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 I. Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2008, 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 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

• use our approximately 245-member specialty sales and marketing team focused on high-prescribing U.S. gastroenterologists, who are doctors who specialize in gastrointestinal disorders, to sell our products.

Our current products demonstrate our ability to execute this strategy. As of September 30, 2009, our products were:

• XIFAXAN®(rifaximin) Tablets 200 mg;

• MOVIPREP® (PEG 3350, Sodium Sulfate, Sodium Chloride, Potassium Chloride, Sodium Ascorbate and Ascorbic Acid for Oral Solution);

• OSMOPREP™ (sodium phosphate monobasic monohydrate, USP and sodium phosphate dibasic anhydrous, USP) Tablets;

• VISICOL®(sodium phosphate monobasic monohydrate, USP, and sodium phosphate dibasic anhydrous, USP) Tablets;

• AZASAN®Azathioprine Tablets, USP, 75/100 mg;

• ANUSOL-HC®2.5% (Hydrocortisone Cream, USP), ANUSOL-HC® 25 mg Suppository (Hydrocortisone Acetate);

• PROCTOCORT®Cream (Hydrocortisone Cream, USP) 1% and PROCTOCORT® Suppository (Hydrocortisone Acetate Rectal Suppositories) 30 mg;

• PEPCID®(famotidine) for Oral Suspension;

• Oral Suspension DIURIL® (Chlorothiazide);

• APRISO™ (mesalamine) extended-release capsules 0.375g;

• METOZOLV™ ODT (metoclopramide HCl) 5mg and 10mg orally disintegrating tablets, which we plan to begin selling in the fourth quarter of 2009; and

• COLAZAL®(balsalazide disodium) Capsules 750 mg.

We generate revenue primarily by selling our products, namely prescription drugs, 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 U.S. Food and Drug Administration, or FDA, to U.S. gastroenterologists 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. Currently, this sales force has approximately 160 sales representatives in the field and

markets 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 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. Currently, our sales and marketing staff, including our sales representatives, consists of approximately 245 people.

Because demand for our products originates with doctors, our sales force calls on high-prescribing specialists, primarily gastroenterologists, 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 used up.

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

             Compound                            Indication                    Status
Rifaximin                            Hepatic encephalopathy               NDA submitted
                                                                          June 24, 2009

Rifaximin                            Irritable bowel syndrome             Phase III

Rifaximin                            Travelers' diarrhea prevention       Phase III

Rifaximin                            C. difficile - associated diarrhea   Phase III

Crofelemer                           HIV-associated diarrhea              Phase III

Balsalazide disodium tablet          Ulcerative colitis                   Complete response
                                                                          submitted to FDA
                                                                          October 26, 2009

Critical Accounting Policies

In our Annual Report on Form 10-K for the year ended December 31, 2008, we identified our most critical accounting policies and estimates upon which our financial status depends as those relating to revenue recognition, allowance for product returns, allowance for rebates and coupons, inventory, intangible assets and goodwill, allowance for uncollectible accounts, cash and cash equivalents, and research and development expenses. We reviewed our policies and determined that those policies remained our most critical accounting policies for the nine-month period ended September 30, 2009. We did not make any changes in those policies during the quarter.

We recognize 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 seller's price to the buyer is fixed and determinable; and (d) collectibility is reasonably assured.

We recognize revenue from sales transactions where the buyer has the right to return the product at the time of sale only if (1) the seller's price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product, (3) the buyer's obligation to the seller 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 that provided by the seller, (5) the seller 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. 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.

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, 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 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.

Allowances for estimated rebates and chargebacks were $15.9 million and $5.4 million as of September 30, 2009 and 2008, respectively. The balances exclude amounts related to Colazal, which are included in the reserve discussed below. 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 continues to be appropriate. 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 in 2008, we would have recorded an adjustment to revenues of approximately $2.1 million, or 1.0%, for the year.

Allowances for product returns were $8.9 million and $6.0 million as of September 30, 2009 and 2008, 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. These balances do not include $2.6 million and $23.2 million at September 30, 2009 and 2008, respectively, reflecting our estimate of Colazal that may be returned to us under our return policy as a result of the approval of three generic balsalazide capsule products by the Office of Generic Drugs in December 2007. 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 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. A change in assumptions that resulted in a 10% change in forecasted return rates for all products other than Colazal would have resulted in a change in total product returns liability at December 31, 2008 of approximately $1.5 million and a corresponding change in 2008 net product revenue of less than 1.0%.

