Salix Pharmaceuticals 10-Q 2013 Q2 Quarterly report

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, 2013

or

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

For the transition period from              to             .

Commission file number: 000-23265

SALIX PHARMACEUTICALS, LTD.

(Exact name of Registrant as specified in its charter)

Delaware	94-3267443
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

8510 Colonnade Center Drive

Raleigh, NC 27615

(Address of principal executive offices, including zip code)

(919) 862-1000

(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” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	x	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	¨

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

The number of shares of the Registrant’s Common Stock outstanding as of August 5, 2013 was 61,674,857.

SALIX PHARMACEUTICALS, LTD.

TABLE OF CONTENTS

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements	1
	Condensed Consolidated Balance Sheets as of June 30, 2013 (unaudited) and December 31, 2012	1
	Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2013 and 2012 (unaudited)	2
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2013 and 2012 (unaudited)	3
	Notes to Condensed Consolidated Financial Statements (unaudited)	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	33
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 6.	Exhibits	45
Signatures		46

PART I. FINANCIAL INFORMATION.

Item 1. Financial Statements

SALIX PHARMACEUTICALS, LTD.

Condensed Consolidated Balance Sheets

(U.S. dollars, in thousands, except share amounts)

	June 30, 2013			December 31, 2012
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	817,982		$	751,006
Accounts receivable, net		282,767			268,239
Inventory		105,014			90,533
Deferred tax assets		57,049			57,050
Prepaid and other current assets		52,328			21,753
Total current assets		1,315,140			1,188,581
Property and equipment, net		26,968			27,878
Goodwill		180,903			180,905
Product rights and intangibles, net		418,900			441,506
Other assets		33,562			35,914
Total assets	$	1,975,473		$	1,874,784
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	20,059		$	31,110
Accrued liabilities		82,072			81,062
Income taxes payable		—			8,507
Reserve for product returns, rebates and chargebacks		175,284			140,191
Current portion of capital lease obligations		49			50
Total current liabilities		277,464			260,920
Long-term liabilities:
Convertible senior notes		875,696			857,209
Lease incentive obligation		8,055			7,554
Acquisition-related contingent consideration		108,100			103,500
Deferred tax liabilities		65,047			64,255
Other long-term liabilities		21,693			20,845
Total long-term liabilities		1,078,591			1,053,363
Stockholders’ equity:
Preferred stock, $0.001 par value; 5,000,000 shares authorized, issuable in series, none outstanding		—			—
Common stock, $0.001 par value; 150,000,000 shares authorized, 61,404,867 and 60,918,391 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively		61			61
Additional paid-in-capital		647,365			631,364
Other comprehensive income (loss)		(69)			456
Accumulated deficit		(27,939	)		(71,380	)
Total stockholders’ equity		619,418			560,501
Total liabilities and stockholders’ equity	$	1,975,473		$	1,874,784

The accompanying notes are an integral part of these consolidated financial statements.

1

SALIX PHARMACEUTICALS, LTD.

Condensed Consolidated Statements of Comprehensive Income

(unaudited)

(U.S. dollars, in thousands, except per share data)

	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Revenues:
Net product revenues	$	235,441		$	181,006		$	438,042		$	352,139
Costs and expenses:
Cost of products sold (excluding amortization of product rights and intangibles of $11,162 and $11,344 for the three-month periods ended June 30, 2013 and 2012, and $22,329 and $22,689 for the six-month periods ended June 30, 2013 and 2012, respectively)		46,489			33,257			79,561			67,447
Amortization of product rights and intangible assets		11,162			11,344			22,329			22,689
Change in acquisition-related contingent consideration		2,100			—			4,600			—
Research and development		45,220			27,157			75,536			53,858
Selling, general and administrative		80,328			65,279			156,600			125,723
Total cost and expenses		185,299			137,037			338,626			269,717
Income from operations		50,142			43,969			99,416			82,422
Loss on extinguishment of debt		—			—			—			(14,369	)
Interest expense		(15,459	)		(15,085	)		(30,788	)		(23,899	)
Interest and other income		622			6,237			636			10,130
Income before provision for income tax		35,305			35,121			69,264			54,284
Income tax expense		(14,305	)		(14,987	)		(25,823	)		(24,197	)
Net income	$	21,000		$	20,134		$	43,441		$	30,087
Net income per share, basic	$	0.34		$	0.35		$	0.71		$	0.51
Net income per share, diluted	$	0.32		$	0.32		$	0.68		$	0.47
Shares used in computing net income per share, basic		61,322			58,116			61,234			58,630
Shares used in computing net income per share, diluted		64,909			63,601			64,253			64,032
Comprehensive income	$	21,411		$	19,878		$	42,916		$	30,091

The accompanying notes are an integral part of these financial statements.

2

SALIX PHARMACEUTICALS, LTD.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(U.S. dollars, in thousands)

	Six months ended June 30,
	2013			2012
Cash flows from operating activities
Net income	$	43,441		$	30,087
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Depreciation and amortization		25,881			26,079
Amortization of debt discount		18,487			12,984
Loss on extinguishment of debt		—			14,369
Gain on adjustment of put option to fair market value		—			(9,325	)
Loss on disposal of property and equipment		113			103
Stock-based compensation expense		12,013			9,318
Changes in operating assets and liabilities:
Accounts receivable, inventory, prepaid expenses and other assets		(56,439	)		(70,670	)
Accounts payable, accrued and other liabilities		(17,200	)		(5,274	)
Reserve for product returns, rebates and chargebacks		35,093			23,997
Change in acquisition-related contingent consideration		4,600			—
Net cash provided (used) by operating activities		65,989			31,668
Cash flows from investing activities
Purchases of property and equipment		(2,755	)		(4,369	)
Net cash used in investing activities		(2,755	)		(4,369	)
Cash flows from financing activities
Principal payments on capital lease obligations		—			(131	)
Proceeds from convertible senior note offering		—			690,000
Debt issuance costs		—			(21,159	)
Purchase of call options		—			(166,980	)
Proceeds from sale of warrants		—			98,994
Repurchase of common stock		—			(74,822	)
Extinguishment of 2028 convertible senior notes		—			(137,196	)
Excess tax benefit from stock-based compensation		2,849			4,434
Payments related to net settlement of stock-based awards		(1,754	)		(1,091	)
Proceeds from issuance of common stock upon exercise of stock options		2,893			3,763
Net cash provided by financing activities		3,988			395,812
Effect of exchange rate changes on cash		(246	)		2
Net increase in cash and cash equivalents		66,976			423,113
Cash and cash equivalents at beginning of period		751,006			292,814
Cash and cash equivalents at end of period	$	817,982		$	715,927
Supplemental Disclosure of Cash Flow Information
Cash paid for income taxes	$	44,896		$	23,558
Cash paid for interest	$	4,744		$	6,394

The accompanying notes are an integral part of these financial statements.

3

SALIX PHARMACEUTICALS, LTD.

Notes to Condensed Consolidated Financial Statements

June 30, 2013

(Unaudited)

1. Organization and Basis of Presentation

Salix Pharmaceuticals, Ltd., a Delaware corporation (“Salix” or the “Company”), is a specialty pharmaceutical company dedicated to acquiring, developing and commercializing prescription drugs and medical devices used in the treatment of a variety of gastrointestinal diseases, which are those affecting the digestive tract.

These condensed consolidated financial statements are stated in U.S. dollars and are prepared under accounting principles generally accepted in the United States. The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company balances and transactions have been eliminated in the consolidation.

The accompanying condensed consolidated financial statements include all adjustments that, in the opinion of management, are necessary for a fair presentation of financial position, results of operations and cash flows. These financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the Securities and Exchange Commission. The results of operations for interim periods are not necessarily indicative of results to be expected for a full year or any future period. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted in accordance with the SEC’s rules and regulations for interim reporting.

2. Revenue Recognition

The Company recognizes revenue when it is realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: (a) persuasive evidence of an arrangement exists; (b) delivery has occurred or services have been rendered; (c) the Company’s price to the buyer is fixed or determinable; and (d) collectability is reasonably assured.

The Company recognizes revenue from sales transactions where the buyer has the right to return the product at the time of sale only if (1) the Company’s price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid the Company, or the buyer is obligated to pay the Company and the obligation is not contingent on resale of the product, (3) the buyer’s obligation to the Company would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from any provided by the Company, (5) the Company does not have significant obligations for future performance to directly bring about resale of the product by the buyer, and (6) the amount of future returns can be reasonably estimated. The Company recognizes revenues for product sales at the time title and risk of loss are transferred to the customer, which is generally at the time products are shipped. The Company’s net product revenue represents the Company’s total revenues less allowances for customer credits, including estimated discounts, rebates, chargebacks and product returns.

The Company establishes allowances for estimated rebates, chargebacks and product returns based on numerous qualitative and quantitative factors, including:

• the number of and specific contractual terms of agreements with customers;

• estimated levels of inventory in the distribution channel;

• historical rebates, chargebacks and returns of products;

• direct communication with customers;

• anticipated introduction of competitive products or generics;

• anticipated pricing strategy changes by the Company and/or its competitors;

• analysis of prescription data gathered by a third-party prescription data provider;

• the impact of changes in state and federal regulations; and

• estimated remaining shelf life of products.

4

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

In its analyses, the Company uses prescription data purchased from a third-party data provider to develop estimates of historical inventory channel pull-through. The Company utilizes an internal analysis to compare historical net product shipments to estimated historical prescriptions written. Based on that analysis, management develops an estimate of the quantity of product in the channel that might be subject to various rebate, chargeback and product return exposures. At least quarterly for each product line, the Company prepares an internal estimate of ending inventory units in the distribution channel by adding estimated inventory in the channel at the beginning of the period, plus net product shipments for the period, less estimated prescriptions written for the period. Based on that analysis, the Company develops an estimate of the quantity of product in the channel that might be subject to various rebate, chargeback and product return exposures. This is done for each product line by applying a rate of historical activity for rebates, chargebacks and product returns, adjusted for relevant quantitative and qualitative factors discussed above, to the potential exposed product estimated to be in the distribution channel. The Company regularly adjusts internal forecasts that are utilized to calculate the estimated number of months in the channel based on input from members of the Company’s sales, marketing and operations groups. The adjusted forecasts take into account numerous factors including, but not limited to, new product introductions, direct communication with customers and potential product expiry issues. Adjustments to estimates are recorded in the period when significant events or changes in trends are identified.

The Company periodically offers promotional discounts to the Company’s existing customer base. These discounts are calculated as a percentage of the current published list price and are treated as off-invoice allowances. Accordingly, the discounts are recorded as a reduction of revenue in the period that the program is offered. In addition to promotional discounts, at the time that the Company implements a price increase, it generally offers its existing customer base an opportunity to purchase a limited quantity of product at the previous list price. Shipments resulting from these programs generally are not in excess of ordinary levels, therefore, the Company recognizes the related revenue upon shipment and includes the shipments in estimating various product related allowances. In the event the Company determines that these shipments represent purchases of inventory in excess of ordinary levels for a given wholesaler, the potential impact on product returns exposure would be specifically evaluated and reflected as a reduction in revenue at the time of such shipments.

Allowances for estimated rebates, chargebacks and promotional programs were $133.7 million and $103.8 million as of June 30, 2013 and December 31, 2012, respectively. These allowances reflect an estimate of the Company’s liability for items such as rebates due to various governmental organizations under the Medicare/Medicaid regulations, rebates due to managed care organizations under specific contracts and chargebacks due to various organizations purchasing products through federal contracts and/or group purchasing agreements. The Company estimates its liability for rebates and chargebacks at each reporting period based on a methodology of applying quantitative and qualitative assumptions discussed above. Due to the subjectivity of the Company’s accrual estimates for rebates and chargebacks, the Company prepares various sensitivity analyses to ensure the Company’s final estimate is within a reasonable range. The Company also reviews prior period activity to ensure that its methodology continues to be appropriate.

Allowances for product returns were $41.6 million and $36.4 million as of June 30, 2013 and December 31, 2012, respectively. These allowances reflect an estimate of the Company’s liability for products that may be returned by the original purchaser in accordance with the Company’s stated return policy. The Company estimates its liability for product returns at each reporting period based on historical return rates, estimated inventory in the channel and the other factors discussed above. Due to the subjectivity of the Company’s accrual estimates for product returns, the Company prepares various sensitivity analyses and also reviews prior period activity to ensure that the Company’s methodology is still reasonable.

The Company’s provision for revenue-reducing items such as rebates, chargebacks, and product returns as a percentage of gross product revenue in the six-month periods ended June 30, 2013 and 2012 was 16.9% and 15.3% for rebates, chargebacks and discounts and was 2.3% and 3.1% for product returns, respectively. The Company’s provision for revenue-reducing items such as rebates, chargebacks, and product returns as a percentage of gross product revenue in the three-month periods ended June 30, 2013 and 2012 was 18.1% and 16.0% for rebates, chargebacks and discounts and was 2.3% and 2.5% for product returns, respectively, excluding the Colazal return reserve.

In December 2011, the Company acquired an exclusive worldwide license to Solesta and Deflux with the completion of its acquisition of Oceana Therapeutics, Inc. Solesta and Deflux are medical devices that the Company sells to specialty distributors who then sell the products to end users, primarily hospitals, surgical centers and physicians. The specialty distributors generally do not purchase these products until an end user is identified. Based on historical experience with these products obtained from Oceana, and historical experience with the Company’s products, specifically Xifaxan 200mg, Xifaxan 550mg and Apriso, which are prescribed by the same physicians as Solesta, management has the ability to estimate returns for Solesta and Deflux and therefore recognized revenue upon shipment to the specialty distributors.

5

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

3. Commitments

Purchase Order Commitments

At June 30, 2013, the Company had binding purchase order commitments for inventory purchases expected to be delivered over the next three years aggregating approximately $217.3 million.

Potential Milestone Payments

The Company has entered into collaborative agreements with licensors, licensees and others. Pursuant to the terms of these collaborative agreements, the Company is obligated to make one or more payments upon the occurrence of certain milestones. The following is a summary of the material payments that the Company might be required to make under its collaborative agreements if certain milestones are satisfied.

Amended and Restated License Agreement with Alfa Wassermann S.p.A—In August 2012 the Company amended and restated its 1996 License Agreement with Alfa Wassermann to develop rifaximin. The Restated Agreement provides the Company with an exclusive license to develop and commercialize rifaximin products for Crohn’s disease in the United States and Canada and a non-exclusive license to develop such products worldwide. The Company paid Alfa a non-refundable upfront fee of $10.0 million in August 2012, and is obligated to make a $25.0 million milestone payment upon receipt of marketing authorization in the United States for a rifaximin product for Crohn’s, and additional milestone payments of up to $200.0 million based on net sales of rifaximin products for Crohn’s. No milestone payments had been earned or made as of June 30, 2013.

License Agreement with Dr. Falk Pharma GmbH for budesonide—In March 2008, the Company entered into a license agreement with Dr. Falk Pharma. The agreement provides the Company with an exclusive license to develop and commercialize in the United States Dr. Falk Pharma’s budesonide products. The products covered in the license agreement include U.S. patent-protected budesonide rectal foam and budesonide gastro-resistant capsule, patents for which expire in 2015 and 2016, respectively. Pursuant to the license agreement the Company is obligated to make an upfront payment and regulatory milestone payments that could total up to $23.0 million to Dr. Falk Pharma, with the majority contingent upon achievement of U.S. regulatory approval. As of June 30, 2013, the Company had paid $1.0 million of these milestone payments.

Development, Commercialization and License Agreement with Lupin Ltd—In September 2009, the Company entered into a Development, Commercialization and License Agreement with Lupin for Lupin’s proprietary drug delivery technology for rifaximin. The Company made an upfront payment of $5.0 million to Lupin upon execution of this agreement.

In March 2011, the Company entered into an amendment and restatement of its Development, Commercialization and License Agreement with Lupin, and further amended it in February 2013 (as so amended, the “Amended License Agreement”). The Amended License Agreement replaces in its entirety the September 2009 agreement. The Amended License Agreement provides that the Company is obligated to pay Lupin an additional upfront payment of $10.0 million, milestone payments that could total up to $53.0 million over the term of the agreement and royalties in connection with the commercialization of relevant products. Through September 30, 2019, the Company must pay Lupin a minimum quarterly payment unless specified payments by the Company to Lupin during that quarter exceed that amount. The Company is permitted to charge against such minimum quarterly payments as it makes in respect of quarters beginning on or after January 1, 2012, the purchase price for certain rifaximin to be supplied to it by Lupin pursuant to a Rifaximin Manufacturing and Supply Agreement into which the Company and Lupin entered in September 2009 and subsequently amended. In the event the Company should exercise its right to terminate the Amended License Agreement for convenience, it must pay Lupin as an early termination fee a specified portion of the minimum quarterly payments payable by it to Lupin through September 30, 2019, that have not been paid or otherwise satisfied as of the date of termination. As of June 30, 2013, the Company had paid the additional $10.0 million upfront payment and the applicable quarterly payments. The milestone payments are contingent upon achievement of certain clinical and regulatory milestones.

License Agreement with Napo Pharmaceuticals, Inc.—In December 2008 the Company entered into a collaboration agreement with Napo. Pursuant to the agreement, the Company has an exclusive, royalty-bearing license to crofelemer for the treatment of HIV-associated diarrhea and additional indications of pediatric diarrhea and acute infectious diarrhea in a specified territory. The Company also has a non-exclusive, worldwide, royalty-bearing license to use Napo-controlled trademarks associated with crofelemer. The Company made an initial payment of $5.0 million to Napo and will make up to $50.0 million in milestone payments to Napo contingent on regulatory approvals and up to $250.0 million in milestone payments contingent on reaching certain sales thresholds. The Company is responsible for the development costs of crofelemer, but costs exceeding $12.0 million for development of crofelemer used for the HIV-associated diarrhea indication will be credited towards regulatory milestones and thereafter against sales milestones. On December 31, 2012, the FDA granted marketing approval for this product, under the trade name Fulyzaq. At June 30, 2013 development costs had exceeded $12.0 million by more than the amount of the milestone due upon FDA marketing approval

6

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

received in December 2012, therefore there was no payment due to Napo. In addition, none of the sales milestones had been met as of June 30, 2013.

License and Supply Agreement with Norgine B.V.—In December 2005, the Company entered into a license and supply agreement with Norgine for the rights to sell NRL944, a bowel cleansing product the Company now markets in the United States under the trade name MoviPrep. Pursuant to the terms of this agreement, the Company is obligated to make upfront and milestone payments to Norgine that could total up to $37.0 million over the term of the agreement. As of June 30, 2013, the Company had paid $27.0 million of these payments. The remaining milestone payments are contingent upon reaching sales thresholds.

License Agreement with Photocure ASA—In October 2010, the Company entered into a license agreement with Photocure for the worldwide exclusive rights, excluding the Nordic region, to develop and commercialize Lumacan^TMfor diagnosing, staging or monitoring gastrointestinal dysplasia or cancer. The Company made an initial payment of $4.0 million to Photocure, and will be responsible for development costs of Lumacan, but Photocure will reimburse the Company up to $3.0 million for certain out-of-pocket costs. In December 2012 the Company made a $4.5 million milestone payment. In addition, the Company is obligated to make up to $72.0 million in milestone payments to Photocure contingent on development and regulatory milestones, and up to $50.0 million in milestone payments contingent on reaching certain sales thresholds over the term of the agreement. No additional milestone payments had been earned or made as of June 30, 2013.

License Agreement with Progenics Pharmaceuticals, Inc.—In February 2011, the Company acquired an exclusive worldwide license to develop and commercialize the products containing methylnaltrexone bromide, or the MNTX Compound, marketed under the name Relistor^®, from Progenics. The Company paid Progenics an up-front license fee payment of $60.0 million. In addition, the Company is obligated to pay development milestone payments of up to $90.0 million contingent upon achieving specified regulatory approvals and commercialization milestone payments of up to $200.0 million contingent upon achieving specified targets for net sales over the term of the agreement. No milestone payments had been earned or made as of June 30, 2013.

License Agreement with Q-MED AB—In connection with the Company’s acquisition of Oceana Therapeutics, Inc. in December 2011, the Company acquired two license agreements with Q-MED AB, which provide it the worldwide right to commercialize Deflux and Solesta. Under the license agreements and a related stock purchase agreement with Q-Med, the Company is obligated to pay commercialization milestone payments of up to $45.0 million contingent upon achieving specified targets for net sales over the term of the agreement. No milestone payments had been earned or made as of June 30, 2013.

4. Financial Instruments, Recurring and Nonrecurring Fair Value Measurements

Recurring Fair Value Measurements

The carrying amounts of the Company’s financial instruments, which include cash and cash equivalents, approximated their fair values as of June 30, 2013 and December 31, 2012 due to the short-term nature of these financial instruments and are considered Level 1 investments. Level 1 investments are investments where there are quoted prices in active markets available for identical assets or liabilities. Accounts receivable, accounts payable, accrued liabilities and capital lease obligations approximated their fair values at June 30, 2013 and December 31, 2012 due to the short-term nature of these financial instruments.

The Company’s convertible senior notes are considered Level 2 instruments, which are defined as those with significant other observable inputs. The fair value of the convertible senior notes was estimated using a Black-Scholes model incorporating the period-ending price of the Company’s common stock and other inputs.

