Edgar Filing: VIROPHARMA INC

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FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2012

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

Commission File Number: 0-21699

VIROPHARMA INCORPORATED

(Exact Name of Registrant as Specified in its Charter)


Delaware		23-2789550
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

730 Stockton Drive

Exton, Pennsylvania 19341

(Address of Principal Executive Offices and Zip Code)

610-458-7300

(Registrant’s Telephone Number, Including Area Code)

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

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

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

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

Number of shares outstanding of the issuer’s Common Stock, par value $.002 per share, as of July 27, 2012: 68,704,558 shares.

VIROPHARMA INCORPORATED

INDEX


			Page
PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements

		Consolidated Balance Sheets (unaudited) at June 30, 2012 and December 31, 2011		3

		Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2012 and 2011		4

		Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three and six months ended June 30, 2012 and 2011		5

		Consolidated Statement of Stockholders’ Equity (unaudited) for the six months ended June 30, 2012		6

		Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2012 and 2011		7

		Notes to the Consolidated Financial Statements (unaudited)		8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations			26

Item 3.	Quantitative and Qualitative Disclosures About Market Risk			44

Item 4.	Controls and Procedures			45

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings			46

Item 1A.	Risk Factors			47

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds			49

Item 6.	Exhibits			50

SIGNATURES				51

ViroPharma Incorporated

Consolidated Balance Sheets

(unaudited)


(in thousands, except share and per share data)	June 30, 2012			December 31, 2011
Assets
Current assets:
Cash and cash equivalents	$	357,213		$	331,352
Short-term investments		114,711			128,478
Accounts receivable		54,614			78,534
Inventory		41,085			60,316
Prepaid expenses and other current assets		24,732			15,059
Prepaid income taxes		19,291			12,137
Deferred income taxes		10,055			10,055

Total current assets		621,701			635,931
Intangible assets, net		630,214			648,659
Property, equipment and building improvements, net		11,132			11,983
Goodwill		99,300			13,184
Debt issue costs, net		3,020			3,488
Deferred income taxes		18,466			11,786
Other assets		17,459			11,766

Total assets	$	1,401,292		$	1,336,797

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	6,502		$	11,339
Contingent consideration		7,730			7,293
Accrued expenses and other current liabilities		178,099			75,983
Income taxes payable		4,544			4,036

Total current liabilities		196,875			98,651
Other non-current liabilities		1,742			1,967
Contingent consideration		13,895			12,896
Deferred tax liability, net		174,345			178,706
Long-term debt		157,542			153,453

Total liabilities		544,399			445,673

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; outstanding 68,676,796 shares at June 30, 2012 and 70,568,501 shares at December 31, 2011		161			159
Treasury shares, at cost. 11,846,990 shares at June 30, 2012 and 9,159,083 shares at December 31, 2011		(241,184	)		(169,661	)
Additional paid-in capital		770,656			749,519
Accumulated other comprehensive loss		(3,049	)		(3,414	)
Retained earnings		330,309			314,521

Total stockholders’ equity		856,893			891,124

Total liabilities and stockholders’ equity	$	1,401,292		$	1,336,797

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Operations

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands, except per share data)	2012			2011			2012			2011
Revenues:
Net product sales	$	94,639		$	128,808		$	230,439		$	255,843
Costs and Expenses:
Cost of sales (excluding amortization of product rights)		24,721			21,309			56,799			40,179
Research and development		16,621			20,417			32,020			30,843
Selling, general and administrative		40,883			32,090			79,046			60,376
Intangible amortization		8,787			7,156			17,614			16,053
Other operating expenses		858			5,528			2,054			6,026

Total costs and expenses		91,870			86,500			187,533			153,477

Operating income		2,769			42,308			42,906			102,366
Other Income (Expense):
Interest income		142			189			278			394
Interest expense		(3,518	)		(3,066	)		(6,965	)		(6,023	)
Other (expense) income, net		(4,783	)		259			(3,548	)		3,353

Income (loss) before income tax expense (benefit)		(5,390	)		39,690			32,671			100,090
Income tax expense (benefit)		(1,187	)		16,894			16,883			40,848

Net income (loss)	$	(4,203	)	$	22,796		$	15,788		$	59,242

Net income (loss) per share:
Basic	$	(0.06	)	$	0.30		$	0.23		$	0.77
Diluted	$	(0.06	)	$	0.28		$	0.22		$	0.70
Shares used in computing net income (loss) per share:
Basic		69,390			76,000			69,951			76,919
Diluted		69,390			89,459			73,028			90,240

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Comprehensive Income (Loss)

(unaudited)


	Three Months Ended June 30,					Six Months Ended June 30,
(in thousands)	2012			2011		2012		2011
Net income (loss)	$	(4,203	)	$	22,796	$	15,788	$	59,242
Other comprehensive income (loss), before tax:
Foreign currency translations adjustments		(639	)		886		364		951
Unrealized gain (loss) on available for sale securities
Unrealized holding gain (loss) arising during period		(1	)		86		1		75
Income tax expense		-			31		-		27

Unrealized gain (loss) on available for sale securities, net of tax		(1	)		56		1		48

Other comprehensive income (loss), net of tax		(640	)		942		365		999

Comprehensive income (loss)	$	(4,843	)	$	23,737	$	16,153	$	60,241

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Stockholders’ Equity

(unaudited)


(in thousands)	Preferred Stock				Common Stock					Treasury Shares					Additional paid-in capital		Accumulated other comprehensive income (loss)			Retained Earnings		Total stockholders’ equity
(in thousands)	Number of shares		Amount		Number of shares			Amount		Number of shares		Amount			Additional paid-in capital		Accumulated other comprehensive income (loss)			Retained Earnings		Total stockholders’ equity
Balance, December 31, 2011		—	$	—		70,568		$	159		9,159	$	(169,661	)	$	749,519	$	(3,414	)	$	314,521	$	891,124
Exercise of common stock options		—		—		757			2		—		—			5,731		—			—		5,733
Restricted stock vested		—		—		27			—		—		—			—		—			—		—
Employee stock purchase plan		—		—		13			—		—		—			214		—			—		214
Share-based compensation		—		—		—			—		—		—			10,360		—			—		10,360
Other comprehensive income		—		—		—			—		—		—			—		365			—		365
Repurchase of shares		—		—		(2,688	)		—		2,688		(71,523	)		—		—			—		(71,523	)
Stock option tax benefits		—		—		—			—		—		—			4,832		—			—		4,832
Net income		—		—		—			—		—		—			—		—			15,788		15,788

Balance, June 30, 2012		—	$	—		68,677		$	161		11,847	$	(241,183	)	$	770,655	$	(3,049	)	$	330,309	$	856,893

See accompanying notes to unaudited consolidated financial statements.

ViroPharma Incorporated

Consolidated Statements of Cash Flows

(unaudited)


	Six Months Ended June 30,
(in thousands)	2012			2011
Cash flows from operating activities:
Net income	$	15,788		$	59,242
Adjustments to reconcile net income to net cash provided by operating activities:
Non-cash share-based compensation expense		10,360			7,163
Non-cash interest expense		4,557			3,974
Non-cash charge for contingent consideration		1,846			2,524
Non-cash charge for option amortization		1,656			—
Deferred tax provision		(11,357	)		(3,898	)
Depreciation and amortization expense		19,040			17,208
Other, net		2,481			569
Changes in assets and liabilities:
Accounts receivable		23,635			(24,383	)
Inventory		18,117			(4,916	)
Prepaid expenses and other current assets		(8,200	)		3,185
Prepaid income taxes and income taxes payable		(798	)		(7,844	)
Other assets		(7,484	)		(240	)
Accounts payable		(4,950	)		2,646
Accrued expenses and other current liabilities		10,411			13,501
Other non-current liabilities		(224	)		(265	)

Net cash provided by operating activities		74,878			68,466
Cash flows from investing activities:
Purchase of Vancocin assets		—			(7,000	)
Purchase of property, equipment and building improvements		(585	)		(2,646	)
Purchase of short-term investments		(77,408	)		(94,975	)
Maturities of short-term investments		90,103			45,058

Net cash provided by (used in) investing activities		12,110			(59,563	)
Cash flows from financing activities:
Payment for treasury shares acquired		(71,523	)		(50,000	)
Net proceeds from issuance of common stock		5,947			3,051
Excess tax benefits from share-based payment arrangements		4,832			1,027

Net cash used in financing activities		(60,744	)		(45,922	)
Effect of exchange rate changes on cash		(383	)		682
Net increase (decrease) in cash and cash equivalents		25,861			(36,337	)
Cash and cash equivalents at beginning of period		331,352			426,732

Cash and cash equivalents at end of period	$	357,213		$	390,395

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

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

On August 6, 2012, FDA approved our supplement to the Cinryze Biologics License Application (BLA) for industrial scale manufacturing which increases our manufacturing capacity of Cinryze. We expect vials previously produced on this industrial scale line to enter into the trade during the third quarter of 2012.

We also sell branded and authorized generic Vancocin HCl capsules, the oral capsule formulation of vancomycin hydrochloride, in the U.S. and its territories. Vancocin is indicated for the treatment of C. difficile-associated diarrhea (CDAD). Vancocin capsules are also used for the treatment of enterocolitis caused by Staphylococcus aureus, including methicillin-resistant strains.

On April 9, 2012, the FDA denied the citizen petition we filed on March 17, 2006 related to the FDA’s proposed in vitro method for determining bioequivalence of abbreviated new drug applications (ANDAs) referencing Vancocin (vancomycin hydrochloride, USP) capsules. The FDA also informed us in the same correspondence that the recent supplemental new drug application (sNDA) for Vancocin which was approved on December 14, 2011 would not qualify for three additional years of exclusivity, as the agency interpreted Section 505(v) of the FD&C Act to require a showing of a significant new use (such as a new indication) for an old antibiotic such as Vancocin in order for such old antibiotic to be eligible for a grant of exclusivity. FDA also indicated that it approved three ANDA’s for generic vancomycin capsules and the companies holding these ANDA approvals indicated that they began shipping generic vancomycin hydrochloride, USP. In June 2012, the FDA approved a fourth ANDA for generic vancomycin capsules.

Pursuant to the terms of a previously entered distribution agreement, we granted a third party a license under our NDA for Vancocin^® (vancomycin hydrochloride capsules, USP) to distribute and sell vancomycin hydrochloride capsules as an authorized generic product. We are also obligated to pay Genzyme royalties of 10 percent, 10 percent and 16 percent of our net sales of Vancocin for the three year period following the approval of the sNDA as well as a lower royalty on sales of our authorized generic version of Vancocin in connection with our purchase of exclusive rights to two studies of Vancocin.

On November 15, 2011, we acquired a 100% ownership interest in DuoCort Pharma AB (DuoCort), a private company based in Helsingborg, Sweden focused on developing Plenadren® (hydrocortisone, modified release tablet) for treatment of adrenal insufficiency (AI). The acquisition of Plenadren further expands our orphan disease commercial product portfolio. On November 3, 2011, the European Commission (EC) granted European Marketing Authorization for Plenadren, an orphan drug for treatment of adrenal insufficiency in adults, which will bring these patients their first pharmaceutical innovation in

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

over 50 years. We anticipate commercial launch of Plenadren in the EU in late 2012 or early 2013. A named patient program is currently available to patients in Europe, which we expect to continue until commercial launch. We are currently conducting an open label trial with Plenadren in Sweden and will initiate a registry study as a condition of approval in the EU.

We acquired Buccolam^® (Oromucosal Solution, Midazolam [as hydrochloride]) in May 2010. In September of 2011, the European Commission granted a Centralized Pediatric Use Marketing Authorization (PUMA) for Buccolam, for treatment of prolonged, acute, convulsive seizures in infants, toddlers, children and adolescents, from 3 months to less than 18 years of age. We have begun to commercialize Buccolam in Europe.

Our product development portfolio is primarily focused on the following programs: C1 esterase inhibitor [human], VP20621 (preventing of CDAD), VP20629 (treatment of Friedreich’s Ataxia) and maribavir for cytomegalovirus (CMV).

We are currently undertaking studies on the viability of subcutaneous administration of Cinryze. In May 2011, Halozyme Therapeutics (Halozyme) granted us an exclusive worldwide license to use Halozyme’s proprietary Enhanze™ technology, a proprietary drug delivery platform using Halozyme’s recombinant human hyaluronidase enzyme (rHuPH20) technology, in combination with a C1 esterase inhibitor which we intend to apply initially to develop a subcutaneous formulation of Cinryze for routine prophylaxis against attacks of HAE. In the first quarter of 2012, we completed a Phase 2 study to evaluate the safety, and pharmacokinetics and pharmacodynamics of subcutaneous administration of Cinryze in combination with rHuPH20 and announced the presentation of positive data.

On August 1, 2012 we were notified by the Center for Biologics Evaluation and Research (CBER) division of the FDA that studies of the combination of Cinryze and rHuPH20 were being placed on temporary clinical hold. Halozyme informed us that they must provide results from additional pre-clinical studies to CBER before clinical investigations in combination with rHuPH20 can resume. FDA stated that the issues are not specific to Cinryze and that we could continue to evaluate subcutaneous administration of Cinryze without rHuPH20.

In light of this FDA action, we are preparing to commence a Phase 2 study that will evaluate the safety and efficacy of two different doses of the subcutaneous administration of Cinryze as a standalone therapy for which we received FDA clearance in 2011 of our Investigational New Drug (IND) application and the related Phase 2 clinical protocol to study subcutaneous administration of Cinryze without rHuPH20.

Additionally, we are working on developing our C1 esterase inhibitor in further therapeutic uses and potential additional indications in other C1 mediated diseases, as well as in alternative modes of administration. We intend to conduct ViroPharma sponsored studies and investigator-initiated studies (IIS) to identify further therapeutic uses and potentially expand the labeled indication for Cinryze to include other C1 mediated diseases, such as Antibody-Mediated Rejection (AMR) and Delayed Graft Function (DGF).

