SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                    FORM 10-K

                Annual Report Pursuant to Section 13 or 15(d) of
                       the Securities Exchange Act of 1934

For the Fiscal Year Ended                            Commission File No. 0-11550
December 31, 1997

                               Pharmos Corporation
             (Exact name of registrant as specified in its charter)

            Nevada                                              36-3207413
(State or other jurisdiction of                           (IRS Employer Id. No.)
incorporation or organization)

33 Wood Avenue South, Suite 466
Iselin, NJ                                                       08830
(Address of principal executive offices)                       (zip code)

Registrant's telephone number, including area code: (732) 603-3526

Securities registered pursuant to Section 12(b) of the Act:

                                      None
                                (Title of Class)

Securities registered pursuant to Section 12(g) of the Act:

                          Common Stock, $.03 par value
                                (Title of Class)

     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 if disclosure of delinquent  filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

     The aggregate  market value of the  registrant's  Common Stock at March 13,
1998  held by  those  persons  deemed  to be  non-affiliates  was  approximately
$87,691,458

     As of March 13, 1998, the Registrant had outstanding  36,296,751  shares of
its $.03 par value Common Stock.


<PAGE>


                                     PART I
Item 1.  Business

Introduction

     Pharmos Corporation (the "Company") is an emerging  pharmaceutical  Company
engaged  in  the  discovery,   design,   development  and  commercialization  of
pharmaceuticals  to meet  significant  therapeutic  needs in major markets.  The
Company is developing pharmaceuticals in various fields including: site specific
drugs for ophthalmic indications,  neuroprotective agents with a novel mechanism
of action for the treatment of central nervous system ("CNS")  disorders,  newly
designed molecules to treat cancer, and emulsion-based  products for topical and
systemic  applications.  On March 10, 1998, the Company,  together with Bausch &
Lomb  Pharmaceuticals,  Inc ("BLP"),  announced the receipt of approval from the
Food and Drug  Administration  ("FDA") to manufacture  and market two ophthalmic
products,  LotemaxTM  (loteprednol  etabonate  ophthalmic  suspension  0.5%) and
AlrexTM (loteprednol etabonate ophthalmic suspension 0.2%).

     Lotemax  is a  topical,  site-specific  steroid  that will be used to treat
post-operative  eye  inflammation  such as that experienced  following  cataract
surgery.  The new  prescription  eye drop  will also be used for  various  other
inflammatory eye conditions.  The novel chemical  structure of Lotemax allows it
to be predictably  transformed by enzymes in the eye to an inactive  metabolite,
and increases its safety profile. The safety profile of Lotemax was demonstrated
in clinical  trials by a low  incidence of  increased  intraocular  pressure,  a
significant side effect of ophthalmic steroid use. In addition,  Lotemax has the
broadest range of indications of any ophthalmic steroid on the market.

     Alrex is a specially  developed formula of loteprednol  etabonate that will
be used in the  treatment of  ophthalmic  allergies.  Alrex is indicated for the
treatment  of  seasonal  allergic  conjunctivitis,  an  inflammation  of the eye
usually caused by pollens.  Seasonal allergic  conjunctivitis  produces itching,
tearing,  redness and swelling in the conjunctiva,  the membrane that covers the
inside of the eyelid and the white part of the eye.

     The  regulatory  approvals for Lotemax and Alrex are the first two of three
to be  sought  for  the  Registrant's  and  BLP's  line of  ophthalmic  products
containing loteprednol  etabonate.  The third product, which combines the active
ingredient   loteprednol   etabonate  with  an   anti-infective   agent,  is  in
development.

     BLP,  a  subsidiary  of  the  global  eye  care  company,   Bausch  &  Lomb
Incorporated,  co-developed  Lotemax  and Alrex  with the  Registrant  after the
Registrant  granted  BLP the  rights to process  and  market the new  ophthalmic
pharmaceutical  line in June 1995. In December 1996,  BLP's rights were extended
to select international markets including Europe and Canada.

     Dexanabinol  (HU-211),  the Company's  lead CNS product aimed  initially at
treating  stroke  and head  trauma,  is  currently  being  studied in a Phase II
clinical  trial  for  severe  head  trauma.   The  Company's   tamoxifen  analog
anti-cancer program is advancing in preclinical development.


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Strategy

     The Company's  business is the design and  development  of novel drugs with
superior  safety and efficacy  profiles,  initially  targeted to ophthalmic  and
neurological   disorders.   The  Company  seeks  to  enter  into   collaborative
relationships with established  pharmaceutical companies to complete development
and commercialize its products.

     The Company is  developing  pharmaceuticals  which are  designed to address
unmet needs in certain  markets and to exhibit  superior  efficacy and/or safety
profiles over  competing  products in other markets.  For example,  many current
anti-inflammatory ophthalmic drugs have either significant side effects, such as
the elevation of intraocular  pressure  ("IOP") by steroids,  or are drugs which
are safer,  but only  moderately  effective  at reducing  inflammation,  such as
non-steroidal   anti-inflammatory   drugs  ("NSAIDs").   For  many  neurological
indications,  such  as  head  trauma,  there  are no  effective  drug  therapies
available. In the case of cancer treatment,  potential side effects make current
therapies less desirable.

     The Company is applying  its  experience  in drug design and its novel drug
delivery technology in developing products directed at several fields including:
site  specific  drugs  for  ophthalmic  indications,  neuroprotective  compounds
targeted at specific  CNS  biochemical  pathways  associated  with  neurological
indications,  and systemic drugs specifically designed to avoid CNS side effects
and to have an excellent  peripheral  safety profile.  The Company is also using
proprietary  lipid-based  technologies,  primarily submicron emulsions, in tests
designed to achieve better delivery routes.

Products

     Loteprednol Etabonate

     Lotemax and Alrex are the trade  names of drug  products in the form of eye
drop suspensions in which the active compound is loteprednol  etabonate  ("LE").
LE is a unique  steroid,  designed to act in the eye and cure  inflammatory  and
allergic  conditions,  quickly hydrolyzed into a predictable inactive metabolite
once it reaches  the inner eye or  systemic  circulation.  This  pharmacological
profile  results in improved  safety by  avoiding  the side  effects  related to
exposure to most ocular  steroids.  In the eye, the most unwanted side effect of
steroids  is  the  elevation  of  IOP,  which  can be  sight-threatening.  While
glucocorticoids,  for lack of an  alternative,  are  regularly  used for  severe
inflammatory  conditions of the eye, milder conditions,  such as allergies,  are
preferentially treated with less effective non-steroidal agents.

     In March  1998,  Lotemax  received  product  approval  from the FDA for the
treatment  of steroid  responsive  inflammatory  conditions  of the eye, for the
treatment  of uveitis and for post  operative  eye  inflammation.  Also in March
1998, Alrex received product approval from the FDA for the treatment of seasonal
allergic  conjunctivitis.  A combination  of LE with the  antibiotic  tobramycin
("LE-T") for the treatment of  inflammatory  and  infectious  indications  is in
development. A Phase III clinical trial is anticipated to begin in 1998.


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     On June 30, 1995, the Company  entered into an agreement with Bausch & Lomb
to market  Lotemax,  Alrex  and LE-T in the U.S.  A second  agreement,  covering
Europe,  Canada and other selected countries,  was signed on December 12, 1996 .
Both  agreements  give Bausch & Lomb the right to purchase the "drug  substance"
from the Company, to manufacture the "drug product" and to assist the Company in
developing  the  products.  In 1995,  the Company also signed an agreement  with
SIPSY Chemical  Corporation  for exclusive  manufacturing  of LE for sale to the
Company.

     Dexanabinol (HU-211)

     Dexanabinol  (HU-211) is the Company's lead synthetic  cannabinoid compound
in a family of non psychotic cannabinoids molecules originally designed to avoid
the psychotropic and sedative spectrum of cannabinimetic agents, while retaining
their  beneficial  properties  as  anti-emetics,  analgesics  and  anti-glaucoma
agents.

     It is now well established  that the  psychotropic  effects of cannabinoids
are mediated via stereo selective (-) preferring receptors. Dexanabinol is a (+)
optical  isomer  and does not  interact  with  cannabinoid  receptors.  It does,
nevertheless, retain anti-emetic and anti-glaucoma properties. More importantly,
it is also a stereo selective,  non-competitive antagonist of the glutamate NMDA
receptor  channel with a unique safety profile,  activation of which is believed
to play a key role in secondary  neuronal damage due to head trauma,  stroke and
cardiac arrest.  The molecule also has free radical scavenging  properties,  and
anti-inflammatory  properties (involving inhibition of TNF-[alpha]  production).
Both of these latter  mechanisms are important for  neuroprotection.  Therefore,
dexanabinol  appears to have a unique  modality  to  neuroprotection,  combining
three relevant  mechanisms of action in a single molecule which act at different
steps of the neurotoxic  process in stroke,  head trauma and  potentially  other
indications.

     While  head  trauma and stroke are the  highest  priority  indications  for
dexanabinol,  its spectrum of activities  has potential as an  anti-inflammatory
and protectant in other diseases such as glaucoma,  Parkinson's  and Alzheimer's
diseases,  as well as various  other  inflammatory  conditions.  Development  of
dexanabinol  for these chronic  indications is being explored at the preclinical
level.

     In several animal models  (including  closed head injury,  focal and global
forebrain ischemia and optic nerve crush), the drug has demonstrated significant
neuroprotective  activity.  In these studies,  a single injection of dexanabinol
given after the injury suggests significant long term functional improvement and
an increase in neuronal survival.

     In  early  1996,  a Phase I study  of  rising  dose  tolerance  in  healthy
volunteers  (50 subjects)  showed  dexanabinol  to be safe and well tolerated at
doses up to and including the expected  therapeutic doses.  Specifically,  there
were no hallucinations,  sedation or blood pressure changes of the type reported
with other glutamate antagonists. In late 1996, the Company commenced a Phase II
study of head injured patients, which is targeted for completion in late 1998 or
early 1999.  This study,  being  conducted  at six medical  centers in Israel on
patients with moderate to severe head injury,  has been reviewed and approved by
the American Brain Institute Consortium (ABIC) and


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<PAGE>


the European Brain Institute Consortium (EBIC). As of March, 1998, there were 67
patients enrolled in the study,  which is expected to have a total enrollment of
approximately 90 patients.

     Tamoxifen Analogs

     Several  diseases  are  currently  treated  with drugs that produce mild to
dose-limiting CNS side effects. For instance,  tamoxifen, which is used to treat
breast cancer patients and has been suggested for use as a prophylactic agent in
healthy women at risk of developing  the disease,  causes hot flashes and may be
associated  with  cognitive  and  affective  deficits  as  well.   Additionally,
corticosteroids,  used to treat chronic  inflammatory and auto-immune  diseases,
cause  psychotic  reactions  in some  patients  and  have  been  shown  to cause
selective  neuronal  death in  animals.  Neuropathic  pain  could be  treated by
certain  systemic  anesthetics,  but the  resulting  CNS side  effects make such
therapy  unsafe.  These side effects could be addressed by designing  drugs with
limited passage to the brain through the blood brain barrier (BBB).

     In light of this concept,  several  analogs of tamoxifen and lidocaine with
poor CNS uptake  have been  synthesized  and tested in  several  animal  models.
Tamoxifen methiodide, a permanently charged tamoxifen derivative,  was tested in
animals  (nude  mice)  inoculated  with human  breast  cancer  cells.  Treatment
resulted in rapid arrest of growth followed by tumor  regression.  Growth arrest
was also  observed in  estrogen-independent  tumors.  The rate and  magnitude of
response was higher than that seen with tamoxifen  itself.  The compound retains
the  anti-osteoporotic  effects of  tamoxifen in bone but is  considerably  less
active  than  tamoxifen  as a utero  trophic  agent,  demonstrating  an improved
therapeutic  profile as compared  to the parent  compound.  Permanently  charged
lidocaine   analogs   suppress   electrophysiological   activities   typical  to
neuropathic pain in vivo, similar to that achieved with the parent compound.

     Further preclinical pharmacology is underway to identify additional analogs
of tamoxifen and to gain a fuller understanding of the mechanism of action.

Competition

     The pharmaceutical industry is highly competitive, and research relating to
drug delivery and formulation  technologies is developing  rapidly.  The Company
competes  with  a  number  of  pharmaceutical  companies  that  have  financial,
technical  and  marketing  resources  significantly  greater  than  those of the
Company.  Some  companies  with  established  positions  in  the  pharmaceutical
industry may be better  equipped than the Company to develop and market products
in the  markets  the  Company  is  seeking  to enter.  A  significant  amount of
pharmaceutical  research  is also being  carried out at  universities  and other
not-for-profit   research   organizations.   These   institutions  are  becoming
increasingly  aware of the  commercial  value of their findings and are becoming
more active in seeking patent  protection and licensing  arrangements to collect
royalties for the use of technology they have developed.  These institutions may
also  market  competitive  commercial  products  on their own or  through  joint
ventures  and will  compete  with the  Company in  recruiting  highly  qualified
scientific personnel.


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     The Company is pursuing  areas of product  development  in which there is a
potential for extensive technological innovation.  The Company's competitors may
succeed  in  developing  products  that are  more  effective  than  those of the
Company.  Rapid technological change or developments by others may result in the
Company's potential products becoming obsolete or non-competitive.

Collaborative Relationships

     The Company's commercial strategy is to develop products independently and,
where appropriate,  in collaboration with established  pharmaceutical  companies
and  institutions.  Collaborative  partners  may  provide  financial  resources,
research and manufacturing  capabilities and marketing  infrastructure to aid in
the  commercialization  of the Company's  products in development  and potential
future  products.  Depending on the  availability  of  financial,  marketing and
scientific  resources,   among  other  factors,  the  Company  may  license  its
technology   or  products  to  others  and  retain  profit   sharing,   royalty,
manufacturing,   co-marketing,   co-promotion  or  similar   rights.   Any  such
arrangements could limit the Company's  flexibility in pursuing alternatives for
the  commercialization  of its  products.  There  can be no  assurance  that the
Company will establish any  additional  collaborative  arrangements  or that, if
established, any such relationships will be successful.

     Bausch & Lomb

     On June 30, 1995, the Company  signed a definitive  agreement with Bausch &
Lomb to manufacture  and market Lotemax and Alrex,  the Company's lead products,
in the United  States upon receipt of FDA approval.  The agreement  includes one
other loteprednol etabonate-based product (LE-T) currently being co-developed by
the Company and Bausch & Lomb.  A second  agreement  signed  December  12, 1996,
extends  Bausch & Lomb's rights to market these  products in Europe,  Canada and
other selected countries pending regulatory approval.

     Under the agreements, Bausch & Lomb will purchase the active drug substance
from the  Company.  As of March 1, 1998,  Bausch & Lomb has provided the Company
with a total  of $5  million  in cash  advances  against  future  sales  of drug
substance  to Bausch & Lomb.  Another  $1 million  is due  subject to  receiving
regulatory approval for LE-T in the United States. An additional $1.6 million in
advances  against  future  sales of Bausch & Lomb will be payable to the Company
following  receipt of  regulatory  clearance in certain  markets  outside of the
United States.  Bausch & Lomb  collaborates in the development of these products
by making  available  amounts up to 50% of their Phase III clinical trial costs.
The Company retains certain  conditional  co-marketing rights in the U.S. to all
of the products covered by the marketing agreement.

     In a separate agreement completed in December 1996, Bausch & Lomb made a $2
million investment in the common stock of the Company.

Patents, Proprietary Rights and Licenses

     Patents and Proprietary Rights


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     Proprietary  protection  generally has been important in the pharmaceutical
industry,  and the commercial  success of products  incorporating  the Company's
technologies  may  depend,  in part,  upon the ability to obtain  strong  patent
protection.