The fair value of the contingent consideration liability, consisting of future potential milestone payments related to the Oceana, Progenics and Alfa Wassermann EIR acquisitions was $108.1 million and $103.5 million at June 30, 2013 and December 31, 2012, respectively. The Company considers this liability a Level 3 instrument in the fair value hierarchy, which is defined as one with significant unobservable inputs. The Company determined fair values based on the income approach using probability-weighted discounted cash flows that included probability assessments of occurrence of triggering events appropriately discounted considering the uncertainties associated with the obligation, calculated in accordance with the terms of the acquisition agreement based on management’s forecasts, and Monte-Carlo simulation models. The most significant unobservable inputs are the probability of receiving FDA approval for the relevant compounds and the subsequent commercial success of these compounds, if approved. The fair value of the related contingent consideration would be minimal if a compound does not receive FDA approval. The Company reviews the fair value of contingent consideration quarterly or whenever events or changes in circumstances occur that indicate there has been a change in the fair value.

The change in the fair value of the contingent consideration liability during the three-month and six-month periods ended June 30, 2013 was a result of the reduction of the discount period due to the passage of time.

Nonrecurring Fair Value Measurements

The fair value of the put option granted to the majority holder of the Company’s 2028 Notes, a Level 3 instrument in the fair value hierarchy, which is defined as one with significant unobservable inputs, was $5.6 million at March 31, 2012. The Company

7

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

determined the fair value based on a Black-Scholes model incorporating the period-ending price of the Company’s common stock and other inputs. The put option expired unexercised in June 2012.

The Company’s non-financial assets, such as intangible assets and property and equipment, are measured at fair value when there is an indicator of impairment and recorded at fair value only when an impairment charge is recognized. The Company reassessed the value of the indefinite lived intangible asset related to methylnaltrexone bromide injection for subcutaneous use for the treatment of opioid-induced constipation, or OIC, in adult patients with chronic, non-cancer pain and recorded a non-cash charge to earnings of $41.6 million in the three-month period ended September 30, 2012. The Company determined the fair value of the indefinite lived intangible asset using a discounted cash flow approach, which contains significant unobservable inputs and therefore is considered a Level 3 fair value measurement. The unobservable inputs in the analysis included future cash flow projections and a discount rate.

5. Cash and Cash Equivalents

The Company considers all highly liquid investments with maturities from date of purchase of three months or less to be cash equivalents. The Company maintains its cash and cash equivalents in several different financial instruments with various banks and brokerage houses. This diversification of risk is consistent with Company policy to maintain liquidity and ensure the safety of principal. At June 30, 2013 and December 31, 2012, cash and cash equivalents consisted primarily of demand deposits, overnight investments in Eurodollars, certificates of deposit and money market funds at reputable financial institutions and did not include any auction rate securities.

6. Inventory

The Company states raw materials, work-in-process and finished goods inventories at the lower of cost (which approximates actual cost on a first-in, first-out cost method) or market value. In evaluating whether inventory is stated at the lower of cost or market, management considers such factors as the amount of inventory on hand and in the distribution channel, estimated time required to sell such inventory, remaining shelf life, and current and expected market conditions, including levels of competition, including generic competition. The Company measures inventory adjustments as the difference between the cost of the inventory and estimated market value based upon assumptions about future demand and charged to the provision for inventory, which is a component of cost of sales. At the point of the loss recognition, the Company establishes a new, lower-cost basis for that inventory, and any subsequent improvements in facts and circumstances do not result in the restoration or increase in that newly established cost basis.

The Company expenses pre-approval inventory unless the Company believes it is probable that the inventory will be saleable. The Company capitalizes inventory costs associated with marketed products and certain products prior to regulatory approval and product launch, based on management’s judgment of probable future commercial use and net realizable value. Capitalization of this inventory does not begin until the product candidate is considered to have a high probability of regulatory approval, which is generally after the Company has analyzed Phase 3 data or filed an NDA. If the Company is aware of any specific risks or contingencies that are likely to impact the expected regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling of the product candidate, the Company does not capitalize the related inventory. Once the Company capitalizes inventory for a product candidate that is not yet approved, the Company monitors, on a quarterly basis, the status of this candidate within the regulatory approval process. The Company could be required to expense previously capitalized costs related to pre-approval inventory upon a change in its judgment of future commercial use and net realizable value, due to a denial or delay of approval by regulatory bodies, a delay in the timeline for commercialization or other potential factors. On a quarterly basis, the Company evaluates all inventory, including inventory capitalized for which regulatory approval has not yet been obtained, to determine if any lower of cost or market adjustment is required. As it relates to pre-approval inventory, the Company considers several factors including expected timing of FDA approval, projected sales volume and estimated selling price. At June 30, 2013 and December 31, 2012, there were no amounts included in inventory related to pre-approval inventory.

Inventory at June 30, 2013 consisted of $49.5 million of raw materials, $15.8 million of work-in-process, and $39.7 million of finished goods. Inventory at December 31, 2012 consisted of $42.9 million of raw materials, $14.8 million of work-in-process, and $32.8 million of finished goods.

8

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

7. Intangible Assets and Goodwill

The Company’s intangible assets consist of license agreements, product rights or other identifiable intangible assets, which result from product and business acquisitions. Goodwill represents the excess purchase price over the fair value of assets acquired and liabilities assumed in a business combination.

When the Company makes product acquisitions that include license agreements, product rights and other identifiable intangible assets, it records the purchase price of such intangibles, along with the value of the product related liabilities that it assumes, as intangible assets. The Company allocates the aggregate purchase price to the fair value of the various tangible and intangible assets in order to determine the appropriate carrying value of the acquired assets and then amortizes the cost of finite lived intangible assets as an expense in its consolidated statements of comprehensive income over the estimated economic useful life of the related assets. Finite lived intangible assets consist primarily of product rights for currently marketed products, which the Company amortizes over their expected economic life. The Company accounts for acquired in-process research and development as indefinite lived intangible assets until regulatory approval or discontinuation. The Company assesses the impairment of identifiable intangible assets whenever events or changes in circumstances indicate that the carrying value might not be recoverable. The Company believes that the following factors could trigger an impairment review: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s overall business; approval of generic competitive products; and significant negative industry or economic trends.

In assessing the recoverability of its intangible assets, the Company must make assumptions regarding estimated future cash flows and other factors. If the estimated undiscounted future cash flows do not exceed the carrying value of the intangible assets, the Company must determine the fair value of the intangible assets. If the fair value of the intangible assets is less than the carrying value, the Company will recognize an impairment loss in an amount equal to the difference. The Company reviews goodwill and indefinite lived intangibles for impairment on an annual basis in the fourth quarter, and goodwill and other intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. As discussed below, the Company reassessed the value of the indefinite lived intangible asset related to methylnaltrexone bromide injection for subcutaneous use for the treatment of opioid-induced constipation, or OIC, in adult patients with chronic, non-cancer pain and recorded a non-cash charge to earnings of $41.6 million in the three-month period ended September 30, 2012. As of June 30, 2013, management believed that the reporting unit was not at risk of failing step one of the goodwill impairment test.

The following table reflects the components of all specifically identifiable intangible assets as of June 30, 2013 and December 31, 2012 (in thousands):

	June 30, 2013									December 31, 2012
	Gross Amount		Accumulated Amortization		Foreign Exchange Translation			Net Carrying Value		Gross Amount		Accumulated Amortization		Foreign Exchange Translation		Net Carrying Value
Goodwill	$	180,905	$	—	$	(2	)	$	180,903	$	180,905	$	—	$	—	$	180,905
Finite lived intangible assets		490,367		126,790		(277	)		363,300		490,367		104,679		218		385,906
Indefinite lived intangible assets		55,600		—		—			55,600		55,600		—		—		55,600
Total	$	726,872	$	126,790	$	(279	)	$	599,803	$	726,872	$	104,679	$	218	$	622,411

The weighted-average remaining life of the Company’s finite lived intangible assets was nine years at June 30, 2013 and December 31, 2012.

The Company recorded goodwill of $101.8 million in connection with the Oceana acquisition in December 2011, which was decreased by $6.1 million in 2012, upon completion of the measurement period. The measurement period adjustments were primarily related to adjustments to deferred tax liability balances.

The Company calculates amortization expense on a straight-line basis over the estimated useful life of the asset. Amortization expense for the six-month periods ended June 30, 2013 and 2012 was $22.3 million and $22.7 million, respectively. Amortization expense for the three-month periods ended June 30, 2013 and 2012 was $11.2 million and $11.3 million, respectively.

In June 2004, the Company acquired the exclusive U.S. rights to Anusol-HC 2.5% (hydrocortisone Cream USP), Anusol-HC 25 mg Suppository (Hydrocortisone Acetate), Proctocort Cream (Hydrocortisone Cream USP) 1% and Proctocort Suppositories

9

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

(Hydrocortisone Acetate Rectal Suppositories, 30 mg) from King Pharmaceuticals, Inc. for $13.0 million. The purchase price was fully allocated to product rights and related intangibles and is being amortized over a period of ten years. Although Anusol-HC and Proctocort do not have any patent protection, the Company believes ten years is an appropriate amortization period based on established product sales history and management’s experience. At June 30, 2013 and December 31, 2012, accumulated amortization for the King product intangibles was $11.7 million and $11.0 million, respectively.

In September 2005, the Company acquired InKine Pharmaceutical Company, Inc. for $210.0 million. The Company allocated $74.0 million of the purchase price to in-process research and development, $9.3 million to net assets acquired and $37.0 million to specifically identifiable product rights and related intangibles with an ongoing economic benefit to the Company. The Company allocated the remaining $89.7 million to goodwill, which is not being amortized. The InKine product rights and related intangibles were being amortized over an average period of 14 years, which the Company believed was an appropriate amortization period due to the product’s patent protection and the estimated economic lives of the product rights and related intangibles. In September 2010, the Company entered into a Sublicense Agreement which granted Novel Laboratories, Inc. a license under the patents covering OsmoPrep permitting Novel to launch a generic OsmoPrep on November 16, 2019. As a result of this agreement the amortization period was adjusted prospectively, and the remaining net book value of the intangible asset will be amortized through November 16, 2019, which is the Company’s revised estimate of its remaining economic life. The Company assessed whether there was an impairment to the carrying value of the related intangible asset due to its reduced economic life and determined that there was no impairment. At June 30, 2013 and December 31, 2012, accumulated amortization for the InKine intangibles was $21.7 million and $20.4 million, respectively.

In December 2005, the Company entered into a License and Supply Agreement with Norgine B.V., granting Salix the exclusive right to sell a patent-protected, liquid PEG bowel cleansing product, NRL 944, in the United States. In August 2006, the Company received Food and Drug Administration marketing approval for NRL 944 under the branded name of MoviPrep. In January 2007 the United States Patent Office issued a patent providing coverage to September 1, 2024. Pursuant to the terms of the Agreement, Salix paid Norgine milestone payments of $15.0 million in August 2006, $5.0 million in December 2008 and $5.0 million in December 2009. The Company was amortizing these milestone payments over a period of 17.3 years through 2022, which the Company believed was an appropriate amortization period due to the product’s patent protection and the estimated economic life of the related intangible. In August 2010 the Company entered into a Sublicense Agreement that granted Novel Laboratories, Inc. a license to the patents covering MoviPrep permitting Novel to launch a generic MoviPrep on September 24, 2018. As a result of this agreement the amortization period was adjusted prospectively, and the remaining net book value of the intangible asset will be amortized through September 24, 2018, which is the Company’s revised estimate of its remaining economic life. The Company assessed whether there was an impairment to the carrying value of the related intangible asset due to its reduced economic life and determined that there was no impairment. At June 30, 2013 and December 31, 2012, accumulated amortization for the MoviPrep intangible was $12.7 million and $11.5 million, respectively.

In February 2007, the Company entered into a Master Purchase and Sale and License Agreement with Merck & Co. Inc., to purchase the U.S prescription pharmaceutical product rights to Pepcid Oral Suspension and Diuril Oral Suspension from Merck. The Company paid Merck $55.0 million at the closing of this transaction. The Company fully allocated the purchase price to product rights and related intangibles, and it is being amortized over a period of 15 years. Although Pepcid and Diuril do not have patent protection, the Company believes 15 years was an appropriate amortization period based on established product history and management’s experience. In May 2010, the FDA approved a generic famotidine oral suspension product, and the Company launched an authorized generic famotidine product. In June 2010 the FDA approved another generic famotidine oral suspension product. As a result of these events, the Company assessed whether there was an impairment to the carrying value of the related intangible asset. Based on this analysis, the Company recorded a $30.0 million impairment charge to reduce the carrying value of the intangible asset to its estimated fair value during the three-month period ended June 30, 2010. At June 30, 2013 and December 31, 2012, accumulated amortization for the Merck products was $15.6 million and $15.1 million, respectively and the carrying value was $9.4 million and $9.9 million at March 31, 2013 and December 31, 2012, respectively.

In July 2002, the Company acquired the rights to develop and market a granulated formulation of mesalamine from Dr. Falk Pharma GmbH. On October 31, 2008, the FDA granted marketing approval for Apriso for the maintenance of remission of ulcerative colitis in adults. In November 2008, the Company made a $8.0 million milestone payment to Dr. Falk. The Company is amortizing this milestone payment over a period of 9.5 years, which the Company believes is an appropriate amortization period due to the product’s patent protection and the estimated economic life of the related intangible. At June 30, 2013 and December 31, 2012, accumulated amortization for the Apriso intangible was $4.0 million and $3.5 million, respectively.

In September 2007, the Company acquired the exclusive, worldwide right to sell metoclopramide-Zydis^® (trade name Metozolv) from Wilmington Pharmaceuticals, LLC. On September 8, 2009 the FDA granted marketing approval for Metozolv™ ODT (metoclopramide HCl) 5 mg and 10 mg orally disintegrating tablets. Metozolv ODT is indicated for the relief of symptomatic gastroesophageal reflux or short-term (4-12 weeks) therapy for adults with symptomatic, documented gastroesophageal reflux who fail to respond to conventional therapy and diabetic gastroparesis or the relief of symptoms in adults associated with acute and recurrent diabetic gastroparesis. In October 2009, the Company made a $7.3 million milestone payment to Wilmington. The Company was amortizing this milestone payment over a period of eight years, which the Company believed was an appropriate amortization period

10

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

due to the product’s patent protection and the estimated economic life of the related intangible. On November 3, 2010, the Company received a paragraph IV notification from Novel stating that Novel had filed an ANDA application to seek approval to market a generic version of Metoclopramide Hydrochloride ODT, 5 mg and 10 mg. The notification letter asserted non-infringement of U.S. Patent No. 6,413,549 (the ‘549 patent). Upon examination of the relevant sections of the ANDA, the Company concluded that the ‘549 patent would not be enforced against Novel Laboratories. As a result of this event, the Company assessed whether there was an impairment to the carrying value of the related intangible asset. Based on this analysis, the Company recorded a $4.6 million impairment charge to reduce the carrying value of the intangible asset to its estimated fair value during the three-month period ended December 31, 2010. At June 30, 2013 and December 31, 2012 accumulated amortization for the Metozolv intangible was $2.6 million and the carrying value was $0.0 million.

In February 2011, the Company acquired an exclusive worldwide license to develop and commercialize the products containing methylnaltrexone bromide, or the MNTX Compound, marketed under the name Relistor^®, from Progenics Pharmaceuticals, Inc. (except in Japan, where Ono Pharmaceutical Co. Ltd. has previously licensed the subcutaneous formulation of the drug from Progenics) and a non-exclusive license to manufacture the MNTX Compound and products containing that compound in the same territory. Relistor Subcutaneous Injection is indicated for the treatment of opioid-induced constipation in patients with advanced illness who are receiving palliative care, when response to laxative therapy has not been sufficient. The Company paid Progenics an up-front license fee payment of $60.0 million. The Company also agreed to pay development milestone payments of up to $90.0 million contingent upon achieving specified regulatory approvals and commercialization milestone payments of up to $200.0 million contingent upon achieving specified targets for net sales. The Company must pay Progenics 60% of any revenue received from sublicensees in respect of any country outside the United States. Additionally, the Company must pay Progenics royalties based on a percentage ranging from the mid- to high-teens of net sales by the Company and its affiliates of any product containing the MNTX Compound.

The Company accounted for the Progenics transaction as a business combination under the acquisition method of accounting and recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition date. The determination of estimated fair value required management to make significant estimates and assumptions. As of the acquisition date, the estimated fair value of the assets acquired was $113.0 million, including the Company’s estimate of the fair value of the contingent consideration related to the transaction discussed above of $53.0 million which is included as a long-term liability on the consolidated balance sheets. The Company determined this liability amount using a probability-weighted discounted cash flow model based on the current regulatory status of the methylnaltrexone bromide development programs. The Company assesses the fair value of the contingent consideration quarterly, or whenever events or changes in circumstances indicate that the fair value may have changed, primarily as a result of clinical or regulatory results in the related in-process development programs. In December 2011, the Company announced positive Phase 3 data from the OIC Oral development program. Based on this information, the Company reassessed the fair value of the contingent consideration and recorded a $27.0 million increase in the contingent consideration and a corresponding charge to earnings in the fourth quarter of 2011. At June 30, 2013 and December 31, 2012, accumulated amortization for the intangible related to the currently approved indication for Relistor was $5.9 million and $4.6 million, respectively.

On July 27, 2012 the Company received a Complete Response Letter, or CRL, from the FDA following its review of a Supplemental New Drug Application (sNDA) for methylnaltrexone bromide injection for subcutaneous use for the treatment of OIC in adult patients with chronic, non-cancer pain. The CRL requested additional clinical data. In October 2012 the Company and Progenics held an End-of-Review meeting with the Division of Gastroenterology and Inborn Errors Products to better understand the contents of the CRL. Based on the results of this meeting, the Company reassessed the value of the indefinite lived intangible asset related to methylnaltrexone bromide injection for subcutaneous use for the treatment of OIC in chronic non-cancer pain and recorded a non-cash charge to earnings of $41.6 million in the three-month period ended September 30, 2012. Based on these events, the Company reassessed the fair value of the contingent consideration related to the Progenics transaction and recorded a $33.0 million decrease in the contingent consideration and a corresponding non-cash charge to earnings in the three-month period ended September 30, 2012. The Company is currently evaluating the oral OIC development program and currently believes it will continue this program. However, additional information and additional guidance from the FDA could result in the termination of the oral OIC development program, which would result in impairment of the related intangible asset and a decrease in the related contingent consideration.

In December 2011, the Company completed its acquisition of Oceana Therapeutics, Inc. for a purchase price of approximately $303.0 million. Under license agreements and a related stock purchase agreement with Q-Med acquired with this acquisition, the Company is obligated to pay development milestone payments of up to $45.0 million contingent upon achieving specified targets for net sales. Additionally, the Company must pay low double-digit royalties under these license agreements based on a percentage of net sales of these products by the Company and its affiliates.

The Company accounted for the Oceana transaction as a business combination under the acquisition method of accounting and recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition date. The determination of estimated fair value required management to make significant estimates and assumptions. As of the acquisition date, the estimated fair

11

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

value of the assets acquired was approximately $342.8 million, including the Company’s estimate of the fair value of the contingent consideration related to the transaction discussed above of $39.7 million which is included as a long-term liability on the consolidated balance sheets. The Company determined this liability amount using a probability-weighted discounted cash flow model. The Company assesses the fair value of the contingent consideration quarterly, or whenever events or changes in circumstances indicate that the fair value might have changed, primarily as a result of significant changes in our forecast of net sales for Solesta. At June 30, 2013 and December 31, 2012, accumulated amortization for the Deflux intangible was $6.9 million and $4.7 million, respectively. At June 30, 2013 and December 31, 2012, accumulated amortization for the Solesta intangible was $43.6 million and $29.0 million, respectively.

In August 2012 the Company amended its 1996 License Agreement with Alfa Wassermann to develop rifaximin. The new agreement provides the Company with an exclusive license to develop and commercialize rifaximin products for travelers’ diarrhea (TD), hepatic encephalopathy (HE) or irritable bowel syndrome (IBS) in the United States and Canada. The Company is obligated to pay Alfa royalties, at the same range of rates as under the previous agreement, on net sales of such products. In addition, the Restated Agreement provides the Company with an exclusive license to develop and commercialize rifaximin products for Crohn’s disease in the United States and Canada and a non-exclusive license to develop such products worldwide. The Company paid Alfa a non-refundable upfront fee of $10.0 million in August 2012, and is obligated to make a $25.0 million milestone payment upon receipt of marketing authorization in the United States for an extended intestinal release, or EIR, formulation product for CD, and additional milestones based on net sales of EIR formulation products for CD of up to $200.0 million. In addition, the Company is required to pay Alfa royalties on sales of rifaximin products for Crohn’s at percentage rates ranging in the low double digits.

The Company accounted for the Alfa Wassermann transaction as a business combination under the acquisition method of accounting and recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition date. The determination of estimated fair value required management to make significant estimates and assumptions. As of the acquisition date, the estimated fair value of the assets acquired was $23.4 million, which is included as an indefinite lived intangible asset on the consolidated balance sheet, and includes the Company’s estimate of the fair value of the contingent consideration related to the transaction discussed above of $13.4 million, which is included as a long-term liability on the consolidated balance sheets. The Company determined this liability amount using a probability-weighted discounted cash flow model based on the current regulatory status of the EIR development program. The Company assesses the fair value of the contingent consideration quarterly, or whenever events or changes in circumstances indicate that the fair value may have changed, primarily as a result of clinical or regulatory results in the related in-process development programs.