Colazal, our balsalazide disodium capsule, accounted for a majority of the Company's revenue prior to 2008. On December 28, 2007, the Office of Generic Drugs, or OGD, approved three generic balsalazide capsule products. As a result of these generic approvals, the Company expects the future sales of Colazal to be significantly less than historical sales of Colazal. At September 30, 2009 and 2008, respectively, $2.6 million and $23.2 million were recorded as a liability to reflect the Company's estimate of the Company's liability for Colazal that may be returned by the original purchaser in accordance with the Company's stated return policy as a result of these generic approvals. The decrease in the liability from December 31, 2008 to September 30, 2009 is a result of actual Colazal returns, rebates and chargebacks. This estimate was developed based on the following estimates:

• our estimate of the quantity and expiration dates of Colazal inventory in the distribution channel based on historical net product shipments less estimated historical prescriptions written;

• our estimate of future demand for Colazal based on the actual erosion of product demand for several comparable products that were previously genericized, and the most recent demand for Colazal prior to the generic approvals;

• the actual demand for Colazal experienced during 2008 and 2009 subsequent to the generic approvals;

• our estimate of chargeback and rebate activity based on price erosion as a result of the generic approvals; and

• other relevant factors.

Due to the subjectivity of this estimate, the Company prepares various sensitivity analyses to ensure the Company's final estimate is within a reasonable range. A change in assumptions that resulted in a 10% change in the quantity of Colazal inventory in the distribution channel would have resulted in a change in the Colazal return reserve of approximately $1.1 million and a corresponding change in 2008 net product revenue of less than 1%. A change in assumptions that resulted in a 10% change in the estimated future demand of Colazal would not have resulted in a change in the Colazal return reserve.

For the nine-month periods ended September 30, 2009 and 2008, our absolute exposure for rebates, chargebacks and product returns has grown primarily as a result of increased sales of our existing products, the approval of new products and the acquisition of products, and also as a result of the approval of generic balsalazide capsule 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 nine-month periods ended September 30, 2009 and 2008 was 9.7% and 6.5% for rebates, chargebacks and discounts and was 5.6% and 6.0% for product returns excluding the Colazal return reserve, respectively.

Results of Operations

Three-month and Nine-month Periods Ended September 30, 2009 and 2008

Revenues

The following table summarizes net product revenues for the three-month and
nine-month periods ended September 30 (in thousands):



                                                Three months ended                  Nine months ended
                                                   September 30,                      September 30,
                                               2009             2008             2009              2008

Inflammatory Bowel Disease -
Colazal/Apriso                               $ (2,379 )       $ (1,266 )       $  (1,521 )       $      79
% of net product revenues                          (3 )%            (3 )%             (1 )%             -  %
Xifaxan                                        42,668           21,373            93,027            56,132
% of net product revenues                          65 %             50 %              57 %              48 %
Purgatives - Visicol/OsmoPrep/ MoviPrep        16,638           15,531            45,806            41,506
% of net product revenues                          25 %             36 %              28 %              35 %
Other -
Anusol/Azasan/Diuril/Pepcid/Proctocort          8,731            7,234            25,354            20,480
% of net product revenues                          13 %             17 %              16 %              17 %


Net product revenues                         $ 65,658         $ 42,872         $ 162,666         $ 118,197

Net product revenues for the three-month period ended September 30, 2009 were $65.7 million, compared to $42.9 million for the corresponding three-month period in 2008, a 53% increase. The net product revenue increase for the three-month period ended September 30, 2009 compared to the three-month period ended September 30, 2008 was primarily due to:

• increased unit sales of Xifaxan;

• increased unit sales of MoviPrep;

• increased unit sales of Pepcid ; and

• price increases on our products.

These increases were partially offset by decreased unit sales of OsmoPrep and an adjustment in the reserve for Colazal returns.

Prescription growth for the three-month period ended September 30, 2009 compared to the corresponding three-month period in 2008 was 15% for Xifaxan and 11% for our purgative franchise. Prescriptions for MoviPrep increased 66% for the three-month period ended September 30, 2009 compared to prescriptions for the three-month period ended September 30, 2008. Prescriptions for OsmoPrep for the three-month period ended September 30, 2009 declined 45% compared to prescriptions for the three-month period ended September 30, 2008 due to the boxed label warning announced by the FDA on December 11, 2008.

Net product revenues for the nine-month period ended September 30, 2009 were $162.7 million, compared to $118.2 million for the corresponding nine-month period in 2008, a 38% increase. The net product revenue increase for the nine-month period ended September 30, 2009 compared to the nine-month period ended September 30, 2008 was primarily due to:

• increased unit sales of MoviPrep;

• sales of Apriso, which the FDA approved in October 2008 and we launched in February 2009;

• increased unit sales of Pepcid; and

• price increases on our products.

These increases were partially offset by decreased unit sales of OsmoPrep and an adjustment in the reserve for Colazal returns.

Prescription growth for the nine-month period ended September 30, 2009 compared to the corresponding nine-month period in 2008 was 13% for Xifaxan and 19% for our purgatives. Prescriptions for MoviPrep for the nine-month period ended September 30, 2009 increased 79% compared to prescriptions for the nine-month period ended September 30, 2008. Prescriptions for OsmoPrep for the nine-month period ended September 30, 2009 declined 37% compared to prescriptions for the nine-month period ended September 30, 2008 due to the boxed label warning announced by the FDA on December 11, 2008.

