to support such Early Stage Research Programs. We expense these payments as R&D expense when due. We have a right of first refusal to further develop and commercialize the subject matter of each such early stage research program worldwide (except for the excluded territory as fully described in our Form 10-K for the year ended December 31, 2009) subject to Sanquin’s and its research partners’ right to use any such intellectual property for their internal, non-commercial research purposes. Except for the early stage research programs, we will be solely responsible for conducting all clinical trials and other development activities necessary to support our efforts to obtain regulatory approval of Cinryze in additional territories as well as any future C1-INH derived products developed pursuant to the Rest of World Agreement, as fully described in our Form 10-K for the year ended December 31, 2009. Sanquin has the right to approve any such clinical trials and development activities through the Joint Steering Committee.

Note 14. Supplemental Cash Flow Information


	Three Months Ended March 31,
(in thousands)	2010			2009
Supplemental disclosure of non-cash transactions:
Employee share-based compensation	$	2,661		$	4,296
Unrealized losses on available for sale securities, net		(22	)		—
Non-cash increase of intangible assets for Vancocin obligation to Lilly		3,764			2,987
Establishment of landlord allowance		—			(19	)
Non-current liability to current		—			(1,208	)
Debt buy back deferred tax impact		—			308
Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	4,098		$	105
Cash paid for interest		2,050			2,500
Cash received for stock option exercises		1,075			20
Cash received for employee stock purchase plan		66			128

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

We intend to continue to evaluate in-licensing or other opportunities to acquire products in development, or those that are currently on the market. We plan to seek products that treat serious or life threatening illnesses with a high unmet medical need, require limited commercial infrastructure to market, and that provide both top and bottom line growth over time.

Executive Summary

Since December 31, 2009, we experienced the following:

Business Activities

Cinryze:

•

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;

•

Shipped approximately 9,000 doses of Cinryze to specialty pharmacy/specialty distributors (SP/SD’s);

•

EMA accepted the filing of our MAA for Cinryze for acute treatment and prophylaxis against HAE;

•

Initiated an open-label, single-dose Phase 2 study to evaluate doses of Cinryze for treatment of acute angioedema attacks in children less than 12 years of age with HAE; and

•

Initiated a multi-dose Phase 2 study to evaluate the safety, pharmacokinetics and pharmacodynamics of subcutaneous versus intravenous administration of Cinryze;

C. difficile infection (CDI):

•

Continued work on Phase 1 clinical trial for NTCD; and

•

Vancocin scripts decreased 6.4% in the first quarter of 2010 as compared to the first quarter of 2009;

Financial Results

•

Increased net sales of Cinryze of $34.9 million as compared to $6.7 million in the first quarter of 2009;

•

Net sales of Vancocin increased to $55.8 million for the first quarter of 2010 from $53.5 million in the first quarter of 2009; and

•

Reported net income of $21.3 million;

Liquidity

•

Generated net cash from operations of $38.3 million; and

•

Ended the first quarter of 2010 with working capital of $436.0 million, which includes cash and cash equivalents of $371.8 million.

During the remainder of 2010 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.

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% is 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. The PPACA also imposes a manufacturer’s fee on the sale of branded Pharmaceuticals (excluding orphan drugs), 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”. 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.

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 approach regarding the conditions that must be met in order for a generic drug applicant to request a waiver of in-vivo bioequivalence testing 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 and the commercial success of Cinryze will depend 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; sufficient supply and reasonable pricing of raw materials necessary to manufacture Cinryze; and 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 will impact our ability to generate future revenues from Cinryze.

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 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 gaining regulatory approval of any of our product candidates in the timeframes that we expect, or at all. For example, on February 9, 2009, we announced that our Phase 3 trial evaluating maribavir used as prophylaxis in allogeneic stem cell, or bone, marrow, transplant patients did not achieve its primary endpoints. In the primary analysis, there was no statistically significant difference between maribavir and placebo in reducing the rate of CMV disease. In addition, the study failed to meet its key secondary endpoints. Maribavir was generally well tolerated in this clinical study. We continue to evaluate our potential development strategy for the maribavir program in light of the Phase 3 clinical trials results and evolving information.