8. Convertible Senior Notes

Convertible Senior Notes Due 2028

On August 22, 2008 the Company closed an offering of $60.0 million in Convertible Senior Notes due 2028 (“2028 Notes”). Net proceeds from the offering were $57.3 million. The 2028 Notes are governed by an indenture, dated as of August 22, 2008, between the Company and U.S. Bank National Association, as trustee.

The 2028 Notes bear interest at a rate of 5.5% per year, payable semiannually in arrears on February 15 and August 15 of each year, beginning on February 15, 2009. The 2028 Notes will mature on August 15, 2028, unless previously converted or repurchased in accordance with their terms prior to such date.

The 2028 Notes are senior unsecured obligations, and rank (i) equally to any of the Company’s existing and future unsecured senior debt, (ii) senior to any of the Company’s future indebtedness that is expressly subordinated to these 2028 Notes, and (iii) effectively junior to any secured indebtedness to the extent of the value of the assets securing such indebtedness.

The Company may redeem the 2028 Notes, in whole or in part, at any time after August 15, 2013 for cash equal to the principal amount of the Notes to be redeemed, plus any accrued and unpaid interest.

On August 15, 2013, August 15, 2018 and August 15, 2023 or upon the occurrence of a “fundamental change”, as defined in the indenture, the holders may require the Company to repurchase all or a portion of the 2028 Notes for cash at 100% of the principal amount of the Notes being purchased, plus any accrued and unpaid interest.

In March 2012, the Company entered into a note repurchase agreement with the holder of a majority in principal amount of the 2028 Notes. The Company used a portion of the proceeds from its offering of the 2019 Notes discussed below to purchase from this holder and another holder approximately 42.1% of the 2028 Notes for an aggregate purchase price of approximately $137.2 million. In addition, for a period of 90 days after March 12, 2012, the majority holder had the option to require the Company to purchase its remaining 2028 Notes at the same price, which represented approximately 37.1% of the 2028 Notes. This option expired unexercised in June 2012. The Company incurred a loss on extinguishment of debt during the three-month period ended March 31, 2012 of $14.4 million, which primarily consists of $9.3 million in estimated fair market value of the put option granted to the majority holder,

12

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

$2.5 million in estimated fair market value of the notes extinguished over their book value at the extinguishment date, and $2.0 million paid to the note holder for interest that the note holders would have received through August 2013, the first date the Company could call the debt under the original debt indenture. In December 2012 one of the holders of the 2028 Notes converted notes with a par value of $22.3 million under the terms of the note indenture, and received cash equal to the par value of the notes and interest on these notes through February 15, 2013 , and 1.9 million shares of common stock. The Company incurred a loss on extinguishment of debt during the three-month period ended December 31, 2012 of $1.2 million, which primarily consists of $1.1 million in estimated fair market value of the notes extinguished over their book value at the extinguishment date, and $0.1 million paid to the note holder for interest that the note holders would have received through February 2013.

The remaining 2028 Notes are convertible into approximately 1,351,000 shares of the Company’s common stock under certain circumstances prior to maturity at a conversion rate of 108.0847 shares per $1,000 principal amount of 2028 Notes, which represents a conversion price of approximately $9.25 per share, subject to adjustment under certain conditions. Holders may convert their 2028 Notes at their option on any day prior to the close of business on the business day immediately preceding the maturity date of August 15, 2028 only if one or more of the following conditions is satisfied: (1) during any fiscal quarter commencing after September 30, 2008, if the last reported sale price of the Company’s common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is equal to or more than 130% of the conversion price of the 2028 Notes on the last day of such preceding fiscal quarter; (2) during the five business day period following any five consecutive trading day period in which the trading price for the 2028 Notes, per $1,000 principal amount of the 2028 Notes, for each such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate of the Notes on such date; (3) if the Company enters into specified corporate transactions; or (4) upon a redemption notice. The first of these conditions was met as of June 30, 2013. The 2028 Notes will be convertible, regardless of whether any of the foregoing conditions have been satisfied, on or after March 15, 2028 at any time prior to the close of business on the business day immediately preceding the stated maturity date of August 15, 2028. Upon conversion, the Company may pay cash, shares of the Company’s common stock or a combination of cash and stock, as determined by the Company in its discretion.

Prior to March 2012, as long as the 2028 Notes were outstanding, the Company and its subsidiaries were prohibited from incurring any debt other than “permitted debt”, as defined in the indenture, except that the Company and its subsidiaries may have incurred debt in certain circumstances, including meeting a consolidated leverage ratio test and a consolidated fixed charge coverage ratio test. The 2015 Notes described below were “permitted debt” under the indenture. In March 2012, the Company and the holders of a majority in outstanding principal amount of the 2028 Notes amended the indenture to delete this prohibition.

In connection with the issuance of the 2028 Notes, the Company incurred $2.7 million of issuance costs, which primarily consisted of investment banker, legal and other professional fees. These costs are being amortized and are recorded as additional interest expense through August 2013, the first scheduled date on which holders have the option to require the Company to repurchase the 2028 Notes.

The Company has separately accounted for the liability and equity components of the convertible debt instrument by allocating the proceeds from issuance of the 2028 Notes between the liability component and the embedded conversion option, or equity component. This allocation was done by first estimating an interest rate at the time of issuance for similar notes that do not include the embedded conversion option. This interest rate of 12.5% was used to compute the initial fair value of the liability component of $44.1 million.

The excess of the initial proceeds received from the convertible 2028 Notes over the initial amount allocated to the liability component, of $15.9 million, is allocated to the embedded conversion option, or equity component. This excess is reported as a debt discount and subsequently amortized as interest cost, using the interest method, through August 2013, the first scheduled date on which the holders have the option to require the Company to repurchase the 2028 Notes.

The carrying value of the equity component at June 30, 2013 and December 31, 2012 was $6.6 million. The effective interest rate on the liability component for the three-month and six-month periods ended June 30, 2013 and 2012 was 12.6%. Total interest cost of $0.8 million and $2.9 million was recognized during the six-month periods ended June 30, 2013 and 2012, respectively, including $0.4 million and $0.7 million of amortization of debt discount, respectively. Total interest cost of $0.4 million and $1.1million was recognized during the three-month periods ended June 30, 2013 and 2012, respectively, including $0.2 million and $0.5 million of amortization of debt discount, respectively. The fair value of the 2028 Notes was approximately $91.0 million at June 30, 2013.

13

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

Convertible Senior Notes Due 2015

On June 3, 2010 the Company closed an offering of $345.0 million in Convertible Senior Notes due May 15, 2015 (“2015 Notes”). Net proceeds from the offering were approximately $334.2 million. The 2015 Notes are governed by an indenture, dated as of June 3, 2010 between the Company and U.S. Bank National Association, as trustee.

The 2015 Notes bear interest at a rate of 2.75% per year, payable semiannually in arrears on May 15 and November 15 of each year, beginning on November 15, 2010. The 2015 Notes will mature on May 15, 2015, unless earlier converted or repurchased in accordance with their terms prior to such date.

The 2015 Notes are senior unsecured obligations, and rank (i) equally to any of the Company’s existing and future unsecured senior debt, (ii) senior to any of the Company’s future indebtedness that is expressly subordinated to these 2015 Notes, and (iii) effectively junior to any secured indebtedness to the extent of the value of the assets securing such indebtedness.

The 2015 Notes are convertible into approximately 7,439,000 shares of the Company’s common stock under certain circumstances prior to maturity at a conversion rate of 21.5592 shares per $1,000 principal amount of 2015 Notes, which represents a conversion price of approximately $46.38 per share, subject to adjustment under certain conditions. Holders may convert their 2015 Notes at their option on any day prior to the close of business on the business day immediately preceding the maturity date of May 15, 2015 only if one or more of the following conditions is satisfied: (1) during any fiscal quarter commencing after June 30, 2010, if the last reported sale price of the Company’s common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is equal to or more than 130% of the conversion price of the 2015 Notes on the last day of such preceding fiscal quarter; (2) during the five business day period following any five consecutive trading day period in which the trading price for the 2015 Notes, per $1,000 principal amount of the 2015 Notes, for each such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate of the 2015 Notes on such date; or (3) if the Company enters into specified corporate transactions. The first of these conditions was met as of June 30, 2013. The 2015 Notes will be convertible, regardless of whether any of the foregoing conditions have been satisfied, on or after January 13, 2015 at any time prior to the close of business on the second scheduled trading day immediately preceding the stated maturity date of May 15, 2015. Upon conversion, the Company may pay cash, shares of the Company’s common stock or a combination of cash and stock, as determined by the Company in its discretion.

The Company is required to separately account for the liability and equity components of the convertible debt instrument by allocating the proceeds from issuance of the 2015 Notes between the liability component and the embedded conversion option, or equity component. This allocation was done by first estimating an interest rate at the time of issuance for similar notes that do not include the embedded conversion option. This interest rate of 8.35% was used to compute the initial fair value of the liability component of $265.6 million. The excess of the initial proceeds received from the convertible 2015 Notes over the initial amount allocated to the liability component, of $79.4 million, is allocated to the embedded conversion option, or equity component. This excess is reported as a debt discount and subsequently amortized as interest cost, using the interest method, through May 2015, the maturity date of the 2015 Notes.

In connection with the issuance of the 2015 Notes, the Company incurred $10.8 million of issuance costs, which primarily consisted of investment banker, legal and other professional fees. The portion of these costs related to the equity component of $2.5 million was charged to additional paid-in capital. The portion of these costs related to the debt component of $8.3 million is being amortized and is recorded as additional interest expense through May 2015, the maturity date of the 2015 Notes.

In connection with the issuance of the 2015 Notes, the Company entered into capped call transactions with certain counterparties covering approximately 7,439,000 shares of the Company’s common stock. The capped call transactions have a strike price of $46.38 and a cap price of $62.44, and are exercisable when and if the 2015 Notes are converted. If upon conversion of the 2015 Notes, the price of the Company’s common stock is above the strike price of the capped calls, the counterparties will deliver shares of the Company’s common stock and/or cash with an aggregate value approximately equal to the difference between the price of the Company’s common stock at the conversion date (as defined, with a maximum price for purposes of this calculation equal to the cap price) and the strike price, multiplied by the number of shares of the Company’s common stock related to the capped call transactions being exercised. The Company paid $44.3 million for these capped calls and charged this to additional paid-in capital.

The carrying value of the equity component related to the 2015 Notes at June 30, 2013 and December 31, 2012 was $79.4 million. The effective interest rate on the liability component for the three-month and six-month periods ended June 30, 2013 and 2012 was 8.35%. Total interest cost of $13.7 million and $13.0 million was recognized during the six-month periods ended June 30, 2013 and 2012, respectively, including $8.1 million and $7.5 million of amortization of debt discount, respectively. Total interest cost of $6.9 million and $6.6 million was recognized during the three-month periods ended June 30, 2013 and 2012, respectively, including $4.1 million and $3.8 million of amortization of debt discount, respectively. The fair value of the 2015 Notes was approximately $510.8 million at June 30, 2013.

14

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

Convertible Senior Notes Due 2019

On March 16, 2012 the Company closed an offering of $690.0 million in Convertible Senior Notes due March 15, 2019 (“2019 Notes”). Net proceeds from the offering were approximately $668.3 million. The 2019 Notes are governed by an indenture, dated as of March 16, 2012 between the Company and U.S. Bank National Association, as trustee.

The 2019 Notes bear interest at a rate of 1.50% per year, payable semiannually in arrears on March 15 and September 15 of each year, beginning on September 15, 2012. The 2019 Notes will mature on March 15, 2019, unless earlier converted or repurchased in accordance with their terms prior to such date.

The 2019 Notes are senior unsecured obligations, and rank (i) equally to any of the Company’s existing and future unsecured senior debt, (ii) senior to any of the Company’s future indebtedness that is expressly subordinated to these 2019 Notes, and (iii) effectively junior to any secured indebtedness to the extent of the value of the assets securing such indebtedness.

The 2019 Notes are convertible into approximately 10,484,000 shares of the Company’s common stock under certain circumstances prior to maturity at a conversion rate of 15.1947 shares per $1,000 principal amount of 2019 Notes, which represents a conversion price of approximately $65.81 per share, subject to adjustment under certain conditions. Holders may convert their 2019 Notes at their option on any day prior to the close of business on the business day immediately preceding the maturity date of March 15, 2019 only if one or more of the following conditions is satisfied: (1) during any fiscal quarter commencing after June 30, 2012, if the last reported sale price of the Company’s common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is equal to or more than 130% of the conversion price of the 2019 Notes on the last day of such preceding fiscal quarter; (2) during the five business day period following any five consecutive trading day period in which the trading price for the 2019 Notes, per $1,000 principal amount of the 2019 Notes, for each such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate of the 2019 Notes on such date; or (3) if the Company enters into specified corporate transactions. None of these conditions had been met as of June 30, 2013. The 2019 Notes will be convertible, regardless of whether any of the foregoing conditions have been satisfied, on or after November 9, 2018 at any time prior to the close of business on the second scheduled trading day immediately preceding the stated maturity date of March 15, 2019. Upon conversion, the Company may pay cash, shares of the Company’s common stock or a combination of cash and stock, as determined by the Company in its discretion.

The Company is required to separately account for the liability and equity components of the convertible debt instrument by allocating the proceeds from issuance of the 2019 Notes between the liability component and the embedded conversion option, or equity component. This allocation was done by first estimating an interest rate at the time of issuance for similar notes that do not include the embedded conversion option. This interest rate of 5.50% was used to compute the initial fair value of the liability component of $529.3 million. The excess of the initial proceeds received from the convertible 2019 Notes over the initial amount allocated to the liability component, of $160.7 million, is allocated to the embedded conversion option, or equity component. This excess is reported as a debt discount and subsequently amortized as interest cost, using the interest method, through March 2019, the maturity date of the 2019 Notes.

In connection with the issuance of the 2019 Notes, the Company incurred $21.7 million of issuance costs, which primarily consisted of investment banker, legal and other professional fees. The portion of these costs related to the equity component of $5.1 million was charged to additional paid-in capital. The portion of these costs related to the debt component of $16.6 million is being amortized and is recorded as additional interest expense through March 2019, the maturity date of the 2019 Notes.

In connection with the issuance of the 2019 Notes, the Company entered into convertible bond hedge transactions with certain counterparties covering approximately 10,484,000 shares of the Company’s common stock. The convertible bond hedge transactions have a strike price of $65.81 and are exercisable when and if the 2019 Notes are converted. If upon conversion of the 2019 Notes, the price of the Company’s common stock is above the strike price of the convertible bond hedge transactions, the counterparties will deliver shares of the Company’s common stock and/or cash with an aggregate value approximately equal to the difference between the price of the Company’s common stock at the conversion date and the strike price, multiplied by the number of shares of the Company’s common stock related to the convertible bond hedge transaction being exercised. The Company paid $167.0 million for these convertible bond hedge transactions and charged this to additional paid-in capital.

Simultaneously with entering into the convertible bond hedge transactions, the Company entered into privately negotiated warrant transactions whereby the Company sold the counterparties to these transactions warrants to acquire, subject to customary adjustments, approximately 10,484,000 shares of the Company’s common stock at a strike price of $85.31 per share, also subject to adjustment. The Company received $99.0 million for these warrants and credited this amount to additional paid-in capital.

The carrying value of the equity component related to the 2019 Notes at June 30, 2013 was $160.7 million. The effective interest rate on the liability component for the three-month and six-month periods ended June 30, 2013 and 2012 was 5.50%. Total interest cost of $16.3 million and $8.0 million was recognized during the six-month periods ended June 30, 2013 and 2012,

15

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

respectively, including $10.0 million and $4.3 million of amortization of debt discount, respectively. Total interest cost of $8.2 million and $7.4 million was recognized during the three-month periods ended June 30, 2013 and 2012, respectively, including $5.0 million and $4.3 million of amortization of debt discount, respectively. The fair value of the 2019 Notes was approximately $776.7 million at June 30, 2013.

The following table summarizes information on the convertible debt as of (in thousands):

	June 30, 2013			December 31, 2012
Convertible Notes due 2028:
Principal amount of the liability component	$	12,500		$	12,500
Unamortized discount		(178	)		(609	)
Net carrying amount	$	12,322		$	11,891
Convertible Notes due 2015:
Principal amount of the liability component	$	345,000		$	345,000
Unamortized discount		(34,807	)		(42,914	)
Net carrying amount	$	310,193		$	302,086
Convertible Notes due 2019:
Principal amount of the liability component	$	690,000		$	690,000
Unamortized discount		(136,819	)		(146,768	)
Net carrying amount	$	553,181		$	543,232
Total Convertible Senior Notes
Principal amount of the liability component	$	1,047,500		$	1,047,500
Unamortized discount		(171,804	)		(190,291	)
Net carrying amount	$	875,696		$	857,209

9. Research and Development

The Company expenses research and development costs, both internal and externally contracted, as incurred. For nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities, the Company initially capitalizes the advance payment. The Company then recognizes such amounts as an expense as the related goods are delivered or the related services are performed. At June 30, 2013 and December 31, 2012, the net liability related to on-going research and development activities was $11.6 million and $14.1 million, respectively.

10. Comprehensive Income

Other comprehensive income is composed entirely of adjustments resulting from the translation of the financial statements of the Company’s foreign subsidiary, Oceana Therapeutics, Limited, which the Company acquired in December 2011, into U.S. dollars.

11. Stockholders’ Equity

Additional Paid-In Capital

The following table summarizes the activity in additional paid-in-capital for the six-month periods ended June 30:

	2013			2012
Balance at December 31	$	631,364		$	685,315
Issuance of common stock upon exercise of stock options		2,893			3,763
Payments related to net settlement of stock-based awards		(1,754	)		(1,091	)
Income tax benefit from non-qualified stock option exercises		2,849			4,434
Issuance of convertible debt, net of deferred tax		—			92,153
Extinguishment of 2028 notes		—			(109,352	)
Purchase of convertible note hedge, net of deferred tax		—			(98,702	)
Sale of warrants		—			98,994
Repurchase of common stock		—			(74,821	)
Compensation expense related to restricted stock awards		12,013			9,318
Balance at June 30	$	647,365		$	610,011

16

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

Share-Based Compensation

At June 30, 2013, the Company had one active share-based compensation plan, the 2005 Stock Plan, allowing for the issuance of stock options and restricted stock. The Company estimates the fair value of share-based payment awards on the date of the grant. The Company recognizes cost over the period during which an employee is required to provide service in exchange for the award.

Starting in 2006, the Company began issuing restricted shares to employees, executives and directors of the Company. The restrictions on the restricted stock lapse according to one of two schedules. For employees and executives of the Company, restrictions lapse 25% annually over four years. For Board members of the Company, restrictions lapse 100% after approximately one year. The fair value of the restricted stock was estimated using an assumed forfeiture rate of 9.5% and is being expensed on a straight-line basis over the period during which the restrictions lapse. For the six-month periods ended June 30, 2013 and 2012, the Company recognized $12.0 million and $9.3 million in share based compensation expense related to the restricted shares, respectively. For the three-month periods ended June 30, 2013 and 2012, the Company recognized $7.0 million and $5.3 million in share based compensation expense related to the restricted shares, respectively. As of June 30, 2013, the total amount of unrecognized compensation cost related to nonvested restricted stock awards, to be recognized as expense subsequent to June 30, 2013, was approximately $50.4 million, and the related weighted-average period over which it is expected to be recognized is approximately 3 years.

Aggregate stock plan activity is as follows:

				Stock Options					Restricted Shares					Stock Options and Restricted Shares
	Total Shares Available For Grant			Number			Weighted Average Price		Number Subject to Issuance			Weighted Average Price		Number			Weighted Average Price
Balance at December 31, 2012		3,499,458			762,247		$	17.46		1,589,574		$	38.94		2,351,821		$	31.98
Granted		(604,365	)		—					604,365		$	49.14		604,365		$	49.14
Exercised		—			(193,291	)	$	14.97		—			—		(193,291	)	$	14.97
Vested		—			—			—		(293,185	)	$	41.85		(293,185	)	$	41.85
Canceled		104,936			—			—		(104,936	)	$	42.45		(104,936	)	$	42.45
Balance at June 30, 2013		3,000,029			568,956		$	18.31		1,795,818		$	41.69		2,364,774		$	36.07

For the six-month period ended June 30, 2013, the Company issued 0.2 million shares of the Company’s outstanding stock with a market value of $10.1 million upon the exercise of stock options. For the six-month period ended June 30, 2012, the Company issued 0.3 million shares of the Company’s outstanding stock with a market value of $17.1 million upon the exercise of stock options. The Company recognized no share-based compensation expense related to stock options for the three-month or six-month periods ended June 30, 2013 or 2012, nor any income tax benefit. The total intrinsic value of options exercised for the six-month periods ended June 30, 2013 and 2012 was $7.2 million and $13.3 million, respectively. As of June 30, 2013, there was no unrecognized compensation cost for stock options because all stock options were fully vested. For the six-month periods ended June 30, 2013 and 2012 the Company received $2.9 million and $3.8 million in cash from stock option exercises, respectively.

The following table summarizes stock-based compensation expense incurred (in thousands):

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Research and development	$	1,616	$	1,080	$	2,760	$	2,225
Selling, general and administrative		5,361		4,247		9,253		7,093
Total	$	6,977	$	5,327	$	12,013	$	9,318

12. Income Taxes

The Company provides for income taxes under the liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the tax basis of assets or liabilities and their carrying amounts in the consolidated financial statements. The Company provides a valuation allowance for deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize their benefit or if future deductibility is uncertain.

