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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2003

or

o           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)

8540 Colonnade Center Drive, Suite 501
Raleigh, North Carolina 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.

               The number of shares of the Registrant’s Common Stock outstanding as of May 12, 2003 was 21,459,904.

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SALIX PHARMACEUTICALS, LTD.

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PART I.     FINANCIAL INFORMATION
Item 1.        Condensed Consolidated Financial Statements

SALIX PHARMACEUTICALS, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. dollars, in thousands, except share amounts)

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

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SALIX PHARMACEUTICALS, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(U.S. dollars, in thousands, except per share data)

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

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SALIX PHARMACEUTICALS, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(U.S. dollars, in thousands)

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

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SALIX PHARMACEUTICALS, LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2003
(Unaudited)

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10.     Stock-Based Compensation

          The Company accounts for stock-based awards to employees under the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and has adopted the disclosure-only alternative of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”. Under APB 25, the Company generally recognizes no compensation expense with respect to such awards.

          In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, “Account for Stock Based Compensation-Transition and Disclosure and amendment of FASB Statement No. 123”.  This statement amends FASB Statement No. 123 “Accounting for Stock Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock based employee compensation.  In addition, this statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock based employee compensation and the effects of the method used on reported results (see below).  The standard is effective beginning with these financial statements and the provisions have been adopted herein. 

          Had compensation cost for the Company’s stock-based compensation plan been determined based on fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, the Company’s net loss and loss per share would have been increased to the pro forma amounts indicated below for the periods ended March 31, 2003 and 2002, respectively.

          Future pro forma net income (loss) and earnings (loss) per share results might be materially different from actual amounts reported.

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 “Cautionary Statement” included in this “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 diseases, 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 80-person sales force focused on high-prescribing U.S. gastroenterologists to sell our products. We rely on distribution relationships with third parties to sell our products outside the United States and might do so for future sales to U. S. doctors other than gastroenterologists.

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          We in-licensed rights to balsalazide disodium from Biorex Laboratories Limited in 1992.  In May 2000, we signed an agreement with Shire Pharmaceuticals Group plc under which Shire purchased from us the exclusive rights to balsalazide disodium for Austria, Belgium, Denmark, Finland, France, Germany, Iceland, Republic of Ireland, Luxembourg, Norway, The Netherlands, Switzerland, Sweden and the United Kingdom. Under the agreement, Shire agreed to pay us up to a total of approximately $24.0 million in cash and Shire stock, including approximately $12.1 million in up-front fees and up to $12.0 million upon the achievement of milestones. In accordance with our license agreement with Biorex, we shared and will continue to share a portion of the cash payments with Biorex. In addition, we delivered all of the Shire stock we received to Biorex. In May 2000, Shire paid us $9.6 million of cash and $2.5 million by way of the issuance of 160,546 Shire shares. In August 2000, Shire paid us $4.4 million in connection with the transfer to Shire of the United Kingdom product license for balsalazide.

          In July 2000, the FDA approved Colazal for marketing in the United States for the treatment of mildly to moderately active ulcerative colitis. In December 2000, we established our own 30-member, direct sales force to market Colazal in the United States. This sales force had approximately 80 members as of March 31, 2003. Although the creation of an independent sales organization involved substantial costs, we believe that the financial returns from balsalazide and rifaximin and other future products, if acquired and approved, will be more favorable to us than those from the indirect sale of product through marketing partners.

          In 1996, we in-licensed rights to our second drug, rifaximin, in the United States and Canada from Alfa Wassermann. In December 2001, we submitted an NDA to the FDA for rifaximin, as a treatment for travelers’ diarrhea. We received an approvable letter from the FDA in October 2002 and are currently working the FDA to submit an amendment to the NDA, which we currently expect to do in or prior to November 2003 and complete the approval process. We believe there are opportunities to develop rifaximin for other indications, including bacterial overgrowth in the small intestine, “c. difficile” and other forms of colitis, pouchitis, Crohn’s disease, and hepatic encephalopathy, and we intend to pursue these opportunities, as we deem appropriate. If FDA approval is obtained, we intend to market rifaximin to gastroenterologists in the United States through our own direct sales force.  We are also exploring potential co-promotion arrangements to market rifaximin to other physicians.

          In July 2002, we in-licensed exclusive development and marketing rights in the United States to a granulated formulation of mesalamine from Dr. Falk Pharma. We intend to complete the development work required to secure regulatory approval for the product in the United States.