We cannot assure you that our current cash and cash equivalents or cash flows from Vancocin and Cinryze 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 assumption described in this Quarterly Report on Form 10-Q. The risks described in this report, our Form 10-Q for the Quarter ended March 31, 2010 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, 2009 in Item 1A, which describe other important matters relating to our business.

Results of Operations

Three Months Ended March 31, 2010 and 2009


	Three Months Ended March 31, 2010
(in thousands, except per share data)	2010		2009
Net product sales	$	90,647	$	60,190
Cost of sales (excluding amortization of product rights)	$	13,958	$	3,929
Operating income (loss)	$	38,454	$	(60,157	)
Net income (loss)	$	21,282	$	(59,215	)
Net income (loss) per share:
Basic	$	0.27	$	(0.77	)
Diluted	$	0.26	$	(0.77	)

The $38.5 million in operating income for the three-month period ended March 31, 2010 increased as compared to a net operating loss of $60.2 million in the same period in 2009. This increase is primarily the result of the impairment of goodwill in the first quarter of

2009 ($65.1 million) for which no impairment occurred in the first quarter of 2010, increased net sales of Vancocin and Cinryze ($30.4 million), and a decrease in our research and development expense due to the wind-down of our CMV program ($10.1 million), partially offset by increased cost of sales ($10.0 million).

Revenues

Revenues consisted of the following:


	Three Months Ended March 31,
(in thousands)	2010		2009
Net product sales
Vancocin	$	55,753	$	53,535
Cinryze		34,894		6,655

Total revenues	$	90,647	$	60,190

Revenue—Vancocin and Cinryze product sales

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. We are temporarily managing the rate at which additional patients are started on drug to ensure that those already receiving commercial drug, and those new patients who start their routine prophylaxis will continue with a reliable uninterrupted supply of Cinryze. Our team is working with Sanquin to complete a two tiered scale up process that is intended to significantly increase available supply in the second quarter of 2010 and beyond. When the additional supply enters the market, we will then return to adding new patients at a normal rate. We previously recognized revenue upon shipment of Cinryze from our SP/SD’s to patients.

During the three months ended March 31, 2010, net sales of Vancocin increased 4.1% compared to the same period in 2009 primarily due to the price increases during 2009, offset by lower sales volumes. Based upon data reported by IMS Health Incorporated, prescriptions during the three months ended March 31, 2010 decreased from the same period in 2009 period by 6.4% which we believe is due to a decrease in the severity of the disease state and a suspected increase in compounding seen both in the hospital and long-term care marketplace. The units sold for the three months ended March 31, 2010 decreased by approximately 7% compared to the same period in 2009. Our net sales of Cinryze during the three months ended March 31, 2010 increased over the same period in the prior year due to the increase in the number of patients receiving commercial drug.

Our Vancocin net sales for the current quarter was negatively impacted by the PPACA by approximately $1.0 million because of the increases in both the amounts of rebates per unit and the scope of the participants in various programs subject to these rebates. We expect this negative impact on Vancocin net sales will continue in the near term. We currently do not believe that the PPACA will have a material impact on Cinryze net sales in the near term.

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 patients are placed on commercial drug. 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 March 31, 2010, the wholesalers and SP/SD’s did not have excess channel inventory.

Cost of sales (excluding amortization of product rights)

Cost of sales increased over the prior year by $10.0 million due to the increase in Cinryze units sold. Additionally, we expensed $1.5 million in the first quarter of 2010 related to non-refundable start up costs paid to our new plasma supplier. Vancocin and Cinryze cost of sales includes the cost of materials and distribution costs and excludes amortization of product rights. As part of our October 2008 purchase of Lev, we acquired Cinryze inventory which was recorded at fair value in purchase accounting. This step-up of inventory value increased the cost of sales during the three months ended March 31, 2009 by $1.1 million. We have utilized all inventory that was recorded at fair value as part of the Lev purchase in 2009.

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. Additionally, as Cinryze becomes a larger part of our total net sales, our cost of sales (excluding amortization of product rights) as a percentage of net sales will continue to increase due to the variation in inventory costs.

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 preclinical and development costs. Indirect expenses include personnel, facility, stock compensation and other overhead costs. Due to advancements in our NTCD preclinical program, and our Cinryze Phase 4 commitment and Phase 2 study in children, we expect costs in these programs to exceed current costs.