The Company applies the provision of ASC 740-10 with respect to Accounting for Uncertainty in Income Taxes. As of June 30, 2013, the Company’s unrecognized tax benefits totaled $21.4 million. Of this amount, approximately $19.8 million would impact the Company’s effective tax rate if recognized. The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense. The Company has recorded $0.5 million of interest expense and no penalties have been recorded by the Company

17

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

through June 30, 2013. During the six months ended June 30, 2013, the Company reduced its unrecognized tax benefit by $0.1 million. The reduction was the net effect of additional interest expense $0.3 million, additional unrecognized tax benefit related to the federal research and development tax credit $0.1 million, and reduction in unrecognized tax benefit related to an issue that was effectively settled ($0.5) million. The Company’s net unrecognized tax benefits could change significantly due to tax benefits and liabilities that may be effectively settled within the next 12 months. The results and timing of the settlements is highly uncertain and the Company is unable to estimate the range of the possible changes to the balance of unrecognized tax benefits.

The Company files a consolidated U.S. federal income tax return and consolidated and separate company income tax returns in many U.S. state jurisdictions. Generally, the Company is no longer subject to federal and state income tax examinations by U.S. tax authorities for years prior to 1993. Currently Salix is under audit in certain state jurisdictions, at this time we are not aware of any potential audit adjustments that will materially impact the financial statements.

The provision for income taxes reflects the Company’s estimate of the effective tax rate expected to be applicable for the full fiscal year. The Company’s effective tax rate for the six-month periods ended June 30, 2013 and 2012 were 37.3% and 44.6%, respectively. The Company’s effective tax rate for the three-month periods ended June 30, 2013 and 2012 were 40.5% and 42.7%, respectively. The decrease in our effective tax rate for the three-months ended June 30, 2013, as compared to the same period in 2012, is due primarily to the reinstatement of the federal research and development credit during 2013 and the non-deductible loss on extinguishment of debt that occurred during 2012. The Company re-evaluates this estimate each quarter based on the Company’s estimated tax expense for the year. The Company’s effective tax rate might fluctuate throughout the year due to various items including, but not limited to, certain transactions the Company enters into, the implementation of tax planning strategies, and changes in the tax law. The Company’s effective tax rates differ from the statutory rate of 35% primarily due to state income taxes, federal research and development credits, and expenses and losses which are non-deductible for federal and state income tax purposes.

13. Net Income per Share

The Company computes basic net income per share by dividing net income by the weighted average number of common shares outstanding. The Company computes diluted net income per share by dividing net income by the weighted average number of common shares and dilutive common share equivalents then outstanding. Common share equivalents consist of the incremental common shares issuable upon the exercise of stock options and the impact of unvested restricted stock grants. The Company accounts for the effect of the convertible notes on diluted net income per share using the treasury stock method. As a result, the convertible notes have no effect on diluted net income per share until the Company’s stock price exceeds the conversion price of $9.25 per share for the 2028 Notes, $46.38 for the 2015 Notes, and $65.81 for the 2019 Notes. For the three-month and six-month periods ended June 30, 2013 and 2012, weighted average common shares, diluted, includes the effect of approximately 6,486,000 shares issuable upon conversion of the 2028 Notes calculated using the treasury stock method, taking into effect the repurchase in March and December 2012 of 2028 Notes convertible into approximately 2,730,000 and 2,405,000 shares, respectively, since the Company’s average stock price exceeded $9.25 during those periods. For the three-month and six-month periods ended June 30, 2013 and 2012, weighted average common shares, diluted, includes the effect of approximately 7,439,000 share issuable upon conversion of the 2015 Notes calculated using the treasury stock method, since the Company’s average stock price exceeded $46.38 during that period. For the three-month and six-month periods ended March 31, 2013 and 2012, the effect of the approximately 10,484,000 shares issuable upon conversion of the 2019 Notes issued in March 2012 were excluded from the diluted net income per share calculation, because the Company’s average stock price did not exceed $65.81 during those periods.

For the six-month periods ended June 30, 2013 and 2012, there were 22,152 and 67,787, respectively, potential common shares outstanding that were excluded from the diluted net income per share calculation because their effect would have been anti-dilutive.

For the three-month periods ended June 30, 2013 and 2012, there were 21,099 and 44,588, respectively, potential common shares outstanding that were excluded from the diluted net income per share calculation because their effect would have been anti-dilutive.

18

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

The following table reconciles the numerator and denominator used to calculate diluted net income per share (in thousands):

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Numerator:
Net income	$	21,000	$	20,134	$	43,441	$	30,087
Denominator:
Weighted average common shares, basic		61,322		58,116		61,234		58,630
Dilutive effect of restricted stock		628		783		556		758
Dilutive effect of convertible debt		2,538		3,724		2,016		3,599
Dilutive effect of stock options		421		978		447		1,045
Weighted average common shares, diluted		64,909		63,601		64,253		64,032

14. Segment Reporting

The Company operates in a single industry acquiring, developing and commercializing prescription drugs used in the treatment of a variety of gastrointestinal diseases, which are those affecting the digestive tract. Accordingly, the Company’s business is classified as a single reportable segment.

The following table presents net product revenues by product category (in thousands):

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Inflammatory Bowel Disease – Colazal/Apriso	$	45,146	$	22,745	$	63,606	$	38,227
Xifaxan		150,587		116,652		303,872		229,588
Purgatives – Visicol/OsmoPrep/MoviPrep		20,814		20,892		34,876		43,325
Other – Anusol/Azasan/Diuril/Pepcid/Proctocort/Relistor/ Deflux/Solesta		18,894		20,717		35,688		40,999
Net product revenues	$	235,441	$	181,006	$	438,042	$	352,139

15. Legal Proceedings

From time to time, the Company is involved in various litigation matters that are being defended and handled in the ordinary course of business. The assessment of whether a loss is probable or reasonably possible, and whether the loss or a range of loss is estimable, often involves a series of complex judgments about future events. Management maintains accruals for such losses that are probable of being incurred and subject to reasonable estimation. For current matters not specifically reported herein, management does not anticipate that the ultimate liabilities, if any, arising from the resolution of such current matters would have a material effect on the Company’s financial condition or results of operations. It is possible, however, that future results of operations for any particular period could be materially affected by changes in the Company’s assessment related to any of these matters.

The Company is currently and might continue to be subject to product liability claims that arise through the testing, manufacturing, marketing and sale of its products, including a number of claims relating to OsmoPrep and Visicol in connection with their respective “box” label warning. The Company is vigorously defending these claims and intends to continue to do so. The Company currently maintains liability coverage for its products but it is possible that this coverage, and any future coverage, will be insufficient to satisfy any liabilities that arise. The Company would have to assume defense of the lawsuits and be responsible for damages, fees and expenses, if any, that are awarded against it or for amounts in excess of the Company’s product liability coverage.

During the fourth quarter of 2011 the Company settled a number of the OsmoPrep and Visicol lawsuits and was notified by its insurer that settlement of these claims exceeded the limits of the policies related to these claims. Based on the Company’s settlement history with these cases, the Company recorded a $3.5 million charge in the fourth quarter of 2011 as an estimate of the settlements remaining on cases the Company is currently aware of. Actual settlements of these claims could exceed this estimate, and additional claims may be made against the Company that the Company is not currently aware of. In addition, the Company will incur additional litigation costs that will be expensed when incurred.

19

SALIX PHARMACEUTICALS, LTD.

Notes to Consolidated Financial Statements—Continued

On May 5, 2011, Napo Pharmaceuticals, Inc. filed a lawsuit against the Company in the Supreme Court of the State of New York, County of New York, alleging that the Company had engaged in fraudulent conduct, breached its Collaboration Agreement with Napo dated December 9, 2008, and breached its duty of good faith and fair dealing. Napo also sought a declaratory judgment that Napo had the right to terminate the Collaboration Agreement and sought unspecified damages in excess of $150 million. On or about December 28, 2011, Napo filed an Amended Complaint seeking an unspecified amount of damages for alleged breaches of the Collaboration Agreement by the Company and replacing Napo’s original Complaint. Napo’s Amended Complaint no longer seeks a declaratory judgment that Napo has the right to terminate the Collaboration Agreement and removed the need for the Court to rule on the Company’s motion to dismiss the original Complaint. The Company believes that Napo’s allegations continue to be without merit and their lawsuit baseless. The Company filed an Answer to the Amended Complaint and Counterclaims on or about January 17, 2012, and is vigorously defending against the lawsuit. Discovery concluded earlier this year, and, on May 31, 2013 the Company filed a motion for partial summary judgment. The court is expected to hear oral arguments on the motion in August 2013, and issue its ruling some time thereafter. A trial date for the case has not been set. On December 31, 2012 the FDA approved crofelemer for commercialization. The Company is moving forward with its commercialization plan for crofelemer in accordance with the existing Collaboration Agreement. Currently, the Company cannot predict or determine the timing or outcome of this litigation or its impact, if any, on the Company’s financial condition or results of operations.

On September 7, 2012, the Company and Dr. Falk Pharma filed a patent infringement complaint against Lupin Ltd. and Lupin Pharmaceuticals, Inc. in the U.S. District Court for the District of Delaware. The Complaint alleges infringement of U. S. Patent No. 6,551,620, or the ‘620 patent, based on Lupin’s filing of an Abbreviated New Drug Application, or ANDA, seeking approval to market and sell a generic version of Apriso before the expiration of the ‘620 patent. The filing of this suit within the 45 day response period provided by the Hatch Waxman Act imposes an automatic 30 month stay of approval of Lupin’s ANDA. On March 4, 2013, the Company and Dr. Falk Pharma filed an amended complaint to also enforce newly issued U.S. Patent No. 8,337,886 in the pending suit. Discovery is ongoing. On July 30, 2013 the USPTO issued US Patent No. 8,496,965, which protects the Apriso product. The Company and Dr. Falk Pharma plan to enforce this newly issued patent against Lupin. The Company continues to evaluate its intellectual property protecting Apriso in which it has full confidence. The Company intends to vigorously enforce its intellectual property rights.

On February 1, 2013, the Company’s wholly owned subsidiary Salix Pharmaceuticals, Inc. received a subpoena from the U.S. Attorney’s Office for the Southern District of New York requesting documents regarding the Company’s sales and promotional practices for Xifaxan^® , Relistor^® and Apriso^®. The Company is in the process of responding to the subpoena and intends to cooperate fully with the subpoena and related government investigation. Currently, the Company cannot predict or determine the timing or outcome of this inquiry or its impact, if any, on the Company’s financial condition or results of operations.

20

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

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are subject to risks and uncertainties, including those set forth under “Part II. Item 1A. Risk Factors” and “Cautionary Statement” included in this “Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report, that could cause actual results to differ materially from historical results or anticipated results. The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and notes thereto included elsewhere in this report.

OVERVIEW

We are a specialty pharmaceutical company dedicated to acquiring, developing and commercializing prescription drugs and medical devices used in the treatment of a variety of gastrointestinal disorders, which are those affecting the digestive tract. Our strategy is to:

• identify and acquire rights to products that we believe have potential for near-term regulatory approval or are already approved;

• apply our regulatory, product development, and sales and marketing expertise to commercialize these products; and

• market our products through our approximately 335-member specialty sales and marketing team primarily focused on high-prescribing U.S. physicians in the following specialties: gastroenterologists, who are doctors who specialize in gastrointestinal disorders; hepatologists, who are doctors who specialize in liver disease; and colorectal surgeons, who are doctors who specialize in disorders of the colon and rectum.

Our current products demonstrate our ability to execute this strategy. As of June 30, 2013, our products were:

• XIFAXAN^® (rifaximin) Tablets 200 mg, indicated for travelers’ diarrhea;

• XIFAXAN^®550mg (rifaximin) Tablets 550 mg, indicated for overt hepatic encephalopathy, or HE;

• MOVIPREP^® (PEG 3350, Sodium Sulfate, Sodium Chloride, Potassium Chloride, Sodium Ascorbate and Ascorbic Acid for Oral Solution), indicated for cleansing of the colon as a preparation for colonoscopy in adults 18 years of age or older;

• APRISO™ (mesalamine) extended-release capsules, indicated for the maintenance of remission of ulcerative colitis;

• RELISTOR^® (methylnaltrexone bromide) subcutaneous injection (SI) indicated for the treatment of opioid-induced constipation (OIC) in patients with advanced illness who are receiving palliative care, when response to laxative therapy has not been sufficient, which we began promoting in the second quarter of 2011;

• OSMOPREP™ (sodium phosphate monobasic monohydrate, USP and sodium phosphate dibasic anhydrous, USP) Tablets, indicated for cleansing of the colon as a preparation for colonoscopy in adults 18 years of age or older;

• SOLESTA^®, a biocompatible tissue-bulking agent indicated for the treatment of fecal incontinence;

• DEFLUX^®, a biocompatible tissue-bulking agent indicated for the treatment of vesicoureteral reflux (VUR);

• FULYZAQ™, (crofelemer) delayed-release tablets, indicated for the symptomatic relief of non-infectious diarrhea in adult patients with HIV/AIDS on anti-retroviral therapy, which the FDA approved on December 31, 2012;

• GIAZO™, (balsalazide disodium) tablets, indicated for the treatment of mildly to moderately active ulcerative colitis in male patients 18 years of age and older;

• METOZOLV™ ODT (metoclopramide hydrochloride) 5mg and 10mg orally disintegrating tablets, indicated for short-term (4 to 12 weeks) use in adults for treatment of refractory GERD, which is symptomatic, documented gastroesophageal reflux disease that fails to respond to conventional therapy, and for relief of symptoms of acute and recurrent diabetic gastroparesis;

• AZASAN^® Azathioprine Tablets, USP, 75mg and 100 mg, indicated as an adjunct for the prevention of rejection in renal homotransplantations and to reduce signs and symptoms of severe active rheumatoid arthritis;

• ANUSOL-HC^® 2.5% (Hydrocortisone Cream, USP), ANUSOL-HC^® 25 mg Suppository (Hydrocortisone Acetate), indicated for the relief of the inflammatory and pruritic manifestations of corticosteroid-responsive dermatoses;

21

• PROCTOCORT^® Cream (Hydrocortisone Cream, USP) 1% and PROCTOCORT^® Suppository (Hydrocortisone Acetate Rectal Suppositories) 30 mg, indicated for the relief of the inflammatory and pruritic manifestations of corticosteroid-responsive dermatoses;

• PEPCID^® (famotidine) for Oral Suspension, indicated for the short-term treatment of gastroesophageal reflux disease (GERD), active duodenal ulcer, active benign gastric ulcer, erosive esophagitis due to GERD, and peptic ulcer disease;

• DIURIL^® (Chlorothiazide), indicated for the treatment of hypertension and also as adjunctive therapy in edema associated with congestive heart failure, cirrhosis of the liver, corticosteroid and estrogen therapy, and kidney disease; and

• COLAZAL^® (balsalazide disodium) Capsules 750 mg, indicated for the treatment of mildly to moderately active ulcerative colitis (UC) in patients 5 years of age and older.

We generate revenue primarily by selling our products to pharmaceutical wholesalers. These direct customers resell and distribute our products to and through pharmacies to patients who have had our products prescribed by doctors. We currently market our products, and intend to market future products, if approved by the FDA, to U.S. gastroenterologists, hepatologists, colorectal surgeons and other physicians through our own direct sales force. In December 2000, we established our own field sales force to market Colazal in the United States. As of June 30, 2013, this sales force had approximately 235 sales representatives in the field marketing our approved products. Although the creation of an independent sales organization involved substantial costs, we believe that the financial returns from our direct product sales have been and will continue to be more favorable to us than those from the indirect sale of products through marketing partners. We generally enter into distribution or licensing relationships outside the United States and in certain markets in the U.S. where a larger sales organization is appropriate. As a result of our acquisition of Oceana Therapeutics, Inc. in December 2011, we have approximately ten sales representatives based in Europe who sell Solesta and Deflux there. We also sell Deflux through distributors in approximately 20 countries outside the United States and Europe. As of June 30, 2013, our sales and marketing staff, including our sales representatives, consisted of approximately 335 people.

Because demand for our products originates with doctors, our sales force calls on high-prescribing specialists, primarily gastroenterologists, hepatologists and colorectal surgeons, and we monitor new and total prescriptions for our products as key performance indicators for our business. Prescriptions result in our products being used by patients, requiring our direct customers to purchase more products to replenish their inventory. However, our revenue might fluctuate from quarter to quarter due to other factors, such as increased buying by wholesalers in anticipation of a price increase or because of the introduction of new products. Revenue could be less than anticipated in subsequent quarters as wholesalers’ increased inventory is consumed.

Our primary product candidates currently under development and their status are as follows:

Compound	Indication	Status
Rifaximin	Irritable bowel syndrome, or IBS	Supplemental New Drug Application, or sNDA, submitted June 7, 2010; Complete Response Letter, or CRL, received on March 7, 2011; FDA meeting held on June 20, 2011; Advisory Committee held on November 16, 2011; currently in Phase 3 retreatment study
Methylnaltrexone bromide (SI)	Opioid induced constipation in patients with chronic non-malignant pain; subcutaneous injection	sNDA accepted for filing; CRL received July 27, 2012; FDA request for Advisory Committee Meeting received on June 11, 2013, meeting date to be determined
Methylnaltrexone bromide oral	Opioid induced constipation in patients with chronic non-malignant pain; oral	Phase 3
Budesonide foam	Ulcerative proctitis	Phase 3
Rifaximin EIR	Crohn’s disease	Phase 2
Rifaximin SSD / next generation	Prevention of complications in compensated liver cirrhosis	Phase 2

22

CRITICAL ACCOUNTING POLICIES

Critical Accounting Policies

In our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, we identified our most critical accounting policies and estimates upon which our financial status depends as those relating to: revenue recognition, including allowance for product returns and allowance for rebates and coupons; inventories; valuation of intangible assets and contingent consideration liabilities acquired in business combinations; intangible assets and goodwill; research and development; convertible debt transactions; and deferred tax asset valuation. We reviewed our policies and determined that those policies remained our most critical accounting policies for the three-month period ended June 30, 2013. We did not make any changes in those policies during the quarter.

We recognize revenue from sales transactions where the buyer has the right to return the product at the time of sale only if (1) our price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid us, or the buyer is obligated to pay us and the obligation is not contingent on resale of the product, (3) the buyer’s obligation to us would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from any provided by us, (5) we do not have significant obligations for future performance to directly bring about resale of the product by the buyer, and (6) the amount of future returns can be reasonably estimated. We recognize revenues for product sales at the time title and risk of loss are transferred to the customer, which is generally at the time products are shipped. Our net product revenue represents our total revenues less allowances for customer credits, including estimated discounts, rebates, chargebacks, and product returns.

We establish allowances for estimated rebates, chargebacks and product returns based on numerous quantitative and qualitative factors, including:

• the number of and specific contractual terms of agreements with customers;

• estimated levels of inventory in the distribution channel;

• historical rebates, chargebacks and returns of products;

• direct communication with customers;

• anticipated introduction of competitive products or generics;

• anticipated pricing strategy changes by us and/or our competitors;

• analysis of prescription data gathered by a third-party prescription data provider;

• the impact of changes in state and federal regulations; and

• estimated remaining shelf life of products.

In our analyses, we use prescription data purchased from a third-party data provider to develop estimates of historical inventory channel pull-through. We utilize an internal analysis to compare historical net product shipments to estimated historical prescriptions written. Based on that analysis, we develop an estimate of the quantity of product in the channel that might be subject to various rebate, chargeback and product return exposures. At least quarterly for each product line, we prepare an internal estimate of ending inventory units in the distribution channel by adding estimated inventory in the channel at the beginning of the period, plus net product shipments for the period, less estimated prescriptions written for the period. Based on that analysis, we develop an estimate of the quantity of product in the channel that might be subject to various rebate, chargeback and product return exposures. This is done for each product line by applying a rate of historical activity for rebates, chargebacks and product returns, adjusted for relevant quantitative and qualitative factors discussed above, to the potential exposed product estimated to be in the distribution channel. Internal forecasts that are utilized to calculate the estimated number of months in the channel are regularly adjusted based on input from members of our sales, marketing and operations groups. The adjusted forecasts take into account numerous factors including, but not limited to, new product introductions, direct communication with customers and potential product expiry issues. Adjustments to estimates are recorded in the period when significant events or changes in trends are identified.

Consistent with industry practice, we periodically offer promotional discounts to our existing customers. These discounts are calculated as a percentage of the current published list price and are treated as off-invoice allowances. Accordingly, we record the discounts as a reduction of revenue in the period that we offer the program. In addition to promotional discounts, at the time that we implement a price increase, we generally offer our existing customers an opportunity to purchase a limited quantity of product at the previous list price. Shipments resulting from these programs generally are not in excess of ordinary levels, therefore, we recognize the related revenue upon shipment and include the shipments in estimating our various product related allowances. In the event we determine that these shipments represent purchases of inventory in excess of ordinary levels for a given wholesaler, the potential impact on product returns exposure would be specifically evaluated and reflected as a reduction in revenue at the time of such shipments.