During the second quarter 2012, we announced the initiation of a Phase 2 program to evaluate maribavir for the treatment of CMV infections in transplant recipients. The planned program will consist of two independent Phase 2 clinical studies that will include subjects who have asymptomatic CMV, and those who have failed therapy with other anti-CMV agents.

We are also developing VP20621 for the prevention of CDAD. In May 2011, we initiated a Phase 2 dose-ranging clinical study to evaluate the safety, tolerability, and efficacy of VP20621 for prevention of recurrence of CDAD in adults previously treated for CDAD.

On September 30, 2011, we entered into a license agreement for the worldwide rights of Intellect Neurosciences, Inc. (INS) to its clinical stage drug candidate, VP20629, which we expect to develop for the treatment of Friedreich’s Ataxia (FA), a rare, hereditary, progressive neurodegenerative disease. VP20629, or indole-3-propionic acid, is a naturally occurring, small molecule that has potent anti-oxidant properties that can protect against neurodegenerative disease. In a recent Phase 1 safety and tolerability study conducted in the Netherlands, VP20629 was demonstrated to be safe and well tolerated at all dose levels tested. We expect to initiate a phase 1 study by the end of the first half of 2013. We intend to file for Orphan Drug Designation upon review of the phase 2 proof of concept data.

In addition to these programs, we have several other assets in which we may make additional investments. These investments will be limited and dependent on our assessment of the potential future commercial success of or benefits from the asset. These assets include recombinant C1-INH and other compounds.

On December 22, 2011, we entered into an exclusive development and option agreement with Meritage Pharma, Inc. (Meritage) , a private company based in San Diego, CA focused on developing oral budesonide suspension (OBS) as a treatment for eosinophilic esophagitis (EoE). EoE is a newly recognized chronic disease that is increasingly being diagnosed in children and adults. It is characterized by inflammation and accumulation of a specific type of immune cell, called an eosinophil, in the esophagus. EoE patients may have persistent or relapsing symptoms, which include dysphagia (difficulty in swallowing), nausea, stomach pain, chest pain, heartburn, loss of weight and food impaction.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

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 which we believe will provide both revenue and earnings growth over time.

Basis of Presentation

The consolidated financial information at June 30, 2012 and for the three and six months ended June 30, 2012 and 2011, 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, 2011 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Subsequent Events

We have evaluated all subsequent events through the date the financial statements were issued and have not identified any such events.

Use of Estimates

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

Adoption of Standards

In May 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, and the IASB issued IFRS 13, Fair Value Measurement. The new guidance results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and IFRS. The ASU is effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. The new guidance changes certain fair value measurement principles and disclosure requirements. We adopted this ASU January 1, 2012. The adoption of the provisions of this guidance did not have a material impact on our results of operations, cash flows, and financial position.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (Topic 220). This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. The standard is intended to enhance comparability between entities that report under US GAAP and those that report under IFRS, and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity. Under the ASU, an entity can elect to present items of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive, statements. Each component of net income and each component of other comprehensive income, together with totals for comprehensive income and its two parts, net income and other comprehensive income, would need to be displayed under either alternative. The statement(s) would need to be presented with equal prominence as the other primary financial statements. This ASU does not change items that constitute net income and other comprehensive income, when an item of other comprehensive income must be reclassified to net income or the earnings-per-share computation (which will continue to be based on net income). The new US GAAP requirements are effective for public entities as of the beginning of a fiscal year that begins after December 15, 2011 and interim and annual periods thereafter. We adopted this ASU January 1, 2012. The adoption of the provisions of this guidance did not have a material impact on our results of operations, cash flows, and financial position.

In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Amendments to Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update 2011-05. This ASU defers certain provisions of ASU 2011-05, which required entities to present reclassification adjustments out of accumulated other comprehensive income by component in the statement in which net income is presented and the statement in which comprehensive income is presented for both interim and annual periods. This requirement is indefinitely deferred by this ASU and will be further deliberated by the FASB at a future date. The new ASU is effective for public entities as of the beginning of a fiscal year that begins after December 15, 2011 and interim and annual periods thereafter, the same as that for the unaffected provisions of ASU 2011-05. We adopted this ASU January 1, 2012.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment (the revised standard) (Topic 350). The objective of this ASU is to simplify how entities test goodwill for impairment. The amendments in the ASU provide the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. The revised standard includes examples of events and circumstances that might indicate that a reporting unit’s fair value is less than its carrying amount. These include macro-economic conditions such as deterioration in the entity’s operating environment, entity-specific events such as declining financial performance, and other events such as an expectation that a reporting unit will be sold. An entity should also consider in its qualitative assessment the “cushion” between a reporting unit’s fair value and carrying amount if determined in a recent fair value calculation. The revised standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of the provisions of this guidance is not expected to have a material impact on our results of operations, cash flows, and financial position.

Note 2. Short-Term Investments

Short-term investments consist of fixed income securities with remaining maturities of greater than three months at the date of purchase, debt securities and equity securities. At June 30, 2012, all of our short-term investments are classified as available for sale investments and measured as level 1 instruments of the fair value measurements standard.

The following summarizes the Company’s available for sale investments at June 30, 2012:


(in thousands)	Cost		Gross unrealized gains		Gross unrealized losses		Fair value
Debt securities:
U.S. Treasury	$	50,000	$	19	$	22	$	49,997
Corporate		64,726		26		38		64,714

Total	$	114,726	$	45	$	60	$	114,711

Maturities of investments were as follows:
Less than one year	$	56,987	$	25	$	32	$	56,980
Greater than one year		57,739		20		28		57,731

Total	$	114,726	$	45	$	60	$	114,711

The following summarizes the Company’s available for sale investments at December 31, 2011:


(in thousands)	Cost		Gross unrealized gains		Gross unrealized losses		Fair value
Debt securities:
U.S. Treasury	$	48,351	$	14	$	3	$	48,362
Corporate bonds		80,143		43		70		80,116

Total	$	128,494	$	57	$	73	$	128,478

Maturities of investments were as follows:
Less than one year	$	99,190	$	42	$	39	$	99,193
Greater than one year		29,304		15		34		29,285

Total	$	128,494	$	57	$	73	$	128,478

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

Note 3. Inventory

Inventory is stated at the lower of cost or market using actual cost. The following represents the components of inventory at June 30, 2012 and December 31, 2011:


(in thousands)	June 30, 2012		December 31, 2011
Raw Materials	$	26,745	$	50,045
Work In Process		9,094		6,035
Finished Goods		5,246		4,236

Total	$	41,085	$	60,316

Note 4. Intangible Assets

The following represents the balance of the intangible assets at June 30, 2012:


(in thousands)	Gross Intangible Assets		Accumulated Amortization		Net Intangible Assets
Cinryze Product rights	$	521,000	$	76,974	$	444,026
Vancocin Intangibles		168,099		51,423		116,676
Buccolam Product rights		6,348		529		5,819
Auralis Contract rights		9,048		2,023		7,025
Plenadren Product rights		60,174		3,506		56,668

Total	$	764,669	$	134,455	$	630,214

The following represents the balance of the intangible assets at December 31, 2011:


(in thousands)	Gross Intangible Assets		Accumulated Amortization		Net Intangible Assets
Cinryze Product rights	$	521,000	$	66,554	$	454,446
Vancocin Intangibles		168,099		48,074		120,025
Buccolam Product rights		6,271		209		6,062
Auralis Contract rights		8,938		1,579		7,359
Plenadren Product rights		61,277		510		60,767

Total	$	765,585	$	116,926	$	648,659

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

On April 9, 2012, FDA denied the citizen petition filed on March 17, 2006 related to the FDA’s proposed in vitro method for determining bioequivalence of abbreviated new drug applications (ANDAs) referencing Vancocin capsules. In the FDA’s response to the citizen petition, the agency denied our citizen petition and also informed us that a final guidance for vancomycin bioequivalence consistent with the FDA’s citizen petition response is forthcoming.

The FDA also informed us in the same correspondence that the recent supplemental new drug application (sNDA) for Vancocin which was approved on December 14, 2011 would not qualify for three additional years of exclusivity, as the agency interpreted Section 505(v) of the FD&C Act to require a showing of a significant new use (such as a new indication) for an old antibiotic such as Vancocin in order for such old antibiotic to be eligible for a grant of exclusivity. FDA also indicated that it is approving three ANDA’s for generic vancomycin capsules. In June 2012, FDA approved a fourth ANDA for generic vancomycin capsules.

In addition, we have received a notification that the Federal Trade Commission (FTC) is conducting an investigation into whether we engaged in unfair methods of competition with respect to Vancocin. The existence of an investigation does not indicate that the FTC has concluded that we have violated the law and we do not believe that we have engaged in unfair methods of competition with respect to Vancocin. We intend to cooperate with the FTC investigation and at this time we cannot assess potential outcomes of this investigation.

We have begun shipping authorized generic vancomycin hydrochloride, USP, in addition to continuing the sales of Vancocin. However, the approval of generic copies of Vancocin has and will continue to adversely impact our revenues, operating results and cash flows compared to historical levels. We tested the Vancocin intangible assets for impairment as of March 31, 2012. There was no impairment of these intangible assets as of March 31, 2012. Vancocin will continue to be utilized and sold as a branded drug product and we are selling an authorized generic version of Vancocin along with generics of other companies that have entered the market. There have been no events during the quarter ended June 30, 2012 that would indicate we must re-test these assets for impairment. However, should future events occur that may cause further reductions in revenue or operating results we may be required to test the recoverability of these assets and may incur an impairment.

We were obligated to pay Eli Lilly and Company (Lilly) additional purchase price consideration based on net sales of Vancocin within a calendar year through 2011. We accounted for these additional payments as additional purchase price which requires that the additional purchase price consideration is recorded as an increase to the intangible asset of Vancocin and is amortized over the remaining estimated useful life of the intangible asset. In addition, at the time of recording the additional intangible assets, a cumulative adjustment was 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 December 31, 2011, we have paid an aggregate of $51.1 million to Lilly in additional purchase price consideration, as our net sales of Vancocin surpassed the maximum obligation level of $65 million in 2005 through 2011. In June 2011, we satisfied our obligations to Lilly to make additional purchase price consideration payments under the purchase agreement.

On May 28, 2010 we acquired Auralis Limited, a UK based specialty pharmaceutical company. With the acquisition of Auralis we added one marketed product and several development assets to our portfolio. We recognized an intangible asset related to certain supply agreements for the marketed product and one of the development assets. Additionally, we recognized in-process research and development (IPR&D) assets related to the development assets which are currently not approved. We determined that these assets meet the criterion for separate recognition as intangible assets and the fair value of these assets have been determined based upon discounted cash flow models. The contract rights acquired as part of the Auralis acquisition are being amortized on a straight-line basis over their estimated useful lives of 12 years and the product rights acquired are being amortized on a straight-line basis over their estimated useful lives of 10 years. In 2011, the European Commission granted a Centralized Pediatric Use Marketing Authorization (PUMA) for Buccolam, for treatment of prolonged, acute, convulsive seizures in infants, toddlers, children and adolescents, from 3 months to less than 18 years of age. This asset was previously classified as an IPR&D asset. As a result of this approval we began to amortize this asset over its estimated useful life of 10 years.

Due to the approval and launch of Buccolam, coupled with the approval and launch of Cinryze in Europe, we decided to alter our development and commercialization plans for the remaining Auralis IPR&D asset. The decision resulted in the impairment of the IPR&D asset and a portion of the Auralis Contract rights. Accordingly, we recorded a charge of approximately £5.4 million (approximately $8.5 million) during the third quarter of 2011.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

On November 15, 2011, we acquired DuoCort Pharma AB (DuoCort), a company focused on improving glucocorticoid replacement therapy for treatment of adrenal insufficiency (AI). The acquisition of Duocort further expands our orphan disease commercial product portfolio. On November 3, 2011, the European Commission (EC) granted European Marketing Authorization for Plenadren^® (hydrocortisone, modified release tablet), an orphan drug for treatment of adrenal insufficiency in adults, which will bring these patients their first pharmaceutical innovation in over 50 years. We recognized an intangible asset related to the Plenadren product rights. The product rights acquired are being amortized on a straight-line basis over their estimated useful lives of 10 years.

Note 5. Goodwill

On October 21, 2008, we completed our acquisition of Lev Pharmaceuticals, Inc. The terms of the merger agreement provided for a contingent value right (CVR) to the former shareholders of $0.50 per share, or approximately $87.5 million, if Cinryze reaches at least $600 million in cumulative net product sales by October 2018. As of June 30, 2012, we have recognized cumulative sales of Cinryze in excess of the $600 million threshold and we will make this CVR payment along with certain other contingent payments specified in the merger agreement totaling approximately $92.1 million in the third quarter of 2012. Accordingly, we recorded these liabilities in the second quarter of 2012 with a corresponding increase to goodwill of approximately $86.2 million, net of tax benefits.

On November 15, 2011, we acquired DuoCort Pharma AB (DuoCort), a company focused on improving glucocorticoid replacement therapy for treatment of adrenal insufficiency (AI). As a result of this acquisition we initially recorded goodwill of approximately $7.3 million. The change in goodwill since acquisition is attributable to foreign currency fluctuations.

In May 2010 we acquired a 100% ownership interest in Auralis Limited, a UK based specialty pharmaceutical company. As a result of this acquisition we recorded initial goodwill of approximately $5.9 million. The changes in goodwill since the acquisition date are attributable to foreign currency fluctuations.

Note 6. Long-Term Debt

Long-term debt as of June 30, 2012 and December 31, 2011 is summarized in the following table:


(in thousands)	June 30, 2012		December 31, 2011
Senior convertible notes	$	157,542	$	153,453
less: current portion		—		—

Total debt principal	$	157,542	$	153,453

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.