     Some of the technologies  underlying the Company's  potential products were
invented or are owned by various  third  parties,  including  the  University of
Florida,  Dr. Nicholas Bodor,  and the Hebrew  University of Jerusalem  ("Hebrew
University").  The Company is the licensee of these  technologies  under patents
held by the applicable  owner through  licenses which generally remain in effect
for the life of the applicable patent. The Company generally  maintains,  at its
expense,  U.S. and foreign  patent  rights with respect to both the licensed and
its own technology and files and/or prosecutes the relevant patent  applications
in the U.S. and foreign  countries.  The Company also relies upon trade secrets,
know-how,  continuing  technological  innovations and licensing opportunities to
develop  its  competitive  position.  The  Company's  policy is to  protect  its
technology by, among other things,  filing, or requiring the applicable licensor
to file, patent  applications for technology that it considers  important to the
development  of its  business.  The Company  intends to file  additional  patent
applications, when appropriate, relating to its technology,  improvements to its
technology and to specific products it develops.  There can be no assurance that
any  additional  patents  will be  issued,  or if  issued,  that they will be of
commercial benefit to the Company.  In addition,  it is impossible to anticipate
the breadth or degree of protection that any such patents will afford.

     The patent positions of pharmaceutical  firms,  including the Company,  are
uncertain  and involve  complex  factual  questions.  In addition,  the coverage
claimed in a patent application can be significantly reduced before or after the
patent is issued.  Consequently,  the Company  does not know  whether any of the
pending patent  applications  underlying the licensed  technology will result in
the issuance of patents or, if any patents are issued, whether they will provide
significant proprietary protection or will be circumvented or invalidated. Since
patent  applications  in the U.S. are  maintained in secrecy until patents issue
and since  publication of  discoveries  in the  scientific or patent  literature
often lag behind actual  discoveries,  the Company  cannot be certain that it or
its licensors, as the case may be, were the first creators of inventions covered
by pending and issued patents or that it or its  licensors,  as the case may be,
were the first to file patent  applications for such inventions.  Moreover,  the
Company may have to participate in interference proceedings declared by the U.S.
Patent and  Trademark  Office to determine  priority of  invention,  which could
result in  substantial  cost to the  Company,  even if the  eventual  outcome is
favorable to the Company. There can be no assurance that the patents relating to
the  licensed  technology,  if  issued,  will be upheld by a court of  competent
jurisdiction  or that a  competitor's  product  will be found to  infringe  such
patents.

     Other  pharmaceutical and drug delivery companies and research and academic
institutions  may have filed  patent  applications  or  received  patents in the
Company's  fields.  If  patents  are  issued  to other  companies  that  contain
competitive or conflicting  claims and such claims are ultimately  determined to
be valid,  there can be no  assurance  that the Company  would be able to obtain
licenses to these  patents at a reasonable  cost or be able to develop or obtain
alternative technology.

     The Company also relies upon trade secret  protection for its  confidential
and proprietary


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information.  There  can be no  assurance  that  others  will not  independently
develop  substantially  equivalent  proprietary  information  and  techniques or
otherwise gain access to the Company's trade secrets.

     It is the Company's policy to require its employees,  consultants,  outside
scientific collaborators and sponsored researchers and other advisors to execute
confidentiality  agreements upon the commencement of employment or consulting or
advisory relationships with the Company. These agreements generally provide that
all confidential  information  developed or made known to the individual  during
the  course of the  individual's  relationship  with the  Company  is to be kept
confidential   and  not   disclosed   to  third   parties   except  in  specific
circumstances.  In the case of employees and certain consultants, the agreements
provide that all  inventions  conceived by the individual in the course of their
employment or  consulting  relationship  shall be the exclusive  property of the
Company. There can be no assurance,  however, that these agreements will provide
meaningful  protection or adequate  remedies for the Company's  trade secrets in
the event of unauthorized use or disclosure of such  information.  The Company's
patents and licenses  underlying  its potential  products  described  herein are
summarized below.

     Site-Specific  Drugs. In the general category of site-specific  drugs which
are active mainly in the eye and have limited systemic side effects, the Company
has licensed  several patents from Dr. Nicholas Bodor. The earliest patents date
from 1984 and the most recent from 1996. Some of these patents cover loteprednol
etabonate-based  products and adaprolol maleate, a patented beta blocker for the
treatment of glaucoma.

     Neuroprotective   Agents.   The  Company  has  licensed   from  the  Hebrew
University,  which is the academic  affiliation  of the  inventor,  Dr.  Raphael
Mechoulam,  patents  covering  novel  compounds that have  demonstrated  certain
beneficial neuropharmacological activity while appearing to be devoid of most of
the deleterious  effects usually  associated with this class of compounds.  This
group of patents has been designed to protect this family of compounds and their
uses devised by the Company and the inventors.  The earliest patent applications
resulted in patents  issued in 1989, and the most recent patents date from 1997.
These patents cover Dexanabinol, which is under development for the treatment of
head trauma, stroke and glaucoma and other indications.

     Tamoxifen Analogs.  The Company has filed patent  applications in the U.S.,
Israel,  Australia,  Canada,  Japan and the  European  Patent  Office to protect
pharmaceutical  compositions of Tamoxifen analogs and Tamoxifen  Methiodide.  In
November 1996, the Company  received a Notice of Allowance from the U.S.  Patent
and  Trademark  Office  for a  new  patent  with  claims  covering  the  use  of
permanently ionic derivatives of steroid hormones and their antagonists known as
Tamoxifen  Analogs.  The patent also claims novel analogs of tamoxifen and other
steroid hormones and their antagonists.  The Company believes that these charged
derivatives are superior to the parent  compounds in that they are devoid of CNS
side effects and show an overall improved pharmacological profile.

     Emulsion-based  Drug Delivery Systems. In the general category of SubMicron
Emulsion  (SME)  technology,  the  Company  licensed  two  patents  from  Hebrew
University and has separately


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filed ten patent  applications  which are at  different  stages of  prosecution.
These  patents and patent  applications  have been devised to protect a group of
formulation technologies devised by the Company and the inventors as they relate
to pharmaceutical  and medicinal  products.  The earliest patent filings for SME
technology  date from 1986 and the most recent from 1996.  These  patents  cover
Pilocarpine-SME, which is an improved formulation to treat glaucoma.

     Licenses

     The  Company's  license  agreements   generally  require  the  Company,  as
licensee,  to pay  royalties  on sale of products  developed  from the  licensed
technologies,  and fees on revenues the Company receives for sublicenses,  where
applicable. The royalty rates defined in the licenses are customary and usual in
the  pharmaceutical  industry.  The royalties  will be payable for periods up to
fifteen years from the date of certain specified  events,  including the date of
the first sale of such  products,  or the date from  which the first  registered
patent from the developed  technologies  is in force,  or the year following the
date in which FDA approval has been received for a developed product. Certain of
the license agreements also require annual payments.

Government Regulation

     The  Company's  activities  and products are  significantly  regulated by a
number  of  governmental  entities,  especially  the  FDA,  in the  U.S.  and by
comparable authorities in other countries.  These entities regulate, among other
things,  research  and  development  activities  and the  testing,  manufacture,
safety, effectiveness, labeling, storage, record keeping, approval, advertising,
promotion,  distribution and sale of the Company's potential  products.  Product
development and approval within this regulatory framework take a number of years
and involve the expenditure of substantial resources.  Many products that appear
promising initially ultimately do not reach the market because they are found to
be unsafe  (perhaps  too toxic) or to lack  effectiveness,  as  demonstrated  by
testing required by government  regulation  during the development  process.  In
addition,  there can be no assurance  that this  regulatory  framework  will not
change  or that  additional  regulation  will  not  arise  at any  stage  of the
Company's  product  development that may preclude or otherwise  adversely affect
approval,  delay  an  application  or  require  additional  expenditures  by the
Company.  Moreover, even if approval is obtained, failure to comply with present
or future regulatory  requirements,  or new information  adversely reflecting on
the safety or  effectiveness of the approved drug, can lead to FDA withdrawal of
approval to market the product.

     The  regulatory  process  required to be  completed by the FDA before a new
drug  delivery  system may be  marketed  in the U.S.  depends  significantly  on
whether  the drug  (which  will be  delivered  by the drug  delivery  system  in
question) has existing  approval for use and in what dosage form. If the drug is
a new  chemical  entity that has not been  approved,  the process  includes  (i)
preclinical  laboratory  and animal  tests,  (ii) an IND  application  which has
become effective,  (iii) adequate and  well-controlled  human clinical trials to
establish the safety and  effectiveness of the drug for its intended  indication
and  (iv) FDA  approval  of a  pertinent  NDA.  If the drug has been  previously
approved,  the approval  process is similar,  except that certain toxicity tests
normally  required  for the IND  application  may not be  necessary.  Even  with
previously approved drugs,


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additional   toxicity  testing  may  be  required  when  the  delivery  form  is
substantially  changed,  or when a company  does not have access to the raw data
from the prior preclinical studies.

     The activities required before a pharmaceutical  product may be marketed in
the U.S. begin with preclinical  testing.  Preclinical tests include  laboratory
evaluation  of product  chemistry  and other end  points  and animal  studies to
assess the  potential  safety and  efficacy  of the product as  formulated.  The
conduct  of  preclinical  studies  is  regulated  by the FDA  under a series  of
regulations called the Good Laboratory Practice regulations. Violations of these
regulations  can, in some  cases,  lead to  invalidation  of the data from these
studies, requiring such studies to be replicated.

     The entire body of  preclinical  development  work  necessary to administer
investigational   drugs  to   volunteers   or  patients  is   summarized  in  an
Investigative New Drug ("IND")  application to the FDA. FDA regulations  provide
that human  clinical  trials may begin thirty days  following the submission and
receipt of an IND  application,  unless the FDA  advises  otherwise  or requests
additional  information,  clarification  or  additional  time to review  the IND
application;  it is generally considered good practice to obtain affirmative FDA
response before commencing trials.  There is no assurance that the submission of
an IND application will eventually allow a company to commence  clinical trials.
Once trials have commenced,  the FDA may stop the trials, or particular types or
parts of trials, by placing a "clinical hold" on such trials because of concerns
about,  for example,  safety of the product  being tested or the adequacy of the
trial  design.  Such  holds can cause  substantial  delay and in some  cases may
require abandonment of a product.

     Clinical  testing  involves  the  administration  of the  drug  to  healthy
volunteers  or to  patients  under  the  supervision  of a  qualified  principal
investigator,  usually a physician  pursuant to an FDA-reviewed  protocol.  Each
clinical  study is  conducted  under the auspices of  independent  Institutional
Review Boards ("IRBs") at the institutions at which the study will be conducted.
An IRB will consider,  among other things,  ethical factors, the safety of human
subjects and the possible liability of the institution.

     Phase I clinical  studies are commonly  performed in 20 to 40 healthy human
subjects  or, more rarely,  in selected  patients  with the targeted  disease or
disorder.  Their goal is to establish initial data about tolerance and safety of
the drug in humans. Also, the first data regarding the absorption, distribution,
metabolism, and excretion of the drug in humans are established.

     In  Phase  II  human  clinical  studies,  preliminary  evidence  is  sought
regarding the  pharmacological  effects of the drug and the desired  therapeutic
efficacy in limited studies with small numbers of selected patients (50 to 200).
Efforts are made to evaluate the effects of various  dosages and to establish an
optimal dosage level  schedule and validate  clinical  efficacy  endpoints to be
used in Phase III trials.  Additional  safety data are also  gathered from these
studies.

     Phase III  clinical  studies  consist of expanded,  large scale  studies of
patients  (200 to several  thousand)  with the target  disease or  disorder,  to
obtain  definitive  statistical  evidence of the effectiveness and safety of the
proposed  product and dosing  regimen.  These studies may also include  separate
investigations  of the  effects  in  subpopulations  of  patients,  such  as the
elderly.


                                       10


<PAGE>


     At the same  time  that the  human  clinical  program  is being  performed,
additional  non-clinical  (i.e.,  animal)  studies  are  also  being  conducted.
Expensive, long duration (12-18 months) toxicity and carcinogenicity studies are
done to demonstrate the safety of drug administration for the extended period of
time required for effective therapy. Also, a variety of laboratory,  animal, and
initial  human studies may be performed to establish  manufacturing  methods for
the drug, as well as stable, effective dosage forms.

     The  results of  product  development,  preclinical  studies  and  clinical
studies  and  other  information  are  submitted  to the  FDA in an NDA to  seek
approval for the marketing and interstate  commercial shipment of the drug. With
the NDA, a company must pay the FDA a user fee in excess of $200,000.  Companies
with less than 500  employees  and no revenues from products may be eligible for
an exception.  This exception was granted to the Company in connection  with the
NDA for Lotemax and reduced the fee by 50%, which is payable 12 months after the
NDA is filed by the FDA. The FDA may refuse to file or deny an NDA if applicable
regulatory requirements,  such as compliance with Current Good Clinical Practice
("cGCP")  requirements,  are not  satisfied or may require  additional  clinical
testing. Even if such data are submitted, the FDA may ultimately decide that the
NDA does not satisfy the requirements  for approval.  If the FDA does ultimately
approve the product, it may require, among other things, post-marketing testing,
including  potentially  expensive Phase IV studies,  and surveillance to monitor
the safety  and  effectiveness  of the drug.  In  addition,  the FDA may in some
circumstances  impose  restrictions on the use of the drug that may be difficult
and expensive to  administer,  and almost always seeks to require prior approval
of promotional materials.  Product approvals may be withdrawn if compliance with
regulatory requirements is not maintained or if problems occur after the product
reaches the market.  After a product is filed for a given  indication in an NDA,
subsequent  new  indications or dosages for the same product are reviewed by the
FDA via the filing and upon receipt of a Supplemental NDA ("sNDA") submission as
well as payment of a separate  user fee.  The sNDA is more  focused than the NDA
and deals  primarily  with  safety  and  effectiveness  data  related to the new
indication  or dosage,  and  labeling  information  for the sNDA  indication  or
dosage.  Finally,  the FDA  requires  reporting  of certain  information,  e.g.,
adverse experience reports,  that becomes known to a manufacturer of an approved
drug.

     Each domestic drug product  manufacturing  establishment must be registered
with,  and  approved  by,  the FDA and must pay the FDA a  registration  fee and
annual fee. In addition,  each such  establishment  must inform the FDA of every
drug  product  it has in  commercial  distribution  and keep such list  updated.
Establishments handling controlled substances must be licensed and are inspected
by the U.S.  Drug  Enforcement  Agency  ("DEA").  The  Company has a current DEA
license  appropriate  for handling  the  substances  it uses in its  facilities.
Domestic establishments are also subject to inspection by the FDA for compliance
with  cGMP  regulations  after an NDA has been  filed and  thereafter,  at least
biennially.  The labeling,  advertising and promotion of drug products also must
be in compliance with pertinent FDA regulatory  requirements.  Failure to comply
with applicable  requirements relating to production,  distribution or promotion
of a drug product can lead to FDA demands that  production  and shipment  cease,
and, in some cases, that product be recalled, or to enforcement actions that can
include seizures, injunctions and criminal prosecution.



                                       11


<PAGE>


     To develop and market its potential  products  abroad,  the Company is also
subject to numerous and varying foreign regulatory requirements,  implemented by
foreign  health  authorities,  governing,  among  other  things,  the design and
conduct of human clinical trials, pricing and marketing.  The approval procedure
varies among countries and can involve additional testing, and the time required
to obtain  approval  may differ from that  required to obtain FDA  approval.  At
present,  foreign marketing  authorizations are applied for at a national level,
although  within the European Union ("EU") certain  registration  procedures are
available  to  companies  wishing to market a product in more than one EU member
country.  If a  regulatory  authority  is satisfied  that  adequate  evidence of
safety,  quality and efficacy has been  presented,  marketing  authorization  is
almost always granted.  The foreign regulatory  approval process includes all of
the risks  associated  with obtaining FDA approval set forth above.  Approval by
the FDA does not ensure approval by other countries.

     Various aspects of the Company's business and operations are also regulated
by a number of other governmental agencies including the DEA, U.S. Department of
Agriculture,  Environmental Protection Agency and Occupational Safety and Health
Administration  as well as by other  federal,  state and local  authorities.  In
addition,  any future international sales would be regulated by numerous foreign
authorities.