          In March 2002, we raised approximately $57.4 million, net of offering expenses, through the public offering of 4.6 million shares of our common stock.   On December 31, 2001, we changed our place of incorporation from the British Virgin Islands to the state of Delaware.

          We have made significant investments over the past few years to develop our commercialization infrastructure.  As a result, we have sustained continuing operating losses and had an accumulated deficit of $76.1 million as of March 31, 2003.  We expect to incur operating losses during 2003 and in 2004 until product revenues reach a sufficient level to support ongoing operations.  We currently expect to become profitable in the second half of 2004 excluding any effects of a potential rifaximin launch.  We further believe that we will be profitable for the year ending December 31, 2004, if rifaximin is approved and launched in 2004 as expected.

Critical Accounting Policies

          In our Annual Report on Form 10-K for the fiscal year ended December 31, 2002, we identified our most critical accounting policies and estimates upon which our financial status depends as those relating to revenue recognition, investments, inventory, allowance for uncollectable accounts, and allowance for rebates and coupons.  We reviewed our policies and determined that those policies remain our most critical accounting policies for the three months ended March 31, 2003.  We did not make any changes in those policies during the quarter.

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Results of Operations

Three-Month Periods Ended March 31, 2003 and 2002

                  Product revenue for the three-month period ended March 31, 2003 were $11.5 million.  During the three-month period ended March 31, 2002, we recorded product revenue of $6.2 million.  Higher product revenues for the three-month period ended March 31, 2003 are the result of increased volume of U.S. sales of Colazal.

                  Costs and expenses for the three-month period ended March 31, 2003 were $17.6, compared to $11.1 million for the corresponding three-month period in 2002.  Higher operating expenses in absolute terms were due primarily to increased expenditures associated with some expansion of our commercialization infrastructure, increased clinical trial activity and the marketing campaign for Colazal.  However, as expected, as we increase revenue using the commercialization infrastructure built with significant investment over the past few years, costs and expenses in 2003 were less, as a percentage of revenue, than in 2002.  We expect this trend to continue.

                  Cost of products sold for the three-month period ended March 31, 2003 was $2.8 million, compared with $1.6 million three-month period in 2002.  Gross margins for the three-month period ended March 31, 2003 were $8.8 million, compared to $4.6 million for the corresponding three-month period of 2002.  Gross margins were 76% for the three-month period ended March 31, 2003.

                  License fees and costs related to collaborative agreements for the three-month periods ended March 31, 2002 and 2003 were constant at $31,000. 

                  Research and development expenses were $5.2 million for the three-month period ended March 31, 2003, compared to $2.5 million for the comparable period in 2002.  Our current major research and development project is rifaximin.  The increase in research and development expenses for the three-month period ended March 31, 2003 was due primarily to costs associated with maintaining the NDA and initiating a study to support the NDA for rifaximin as a treatment for travelers’ diarrhea, as well as the completion of a multi-center study for rifaximin as a treatment for hepatic encephalopathy and the single-center study for rifaximin as a treatment for Crohn’s disease.  To date, we have incurred research and development expenditures of approximately $16.3 million for balsalazide and $17.8 million for rifaximin.  Due to the risks and uncertainties of the drug development and regulatory approval process, research and development expenditures are difficult to forecast and subject to unexpected increases.  We expect research and development costs to continue to increase in absolute terms as we pursue additional indications for balsalazide and rifaximin, pursue development of the mesalamine pellets product, and if and when we acquire new products.

                  Selling, general and administrative expenses were $9.6 million for the three-month period ended March 31, 2003, compared to $7.0 million in the corresponding three-month period in 2002.  This increase was primarily due to some expansion of our commercialization infrastructure and the marketing campaign for Colazal.  Selling, general, and administrative expenses for the next quarter or two are likely to increase because of the hostile tender offer and related proxy contest by Axcan Pharma, Inc.

                  Interest and other income (expense) was $0.6 million for the three-month period ended March 31, 2003, compared to $0.1 million in the corresponding three-month period in 2002.  Increased interest and other income (expense) for the three-month period ended March 31, 2003, compared to the same prior year periods, was mainly attributable to larger average cash and investment balances resulting from the completion of a public offering in March 2002, as well as income related to a co-promotion agreement with PBM Pharmaceuticals.

                  We experienced net losses of $5.5 million for the three-month period ended March 31, 2003, compared with net losses of $4.7 million in the corresponding three-month period in the prior year. 