The debt and equity components of our senior convertible debt securities were bifurcated and accounted for separately based on the value and related interest rate of a non-convertible debt security with the same terms. The fair value of a non-convertible debt instrument at the original issuance date was determined to be $148.1 million. The equity (conversion options) component of our

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

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

As of June 30, 2012 senior convertible notes representing $205.0 million of principal debt are outstanding with a carrying value of $157.5 million and a fair value of approximately $298.2 million, based on the Level 2 valuation hierarchy of the fair value measurements standard.

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

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 cost of the transactions was $23.3 million.

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 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 common stock 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.

Initially, the purchased call options and warrants sold with the terms described above were based upon the $250.0 million offering, and the number of shares we would purchase under the call option and the number of shares we would sell under the warrants was 13.25 million, to correlate to the $250.0 million principal amount. 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.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

As a result of the above negotiated sale and purchase transactions we are now entitled to receive approximately 10.87 million shares of our 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, which correlates to $205 million of convertible notes outstanding.

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 provisions.

As of June 30, 2012, we have accrued $1.2 million in interest payable to holders of the senior convertible notes. Debt issuance costs of $4.8 million have been capitalized and are being amortized over the term of the senior convertible notes, with an unamortized balance of $1.8 million at June 30, 2012.

The senior convertible notes were convertible into shares of our common stock during the second quarter of 2012 at the election of the holders as the last reported sale price of our common stock for the 20 or more trading days in the 30 consecutive trading days ending on March 30, 2012 exceeded 130% of the conversion price, $18.87 per share, in effect on March 30, 2012. No notes were converted during the second quarter and the notes are not convertible in the third quarter of 2012 as none of the contingent conversion criteria described above was met as of June 30, 2012.

Credit Facility

On September 9, 2011, we entered into a $200 million, three-year senior secured revolving credit facility (the “Credit Facility”), the terms of which are set forth in a Credit Agreement dated as of September 9, 2011 (the “Credit Agreement”) with JPMorgan Chase Bank, N.A., as administrative agent, BMO Harris Financing Inc., TD Bank, N.A. and Morgan Stanley Bank, NA as co-syndication agents and certain other lenders.

The Credit Facility is available for working capital and general corporate purposes, including acquisitions which comply with the terms of the Credit Agreement. The Credit Agreement provides separate sub-limits for letters of credit up to $20 million and swing line loans up to $10 million.

The Credit Agreement requires us to maintain (i) a maximum senior secured leverage ratio of less than 2.00 to 1.00, (ii) a maximum total leverage ratio of less than 3.50 to 1.00, (iii) a minimum interest coverage ratio of greater than 3.50 to 1.00 and (iv) minimum liquidity equal to or greater than the sum of $100,000,000 plus the aggregate amount of certain contingent consideration payments resulting from business acquisitions payable by us within a specified time period. The Credit Agreement also contains certain other usual and customary affirmative and negative covenants, including but not limited to, limitations on capital expenditures, asset sales, mergers and acquisitions, indebtedness, liens, dividends, investments and transactions with affiliates.

Our obligations under the Credit Facility are guaranteed by certain of our domestic subsidiaries (the “Subsidiary Guarantors”) and are secured by substantially all of our assets and the assets of the Subsidiary Guarantors. Borrowings under the Credit Facility will bear interest at an amount equal to a rate calculated based on the type of borrowing and our senior secured leverage ratio (as defined in the Credit Agreement) from time to time. For loans (other than swing line loans), we may elect to pay interest based on adjusted LIBOR plus between 2.25% and 2.75% or an Alternate Base Rate (as defined in the Credit Agreement) plus between 1.25% and 1.75%. We will also pay a commitment fee of between 35 to 45 basis points, payable quarterly, on the average daily unused amount of the Credit Facility based on our senior secured leverage ratio from time to time.

As of the date of this filing, we have not drawn any amounts under the Credit Facility and are in compliance with our covenants. However, because of the negative impact of approval of generic vancomycin on our operating results and the resulting effect on certain covenants, the availability under the facility may be limited at times.

As of June 30, 2012, we have accrued $0.2 million in interest expense for the revolver. Financing costs of approximately $1.7 million incurred to establish the Credit Facility were deferred and are being amortized to interest expense over the life of the Credit Facility, with an unamortized balance of $1.2 million as of June 30, 2012.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

Note 7. Stockholder’s Equity

Preferred Stock

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

Share Repurchase Program

On March 9, 2011, our Board of Directors authorized the use of up to $150 million to repurchase shares of our common stock and/or our 2% Senior Convertible Notes due 2017. On September 14, 2011, our Board of Directors authorized the use of up to an additional $200 million to repurchase shares of our common stock and/or our 2% Senior Convertible Notes due 2017. Purchases may be made by means of open market transactions, block transactions, privately negotiated purchase transactions or other techniques from time to time. During 2011, we reacquired approximately 9.2 million shares at a cost of approximately $169.7 million or an average price of $18.52 per share.

During the first six months of 2012, through open market purchases, we reacquired approximately 2.7 million shares at a cost of approximately $71.5 million or an average price of $26.61 per share.

Note 8. Share-based Compensation

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

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

•

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

•

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

•

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

•

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

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

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

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


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2012		2011		2012		2011
Stock options	$	4,095	$	3,073	$	7,976	$	6,034
Performance shares		1,047		480		1,837		886
Restricted shares		263		116		444		166
Employee Stock Purchase Plan		52		38		103		77

Total	$	5,457	$	3,707	$	10,360	$	7,163

Our share-based compensation expense is recorded as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2012		2011		2012		2011
Research and development	$	1,152	$	999	$	2,235	$	1,986
Selling, general and administrative		4,305		2,708		8,125		5,177

Total	$	5,457	$	3,707	$	10,360	$	7,163

We currently have three share-based award plans in place: a 1995 Stock Option and Restricted Share Plan (1995 Plan), a 2001 Equity Incentive Plan (2001 Plan) and a 2005 Stock Option and Restricted Share Plan (2005 Plan) (collectively, the “Plans”). In September 2005, the 1995 Plan expired and no additional grants will be issued from this plan. The Plans were adopted by our board of directors to provide eligible individuals with an opportunity to acquire or increase an equity interest in the Company and to encourage such individuals to continue in the employment of the Company.

In May 2008, the 2005 Plan was amended and an additional 5,000,000 shares of common stock was reserved for issuance upon the exercise of stock options or the grant of restricted shares or restricted share units. This amendment was approved by stockholders at our Annual Meeting of Stockholders in May of 2010. In April 2012, the 2005 Plan was amended and an additional 2,500,000 shares of common stock was reserved for issuance upon the exercise of stock options or the grant of restricted shares or restricted share units. This amendment was approved by stockholders at our Annual Meeting of Stockholders in May of 2012.

As of June 30, 2012, there were 4,783,599 shares available for grant under the Plans.

The following table lists information about these equity plans at June 30, 2012:


	1995 Plan		2001 Plan		2005 Plan		Combined
Shares authorized for issuance		4,500,000		500,000		15,350,000		20,350,000
Shares outstanding		4,500,000		500,000		10,566,401		15,566,401

Shares available for grant		—		—		4,783,599		4,783,599

Employee Stock Option Plans

We granted 1,823,899 stock options during the six months ended June 30, 2012. The weighted average fair value of the grants was estimated at $ 14.06 per share using the Black-Scholes option-pricing model using the following assumptions:

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

We have 9,334,344 option grants outstanding at June 30, 2012 with exercise prices ranging from $1.00 per share to $32.69 per share and a weighted average remaining contractual life of 7.12 years. The following table lists the outstanding and exercisable option grants as of June 30, 2012:


	Number of options		Weighted average exercise price		Weighted average remaining contractual term (years)		Aggregate intrinsic value (in thousands)
Outstanding		9,334,344	$	14.67		7.12	$	88,842
Exercisable		5,020,133	$	11.44		5.68	$	61,527

The following table summarizes information regarding our stock option awards at June 30, 2012:


	Shares Under Option			Weighted Average Exercise Price
Balance at December 31, 2011		8,485,241		$	12.03
Granted		1,823,899		$	24.46
Exercised		(797,231	)	$	8.73
Forfeited		(176,315	)	$	15.95
Cancelled		(1,250	)	$	11.55

Balance at June 30, 2012		9,334,344		$	14.67

As of June 30, 2012, there was $41.7 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 2.97 years.

Performance Awards

Beginning in 2011, employees receive annual grants of performance award units, or PSUs, in addition to stock options which give the recipient the right to receive common stock that is contingent upon achievement of specified pre-established company performance goals over a three year performance period. The performance goals for the PSUs granted, which are accounted for as equity awards, are based upon the following performance measures: (i) our revenue growth over the performance period, (ii) our adjusted net income as a percent of sales at the end of the performance period, and (iii) our relative total shareholder return, or TSR, compared to a peer group of companies at the end of the performance period.

In 2012 and 2011, approximately 186,000 and 155,000 PSUs subject to company specific performance metrics were granted with weighted average grant date fair values of $28.16 and $17.84 per share, respectively. In 2012 and 2011, approximately 21,000 and 17,000 PSUs subject to the TSR metric were granted with weighted average grant date fair values of $45.37 and $24.38 per share, respectively. The number of PSUs reflected as granted represents the target number of shares that are eligible to vest subject to the attainment of the performance goals. Depending on the outcome of these performance goals, a recipient may ultimately earn a number of shares greater or less than their target number of shares granted, ranging from 0% to 200% of the PSUs granted. Shares of our common stock are issued on a one-for-one basis for each PSU earned. Participants vest in their PSUs at the end of the performance period.

The fair value of the PSUs subject to company specific performance metrics is equal to the closing price of our common stock on the grant date.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

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


	Six Months Ended June 30,
(in thousands)	2012			2011
Closing stock price on grant date	$	28.16		$	17.84
Performance period starting price	$	24.94		$	16.85
Term of award (in years)		2.99			2.99
Volatility		65.06	%		69.75	%
Risk-free interest rate		0.45	%		1.19	%
Expected dividend yield		0.00	%		0.00	%
Fair value per TSR PSU	$	45.37		$	24.38

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

At June 30, 2012, there was approximately $ 9.5 million of unrecognized compensation cost related to all PSUs that is expected to be recognized over a weighted-average period of approximately 2.31 years.

The following table summarizes select information regarding our PSUs as of June 30, 2012:


	Share Units (in thousands)			Weighted- average grant date fair value
Balance at December 31, 2011		164,692		$	18.50
Granted		206,900		$	29.88
Forfeited		(12,356	)	$	23.63
Vested		—		$	—

Balance at June 30, 2012		359,236		$	24.88

Restricted Stock Awards

Beginning in 2011, we also grant our non-employee directors restricted stock awards that generally vest after one year of service. In 2012 and 2011, 37,750 and 27,000 RSUs were granted with weighted average grant date fair values of $31.12 and $17.30 per share, respectively. The fair value of a restricted stock award is equal to the closing price of our common stock on the grant date.

The following summarizes select information regarding our restricted stock awards as of June 30, 2012:


	Share Units (in thousands)			Weighted- average grant date fair value
Balance at December 31, 2011		27,000		$	17.30
Granted		37,750		$	31.12
Vested		(27,000	)	$	17.30

Balance at June 30, 2012		37,750		$	31.12

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

As of June 30, 2012, there was approximately $ 0.80 million of unrecognized compensation cost related to RSUs which is expected to be recognized over a weighted average period of 0.99 years.

Employee Stock Purchase Plan

During the first six months of 2012, no shares were sold to employees. During the year ended December 31, 2011, 29,982 shares were sold to employees. As of June 30, 2012 there are approximately 385,319 shares available for issuance under this plan.

Under this plan, there are two plan periods: January 1 through June 30 (Plan Period One) and July 1 through December 31 (Plan Period Two). For Plan Period One in 2012, the fair value of approximately $103,000 was estimated using the Type B model with a risk free interest rate of 0.06%, volatility of 47.7% and an expected option life of 0.5 years. This fair value was amortized over the six month period ending June 30, 2012.

Note 9. Income Tax Expense

Our income tax expense (benefit) was ($1.2) million and $16.9 million for the quarters ended June 30, 2012 and 2011, respectively, and $16.9 million and $40.8 million for the six months ended June 30, 2012 and June 30, 2011, respectively. Our income tax expense includes federal, state and foreign income taxes at statutory rates and the effects of various permanent differences.

Our effective tax rates for the six months ended June 30, 2012 and June 30, 2011, were 51.7% and 40.8%, respectively.

The effective tax rates for the six month periods ended June 30, 2012 and 2011 are higher than the statutory U.S. tax rate due to state income taxes, certain share-based compensation that is not tax deductible and an increase in the fair value of contingent consideration that is also not deductible for tax purposes. In addition, the effective tax rate for the six months ended June 30, 2012 is higher than the statutory U.S. tax rate due to foreign losses on which no tax benefit is provided or on which the tax benefit is less than the U.S. statutory tax rate and non-deductible amortization expense. These increases to the effective tax rate are partially offset by tax benefits related to orphan drug credits, manufacturing deductions and charitable contributions. Tax expense (benefit) for the quarters ended June 30, 2012 and 2011 are a combination of the six month effective tax rate and adjustments for changes in the effective tax rate from the prior quarter.

During the six months ended June 30, 2012, we had no material changes to our liability for uncertain tax positions. Our last U.S. tax examination for 2008 concluded in the first quarter of 2011 with no material adjustments. We are currently under examination in a foreign tax jurisdiction and various state income tax returns are also currently under examination. At this time, we do not believe that the results of these examinations will have a material impact on our financial statements.