     There continue to be a number of legislative and regulatory proposals aimed
at changing the health care system.  It is uncertain  what, if any,  legislative
proposals will be adopted or what actions  federal or state  agencies,  or third
party  payors  may take in  response  to any health  care  reform  proposals  or
legislation. Although the Company cannot predict whether any such legislative or
regulatory  proposals  will be adopted or the effect such  proposals may have on
its business,  the uncertainty  surrounding such proposals could have a material
adverse  effect  on  the  Company.   Furthermore,   the  Company's   ability  to
commercialize its potential  product portfolio may be adversely  affected to the
extent  that such  proposals  have a material  adverse  effect on the  business,
financial  condition and  profitability  of other companies that are prospective
collaborators for certain of the Company's potential products.

     The Company's ability to commercialize its products successfully may depend
in part on the extent to which  reimbursement  for the cost of such products and
related  treatments  will be available  from  government  health  administration
authorities,  private health insurers and other  organizations.  There can be no
assurance  that  adequate  third-party  coverage will be available to enable the
Company or any of its future  licensees to maintain  price levels  sufficient to
realize an appropriate return on its investment in product development.


                                       12


<PAGE>


Corporate History

     Pharmos Corporation (the "Company"),  a Nevada corporation,  formerly known
as Pharmatec,  Inc., was  incorporated  under the laws of the State of Nevada on
December 20,  1982.  On October 29,  1992,  the Company  completed a merger (the
"Merger") with Pharmos Corporation,  a privately held New York corporation ("Old
Pharmos"),  and on October  30, 1992  exercised  an option to acquire all of the
outstanding shares of Xenon Vision,  Inc., a privately held Delaware corporation
("Xenon"). Prior to the Merger, Old Pharmos was a biopharmaceutical company with
proprietary drug delivery and formulation technologies, one of which involved an
initial  application of ophthalmic drugs, and another of which involved research
pharmaceuticals with neuroprotective properties being developed for applications
such as  stroke  and  head  trauma.  Prior  to the  Merger,  the  Company  was a
publicly-held  company  primarily  engaged in the  development  and testing of a
chemical  delivery  system which has been shown in animal  studies to permit the
passage of drugs across the blood-brain barrier. Prior to its acquisition, Xenon
was a research-based pharmaceutical company developing several patented products
for the ophthalmic field. In April 1995, the Company acquired Oculon Corporation
("Oculon")  a  privately-held   development  stage  company  with  anti-cataract
technologies   and  net  assets  of  approximately   $3.5  million,   consisting
substantially of cash and cash equivalents.

Human Resources

     As of March 1, 1998, the Company had 37 full time employees,  5 in the U.S.
and 32 in Israel, of whom approximately 15 hold doctorate or medical degrees.

     The  Company's  employees  are  not  covered  by  a  collective  bargaining
agreement.  The Company has never experienced  employment-related work stoppages
and considers its employee relations to be excellent.

Public Funding and Grants

     The Company's  subsidiary,  Pharmos Ltd., has received certain funding from
the Chief  Scientist  of the Israel  Ministry of Industry  and Trade (the "Chief
Scientist")  for research and  development  of SME  technology for injection and
nutrition as well as for research  relating to  pilocarpine,  dexamethasone  and
ophthalmic  formulations for dry eyes. The Company has received $1,827,192 under
such agreements  through  December 31, 1997. The Company will be required to pay
royalties to the Chief Scientist from the sale of products developed, if any, as
a result of the research activities conducted with such funds. Aggregate royalty
payments are limited to the amount of funding received. Additionally, funding by
the Chief  Scientist  places  certain  legal  restrictions  on the  transfer  of
know-how  and the  manufacture  of  resulting  products  outside of Israel.  See
"Conditions in Israel."

     The Company has received  certain  funding of $925,780 from the Israel-U.S.
Binational Industrial Research and Development  Foundation ("BIRD-F") to develop
Lotemax and LE-T.  The Company will be required to pay  royalties to BIRD-F from
the sale of products developed, if any,


                                       13


<PAGE>


as a result of the  research  activities  conducted  with such funds.  Aggregate
royalty  payments  are limited to 150% of the amount of such  funding  received,
linked to the exchange rate of the U.S. dollar and the New Israeli Shekel.

Conditions in Israel

     The  Company  conducts   significant   operations  in  Israel  through  its
subsidiary,  Pharmos Ltd., and therefore is affected by the political,  economic
and military conditions to which that country is subject.

     Pharmos Ltd. has received  certain  funding from the Chief  Scientist  with
respect  to its  SubMicron  Emulsion  Technology  and  with  respect  to its new
chemical entity,  Dexanabinol.  The proclaimed  purpose of the legislation under
which such funding was provided is to develop local industry,  improve the state
balance of trade and to create new jobs in Israel.  Such funding  prohibits  the
transfer  or license of  know-how  and the  manufacture  of  resulting  products
outside of Israel without the permission of the Chief Scientist.  Although it is
the Company's  belief that the Chief  Scientist does not  unreasonably  withhold
this   permission   if  the  request  is  based  upon   commercially   justified
circumstances   and  any  royalty   obligations  to  the  Chief   Scientist  are
sufficiently assured, there can be no assurance that such consent, if requested,
would be granted upon terms satisfactory to the Company or granted at all.

Item 2. Properties

     The  Company is  headquartered  in Iselin,  New Jersey  where it leases its
general  administrative  facilities.  The Company also leases facilities used in
the   operation  of  its  research,   development,   pilot   manufacturing   and
administrative  activities  in  Rehovot,  Israel.  These  facilities  have  been
improved to meet the special  requirements  necessary  for the  operation of the
Company's research and development activities.  In the opinion of the management
these  facilities  are  sufficient  to meet the current and  anticipated  future
requirements  of the  Company.  In  addition  management  believes  that  it has
sufficient  ability to renew its present leases  related to these  facilities or
obtain suitable replacement facilities.

Item 3. Legal Proceedings

     None.

Item 4. Submission of Matters to a Vote of Security Holders

     At its  Annual  Meeting  held on January  9, 1998 the  stockholders  of the
Company elected the following persons as directors of the Company to hold office
until the next annual meeting of the  stockholders or until their successors are
duly elected and qualified: Haim Aviv


                                       14


<PAGE>


(26,386,186   votes  for  and  1,150,059  votes  against),   Stephen  C.  Knight
(26,391,624 votes for and 1,144,621 votes against),  David Schlachet (26,391,149
votes for and 1,145,096 votes against), Marvin P. Loeb (26,362,624 votes for and
1,173,621 votes against),  E. Andrews  Grinstead,  III (26,391,624 votes for and
1,144,621 votes against),  Fredric D. Price  (26,391,624 votes for and 1,144,621
votes  against)  and Mony Ben Dor  (26,391,149  votes  for and  1,145,096  votes
against). The stockholders of the Company also voted to adopt the Company's 1997
Incentive  and  NonQualified  Stock  Option  Plan  (24,091,679  voted in  favor,
2,646,101 voted against and 269,097  abstained or were  withheld).  In addition,
the stockholders of the Company voted to amend the Company's  Restated  Articles
of Incorporation  to increase the authorized  capital stock of the Company to 60
million  shares of common  stock  (24,533,973  voted in favor,  2,259,826  voted
against and 213,078 abstained or were withheld).

                                     PART II

Item 5. Market for Registrant's Common Stock and Related Stockholder Matters

     From October 20, 1993 until January 26, 1995,  the  Company's  Common Stock
was traded on the NASDAQ  National  Market System under the symbol  "PARS",  and
prior thereto was traded on the Nasdaq SmallCap Market. Prior to the Merger, the
Common Stock was quoted under the symbol "PHTC".  The Company's Common Stock was
moved to the Nasdaq SmallCap Market,  effective January 27, 1995, as a result of
the  Company's   non-compliance   with  certain  Nasdaq   corporate   governance
requirements.  The  following  table  sets  forth  the range of high and low bid
prices for the Common Stock as reported on the NASDAQ National Market System and
the Nasdaq SmallCap Market during the periods indicated.

         Year ended December 31, 1997                 HIGH               LOW
         ----------------------------                 ----               ---

         1st Quarter.................                $1.94              $1.28
         2nd Quarter................                  2.19               1.09
         3rd Quarter.................                 3.00               1.44
         4th Quarter.................                 3.00               1.66

         Year ended December 31, 1996                 HIGH                LOW
         ----------------------------                 ----                ---

         1st Quarter.................                $2.50              $1.38
         2nd Quarter................                  2.88               1.69
         3rd Quarter.................                 2.00               1.22
         4th Quarter.................                 1.78               1.16


     The  foregoing  represent  inter-dealer  prices,  without  retail  mark-up,
mark-down or


                                       15


<PAGE>


commission, and may not necessarily represent actual transactions.

     On March 13, 1998, there were 468 record holders of the Common Stock of the
Company and  approximately  5,473  beneficial  owners of the Common Stock of the
Company, based upon the number of shares of Common Stock held in "street name".

     The Company has paid no  dividends  on its Common Stock and does not expect
to pay cash dividends in the  foreseeable  future.  The Company is not under any
contractual  restriction  as to its present or future  ability to pay dividends.
The  Company  currently  intends to retain any future  earnings  to finance  the
growth and development of its business.

Item 6. Selected Financial Data

<TABLE>
<CAPTION>
                                                                      Year Ended December 31,
                                                                      -----------------------
                                                    1997             1996              1995              1994               1993
                                               ------------      ------------      ------------      ------------      ------------
<S>                                            <C>               <C>               <C>               <C>               <C>
Revenues                                                 --                --      $     75,000      $      7,815      $     81,900
Operating expenses                               (8,563,019)       (8,354,991)       (8,253,666)      (13,036,461)       (9,594,091)
Loss Before Extraordinary                        (8,233,547)       (8,077,210)       (8,096,085)      (12,955,299)       (9,398,695)
Item
Extraordinary gain from
forgiveness of debt                                 416,248                --                --                --                --
Dividend embedded in
convertible preferred stock                      (1,952,767)               --                --                --                --
Preferred Stock dividends                          (240,375)               --                --                --                --
Net loss applicable to
common shareholders                            ($10,010,441)     ($ 8,077,210)     ($ 8,096,085)     ($12,955,299)     ($ 9,398,695)
                                               ============      ============      ============      ============      ============
Net loss per share                             ($      0.31)     ($      0.28)     ($      0.37)     ($      1.19)     ($      1.24)
                                               ------------      ------------      ------------      ------------      ------------
Total assets                                   $  8,421,841      $  7,468,293      $  9,461,654      $  4,289,416      $ 10,608,458
                                               ------------      ------------      ------------      ------------      ------------
Long term obligations                          $  4,100,000      $  4,161,767      $  2,294,268      $     91,318      $    129,240
                                               ------------      ------------      ------------      ------------      ------------
Cash dividends declared                                  --                --                --                --                --
</TABLE>


Item 7. Management's  Discussion and Analysis of Financial Condition and Results
of Operations


                                       16
<PAGE>


     The Company has generated  limited revenues from product sales and has been
dependent upon external financing, interest income, and research and development
contracts to pursue its intended business  activities.  The Company has not been
profitable since inception and has incurred a cumulative net loss of $72,069,727
through December 31, 1997. Losses have resulted  principally from costs incurred
in research activities aimed at identifying and developing the Company's product
candidates,  clinical  research  studies,  merger  and  acquisition  costs,  the
write-off of purchased research and development,  and general and administrative
expenses.  The Company expects to incur additional  operating  expenses over the
next several years as the Company's research and development and clinical trials
programs continue.  The Company's ability to achieve  profitability is dependent
on the level of revenues from the sale of drug substance to support  Lotemax and
Alrex  coupled with its ability to develop and obtain  regulatory  approvals for
its product  candidates,  to enter into  agreements for product  development and
commercialization  with strategic corporate partners and to develop the capacity
to manufacture and sell its products,  and to secure additional  financing.  See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations - Liquidity and Capital Resources."

Results of Operations

Years Ended December 31, 1997 and 1996

Total  operating  expenses  increased by $208,028,  or 2.5 %, from $8,354,991 in
1996 to  $8,563,019  in 1997.  Overall,  the net  decrease  was  related to bulk
material purchases of loteprednol etabonate ("LE"), the active drug-substance of
Lotemax and Alrex, which was principally offset by reductions in other operating
expenses related to the filing of NDA's for Lotemax and Alrex.

Net research and  development  expenses  decreased  by $141,084,  or 2.5%,  from
$5,604,592 in 1996 to $5,463,508 in 1997. The completion of the clinical  trials
associated  with the Company's NDA  submissions for LE resulted in a decrease in
R&D expense.  The company increased  participation in approved R&D reimbursement
programs which  contributed to a reduction in R&D expense.  Increased  costs for
toxicology studies for the LE-T program (a combination of LE and Tobramycin) and
Dexanabinol, as well as activities to advance the manufacturing of LE, partially
offset the decrease in R&D expense.

In  anticipation of approval by the FDA of the NDAs for Lotemax and Alrex and in
accordance with its obligations under the Marketing  Agreements to supply Bausch
& Lomb with certain specified quantities of LE ( the active drug-substance), the
Company  purchased  quantities  of LE and smaller  quanitities  of a key reagent
required  for  the  manufacture  of LE,  in the  amount  of  $2,403,012  Certain
purchases of LE,  totaling  $598,385,  have been  expensed in 1997.  This amount
represents inventory to be used in testing,  manufacturing and various marketing
programs.

On  September 8, 1997,  the Company  signed an  agreement  terminating  the 1992
licensing  agreement with the University of Florida,  and returned the rights to
technologies that the Company had previously ceased developing.  The termination
agreement included a waiver of $416,249 in outstanding debts due the


                                       17


<PAGE>


University.

Patent expenses decreased by $70,096,  or 25%, from $281,412 in 1996 to $211,316
in 1997.  This  decrease is due to the timing of  completion  of certain  patent
applications.

General and administrative  expense decreased by $89,300, or 4%, from $2,123,392
in 1996 to $2,034,092 in 1997. Lower expenses  associated with the completion of
the  Company's  NDAs for Lotemax and Alrex as well as the closure of its Florida
facility were primarily responsible for the decreased general and administrative
costs.

Depreciation  and  amortization  expenses  decreased  by $89,877,  or 26%,  from
$345,595 in 1996 to $255,718 in 1997,  reflecting reduced  depreciation  expense
relating to the Alachua, Florida operation.

Interest  and other  income,  net of interest and other  expenses,  increased by
$51,692,  or 19%, from $277,782 in 1996 to $329,472 in 1997.  Interest and other
income,  net,  increased as a result of higher average cash  balances,  favorite
transaction  gains and the  waiver of  outstanding  debts to the  University  of
Florida.

Years Ended December 31, 1996 and 1995

     Total revenues decreased by $75,000 from 1995.  Revenues in 1995 related to
fees the Company received as a result of sublicensing certain technologies which
were not being actively developed by the Company.

     Total operating expenses  increased by $101,325,  or 1%, from $8,253,666 in
1995 to $8,354,991 in 1996 due to increased  research and  development  spending
partially offset by lower general, administrative and other expenses.

     Research and development expenses increased by $925,513,  or 20%, primarily
due to significant  spending on clinical  trails in 1996.  During the past year,
the company initiated and completed Phase III clinical trials of Lotemax for the
treatment  of uveitis and post  cataract  surgery as well as Phase III  clinical
trials of Alrex for the treatment of seasonal  ocular  allergies.  In October of
1996,  the Company  commenced a Phase II study of HU-211 for severe head injury.
In February 1997, the Company  submitted an NDA for Alrex and in March 1997, the
Company amended and  supplemented  the previously filed NDA for Lotemax with the
results of the 1996 clinical trials.  The increased clinical trial expenses were
partially offset by cost saving measures taken by the Company in early 1995 that
focused  research and  development  activities on products which were closest to
commercialization.  Bausch & Lomb net reimbursements for clinical trials totaled
$1.2 million during 1996, thereby reducing research and development  expenses by
this amount.

     Patent expense decreased by $199,447, or 41%, in 1996. The company was able
to reduce  patent  maintenance  costs by returning to an original  patent holder
several  patents  covering  technologies  which  are no  longer  being  pursued.
Further,  the Company's  in-house  patent  counsel now executes work  previously
undertaken by external patent attorneys.


                                       18


<PAGE>


     General and  administrative  costs decreased by $434,326,  or 17%, in 1996.
This  reduction  resulted  primarily  from  the  1995  relocation  of  corporate
headquarters  from New  York to the  Company's  existing  facility  in  Alachua,
Florida.