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


	Three Months Ended March 31,
(in thousands)	2010		2009
*Direct – Core programs*
Non-toxigenic strains of C. difficle (NTCD)		2,234		1,849
Cinryze		1,778		2,676
Vancocin		297		317
HCV		—		10

*Direct – Non-core programs*
CMV	$	321	$	9,428

*Indirect*
Development		5,111		5,518

Total	$	9,741	$	19,798

Direct Expenses—Core Development Programs

The increase in costs of NTCD in the three months ended March 31, 2010 over 2009 relates to costs associated with our Phase 1 clinical trial.

Our costs associated with our Cinryze program decreased during the three months ended March 31, 2010, as we incurred costs related to our Phase 4 clinical trial and the development of our life cycle program. In the prior year, we incurred costs related to our open label trials which closed on March 31, 2009.

Vancocin costs in the three months ended March 31, 2010 and 2009 related to additional research activities.

Direct Expenses—Non-core Development Programs

Our direct expenses related to our CMV program decreased in the three months ended March 31, 2010 as we wound down our stem cell and liver transplant studies. In February 2009, based upon preliminary analysis of the data, we announced that our Phase 3 trial evaluating maribavir used as prophylaxis in allogeneic stem cell, or bone marrow, transplant patients did not achieve its primary endpoints. In the primary analysis, there was no statistically significant difference between maribavir and placebo in reducing the rate of CMV disease. In addition, the study failed to meet its key secondary endpoints. We are continuing to analyze the study results. Additionally, we announced that our Phase 3 trial evaluating maribavir in liver transplant patients was discontinued and that all patients on study drug were moved to current standard of care. This decision was made based on the results of the Phase 3 study of maribavir in stem cell transplant patients, and the recommendation from our independent Data Monitoring Committee who considered the rate of viremia in both arms of the study. During 2009 we continued enrollment in our solid organ (liver) study through February 2009, conducted follow-up visits necessary to complete both our Phase 3 studies following receipt of the results of our stem cell transplant study and continued to evaluate the results of our Phase 3 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. During the second half of 2009, our development team shifted its focus from our CMV program to our Cinryze and NTCD programs.

Selling, general and administrative expenses

Selling, general and administrative expenses (SG&A) decreased $3.3 million for the three months ended March 31, 2010 as compared to 2009. This decrease was driven by a decrease in compensation expense ($1.6 million) and decreased medical education activities ($2.0 million). Included in SG&A are legal and consulting costs incurred related to our opposition to the attempt by the OGD regarding the conditions that must be met in order for a generic drug application to request a waiver of in-vivo bioequivalence testing for copies of Vancocin, which were $1.2 million and $1.3 million for the three-months of 2010 and 2009, respectively. We anticipate that these additional legal and consulting costs will gradually diminish in future periods. We anticipate continued increased spending in selling, general and administrative expenses in future periods as we continue the commercial launch of Cinryze.

Intangible amortization and acquisition of technology rights

Intangible amortization is the result of the Vancocin product rights acquisition in the fourth quarter of 2004 as well as the acquisition of Cinryze product rights in October 2008. Additionally, as described in our agreement with Lilly, to the extent that we incur an obligation to Lilly for additional payments on Vancocin sales, we have contingent consideration. We record the obligation as an adjustment to the carrying amount of the related intangible asset and a cumulative adjustment to the intangible amortization upon achievement of the related sales milestones. Contingent consideration and Lilly related additional payments are more fully described in Note 4 of the Unaudited Consolidated Financial Statements.

Intangible amortization for the three months ended March 31, 2010 and 2009 was $7.6 million and $7.3 million, respectively.

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 March 31, 2010. 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.

Impairment losses

During the first quarter of 2009, the market capitalization of ViroPharma fell below the carrying value of ViroPharma’s net assets due to the announcements surrounding our maribavir development program. This situation required us to test for impairment of our goodwill and other intangible assets which lead to a goodwill impairment charge of $65.1 million.

Other Income (Expense)

Interest Income

Interest income for three months ended March 31, 2010 and 2009 was $31,000 and $144,000, respectively.