23

Allowances for estimated rebates, chargebacks and promotional programs were $133.7 million and $103.8 million as of June 30, 2013 and December 31, 2012, respectively. These allowances reflect an estimate of our liability for items such as rebates due to various governmental organizations under the Medicare/Medicaid regulations, rebates due to managed care organizations under specific contracts and chargebacks due to various organizations purchasing certain of our products through federal contracts and/or group purchasing agreements. We estimate our liability for rebates and chargebacks at each reporting period based on a methodology of applying the relevant quantitative and qualitative assumptions discussed above. Due to the subjectivity of our accrual estimates for rebates and chargebacks, we prepare various sensitivity analyses to ensure our final estimate is within a reasonable range as well as review prior period activity to ensure that our methodology is still reasonable. Had a change in one or more variables in the analyses (utilization rates, contract modifications, etc.) resulted in an additional percentage point change in the trailing average of estimated chargeback and rebate activity for the year ended December 31, 2012, we would have recorded an adjustment to revenues of approximately $9.3 million, or 1.3%, for the year.

Allowances for product returns were $41.6 million and $36.4 million as of June 30, 2013 and December 31, 2012, respectively. These allowances reflect an estimate of our liability for product that may be returned by the original purchaser in accordance with our stated return policy. We estimate our liability for product returns at each reporting period based on historical return rates, the estimated inventory in the channel, and the other factors discussed above. Due to the subjectivity of our accrual estimates for product returns, we prepare various sensitivity analyses as well as review prior period activity to ensure that our methodology is still reasonable.

For the three-month and six-month periods ended June 30, 2013 and 2012, our absolute exposure for rebates, chargebacks and product returns grew primarily as a result of increased sales of our existing products, the approval of new products and the acquisition of products. Accordingly, reductions to revenue and corresponding increases to allowance accounts have likewise increased. The estimated exposure to these revenue-reducing items as a percentage of gross product revenue in the three-month periods ended June 30, 2013 and 2012 was 18.1%,and 16.0% for rebates, chargebacks and discounts and was 2.3% and 2.5% for product returns, respectively.

In December 2011 we acquired an exclusive worldwide license to Solesta and Deflux with the completion of our acquisition of Oceana. Solesta and Deflux are medical devices that we sell to specialty distributors who then sell the products to end users, primarily hospitals, surgical centers and physicians. The specialty distributors generally do not purchase these products until an end user is identified. Based on historical experience with these products obtained from Oceana, and historical experience with our products, specifically Xifaxan 200mg, Xifaxan 550mg and Apriso, which are prescribed by the same physicians as Solesta, management has the ability to estimate returns for Solesta and Deflux, and therefore we recognize revenue upon shipment to the specialty distributors.

The enactment of the “Patient Protection and Affordable Care Act” and “The Health Care and Education Reconciliation Act of 2010” in March 2010 brings significant changes to U.S. health care. These changes began to take effect in the first quarter of 2010. Changes to the rebates for prescription drugs sold to Medicaid beneficiaries, which increase the minimum statutory rebate for branded drugs from 15.1% to 23.1%, were generally effective in the first quarter of 2010. This rebate has been expanded to managed Medicaid, a program that provides for the delivery of Medicaid benefits via managed care organizations, under arrangements between those organizations and state Medicaid agencies. Additionally, a prescription drug discount program for outpatient drugs in health care facilities that serve low-income and uninsured patients, known as 340B facilities, has been expanded. The effect of these changes was not material to our financial results for the three-month and six-month periods ended June 30, 2013 and 2012. Based on our current product and payor mix, we believe the effect of these changes should not be material to our future financial results.

Also, there are changes to the tax treatment of subsidies paid by the government to employers who provide their retirees with a drug benefit at least equivalent to the Medicare Part D drug benefit. Beginning in 2013, the federal government will tax the subsidy it provides to such employers. We do not provide retirees with any drug benefits, therefore this change should not affect our financial results.

Beginning in 2011, drug manufacturers will provide a discount of 50% of the cost of branded prescription drugs for Medicare Part D participants who are in the “doughnut hole” coverage gap in Medicare prescription drug coverage. The doughnut hole will be phased out by the federal government between 2011 and 2020. Based on our current product and payor mix, the cost of this discount was less than 1% of our gross revenue for the year ended December 31, 2012, however, the cost of this discount might have a material effect on our results of operations in future periods.

Beginning in 2011, pharmaceutical manufacturers and importers that sell branded prescription drugs to specified government programs had to pay a non-tax deductible annual fee to the federal government. Companies have to pay an amount based on their prior calendar year market share for branded prescription drug sales into these government programs. Based on our current product and payor mix, the effect of this tax was not material to our financial results for the three-month and six-month periods ended June 30, 2013 and 2012, and we do not believe the effect of this tax will be material to future periods.

24

Additionally, the 2010 healthcare reform legislation imposes a 2.3 % excise tax on U.S. sales of Class I, II and III medical devices beginning in 2013. This tax did not have a material effect on our financial statements for the three-month and six-month periods ended June 30, 2013, and we do not believe the effect of this tax will be material to future periods.

Results of Operations

Three-month and Six-month Periods Ended June 30, 2013 and 2012

Revenues

The following table summarizes net product revenues for the three month and six-month periods ended June 30:

	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Inflammatory Bowel Disease – Colazal/Apriso	$	45,146		$	22,745		$	63,606		$	38,227
% of net product revenues		19	%		13	%		15	%		11	%
Xifaxan		150,587			116,652			303,872			229,588
% of net product revenues		64	%		64	%		69	%		65	%
Purgatives – Visicol/OsmoPrep/ MoviPrep		20,814			20,892			34,876			43,325
% of net product revenues		9	%		12	%		8	%		12	%
Other –
Anusol/Azasan/Diuril/Pepcid/Proctocort/Relistor/ Deflux/Solesta		18,894			20,717			35,688			40,999
% of net product revenues		8	%		11	%		8	%		12	%
Net product revenues	$	235,441		$	181,006		$	438,042		$	352,139

Net product revenues for the three-month period ended June 30, 2013 were $235.4 million, compared to $181.0 million for the corresponding three-month period in 2012, a 30% increase. The net product revenue increase for the three-month period ended June 30, 2013 compared to the three-month period ended June 30, 2012 was primarily due to:

• increased unit sales of Apriso, Xifaxan, Relistor and Moviprep; and

• price increases on our products.

These increases were partially offset by reduced unit sales of OsmoPrep.

Total milligrams of Xifaxan prescribed for the three-month period ended June 30, 2013 compared to the corresponding three-month period in 2012 increased 21%. Prescriptions for our purgatives increased 1% for the three-month period ended June 30, 2013 compared to the corresponding three-month period in 2012. Prescriptions for MoviPrep were flat for the three-month period ended June 30, 2013 compared to the corresponding three-month period in 2012. Prescriptions for OsmoPrep for the three-month period ended June 30, 2013 declined 8% compared to the corresponding three-month period in 2012, due to the continued impact of the boxed label warning announced by the FDA on December 11, 2008. Prescriptions for Apriso increased 45% for the three-month period ended June 30, 2013 compared to the corresponding three-month period in 2012.

Net product revenues for the six-month period ended June 30, 2013 were $438.0 million, compared to $352.1 million for the corresponding six-month period in 2012, a 24% increase. The net product revenue increase for the six-month period ended June 30, 2013 compared to the six-month period ended June 30, 2012 was primarily due to:

• increased unit sales of Xifaxan, Apriso and Giazo, which we launched in the first quarter of 2013; and

• price increases on our products.

These increases were partially offset by reduced unit sales of MoviPrep, OsmoPrep and Relistor.

Total milligrams of Xifaxan prescribed for the six-month period ended June 30, 2013 compared to the corresponding six-month period in 2012 increased 20%. Prescriptions for our purgatives decreased 1% for the six-month period ended June 30, 2013 compared to the corresponding six-month period in 2012. Prescriptions for MoviPrep increased 2% for the six-month period ended June 30, 2013 compared to the corresponding six-month period in 2012. Prescriptions for OsmoPrep for the six-month period ended June 30, 2013 declined 27% compared to the corresponding six-month period in 2012, due to the continued impact of the boxed label warning announced by the FDA on December 11, 2008. Prescriptions for Apriso increased 28% for the six-month period ended June 30, 2013 compared to the corresponding six-month period in 2012.

25

Costs and Expenses

Costs and expenses for the three-month period ended June 30, 2013 were $185.4 million, compared to $137.0 million for the corresponding three-month period in 2012 and $338.7 million for the six-month period ended June 30, 2013, compared to $269.7 million for the corresponding six-month period in 2012. Higher operating expenses in absolute terms were due primarily to increased selling, general and administrative costs due to the expansion of our sales force in mid-2012.

Cost of Products Sold

Cost of products sold for the three-month period ended June 30, 2013 was $46.5 million, compared with $33.3 million for the corresponding three-month period in 2012. Cost of products sold for the six-month period ended June 30, 2013 was $79.6 million, compared with $67.4 million for the corresponding six-month period in 2012. The increase in cost of products sold in absolute terms was due to the increase in net product revenues discussed above.

Gross margin on total product revenue, excluding $11.2 million and $11.3 million in amortization of product rights and intangible assets for the three-month periods ended June 30, 2013 and 2012, respectively, was 80.3% for the three-month period ended June 30, 2013 and 81.6% for the three-month period ended June 30, 2012. Gross margin on total product revenue, excluding $22.3 million and $22.7 million in amortization of product rights and intangible assets for the six-month periods ended June 30, 2013 and 2012, respectively, was 81.8% for the six-month period ended June 30, 2013 and 80.8% for the six-month period ended June 30, 2012. The period-to-period changes in gross margin are due to the product revenue mix in the respective periods.

Amortization of Product Rights and Intangible Assets

Amortization of product rights and intangible assets remained flat and consists of amortization of the costs of license agreements, product rights and other identifiable intangible assets, which result from product and business acquisitions.

Research and Development

Research and development expenses were $45.2 million for the three-month period ended June 30, 2013, compared to $27.2 million for the comparable period in 2012. The increase in research and development expenses for the three-month period ended June 30, 2013 compared to the corresponding period in 2012 was due primarily to:

• increased expenses related to our development programs for rifaximin for irritable bowel syndrome, rifaximin next generation, rifaximin EIR and budesonide foam;

• the $10 million payment to Olon S.p.A. for the purchase of intellectual property; and

• increased personnel costs, partially offset by

• decreased expenses related to our development programs for crofelemer and methylnaltrexone.

Research and development expenses were $75.5 million for the six-month period ended June 30, 2013, compared to $53.9 million for the comparable period in 2012. The increase in research and development expenses for the six-month period ended June 30, 2013 compared to the corresponding period in 2012 was due primarily to:

• increased expenses related to our development programs for rifaximin for irritable bowel syndrome, rifaximin next generation, rifaximin EIR and budesonide foam;

• the $10 million payment to Olon S.p.A. for the purchase of intellectual property; and

• increased personnel costs, partially offset by

• decreased expenses related to our development programs for crofelemer and methylnaltrexone.

From inception through June 30, 2013, we have incurred research and development expenditures of approximately $41.7 million for balsalazide, $192.9 million for rifaximin, $32.2 million for granulated mesalamine, $35.5 million for crofelemer, $37.0 million for methylnaltrexone bromide and $36.2 million for budesonide foam.

Due to the significant risks and uncertainties inherent in the clinical development and regulatory approval processes, we cannot reasonably estimate the cost to complete projects and development timelines for their completion. Enrollment in clinical trials might be delayed or occur faster than anticipated for reasons beyond our control, requiring additional cost and time or accelerating spending. Results from clinical trials might not be favorable, or might require us to perform additional unplanned clinical trials, accelerating spending, requiring additional cost and time, or resulting in termination of the project. Further, as evidenced by the Complete Response Letter for rifaximin as a treatment for IBS, data from clinical trials is subject to varying interpretation, and might be deemed insufficient by the regulatory bodies reviewing applications for marketing approvals, requiring additional cost and time, or resulting in termination of the project. Regulatory reviews can also be delayed. For example the PDUFA action dates for Relistor and crofelemer were each extended by three months. Process development and manufacturing scale-up for production of clinical and commercial

26

product supplies might take longer and cost more than our forecasts. As a result, clinical development and regulatory programs are subject to risks and changes that might significantly impact cost projections and timelines.

The following table summarizes costs incurred for our significant projects, in thousands. We consider a project significant if expected spend for any year exceeds 10% of our development project budget for that period.

Project	Three Months Ended June 30,				Six Months Ended June 30,				Cumulative through  June 30, 2013
	2013		2012		2013		2012
Rifaximin for hepatic encephalopathy, or HE	$	2,633	$	1,030	$	4,150	$	1,030	$	48,460
Rifaximin for irritable bowel syndrome, or IBS		9,372		4,003		18,520		6,308		90,012
Crofelemer for HIV-associated diarrhea		374		1,763		685		6,399		35,526
Budesonide foam for ulcerative proctitis		2,032		1,414		3,381		2,232		36,273
Methylnaltrexone bromide for opioid induced constipation in patients with chronic pain		2,293		4,008		2,912		7,547		36,973
Next generation rifaximin		1,802		—		2,988		—		2,988
Other non-significant rifaximin clinical projects (2 in 2013, 2 in 2012)		81		1,261		420		4,334		N/A
All other clinical programs (5 in 2013, 4 in 2012)		1,981		2,218		4,105		4,006		N/A

We generally expect research and development costs to increase in absolute terms in future periods as we pursue additional indications and formulations for rifaximin, continue development for our budesonide product candidate, Relistor, rifaximin EIR and crofelemer, and if and when we acquire new products.

Selling, General and Administrative

Selling, general and administrative expenses were $80.3 million for the three-month period ended June 30, 2013, compared to $65.3 million in the corresponding three-month period in 2012. This increase was primarily due to:

• increased personnel costs, including costs related to the addition of 10 sales representatives in the second quarter of 2012 and 22 sales representatives in the third quarter of 2012;

• increased marketing expenses related to Fulyzaq (which was approved in December 2012), Deflux and Giazo; and

• increased legal expenses related to our product liability litigation, our patent infringement complaint against Lupin, and the subpoena from the U.S. Attorney’s Office for the Southern District of New York received in February 2013.

These increases were partially offset by reduced marketing expenses related to Relistor.

Selling, general and administrative expenses were $156.6 million for the six-month period ended June 30, 2013, compared to $125.7 million in the corresponding six-month period in 2012. This increase was primarily due to:

• increased personnel costs, including costs related to the addition of 10 sales representatives in the second quarter of 2012 and 22 sales representatives in the third quarter of 2012;

• increased marketing expenses related to Fulyzaq (which was approved in December 2012), Deflux, Solesta and Giazo; and

• increased legal expenses related to our product liability litigation, our patent infringement complaint against Lupin, and the subpoena from the U.S. Attorney’s Office for the Southern District of New York received in February 2013.

These increases were partially offset by reduced marketing expenses related to Relistor.

We expect selling, general and administrative expenses to increase in absolute terms as we expand our sales and marketing efforts for our current products, including Xifaxan, Relistor, Solesta, Fulyzaq and Deflux, and other indications for rifaximin and methylnaltrexone bromide, if approved.

Loss on Extinguishment of Debt

In March 2012, we entered into a note repurchase agreement with the holder of a majority in principal amount of the 2028 Notes. We used a portion of the proceeds from this offering of the 2019 Notes to purchase from this holder and another holder approximately 42.1% of the 2028 Notes for an aggregate purchase price of approximately $137.2 million. Loss on extinguishment of debt primarily consists of $9.3 million in estimated fair market value of the put option granted to the majority holder, $2.5 million in estimated fair market value of the notes extinguished over their book value at the extinguishment date, and $2.0 million paid to the note holder for interest that the note holders would have been received through August 2013, the first date we could call the debt under the original debt indenture.

27

Interest Expense

Interest expense was $15.5 million for the three-month period ended June 30, 2013, compared to $15.1 million in the corresponding three-month period in 2012. Interest expense for the three-month period ended June 30, 2013 consisted of:

• $6.9 million of interest expense on our 2015 convertible notes issued in June 2010, including $4.1 million of amortization of debt discount;

• $0.4 million of interest expense on our 2028 convertible notes issued in August 2008, including $0.2 million of amortization of debt discount; and

• $8.2 million of interest expense on our 2019 convertible notes issued in March 2012, including $5.0 million of amortization of debt discount.

Interest expense for the three-month period ended June 30, 2012 consisted of:

• $6.6 million of interest expense on our 2015 convertible notes issued in June 2010, including $3.8 million of amortization of debt discount;

• $1.1 million of interest expense on our 2028 convertible notes issued in August 2008, including $0.5 million of amortization of debt discount; and

• $7.4 million of interest expense on our 2019 convertible notes issued in March 2012, including $4.3 million of amortization of debt discount.

Interest expense was $30.8 million for the six-month period ended June 30, 2013, compared to $23.9 million in the corresponding six-month period in 2012. Interest expense for the six-month period ended June 30, 2013 consisted of:

• $13.7 million of interest expense on our 2015 convertible notes issued in June 2010, including $8.1 million of amortization of debt discount;

• $0.8 million of interest expense on our 2028 convertible notes issued in August 2008, including $0.4 million of amortization of debt discount; and

• $16.3 million of interest expense on our 2019 convertible notes issued in March 2012, including $10.0 million of amortization of debt discount.

. Interest expense for the six-month period ended June 30, 2012 consisted of:

• $13.0 million of interest expense on our 2015 convertible notes issued in June 2010, including $7.5 million of amortization of debt discount;

• $2.9 million of interest expense on our 2028 convertible notes issued in August 2008, including $0.7 million of amortization of debt discount; and

• $8.0 million of interest expense on our 2019 convertible notes issued in March 2012, including $4.3 million of amortization of debt discount.

Interest and Other Income

Interest and other income was $0.6 million for the three-month period ended June 30, 2013 and $6.2 million for the three-month period ended June 30, 2012. Interest and other income was $0.6 million for the six-month period ended June 30, 2013 and $10.1 million for the six-month period ended June 30, 2012. Other income for the three-month period ended June 30, 2013 includes interest income of $0.6 million. Other income for the six-month period ended June 30, 2013 includes $0.4 million of foreign currency exchange losses, offset by interest income of $1.0 million. Other income for the three-month period ended June 30, 2012 includes $5.7 million related to the expiration of the put option granted to the majority holder of the 2028 notes discussed above, which expired unexercised in June 2012. Other income for the six-month period ended June 30, 2012 includes $9.3 million related to the put option granted to the majority holder of the 2028 notes discussed above, which expired unexercised in June 2012.

Due to the current economic climate, we expect 2013 interest rates paid to us on our cash and cash equivalents will be equal to or lower than we experienced during 2012.

Provision for Income Tax

Income tax expense was $14.3 million and $15.0 million for the three-month periods ended June 30, 2013 and 2012, respectively. Our effective tax rate for the three-month periods ended June 30, 2013 and 2012 were 40.5% and 42.7%, respectively. Income tax expense was $25.8 million and $24.7 million for the six-month periods ended June 30, 2013 and 2012, respectively. Our effective tax rate for the six-month periods ended June 30, 2013 and 2012 were 37.3% and 44.6%, respectively. The decrease in our effective tax rate during the three-month and six-month periods ended June 30, 2013, as compared to the same periods June 30, 2012, is due primarily to the reinstatement of the federal research and development credit during 2013 and the non-deductible loss on

28

extinguishment of debt which occurred during 2012. Our effective rate for the period ended June 30, 2013 differs from the statutory federal income tax rate of 35% primarily due to state income taxes, federal research and development credits, and expenses and losses which are non-deductible for federal and state income tax purposes. The Company’s effective tax rate could be materially impacted due to changes to the Company’s net unrecognized tax benefits that may be effectively settled within the next 12 months. The results and timing of the settlements is highly uncertain and the Company is unable to estimate the range of the possible changes to the balance of unrecognized tax benefits at this time.

Net Income

Net income was $21.0 million for the three-month period ended June 30, 2013, compared to $20.1 million for the three-month period ended June 30, 2012. Net income was $43.4 million for the six-month period ended June 30, 2013, compared to $30.1 million for the six-month period ended June 30, 2012.

Liquidity and Capital Resources

From inception until first achieving profitability in the third quarter of 2004, we financed product development, operations and capital expenditures primarily from public and private sales of equity securities and from funding arrangements with collaborators. Since launching Colazal in January 2001, net product revenue has been a growing source of cash. In August 2008 we closed an offering of $60.0 million in convertible senior notes due 2028 (“2028 Notes”), with net proceeds of $57.3 million. On June 3, 2010 we closed an offering of $345.0 million in convertible senior notes due May 15, 2015 (“2015 Notes”), with net proceeds of approximately $334.2 million. On March 16, 2012 we closed an offering of $690.0 million in convertible senior notes due March 15, 2019 (“2019 Notes”), with net proceeds of approximately $668.3 million. As of June 30, 2013, we had $818.0 million in cash and cash equivalents, compared to $751.0 million as of December 31, 2012.