     Depreciation and amortization  expenses  decreased by $190,415,  or 35%, in
1996 due to the absence in 1996 of depreciation of New York facilities following
the 1995  closing,  a write-off of certain  leasehold  improvements,  as well as
reduced depreciation relating to the Florida operation.

     Net interest  income  increased by $195,200 in 1996,  reflecting the higher
level of investable funds in 1996. In addition,  the Company had higher interest
expense in 1995 relating to interest on the convertible debentures issued by the
Company in February 1995 , and converted  into Common Stock by July 1995,  and a
note that was paid in full.

Liquidity and Capital Resources

     The  Company  has had no sources of  recurring  revenues  and has  incurred
operating  losses since its inception.  At December 31, 1997, the Company has an
accumulated deficit of $72,069,727. The Company has financed its operations with
public and private offerings of securities,  advances and other funding pursuant
to a marketing agreement with Bausch & Lomb,  research contracts,  license fees,
royalties and sales, and interest income.

     The Company had working  capital of $1.9 million,  including  cash and cash
equivalents  of $4.4 million,  as of December 31, 1997. On February 4, 1998, the
Company  completed  a  private  placement  of  convertible  preferred  stock and
warrants that generated $ 5 million in gross proceeds.  Management believes that
existing cash and cash  equivalents  combined with anticipated cash inflows from
investment  income, R&D grants and proceeds from sales of the drug substance for
Lotemax  and Alrex to Bausch & Lomb will be  sufficient  to  support  operations
through the first quarter of 1999. The Company is continuing to actively  pursue
various  funding  options,  including  additional  equity  offerings,  strategic
corporate  alliances,  business  combinations  and the  establishment of product
related research and development limited partnerships,  to obtain the additional
financing that would be required to continue the development of its products and
bring them to  commercial  markets.  The  Company's  success  depends  upon many
factors  that are beyond  the  Company's  immediate  control,  including  market
acceptance  of  Lotemax  and  Alrex,  competition,  and the  ability  to  obtain
additional  financing.  There can be no  assurance  that  Lotemax  or Alrex will
achieve  market  acceptance  or that the Company will be successful in obtaining
additional financing or commercializing its product candidates.

During 1997, the Company raised  additional  equity of $5.8 million  through the
issuance of common stock,  convertible  preferred  stock and  warrants.  All net
proceeds were available to fund the Company's  operations.  Pursuant to the U.S.
Marketing  agreement  with Bausch & Lomb and  following the NDA  submission  for
Alrex, the Company received in March 1997, an additional $ 1 million in advances
against  future sales of the active drug substance  (needed to  manufacture  the
drug),  $ 143,333  of which  was  advanced  to the  license  holder.  Cumulative
advances  from Bausch & Lomb as of December 31, 1997 total $5 million.  Bausch &
Lomb will be entitled to recoup the advances by way of credits from future sales
of Lotemax,  Alrex and line extension products.  The Company may be obligated to
repay  such  advances  if it is  unable to  supply  Bausch & Lomb  with  certain
specified quantities of the active drug substance.


                                       19


<PAGE>


The Year 2000

     Management believes,  based on available information,  that it will be able
to manage its Year 2000  transition for systems and  infrastructure  without any
material  adverse  effect on its  business  operations,  products  or  financial
prospects.  There can be no  assurance,  however,  that a failure to resolve any
issue relating to such  transition  would not have a material  adverse effect on
the Company.

Item 8. Financial Statements and Supplementary Data

     The information  called for by this Item 8 is included following the "Index
to Financial Statements" contained in this Annual Report on Form 10-K.

Item  9.  Changes  in and  Disagreements  with  Accountants  on  Accounting  and
Financial Disclosure

     None.


                                       20


<PAGE>


                                    PART III

Item 10. Directors and Executive Officers of the Registrant

     The directors, officers and key employees of the Company are as follows:


Name                           Age      Position
----                           ---      --------
Haim Aviv, Ph.D.               57       Chairman, Chief Executive Officer,
                                          Chief Scientist and Director
Gad Riesenfeld, Ph.D.          54       President, Chief Operating Officer
Robert W. Cook                 42       Vice President Finance and
                                          Chief Financial Officer
Anat Biegon, Ph.D.             44       Vice President/Research and Development
Marvin P. Loeb                 71       Director
E. Andrews Grinstead III       52       Director
Stephen C. Knight, M.D.        38       Director
David Schlachet                52       Director
Fredric D. Price               52       Director
Mony Ben Dor                   52       Director

     Haim Aviv, Ph.D., is Chairman, Chief Executive Officer, Chief Scientist and
a Director of the Company and  co-founded in 1990,  Pharmos  Corporation,  a New
York corporation  ("Old Pharmos"),  which merged into the Company on October 29,
1992 (the "Merger").  Dr. Aviv also served as Chairman, Chief Executive Officer,
Chief Scientist and a Director of Old Pharmos prior to the Merger.  Dr. Aviv was
the   co-founder   in  1980  of   Bio-Technology   General  Corp.   ("BTG"),   a
publicly-traded company engaged in the development of products using recombinant
DNA, its General  Manager and Chief  Scientist from 1980 to 1985, and a Director
and Senior Scientific Consultant until August 1993. Prior to that time, Dr. Aviv
was a professor of molecular biology at the Weizmann  Institute of Science.  Dr.
Aviv is the principal  stockholder of Avitek Ltd., a stockholder of the Company.
Dr.  Aviv  is  also  an  officer  and/or  significant   stockholder  of  several
privately-held  Israeli  pharmaceutical  and venture  capital  companies and was
recently appointed Chairman of the Israel National Committee for Biotechnology .


                                       21


<PAGE>


     Gad Riesenfeld,  Ph.D., was named President and Secretary in February 1997,
and has  served  as Chief  Operating  Officer  since  March  1995.  He served as
Executive Vice President from December 1994 to February 1997,  Vice President of
Corporate  Development  and General  Manager of Florida  Operations from October
1992 to December  1994,  and was  employed by Pharmos  from March 1992 until the
Merger.  Prior thereto, he was engaged in free-lance  consulting relating to the
commercialization of intellectual property,  primarily in the pharmaceutical and
medical fields.  From March 1990 through May 1991 Dr.  Riesenfeld was a Managing
Director  of  Kamapharm  Ltd.,  a private  company  specializing  in human blood
products.  Prior  thereto,  from May 1986,  he was Managing  Director of Galisar
Ltd., a private company involved in extracorporeal blood therapy.

     Robert W. Cook was elected  Vice  President  - Finance and Chief  Financial
Officer of Pharmos in January 1998.  From May 1995 until his  appointment as the
Company's  Chief  Financial  Officer,  he was a vice  president  in GE Capital's
commercial finance subsidiary, based in New York. From 1978 until 1995, Mr. Cook
held a variety of corporate  finance and capital markets  positions at The Chase
Manhattan Bank,  both in the U.S. and in several  overseas  locations.  He was a
named a managing  director of Chase in January 1986.  Mr. Cook holds a degree in
international finance from The American University, Washington, D.C.

     Anat  Biegon,   Ph.D.,  has  served  as  Vice  President  of  Research  and
Development  since  December  1994.  Dr.  Biegon  became  head of  Research  and
Development  for the  Company  in 1994.  From  1992 to 1994,  Dr.  Biegon  was a
director in Pharmos Ltd.'s  Department of  Pharmacology.  From 1991 to 1992, she
was a Staff Physiologist at the University of California at Berkeley's  Lawrence
Berkeley  Laboratory,  Division of Research  Medicine and Radiation  Biophysics.
From  1990 to  1991,  Dr.  Biegon  was a  Research  Associate  Professor  in the
Department of Psychiatry at New York  University  Medical  Center.  From 1988 to
1990, she was an Associate  Professor in the Department of  Neurobiology  at the
Weizmann Institute of Science.

     Marvin P. Loeb, a Director,  was Chairman of the Board of the Company (then
known as Pharmatec,  Inc.) from December 1982 through  October 1992. He has been
Chairman of Trimedyne,  Inc. (and its  subsidiaries),  a  publicly-held  company
engaged in the manufacture of lasers, optical fibers and laser delivery systems,
since April 1981;  a Director of Gynex  Pharmaceuticals,  Inc.,  from April 1986
until its merger with and into  Biotechnology  General  Corporation  in 1993,  a
publicly-held  company  engaged  in the  development  and  commercialization  of
pharmaceutical  products; a Director of Petrogen, Inc., a privately-held company
engaged in the  genetic  engineering  of  bacteria  for cleanup of oil waste and
toxic  waste,  from April 1987 to April 1992  (Chairman  from  November  1980 to
December 1982 and from July 1983 to April 1987); Chairman of Automedix Sciences,
Inc., an inactive,  publicly-held company engaged in the development of products
for  treating  cancer and other  diseases,  since  September  1980;  Chairman of
Cardiomedics,  Inc., a privately-held,  development stage company engaged in the
development  of heart assist  devices,  from May 1986;  Chairman of  Xtramedics,
Inc., a  publicly-held  company  developing  a feminine  hygiene  product,  from
November 1986 to February  1994 and a Director of Xtramedics  from November 1986
until May 1994;  Chairman of  Ultramedics,  Inc.,  an  inactive,  privately-held
company developing blood treatment products,  since November 1988; and President
and Director of Marvin P. Loeb & Co.  since 1965,  and Master  Health  Services,
Inc. since 1972, both of which are family-held companies engaged in licensing of
inventions and financial consulting.

     E.  Andrews  Grinstead,  III, a Director  of the  Company  since  1991,  is
Chairman  of the  Board  and  Chief  Executive  Officer  of  Hybridon,  Inc.,  a
privately-held  biotechnology  company.  Mr.  Grinstead joined Hybridon in 1991.
From 1987 to October 1990,  he was Managing  Director and Group Head of the life
sciences  group at  PaineWebber,  Inc.  From  1986 to 1987,  Mr.  Grinstead  was
Managing Director and Group Head of the life sciences group at Drexel

                                       22


<PAGE>


Burnham  Lambert,  Inc.  From 1984 to 1986,  he was a Vice  President at Kidder,
Peabody & Co.,  Inc.,  where he developed  the life sciences  corporate  finance
specialty group.  Prior to his seven years on Wall Street,  Mr. Grinstead served
in a variety of  operational  and executive  positions with Eli Lilly & Company,
most recently as general manager of Venezuelan Pharmaceutical, Animal Health and
Agricultural  Chemical  Operations.  Since 1991,  Mr.  Grinstead has served as a
Director of EcoScience Corporation,  a development-stage  company engaged in the
development of  biopesticides.  He also serves as a director of Meridian Medical
Technologies,  Inc., a pharmaceutical and medical device company.  Mr. Grinstead
has served as a member of the Board of Trustees for the Albert B. Sabine Vaccine
Foundation,  a 501(c)(3)  charitable  foundation dedicated to disease prevention
since 1994, and on the Board of the  Massachusetts  Biotech  Counsel since 1997.
Mr.  Grinstead was appointed to the President's  Council of the National Academy
of Sciences and the  Institute of Medicine in 1992.  Mr.  Grinstead  received an
A.B. from Harvard College in 1967, a J.D. from the University of Virginia School
of Law in 1974 and an  M.B.A.  from the  Harvard  Graduate  School  of  Business
Administration in 1976.

     Stephen C. Knight, M.D., a Director of the Company since November 10, 1994,
is Senior Vice President Finance,  Corporate Development,  of Epix Medical, Inc.
Prior to joining Epix Medical in July 1996,  Dr. Knight was a Senior  Consultant
at Arthur D. Little,  Inc. During the past five years, he has been involved in a
variety of corporate and research and development strategic planning, technology
assessment,   and  merger  and  acquisition   studies  in  the   pharmaceutical,
biotechnology,   health  care  information,  medical  equipment  and  diagnostic
industries. Prior to joining Arthur D. Little, Dr. Knight worked as a consultant
at  APM,  Inc.  Dr.  Knight  has  performed  medical  research  at the  National
Institutes   of  Health,   AT&T  Bell   Laboratories,   and  Yale  and  Columbia
Universities.  Dr.  Knight  holds an M.D.  from the Yale  University  School  of
Medicine and an MPPM from the Yale School of Organization and Management.

     David  Schlachet,  a Director of the Company  since  December 15, 1994,  is
Chief Executive  Officer at Strauss  Holdings Ltd. and Vice President at Strauss
Dairies  Ltd.  The  Strauss  Group is  Israel's  largest  privately  owned  food
manufacturer.  Mr. Schlachet was Vice President of Finance and Administration at
the  Weizmann  Institute  of Science in Rehovot,  Israel from 1990 to  December,
1995. Mr.  Schlachet was  responsible  for the  Institute's  administration  and
financial  activities,   including  personnel,   budget  and  finance,  funding,
investments,  acquisitions  and  collaboration  with the industrial and business
communities.  From 1989 to 1990, Mr. Schlachet was President and Chief Executive
Officer of YEDA  Research and  Development  Co. Ltd., a marketing  and licensing
company at the  Weizmann  Institute of Science.  Mr.  Schlachet is a Director of
Taya Investment Company Ltd., an Israeli publicly-held investment company.

     Fredric  Price,  a  Director  of the  Company  since  August  1996 has been
President,  Chief Executive  Officer,  and a member of the Board of Directors of
AMBI Inc. (NASDAQ: AMBI), a company that develops and commercializes proprietary
nutrition  products for  cardiovascular  conditions and diabetes since September
1994. He is Secretary  and a member of the  Executive  Committee of the Board of
Directors of the of the New York  Biotechnology  Association.  From July 1991 to
September  1994,  he was Vice  President  Finance  &  Administration  and  Chief
Financial  Officer of Regeneron  Pharmaceuticals,  Inc.  From March 1986 to July
1991, he was a pharmaceuticals and biotechnology  industry strategy  consultant.
From 1973 to 1986, he was employed by Pfizer Pharmaceuticals where he was a Vice
President.  Mr.  Price  received a B.A.  in 1967 from  Dartmouth  College and an
M.B.A. in 1969 from the Wharton School of the University of Pennsylvania.

     Mony Ben Dor, a Director  of the  Company  since  September  1997,  is Vice
President of The Israel  corporations,  Ltd. and chairman of two publicly traded
subsidiaries: H.L. Finance and Leasing and Albany Bonded International Trade. He
is also a director of a number of subsidiary  companies of Israel Chemicals Ltd.
From 1992 to 1997,  Mr. Ben Dor was Vice President of Business  Development  for
Clal Industries Ltd. (a subsidiary of Clal Israel),  which is one of the leading
investment groups in Israel. He was actively involved in the acquisition of


                                       23


<PAGE>


companies  including  Jaffora Ltd. and a portfolio of  pharmaceutical  companies
including  Pharmaceutical  Resources  Inc.  and  Finetech  Ltd.  He  served as a
director  representing Clal Industries in all of the acquired  companies as well
as other companies of Clal Industries.  Prior to his position at Clal Industries
Ltd.,  Mr.  Ben Dor  served as  Business  Executive  at the  Eisenberg  Group of
companies.

Section 16 Filings

     No person  who,  during the fiscal  year ended  December  31,  1997,  was a
director,  officer or beneficial owner of more than ten percent of the Company's
Common  Stock which is the only class of  securities  of the Company  registered
under  Section  12 of  the  Securities  Exchange  Act of  1934  (the  "Act"),  a
"Reporting Person" failed to file on a timely basis, reports required by Section
16 of the Act during the most recent fiscal year.  The foregoing is based solely
upon a review by the Company of Forms 3 and 4 during the most recent fiscal year
as furnished to the Company under Rule  16a-3(d)  under the Act, and Forms 5 and
amendments  thereto  furnished  to the Company  with  respect to its most recent
fiscal year, and any  representation  received by the Company from any reporting
person that no Form 5 is required.


                                       24


<PAGE>


Item 11. Executive Compensation

             The following table summarizes the total  compensation of the Chief
Executive Officer of the Company for 1997 and the two previous years, as well as
all other executive officers of the Company who received  compensation in excess
of $100,000 for 1997.