Liquidity and Capital Resources

                  Since inception, we have financed product development, operations and capital expenditures primarily from funding arrangements with collaborative partners and from public and private sales of equity securities.  As of

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March 31, 2003, we had approximately $47.0 million in cash, cash equivalents and investments, compared to $55.7 million as of December 31, 2002.

                  Cash used in our operations was $8.8 million for the three-month period ended March 31, 2003, compared with $6.2 million in the corresponding three-month period in 2002.  Negative operating cash flows during these periods were caused primarily by operating losses. Our capital expenditures were $48,000 for the three-month period ended March 31, 2003, compared with $0.2 million in the corresponding three-month period in 2002, with the expenditures primarily attributable to the purchase of office furniture and equipment.

                  To date, we have not experienced any material accounts receivable collection issues.  However, based on a review of specific customer balances, industry experience and the current economic environment, we currently reserve 1% of the outstanding accounts receivable balance as an allowance for uncollectable accounts, which at March 31, 2003 was approximately $77,000. 

                  During the third quarter of 2002, we restructured our working capital line of credit.  We entered into a $7.0 million dollar line of credit, with borrowing capacity of up to 75% of our eligible accounts receivable under 90 days old from the date of invoice.  We had no outstanding balance under this line as of March 31, 2003.  As of March 31, 2003, we had no long-term debt outstanding.

                  As of March 31, 2003, we had non-cancelable purchase order commitments for inventory purchases of approximately $10.6 million over 10 months.  We anticipate significant expenditures in 2003 related to our continued sales, marketing, product launch and development efforts associated with Colazal, rifaximin and the pellet form of mesalamine.  To the extent we acquire rights to additional products, we will incur additional expenditures.

                  We have sustained continuing operating losses and had an accumulated deficit of $76.1 million as of March 31, 2003. We expect to incur operating losses in 2003 and into 2004 until product revenues reach a sufficient level to support ongoing operations.  We believe our cash, cash equivalent and investments balances at March 31, 2003 should be sufficient to satisfy our cash requirements for the foreseeable future. However, our actual cash needs might vary materially from those now planned because of a number of factors, including our success in selling products, the results of research and development activities, FDA and foreign regulatory processes, establishment of and change in relationships with strategic partners, technological advances by us and other pharmaceutical companies, the terms of our collaborative arrangements with strategic corporate partners, the status of competitive products and whether we acquire rights to additional products.   Defending against the hostile tender offer launched in April 10, 2003 and the related proxy contest by Axcan Pharma, Inc. will also consume cash that we did not plan to spend.  We might seek additional debt or equity financing or both to fund our operations. If we increased our debt levels, 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 with corporate partners 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.

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.

                  Statements contained in this From 10-Q which 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, we can give no assurance that our expectations will 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 unpredictability of the duration and results of regulatory review of New Drug Applications and Investigational New Drug Applications; our dependence on our first three pharmaceutical products, balsalazide, rifaximin and granulated mesalamine and the uncertainty of market acceptance of those products; the high cost and uncertainty of the research, clinical trials and other development activities involving pharmaceutical products; our limited sales and

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marketing experience; the uncertainty of obtaining, and our dependence on, third parties to manufacture and sell our products; intense competition; the possible impairment of, or inability to obtain, intellectual property rights and the costs of obtaining such rights from third parties; and results of future litigation and other risk factors detailed from time to time in our other SEC filings.

Item 3.     Quantitative and Qualitative Disclosures About Market Risk

                  Our purchases of raw materials and product sales to European distribution partners are denominated in Euros. Translation into our reporting currency, the United States dollar, has not historically had a material impact on our financial position.  Additionally, our net assets denominated in currencies other than the functional currency have not 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.

                  Pursuant to our investment policy, we have invested a portion of our available cash in government agency and high-grade corporate bonds. Due to the nature and maturity terms of these investments, we do not believe these investments present significant market risk.

Item 4.     Controls and Procedures

                   (a) Evaluation of disclosure controls and procedures. As of a date within ninety days before the filing date of this report our Principal Executive Officer and Principal Financial Officer reviewed and evaluated the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-14(c) and 15d-14(c). Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures are effective.

                   (b) Changes in internal controls. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of evaluation.

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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.

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CERTIFICATION

I, Carolyn J. Logan, certify that:

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CERTIFICATION

I, Adam C. Derbyshire, certify that:

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