Note 10. Accumulated Other Comprehensive Income (Loss)

The following table presents the changes in the components of accumulated other comprehensive income (loss) for the six months ended June 30, 2012:


	Cumulative Translation			Unrealized gains (losses) on securities			Accumulated other comprehensive income (loss)
(in thousands)
Balance December 31, 2011	$	(3,403	)	$	(11	)	$	(3,414	)
Current period other comprehensive income, net		364			1			365

Balance June 30, 2012	$	(3,039	)	$	(10	)	$	(3,049	)

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

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

Note 11. Earnings (loss) per share


	Three Months Ended June 30,					Six Months Ended June 30,
(in thousands, except per share data)	2012			2011		2012		2011
Basic Earnings Per Share
Net income (loss)	$	(4,203	)	$	22,796	$	15,788	$	59,242
Common stock outstanding (weighted average)		69,390			76,000		69,951		76,919

Basic net income (loss) per share	$	(0.06	)	$	0.30	$	0.23	$	0.77

Diluted Earnings Per Share
Net income (loss)	$	(4,203	)	$	22,796	$	15,788	$	59,242
Add interest expense on senior convertible notes, net of income tax		—			1,883		—		3,727

Diluted net income (loss)	$	(4,203	)	$	24,679	$	15,788	$	62,969
Common stock outstanding (weighted average)		69,390			76,000		69,951		76,919
Add shares from senior convertible notes		—			10,864		—		10,864
Add “in-the-money” stock options and stock awards		—			2,595		3,077		2,457

Common stock equivalents		69,390			89,459		73,028		90,240

Diluted net income (loss) per share	$	(0.06	)	$	0.28	$	0.22	$	0.70

The following common stock equivalents were excluded from the calculations of diluted earnings per share as their effect would be anti-dilutive:


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2012		2011		2012		2011
“Out-of-the-money” stock options		3,015		1,749		1,997		1,613
Shares from senior convertible notes		10,864		—		10,864		—
“In-the-money” stock options		2,557		—		—		—

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.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of June 30, 2012:


			Fair Value Measurements at June 30, 2012
(in thousands)	Total Carrying Value at June 30, 2012		(Level 1)		(Level 2)		(Level 3)
Cash and cash equivalents	$	357,213	$	357,213	$	—	$	—
Short term investments	$	114,711	$	114,711	$	—	$	—
Contingent consideration, short-term	$	7,730	$	—	$	—	$	7,730
Contingent consideration, long-term	$	13,895	$	—	$	—	$	13,895

The following table provides a rollfoward of activity in Level 3:


(in thousands)
Balance December 31, 2011	$	20,189
Change in fair value from re-measurement		1,846
Impact of foreign currency translation		(410	)

Balance June 30, 2012	$	21,625

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 three and six months ended June 30, 2012.

In the fourth quarter of 2011, we recognized contingent consideration liabilities related to our acquisition of DuoCort. The fair values of the contingent consideration is measured using significant inputs not observable in the market, which are referred to in the guidance as Level 3 inputs. The contingent consideration payments are classified as liabilities and are subject to the recognition of subsequent changes in fair value through our results of operations in other operating expenses.

The fair value of the contingent consideration payments related to regulatory approvals, is estimated by applying risk adjusted discount rates, 13% and 20.3%, to the probability adjusted contingent payments and the expected approval dates. The fair value of the contingent consideration payment related to the attainment of future revenue targets is estimated by applying a risk adjusted discount rate, 16%, to the potential payments resulting from probability weighted revenue projections and expected revenue target attainment dates. These fair value estimates are most sensitive to changes in the probability of regulatory approvals or the probability of the achievement of the revenue targets.

There were no changes in the valuation techniques during the period and there were no transfers into or out of Levels 1 and 2.

Our 2% senior convertible notes due March 2017 are measured at amortized cost in our consolidated balance sheets and not fair value. The principal balance outstanding is $205.0 million with a carrying value of $157.5 million and a fair value of approximately $298.2 million, based on the level 2 valuation hierarchy of the fair value measurements standard.

We believe that the fair values of our other financial instruments approximate their reported carrying amounts.

Note 13. Acquisitions

On November 15, 2011, we acquired a 100% ownership interest in DuoCort Pharma AB (DuoCort), a private company based in Helsingborg, Sweden focused on improving glucocorticoid replacement therapy for treatment of adrenal insufficiency (AI). We paid approximately 213 million Swedish Krona (SEK) or approximately $32.1 million in upfront consideration. We have also agreed to make additional payments ranging from SEK 240 million up to SEK 860 million or approximately $34 million to $122 million, contingent on the achievement of certain milestones. Up to SEK 160 million or approximately $23 million of the contingent payments relate to specific regulatory milestones; and up to SEK 700 million or approximately $99 million of the contingent payments are related to commercial milestones based on the success of the product.

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

The DuoCort contingent consideration consists of three separate contingent payments. The first will be payable upon the regulatory approval to manufacture bulk product in the EU. The second contingent payment is based on the attainment of specified revenue targets and the third contingent payment is payable upon regulatory approval of the product in the United States.

The fair value of the first and third contingent consideration payments recognized on the acquisition date was estimated by applying a risk adjusted discount rate to the probability adjusted contingent payments and the expected approval dates. The fair value of the second contingent consideration payment recognized on the acquisition date was estimated by applying a risk adjusted discount rate to the potential payments resulting from probability weighted revenue projections and expected revenue target attainment dates.

These fair values are based on significant inputs not observable in the market, which are referred to in the guidance as Level 3 inputs. The contingent considerations are classified as liabilities and are subject to the recognition of subsequent changes in fair value through our results of operations.

The DuoCort results of operations have been included in the Consolidated Statement of Operations beginning November 15, 2011.

The results of operations of DuoCort since the acquisition date and had the acquisition occurred on January 1, 2011 are immaterial to our consolidated results of operation. We incurred approximately $1.4 million of transaction cost as part of this acquisition.

Meritage Pharma, Inc.

On December 22, 2011, we entered into an exclusive development and option agreement with Meritage Pharma, Inc. (Meritage) , a private development-stage company based in San Diego, CA focused on developing oral budesonide suspension (OBS) as a treatment for eosinophilic esophagitis (EoE). EoE is a chronic disease that is increasingly being diagnosed in children and adults. It is characterized by inflammation and accumulation of a specific type of immune cell, called an eosinophil, in the esophagus. EoE patients may have persistent or relapsing symptoms, which include dysphagia (difficulty in swallowing), nausea, stomach pain, chest pain, heartburn, loss of weight and food impaction.

As consideration for the agreement, we made an initial $7.5 million non-refundable payment to Meritage. Meritage will utilize the funding to conduct additional Phase 2 clinical assessment of OBS. We have an exclusive option to acquire Meritage, at our sole discretion, by providing written notice at any time during the period from December 22, 2011 to and including the date that is the earlier of (a) the date that is 30 business days after the later of (i) the receipt of the final study data for the Phase 2 study and (ii) identification of an acceptable clinical end point definition for a pivotal induction study agreed to by the FDA. If we exercise this option, we have agreed to pay $69.9 million for all of the outstanding capital stock of Meritage. Meritage stockholders could also receive additional payments of up to $175 million, upon the achievement of certain clinical and regulatory milestones.

We have determined that Meritage is a variable interest entity (VIE), however because we do not have the power to direct the activities of Meritage that most significantly impact its economic performance we are not the primary beneficiary of this VIE at this time. Further, we have no oversight of the day-to-day operations of Meritage, nor do we have sufficient rights or any voting representation to influence the operating or financial decisions of Meritage, nor do we participate on any steering or oversight committees. Therefore, we are not required to consolidate Meritage into our financial statements. This consolidation status could change in the future if the option agreement is exercised, or if other changes occur in the relationship between Meritage and us.

We valued the non-refundable $7.5 million upfront payment using the cost method. In June, 2012, Meritage completed the delivery of all the documents and notifications needed to satisfy the conditions of the First Option Milestone, as defined in the agreement. As a result of achieving this milestone they are due a $5.0 million milestone payment, which will be paid in the third quarter of 2012. Accordingly, in the second quarter of 2012, we recorded this liability and increased the carrying value of our cost method investment. We have the option to provide Meritage up to an additional $7.5 million for the development of OBS

Under the cost method, the fair value of the investment is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. As of June 30, 2012, we were not aware of any such adverse effects, as such no fair value estimate has been prepared. The asset is recorded as an other long-term asset on our consolidated balance sheets and is amortized through other income (expense) in our results of operations over the expected term of the option agreement which is expected to be December 2014. We recognized approximately $1.7 million of amortization expense during the first six months of 2012 related to this asset.

Intellect Neurosciences, Inc. License Agreement

ViroPharma Incorporated

Notes to the Unaudited Consolidated Financial Statements – (Continued)

neurodegenerative disease. We expect to initiate a phase 1 study by the end of the first half of 2013. We intend to file for Orphan Drug Designation upon review of the phase 2 proof of concept data. Under the terms of the agreement, we have exclusive worldwide rights to develop and commercialize VP20629 for the treatment, management or prevention of any disease or condition covered by INS’s patents. We paid INS a $6.5 million up-front licensing fee and may pay additional milestones up to $120 million based upon defined events. We will also pay a tiered royalty of up to a maximum percentage of low teens, based on annual net sales.

Halozyme Therapeutics License Agreement

In May 2011, Halozyme Therapeutics (Halozyme) granted us an exclusive worldwide license to use Halozyme’s proprietary Enhanze™ technology, a proprietary drug delivery platform using Halozyme’s recombinant human hyaluronidase enzyme (rHuPH20) technology in combination with a C1 esterase inhibitor. We intend to apply rHuPH20 initially to develop a novel subcutaneous formulation of Cinryze for routine prophylaxis against attacks. Under the terms of the license agreement, we paid Halozyme an initial upfront payment of $9 million. In the fourth quarter of 2011, we made a milestone payment of $3 million related to the initiation of a Phase 2 study begun in September 2011 to evaluate the safety, and pharmacokinetics and pharmacodynamics of subcutaneous administration of Cinryze in combination with rHuPH20. Pending successful completion of an additional series of clinical and regulatory milestones, anticipated to begin during 2012, we may make further milestone payments to Halozyme which could reach up to an additional $41 million related to HAE and up to $30 million of additional milestone payments for three additional indications. Additionally, we will pay an annual maintenance fee of $1 million to Halozyme until specified events have occurred. Upon regulatory approval, Halozyme will receive up to a 10% royalty on net sales of the combination product utilizing Cinryze and rHuPH20, depending on the existence of a valid patent claim in the country of sale.

Auralis Acquisition

In May 2010 we acquired a 100% ownership interest in Auralis Limited, a UK based specialty pharmaceutical company for approximately $14.5 million in upfront consideration for the acquisition of the company and its existing pharmaceutical licenses and products. We have also agreed to pay an additional payment of £10 million Pounds Sterling contingent upon the first regulatory approval of Buccolam, a product in late stage development.

In September of 2011, the European Commission granted a Centralized Pediatric Use Marketing Authorization (PUMA) for Buccolam, and accordingly the additional consideration was paid. The U.S. dollar equivalent of the payment was approximately $15.8 million.

Note 14. Litigation and Claims

On May 17, 2012, a class action complaint was filed in the United States District Court for the Eastern District of Pennsylvania naming as defendants ViroPharma Incorporated and Vincent J. Milano. The complaint alleges, among other things, possible securities laws violations by the defendants in connection with certain statements made by the defendants related to the Company’s Vancocin product. The defendants believe that the allegations in the class action complaint are without merit and intend to defend the lawsuit vigorously; however, there can be no assurance regarding the ultimate outcome of this lawsuit. It is possible that other plaintiffs may file class actions containing similar allegations.

On April 13, 2012, we filed a complaint for declaratory and injunctive relief with the United States District Court for the District of Columbia against the Food and Drug Administration, Margaret A. Hamburg, M.D., in her official capacity as Commissioner of Food and Drug Administration, the United States Department of Health and Human Services, and Kathleen Sebelius, in her official capacity as Secretary of HHS. The complaint seeks to set aside under the Administrative Procedure Act the FDA’s denial of our petition for stay of action and the FDA’s approval of three Abbreviated New Drug Applications for generic versions of Vancocin^® (vancomycin hydrochloride) capsules. Concurrent with the filing of the complaint, we filed a motion for a temporary restraining order and/or a preliminary injunction, which the District Court denied on April 23, 2012. Adjudication of the merits of this lawsuit remains pending.

On April 6, 2012, we received a notification that the Federal Trade Commission (FTC) is conducting an investigation into whether we engaged in unfair methods of competition with respect to Vancocin. The existence of an investigation does not indicate that the FTC has concluded that we have violated the law and we do not believe that we have engaged in unfair methods of competition with respect to Vancocin. We intend to cooperate with the FTC investigation; however, at this time we cannot assess potential outcomes of this investigation.