We believe our cash and cash equivalent balances should be sufficient to satisfy our cash requirements for the foreseeable future. At June 30, 2013, our cash and cash equivalents consisted primarily of demand deposits, certificates of deposit, overnight investments in Eurodollars and money market funds at reputable financial institutions, and did not include any auction rate securities. We have not realized any material loss in principal or liquidity in any of our investments to date. However, declines in the stock market and deterioration in the overall economy could lead to a decrease in demand for our marketed products, which could have an adverse effect on our business, financial condition and results of operations. Based on our current projections, we believe that we will continue positive cash flow from operations without requiring additional capital. However, we might seek additional debt or equity financing or both to fund our operations or acquisitions, and our actual cash needs might vary materially from those now planned because of a number of factors including: whether we acquire additional products or companies; risk associated with acquisitions; FDA and foreign regulation and regulatory processes; the status of competitive products, including potential generics in an increasingly global industry; intellectual property and related litigation risks in an increasingly global industry; product liability litigation; our success selling products; the results of research and development activities; establishment of and change in collaborative relationships; general economic conditions; and technological advances by us and other pharmaceutical companies. If we incur more debt, we might be restricted in our ability to raise additional capital and might be subject to financial and restrictive covenants. If we issue additional equity, our stockholders could suffer dilution. We might also enter into additional collaborative arrangements that could provide us with additional funding in the form of equity, debt, licensing, milestone and/or royalty payments. We might not be able to enter into such arrangements or raise any additional funds on terms favorable to us or at all.

Cash Flows

Net cash provided by operating activities was $66.0 million for the six-month period ended June 30, 2013 and was primarily attributable to our net income for the period, net of non-cash charges, offset by increases in accounts receivable, inventory and current liabilities. Net cash provided by operating activities was $31.7 million for the six-month period ended June 30, 2012 and was primarily attributable to our net income for the period, net of non-cash charges, partially offset by increases in accounts receivable and inventory.

Net cash used in investing activities was $2.8 million for the six-month period ended June 30, 2013 and was primarily due to purchases of property and equipment. Net cash used in investing activities was $4.4 million for the six-month period ended June 30, 2012 and was primarily due to purchases of property and equipment.

Net cash provided by financing activities of $4.0 million for the six-month period ended June 30, 2013 consisted primarily of the proceeds from the exercise of stock options. Net cash provided by financing activities of $395.8 million for the six-month period ended June 30, 2012 related primarily to our offering of $690.0 million in convertible senior notes, including net proceeds of $669.0 million, the receipt of $99.0 million from the sale of warrants, offset by $167.0 million for the purchase of call options, $137.2 million for the repurchase of a portion of our 2028 convertible senior notes, and $74.8 million for the repurchase of common stock.

29

Commitments

As of June 30, 2013, we had non-cancelable purchase order commitments for inventory purchases of approximately $217.3 million, which included any minimum purchase commitments under our manufacturing agreements. We anticipate significant expenditures related to our on-going sales, marketing, product launch efforts and our on-going development efforts for rifaximin, our budesonide product candidates, methylnaltrexone bromide and rifaximin EIR. To the extent we acquire rights to additional products, we will incur additional expenditures.

Our contractual commitments for non-cancelable purchase commitments of inventory, minimum lease obligations for all non-cancelable operating leases, debt and minimum capital lease obligations (including interest) as of June 30, 2013 were as follows (in thousands):

	Total		< 1 year		1-3 years		3-5 years		> 5 years
Operating leases	$	48,841	$	4,031	$	10,758	$	10,980	$	23,072
Purchase commitments		217,349		86,227		76,122		55,000		—
2028 convertible senior notes(1)		12,586		12,586		—		—		—
2015 convertible senior notes(2)		363,185		9,488		353,697		—		—
2019 convertible senior notes(3)		749,513		10,350		20,700		20,700		697,763
Capital lease obligations		49		49		—		—		—
Total	$	1,391,523	$	122,731	$	461,277	$	86,680	$	720,835

(1) Contractual interest and principal obligations related to our 2028 convertible senior notes total $12.6 million at June 30, 2013, including $12.6 million due in one year or less. If these notes had been converted at June 30, 2013 based on the closing price of our stock of $66.15 per share on that date and we chose to settle them in cash, the settlement amount would have been approximately $89.4million.

(2) Contractual interest and principal obligations related to our 2015 convertible senior notes total $363.2 million at June 30, 2013, including $9.5 million and $353.7 million due in one year or less and one to three years, respectively. If these notes had been converted at June 30, 2013 based on the closing price of our stock of $66.15 per share on that date and we chose to settle them in cash, the settlement amount would have been approximately $492.0 million.

(3) Contractual interest and principal obligations related to our 2019 convertible senior notes total $749.5 million at June 30, 2013, including $10.3 million, $20.7 million, $20.7 million and $697.8 million due in one year or less, one to three years, and three to five years, and greater than five years, respectively.

We enter into license agreements with third parties that sometimes require us to make royalty, milestone or other payments contingent upon the occurrence of certain future events linked to the successful development and commercialization of pharmaceutical products. Some of the payments are contingent upon the successful achievement of an important event in the development life cycle of these pharmaceutical products, which might or might not occur. If required by the agreements, we will make royalty payments based upon a percentage of the sales of a pharmaceutical product if regulatory approval to market this product is obtained and the product is commercialized. Because of the contingent nature of these payments, we have not attempted to predict the amount or period in which such payments would possibly be made and thus they are not included in the table of contractual obligations.

2028 Notes

On August 22, 2008 we closed an offering of $60.0 million in 2028 Notes. Net proceeds from the offering were $57.3 million. The 2028 Notes are governed by an indenture, dated as of August 22, 2008, between us and U.S. Bank National Association, as trustee. The 2028 Notes bear interest at a rate of 5.5% per year, payable semiannually in arrears on February 15 and August 15 of each year, beginning on February 15, 2009. The 2028 Notes will mature on August 15, 2028, unless previously converted or repurchased in accordance with their terms prior to such date. The 2028 Notes are senior unsecured obligations, and rank (i) equally to any of our existing and future unsecured senior debt, (ii) senior to any of our future indebtedness that is expressly subordinated to these 2028 Notes, and (iii) effectively junior to any secured indebtedness to the extent of the value of the assets securing such indebtedness. We may redeem the 2028 Notes, in whole or in part, at any time after August 15, 2013 for cash equal to the principal amount of the 2028 Notes to be redeemed, plus any accrued and unpaid interest. On August 15, 2013, August 15, 2018 and August 15, 2023 or upon the occurrence of a “fundamental change”, as defined in the Indenture, the holders may require us to repurchase all or a portion of the 2028 Notes for cash at 100% of the principal amount of the 2028 Notes being purchased, plus any accrued and unpaid interest.

In March 2012, we entered into a note repurchase agreement with the holder of a majority in principal amount of the 2028 Notes. We used a portion of the proceeds from our offering of the 2019 Notes discussed below to purchase from this holder and another holder approximately 42.1% of the 2028 Notes for an aggregate purchase price of approximately $137.2 million. In addition, for a period of 90 days after March 12, 2012, the majority holder had the option to require us to purchase at the same price its remaining 2028 Notes, which represented approximately 37.1% of the 2028 Notes. This put option expired unexercised in June 2012. In December 2012 one of the holders of the 2028 Notes converted notes with a par value of $22.3 million under the terms of the note

30

indenture, and received cash equal to the par value of the notes and interest on these notes through February 15, 2013, and 1.9 million shares of common stock.

The remaining outstanding 2028 Notes are convertible into approximately 1,351,000 shares of our common stock under certain circumstances prior to maturity at a conversion rate of 108.0847 shares per $1,000 principal amount of 2028 Notes, which represents a conversion price of approximately $9.25 per share, subject to adjustment under certain conditions. Holders of the 2028 Notes may convert their 2028 Notes at their option on any day prior to the close of business on the business day immediately preceding the maturity date of August 15, 2028 only if one or more of the following conditions is satisfied: (1) during any fiscal quarter commencing after September 30, 2008, if the last reported sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is equal to or more than 130% of the conversion price of the 2028 Notes on the last day of such preceding fiscal quarter; (2) during the five business day period following any five consecutive trading day period in which the trading price for the 2028 Notes, per $1,000 principal amount of the 2028 Notes, for each such trading day was less than 98% of the product of the last reported sale price of our common stock and the conversion rate of the 2028 Notes on such date; (3) if we enter into specified corporate transactions; or (4) upon a redemption notice. The first of these conditions was met as of June 30, 2013. The 2028 Notes will be convertible, regardless of whether any of the foregoing conditions has been satisfied, on or after March 15, 2028 at any time prior to the close of business on the business day immediately preceding the stated maturity date of August 15, 2028. Upon conversion, we will pay cash, shares of our common stock or a combination of cash and stock, as determined by us in our discretion.

Prior to March 2012, the 2028 Notes prohibited us from incurring any debt other than “permitted debt,” as defined in the Indenture, except that we may incur debt in certain circumstances, including meeting a consolidated leverage ratio test and a consolidated fixed charge coverage ratio test. The 2015 Notes described below were “permitted debt” under the Indenture. In March 2012, the Company and holders of a majority in outstanding principal amount of the 2028 Notes amended the indenture to delete this prohibition.

2015 Notes

On June 3, 2010 we closed an offering of $345.0 million in 2015 Notes. Net proceeds from the offering were $334.2 million. The 2015 Notes are governed by an indenture, dated as of June 3, 2010, between us and U.S. Bank National Association, as trustee. The 2015 Notes bear interest at a rate of 2.75% per year, payable semiannually in arrears on May 15 and November 15 of each year, beginning on November 15, 2010. The 2015 Notes will mature on May 15, 2015, unless previously converted or repurchased in accordance with their terms prior to such date. The 2015 Notes are senior unsecured obligations, and rank (i) equally to any of our existing and future unsecured senior debt, (ii) senior to any of our future indebtedness that is expressly subordinated to these 2015 Notes, and (iii) effectively junior to any secured indebtedness to the extent of the value of the assets securing such indebtedness.

The 2015 Notes are convertible into approximately 7,439,000 shares of our common stock under certain circumstances prior to maturity at a conversion rate of 21.5592 shares per $1,000 principal amount of 2015 Notes, which represents a conversion price of approximately $46.38 per share, subject to adjustment under certain conditions. Holders may convert their 2015 Notes at their option on any day prior to the close of business on the business day immediately preceding the maturity date of May 15, 2015 only if one or more of the following conditions is satisfied: (1) during any fiscal quarter commencing after June 30, 2010, if the last reported sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is equal to or more than 130% of the conversion price of the 2015 Notes on the last day of such preceding fiscal quarter; (2) during the five business day period following any five consecutive trading day period in which the trading price for the 2015 Notes, per $1,000 principal amount of the 2015 Notes, for each such trading day was less than 98% of the product of the last reported sale price of our common stock and the conversion rate of the 2015 Notes on such date; or (3) if we enter into specified corporate transactions. The first of these conditions had been met as of June 30, 2013. The 2015 Notes will be convertible, regardless of whether any of the foregoing conditions have been satisfied, on or after January 13, 2015 at any time prior to the close of business on the second scheduled trading day immediately preceding the stated maturity date of May 15, 2015. Upon conversion, we may pay cash, shares of our common stock or a combination of cash and stock, as determined by us at our discretion.

In connection with the issuance of the 2015 Notes, we entered into capped call transactions covering approximately 7,439,000 shares of our common stock. The capped call transactions have a strike price of $46.38 and a cap price of $62.44, and are exercisable when and if the 2015 Notes are converted. If upon conversion of the 2015 Notes, the price of our common stock is above the strike price of the capped calls, the counterparties will deliver shares of our common stock and/or cash with an aggregate value approximately equal to the difference between the price of our common stock at the conversion date (as defined, with a maximum price for purposes of this calculation equal to the cap price) and the strike price, multiplied by the number of shares of our common stock related to the capped call transactions being exercised. We paid $44.3 million for these capped calls, and charged that amount to additional paid-in capital.

31

2019 Notes

On March 16, 2012 we closed an offering of $690.0 million in 2019 Notes. Net proceeds from the offering were approximately $668.3 million. The 2015 Notes are governed by an indenture, dated as of March 16, 2012 between the Company and U.S. Bank National Association, as trustee. The 2019 Notes bear interest at a rate of 1.50% per year, payable semiannually in arrears on March 15 and September 15 of each year, beginning on September 15, 2012. The 2019 Notes will mature on March 15, 2019, unless earlier converted or repurchased in accordance with their terms prior to such date. The 2019 Notes are senior unsecured obligations, and rank (i) equally to any of our existing and future unsecured senior debt, (ii) senior to any of our future indebtedness that is expressly subordinated to them, and (iii) effectively junior to any secured indebtedness to the extent of the value of the assets securing such indebtedness.

The 2019 Notes are convertible into approximately 10,484,000 shares of our common stock under certain circumstances prior to maturity at a conversion rate of 15.1947 shares per $1,000 principal amount of 2019 Notes, which represents a conversion price of approximately $65.81 per share, subject to adjustment under certain conditions. Holders may convert their 2019 Notes at their option on any day prior to the close of business on the business day immediately preceding the maturity date of March 15, 2019 only if one or more of the following conditions is satisfied: (1) during any fiscal quarter commencing after June 30, 2012, if the last reported sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is equal to or more than 130% of the conversion price of the 2019 Notes on the last day of such preceding fiscal quarter; (2) during the five business day period following any five consecutive trading day period in which the trading price for the 2019 Notes, per $1,000 principal amount of the 2019 Notes, for each such trading day was less than 98% of the product of the last reported sale price of our common stock and the conversion rate of the 2019 Notes on such date; or (3) if we enter into specified corporate transactions. None of these conditions had been met as of June 30, 2013. The 2019 Notes will be convertible, regardless of whether any of the foregoing conditions have been satisfied, on or after November 9, 2018 at any time prior to the close of business on the second scheduled trading day immediately preceding the stated maturity date of March 15, 2019. Upon conversion, we may pay cash, shares of our common stock or a combination of cash and stock, as determined by us at our discretion.

In connection with the issuance of the 2019 Notes, we entered into convertible bond hedge transactions with certain counterparties covering approximately 10,484,000 shares of our common stock. The convertible bond hedge transactions have a strike price of $65.81 and are exercisable when and if the 2019 Notes are converted. If upon conversion of the 2019 Notes, the price of our common stock is above the strike price of the convertible bond hedge transactions, the counterparties will deliver shares of our common stock and/or cash with an aggregate value approximately equal to the difference between the price of our common stock at the conversion date and the strike price, multiplied by the number of shares of our common stock related to the convertible bond hedge transaction being exercised. We paid $167.0 million for these convertible bond hedge transactions and charged this to additional paid-in capital.

Simultaneously with entering into the convertible bond hedge transactions, we entered into privately negotiated warrant transactions whereby we sold the counterparties to these transactions warrants to acquire, subject to customary adjustments, approximately 10,484,000 shares of our common stock at a strike price of $85.31 per share, also subject to adjustment. We received $99.0 million for these warrants and credited this amount to additional paid-in capital.

Cautionary Statement

We operate in a highly competitive environment that involves a number of risks, some of which are beyond our control. The following statement highlights some of these risks. For more detail, see “Part II. Item 1A . Risk Factors” below.

Statements contained in this Form 10-Q that are not historical facts are or might constitute forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Although we believe the expectations reflected in such forward-looking statements are based on reasonable assumptions, our expectations might not be attained. Forward-looking statements involve known and unknown risks that could cause actual results to differ materially from expected results. Factors that could cause actual results to differ materially from our expectations expressed in the report include, among others: the high cost and uncertainty of the research, clinical trials and other development activities involving pharmaceutical products; the unpredictability of the duration and results of regulatory review of New Drug Applications and Investigational New Drug Applications; intense competition, including from generics in an increasingly global market; the possible impairment of, or inability to obtain intellectual property rights and the costs of obtaining such rights from third parties in an increasingly global market; our dependence on our first nine pharmaceutical products, particularly Xifaxan, and the uncertainty of market acceptance of our products; general economic conditions; our need to maintain profitability; the uncertainty of obtaining, and our dependence on, third parties to manufacture and sell our products; and results of current and any future litigation and investigations; and other risk factors detailed from time to time herein and in our other SEC filings.

32

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our purchases of raw materials and finished goods are denominated primarily in U.S. dollars and purchases denominated in currencies other than the U.S. dollar are insignificant. Additionally, our net assets denominated in currencies other than the U.S. dollar are insignificant and have not historically exposed us to material risk associated with fluctuations in currency rates. Given these facts, we have not considered it necessary to use foreign currency contracts or other derivative instruments to manage changes in currency rates. However, these circumstances might change.

We have outstanding $12.5 million of 5.5% convertible senior notes due 2028, $345.0 million of 2.75% convertible senior notes due 2015 and $690.0 million of 1.5% convertible senior notes due 2019. The interest rates on these notes are fixed and therefore they do not expose us to risk related to rising interest rates.

In connection with the June 2010 offering of the 2015 Notes, we paid $44.3 million to purchase capped call options covering approximately 7,439,000 shares of our common stock. If the per share price of our common stock remains below $46.38, these call options will be worthless. If the per share price of our common stock exceeds $62.44, then to the extent of the excess, these call options will not provide us protection against dilution from conversion of the 2015 Notes.

In connection with the March 2012 offering of the 2019 Notes, we paid $167.0 million to purchase convertible bond hedge transactions covering approximately 10,484,000 shares of our common stock. If the per share price of our common stock remains below $65.81, these call options will be worthless. Simultaneously with entering into the convertible bond hedge transactions, we sold warrants to acquire, subject to customary adjustments, approximately 10,484,000 shares of our common stock at a strike price of $85.31 per share, also subject to adjustment. If the per share price of our common stock exceeds $85.31, then to the extent of the excess, these warrants will counter any benefit of the convertible bond hedges we purchased.

Item 4. Controls and Procedures

Disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) are designed only to provide reasonable assurance that information to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and accumulated and communicated to the issuer’s management, including its principal financial officer, or persons performing similar functions, as appropriate to allow timely decision regarding required disclosure. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and Executive VP, Finance and Administration and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, our President and Chief Executive Officer and Executive VP, Finance and Administration and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to provide the reasonable assurance discussed above.

There was no change in our internal control over financial reporting in the quarter ended June 30, 2013 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

33

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we are party to various legal proceedings or claims, either asserted or unasserted, which arise in the ordinary course of business. Management has reviewed pending legal matters and believes that the resolution of such matters will not have a significant adverse effect on our financial condition or results of operations, except as otherwise discussed below.

We are currently and might continue to be subject to product liability claims that arise through the testing, manufacturing, marketing and sale of our products, including a number of claims relating to OsmoPrep, Visicol and Metozolv ODT in connection with their respective “box” label warning. We are vigorously defending these claims and intend to continue to do so. During the fourth quarter of 2011 we recorded a $3.5 million reserve, which is our estimate of the settlements of the remaining claims we are aware of, after being notified by our insurer that settlement of certain OsmoPrep and Visicol lawsuits exceeded the limits of the policies related to these claims. However, the eventual settlement of these claims could exceed this estimate, and we might receive additional claims we are not currently aware of.

On May 5, 2011, Napo Pharmaceuticals, Inc. filed a lawsuit against us in the Supreme Court of the State of New York, County of New York, alleging that we had engaged in fraudulent conduct, breached our Collaboration Agreement with Napo dated December 9, 2008, and breached our duty of good faith and fair dealing. Napo also sought a declaratory judgment that Napo had the right to terminate the Collaboration Agreement and sought unspecified damages in excess of $150 million. On or about December 28, 2011, Napo filed an Amended Complaint seeking an unspecified amount of damages for alleged breaches of the Collaboration Agreement by the Company and replacing Napo’s original Complaint. Napo’s Amended Complaint no longer seeks a declaratory judgment that Napo has the right to terminate the Collaboration Agreement and removed the need for the Court to rule on the Company’s motion to dismiss the original Complaint. We believe that Napo’s allegations continue to be without merit and their lawsuit baseless. We filed an Answer to the Amended Complaint and Counterclaims on or about January 17, 2012, and are vigorously defending against the lawsuit. Discovery concluded earlier this year, and, on May 31, 2013 we filed a motion for partial summary judgment. The court is expected to hear oral arguments on the motion in August 2013, and issue its ruling some time thereafter. A trial date for the case has not been set. On December 31, 2012 the FDA approved crofelemer for commercialization. We are moving forward with our commercialization plan for crofelemer in accordance with the existing Collaboration Agreement.

On September 7, 2012, we and Dr. Falk Pharma filed a patent infringement complaint against Lupin Ltd. and Lupin Pharmaceuticals, Inc. in the U.S. District Court for the District of Delaware. The Complaint alleges infringement of U. S. Patent No. 6,551,620, or the 620 patent, based on Lupin’s filing of an Abbreviated New Drug Application, or ANDA, seeking approval to market and sell a generic version of Apriso before the expiration of the 620 patent. The filing of this suit within the 45 day response period provided by the Hatch Waxman Act imposes an automatic 30 month stay of approval of Lupin’s ANDA. On March 4, 2013, we and Dr. Falk Pharma filed an amended complaint to also enforce newly issued U.S. Patent No. 8,337,886 in the pending suit. On July 30, 2013 the USPTO issued US Patent No. 8,496,965, which protects the Apriso product. The Company and Dr. Falk Pharma plan to enforce this newly issued patent against Lupin. Discovery is ongoing. We continue to evaluate our intellectual property protecting Apriso, in which we have full confidence. We intend to vigorously enforce its intellectual property rights.

On February 1, 2013, our wholly owned subsidiary Salix Pharmaceuticals, Inc. received a subpoena from the U.S. Attorney’s Office for the Southern District of New York requesting documents regarding our sales and promotional practices for Xifaxan^® (rifaximin), Relistor^® (methyinaltrexone bromide) and Apriso^® (mesalamine). The Company is in the process of responding to the subpoena and intends to cooperate fully with the subpoena and related government investigation. Currently, we cannot predict or determine the timing or outcome of this inquiry or its impact on financial condition or results of operations.