Interest Expense


	Three Months Ended March 31,
(in thousands)	2010		2009
Interest expense on 2% senior convertible notes	$	1,022	$	1,250
Amortization of debt discount		1,719		1,938
Amortization of finance costs		97		121

Total interest expense	$	2,838	$	3,309

Interest expense and amortization of finance costs in 2010 and 2009 relates entirely to the senior convertible notes issued on March 26, 2007, as described in Note 7 to the Unaudited Consolidated Financial Statements.

Other expense, net

Our other expense, net includes foreign exchange gains and losses and the rental income attributable to our previous corporate headquarters.

Income Tax Expense

Our income tax expense was $13.8 million and $5.0 million for the three months ended March 31, 2010 and 2009, respectively. The income tax expense in the first three months of 2009 reflects the full impact of our gain on the repurchase of a portion of our convertible notes and our estimate of orphan drug credits for maribavir, which will be significantly reduced in 2010 from 2009 levels.

Liquidity

We expect that our sources of revenue will continue to arise from Cinryze and Vancocin product sales. However, we cannot predict what the actual sales of Vancocin will be in the future 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 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 NTCD 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 business development efforts, general and administrative expenses, servicing our debt, 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 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, we anticipate we will continue to invest in our pipeline on our initiative to develop 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, future costs may exceed current costs. 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. Additionally, our operating expenses will not decrease significantly due to the introduction of a generic Vancocin. We are also required to pay contingent consideration to Lev shareholders upon achievement of a commercial milestone. Also, 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. The most significant of our near-term operating development cash outflows are as described under “Development Programs” as set forth below.

While we anticipate that cash flows from Cinryze and Vancocin, as well as our current cash, cash equivalents and short-term investments, will allow us to fund substantially all of 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 March 31, 2010, we had cash, cash equivalents and short-term investments of $371.8 million. At March 31, 2010, the annualized weighted average nominal interest rate on our short-term investments was 0.6% and the weighted average length to maturity was 10.4 months.

Overall Cash Flows

During the quarter ended March 31, 2010, we generated $38.3 million of net cash from operating activities, primarily from our net income plus non-cash items and the change in accounts payable. We used $17.7 million of cash from investing activities to purchase our short-term investments and our net cash provided by financing activities for the quarter ended March 31, 2010 was $2.3 million and relates to stock option exercises. For the prior year period ended March 31, 2009, we used $9.2 million of net cash from operating activities, primarily from the increase in accounts receivable and inventory. We used $0.8 million of cash from investing activities and our net cash used in financing activities for the quarter ended March 31, 2009 was $20.9 million, mainly in the repurchase of a portion of our senior convertible notes.

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 March 31, 2010 have spent approximately $14.1 million in direct research and development costs related to Cinryze since acquisition. During the remainder of 2010, we continue to expect research and development costs related to Cinryze 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. We are solely responsible for the costs of Cinryze development.

NTCD—We acquired NTCD in February 2006 and through March 31, 2010 have spent approximately $18.5 million in direct research and development costs. During the remainder of 2010, we expect our research and development activities related to NTCD to increase as we continue our development program.

Vancocin—We acquired Vancocin in November 2004 and through March 31, 2010, we have spent approximately $1.9 million in direct research and development costs related to Vancocin activities since acquisition.

Non-Core Development Programs

CMV program—During the remainder of 2010, we do not anticipate that our CMV program will be an active development program as we will determine whether there are any potential alternative uses for maribavir. We will continue to perform program wind down related activities and we expect the expenses associated with these activities to be minimal.

Business development activities

We intend 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.

Senior Convertible Notes

On March 26, 2007, we issued $250.0 million of 2% senior convertible notes due March 2017 (the “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.

On March 24, 2009 the Company repurchased, in a privately negotiated transaction, $45.0 million in principal amount of the Company’s 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. Following these repurchases, senior convertible notes representing $205.0 million of principal debt are outstanding with a carrying value of $140.3 million as of March 31, 2010. Additionally, in negotiated transactions, the Company 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 the Company in March 2007. The Company 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.

The senior convertible notes are convertible into shares of the Company’s 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 March 31, 2010, the fair value of the principal of the $205.0 million convertible senior notes outstanding was approximately $194.9 million, based on the level 2 valuation hierarchy of the fair value measurements standard.