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

Note 15. Supplemental Cash Flow Information


	Six Months Ended June 30,
(in thousands)	2012			2011
Supplemental disclosure of non-cash transactions:
Employee share-based compensation	$	10,360		$	7,163
Unrealized gains on available for sale securities, net of tax		(11	)		48
Non-cash increase in goodwill related to the acquisition of Lev Pharmaceuticals, Inc.		86,165			-
Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	24,119		$	53,274
Cash paid for interest		2,589			2,050

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

Executive Summary

Since March 31, 2012, we experienced the following:

Business Activities

Cinryze:

•

Shipped approximately 19,000 doses of Cinryze to U.S. specialty pharmacy/specialty distributors (SP/SD’s) and approximately 800 doses to wholesalers in the EU; and

•

On August 6, 2012, FDA approved our Prior Approval Supplement for industrial scale manufacturing of Cinryze;

C. difficile infection (CDAD):

•

Announced that FDA denied the citizen petition we filed on March 17, 2006, determined the (sNDA) for Vancocin approved December 14, 2011 would not qualify for three years of exclusivity and approved several ANDA’s for generic vancomycin capsules; and

•

Based upon data reported by IMS Health Incorporated, Vancocin branded product had approximately a 14% share of the total vancomycin prescriptions as of June 30, 2012;

CMV:

•

Announced the initiation of a Phase 2 program to evaluate maribavir for the treatment of CMV infections in transplant recipients;

Financial Results

•

Increased net sales of Cinryze to $76.6 million as compared to $62.5 million in the second quarter of 2011;

•

Net sales of Vancocin decreased to $15.9 million from $65.2 million in the second quarter of 2011;

•

Generated net sales of approximately $3.8 million in Europe; and

•

Reported net loss of $4.2 million in the second quarter of 2012;

Liquidity

•

Generated net cash from operations of $74.9 million;

•

Ended the second quarter of 2012 with working capital of $424.8 million, which includes cash and cash equivalents of $357.2 million and short-term investments of $114.7 million; and

•

Repurchased approximately 1.1 million shares of our common stock at a cost of approximately $21.5 million, or an average price of $19.90 per share.

During the remainder of 2012 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 sales will meet or exceed the historical rate of sales for the product, for reasons that include, but are not limited to, competition and/or changes in prescribing habits or disease incidence.

On April 9, 2012, FDA denied the citizen petition filed on March 17, 2006 related to the FDA’s proposed in vitro method for determining bioequivalence of abbreviated new drug applications (ANDAs) referencing Vancocin Capsules. In the FDA’s response to the citizen petition, the agency denied our citizen petition and also informed us that a final guidance for vancomycin bioequivalence consistent with the FDA’s citizen petition response is forthcoming.

The FDA also informed us in the same correspondence that the recent supplemental new drug application (sNDA) for Vancocin which was approved on December 14, 2011 would not qualify for three additional years of exclusivity, as the agency interpreted Section 505(v) of the FD&C Act to require a showing of a significant new use (such as a new indication) for an old antibiotic such as Vancocin in order for such old antibiotic to be eligible for a grant of exclusivity. FDA also indicated that it has approved three ANDA’s for generic vancomycin capsules. In June, 2012, FDA approved a fourth ANDA for generic vancomycin capsules.

The approval of generic copies of Vancocin has and will continue to adversely impact our revenues, operating results and cash flows during the remainder of 2012 and in future periods. We tested the Vancocin intangible assets for impairment as of March 31, 2012. There was no impairment to these intangible assets as of March 31, 2012. Vancocin will continue to be utilized and sold as a branded drug product and we are selling an authorized generic version of Vancocin in competition with generics of other companies that have entered the market. There have been no events during the quarter ended June 30, 2012 that would indicate we must re-test these assets for impairment. However, should future events occur that may cause further reductions in revenue or operating results we may be required to test the recoverability of these assets and may incur an impairment.

In addition, we have received a notification that the Federal Trade Commission (FTC) is conducting an investigation into whether we engaged in unfair methods of competition with respect to Vancocin. The existence of an investigation does not indicate that the FTC has concluded that we have violated the law and we do not believe that we have engaged in unfair methods of competition with respect to Vancocin. We intend to cooperate with the FTC investigation; however, at this time we cannot assess potential outcomes of this investigation.

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

Since the first quarter of 2012, Cinryze inventory in the channel has been below normal levels. However, on August 6, 2012, FDA approved our supplement to the Cinryze Biologics License Application (BLA) for industrial scale manufacturing which increases our manufacturing capacity of Cinryze. We expect vials previously produced on this industrial scale line to enter into the trade during the third quarter of 2012.

The licensing and availability of Buccolam follows its central approval in the European Union through the Pediatric Use Marketing Authorization (PUMA) in the fourth quarter of 2011. Buccolam is the first product approved using a PUMA, which is a type of centralized marketing authorization procedure requested for medicines already authorized but no longer covered by intellectual property rights and exclusively developed for use in children. In most European markets, the key competitors for Buccolam are typically either availably generically or are used off label. There are a number of potential future competitors in the same or similar medical areas.

The commercial success of Cinryze and Buccolam in Europe will depend on a number of factors, including the impact of the loss of orphan designation on Cinryze, market acceptance of each of the products and our ability to manufacture sufficient quantities of product to meet patient needs.

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. 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. We continue to evaluate PPACA 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 our business over time.

We will face intense competition in acquiring additional products to further expand our product portfolio. Many of the companies and institutions that we will compete with in acquiring additional products to further expand our product portfolio have substantially

greater capital resources, research and development staffs and facilities than we have, and greater resources to conduct business development activities. We may need additional financing in order to acquire new products in connection with our plans as described in this report. Upon completion of business development transactions, we will face risks related to the integration of the acquired asset or business which could result in delays in development timelines, increased expenses or assumption of undisclosed liabilities, and disruption from the transaction making it more difficult to maintain relationships with manufacturers, employees or other suppliers.

The outcome of our clinical development programs is subject to considerable uncertainties.

We are currently undertaking studies on the viability of subcutaneous administration of Cinryze. In May 2011, Halozyme Therapeutics (Halozyme) granted us an exclusive worldwide license to use Halozyme’s proprietary Enhanze^™ technology, a proprietary drug delivery platform using Halozyme’s recombinant human hyaluronidase enzyme (rHuPH20) technology, in combination with a C1 esterase inhibitor which we intend to apply initially to develop a subcutaneous formulation of Cinryze for routine prophylaxis against attacks of HAE. In the first quarter of 2012, we completed a Phase 2 study to evaluate the safety, and pharmacokinetics and pharmacodynamics of subcutaneous administration of Cinryze in combination with rHuPH20 and announced the presentation of positive data.

We are also undertaking studies to identify additional therapeutic uses and potentially expand the labeled indication for Cinryze to include other C1 mediated diseases, such as AMR and DGF. In addition, we are also developing VP20621 for the treatment and prevention of CDAD, and in May 2011 we initiated a Phase 2 dose-ranging clinical study. We anticipate that we will commence pre-clinical and clinical studies with VP20629 for the treatment of Friedreich’s Ataxia. There can be no assurance that our clinical programs with Cinryze, VP20621 and VP20629 will yield positive results or support further development. There can also be no assurance that the OBS development efforts at Meritage will yield positive results or support further development. During the second quarter 2012, we announced the initiation of a Phase 2 program to evaluate maribavir for the treatment of CMV infections in transplant recipients. The planned program will consist of two independent Phase 2 clinical studies, one that will include subjects who have asymptomatic CMV, and one in subjects who have failed therapy with other anti-CMV agents. There can be no assurance that our clinical program with maribavir will yield positive results or support further development as we were not successful in previous studies to prevent CMV disease in transplant patients.

We cannot be certain that we will be successful in developing and ultimately commercializing any of our product candidates, that the FDA or other regulatory authorities will not require additional or unanticipated studies or clinical trial outcomes before granting regulatory approval, or that we will be successful in obtaining regulatory approval of any of our product candidates in the timeframes that we expect, or at all.

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

Our actual results could differ materially from those results expressed in, or implied by, our expectations and assumptions described in this Quarterly Report on Form 10-Q. The risks described in this report, our Form 10-Q for the quarter ended June 30, 2012, 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-Q for the Quarter ended March 31, 2012 and our Form 10-K for the year ended December 31, 2011 in Item 1A, which describe other important matters relating to our business.

Results of Operations

Three and Six Months Ended June 30, 2012 and 2011


(in thousands, except per share data)	For the three months ended June 30,					For the six months ended June 30,
	2012			2011		2012		2011
Net product sales	$	94,639		$	128,808	$	230,439	$	255,843
Cost of sales (excluding amortization of product rights)	$	24,721		$	21,309	$	56,799	$	40,179
Operating income	$	2,769		$	42,308	$	42,906	$	102,366
Net income (loss)	$	(4,203	)	$	22,796	$	15,788	$	59,242
Net income (loss) per share:
Basic	$	(0.06	)	$	0.30	$	0.23	$	0.77
Diluted	$	(0.06	)	$	0.28	$	0.22	$	0.70

The $2.8 million in operating income for the three months ended June 30, 2012 decreased $39.5 million as compared to the same period in 2011. The decrease in operating income is driven primarily by the following: a decrease in net sales of $34.2 million period over period due to lower Vancocin revenues as a result of the entrance of generic vancomycin and the relative increase in the sales of our branded Vancocin into lower priced governmental programs; an increase of $3.4 million in cost of sales due to the mix effect of increased Cinryze volume coupled with reduced Vancocin volume and the royalty due to Genzyme for sales of Vancocin (including branded and authorized generic sales) and reduced margins from authorized generic vancomycin sales; and, an increase of $8.8 million in selling, general and administrative expenses primarily related to the growth of our global organization and our European commercialization efforts. Operating income in the prior period was impacted by the payment of a $9.0 million upfront fee related to our license arrangement with Halozyme paid in the second quarter of 2011, partially offset by increased spending associated with our Cinryze programs, our Phase 2 study of subcutaneous administration of Cinryze in combination with rHuPH20, our VP20621 development and the costs associated with a Phase 2 program to evaluate maribavir for the treatment of CMV infections in transplant recipients during the second quarter of 2012. As a result, research and development expenses were $3.8 million less in the second quarter of 2012 as compared to the same period in 2011.

The $42.9 million in operating income for the six months ended June 30, 2012 decreased $59.5 million compared to the same period in 2011. The primary drivers of this were lower net sales of $25.4 million due to lower Vancocin revenues; increased cost of sales of $16.6 million due to increased Cinryze volume; and increased selling, general and administrative expenses of $18.7 million due to our European commercialization efforts and the growth of our global organization.

We sell Diamorphine in the UK, primarily to hospitals, through approved wholesalers. We began commercial sales of Cinryze and Buccolam in Europe during the fourth quarter of 2011. The revenues and operating income from these sales are not material to our consolidated revenues and operating income for 2012 or 2011.

Revenues

Revenues consisted of the following:


(in thousands)	For the three months ended June 30,				For the six months ended June 30,
	2012		2011		2012		2011
Net product sales
Cinryze	$	76,642	$	62,459	$	144,805	$	119,048
Vancocin		15,908		65,191		82,078		134,474
Other		2,089		1,158		3,556		2,321

Total revenues	$	94,639	$	128,808	$	230,439	$	255,843

Net product sales

On April 9, 2012, we announced the FDA denied the citizen petition we filed on March 17, 2006 related to the FDA’s proposed in vitro method for determining bioequivalence of abbreviated new drug applications (ANDAs) referencing Vancocin (vancomycin hydrochloride, USP) capsules. FDA also indicated that it is approving three ANDA’s for generic vancomycin capsules. In June 2012, FDA approved a fourth ANDA.

Pursuant to the terms of a previously entered distribution agreement, we granted a third party a license under our NDA for Vancocin^® (vancomycin hydrochloride capsules, USP) to distribute and sell vancomycin hydrochloride capsules as an authorized generic product. We also continue to sell branded Vancocin. We are also obligated to pay Genzyme royalties of 10 percent, 10 percent and 16 percent of net sales of Vancocin for the three year period following the approval of the sNDA as well as a lower royalty on sales of our authorized generic version of Vancocin in connection with our purchase of exclusive rights to two studies of Vancocin.

The approval of generic copies of Vancocin has and will continue to adversely impact our sales of our Vancocin brand prescription products and have a negative impact on our financial condition and results of operations, including causing a significant decrease in our revenues, operating income and cash flows compared to historical levels.

In the US, we sell Cinryze to specialty pharmacy/specialty distributors (SP/SD’s) who then distribute to physicians, hospitals and patients, among others. In Europe, we sell Cinryze to wholesalers who then distribute the product principally to pharmacies and hospitals. We continue to work to expand our manufacturing capacity to ensure the availability of Cinryze to meet growing patient needs and believe our efforts will allow us to continue to meet this growing patient demand for the foreseeable future. In order to meet anticipated longer term demand, we submitted to the FDA a Prior Approval Supplement (PAS) in the second quarter of 2010. The PAS involves a larger scale manufacturing project to significantly increase the Cinryze production capabilities at Sanquin. In October 2010, the FDA issued a complete response letter regarding the Cinryze industrial scale manufacturing expansion activities. In the complete response letter the FDA has requested additional information related to observations from the pre-approval inspection and review of the technical processes. In February 2012, the FDA issued a second complete response letter which included three comments related to a portion of the cleaning validation for industrial scale manufacturing. On August 6, 2012, FDA approved our PAS to the Cinryze Biologics License Application (BLA) for industrial scale manufacturing which increases our manufacturing capacity of Cinryze.

Since the first quarter of 2012, Cinryze inventory in the channel has been below normal levels. However, with the approval of our PAS we expect vials previously produced on this industrial scale line to enter into the trade during the third quarter of 2012.

Our net sales of Cinryze during the three and six months ended June 30, 2012 increased 22.7% and 21.6%, respectively, over the same periods in the prior year due to increased volume arising from an increased number of patients treated with Cinryze in the U.S. Also affecting the increase was approximately $1.2 million and $1.7 million of the Cinryze revenue in the EU during the three and six months ended June 30, 2012, respectively. We had no European Cinryze revenue during the three and six months ended June 30, 2011.

During the three month period ended June 30, 2012, net sales of Vancocin decreased 75.6% compared to the same period in 2011 due to the introduction of authorized generic vancomycin. During the six months ended June 30, 2012, net sales of Vancocin decreased 39.0% compared to the same period in 2011 due to the introduction of authorized generic vancomycin.

Based upon data reported by IMS Health Incorporated, Vancocin branded product had approximately a 14% share of the total vancomycin prescriptions as of June 30, 2012.

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 for the three and six months ended June 30, 2012, the wholesalers and SP/SD’s did not have excess channel inventory of our products.