Item 1A. Risk Factors

This report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed in this report. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this report and in any documents incorporated in this report by reference.

If any of the following risks, or other risks not presently known to us or that we currently believe to not be significant, develop into actual events, then our business, financial condition, results of operations or prospects could be materially adversely affected. If that happens, the market price of our common stock could decline, and stockholders might lose all or part of their investment.

Future sales of Xifaxan and our other marketed products might be less than expected.

We currently actively market and sell seven primary products. We expect Xifaxan, which was launched in mid-2004 for the treatment of traveler’s diarrhea, and approved and launched in March 2010 for the treatment of hepatic encephalopathy, or HE, to continue to be our most significant source of revenue in the future. If sales of our marketed products decline or if we experience

34

product returns significantly in excess of estimated amounts recorded, particularly with respect to Xifaxan, it would have a material adverse effect on our business, financial condition and results of operations.

The degree of market acceptance of our products among physicians, patients, healthcare payors and the medical community will depend upon a number of factors including:

• the timing of regulatory approvals and product launches by us or competitors, and including any generic or over-the-counter competitors;

• perceptions by physicians and other members of the healthcare community regarding the safety and efficacy of the products;

• price increases, and the price of our products relative to other drugs or competing treatments;

• patient and physician demand;

• adverse side effects or unfavorable publicity concerning our products or other drugs in our class;

• the results of product development efforts for new indications;

• the scope and timing of additional marketing approvals and favorable reimbursement programs for expanded uses;

• availability of sufficient commercial quantities of the products; and

• our success in getting other companies to distribute our products outside of the U.S. gastroenterology, hepatology and colorectal surgery markets.

Regulatory approval of our product candidates is time-consuming, expensive and uncertain, and could result in unexpectedly high expenses and delay our ability to sell our products.

Development of our products is subject to extensive regulation by governmental authorities in the United States and other countries. In early 2008, the FDA announced that because of its large workload it might not meet its target dates to respond to NDA submissions, and since then we have experienced delays in FDA review of Metozolv, balsalazide tablets, crofelemer, rifaximin for HE, rifaximin for IBS and Relistor for chronic pain. This regulation and workload could require us to incur significant unexpected expenses or delay or limit our ability to sell our product candidates, including specifically rifaximin for irritable bowel syndrome, or IBS. In August 2010, the FDA accepted our NDA for rifaximin for IBS, and gave us an action date of December 7, 2010. In October 2010 the FDA informed us they were extending the action date by three months to provide for a full review and extended our action date to March 7, 2011. We received a Complete Response Letter, or CRL, on March 7, 2011. The FDA issues a CRL to indicate that the review cycle for an application is complete and that the application is not ready for approval. The FDA deems that the Xifaxan 550 mg sNDA is not ready for approval, primarily due to a newly expressed need for retreatment information. We initiated enrollment in a retreatment trial in the first quarter of 2012, but there is no assurance that the FDA will approve rifaximin for IBS in a timely manner, or at all. On July 27, 2012, the FDA issued a CRL following the FDA’s review of a Supplemental New Drug Application for Relistor injection for subcutaneous use for the treatment of opioid-induced constipation in adult patients with chronic, non-cancer pain. The CRL requests additional clinical data. In October 2012 Salix and Progenics held an End-of-Review meeting with the Division of Gastroenterology and Inborn Errors Products to better understand the contents of the CRL. Based on the results of this meeting, we believe we might terminate our development program for methylnaltrexone bromide injection for subcutaneous use for the treatment of OIC in chronic non-cancer pain. We are currently evaluating the oral OIC development program and currently believe we will continue this program. However, additional information and additional guidance from the FDA could result in the termination of the oral OIC development program. There is no assurance the FDA will approve Relistor injection for oral use for the treatment of opioid-induced constipation in adult patients with chronic, non-cancer pain in a timely manner, or at all.

Our clinical studies might be delayed or halted, or additional studies might be required, for various reasons, including:

• the drug is not effective;

• patients experience severe side effects during treatment;

• patients do not enroll in the studies at the rate expected, as was the case with our Xifaxan Phase 3 trial in Thailand for the prevention of travelers’ diarrhea, and might be the case with our Xifaxan irritable bowel syndrome retreatment study;

• drug supplies are not sufficient to treat the patients in the studies; or

• we decide to modify the drug during testing.

If regulatory approval of any product is granted, it will be limited to those indications for which the product has been shown to be safe and effective, as demonstrated to the FDA’s satisfaction through clinical studies. For example, rifaximin has been approved for treatment of travelers’ diarrhea and HE, but we are developing rifaximin for IBS and other indications. The FDA might not ever approve any of our compounds in the indications we are pursuing, which would mean we cannot market these compounds for use in these indications.

35

Regulatory approvals, even if granted, might entail ongoing requirements or restrictions on marketing. These requirements or restrictions, or inquiries into our marketing practices, could increase our expenses and limit revenue.

Regulatory approvals might entail ongoing requirements for post-marketing studies or limit how or to whom we can sell our products. Even if we obtain regulatory approvals, labeling and promotional activities are subject to continual scrutiny by the FDA and other federal and state authorities. For example, in 2008 the FDA required us to put a “black box” warning on the OsmoPrep and Visicol labels regarding potential kidney damage that could result from their use, and a “black box” warning for Metozolv regarding tardive dyskensia which could result from its use. We believe these warnings contributed to reduced sales of those products, and they could limit future sales of those products.

In addition, we periodically receive inquiries from authorities, including specifically the Office of Prescription Drug Promotion of the FDA, or OPDP, formerly known as the Division of Drug Marketing, Advertising, and Communications of the FDA, or DDMAC, regarding compliance with marketing and other regulations. Responding to inquiries from authorities can be costly and divert the time and attention of our senior management away from our business operations and result in increased legal expenses. On February 1, 2013, our wholly owned subsidiary Salix Pharmaceuticals, Inc. received a subpoena from the U.S. Attorney’s Office for the Southern District of New York requesting documents regarding our sales and promotional practices for Xifaxan^® (rifaximin), Relistor^® (methyinaltrexone bromide) and Apriso^® (mesalamine). The Company is in the process of responding to the subpoena and intends to cooperate fully with the subpoena and related government investigation, which has and will continue to increase our legal expenses, and might require management time and attention. Currently, we cannot predict or determine the timing or outcome of this inquiry or its impact on financial condition or results of operations. The laws and regulations regarding off-label promotion and the authorities’ interpretation of them might increase our expenses, impair our ability to effectively market our products, and limit our revenue.

Our intellectual property rights might not afford us with meaningful protection.

The intellectual property rights protecting our products might not afford us with meaningful protection from generic and other competition. In addition, because our strategy is to in-license or acquire pharmaceutical products which typically have been discovered and initially researched by others, future products might have limited or no remaining patent protection due to the time elapsed since their discovery. Competitors could also design around any of our intellectual property or otherwise design competitive products that do not infringe our intellectual property.

Any litigation in which we become involved to enforce intellectual property rights could result in substantial cost to us. In addition, claims by others that we infringe their intellectual property could be costly. Our patent or other proprietary rights related to our products might conflict with the current or future intellectual property rights of others. Litigation or patent interference proceedings, either of which could result in substantial cost to us, might be necessary to defend any patents to which we have rights and our other proprietary rights or to determine the scope and validity of other parties’ proprietary rights. The defense of patent and intellectual property claims is both costly and time-consuming, even if the outcome is favorable. Any adverse outcome could subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties, or require us to cease selling one or more of our products. We might not be able to obtain a license to any third-party technology that we require to conduct our business, or, if obtainable, that technology might not be available at a reasonable cost.

Upon patent expiration, our drugs could be subject to generic competition, which could negatively affect our pricing and sales volume. As previously disclosed, this has already happened to Colazal, which had been our largest selling drug prior to 2008.

The patents for the rifaximin composition of matter (also covering a process of making rifaximin and using rifaximin to treat gastrointestinal infectious diseases) expired in May 2001 in the United States and Canada. Rifaximin was a new chemical entity and was granted a five-year new chemical exclusivity by the FDA when it was approved in May 2004. Rifaximin, therefore, had data exclusivity to May 2009. Rifaximin 550mg, which is approved for the reduction in risk of HE recurrence in patients greater than 18 years of age was granted orphan exclusivity through March 2017. Patents covering several physical states, or polymorphic forms, of rifaximin that provide protection for all indications currently marketed and being assessed are listed below in the table. Alfa Wasserman S.p.a., the owner of the indicated patents, has licensed the rights to Salix in the United States. In July 2006, Salix entered into an agreement with Cedars-Sinai Medical Center, or CSMC, for the right to use its patent and patent applications relating to methods of diagnosis and treating irritable bowel syndrome and other disorders caused by small intestinal bacterial overgrowth. The CSMC agreement provides Salix the right to use the patents listed below as well as other members of the patent family indicated as licensed from CSMC. On April 19, 2011, the USPTO issued the method of treatment patent U.S. 7,928,115 to Salix directed to the use of rifaximin in Travelers’ Diarrhea, which should provide protection until July 2029. In November 2012, the USPTO issued an additional patent coving methods of using rifaximin to treat IBS, which should provide protection until July 2029.

36

U.S. Patent No.		Issue Date		Expiration		Subject
	7,045,620*		May-06		Jun-24	Composition of matter and process patent covering several physical states of rifaximin
	7,612,199*		Nov-09		Jun-24	Covers several physical states, or polymorphous forms of rifaximin
	7,906,542*		May-11		Jun-25	Covers several physical states, or polymorphous forms of rifaximin in pharmaceutical formulations
	7,902,206*		Mar-11		Jun-24	Covers several physical states, or polymorphous forms of rifaximin
	7,452,857**		Nov-08		Aug-19	Use of rifaximin for treating irritable bowel syndrome
	7,605,240**		Oct-09		Aug-19	Treatment of bloating caused by small intestinal bacterial overgrowth associated with irritable bowel syndrome
	7,718,608**		May-10		Aug-19	Use of rifaximin for treating irritable bowel syndrome
	7,935,799**		May-11		Aug-19	Use of rifaximin for treating diarrhea
	7,928,115		Apr-11		Jul-29	Use of rifaximin for treating travelers’ diarrhea
	8,158,781*		Apr-12		Jun-24	Covers physical states, or polymorphous forms of rifaximin
	8,158,644*		Apr-12		Jun-24	Covers physical states, or polymorphous forms of rifaximin
	8,193,196*		Jun-12		Sept-27	Covers physical states, or polymorphous forms of rifaximin
	8,309,569		Nov-12		Jul-29	Use of rifaximin for treating IBS

* Licensed from Alfa Wasserman S.p.a.

** Licensed from Cedars-Sinai Medical Center

The patent for the treatment of the intestinal tract with Apriso, the granulated mesalamine product, provides patent coverage to 2018. In June 2009, U.S. Patent No. 7,547,451 issued, which relates to methods of producing Apriso and provides further protection. In September 2012 the FDA posted draft guidance on mesalamine. The guidance recommends conducting fed and fasted pK studies measuring mesalamine in the plasma of normal healthy subjects as well as an in vitro comparative dissolution study. On September 7, 2012, we and Dr. Falk Pharma filed a patent infringement complaint against Lupin Ltd. and Lupin Pharmaceuticals, Inc. in the District of Delaware. The Complaint alleges infringement of U. S. Patent No. 6,551,620, or the 620 patent, based on Lupin’s filing of an Abbreviated New Drug Application, or ANDA, seeking approval to market and sell a generic version of Apriso before the expiration of the 620 patent. The filing of this suit within the 45 day response period provided by the Hatch Waxman Act imposes an automatic 30 month stay of approval of Lupin’s ANDA. We continue to evaluate our intellectual property protecting Apriso in which we have full confidence. We intend to vigorously enforce its intellectual property rights. In December 2012 the USPTO issued US Patent No. 8,337,886, or the ‘886 patent, which will provide further protection for the Apriso formulation as well as methods of using Apriso until 2018. In February 2013 we received a certification letter to the ‘886 patent from Lupin. We intend to vigorously enforce our rights in the ‘886 patent. On July 30, 2013 the USPTO issued US Patent No. 8,496,965, which protects the Apriso product. The Company and Dr. Falk Pharma plan to enforce this newly issued patent against Lupin

The patent application relating to the dosage form for metoclopramide should protect the product until July 2017.

As a new chemical entity, crofelemer was granted a five-year exclusivity by the FDA when it was approved in December 2012. Crofelemer, therefore, has data exclusivity to December 2017. The patents for crofelemer, relating to enteric formulations and uses thereof should provide protection until 2018 and should be entitled to patent term restoration as a new molecular entity, but there is no assurance that patent term restoration applications will be granted.

The patent for Giazo (balsalazide 1100 mg tablets) provides patent coverage to 2018. U.S. Patent Nos. 7,452,872 and 7,625,884, which relate to the use of balsalazide tablets to increase the bioavailability provide coverage for balsalazide 1100 mg tablets until August 2026. On July 30, 2013 the USPTO issued US Patent No. 8,497,256, which provides further coverage for methods of using Giazo until June 2031.

The budesonide rectal foam product has patent coverage in the U.S. until 2015.

The patents for Lumacan including, U.S. 6,034,267 and U.S. 7,247,655 provide protection until March 2016.

Patent expiration dates listed herein, unless otherwise noted, are for U.S. patents and assume there are no patent term adjustments, extensions or other adverse events that could affect the term or scope of a patent. Dates provided herein for the expiration

37

of patent applications are merely estimates based on knowledge at this time and could be altered, for example, by terminal disclaimer or if patent term extensions or adjustments are available.

In January 2007, the USPTO issued a patent covering composition of matter and kit claims for MoviPrep. The MoviPrep patent provides coverage to September 2024. Norgine, B.V. and Norgine Europe, B.V., which we refer to collectively as Norgine, own U.S. Patent No. 7,169,381, or the ‘381 patent. The ‘381 patent is listed with the FDA as protecting our MoviPrep product. Norgine licensed MoviPrep and the ‘381 patent to the Company for commercialization in the United States. Novel filed an Abbreviated New Drug Application, or ANDA, with the FDA seeking approval to market a generic version of MoviPrep in the United States prior to the September 2024 expiration of the ‘381 patent. On May 14, 2008, we and Norgine filed a lawsuit in the United States District Court for the District of New Jersey against Novel for infringement of the ‘381 patent. Upon entry by the court on August 30, 2010 of a Consent Judgment included as an exhibit to the Settlement Agreement among the parties and Actavis, Inc., the settlement will resolve all of the parties’ outstanding claims and defenses in the lawsuit. The Consent Judgment provides that Novel’s proposed generic product, absent a license as granted to Novel under the settlement, would infringe the ‘381 patent and further provides that Novel acknowledges and agrees not to contest the validity and enforceability of the ‘381 patent. In addition to the Settlement Agreement, we have entered into a Sublicense Agreement with Norgine and Novel, as well as a Supply Agreement with Novel and Actavis and a First Amendment to License and Supply Agreement with Norgine. Under the terms of the Sublicense Agreement, we and Norgine have granted Novel a fully paid up license under the MoviPrep patents such that it is permitted to launch a generic MoviPrep product on September 24, 2018.

The patent for Visicol and OsmoPrep will expire in 2013. U.S. 7,687,075 issued 30 March 2010 and provides protection for OsmoPrep until June 2028. CDC III, LLC, owns U.S. Patent No. 5,616,346, or the ‘346 patent. The ‘346 patent is listed with the FDA as protecting our OsmoPrep product. CDC licensed OsmoPrep and the ‘346 patent to us for commercialization in the United States. In addition, we own U.S. Patent No. 7,687,075, or the ‘075 patent, protecting OsmoPrep. Novel Laboratories, Inc., filed an ANDA with the FDA seeking approval to market a generic version of OsmoPrep in the United States prior to the May 2013 expiration of the ‘346 patent and the 2028 expiration of the ‘075 patent. On September 8, 2008, we filed a lawsuit in the United States District Court for the District of New Jersey against Novel for the infringement of the ‘346 patent and seeking a declaratory judgment confirming the validity of the patent. The lawsuit also joined CDC as a party. With the entry by the court of a Consent Judgment, the settlement will resolve all of the parties’ outstanding claims and defenses in the lawsuit. The Consent Judgment provides that Novel’s proposed generic product, absent a license as granted to Novel under the Sublicense Agreement described below, would infringe the ‘346 patent and further provides that Novel acknowledges and agrees not to contest the validity and enforceability of the ‘346 patent. In connection with the settlement, we entered into: a Settlement Agreement with CDC, Novel, Actavis Inc. and the general partnership of Craig Aronchick, William H. Lipshutz and Scott H. Wright (the “General Partnership”) that was the initial licensor of the ‘346 patent to Salix; a Sublicense Agreement with CDC, the General Partnership and Novel; a Supply Agreement with Novel; and, a Second Amendment to Supply Agreement with CDC and the General Partnership. Under the terms of the Sublicense Agreement, we, CDC and the General Partnership have granted Novel a fully paid up, non-exclusive license under the OsmoPrep patents such that it is permitted to launch a generic OsmoPrep product on November 16, 2019.

Rifaximin is a new chemical entity and was granted five-year new chemical entity exclusivity by the FDA when it was approved in May 2004. Rifaximin, therefore, had data exclusivity until May 2009. Accordingly, the Office of Generic Drugs of the U.S. Food and Drug Administration, or OGD, would have been able to accept an ANDA for Xifaxan tablets on or any time subsequent to May 2008, if the applicant made certifications of patent non-infringement or invalidity. If this occurred, a Paragraph IV notification would have to be provided to us by the applicant. Although we do not possess any specific knowledge of any such filing at the current time, the expiration of data exclusivity could result in a challenge to the related intellectual property rights of Xifaxan 200mg tablets at any time in the future. In May 2008 we submitted a Citizen Petition, requesting the director of OGD impose scientifically appropriate standards for the demonstration of bioequivalence for abbreviated new drug applications citing Xifaxan as the reference listed drug. Rifaximin 550mg, which is approved for the reduction in risk of HE recurrence in patients 18 years of age and older, was granted orphan exclusivity through March 2017. Accordingly OGD would have been able to accept an ANDA for Xifaxan 550mg tablets on or any time subsequent to March 2010, if the applicant made certifications of patent non-infringement or invalidity. If this occurred, a Paragraph IV notification would have to be provided to us by the applicant. Although we do not possess any specific knowledge of any such filing at the current time, the orphan exclusivity period does not prohibit the filing of an ANDA and thus, an ANDA filing could result in a challenge to the related intellectual property rights of Xifaxan 550mg tablets at any time in the future. The OGD would be unable to finally approve an ANDA until the expiration of the orphan exclusivity in March 2017. On November 29, 2011 the FDA posted draft bioequivalence guidance for rifaximin 200mg tablets for the treatment of travelers’ diarrhea. This guidance recommends successful completion of a randomized, double blind, parallel placebo controlled clinical trial in humans with clinical endpoints in order to file an ANDA for approval of a generic rifaximin 200mg tablet for the treatment of travelers’ diarrhea. In February 2012, the FDA posted draft bioequivalence guidance for rifaximin 550 mg tablets. The draft guidance for rifaximin 550 mg tablets recommends that in addition to conducting the program outlined in the FDA posted draft guidance document for rifaximin 200 mg tablets discussed above, a single-dose, three-way crossover in-vivo study of fasting bioequivalence with pharmacokinetic endpoints in both fasting and fed states be performed in the 500mg tablets. Additionally, the guidance stipulated that the formulation

38

of the 550 mg strength should be proportionally similar to that of the 200 mg strength in order to file an ANDA for approval of a generic rifaximin 550 mg tablet for the treatment of hepatic encephalopathy.

On November 3, 2010, we received a paragraph IV notification from Novel Laboratories, Inc. stating that Novel had filed an ANDA application to seek approval to market a generic version of Metoclopramide Hydrochloride ODT, 5 mg and 10 mg. The notification letter asserted non-infringement of U.S. Patent No. 6,413,549, or the ‘549 patent. Upon examination of the relevant sections of the ANDA, we concluded that the ‘549 patent would not be enforced against Novel Laboratories. On March 15, 2001 we received a paragraph IV notification from Zydus Pharmaceuticals stating that Zydus had filed an ANDA application to seek approval to market a generic version of Metoclopramide Hydrochloride ODT, 5 mg and 10 mg. The notification letter asserted non-infringement of the ‘549 patent. Upon examination of the relevant sections of the ANDA, we concluded that the ‘549 patent would not be enforced against Zydus.

In February 2011, Salix licensed exclusive worldwide (except Japan) rights to Relistor (methylnaltrexone bromide). The Relistor subcutaneous injection product was granted five year regulatory new chemical entity exclusivity until April 24, 2013. The exclusivity prevents the FDA from approving an ANDA until April 24, 2013; however, an ANDA may be filed after April 24, 2012. The Relistor subcutaneous injection has patent protection to November 2017. In August 2012 the USPTO issued U.S. Patent No. 8,247,425 covering Relistor subcutaneous injection in a prefilled syringe. The patent provides coverage until December 2030. In April 2013 the USPTO issued U.S. Patent No. 8,420,663 covering all Relistor subcutaneous products. This patent provides protection until September 2029. There are other patents pending on the formulation, that if issued will provide protection to April 2024. Patent application for an oral version of Relistor, if issued, should provide protection to March 2031.