Summary Compensation Table

<TABLE>
<CAPTION>
                               Annual Compensation                                                  Long Term Compensation
                               -------------------                                                  ----------------------
                                                                                                                       Stock
Name/                                                                                                Restricted     Underlying
Principal Position             Year         Salary            Bonus                    Other           Stock         Options
------------------             ----         ------           ------                    -----           -----         --------
<S>                            <C>         <C>               <C>                    <C>              <C>            <C>

Haim Aviv, Ph.D
Chairman, Chief                1997        $227,471          $ 40,000               $ 16,119(1)
Executive Officer, and         1996         236,453                                   27,435(1)
Chief Scientist                1995         200,230                                                                 324,376


Gad Riesenfeld, Ph.D
President and                  1997        $175,000                                   44,948(2)
Chief Operating Officer        1996         150,000                                   43,798(2)
                               1995         136,664                                   34,481(2)                      79,333


Alan M. Mark
Acting Chief                   1997                                                 $255,000(3)
Financial Officer(4)           1996                                                  150,000(3)


Anat Biegon, Ph.D
Vice President of              1997        $ 81,873          $ 20,456               $ 27,860(1)
Research and                   1996          85,516                                   26,565(1)
Development
</TABLE>


1)   Consists of  contributions  to insurance  premiums,  car  allowance and car
     expenses.

2)   Consists of housing allowance, contributions to insurance premiums, and car
     allowance.

3)   Consists of non-employee compensation.

4)   Acting Chief Financial Officer from July 1996 through July 1997. On January
     1, 1998, Mr. Robert W. Cook was appointed Vice President  Finance and Chief
     Financial Officer of the Company.

                                       25


<PAGE>


     The  following  tables  set forth  information  with  respect  to the named
executive  officers  concerning  the grant,  repricing  and  exercise of options
during the last fiscal year and  unexercised  options  held as of the end of the
fiscal year.


Option Grants for the Year
Ended December 31, 1997:

     None.(1)(2)(3)

          (1)  In 1997, the Company issued  warrants to purchase an aggregate of
               1,030,000  shares of common  stock to  certain  employees  of the
               Company.  Of such  warrants,  955,000 were granted at an exercise
               price of $1.59 per share and 75,000  were  granted at an exercise
               price of $1.66  per  share,  250,000  were  issued  to Dr.  Aviv,
               175,000 were issued to Dr. Riesenfeld, and 125,000 were issued to
               Dr. Biegon. Such warrants become exercisable in increments of 25%
               each, on their respective  anniversary  dates, in the years 1998,
               1999,  2000 and  2001.  All of such  warrants  expire in the year
               2007.

          (2)  In 1997, the Company  issued an aggregate of 201,052  warrants to
               Alan Mark.  Of such  warrants  15,000  were issued at an exercise
               price of $1.59 per share, 15,000 were issued at an exercise price
               of $1.22 per share and 171,052  were issued at an exercise  price
               of $1.38 per share. The 171,052 warrants were issued as a finders
               fee for a private  placement  transaction  that was  completed in
               March 1997.

          (3)  On January 9, 1998,  the  Company  issued  options to purchase an
               aggregate of 100,000  shares of common stock at an exercise price
               of $2.00 to Robert W. Cook,  the  Company's  new Chief  Financial
               Officer.  Of such  options,  25,000 vested  immediately,  and the
               remainder  will become  exercisable  in  increments  of 25,000 on
               January   1,  1999,   January  1,  2000  and   January  1,  2001,
               respectively.


Aggregated  Option  Exercises
for the Year Ended  December 31, 1997
and Option Values as of December 31, 1997:

<TABLE>
<CAPTION>
                                                                                             Value of Unexercised
                      Number of                            Number of Unexercised           In-the-Money Options at
                       Shares                              Options at December 31,            December 31, 1997
                     Acquired on        Value          --------------------------------  -----------------------------
Name                  Exercise         Realized                    1997                  Exercisable     Unexercisable
----                  --------         --------                    ----                  -----------     -------------
                                                        Exercisable      Unexercisable
                                                        -----------      -------------
<S>                      <C>              <C>             <C>                <C>           <C>              <C>
Haim Aviv,
Ph.D.                    0                0               255,376            69,000        $72,000           $48,000

Gad
Riesenfeld,              0                0               57,466             21,867        $48,000          $32,000
Ph.D.

Anat Biegon,             0                0               34,426             16,107        $36,000          $24,000
Ph.D.

</TABLE>


                                       26


<PAGE>


Stock Option Plans

     It is currently  the  Company's  policy that all full time key employees be
considered  annually for the possible  grant of stock  options,  depending  upon
employee performance. The criteria for the awards are experience,  uniqueness of
contribution  to the Company  and level of  performance  shown  during the year.
Stock options are intended to improve  loyalty to the Company and help make each
employee  aware of the  importance of the business  success of the Company.  The
amount and exercise price of all options discussed herein have been adjusted for
the Reverse Share Split.

     As of December 31, 1997, the Company has 833,601 options to purchase shares
of the Company's Common Stock outstanding under various option plans, 247,626 of
which were issued under no  established  plan.  During 1997, the Company did not
grant any options to purchase shares of its Common Stock to employees. A summary
of the various established stock option plans is as follows:

     1983, 1984,  1986, 1988 Plans. The Company (then known as Pharmatec,  Inc.)
established  Incentive  Stock  Option  Plans  in 1983,  1984,  1986 and 1988 for
officers and employees.  There are currently no options  outstanding under these
plans and it is anticipated that future grants of stock options will not be made
from these plans.

     1991 Plan. Old Pharmos  established a stock option plan in 1991.  There are
currently 11,476 options  outstanding under this plan and it is anticipated that
future grants of stock options will not be made from this plan.

     1992 Plan.  The  maximum  number of shares of the  Company's  Common  Stock
available  for  issuance  under  the 1992 Plan is  750,000  shares,  subject  to
adjustment   in  the  event  of  stock   splits,   stock   dividends,   mergers,
consolidations  and the like.  Common Stock subject to options granted under the
1992 Plan that expire or  terminate  will again be  available  for options to be
issued  under the 1992 Plan.  As of December  31,  1997,  there were  options to
purchase  574,499 shares of the Company's  Common Stock  outstanding  under this
plan.  Each option  granted  outstanding  under the 1992 plan as of December 31,
1997 expires on October 31, 2005.

     1997 Plan. The 1997 Plan will be administered  by a committee  appointed by
the  Board  of  Directors  (the  "Compensation   Committee").   Members  of  the
Compensation  Committee  will not be eligible to receive  options while they are
members except to the extent otherwise  permitted under the requirements of Rule
16b-3 under the Securities Exchange Act of 1934. The Compensation Committee will
designate the persons to receive  options,  the number of shares  subject to the
options  and the  terms of the  options,  including  the  option  price  and the
duration of each option, subject to certain limitations.

     The maximum  number of shares of Common Stock  available for issuance under
the 1997 Plan is 600,000  shares,  subject to  adjustment  in the event of stock
splits,  stock dividends,  mergers,  consolidations  and the like.  Common Stock
subject to options  granted  under the 1997 Plan that expire or  terminate  will
again be available for options to be issued under the 1997 Plan.

     The price at which shares of Common Stock may be purchased upon exercise of
an  incentive  stock  option must be at least 100% of the fair  market  value of
Common  Stock on the date the option is granted (or at least 110% of fair market
value in the case of a person holding more than 10% of the outstanding


                                       27


<PAGE>


shares of Common Stock (a "10% Stockholder")).

     The  aggregate  fair  market  value  (determined  at the time the option is
granted)  of Common  Stock with  respect to which  incentive  stock  options are
exercisable  for the first time in any  calendar  year by an optionee  under the
1997 Plan or any other  plan of the  Company or a  subsidiary,  shall not exceed
$100,000.  The  Compensation  Committee will fix the time or times when, and the
extent to  which,  an option is  exercisable,  provided  that no option  will be
exercisable  earlier  than one year or later  than ten  years  after the date of
grant (or five  years in the case of a 10%  Stockholder).  The  option  price is
payable in cash or by check. However, the Board of Directors may grant a loan to
an employee, pursuant to the loan provision of the 1997 Plan, for the purpose of
exercising  an option or may  permit  the  option  price to be paid in shares of
Common Stock at the then current fair market value, as defined in the 1997 Plan.

     Upon  termination of an optionee's  employment or consultancy,  all options
held  by  such  optionee  will  terminate,  except  that  any  option  that  was
exercisable on the date employment or consultancy  terminated may, to the extent
then  exercisable,  be exercised  within three  months  thereafter  (or one year
thereafter if the termination is the result of permanent and total disability of
the  holder),  and  except  such  three  month  period  may be  extended  by the
Compensation  Committee in its  discretion.  If an optionee  dies while he is an
employee or a consultant or during such  three-month  period,  the option may be
exercised  within one year after death by the decedent's  estate or his legatees
or distributees, but only to the extent exercisable at the time of death.

     The 1997 Plan  provides  that  outstanding  options  shall  vest and become
immediately  exercisable in the event of a "sale" of the Company,  including (i)
the  sale of more  than  75% of the  voting  power  of the  Company  in a single
transaction  or a series of  transactions,  (ii) the sale of  substantially  all
assets of the Company,  (iii) approval by the stockholders of a  reorganization,
merger or  consolidation,  as a result of which the  stockholders of the Company
will own less  than  50% of the  voting  power  of the  reorganized,  merged  or
consolidated company.

     The Board of Directors may amend, suspend or discontinue the 1997 Plan, but
it must obtain stockholder approval to (i) increase the number of shares subject
to the 1997 Plan, (ii) change the  designation of the class of persons  eligible
to receive  options,  (iii)  decrease the price at which options may be granted,
except that the Board may, without stockholder  approval accept the surrender of
outstanding  options and authorize  the granting of new options in  substitution
therefor specifying a lower exercise price that is not less than the fair market
value of Common  Stock on the date the new option is  granted,  (iv)  remove the
administration of the 1997 Plan from the Compensation Committee,  (v) render any
member of the  Compensation  Committee  eligible to receive an option  under the
1997 Plan while  serving  thereon,  or (vi) amend the 1997 Plan in such a manner
that options issued under it intend to be incentive stock options,  fail to meet
the  requirements  of Incentive  Stock  Options as defined in Section 422 of the
Code.

     Under current  federal income tax law, the grant of incentive stock options
under the 1997 Plan will not result in any taxable income to the optionee or any
deduction  for the  Company at the time the options are  granted.  The  optionee
recognizes  no gain upon the exercise of an option.  However the amount by which
the fair  market  value of  Common  Stock at the time the  option  is  exercised
exceeds the option price is an


                                       28


<PAGE>


"item of tax  preference"  of the  optionee,  which may cause the optionee to be
subject to the  alternative  minimum  tax. If the  optionee  holds the shares of
Common Stock  received on exercise of the option at least one year from the date
of exercise  and two years from the date of grant,  he will be taxed at the time
of sale at long-term  capital  gains  rates,  if any, on the amount by which the
proceeds of the sale exceed the option  price.  If the optionee  disposes of the
Common Stock before the required  holding period is satisfied,  ordinary  income
will generally be recognized in an amount equal to the excess of the fair market
value of the  shares of Common  Stock at the date of  exercise  over the  option
price, or, if the disposition is a taxable sale or exchange,  the amount of gain
realized on such sale or exchange if that is less.  If, as permitted by the 1997
Plan,  the Board of  Directors  permits an  optionee  to  exercise  an option by
delivering already owned shares of Common Stock valued at fair market value) the
optionee will not recognize  gain as a result of the payment of the option price
with such already owned shares.  However,  if such shares were acquired pursuant
to the  previous  exercise of an option,  and were held less than one year after
acquisition  or less than two years from the date of grant,  the  exchange  will
constitute a disqualifying  disposition  resulting in immediate  taxation of the
gain on the already  owned  shares as ordinary  income.  It is not clear how the
gain will be  computed on the  disposition  of shares  acquired by payment  with
already owned shares.

1997 Employees and Directors Warrants Plan

     The 1997  Employees and  Directors  Warrants Plan was approved by the Stock
Option Committee as of February 12, 1997 and March 19, 1997.  1,030,000 Warrants
to purchase  1,030,000 shares of Common Stock were granted to certain  employees
of the Company.  Of such warrants,  955,000 were granted at an exercise price of
$1.59 per share and 75,000 were granted and an exercise  price of 1.66 per share
(together,  the "1997 Employees  Warrants").  The 1997 Employees Warrants become
exercisable in increments of 25% each on their first,  second,  third and fourth
anniversaries, respectively, and shall expire in the year 2007. 100,000 Warrants
to purchase  100,000  shares of Common  Stock were  granted to  directors of the
Company at an exercise price of $1.59 per share (the "1997 Directors  Warrants")
on  February  12,  1997.  The 1997  Directors  Warrants  become  exercisable  in
increments of 25% each on the first,  second,  third and fourth anniversaries of
February 12, 1997 and shall expire on February 12, 2003.

     Upon  termination  of  a  Warrant  Holder's   employment,   consultancy  or
affiliation  with the  Company,  all Warrants  held by such Warrant  Holder will
terminate,  except that any Warrant that was  exercisable  on the date which the
employment,  consultancy  or  affiliation  terminated  may,  to the extent  then
exercisable, be exercised within three months thereafter (or one year thereafter
if the  termination  is the  result of  permanent  and total  disability  of the
holder). If a Warrant Holder dies while he or she is an employee,  consultant or
affiliate of the Company,  or during such three month period, the Warrant may be
exercised  within one year after death by the decedent's  estate or his legatees
or distributees, but only to the extent exercisable at the time of death.


Employment/Consulting Contracts/Directors' Compensation

     Haim Aviv,  Ph.D. In addition to serving as Chairman of the Board and Chief
Executive  Officer of the  Company,  Dr. Aviv has provided  consulting  services
under a consulting agreement with an initial three-year


                                       29


<PAGE>


term ended May 3, 1993. The term  automatically  renews for additional  one-year
periods unless either the Company or Dr. Aviv  terminates the agreement at least
90 days prior to a scheduled  expiration date. The agreement has been renewed on
an annual basis and  presently  expires on May 3, 1998.  Dr. Aviv is entitled to
severance  pay  equal  to 25% of his  salary  in the  event  of  termination  or
non-renewal  without cause. Under the agreement,  Dr. Aviv is required to render
certain consulting services to the Company and in consideration  therefore,  Dr.
Aviv is entitled to receive  $170,000 per year,  subject to yearly increases and
review.

     The  Company's  subsidiary,  Pharmos  Ltd.,  employs  Dr. Aviv as its Chief
Executive Officer under an employment  agreement with Dr. Aviv pursuant to which
Dr. Aviv receives $50,000 per year,  subject to yearly increases and review. Dr.
Aviv is required to devote at least 50% of his  business  time and  attention to
the business of Pharmos, Ltd. and to serve on its Board of Directors.


     Gad Riesenfeld,  Ph.D. In October 1992, Old Pharmos entered into a one-year
employment agreement with Dr. Riesenfeld,  which is automatically  renewable for
successive one-year terms unless either party gives three months prior notice of
non-renewal.  Under  the  Agreement,  Dr.  Riesenfeld  devotes  his full time to
serving as  President of the Company.  Dr.  Riesenfeld's  annual gross salary is
$175,000.

     Directors'   Compensation.   In  1997,   Directors   did  not  receive  any
compensation for service on the Board or for attending Board meetings.


                                       30


<PAGE>


Item 12. Security Ownership of Certain Beneficial Owners and Management

     The  following  table sets forth  certain  information  with respect to the
beneficial  ownership of the Company's Common Stock as of March 13, 1998, by (i)
each person who was known by the Company to own beneficially more than 5% of any
class of the Company's Common Stock, (ii) each of the Company's  Directors,  and
(iii) all current  Directors and  executive  officers of the Company as a group.
Except  as  otherwise  noted,  each  person  listed  below has sole  voting  and
dispositive power with respect to the shares listed next to such person's name.