Cost of sales (excluding amortization of product rights)

Cost of sales increased for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011 by $3.4 million and increased for the six months ended June 30, 2012 by $16.6 million compared to the six months ended June 30, 2011. These increases are primarily due to the effect of the shift in product mix from decreased sales of higher margin Vancocin to increased sales of lower margin Cinryze, and the royalty due to Genzyme for Vancocin sales which was not payable in 2011. We anticipate that our cost of sales will remain higher than historical levels due to the introduction of generic vancomycin and the reduction of our sales of Vancocin relative to our Cinryze sales along with the royalty due to Genzyme.

Vancocin and Cinryze cost of sales includes the cost of materials and distribution costs and excludes amortization of product rights.

Research and development expenses

For each of our research and development programs, we incur both direct and indirect expenses. Direct expenses include third party costs related to these programs such as contract research, consulting, cost sharing payments or receipts and clinical and development costs. Indirect expenses include personnel, facility, stock compensation and other overhead costs.

Due to advancements in our VP20621 clinical program, our Cinryze life cycle management programs, our study of subcutaneous administration of Cinryze in combination with rHuPH20 and our study of potential alternative development strategies for maribavir, we expect costs in these programs to increase in the future.

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


(in thousands)	For the three months ended June 30,				For the six months ended June 30,
	2012		2011		2012		2011
*Direct – Core programs*
Non-toxigenic strain of C. difficle (VP20621)	$	2,254	$	2,269	$	5,008	$	4,169
Cinryze & C1 esterase inhibitor		4,863		11,123		9,262		13,344
VP-20629		251		—		263		—
CMV		1,712		80		2,446		261
*Direct – Other Assets*
Plenadren		358		—		434		—
Vancocin		40		49		50		50
New Initiatives		576		700		1,319		1,181
Other assets		140		221		306		317
*Indirect*
Development		6,427		5,975		12,932		11,521

Total	$	16,621	$	20,417	$	32,020	$	30,843

Direct Expenses—Core Development Programs

The costs of VP20621 in the three and six months ended June 30, 2012 remained flat compared to the same periods in 2011 due to the cost of our Phase 2 clinical trial initiated during the second quarter of 2011, while the three and six months in 2011 reflect the costs associated with our Phase 1 clinical trial.

Our costs associated with our Cinryze program decreased during the three and six months ended June 30, 2012, as the costs associated with our Phase 2 study of subcutaneous administration of Cinryze in combination with rHuPH20 and the continuation of our life cycle programs was offset by the $9.0 million upfront payment we made in the second quarter of 2011 related to our entering into a license with Halozyme for the development of subcutaneous administration of Cinryze in combination with rHuPH20 for routine prophylaxis against attacks of HAE. On August 1, 2012 we were notified by the CBER division of the FDA that studies of the combination of Cinryze and rHuPH20 were being placed on temporary clinical hold. In light of this FDA action, we are preparing to commence a Phase 2 study that will evaluate the safety and efficacy of two different doses of the subcutaneous administration of Cinryze as a standalone therapy for which we received FDA clearance in 2011 of our Investigational New Drug (IND) application and the related Phase 2 clinical protocol to study subcutaneous administration of Cinryze without rHuPH20. As such we anticipate that costs associated with our Cinryze program to increase in future periods.

Our direct expenses related to our CMV program increased in the three and six months ended June 30, 2012 compared to the same periods in 2011 as we initiated two Phase 2 clinical studies to evaluate maribavir for the treatment of CMV infections in transplant recipients.

Direct Expenses—Other Assets

Our costs related to New Initiatives represent expenses associated with our evaluation of a recombinant C1-INH technology, spending under our collaboration agreement with Sanquin supporting their early stage research programs. The Plenadren costs incurred during the 2012 periods are primarily related to our open label trial.

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

Indirect Expenses

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

Selling, general and administrative expenses

Selling, general and administrative expenses (SG&A) increased for the three months ended June 30, 2012 by $8.8 million compared to the same period in the prior year primarily due to increases in compensation expense and employee cost of $5.6 million and increased corporate cost of $1.9 million. For the six months ended June 30, 2012, SG&A increased $18.7 million compared to the same period in 2011 primarily driven by increased compensation expense and employee cost of $11.3 million, increased marketing expenses of $1.5 million and increased corporate cost of $3.9 million.

Our European commercialization efforts and the growth of our global organization are predominant reasons for the overall increase in SG&A in both periods. We anticipate that our SG&A spending will continue to increase in future periods as we continue our commercialization and expansion efforts outside the United States.

Intangible amortization

Intangible amortization for the three and six months ended June 30, 2012 were $8.8 million and $17.6 million, respectively, as compared to $7.2 million and $16.1 million, respectively, for the same periods in 2011. The increase is due to the amortization of our Buccolam and Plenadren assets during the 2012 periods.

Other operating expenses

The change during the three and six months ended June 30, 2012 compared to the same periods during 2011 is primarily due to the charges to income resulting from the re-measurement of the fair values of the contingent consideration liabilities incurred as part of our acquisitions. Also included in other operating expenses for the three and six month periods ended June 30, 2011 are approximately $3.4 million of costs associated with the funding of Cinryze manufacturing enhancements at Sanquin.

Other Income (Expense)

Interest Income

Interest income for three and six months ended June 30, 2012 and 2011 was $0.1 million and $0.2 million and $0.3 million and $0.4 million, respectively.

Interest Expense


	For the three months ended June 30,				For the six months ended June 30,
(in thousands)	2012		2011		2012		2011
Interest expense	$	1,207	$	1,025	$	2,408	$	2,050
Amortization of debt discount		2,077		1,944		4,088		3,779
Amortization of finance costs		234		97		469		194

Total interest expense	$	3,518	$	3,066	$	6,965	$	6,023

Interest expense during the first six months of 2012 consists of interest on our senior convertible notes and also commitment fees on the unused credit facility while the first six months of 2011 consists of only interest on our senior convertible notes. The amortization of debt discount relates solely to the senior convertible notes in all periods and the amortization of finance costs during the three and six months ended June 30, 2012 relates to the amortization of debt issue cost on both the senior convertible notes and the $200 million credit facility while the amount in the three and six months ended June 30, 2011 relates solely to the senior convertible notes.

Other income (expense), net

Our other income (expense), net, includes foreign exchange gains and losses in the three and six month periods ended June 30, 2012 and 2011. Additionally, the three and six months ended June 30, 2012 includes approximately $0.6 million and $1.7 million, respectively, of amortization expense of the deferred asset related to the Meritage transaction.

Income Tax Expense

Our income tax expense (benefit) was ($1.2) million and $16.9 million for the quarters ended June 30, 2012 and 2011, respectively and $16.9 million and $40.8 million for the six months ended June 30, 2012 and June 30, 2011, respectively. Our income tax expense includes federal, state and foreign income taxes at statutory rates and the effects of various permanent differences.

Our effective tax rates for the six months ended June 30, 2012 and June 30, 2011, were 51.7% and 40.8%, respectively.

The effective tax rates for the six month periods ended June 30, 2012 and 2011 are higher than the statutory U.S. tax rate due to state income taxes, certain share-based compensation that is not tax deductible and an increase in the fair value of contingent consideration that is also not deductible for tax purposes. In addition, the effective tax rate for the six months ended June 30, 2012 is higher than the statutory U.S. tax rate due to foreign losses on which no tax benefit is provided or on which the tax benefit is less than the U.S. statutory tax rate and non-deductible amortization expense. These increases to the effective tax rate are partially offset by tax benefits related to orphan drug credits, manufacturing deductions and charitable contributions. Tax expense (benefit) for the quarters ended June 30, 2012 and 2011are a combination of the six month effective tax rate and adjustments for changes in the effective tax rate from the prior quarter.

We anticipate that our effective tax rate will continue to be higher than normal in 2012 and to vary based on the operating results of each legal entity and actual permanent differences. Our effective tax rate in future years will depend primarily on our foreign operating results and should decline if our product launches are successful and generate profits.

Our last U.S. tax examination for 2008 concluded in the first quarter of 2011 with no material adjustments. We are currently under examination in a foreign tax jurisdiction and various state income tax returns are also currently under examination. At this time, we do not believe that the results of these examinations will have a material impact on our financial statements.

Liquidity

In the near term, we expect that our sources of revenue will continue to arise from Cinryze product sales. However, there are no assurances that demand for Cinryze will continue to grow or that we will be able to maintain adequate supply of product.

We began the commercial sales of Buccolam and Cinryze in Europe during the fourth quarter of 2011. Although we began commercial sales of Cinryze and Buccolam in Europe during the fourth quarter of 2011, the revenues and operating income from these sales are not material to our consolidated revenues and operating income for 2011 or the first six months of 2012 and there are no assurances that there will be growing demand for products in Europe or we will be successful in our commercialization efforts in Europe or any other territories we have the rights to sell these drug products.

Our ability to generate positive cash flow is also impacted by the timing of anticipated events in our Cinryze, VP20621, VP20629, Plenadren and other development programs, including the timing of our expansions into other territories and the costs of our anticipated commercial activities, the scope of the clinical trials required by regulatory authorities, results from clinical trials, the results of our product development efforts, including the OBS development efforts at Meritage and variations from our estimate of future direct and indirect expenses.

The cash flows we have used in operations historically have been applied to research and development activities, marketing and commercial efforts, business development activities, general and administrative expenses, debt service, and income tax payments. Bringing drugs from the preclinical research and development stage through phase 1, phase 2, and phase 3 clinical trials and FDA and/or EMA regulatory approval is a time consuming and expensive process. Because we have product candidates that are currently in the clinical stage of development, there are a variety of events that could occur during the development process that will dictate the course we must take with our drug development efforts and the cost of these efforts. As a result, we cannot reasonably estimate the costs that we will incur through the commercialization of any product candidate. However, our future costs may exceed current costs as we anticipate we will continue to invest in our pipeline, including our initiative to develop VP20621 (non-toxigenic strains of C. difficile), VP20629, any additional studies to identify additional therapeutic uses and expand the labeled indication for Cinryze to potentially include other C1 mediated diseases as well as new modes of administration for Cinryze. Also, we will incur additional costs as we intend to seek to commercialize Cinryze, Buccolam and Plenadren 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.

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

As of June 30, 2012, we have recognized cumulative sales of Cinryze in excess of the $600 million threshold and we will make this CVR payment along with certain other contingent acquisition related payments totaling approximately $92.1 million in the third quarter of 2012. Accordingly, we recorded these liabilities in the second quarter of 2012 with a corresponding increase to goodwill of approximately $86.2 million, net of tax benefits.

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

In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act (PPACA). The PPACA, as amended, will likely increase certain of our costs as well. For example, an increase in the Medicaid rebate rate from 15.1% to 23.1% was effective as of January 1, 2010, and the volume of rebated drugs has been expanded to include beneficiaries in Medicaid managed care organizations, effective as of March 23, 2010. Beginning in 2011, the PPACA also imposes a manufacturer’s fee on the sale of branded Pharmaceuticals (excluding orphan drugs) to specified government programs, expands the 340B drug discount program (excluding orphan drugs), and includes a 50% discount on brand name drugs for Medicare Part D participants in the coverage gap, or “donut hole”. The manufacturing fee was immaterial relative to our 2011 operating income and cash flow and we anticipate it to be immaterial to our 2012 operating income and cash flow. We currently estimate that our cost associated with the Medicare Part D coverage gap for the full year 2012 may be approximately $3 million to $4 million. We continue to evaluate PPACA 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 our business over time.

Capital Resources

While we anticipate that cash flows from Cinryze, our current cash, cash equivalents and short-term investments (collectively referred to as our cash) and revolving credit facility should allow us to fund our ongoing development and operating costs, as well as our interest payments and future milestone payments or acquisition costs, we may need additional financing in order to expand our product portfolio. At June 30, 2012, we had cash, cash equivalents and short-term investments of $471.9 million. Short-term investments consist of high quality fixed income securities with remaining maturities of greater than three months at the date of purchase and high quality debt securities or obligation of departments or agencies of the United States. At June 30, 2012, the annualized weighted average nominal interest rate on our short-term investments was 0.44% and the weighted average length to maturity was 13.1 months. At June 30, 2012, we also had $200 million available under our revolving credit agreement. As of the date of this filing, we have not drawn any amounts under the Credit Facility and are in compliance with our covenants. However, because of the negative impact of approval of generic vancomycin on our operating results and the resulting effect on certain covenants, the availability under the facility may be limited at times.

At June 30, 2012, approximately $197.0 million of our cash and availability under the credit agreement is subject to the minimum liquidity covenant, as defined in our credit agreement.

Financing

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.

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

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

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

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

Overall Cash Flows

During the six months ended June 30, 2012, we generated $74.9 million of net cash from operating activities, primarily from our net income after adjustments for non-cash items, and the net decrease in accounts receivable and inventories. Cash provided by investing activities of $12.1 million resulted primarily from maturities of short-term investments, net of investment purchases. Our net cash used in financing activities for the six months ended June 30, 2012 was $60.7 million which relates to the common stock repurchases under our share repurchase program net of proceeds and excess tax benefits from stock option exercises. During the six months ended June 30, 2011, we generated $68.5 million of net cash from operating activities, primarily from our net income after adjustments for non-cash items partly offset by our net increase in working capital. We used $59.6 million of cash from investing activities mainly in the purchase of short-term investments, net of investment maturities. Our net cash used in financing activities for the six months ended June 30, 2011 was $45.9 million which relates to the common stock repurchase arrangement entered into during the quarter under our share repurchase program net of proceeds from stock option exercises.