On December 28, 2007, the Office of Generic Drugs approved three generic balsalazide capsule products. As a result of these generic approvals, the Company expects the future sales of Colazal to be significantly less than historical sales of Colazal. In the fourth quarter of 2007, the Company recorded a $34.6 million reserve as a reduction of net product revenues. The balance of this reserve at September 30, 2009 and 2008 was $2.6 million and $23.2 million, respectively. This reserve represents an estimate of the Company's liability for Colazal that may be returned by the original purchaser in accordance with the Company's stated return policy as a result of these generic approvals. The decrease in the liability from December 31, 2008 to September 30, 2009 is a result of actual Colazal returns. We developed this estimate based on the following:

• our estimate of the quantity and expiration dates of Colazal inventory in the distribution channel based on historical net product shipments less estimated historical prescriptions written;

• our estimate of future demand for Colazal based on the actual erosion of product demand for several comparable products that were previously genericized, and the actual demand for Colazal experienced during 2008 and 2009 subsequent to the generic approvals;

• our estimate of chargeback and rebate activity based on actual activity during 2008 and 2009 subsequent to the generic approvals; and

• other relevant factors.

Due to the subjectivity of this estimate, the Company prepares various sensitivity analyses to ensure the Company's final estimate is within a reasonable range. A change in assumptions that resulted in a 10% change in the quantity of Colazal inventory in the distribution channel would have resulted in a change in the Colazal return reserve of approximately $1.1 million and a corresponding change in 2008 net product revenue of less than 1%. A change in assumptions that resulted in a 10% change in the estimated future demand of Colazal would not have resulted in a change in the Colazal reserve for 2008.

Costs and Expenses

Costs and expenses for the three-month period ended September 30, 2009 were $71.5 million, compared to $47.9 million for the corresponding three-month period in 2008, and $195.3 million for the nine-month period ended September 30, 2009, compared to $153.8 million for the corresponding nine-month period in 2008. Higher operating expenses in absolute terms were due primarily to increased research and development costs, general and

administrative expenses, and increased cost of products sold related to the corresponding increase in product revenue.

Cost of Products Sold

Cost of products sold for the three-month period ended September 30, 2009 was $13.2 million, compared with $7.8 million for the corresponding three-month period in 2008. Cost of products sold for the nine-month period ended September 30, 2009 was $34.5 million, compared with $22.1 million for the corresponding nine-month period in 2008. The increase in cost of products sold in absolute terms for the three-month and nine-month periods ended September 30, 2009 compared to the three-month and nine-month periods ended September 30, 2008 was primarily due to the increase in net product revenues discussed above.

Gross margin on total product revenue, excluding $2.6 million and $2.3 million in amortization of product rights and intangible assets for the three-month periods ended September 30, 2009 and 2008, respectively, was 79.9% for the three-month period ended September 30, 2009 and 81.9% for the three-month period ended September 30, 2008. Gross margin on total product revenue, excluding $7.6 million and $6.8 million in amortization of product rights and intangible assets for the nine-month periods ended September 30, 2009 and 2008, respectively, was 78.8% for the nine-month period ended September 30, 2009 and 81.3% for the nine-month period ended September 30, 2008. Lower gross margins for the three-month and nine-month periods ended September 30, 2009 compared to the corresponding periods in 2008 were primarily due to the product revenue mix in the respective periods.

Amortization of Product Rights and Intangible Assets

Amortization of product rights and intangible assets consists of amortization of the costs of license agreements, product rights and other identifiable intangible assets, which result from product and business acquisitions. The increase for the three-month and nine-month periods ended September 30, 2009 compared to the corresponding periods in 2008 is primarily a result of payments during the fourth quarter of 2008 related to the approval of Apriso, and a sales milestone payment to Norgine for MoviPrep.

Research and Development

Research and development expenses were $26.1 million for the three-month period ended September 30, 2009, compared to $14.4 million for the comparable period in 2008. The increase in research and development expenses for the three-month period ended September 30, 2009 compared to the corresponding period in 2008 was due primarily to:

• increased expenses related to the continuation of our development program for crofelemer, which we acquired from Napo in December 2008;

• increased expenses related to our development program for budesonide;

• increased expenses related to investigator initiated studies;

• a $5.0 million upfront payment in connection with our collaboration with Lupin; and

• increased headcount costs.

These increases were partially offset by:

• reduced expenses related to our development program for granulated mesalamine, or Apriso, which the FDA approved in October 2008;

• reduced expenses related to our IBS development program for rifaximin, because our Phase III trials

• reduced expenses related to our hepatic encephalopathy development program for rifaximin, because our Phase III trials were completed in mid 2009.

Research and development expenses were $69.6 million for the nine-month period ended September 30, 2009, compared to $57.3 million for the comparable period in 2008. The increase in research and development expenses for the nine-month . . .