In December 2011, Salix acquired licensed rights to Solesta and Deflux through the acquisition of Oceana Therapeutics, Inc. Deflux and Solesta are protected by U.S. Patent No. 5,633,001, which is directed to composition and method claims and should provide protection to May 2014 and U.S. Patent No. 5,827,937, which is directed to methods of manufacturing and should provide protection to July 2015.

Because Azasan, Anusol-HC, Pepcid and Proctocort are mature products, there are no patents or data exclusivity rights available which subjects us to greater risk of generic competition for those products.

We also rely on trade secrets, proprietary know-how and technological advances, which we seek to protect, in part, through confidentiality agreements with collaborative partners, employees and consultants. These agreements might be breached and we might not have adequate remedies for any such breach. In addition, our trade secrets and proprietary know-how might otherwise become known or be independently developed by others.

Intense competition might render our products noncompetitive or obsolete.

Competition in our business is intense and characterized by extensive research efforts and rapid technological progress. Technological developments by competitors, regulatory approval for marketing competitive products, including potential generic or over-the-counter products, or superior marketing resources possessed by competitors could adversely affect the commercial potential of our products and could have a material adverse effect on our revenue and results of operations. Generic competition is an increasing risk, as we have experienced with Colazal and Pepcid, and with challenges to our bowel-cleansing products’ intellectual property noted above. We believe that there are numerous pharmaceutical and biotechnology companies, including large well-known pharmaceutical companies, as well as academic research groups throughout the world, engaged in research and development efforts with respect to pharmaceutical products targeted at gastrointestinal diseases and conditions addressed by our current and potential products. In particular, we are aware of products in research or development by competitors that address the diseases being targeted by our products. Developments by others might render our current and potential products obsolete or noncompetitive. Competitors might be able to complete the development and regulatory approval process sooner and, therefore, market their products earlier than we can.

Many of our competitors have greater financial, marketing and personnel resources and development capabilities than we do. For example, many large, well-capitalized companies already offer products in the United States and Europe that target the indications for:

• Xifaxan for HE, including lactulose (various manufacturers);

• Xifaxan for travelers’ diarrhea, including ciprofloxacin, commonly known as Cipro (Bayer AG);

• OsmoPrep and MoviPrep, including Colyte, Golytely, Halflytely, SuPrep, and Nulytely (Braintree), Trilyte (Alaven Pharmaceutical LLC) and Prepopik (Ferring Pharmaceuticals, Inc., as well as potential generics from Novel Laboratories or others;

• Apriso, including Asacol and Delzicol (Warner Chilcott), sulfasalazine (Pfizer), Dipentum (Alaven Pharmaceutical LLC), Pentasa (Shire Pharmaceuticals Group, plc), once-a-day Lialda (Shire), and three generic balsalazide capsule products;

39

• Relistor for OIC, including OTC laxatives (various manufacturers), Amitiza (Sucampo Pharmaceuticals, Inc.), and Kristalose (Cumberland);

• Solesta, including various OTC antidiarrheals, fiber, stool softeners and laxatives (various manufacturers), biofeedback, the medical device Inter Stim (Medtronic) and sphincteroplasty surgery;

• Xifaxan under development, including Lotronex^® (Nestle S.A.) and Amitiza (Sucampo Pharmaceuticals, Inc.) for IBS; and

• Metozolv ODT, including ReglanŸ (Alaven Pharmaceutical LLC), and various generics.

In addition, other products are in research or development by competitors that address the diseases and diagnostic procedures being targeted by these and our other products.

We could be exposed to significant product liability claims that could prevent or interfere with our product commercialization efforts.

We have been in the past and might continue to be subjected to product liability claims that arise through the testing, manufacturing, marketing and sale of our products. For example, we are currently and might continue to be subject to a number of product liability claims relating to OsmoPrep and Visicol in connection with their “box” label warning. We intend to defend these claims vigorously. During the fourth quarter of 2011 we settled a number of the OsmoPrep and Visicol lawsuits and were notified by our insurer that settlement of these claims exceeded the limits of the policies related to these claims. As a result, we recorded a $3.5 million reserve, which is our estimate of the costs of the remaining claims we are aware of. However, the eventual settlement of these claims could exceed this estimate, and we might receive additional claims we are not currently aware of.

We have exceeded the limits of our liability coverage related to the claims discussed above, so we are responsible for additional damages, fees and expenses, if any. We currently maintain liability coverage for both clinical trials and the commercialization of our products other than the claims discussed above, but it is possible that this coverage and any future coverage will be insufficient to satisfy any liabilities that arise. We would have to assume defense of the lawsuits and be responsible for damages, fees and expenses, if any, that are awarded against us or for amounts in excess of our product liability coverage. These claims could expose us to significant liabilities that could prevent or interfere with our product commercialization efforts. Product liability claims could require us to spend significant time and money in litigation or to pay significant damages. In the future, we might not be able to obtain adequate coverage at an acceptable cost or might be unable to obtain adequate coverage at all.

If government and other third-party payors do not provide coverage or reimburse patients for our products, our ability to derive revenues might suffer.

Our success will depend in part on the extent to which government and health administration authorities, private health insurers and other third-party payors will pay for our products. Reimbursement for newly approved healthcare products is uncertain. We acquired our first medical devices in December 2011, one of which was launched in 2011, and we are navigating the complex medical device reimbursement system. In the United States and elsewhere, third-party payors, such as Medicaid, are increasingly challenging the prices charged for medical products and services. Government and other third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement for new therapeutic products. In the United States, a number of legislative and regulatory proposals aimed at changing the healthcare system have been passed in recent years, including the Patient Protection and Affordable Care Act. Many significant changes in this legislation do not take effect until 2014.These changes to the healthcare system could increase our costs and reduce the amount we can charge for our products. In addition, an increasing emphasis on managed care in the United States has and will continue to increase pressure on pharmaceutical and medical device pricing. While we cannot predict whether legislative or regulatory proposals will be adopted or what effect those proposals or managed care efforts, including those relating to Medicaid payments, might have on our business, the announcement and/or adoption of such proposals or efforts could increase costs and reduce or eliminate profit margins, which could have a material adverse effect on our business, financial condition and results of operations. Third-party insurance coverage might not be available to patients for our products. If government and other third-party payors do not provide adequate coverage and reimbursement levels for our products, the market acceptance of these products might be reduced.

Our ability to increase revenue in the future will depend in part on our success in in-licensing or acquiring additional pharmaceutical products or medical devices.

We currently intend to in-license or acquire additional pharmaceutical products or medical devices, as we did with crofelemer and budesonide, that have been developed beyond the initial discovery phase and for which late-stage human clinical data is already available, or as we did with Relistor, Deflux and Solesta, that have already received regulatory approval. As we have grown, there are fewer of these opportunities that are large enough to have a material impact on our revenues, and we might encounter more competition from larger companies for these opportunities. These kinds of pharmaceutical products and medical devices might not be available to us on attractive terms or at all. To the extent we acquire rights to additional products, we might incur significant additional expense in connection with the development and, if approved by the FDA, marketing of these products.

40

We are dependent on third parties to supply us with products.

We rely entirely on third parties to supply us with our commercially marketed products and our products under development.

For example, the raw material used in production of the crofelemer drug substance, our anti-secretory agent that is approved for marketing in the United States under the trade name Fulyzaq for the treatment of HIV-associated diarrhea, grows in select countries in South America. Our ability to successfully obtain raw material is not within our control. Failure to obtain crofelemer drug substance, whether due to international, political or economic conditions or otherwise, could delay development, increase expenses, delay regulatory approval, or eventually prevent us from generating revenue from crofelemer, if approved, any of which could have a material adverse effect on our business. A key raw material for Relistor grows in Tasmania. Our inability to obtain this raw material, whether due to international, political or economic conditions or otherwise, could delay development, increase expenses, delay regulatory approval, or eventually prevent us from generating revenue from additional indications for Relistor, if approved, which could have a material adverse effect on our business. Likewise, interruption of supply of any of our other products, whether for clinical use or commercial use, could have a material adverse effect on our business.

We are dependent on third parties to manufacture our products.

We own no manufacturing facilities, and we have limited capabilities in manufacturing pharmaceutical products. We do not generally expect to engage directly in the manufacturing of products, but instead contract with and rely on third-party vendors, including Glenmark Pharmaceuticals, Ltd. of India, which manufactures the drug substance for Fulyzaq, for these services. A limited number of contract manufacturers exist which are capable of manufacturing our marketed products and our product candidates. We might fail to contract with the necessary manufacturers or might contract with manufacturers on terms that may not be entirely acceptable to us. For example, in April 2010 we received a complete response letter from the FDA on our NDA for balsalazide tablets. The sole issue raised in this letter concerned a deficiency of the manufacturing facility for this application, which delayed FDA approval almost two years. Given our ongoing dependence on third party vendors for supply of material for use in clinical trials and for commercial product, our manufacturing strategy presents the following risks:

• the manufacture of products might be difficult to scale up when required and result in delays, inefficiencies and poor or low yields of quality products;

• some of our contracts contain purchase commitments that require us to make minimum purchases that might exceed our needs or limit our ability to negotiate with other manufacturers, which might increase costs;

• the cost of manufacturing certain products might make them prohibitively expensive;

• delays in scale-up to commercial quantities and any change in manufacturers could delay clinical studies, regulatory submissions and commercialization of our products;

• manufacturers are subject to the FDA’s current Good Manufacturing Practices, or cGMP, regulations and similar foreign standards, and we do not have control over compliance with these regulations by the third-party manufacturers;

• if we need to change manufacturers, transfers of technical expertise would be required which would include educating the new manufacturer in the processes necessary for the production of our products, which might not be successful; and

• if we need to change manufacturers, FDA and comparable foreign regulators might require additional testing and compliance inspections prior to the new manufacturer being qualified for the production of our products.

Failure to comply with manufacturing regulation could harm us financially and could hurt our reputation.

We and our third-party manufacturers are also required to comply with the applicable cGMP regulations which include requirements relating to manufacturing, packaging, documentation, quality control, and quality assurance. Further, manufacturing facilities must be approved by the FDA before they can be used to manufacture our products. For example, in April 2010 we received a complete response letter from the FDA regarding our NDA for our balsalazide tablet. In the complete response letter there were no requests for new pre–clinical or clinical trials. The sole issue raised in this letter concerned a deficiency of the manufacturing facility for this application. The manufacturer responded to the FDA and was able to eventually resolve these deficiencies, allowing the FDA to proceed with the approval of this NDA in 2012. Our third-party manufacturers are subject to periodic FDA inspection. Manufacturing regulations can increase our expenses and delay production, either of which could reduce our margins. In addition, if we fail to comply with any of FDA’s continuing regulations, we could be subject to reputational harm and sanctions, including:

• delays, warning letters and fines;

• product recalls or seizures and injunctions on sales;

• refusal of the FDA to review pending applications;

• total or partial suspension of production;

• withdrawals of previously approved marketing applications; and

• civil penalties and criminal prosecutions.

In addition, the occurrence of manufacturing-related compliance issues could require subsequent withdrawal of the drug approval, reformulation of the drug product, additional testing or changes in labeling of the finished product.

41

Because our business and industry are highly regulated and scrutinized, any failure to follow such regulations could result in litigation or government enforcement actions that could have a material adverse effect on our business and results of operations.

Our business and industry are highly regulated and scrutinized, and subject to litigation risks, including product liability risks described above and the risk of government enforcement actions. We are subject to extensive and complex laws and regulations, including but not limited to, health care “fraud and abuse” laws, such as the federal False Claims Act, the federal Anti-Kickback Statute, other state and federal laws and regulations, and, with respect to our international operations, U.S. laws such as the Foreign Corrupt Practices Act, local laws such as the UK Bribery Act 2010 and various foreign laws and regulations. While we have developed and implemented a corporate compliance program designed to promote compliance with applicable laws and regulations, we cannot guarantee that this program will protect us from governmental investigations or other actions or lawsuits stemming from a failure or alleged failure to be in compliance with such laws or regulations. In recent years, there has been a heightened risk of governmental investigations into pharmaceutical companies’ sales and promotional practices for their products, including off-label uses, as evidenced by recent enforcement activity and/or pronouncements by the Office of Inspector General of the Department of Health and Human Services, the Department of Justice and state attorneys general. Matters underlying governmental investigations may also be the subject of private litigation. See the risk factor entitled “Regulatory approvals, even if granted, might entail ongoing requirements or restrictions on marketing. These requirements or restrictions, or inquiries into our marketing practices, could increase our expenses and limit revenue” above, and “Item 1. Legal Proceedings” for information about a pending federal government investigation concerning our sales and promotional practices for Xifaxan, Relistor and Apriso. If we are not successful in defending ourselves or asserting our rights in this investigation, or any other investigation or litigation, we could incur significant damages, fines or other penalties, which could have a material adverse effect on our business and results of operations.

We are subject to numerous environmental laws and regulations and any failure to comply with such laws and regulations could have a material adverse effect on our business and results of operations.

Our research, development and manufacturing efforts, and those of third parties that research, develop and manufacture our products and product candidates on our behalf or in collaboration with us, involve the controlled use of hazardous materials, including chemicals, viruses, bacteria and various radioactive compounds, and are therefore subject to numerous U.S. and international environmental and safety laws and regulations and to periodic inspections for possible violations of these laws and regulations. In addition, we, and our collaborators and third-party manufacturers may also become subject to laws and regulations related to climate change, including the impact of global warming. The costs of compliance with environmental and safety laws and regulations are significant, and the costs of complying with climate change laws could also be significant. Any violations, even if inadvertent or accidental, of current or future environmental, safety or climate change laws or regulations could subject us to substantial fines, penalties or environmental remediation costs, or cause us to lose permits or other authorizations to operate affected facilities, any of which could adversely affect our operations.

We are subject to complex laws and regulations governing our employees and contractors and any failure to comply with such laws and regulations could have a material adverse effect on our business and results of operations.

The laws and regulations applicable to our relationships with our employees and contractors are complex, extensive and fluid, and are subject to evolving interpretations by regulatory and judicial authorities. Failure to comply with these laws and regulations could result in significant damages, orders and/or fines and therefore could adversely affect our operations. For example, a 2010 decision by the U.S. Court of Appeals for the Second Circuit,In re Novartis Wage & Hour Litigation, in a split from an earlier decision from the U.S. Court of Appeals for the Third Circuit, held that Novartis’ pharmaceutical sales representatives were non-exempt employees under the Fair Labor Standards Act. The Second Circuit’s decision might trigger additional litigation against pharmaceutical companies, including us. An adverse result in any such litigation could result in significant damages to us and could therefore have a material adverse effect on our business and results of operations.

Failure to integrate acquired businesses into our operations successfully could adversely affect our business.

Our strategy is to identify and acquire rights to products that we believe have potential for near-term regulatory approval or are already approved, through the purchase or license of products and purchase of companies. Our integration of the operations of acquired products and businesses, including Oceana, which we acquired in December 2011 and which includes foreign employees and operations, requires significant efforts, including the coordination of information technologies, research and development, sales and marketing, operations, manufacturing and finance. These efforts result in additional expenses and involve significant amounts of management’s time. Factors that will affect the success of our acquisitions include the strength of the acquired companies’ or products’ underlying technology and ability to execute, results of clinical trials, regulatory approvals and reimbursement levels of the acquired products and related procedures, our ability to adequately fund acquired in-process research and development projects and retain key employees, and our ability to achieve synergies with our acquired companies and products, such as increasing sales of our products, achieving cost savings and effectively combining technologies to develop new products. Our failure to manage successfully and coordinate the growth of these acquisitions could have an adverse impact on our business. In addition, we cannot be certain that

42

the businesses or products we acquire will become profitable or remain so and if our acquisitions are not successful, we may record related asset impairment charges in the future.

Our results of operations might fluctuate from period to period, and a failure to meet the expectations of investors or the financial community at large could result in a decline in our stock price.

As they have in the past, our results of operations might fluctuate significantly on a quarterly and annual basis due to, among other factors:

• the timing of regulatory approvals and product launches by us or competitors, including potential generic or over-the-counter competitors;

• the level of revenue generated by commercialized products, including potential increased purchases of inventory by wholesalers in anticipation of potential price increases or introductions of new dosages or bottle sizes, and subsequent lower than expected revenue as the inventory is used;

• the timing of any up-front payments that might be required in connection with any future acquisition of product rights;

• the timing of milestone payments that might be required to our current or future licensors;

• fluctuations in our development and other costs in connection with ongoing product development programs;

• the level of marketing and other expenses required in connection with product launches and ongoing product growth;

• the timing of the acquisition and integration of businesses, assets, products and technologies; and

• general and industry-specific business and economic conditions.

We expect to be profitable and have positive cash flow during 2013, but we might need additional capital.

We expect to be profitable and have positive cash flow during 2013, and believe that our current cash and cash equivalents together with cash generated from the sale of our products will be sufficient to fund our operations for 2013 and beyond, but that might not be the case. Our future capital requirements will depend on many factors, including but not limited to:

• our business development activities, including potential acquisition of products or companies, or entry into additional collaborative arrangements;

• the results, costs and timing of our research and development activities, regulatory approvals and product launches;

• the status of competitive products, including current and potential generics;

• the cost and number of products we acquire or in-license;

• the costs and results of ongoing and any future litigation and investigations;

• any impact on us of current conditions and uncertainties in the economy generally and the financial markets;

• patient and physician demand for our products; and

• our ability to reduce our costs in the event product demand is less than expected, or regulatory approvals are delayed or more expensive than expected.

If we need additional capital, we might seek additional debt or equity financing or both to fund our operations or acquisitions. If we incur more debt, we might be restricted in our ability to raise additional capital and might be subject to financial and restrictive covenants. If we issued additional equity, our stockholders could suffer dilution. We might also enter into additional collaborative arrangements that could provide us with additional funding in the form of equity, debt, licensing, milestone and/or royalty payments. We might not be able to enter into such arrangements or raise any additional funds on terms favorable to us or at all, especially in the current economic environment. Our common stock is likely to decrease in value if the market believes that we will be required to raise additional capital.

Our stock price is volatile.

Our stock price has been extremely volatile and might continue to be, making owning our stock risky. Between January 1, 2011 and July 31, 2013, the price of a share of our common stock varied from a low of $25.64 to a high of $75.53. Our stock price increased or decreased by 5% or more on 15 days in 2011, 4 days in 2012 and 2 days in 2013 through July 31.

The securities markets have experienced significant price and volume fluctuations unrelated to the performance of particular companies, including as a result of the current credit and economic crisis. In addition, the market prices of the common stock of many publicly traded pharmaceutical and biotechnology companies have in the past been and can in the future be expected to be especially volatile. Announcements of prescription trends, technological innovations or new products by us or our competitors, generic approvals, developments or disputes concerning proprietary rights, publicity regarding actual or potential medical results relating to products under development by us or our competitors, regulatory developments in both the United States and other countries, public

43

concern as to the safety of pharmaceutical products, economic and other external factors, period-to-period fluctuations in financial results, and stock market speculation regarding any of these factors, might have a significant impact on the market price of our common stock.

Provisions in our charter documents and under Delaware law could discourage a takeover or changes in our current directors or management that stockholders consider favorable.

Provisions in our certificate of incorporation and amended and restated bylaws could have the effect of discouraging, delaying or preventing a takeover or other change of control of us or the removal of our current directors and management, even if these events could be beneficial to stockholders. These provisions, which could also limit the price that investors might be willing to pay for our common stock, include the following:

• Our stockholders may not act by written consent. As a result, a stockholder, or stockholders, controlling a majority of our common stock would not be able to take certain actions without holding a stockholders’ meeting.

• Our board of directors may issue, without stockholder approval, up to 5,000,000 shares of undesignated preferred stock. The ability to issue undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us.

• Only our board of directors has the right to elect directors to fill vacancies created by the expansion of the board of directors or the resignation, death, or removal of directors, which prevents stockholders from being able to fill vacancies on our board of directors.

• Stockholders must provide advance notice to nominate individuals for election to our board of directors or to propose matters that can be acted upon at a stockholders’ meeting. These provisions might discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of our company.

As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us.

44

Item 6. Exhibits

Exhibit Number	Description of Document	Registrant’s Form	Dated	Exhibit Number	Filed Herewith
10.68.3	Third Amendment to Rifaximin Manufacturing and Supply Agreement dated May 15, 2013 between Salix Pharmaceuticals, Inc. and Lupin Ltd.*				X
31.1	Certification by the Chief Executive Officer pursuant to Section 240.13a-14 or Section 240.15d-14 of the Securities and Exchange Act of 1934, as amended.				X
31.2	Certification by the Chief Financial Officer pursuant to Section 240.13a-14 or Section 240.15d-14 of the Securities and Exchange Act of 1934, as amended.				X
32.1	Certification by the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.				X
32.2	Certification by the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.				X
101	Financials in XBRL format				X

* The registrant has requested confidential treatment with respect to portions of this exhibit. Those portions have been omitted from the exhibit and filed separately with the U.S. Securities and Exchange Commission.

45

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.

	SALIX PHARMACEUTICALS, LTD.
Date: August 9, 2013	By:	/s/ Carolyn J. Logan
		Carolyn J. Logan
		President and
		Chief Executive Officer
Date: August 9, 2013	By:	/s/ Adam C. Derbyshire
		Adam C. Derbyshire
		Executive Vice President, Finance & Administration and
		Chief Financial Officer

46