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 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.

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 Consolidated Balance Sheet. As long as the instruments are classified in stockholders’ equity they are not subject to the mark to market requirements of US GAAP.

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.

Capital Resources

While we anticipate that revenues from Vancocin and Cinryze will continue to generate positive cash flow and should allow us to fund substantially all of our ongoing development and other operating costs, we may need additional financing in order to expand our product portfolio. 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, our inability to generate revenue through our existing collaborative agreements, 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.

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, 2009. 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 and Cinryze, 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.

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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 $0.5 million in the period of correction, which we believe is immaterial.

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.

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 intangible assets for possible impairment annually and whenever events occur or circumstances indicate that the carrying amount of an asset may not be recoverable. 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 an impairment exists. These assumptions are subjective and could result in a material impact on operating results in the period of impairment. While we reviewed our intangible assets in March 2006 and December 2008 in light of the actions taken by the OGD, we did not recognize any impairment charges. See Note 4 of the Unaudited Consolidated Financial Statements for further information. Additionally in the fourth quarter of 2009, we reviewed the fair value of our property and building held for sale and have determined that an additional impairment charge was required. See Note 6 of the Unaudited Consolidated Financial Statements for further information.

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. While we reviewed the useful life of our intangible assets in March 2006 and December 2008 in light of the actions taken by the OGD, we did not change the useful life of our intangible assets. See Note 4 of the Unaudited Consolidated Financial Statements for further information.

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– We reviewed the carrying value of goodwill, to determine whether impairment may exist. Based on accounting standards, it is required that goodwill be assessed annually for impairment using fair value measurement techniques, unless a triggering event occurs between annual assessments which would then require an assessment at the end of the quarter in which a triggering event occurred.

During the first quarter of 2009, our market capitalization dropped below the carrying value of our net assets due to the results of our Phase 3 trial evaluating maribavir used as prophylaxis in allogeneic stem cell or bone marrow transplant patients. We concluded that the drop in our market cap was a triggering event which required us to perform an impairment test of our intangible assets and a step 2 test for goodwill impairment. As part of this process, we also assessed our intangible and fixed assets for impairment. Based on the analysis performed under step two, there was no remaining implied value attributable to goodwill and accordingly, we wrote off the entire goodwill balance and recognized a goodwill impairment charge in the first quarter of 2009.

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Share-Based Employee Compensation—The calculation of this expense includes judgment related to the period of time used in calculating the volatility of our common stock, the amount of forfeitures and an estimate of the exercising habits of our employees, which is also influenced by our Insider Trading Policy. Changes in the volatility of our common stock or the habits of our employees could result in variability in the fair value of awards granted.

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Income Taxes—Our annual effective tax rate is based on expected pre-tax earnings, existing 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.

On a periodic basis, we evaluate the realizability of our deferred tax assets and liabilities and will adjust such amounts in light of changing facts and circumstances, including but not limited to future projections of 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. 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 taxes in the year of resolution.

In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which those temporary differences becomes deductible or the NOLs and credit carryforwards can be utilized. When considering the reversal of the valuation allowance, we consider the level of past and future taxable income, the reversal of deferred tax liabilities, the utilization of the 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.

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Acquisition Accounting—Businesses acquired before December 31, 2008 were accounted for in accordance with SFAS No. 141, Business Combinations and the total purchase price was allocated to Lev’s net tangible assets or identifiable intangible assets based on their fair values as of the date of the acquisition. 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.

Businesses acquired subsequent to January 1, 2009 will be accounted for in accordance with the new accounting standards regarding business combinations. Under the new standards, the total purchase price will be allocated to the net tangible assets or identifiable intangible assets based on their fair values as of the date of the acquisition. 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 October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements, or ASU 2009-13. ASU 2009-13, amends existing revenue recognition accounting pronouncements that are currently within the scope of FASB ASC Topic 605. This consensus 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.

In March 2010, the FASB ratified EITF Issue No. 08-9, Milestone Method of Revenue Recognition, 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 will be effective for interim and annual periods beginning on or after June 15, 2010.