                                    Amount of
Name and Address of                 Beneficial              Percentage of
Beneficial Ownership                Ownership                  Total (1)
--------------------                ---------                  ---------

Haim Aviv, Ph.D.(2)                  1,167,305                    3.2%
c/o Pharmos Ltd.
Kiryat Weitzman
Rehovot, Israel


Marvin P. Loeb(3)                      293,990                       *
Trimedyne, Inc.
2810 Barranca Road
Irvine, CA 92714


E. Andrews Grinstead III(4)             98,333                       *
Hybridon, Inc.
One Innovation Drive
Worcester, MA 01605


Stephen C. Knight, M.D.(4)              11,667                       *
Epix Medical, Inc.
71 Rogers Street
Cambridge, MA 02142


David Schlachet(4)                      11,667                       *
Strauss Ltd.
16 Bazel Street
Petach-Tikva, Israel 49510


                                       31


<PAGE>


Mony Ben Dor
The Israel Corporation
4 Weizman St.                                0                       *
Tel-Aviv 61336, Israel

Fredric D. Price (5)                     9,250                       *
Applied Microbiology, Inc.
771 Old Saw Mill River Road
Tarrytown, NY 10591


All Directors and                    1,653,212                    4.5%
Executive Officers
as a group
(9 persons)(6)

----------

*    Indicates ownership of less than 1%.

1)   Based  on  36,296,751  shares  of  Common  Stock  outstanding,   plus  each
     individual's  currently  exercisable  warrants or options.  Assumes that no
     other individual will exercise any warrants and/or options.

(2)  Includes 276,153 shares of Common Stock held in the name of Avitek Ltd., of
     which Dr. Aviv is the Chairman of the Board of Directors  and the principal
     stockholder,  and,  as such,  shares the right to vote and  dispose of such
     shares.  Also includes  currently  exercisable  options to purchase 255,376
     shares of Common Stock.

(3)  Held jointly with his wife. Also includes currently exercisable options and
     warrants to purchase 48,344 shares of Common Stock. Does not include shares
     held by his adult children, his grandchildren or a trust for the benefit of
     his grandchildren.

(4)  Consists of currently  exercisable  options and warrants to purchase Common
     Stock.

(5)  Includes  currently  exercisable  options and  warrants  to purchase  7,500
     shares of Common Stock.

(6)  Based on the number of shares of Common  Stock  outstanding,  plus  556,126
     currently  exercisable  warrants  and/or  options held by the Directors and
     executive officers.


Item 13. Certain Relationships and Related Transactions


             None.


                                       32


<PAGE>


                                     PART IV


Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

     (a)  Financial Statements and Exhibits

          (1)  FINANCIAL STATEMENTS

               Report of Independent Accountants

               Consolidated Balance Sheets at December 31, 1997 and 1996

               Consolidated   Statements  of  Operations  for  the  years  ended
               December 31, 1997, 1996 and 1995

               Consolidated  Statements of Changes in  Shareholders'  Equity for
               the years ended December 31, 1997, 1996 and 1995

               Consolidated  Statements  of  Cash  Flows  for  the  years  ended
               December 31, 1997, 1996 and 1995

               Notes to Consolidated Financial Statements

          (2)  FINANCIAL STATEMENT SCHEDULES

               All financial  statement  schedules are omitted  because they are
               not  applicable  or the  required  information  is  shown  in the
               financial statements or note thereto.

          (3)  EXHIBITS; EXECUTIVE COMPENSATION PLANS

Exhibits

2 Plan of acquisition, reorganization, arrangement, liquidation or succession

     2(a) Agreement  and  Plan of  Merger  dated as of March  28,  1995  between
          Pharmos  Corporation,  PMC Merger  Corporation and Oculon  Corporation
          (Incorporated  by reference to the  Company's  Current  Report on Form
          8-K, dated April 11, 1995, as amended).


                                       33


<PAGE>


3 Articles of Incorporation and By-Laws

     3(a)      Restated Articles of Incorporation  (Incorporated by reference to
               Appendix E to the Joint  Proxy  Statement/Prospectus  included in
               the  Form  S-4  Registration   Statement  of  the  Company  dated
               September   28,   1992   (No.   33-52398)   (the   "Joint   Proxy
               Statement/Prospectus").

     3(b)      Certificate  of Amendment of Restated  Articles of  Incorporation
               (Incorporated  by reference to Annual Report on Form 10-K for the
               year ended December 31, 1994).

     3(c)      Amended and Restated  By-Laws  (Incorporated by reference to Form
               S-1  Registration  Statement  of the Company  dated June 30, 1994
               (No. 33-80916)).

     3(d)      Certificate  of Amendment of Restated  Articles of  Incorporation
               dated  January  16,  1998   (Incorporated  by  reference  to  the
               Company's Current Report on Form 8-K, dated February 6, 1998).

4 Instruments defining the rights of security holders, including indentures

     4(a)      1983  Incentive  Stock Option Plan (The  Company's  1984 and 1986
               Plans are  identical in all  respects  except as to the number of
               shares subject to option) (Incorporated by reference to Form S-18
               Registration  Statement  of the  Company  dated  June 7, 1983 (2-
               84298-C)).

     4(b)      Amendment  of 1983,  1984 and 1986  Incentive  Stock Option Plans
               (Incorporated  by reference to Annual Report on Form 10-K for the
               year ended December 31, 1988).

     4(c)      1988 Incentive  Stock Option Plan  (Incorporated  by reference to
               Annual Report on Form 10-K for the year ended December 31, 1988).

     4(d)      Pharmos    Corporation   1991   Incentive   Stock   Option   Plan
               (Incorporated  by reference to Annual Report on Form 10-K for the
               year ended December 31, 1992).

     4(e)      1992  Incentive and  Non-Qualified  Stock Option Plan (Annexed as
               Appendix F to the Joint Proxy Statement/Prospectus).

     4(f)      Form of Class A Warrant to  purchase  (x) shares of Common  Stock
               and (y) Class B Warrants  (Incorporated  by  reference  to Annual
               Report on Form 10-K for the year ended December 31, 1991).

     4(g)      Form of Class B  Warrant  to  purchase  shares  of  Common  Stock
               (Incorporated  by reference to Annual Report on Form 10-K for the
               year ended December 31, 1991).


                                       34


<PAGE>


     4(h)      Unit Purchase  Option  Agreement  dated February 18, 1992 between
               the Company and David Blech  (Incorporated by reference to Annual
               Report on Form 10-K for the year ended December 31, 1991).

     4(i)      Form of Warrant to purchase  Common Stock at an exercise price of
               $1.31 per share (pre-reverse split) (Incorporated by reference to
               Form S-3  Registration  Statement of the Company dated  September
               14, 1993 (33-68762)).

     4(j)      Form of Placement  Agent's  Warrant  Agreement,  dated August 13,
               1993,  to  purchase  shares  of  Common  Stock  (Incorporated  by
               reference to Form S-3 Registration Statement of the Company dated
               September 14, 1993 (33-68762)).

     4(k)      Registration  Agreement dated as of January 18, 1994 by and among
               the  Company,  David Blech and Lake  Charitable  Remainder  Trust
               (Incorporated by reference to Form S-3 Registration  Statement of
               the Company dated January 28, 1993 (33-74638)).

     4(l)      Form of Stock  Purchase  Agreement  dated as of September 2, 1994
               between the Company and the Purchaser  (Incorporated by reference
               to Form S-1 Registration  Statement of the Company dated June 30,
               1994 [No. 33-80916], Amendment No. 2).

     4(m)      Form of Warrant  Agreement  dated  September  2, 1994 to purchase
               42,000 shares of Common Stock  (Incorporated by reference to Form
               S-1  Registration  Statement  of the Company  dated June 30, 1994
               [No. 33-80916], Amendment No. 2).

     4(n)      Form of Common Stock  Purchase  Agreement  dated as of October 4,
               1994  between  the Company and the  Purchasers  (Incorporated  by
               reference to Form S-3 Registration Statement of the Company dated
               November 25, 1994 [No. 33-86720]).

     4(o)      Warrant  Agreement  dated October 4, 1994 between the Company and
               Judson Cooper (Incorporated by reference to Form S-3 Registration
               Statement of the Company dated November 25, 1994 [No. 33-86720]).

     4(p)      Form of  Convertible  Debenture  Purchase  Agreement  dated as of
               February  7,  1995   between   the  Company  and  the   Investors
               (Incorporated  by reference to Annual Report on Form 10-K for the
               year ended December 31, 1994).

     4(q)      Warrant  Agreement dated February 7, 1995 between the Company and
               Judson Cooper (Incorporated by reference to Annual Report on Form
               10-K for the year ended December 31, 1994).

     4(r)      Form of Employee Warrant Agreement, dated April 11, 1995, between
               the Company and Oculon Corporation  (Incorporated by reference to
               the Company's  Current  Report on Form 8-K, dated April 11, 1995,
               as amended).


                                       35


<PAGE>


     4(s)      Form of Penalty Warrant Agreement,  dated April 11, 1995, between
               the Company and Oculon Corporation  (Incorporated by reference to
               the Company's  Current  Report on Form 8-K, dated April 11, 1995,
               as amended).

     4(t)      Form of Unit  Purchase  Agreement  dated as of September 14, 1995
               between the Company and the Investors  (Incorporated by reference
               to the Company's  Current Report on Form 8-K, dated September 14,
               1995).

     4(u)      Form of Warrant  Agreement dated as of September 14, 1995 between
               the Company and the Investors  (Incorporated  by reference to the
               Company's Current Report on Form 8- K, dated September 14, 1995).

     4(v)      Form of Warrant  Agreement dated as of April 30, 1995 between the
               Company and Charles  Stolper  (Incorporated  by reference to Form
               S-3  Registration  Statement  of the Company  dated  November 14,
               1995, as amended [No. 33-64289]).

     4(w)      Form of Warrant  Agreement dated as of April 30, 1995 between the
               Company and  Janssen/Meyers  Associates,  L.P.  (Incorporated  by
               reference to Form S-3 Registration Statement of the Company dated
               November 14, 1995, as amended [No. 33-64289]).

     4(x)      Form of Warrant  Agreement  dated as of October 31, 1995  between
               the Company and S. Colin Neill (Incorporated by reference to Form
               S-3  Registration  Statement  of the Company  dated  November 14,
               1995, as amended [No. 33-64289]).

     4(y)      Certificate of Designation, Rights, Preferences and Privileges of
               Series  A  Preferred  Stock  of  the  Company   (Incorporated  by
               reference to Form S-3 Registration Statement of the Company dated
               December 20, 1996, as amended [No. 333-15165]).

     4(z)      Form of 5% Preferred Stock Securities Purchase Agreement dated as
               of  September  30, 1996  between  the  Company and the  Investors
               (Incorporated by reference to Form S-3 Registration  Statement of
               the Company dated December 20, 1996, as amended [No. 333-15165]).

     4(a)(a)   Form of Stock  Purchase  Warrant  dated as of September  30, 1996
               between the Company and the Investors  (Incorporated by reference
               to Form S-3 Registration  Statement of the Company dated December
               20, 1996, as amended [No. 333-15165]).

     4(a)(b)   Form of Stock  Purchase  Warrant  dated as of September  30, 1996
               between the Company and Alan M. Mark  (Incorporated  by reference
               to Form S-3 Registration  Statement of the Company dated December
               20, 1996, as amended [No. 333-15165]).

     4(a)(c)   Form of Warrant  Agreement dated as of March 15, 1996 between the
               Company and


                                       36


<PAGE>


               Michael E. Lewis,  Ph.D.  (Incorporated  by reference to Form S-3
               Registration Statement of the Company dated December 20, 1996, as
               amended [No. 333-15165]).

     4(a)(d)   Stock Purchase  Agreement,  dated December 12, 1996,  between the
               Company and Bausch & Lomb  Pharmaceuticals,  Inc.(Incorporated by
               reference to Annual Report on Form 10-K dated March 29, 1997.

     4(a)(e)   Certificate of Designation,  Rights Preferences and Privileges of
               Series  B  Preferred  Stock  of  the  Company   (Incorporated  by
               reference to Form S-3 Registration of the Company dated April 30,
               1997 [No. 333-26155]).

     4(a)(f)   Form of 5% Preferred Stock Securities Purchase Agreement dated as
               of  March  31,  1997  between  the  Company  and  the   Investors
               (Incorporated  by  reference  to  Form  S-3  Registration  of the
               Company dated April 30, 1997 [No. 333-26155]).

     4(a)(g)   Form of Stock Purchase Warrant dated as of March 31, 1997 between
               the Company and the Investors  (Incorporated by reference to Form
               S-3  Registration  Statement of the Company  dated April 30, 1997
               [No. 333-26155]).

     4(a)(h)   Certificate of Designation,  Rights Preferences and Privileges of
               Series  C  Preferred  Stock  of  the  Company   (Incorporated  by
               reference to the  Company's  Current  Report on Form 8-K filed on
               February 6, 1998).

     4(a)(i)   Form of  Securities  Purchase  Agreement  dated as of February 4,
               1998  between  the  Company  and  the  Investor  (Incorporate  by
               reference to the  Company's  Current  Report on Form 8-K filed on
               February 6, 1998).

     4(a)(j)   Form of Stock  Purchase  Warrant  dated as of  February  4,  1998
               between  the  Company  and the  Investor  and the Company and the
               Placement  Agent  (Incorporated  by  reference  to the  Company's
               Current Report on Form 8-K filed on February 6, 1998).

     4(a)(k)   Form of Stock Purchase Warrant dated as of March 31, 1997 between
               the Company and the Investor  (Incorporated  by reference to Form
               S-3  Registration  Statement  of the Company  dated March 5, 1998
               [No. 333-47359]).

10  Material Contracts

     10(a)     License  Agreement  dated as of March 14, 1989  between  National
               Technical Information Service (NTIS), U.S. Department of Commerce
               and the Company  (Incorporated  by reference to Annual  Report on
               Form 10-K for year ended December 31, 1989).

     10(b)     Common Stock and Warrant  Purchase  Agreement,  dated November 5,
               1991, between


                                       37


<PAGE>


               the Company and David Blech  (Incorporated by reference to Annual
               Report on Form 10-K for year ended December 31, 1991).

     10(c)     Private Placement Agreement,  dated November 5, 1991, between the
               Company  and David  Blech and D.  Blech &  Company,  Incorporated
               (Incorporated by reference to Annual Report on Form 10-K for year
               ended December 31, 1991).

     10(d)     Stock  Option  Agreement,  dated  March  20,  1992,  between  the
               Company, Pharmos Corporation, Xenon Vision, Inc. and the security
               holders of Xenon  Vision,  Inc.  (Incorporated  by  reference  to
               Annual Report on Form 10-K for year ended December 31, 1991).

     10(e)     Agreement and Plan of Merger,  dated May 13, 1992, as amended, by
               and among the Company,  Pharmatec Merger  Corporation and Pharmos
               Corporation  (composite copy as amended to date) (Incorporated by
               reference to the Joint Proxy Statement/Registration Statement).

     10(f)     Registration  Rights Agreement dated October 30, 1992 between the
               Company  and  the  security   holders  of  Xenon   Vision,   Inc.
               (Incorporated   by  reference  to  the  Joint  Proxy   Statement/
               Registration Statement).

     10(g)     Agreement  between  Avitek Ltd.  ("Avitek")  and Yissum  Research
               Development   Company  of  the  Hebrew  University  of  Jerusalem
               ("Yissum") dated November 20, 1986  (Incorporated by reference to
               Annual  Report on Form 10-K, as amended by Form 10- K/A, for year
               ended December 31, 1992).(1)

     10(g)(1)  Supplement  to  Agreement  (Incorporated  by  reference to Annual
               Report on Form 10-K,  as amended by Form  10-K/A,  for year ended
               December 31, 1992).1

     10(g)(2)  Hebrew   language   original   executed   version  of   Agreement
               (Incorporated  by  reference  to Annual  Report on Form 10-K,  as
               amended by Form 10-K/A, for year ended December 31, 1992).1

     10(h)     Agreement  between  Avitek  and Yissum  dated  January  25,  1987
               (Incorporated  by  reference  to Annual  Report on Form 10-K,  as
               amended by Form 10-K/A, for year ended December 31, 1992).1

     10(h)(1)  Schedules and Appendixes to Agreement  (Incorporated by reference
               to Annual  Report on Form 10-K,  as amended by Form  10-K/A,  for
               year ended December 31, 1992).1

     10(h)(2)  Hebrew   language   original   executed   version  of   Agreement
               (Incorporated  by  reference  to Annual  Report on Form 10-K,  as
               amended by Form 10-K/A, for year ended December 31, 1992).1


                                       38


<PAGE>


     10(i)     Research, Development and License Agreement between Pharmos Ltd.,
               Pharmos  Corporation ("Old Pharmos") and Yissum dated February 5,
               1991 (Incorporated by reference to Annual Report on Form 10-K, as
               amended by Form 10-K/A, for year ended December 31, 1992).1

     (10)(i)(1)Schedules and Appendixes to Agreement  (Incorporated by reference
               to Annual  Report on Form 10-K,  as amended by Form  10-K/A,  for
               year ended December 31, 1992).1

     10(j)     Pharmos Ltd.  Employment  Agreement with Haim Aviv ("Aviv") dated
               as of May 2, 1990 and Old Pharmos Consulting  Agreement with Aviv
               dated as of May 2, 1990, as amended by letter from Old Pharmos to
               Aviv dated June 27,  1990 and  Unanimous  Written  Consent of the
               Board  of  Directors   of  Old  Pharmos   dated  March  17,  1992
               (Incorporated  by  reference  to Annual  Report on Form 10-K,  as
               amended by Form 10- K/A, for year ended December 31, 1992).