Development Programs

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

Core Development Programs

Cinryze—We acquired Cinryze in October 2008 and through June 30, 2012 have spent approximately $52.1 million in direct research and development costs related to Cinryze since acquisition. During 2012, we continue to expect research and development costs related to Cinryze to increase as we complete our Phase 4 commitment and evaluate additional indications, formulations and territories including our efforts on the C1 esterase inhibitor/rHuPH20 combination sub-subcutaneous formulation, AMR and DGF. We are solely responsible for the costs of Cinryze development. In the first quarter of 2012, we completed a Phase 2 study to evaluate the safety, and pharmacokinetics and pharmacodynamics of subcutaneous administration of Cinryze in combination with rHuPH20 and announced the presentation of positive data. On August 1, 2012 we were notified by the CBER division of the FDA that studies of the combination of Cinryze and rHuPH20 were being placed on temporary clinical hold. In light of this FDA action, we are preparing to commence a Phase 2 study that will evaluate the safety and efficacy of two different doses of the subcutaneous administration of Cinryze as a standalone therapy for which we received FDA clearance in 2011 of our Investigational New Drug (IND) application and the related Phase 2 clinical protocol to study subcutaneous administration of Cinryze without rHuPH20. As such we anticipate that costs associated with our Cinryze program to increase in future periods.

VP20621—We acquired VP20621 in February 2006 and through June 30, 2012 have spent approximately $36.6 million in direct research and development costs. For the remainder of 2012, we expect our research and development activities related to VP20621 to increase as we continue our development program and in May 2011, we initiated a Phase 2 dose-ranging clinical study to evaluate the safety, tolerability, and efficacy of VP 20621 for prevention of recurrence of CDAD in adults previously treated for CDAD. We are solely responsible for the costs of VP20621 development.

VP20629— On September 30, 2011, we entered into a license agreement for the worldwide rights of Intellect Neurosciences, Inc. (INS) to its clinical stage drug candidate, VP20629, being developed for the treatment of Friedreich’s Ataxia (FA), a rare, hereditary, progressive neurodegenerative disease. We expect to initiate a phase 1 study by the end of the first half of 2013. We intend to file for Orphan Drug Designation upon review of the phase 2 proof of concept data. Under the terms of the agreement, we have exclusive worldwide rights to develop and commercialize VP20629 for the treatment, management or prevention of any disease or condition covered by Intellect’s patents. We paid INS a $6.5 million up-front licensing fee and may pay additional milestones up to $120 million based upon defined events. We will also pay a tiered royalty of up to a maximum percentage of low teens, based on annual net sales. We are solely responsible for the costs of VP20629 development.

CMV program—We acquired the rights to maribavir in September 2003 and through June 30, 2012 have spent approximately $102.9 million in direct research and development costs. For the remainder of 2012, we expect our research and development activities related to maribavir to increase as in the second quarter of 2012 we announced the initiation of a Phase 2 program to evaluate maribavir for the treatment of CMV infections in transplant recipients. The planned program will consist of two independent Phase 2 clinical studies that will include subjects who have asymptomatic CMV, and those who have failed therapy with other anti-CMV agents.

Other Assets

Vancocin—We acquired Vancocin in November 2004 and through June 30, 2012 have spent approximately $3.2 million in direct research and development costs related to Vancocin activities since acquisition. As a result of the FDA approval of generic versions of oral vancomycin, we do not anticipate any future research and development expenses related to Vancocin.

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

Business Development Activities

On December 22, 2011, we entered into an exclusive development and option agreement with Meritage Pharma, Inc. (Meritage) , a private company based in San Diego, CA focused on developing oral budesonide suspension (OBS) as a treatment for eosinophilic esophagitis (EoE). We have an exclusive option to acquire Meritage, at our sole discretion, by providing written notice at any time during the period from December 22, 2011 to and including the date that is the earlier of (a) the date that is 30 business days after the later of (i) the receipt of the final study data for the Phase 2 study and (ii) identification of an acceptable clinical end point definition for a pivotal induction study agreed to by the FDA. As consideration for the option, we paid an initial $7.5 million.

In June, 2012, Meritage completed the delivery of all the documents and notifications needed to satisfy the conditions of the First Option Milestone, as defined in the agreement. As a result of achieving this milestone they are due a $5.0 million milestone payment, which will be paid in the third quarter of 2012. Accordingly, in the second quarter of 2012, we recorded this liability and increased the carrying value of our cost method investment. We retain the option to provide Meritage up to an additional $7.5 million for the development of OBS. Meritage will utilize the funding to conduct additional Phase 2 clinical assessment of OBS. If we exercise our option to acquire Meritage, we have agreed to pay $69.9 million for all of the outstanding capital stock of Meritage. Meritage stockholders could also receive additional payments of up to $175 million, upon the achievement of certain clinical and regulatory milestones.

On September 30, 2011, we entered into a license agreement for the worldwide rights of Intellect Neurosciences, Inc. (INS) to its clinical stage drug candidate, VP20629, being developed for the treatment of Friedreich’s Ataxia (FA), a rare, hereditary, progressive neurodegenerative disease. We paid INS a $6.5 million up-front licensing fee and may pay additional milestones up to $120 million based upon defined events. We will also pay a tiered royalty of up to a maximum percentage of low teens, based on annual net sales. We are solely responsible for the costs of VP20629 development.

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

Share Repurchase Program

During the first six months of 2012, through open market purchases, we reacquired approximately 2.7 million shares at a cost of approximately $71.5 million or an average price of $26.61 per share.

Senior Convertible Notes

The debt and equity components of our senior convertible debt securities are bifurcated and accounted for separately based on the value and related interest rate of a non-convertible debt security with the same terms. The fair value of a non-convertible debt instrument at the original issuance date was determined to be $148.1 million. The equity (conversion options) component of our convertible debt securities is included in Additional paid-in capital on our Consolidated Balance Sheet and, accordingly, the initial carrying value of the debt securities was reduced by $101.9 million. Our net income for financial reporting purposes is reduced by recognizing the accretion of the reduced carrying values of our convertible debt securities to their face amount of $250.0 million as additional non-cash interest expense. Accordingly, the senior convertible debt securities will recognize interest expense at effective rates of 8.0% as they are accreted to par value.

As of June 30, 2012 senior convertible notes representing $205.0 million of principal debt are outstanding with a carrying value of $157.5 million and a fair value of approximately $298.2 million, based on the level 2 valuation hierarchy of the fair value measurements standard.

As a result of the above negotiated sale and purchase transactions, we are now entitled to receive approximately 10.87 million shares of our 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, which correlates to $205 million of convertible notes outstanding.

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 provisions.

The senior convertible notes were convertible into shares of our common stock during the second quarter of 2012 at the election of the holders as the last reported sale price of our common stock for the 20 or more trading days in the 30 consecutive trading days ending on March 30, 2012 exceeded 130% of the conversion price, $18.87 per share, in effect on March 30, 2012. No notes were converted during the second quarter and the notes are not convertible during the third quarter of 2012 as none of the contingent conversion criteria described above was met as of June 30, 2012.

Credit Facility

In September 2011, we entered into a $200 million, three-year senior secured revolving credit facility (the “Credit Facility”), the terms of which are set forth in a Credit Agreement dated as of September 9, 2011 (the “Credit Agreement”) with JPMorgan Chase Bank, N.A., as administrative agent, BMO Harris Financing Inc., TD Bank, N.A. and Morgan Stanley Bank, NA as co-syndication agents and certain other lenders.

The Credit Agreement requires us to maintain (i) a maximum senior secured leverage ratio of less than 2.00 to 1.00, (ii) a maximum total leverage ratio of less than 3.50 to 1.00, (iii) a minimum interest coverage ratio of greater than 3.50 to 1.00 and (iv) minimum liquidity equal to or greater than the sum of $100 million plus the aggregate amount of certain contingent consideration payments resulting from business acquisitions payable by us within a specified time period. The Credit Agreement also contains certain other usual and customary affirmative and negative covenants, including but not limited to, limitations on capital expenditures, asset sales, mergers and acquisitions, indebtedness, liens, dividends, investments and transactions with affiliates.

At June 30, 2012, approximately $197.0 million of our cash and availability under the credit agreement is subject to the minimum liquidity covenant (iv), described above.

Contractual Obligations

We have commitments to purchase a minimum number of liters of plasma per year through 2016 from our supplier. Additionally, we are required to purchase a minimum number of units from our third party toll manufacturers. The total minimum purchase commitments for these continuing arrangements as of June 30, 2012 are approximately $268.4 million.

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, 2011. 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 branded and authorized generic product, Cinryze, Buccolam and Diamorphine, less estimates for chargebacks, rebates, distribution service fees, returns and losses. We recognize revenue for product sales when title and risk of loss has passed to the customer, which is typically upon delivery to the customer, when estimated provisions for chargebacks, rebates, distribution service fees, returns and losses are reasonably determinable, and when collectability is reasonably assured. Revenue from the launch of a new or significantly unique product may be deferred until estimates can be made for chargebacks, rebates and losses and all of the above conditions are met and when the product has achieved market acceptance, which is typically based on dispensed prescription data and other information obtained during the period following launch.

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

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

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

Chargebacks and rebates are the most subjective sales related accruals. While we currently have no contracts with private third party payors, such as HMO’s, we do have contractual arrangements with governmental agencies, including Medicaid. We establish accruals for chargebacks and rebates related to these contracts in the period in which we record the sale as revenue. These accruals are based upon historical experience of government agencies’ market share, governmental contractual prices, our current pricing and then-current laws, regulations and interpretations. We analyze the accrual at least quarterly and adjust the balance as needed. These analyses have been adjusted to reflect the U.S. healthcare reform acts and their affect on governmental contractual prices and rebates. We believe that a 10% change in our estimate of the actual rate of sales subject to governmental rebates would affect our operating income and accruals by approximately $2.5 million in the period of adjustment.

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

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

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

In April 2012, we began selling an authorized generic version of our prescription Vancocin capsules under a supply agreement with a distributor. The distributor has agreed to purchase all of its authorized generic product requirements from us and pay a specified invoice supply price for such products. We are also entitled to receive a percentage of the gross margin on net sales of the authorized generic products sold by the distributor. We recognize revenue from shipments to the distributor at the invoice supply price along with our percentage of the gross margin on net sales of the authorized generic products sold by the distributor when the distributor reports to us its gross margin on net sales of the products and our portion thereof. Any adjustments to the net sales previously reported to us related to the distributor’s estimated sales discounts and other deductions are recognized in the period the distributor reports the adjustments to us.

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

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

On August 4, 2009 the FDA’s Pharmaceutical Science and Clinical Pharmacology Advisory Committee voted in favor of the component of the OGD’s 2008 draft guidelines on bioequivalence for Vancocin that permits bioequivalence to be demonstrated through comparable in vitro dissolution for potential vancomycin HCl capsule generic products that contain the same active and inactive ingredients in the same amounts as Vancocin, among other requirements.

On April 9, 2012, FDA denied the citizen petition we filed on March 17, 2006 related to the FDA’s proposed in vitro method for determining bioequivalence of abbreviated new drug applications (ANDAs) referencing Vancocin (vancomycin hydrochloride, USP) Capsules. The FDA also informed us in the same correspondence that the recent supplemental new drug application (sNDA) for Vancocin approved December 14, 2011 would not qualify for three additional years of exclusivity based on the agency’s assertion that in order for an sNDA for an old antibiotic such as Vancocin to be eligible for a grant of exclusivity, it must be a significant new use or indication. FDA also indicated that it approved three ANDA’s for generic vancomycin capsules. In June 2012, FDA approved a fourth ANDA for generic vancomycin capsules.

We have begun shipping authorized generic vancomycin hydrochloride, USP, in addition to continuing the sales of Vancocin. However, the approval of generic copies of Vancocin will materially impact our revenues, operating results and cash flows. We tested the Vancocin intangible assets for impairment as of March 31, 2012. There was no impairment of these intangible assets as of March 31, 2012. Vancocin will continue to be utilized and sold as a branded drug product and we are selling an authorized generic version of Vancocin along with generics of other companies that have entered the market. There have been no events since March 31, 2012 that would indicate we must re-test these assets for impairment. However, should future events occur that may cause further reductions in revenue we may be required to test the recoverability of these assets and may an incur impairment.

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Impairment of Goodwill and Indefinite-lived Intangible Assets – We review the carrying value of goodwill and indefinite-lived intangible assets, to determine whether impairment may exist. In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment. The objective of this Update is to simplify how entities test goodwill for impairment. The amendments in the Update provide the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. The two step goodwill impairment test consists of the following steps. The first step compares a reporting unit’s fair value to its carrying amount to identify potential goodwill impairment. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the second step of the impairment test must be completed to measure the amount of the reporting unit’s goodwill impairment loss, if any. Step two requires an assignment of the reporting unit’s fair value to the reporting unit’s assets and liabilities to determine the implied fair value of the reporting unit’s goodwill. The implied fair value of the reporting unit’s goodwill is then compared with the carrying amount of the reporting unit’s goodwill to determine the goodwill impairment loss to be recognized, if any. The impairment test for indefinite-lived intangible assets is a one-step test, which compares the fair value of the intangible asset to its carrying value. If the carrying value exceeds its fair value, an impairment loss is recognized in an amount equal to the excess. Based on accounting standards, it is required that these assets be assessed at least annually for impairment unless a triggering event occurs between annual assessments which would then require an assessment in the period which a triggering event occurred.

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

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Income Taxes—Our annual effective tax rate is based on pre-tax earnings, enacted tax laws and statutory tax rates, determination of manufacturing income and related deduction limits, 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 effective tax rate.