Contractual Obligations

We have purchase obligations related to the supply and manufacturing of Cinryze. We have committed to purchase a minimum number of liters of plasma per year through 2015 from our suppliers. Additionally, we are required to purchase a minimum number of units from our third party toll manufacturer. The total minimum purchase commitments for these arrangements as of March 31, 2010 are approximately $419.9 million. See Note 17 in our Form 10-K for the year ended December 31, 2009 for further information.

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. 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. Historically, we have typically invested 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 March 31, 2010, was approximately $17.5 million and 0.6%, respectively. A one percent change in the interest rate would have resulted in an immaterial impact to interest income for the quarter ended March 31, 2010.

At March 31, 2010, 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 the Company’s 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 March 31, 2010, the fair value of the principal of the $205.0 million convertible senior notes outstanding was approximately $194.9 million, based on the level 2 valuation hierarchy of the fair value measurements standard.

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 the Company to counterparty credit risk for nonperformance. The Company manages its 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 March 31, 2010. Based on that evaluation, our management, including our CEO and CFO, concluded that as of March 31, 2010 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 first quarter of 2010 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 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, 2009. 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, 2009. 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.

Healthcare reform could adversely affect our revenue and financial results.

Our industry is highly regulated and changes in law may adversely impact our business, operations or financial results. The Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010, or PPACA, 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, may affect us and will likely increase certain of our costs. For example, an increase in the Medicaid rebate rate from 15.1% to 23.1% is 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. The PPACA also imposes an annual fee on pharmaceutical manufacturers beginning in 2011, based on the manufacturer’s sale of branded pharmaceuticals and biologics (excluding orphan drugs); expands the 340B drug discount program (excluding orphan drugs) including the creation of new penalties for non-compliance; and includes a 50% discount on brand name drugs for Medicare Part D participants in the coverage gap, or “doughnut hole”. The law also revises the definition of “average manufacturer price” for reporting purposes (effective October 1, 2010), which could increase the amount of the Company’s Medicaid drug rebates to states, once the provision is effective. Substantial new provisions affecting compliance also have been added, which may require us to modify our business practices with health care practitioners. In addition, the new law establishes an abbreviated licensure pathway for products that are biosimilar to FDA-approved biological products, such as Cinryze, with provisions covering exclusivity periods and a specific reimbursement methodology for biosimilars.

The reforms imposed by the new law will significantly impact the pharmaceutical industry; however, the full effects of the PPACA cannot be known until these provisions are implemented and the Centers for Medicare & Medicaid Services and other federal and state agencies issue applicable regulations or guidance. Moreover, in the coming years, additional changes could be made to governmental healthcare programs that could significantly impact the success of our products. We will continue to evaluate the PPACA, as amended, the implementation of regulations or guidance related to various provisions of the PPACA by federal agencies, as well as trends and changes that may be encouraged by the legislation and that may potentially impact on our business over time.

In addition, Federal, state, and foreign governmental authorities are likely to continue efforts to control the price of drugs and reduce overall healthcare costs. These efforts could impact our ability to market products and generate revenues in the United States and foreign countries.

Item 5.

Other Information.

We licensed the U.S. and Canadian rights for a further product development candidate, an intranasal formulation of pleconaril, to Schering Plough Corporation, now part of Merck & Co., Inc. for the treatment of picornavirus infections. In connection with the merger of Schering Plough and Merck, we have had discussions with Merck regarding their evaluation of the pleconaril development program. Based on these discussions, we believe that it is likely that Merck will terminate the license for pleconaril for the treatment of picornavirus infections.

ITEM 6.

Exhibits

List of Exhibits:


10.1†*		Strategic Supply Agreement dated as of February 26, 2010, by and between ViroPharma Biologics, Inc., a wholly-owned subsidiary of ViroPharma Incorporated, and Biotest Pharmaceuticals Corporation.

10.2†*		Amendment Number 2 to the Agreement for the Purchase and Sale of Blood Plasma dated as of February 5, 2010, by and between ViroPharma Biologics, Inc., a wholly owned subsidiary of ViroPharma Incorporated and DCI Management Group LLC.

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.

*	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: April 28, 2010	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 Chief Accounting Officer and Controller (Principal Accounting Officer)

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