     10(k)     Letter from Old Pharmos to D. Blech & Co. Incorporated ("D. Blech
               & Co.") dated June 27, 1991 re: consulting services (Incorporated
               by  reference to Annual  Report on Form 10-K,  as amended by Form
               10-K/A, for year ended December 31, 1992).

     10(l)     Old Pharmos Employment Agreement with Stephen Streber dated as of
               July 1, 1992  (Incorporated by reference to Annual Report on Form
               10-K,  as amended by Form 10- K/A,  for year ended  December  31,
               1992).

     10(m)     Letter dated July 27, 1992 from Old Pharmos to Henry Dachowitz re
               employment  (Incorporated  by reference to Annual  Report on Form
               10-K,  as amended by Form 10- K/A,  for year ended  December  31,
               1992).

     10(n)     Personal  Employment  Agreement dated October 1, 1992 between Old
               Pharmos and Gad Riesenfeld  (Incorporated  by reference to Annual
               Report on Form 10-K,  as amended by Form  10-K/A,  for year ended
               December 31, 1992).

     10(o)     Lease  Agreement  dated as of  November 1, 1992  between  Talquin
               Development Company and the Company (Incorporated by reference to
               Annual Report on Form 10- K, as amended by Form 10-K/A,  for year
               ended December 31, 1992).

     10(p)     Form of  Purchase  Agreement  dated as of August 13,  1993 by and
               among  the  Registrant  and the  Investors  listed  on  Exhibit A
               thereto  (Incorporated  by  reference  to Form  S-3  Registration
               Statement of the Company dated September 29, 1993 [33-68762]).

     10(q)     Amended and Restated  License  Agreement with Research  Component
               dated  July  1,  1993  between  University  of  Florida  Research
               Foundation,  Inc. and the Company  (Incorporated  by reference to
               Annual  Report on Form 10-K, as amended by Form 10- K/A, for year
               ended December 31, 1993).1


                                       39
<PAGE>


     10(r)     License  Agreement  dated as of April 2, 1993 between the Company
               and Dr.  Nicholas  Bodor  (Incorporated  by  reference  to Annual
               Report on Form 10-K,  as amended by Form  10-K/A,  for year ended
               December 31, 1993).1

     10(s)     Consulting  Agreement  dated as of  January 1, 1993  between  the
               Company and Dr.  Nicholas  Bodor  (Incorporated  by  reference to
               Annual Report on Form 10-K,  as amended by Form 10-K/A,  for year
               ended December 31, 1993).1

     10(t)     Product Development and Clinical Manufacturing Services Agreement
               dated as of October  21,  1994  between  the Company and Bausch &
               Lomb Pharmaceuticals,  Inc.  (Incorporated by reference to Annual
               Report on Form 10-K for the year ended December 31, 1994).

     10(u)     Agreement  and Release  dated as of November 11, 1994 between the
               Company and Stephen R.  Streber  (Incorporated  by  reference  to
               Annual Report on Form 10-K for the year ended December 31, 1994).

     10(v)     Employment  Agreement  dated as of November  11, 1994 between the
               Company and Henry M.  Dachowitz  (Incorporated  by  reference  to
               Annual Report on Form 10-K for the year ended December 31, 1994).

     10(w)     Marketing  Agreement,  dated as of June  30,  1995,  between  the
               Company and Bausch & Lomb Pharmaceuticals,  Inc. (Incorporated by
               reference to the Company's  Quarterly Report on Form 10-Q for the
               quarter ending June 30, 1995).1

     10(x)     Processing  Agreement,  dated as of June 30,  1995,  between  the
               Company and Bausch & Lomb Pharmaceuticals,  Inc. (Incorporated by
               reference to the Company's  Quarterly Report on Form 10-Q for the
               quarter ending June 30, 1995).1

     10(y)     Marketing  Agreement,  dated as of December 12, 1996, between the
               Company and Bausch & Lomb Pharmaceuticals, Inc.1

     10(z)     Consulting  Agreement,  dated  November  11,  1996,  between  the
               Company and Alan Mark.  (Incorporated  by  reference  to Form S-3
               Registration  Statement of the Company  dated April 30, 1997 [No.
               333-26155]).

     10(a)(a)**Employment  Agreement,  dated  December  15,  1997,  between  the
               Company and Robert W. Cook


                                       40


<PAGE>


21 Subsidiaries of the Registrant

     21(a)     Subsidiaries  of the  Registrant  (Incorporated  by  reference to
               Annual Report on Form 10- K, as amended by Form 10-K/A,  for year
               ended December 31, 1992).

----------
**   Filed herewith.

1    Confidential  information  is  omitted  and  identified  by a *  and  filed
     separately with the SEC.

Executive Compensation Plans and Arrangements

     1983  Incentive  Stock Option Plan (The  Company's  1984 and 1986 Plans are
     identical  in all  respects  except as to the  number of shares  subject to
     option) (Incorporated by reference to Exhibit 4(a) to Annual Report on Form
     10-K for the year ended December 31, 1988).

     Amendment of 1983, 1984 and 1986 Incentive Stock Option Plans (Incorporated
     by  reference  to Exhibit  4(b) to Annual  Report on Form 10-K for the year
     ended December 31, 1988).

     1988 Incentive Stock Option Plan (Incorporated by reference to Exhibit 4(c)
     to Annual Report on Form 10-K for the year ended December 31, 1988).

     Pharmos  Corporation  1991  Incentive  Stock Option Plan  (Incorporated  by
     reference to Exhibit 4(e) to Annual  Report on Form 10-K for the year ended
     December 31, 1992).

     1992 Incentive and  Non-Qualified  Stock Option Plan (Annexed as Appendix F
     to the Joint Proxy Statement/Prospectus).

     1997 Incentive and  Non-Qualified  Stock Option Plan (Annexed as Appendix B
     to the Proxy Statement).

     Pharmos Ltd.  Employment  Agreement with Haim Aviv ("Aviv") dated as of May
     2, 1990 and Old Pharmos  Consulting  Agreement with Aviv dated as of May 2,
     1990, as amended by letter from Old Pharmos to Aviv dated June 27, 1990 and
     Unanimous  Written  Consent of the Board of Directors of Old Pharmos  dated
     March 17, 1992 (Incorporated by reference to Exhibit 10(t) to Annual Report
     on Form 10-K, as amended by Form 10-K/A, for year ended December 31, 1992).

     Old Pharmos  Employment  Agreement with Stephen Streber dated as of July 1,
     1992  (Incorporated  by reference to Exhibit 10(x) to Annual Report on Form
     10-K, as amended by Form 10-K/A, for year ended December 31, 1992).

     Letter  dated  July  27,  1992  from Old  Pharmos  to  Henry  Dachowitz  re
     employment  (Incorporated by reference to Exhibit 10(y) to Annual Report on
     Form 10-K, as amended by Form 10-K/A, for year


                                       41


<PAGE>


     ended December 31, 1992).  Personal  Employment  Agreement dated October 1,
     1992 between Old Pharmos and Gad Riesenfeld  (Incorporated  by reference to
     Exhibit 10(z) to Annual Report on Form 10-K, as amended by Form 10-K/A, for
     year ended December 31, 1992).

     Agreement and Release dated as of November 11, 1994 between the Company and
     Stephen R. Streber (Exhibit 10(u) hereto).

     Employment  Agreement dated as of November 11, 1994 between the Company and
     Henry M. Dachowitz (Exhibit 10(t) hereto).

     Employment  Agreement,  dated  December 15,  1997,  between the Company and
     Robert W. Cook (Exhibit 10(a)(a) hereto).

     (b)  Reports on Form 8-K

          Since October 1, 1997,  the Company has filed two reports on Form 8-K,
          one on February 4, 1998 and one on March 10, 1998.

     (c)  Exhibits

          None.

     (d)  Financial Statement Schedules

          See Item 14(a)(2) above


                                       42


<PAGE>


                                   SIGNATURES


     Pursuant  to the  requirements  of  Section  13 or 15(d) 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.

                              PHARMOS CORPORATION


                             By: /s/ HAIM AVIV
                                 ----------------------------
                                 Dr. Haim Aviv, Chairman of the Board and Chief
                                 Executive Officer (Principal Executive Officer)

                                 Date: March 30, 1998

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
report  has  been  signed  below  by the  following  persons  on  behalf  of the
Registrant and in the capacities and on the dates indicated:

<TABLE>
<CAPTION>
Signature                             Title                                           Date
---------                             -----                                           ----
<S>                                   <C>                                             <C>
/s/ Robert Cook                       Chief Financial Officer (Principal              March 30, 1998
----------------------------
Robert Cook                           Financial and Accounting Officer),
                                      and Secretary
/s/ Dr. Gad Riesenfeld                President, Chief Operating Officer              March 30, 1998
----------------------------
Dr. Gad Riesenfeld
/s/ Marvin P. Loeb                    Director                                        March 30, 1998
------------------
Marvin P. Loeb
/s/ E. Andrews Grinstead III          Director                                        March 30, 1998
----------------------------
E. Andrews Grinstead III
/s/ Stephen C. Knight                 Director                                        March 30, 1998
----------------------------
Stephen C. Knight
/s/ David Schlachet                   Director                                        March 30, 1998
----------------------------
David Schlachet
/s/ Fredric D. Price                  Director                                        March 30, 1998
----------------------------
Fredric D. Price
/s/ Mony Ben Dor                      Director                                        March 30, 1998
----------------------------
Mony Ben Dor
</TABLE>



                                       43


<PAGE>

Pharmos Corporation
Consolidated Financial Statements
Years Ended December 31, 1997 and 1996


<PAGE>

                               Pharmos Corporation
                   Index to Consolidated Financial Statements


Report of Independent Accountants                                         F - 2

Consolidated balance sheets as of December 31, 1997 and 1996              F - 3

Consolidated statement of operations for the years ended
   December 31, 1997, 1996 and 1995.                                      F - 4

Consolidated statement of changes in shareholders' (deficit) equity
   for the years ended December 31, 1997, 1996 and 1995.                  F - 5

Consolidated statement of cash flows for the years ended
   December 31, 1997, 1996 and 1995.                                      F - 6

Notes to consolidated financial statements                         F - 7 - F 19




                                       F-1
<PAGE>


                        Report of Independent Accountants


March 16, 1998

To the Board of Directors and
Shareholders of Pharmos Corporation

In our opinion,  the  accompanying  consolidated  balance sheets and the related
consolidated  statements of operations,  of changes in  shareholders'  (deficit)
equity and of cash flows present fairly, in all material respects, the financial
position of Pharmos  Corporation  and its  subsidiary  at December  31, 1997 and
1996,  and the results of their  operations and their cash flows for each of the
three years in the period ended  December 31, 1997 in conformity  with generally
accepted   accounting   principles.   These   financial   statements   are   the
responsibility of the Company's management;  our responsibility is to express an
opinion on these  financial  statements  based on our audit.  We  conducted  our
audits of these  statements  in  accordance  with  generally  accepted  auditing
standards which require that we plan and perform the audit to obtain  reasonable
assurance   about  whether  the  financial   statements  are  free  of  material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the  amounts  and  disclosures  in  the  financial  statements,   assessing  the
accounting  principles  used and  significant  estimates  made by management and
evaluating the overall  financial  statement  presentation.  We believe that our
audits provide a reasonable basis for the opinion expressed above.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company will  continue as a going  concern.  The Company has suffered  recurring
losses from  operations and at December 31, 1997 has an  accumulated  deficit of
$72,069,727  that raise  substantial  doubt  about its  ability to continue as a
going  concern.  Management's  plans in regard to these matters are described in
Note 2. The  financial  statements  do not  include any  adjustments  that might
result from the outcome of this uncertainty.



PRICE WATERHOUSE L.L.P.



Melville, NY



                                      F-2
<PAGE>

Pharmos Corporation

Consolidated Balance Sheets
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                               December 31,
                                                                           1997            1996
<S>                                                                   <C>             <C>
Assets

Current assets:
   Cash and cash equivalents                                          $  4,423,389    $  5,132,906
   Inventories                                                           1,804,627              --
   Grants and other receivables                                            237,655         359,019
   Prepaid royalties                                                       143,333              --
   Prepaid expenses and other current assets                               171,299         247,363
                                                                      ------------    ------------
        Total current assets                                             6,780,303       5,739,288

Fixed assets, net                                                          703,428         629,413
Prepaid royalties, net of current portion                                  573,334         573,334
Intangible assets, net                                                     291,262         337,786
Other assets                                                                73,514         188,472
                                                                      ------------    ------------
    Total assets                                                      $  8,421,841    $  7,468,293
                                                                      ============    ============

Liabilities and Shareholders' (Deficit) Equity

Current liabilities:
   Long term debt, current portion                                    $     55,253    $    115,244
   Accounts payable                                                      2,576,968         847,415
   Accrued expenses                                                        809,869         497,621
   Accrued wages and other compensation                                    401,285         357,981
   Advances against future sales                                         1,000,000              --
                                                                      ------------    ------------
        Total current liabilities                                        4,843,375       1,818,261

Advances against future sales, net of current portion                    4,000,000       4,000,000
Long term debt, net of current portion                                          --         110,648
Other liabilities                                                          100,000          51,119
                                                                      ------------    ------------
        Total liabilities                                                8,943,375       5,980,028

Shareholders' (deficit) equity:

   Preferred stock, $.03 par value, 1,250,000 shares authorized:
      Series A convertible, with a $1,000 liquidation preference,
        0 and 1,900 shares issued and outstanding in 1997
      and 1996, respectively                                                    --              57
    Series B convertible, with a $1,000 liquidation preference,
      2,755 and 0 shares outstanding in 1997 and 1996, respectively             83              --
   Common stock, $.03 par value; 50,000,000 shares authorized,
    34,391,638 and 30,727,525 shares issued and
      outstanding (excluding $551 in 1997 and 1996,
      held in Treasury) in 1997 and 1996, respectively                   1,031,197         921,274
   Paid in capital                                                      70,516,913      62,668,886
   Accumulated deficit                                                 (72,069,727)    (62,101,952)
                                                                      ------------    ------------
    Total shareholders' (deficit) equity                                  (521,534)      1,488,265
                                                                      ------------    ------------
Commitments and contingencies

    Total liabilities and shareholders' (deficit) equity              $  8,421,841    $  7,468,293
                                                                      ============    ============
</TABLE>


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

                                      F-3
<PAGE>

Pharmos Corporation

Consolidated Statement of Operations
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                            Year Ended December 31,
                                                                     1997           1996           1995
<S>                                                            <C>             <C>             <C>
Revenues:
License fees, royalties, net                                   $         --    $         --    $     75,000

Expenses:
   Research and development, net                                  5,463,508       5,604,592       4,679,079
   Drug substance purchase                                          598,385              --              --
   Patents                                                          211,316         281,412         480,859
   General and administrative                                     2,034,092       2,123,392       2,557,718
   Depreciation and amortization                                    255,718         345,595         536,010
                                                               ------------    ------------    ------------
        Total operating expenses                                  8,563,019       8,354,991       8,253,666
                                                               ------------    ------------    ------------
Loss from operations                                             (8,563,019)     (8,354,991)     (8,178,666)