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

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

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

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

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

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long-term sales forecasts,

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

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

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

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

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

Our holdings of financial instruments are primarily comprised of money market funds holding only U.S. government securities and fixed income securities, including a mix of corporate debt and government securities. All such instruments are classified as securities available for sale. Our debt security portfolio represents funds held temporarily pending use in our business and operations. We manage these funds accordingly. Our primary investment objective is the preservation of principal, while at the same time optimizing the generation of investment income. We seek reasonable assuredness of the safety of principal and market liquidity by investing in cash equivalents (such as Treasury bills and money market funds) and fixed income securities (such as U.S. government and agency securities, municipal securities, taxable municipals, and corporate notes) while at the same time seeking to achieve a favorable rate of return. Our market risk exposure consists principally of exposure to changes in interest rates. Our holdings are also exposed to the risks of changes in the credit quality of issuers. We generally invest in financial instruments with maturities of less than one year. The carrying amount, which approximates fair value based on the Level 1 valuation hierarchy of the fair value measurement standard, and the annualized weighted average nominal interest rate of our investment portfolio at June 30, 2012, was approximately $114.7 million and 0.44%, respectively. The weighted average length to maturity was 13.1 months. A one percent change in the interest rate would have resulted in a $0.3 million impact to interest income for the quarter ended June 30, 2012.

At June 30, 2012, we had principal outstanding of $205.0 million of our senior convertible notes. The senior convertible notes bear interest at a rate of 2% per annum, payable semi-annually in arrears on March 15 and September 15 of each year commencing on September 15, 2007. The senior convertible notes are convertible into shares of our common stock at an initial conversion price of $18.87 per share. The senior convertible notes may only be converted: (i) anytime after December 15, 2016; (ii) during the five business-day period after any five consecutive trading day period (the “measurement period”) in which the price per note for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such day; (iii) during any calendar quarter (and only during such quarter) after the calendar quarter ending June 30, 2007, if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter; or (iv) upon the occurrence of specified corporate events. Upon conversion, holders of the senior convertible notes will receive shares of common stock, subject to our option to irrevocably elect to settle all future conversions in cash up to the principal amount of the senior convertible notes, and shares for any excess. We can irrevocably elect this option at any time on or prior to the 35th scheduled trading day prior to the maturity date of the senior convertible notes. The senior convertible notes may be required to be repaid on the occurrence of certain fundamental changes, as defined in the senior convertible notes. As of June 30, 2012, the fair value of the principal of the $205.0 million convertible senior notes outstanding was approximately $298.2 million, based on the Level 2 valuation hierarchy of the fair value measurements standard. The carrying value of the debt at June 30, 2012 is $157.5 million.

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

The senior convertible notes were convertible into shares of our common stock during the second quarter of 2012 at the election of the holders as the last reported sale price of our common stock for the 20 or more trading days in the 30 consecutive trading days ending on March 30, 2012 exceeded 130% of the conversion price, $18.87 per share, in effect on March 30, 2012. No notes were converted during the second quarter and the notes are not convertible during the third quarter of 2012 as none of the contingent conversion criteria described above was met as of June 30, 2012.

Additionally, if we were to utilize amounts under our revolving credit facility, we could be exposed to interest rate risk.

ITEM 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer, or CEO, and our Chief Financial Officer, or CFO, of the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of June 30, 2012. Based on that evaluation, our management, including our CEO and CFO, concluded that as of June 30, 2012 our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to the Company’s management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

During the second quarter of 2012, there were no significant changes in our internal control over financial reporting identified in connection with the evaluation of such controls that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

On April 6, 2012, we received a notification that the Federal Trade Commission (FTC) is conducting an investigation into whether we engaged in unfair methods of competition with respect to Vancocin. On August 3, 2012, we received a Civil Investigative Demand from the FTC requesting additional information related to this matter. The existence of an investigation does not indicate that the FTC has concluded that we have violated the law and we do not believe that we have engaged in unfair methods of competition with respect to Vancocin. We intend to cooperate with the FTC investigation; however, at this time we cannot assess potential outcomes of this investigation.

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, 2011. In addition to the other information set forth below and elsewhere in this report, you should carefully consider the factors discussed under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012. The risks described in our Quarterly Report on Form 10-Q are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

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

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

Problems with these manufacturing processes such as equipment malfunctions, maintenance requirements, facility contamination, labor shortages or other labor problems, raw material shortages, variability in batch yields, contamination, natural disasters, power outages, terrorist activities, or disruptions in the operations of our suppliers and even minor deviations from the normal process, could result in product defects or manufacturing failures that result in lot failures, product recalls, product liability claims and insufficient inventory which could result in our inability to supply product to patients, create opportunities for our competitors and reduce our revenues. In addition, the financial instability of any of our suppliers could result in their inability to meet their contractual obligations to us.

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

In addition, regulatory agencies subject a marketed therapy, its manufacturer and the manufacturer’s facilities to continual review and periodic inspections. The discovery of previously unknown problems with a therapy or the facility or process used to produce the therapy could prompt a regulatory authority to impose restrictions on us or delay approvals for new products or could cause us to voluntarily adopt restrictions, including withdrawal of one or more of our products or services from the market.

In connection with several inspections of two facilities maintained by Sanquin, our contract manufacturer for Cinryze, FDA issued notices of observations on FDA Form 483 for each site. Responses to the observations on 483 have been provided to the FDA, however, several of the responses remain the subject of continuing corrective and preventive action procedures. If any of our manufacturers or processors fails to satisfy regulatory requirements, operations at such facility may be halted which could result in our inability to supply product to patients, create opportunities for our competitors and reduce our revenues.

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

Our subcutaneous Cinryze development program is dependent upon Halozyme’s proprietary rHuPH20 enzyme which is an important component of our current development program, and any failure to supply rHuPH20 or regulatory concerns about rHuPH20 could delay the development and commercialization efforts for our subcutaneous Cinryze development program.

Halozyme is responsible for providing its proprietary rHuPH20 enzyme which is an important component of our current development program for subcutaneous administration of Cinryze. If Halozyme, or any applicable third party service provider of Halozyme, encounters difficulties in the manufacture, storage, delivery, fill, finish or packaging of either components of rHuPH20, such difficulties could: (i) cause the delay of clinical trials or otherwise delay or prevent the regulatory approval of subcutaneous Cinryze; and/or (ii) delay or prevent the effective commercialization of subcutaneous Cinryze. Such delays could have a material adverse effect on our business and financial condition. Additionally, Halozyme has partnered rHuPH20 with other companies that are developing combination products for other indications. In the event the FDA or other foreign regulatory agencies refuse or delay approval of product candidates which include rHuPH20 for reasons related to the safety or efficacy of rHuPH20, we may be required to collect additional clinical or animal safety data or to conduct additional clinical or animal safety studies which may cause lengthy delays and increased costs to our subcutaneous Cinryze development program. For example, in August 2012 Baxter announced that the Center for Biologics Evaluation and Research (CBER) of the FDA had issued a complete response letter for Baxter’s HyQ Biologics License Application which includes rHuPH20 for subcutaneous administration in patients with primary immunodeficiency disease. The letter requested additional preclinical data to support the BLA as a result of potential safety concerns. Pending the provision of additional preclinical data sufficient to address the regulatory questions, CBER has requested that patients should no longer be dosed with rHuPH20 in our Cinryze clinical studies that utilize rHuPH20. There can be no assurance that Halozyme will be able to perform the additional pre-clinical studies requested by CBER before clinical investigations of products in combination with rHuPH20 can resume in a timeframe that we expect, or that the results of such preclinical studies will be acceptable to the FDA or EMA to allow us to continue our planned Phase 2 study of subcutaneous administration of Cinryze in combination with rHuPH20, or that we will be able to conduct any additional clinical studies of the subcutaneous administration of Cinryze in combination with rHuPH20. Additionally, in the event we are able to commence additional studies of subcutaneous administration of Cinryze in combination with rHuPH20 there can be no assurance that the issues identified by CBER related to the use of rHuPH20 will not arise at a future time.

If our efforts to commercialize Buccolam or Plenadren in Europe are delayed or are not as successful as we anticipate, our business will be materially harmed.

In September of 2011, the European Commission granted a Centralized Pediatric Use Marketing Authorization (PUMA) for Buccolam, for treatment of prolonged, acute, convulsive seizures in infants, toddlers, children and adolescents, from 3 months to less than 18 years of age. Additionally, in November 2011, we acquired DuoCort Pharma AB (DuoCort), including the product Plenadren, which had recently received European Marketing Authorization. We anticipate commercial launch of Plenadren in the EU in late 2012 or early 2013. The commercial success of BUCCOLAM and Plenadren in the EU will depend on several factors, including the following:

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the number patients that may be treated with BUCCOLAM and Plenadren;

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acceptance by physicians and patients of BUCCOLAM and Plenadren as a safe and effective treatment;

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our ability to effectively market and distribute BUCCOLAM and Plenadren in Europe;

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cost effectiveness of treatment of epilepsy or other prolonged, acute, convulsive seizures using BUCCOLAM and adrenal insufficiency with Plenadren;

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relative convenience and ease of administration of BUCCOLAM and Plenadren;

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potential advantages of BUCCOLAM and Plenadren over alternative treatments;

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the timing of the approval of competitive products;

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the timing and levels of pricing approvals that are separately required in each country in Europe; and

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manufacturing or supply interruptions, including delays in the scale-up of the manufacturing process, which could impair our ability to acquire an adequate supply of BUCCOLAM or Plenadren to meet demand for the products including, without limitation, sufficient supply and reasonable pricing of raw materials necessary to manufacture BUCCOLAM or Plenadren.

If we are not able to continue to successfully commercialize BUCCOLAM and Plenadren in Europe, or are significantly delayed or limited in doing so, we could fail to achieve our estimates for peak year sales for BUCCOLAM and Plenadren and our financial condition, results of operations and liquidity could be materially adversely impacted.

If we are unable to continue to successfully commercialize Cinryze in the United States, or are delayed in our efforts to commercialize Cinryze in Europe and additional territories, our business will be materially harmed.

The FDA approved Cinryze for routine prophylaxis against angioedema attacks in adolescent and adult patients with hereditary angioedema on October 10, 2008. In June 2011, the European Commission granted us Centralized Marketing Authorization for Cinryze^® in adults and adolescents with HAE for routine prevention, pre-procedure prevention and acute treatment of angioedema attacks. The commercial success of Cinryze will depend on several factors, including the following:

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the number of patients with HAE that may be treated with Cinryze;

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manufacturing or supply interruptions which could impair our ability to acquire an adequate supply of Cinryze to meet demand for the product;

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continued acceptance by physicians and patients of Cinryze as a safe and effective treatment;

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our ability to effectively market and distribute Cinryze in the United States, Europe and additional territories;

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cost effectiveness of HAE treatment using Cinryze;

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relative convenience and ease of administration of Cinryze;

•

potential advantages of Cinryze over alternative treatments;

•

acceptance and utilization of competitive products;

•

patients’ ability to obtain sufficient coverage or reimbursement by third-party payors in the United States and our ability to receive sufficient reimbursement and price approvals that are separately required in each country in Europe;

•

sufficient supply and reasonable pricing of raw materials necessary to manufacture Cinryze; and,

•

our ability to receive regulatory approvals to market Cinryze in territories outside the United States and Europe in the timeframes we anticipate.

Sales of Cinryze represented approximately 46 percent of our revenue in 2011 and we expect Cinryze will account for an increasing percentage of our future revenues. If we are not able to continue to successfully commercialize Cinryze in the United States and Europe, or are significantly delayed or limited in doing so, we could fail to achieve our estimates for peak year sales for Cinryze, our business, financial condition, results of operations and liquidity could be materially impacted.

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

Below is a summary of stock repurchases for the three months ended June 30, 2012:


Month	Total Number of Shares Purchased⁽¹⁾		Average Price Paid per Share⁽²⁾		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs (in thousands)
April 1 – April 30		—	$	—		—	$	130,343
May 1 – May 31		571,304	$	19.89		571,304	$	118,981
June 1 – June 30		510,503	$	19.91		510,503	$	108,816

Total		1,081,807	$	19.90		1,081,807

(1)

In September 2011, our Board of Directors authorized up to $200.0 million for repurchases of ViroPharma Incorporated’s outstanding shares of common stock or 2% senior convertible notes due 2017. The $200.0 million authorization authorizes management to repurchase shares in the open market, in block transactions, in private transactions or other techniques from time to time, depending on market conditions.

During the first six months of 2012, through open market purchases, we reacquired approximately 2.7 million shares at a cost of approximately $71.5 million or an average price of $26.61 per share.

(2)	The Average Price Paid per Share is based on the price paid per share in the open market. The average price was determined based on the volume weighted-average-price of our stock during the day the repurchases had occurred.

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

ITEM 6.

Exhibits

List of Exhibits:



10.1*		Third Amendment to the Agreement for the Purchase and Sale of Blood Plasma dated as of May 22, 2012, by and between ViroPharma Biologics, Inc., a wholly owned subsidiary of ViroPharma Incorporated, and DCI Management Group LLC.

10.2*†		Distribution and Supply Agreement between ViroPharma Incorporated and Prasco, LLC dated November 30, 2007.

10.3*		Amendment No. 1 to Distribution and Supply Agreement between ViroPharma Incorporated and Prasco, LLC dated June 10, 2008.

10.4*†		Amendment No. 2 Distribution and Supply Agreement between ViroPharma Incorporated and Prasco, LLC dated August 18, 2009.

10.5*		Amendment No. 3 Distribution and Supply Agreement between ViroPharma Incorporated and Prasco, LLC dated November 30, 2010.

10.6*		Amendment No. 4 Distribution and Supply Agreement between ViroPharma Incorporated and Prasco, LLC dated November 30, 2011.

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

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

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

101		The following financial information from this Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2012, formatted in XBRL (Extensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Comprehensive Income (Loss) (iv) the Consolidated Statements of Stockholders’ Equity; (v) the Consolidated Statements of Cash Flows; and, (vi) the Notes to the Consolidated Financial Statements.

*	Filed herewith.

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

SIGNATURES

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


	VIROPHARMA INCORPORATED

Date: August 9, 2012	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 and Accounting Officer)