Other income (expenses):
   Interest income                                                  330,453         323,097         209,584
   Other income (expenses), net                                      16,365          (9,393)             --
   Interest expense                                                (17,346)         (35,923)       (127,003)
                                                               ------------    ------------    ------------
    Other income (expense), net                                     329,472         277,781          82,581

Loss before extraordinary item                                   (8,233,547)     (8,077,210)     (8,096,085)
                                                               ------------    ------------    ------------
Extraordinary gain from forgiveness of debt,
 net of $0 of income taxes (Note 3)                                 416,248              --              --
                                                               ------------    ------------    ------------
Net loss                                                         (7,817,299)     (8,077,210)     (8,096,085)
                                                               ------------    ------------    ------------

 Less:  Dividend embedded in convertible preferred
         stock (Note 9)                                          (1,952,767)             --              --
        Preferred stock dividends                                  (240,375)             --              --
                                                               ------------    ------------    ------------
Net loss applicable to common shareholders                     $(10,010,441)   $ (8,077,210)   $ (8,096,085)
                                                               ============    ============    ============

Net loss per share applicable to common shareholders
 before extraordinary gain - basic                                     (.32)           (.28)           (.37)

Extraordinary gain per share applicable to
   common shareholders                                                  .01              --              --
                                                               ------------    ------------    ------------
Net loss per share applicable to common shareholders - basic   $       (.31)   $       (.28)   $       (.37)
                                                               ============    ============    ============
Weighted average shares outstanding - basic                      32,442,981      29,291,401      21,885,862
                                                               ============    ============    ============
</TABLE>


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

                                      F-4
<PAGE>


Pharmos Corporation

Consolidated Statement of Changes in Shareholders' (Deficit) Equity (Note 9)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                                                                 Series A Convertible
                                                                      Common Stock                 Preferred Stock
                                                                 Shares          Amount        Shares            Amount
<S>                                                            <C>           <C>             <C>            <C>
December 31, 1994                                               14,631,726   $    438,952             --    $         --

Issuance of common stock to purchase Oculon Corp.                6,000,000        180,000             --              --
Conversion of debentures to common stock                         2,442,309         73,269             --              --
Warrant exercise                                                    75,000          2,250             --              --
Issuance of common stock, net of offering costs
  of $900,000                                                    6,000,000        180,000             --              --
Warrant grant to consultants                                            --             --             --              --
Share adjustment for reverse split                                       4             --             --              --
Net loss                                                                --             --             --              --
                                                              ------------   ------------   ------------    ------------
December 31, 1995                                               29,149,039        874,471             --              --
Warrant exercise                                                    99,286          2,978             --              --
Issuance of Series A preferred stock, net of offering costs
  of $18,000                                                            --             --          1,900              57
Private placement of common stock                                1,479,200         44,376             --              --
Warrant grant to consultants                                            --             --             --              --
Net loss                                                                --             --             --              --
                                                              ------------   ------------   ------------    ------------
December 31, 1996                                               30,727,525        921,825          1,900              57


Issuance of Series B preferred stock,
 net of offering costs of $260,000                                      --             --             --              --
Warrant exercises                                                   37,500          1,125             --              --
Conversion of Series A preferred stock                           1,492,943         44,788         (1,900)            (57)
Preferred stock dividend paid with common stock                    133,455          4,004             --              --
Conversion of Series B preferred stock                           2,000,215         60,006             --              --
Dividend embedded in convertible preferred stock                        --             --             --              --
Net loss                                                                --             --             --              --
                                                              ------------   ------------   ------------    ------------
December 31, 1997                                               34,391,638   $  1,031,748             --    $         --
                                                              ============   ============   ============    ============

<CAPTION>
                                                                   Series B Convertible
                                                                      Preferred Stock            Paid-in       Accumulated
                                                                    Shares       Amount          Capital         Deficit
<S>                                                           <C>             <C>             <C>             <C>
December 31, 1994                                                       --    $         --    $ 46,669,890    $(45,928,657)

                                                                        --              --       2,892,426              --
Issuance of common stock to purchase Oculon Corp.                       --              --       1,196,731              --
Conversion of debentures to common stock                                --              --          36,750              --
Warrant exercise                                                        --              --              --              --
Issuance of common stock, net of offering costs
  of $900,000                                                           --              --       7,920,000              --
Warrant grant to consultants                                            --              --          48,000              --
Share adjustment for reverse split                                      --              --              --              --
Net loss                                                                --              --              --      (8,096,085)
                                                              ------------    ------------    ------------    ------------
December 31, 1995                                                       --              --      58,763,797     (54,024,742)
Warrant exercise                                                        --              --          55,522              --
Issuance of Series A preferred stock, net of offering costs
  of $18,000                                                            --              --       1,881,943              --
Private placement of common stock                                       --              --       1,955,624              --
Warrant grant to consultants                                            --              --          12,000              --
Net loss                                                                --              --              --      (8,077,210)
                                                              ------------    ------------    ------------    ------------
December 31, 1996                                                       --              --      62,668,886     (62,101,952)


Issuance of Series B preferred stock,
 net of offering costs of $260,000                                   6,000             180       5,739,820              --
Warrant exercises                                                       --              --          66,375              --
Conversion of Series A preferred stock                                  --              --         (44,731)             --
Preferred stock dividend paid with common stock                         --              --         193,705        (197,709)
Conversion of Series B preferred stock                              (3,245)            (97)        (59,909)             --
Dividend embedded in convertible preferred stock                        --              --       1,952,767      (1,952,767)
Net loss                                                                --              --              --      (7,817,299)
                                                              ------------    ------------    ------------    ------------
December 31, 1997                                                    2,755    $         83    $ 70,516,913    $(72,069,727)
                                                              ============    ============    ============    ============

<CAPTION>
                                                                    Treasury                Shareholders'
                                                                     Stock                    (Deficit)
                                                                     Shares       Amount        Equity
<S>                                                            <C>           <C>             <C>
December 31, 1994                                                   18,356   $       (551)   $  1,179,634

                                                                        --             --              --
Issuance of common stock to purchase Oculon Corp.                       --             --       3,072,426
Conversion of debentures to common stock                                --             --       1,270,000
Warrant exercise                                                        --             --          39,000
Issuance of common stock, net of offering costs
  of $900,000                                                           --             --       8,100,000
Warrant grant to consultants                                            --             --          48,000
Share adjustment for reverse split                                      --             --              --
Net loss                                                                --             --      (8,096,085)
                                                              ------------   ------------    ------------
December 31, 1995                                                   18,356           (551)      5,612,975
Warrant exercise                                                        --             --          58,500
Issuance of Series A preferred stock, net of offering costs
  of $18,000                                                            --             --       1,882,000
Private placement of common stock                                       --             --       2,000,000
Warrant grant to consultants                                            --             --          12,000
Net loss                                                                --             --      (8,077,210)
                                                              ------------   ------------    ------------
December 31, 1996                                                   18,356           (551)      1,488,265


Issuance of Series B preferred stock,
 net of offering costs of $260,000                                      --             --       5,740,000
Warrant exercises                                                       --             --          67,500
Conversion of Series A preferred stock                                  --             --              --
Preferred stock dividend paid with common stock                         --             --              --
Conversion of Series B preferred stock                                  --             --              --
Dividend embedded in convertible preferred stock                        --             --              --
Net loss                                                                --             --      (7,817,299)
                                                              ------------   ------------    ------------
December 31, 1997                                                   18,356   $       (551)   $   (521,534)
                                                              ============   ============    ============
</TABLE>




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

                                      F-5
<PAGE>


Pharmos Corporation

Consolidated Statement of Cash Flows
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                  Year Ended December 31,
                                                           1997             1996            1995
<S>                                                    <C>             <C>             <C>
Cash flows from operating activities:
   Net loss                                            $ (7,817,299)   $ (8,077,210)   $ (8,096,085)
   Adjustments to reconcile net loss to net
      cash flow used in operating activities:
      Depreciation and amortization                         255,718         345,595         536,010
      Loss on disposal of fixed assets                       41,560
      Warrant grant to consultants                               --          12,000          48,000
   Changes in operating assets and liabilities, net
      of effects of acquisition in 1995:
        Inventories                                      (1,804,627)             --              --
        Grants receivable                                   121,364        (254,758)        158,389
        Prepaid expenses and other current assets            76,064         239,000         202,240
        Advanced royalties                                 (143,333)       (573,334)             --
        Other assets                                        114,958              --              --
        Accounts payable                                  1,729,553         108,059      (1,180,748)
        Accrued expenses                                    312,248         (18,413)         89,219
        Advances against future sales                     1,000,000       2,122,859       1,877,141
        Accrued wages and other compensation                 43,304         152,645              --
        Other liabilities                                    48,881        (184,360)             --
                                                       ------------    ------------    ------------
        Net cash used in operating activities            (6,021,609)     (6,127,917)     (6,365,834)
                                                       ------------    ------------    ------------
Cash flows from investing activities:
   Purchases of fixed assets, net                          (324,769)        (73,028)        (56,647)
                                                       ------------    ------------    ------------
        Net cash used in investing activities              (324,769)        (73,028)        (56,647)
                                                       ------------    ------------    ------------
Cash flows from financing activities:
   Proceeds from issuance of common stock
    and exercise of warrants, net                            67,500       2,058,500       8,139,000
   Proceeds from issuance of preferred stock, net         5,740,000       1,882,000
   Proceeds from issuance of convertible debentures              --              --       1,270,000
   Proceeds from acquisition of Oculon, net                      --              --       3,072,426
   Payments of loans payable                               (170,639)        (49,440)       (480,219)
                                                       ------------    ------------    ------------
     Net cash provided by financing activities            5,636,861       3,891,060      12,001,207
                                                       ------------    ------------    ------------
Net (decrease) increase in cash and cash equivalents       (709,517)     (2,309,885)      5,578,726
Cash and cash equivalents at beginning of year            5,132,906       7,442,791       1,864,065
                                                       ------------    ------------    ------------
Cash and cash equivalents at end of year               $  4,423,389    $  5,132,906    $  7,442,791
                                                       ============    ============    ============
</TABLE>

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

                                      F-6
<PAGE>


Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

1.   The Company

     Pharmos  Corporation  (the  "Company")  is  a  bio-pharmaceutical   company
     incorporated  under the laws of the state of Nevada  and is  engaged in the
     design and development of novel  pharmaceutical  products in various fields
     including: site specific drugs for ophthalmic indications,  neuroprotective
     agents for treatment of central nervous system ("CNS") disorders,  systemic
     drugs  designed  to avoid CNS  related  side  effects,  and  emulsion-based
     products for topical and systemic applications.  The Company uses a variety
     of patented and  proprietary  technologies  to improve the efficacy  and/or
     safety  of  drugs.  The  Company's  compounds  are  in  various  stages  of
     development,  from preclinical to advanced  clinical trials. On of March 9,
     1998, the Company received  approval for two separate New Drug Applications
     ("NDA") from the U.S. Food and Drug Administration ("FDA"). These approvals
     were for LotemaxTM and AlrexTM. Lotemax has been approved for the treatment
     of several  ocular  inflammatory  indications,  including  uveitis  and for
     post-operative  inflammation.  Alrex has been approved for the treatment of
     seasonal  allergic  conjunctivitis.  In  conjunction  with its  development
     efforts, the Company has also undertaken research and development contracts
     in the past and has sold  fine  chemicals  to the  pharmaceutical  research
     community.  The Company's administrative offices are located in Iselin, New
     Jersey  and  conducts  operations  through  its  wholly  owned  subsidiary,
     Pharmos, Ltd., in Rehovot, Israel.

2.   Liquidity and Business Risks

     The Company  currently  has had no sources of  recurring  revenues  and has
     incurred  operating  losses since its inception.  At December 31, 1997, the
     Company  has an  accumulated  deficit  of  $72,069,727.  Such  losses  have
     resulted  principally  from costs incurred in research and  development and
     from  general  and  administrative  expenses.  The  Company  has funded its
     operations  through the use of cash obtained  principally  from third party
     financing.  Management  believes  that  cash and cash  equivalents  of $4.4
     million as of December 31, 1997,  combined with  anticipated  cash inflows,
     including  revenues  expected to be derived from sales of Lotemax and Alrex
     (See Notes 4 and 17) and the  proceeds  from the  February 4, 1998  private
     placement  (see   "Subsequent   Events")  will  be  sufficient  to  support
     operations  through first quarter of 1999.  The Company's  success  depends
     upon  many  factors  that  are  beyond  the  Company's  immediate  control,
     including  market  acceptance  of Lotemax and Alrex,  competition,  and the
     ability  to obtain  additional  financing.  The  Company is  continuing  to
     actively  pursue  various  funding  options,  including  equity  offerings,
     strategic corporate alliances, business combinations, and the establishment
     of research and development partnerships to obtain the additional financing
     necessary to complete the  development of its product  candidates and bring
     them to commercial markets. There can be no assurance that Lotemax or Alrex
     will achieve  market  acceptance  or that the Company will be successful in
     obtaining additional financing or commercializing its product candidates.

3.   Significant Accounting Policies

     Basis of consolidation

     The accompanying  consolidated  financial  statements include the Company's
     wholly  owned  subsidiary,   Pharmos  Ltd.  All  significant   intercompany
     transactions are eliminated in consolidation.

     Use of Estimates

     The  preparation  of financial  statements  in  conformity  with  generally
     accepted  accounting  principles requires the Company to make estimates and
     assumptions  that affect the reported amounts of assets and liabilities and
     disclosure  of  contingent  assets  and  liabilities  at  the  date  of the
     financial  statements  and the  reported  amounts  of  revenues,  costs and
     expenses  during the  reporting  period.



                                      F-7
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     Actual results could differ from those estimates.

     Net loss per common share

     The Company adopted  Statement of Financial  Accounting  Standards  No.128,
     "Earnings per Share" ("SFAS 128") effective December 1997.

     Basic net loss per common  share is computed by dividing net loss to common
     shareholders  for the  period,  adjusted  to add back any  preferred  stock
     dividends  (embedded,  declared or in  arrears) by the sum of the  weighted
     average  number of shares of common stock issued and  outstanding.  Diluted
     earnings  per share is computed by dividing  net loss for the period by the
     sum of the  weighted  average  number of shares of common  stock issued and
     outstanding,  increased  to include the number of common  shares that would
     have been issued if all outstanding  preferred  stock,  stock options,  and
     stock warrants were converted.  Diluted common shares are based on the most
     advantageous  convertible  rate or exercise price available to the security
     holder.

     At December 31, 1997,  outstanding shares of Series B Convertible Preferred
     Stock,  convertible  into 1,721,875  shares of common stock and outstanding
     options and warrants to purchase  5,568,411  shares of common  stock,  with
     exercise prices ranging from $.75 to $5.20 could  potentially  dilute basic
     earnings  per  share  in the  future  but have  not  been  included  in the
     computation  of  diluted  net  loss  per  share  because  to do so would be
     antidilutive for the periods presented.

     Cash and cash equivalents

     The Company considers all highly liquid debt instruments  purchased with an
     original  maturity  of three  months or less to be cash  equivalents.  Cash
     equivalents primarily consist of commercial paper and money market accounts
     in 1997 and 1996, respectively.

     Revenue recognition

     Revenue for contracted  research and development  services is recognized as
     performed. Revenue from these contracts is recognized as costs are incurred
     (as defined in the  contract),  generally  direct labor and  supplies  plus
     agreed overhead rates. Any advance payments on contracts are deferred until
     the  related  services  are  performed.  License  fees  and  royalties  are
     recognized when earned in accordance with the underlying agreements.  Sales
     revenue is recognized upon shipment of products.

     Inventories

     Inventories  consist of  loteprednol  etabonate,  the compound  used in the
     Company's products, Lotemax and Alrex and is stated at the lower of cost or
     market with cost determined on a weighted average basis.

     Certain purchases of Loteprednol  Estabonate,  totaling $598,385, have been
     expensed in 1997. This amount  represents  inventory to be used in testing,
     manufacturing and various marketing programs.

     Fixed assets

     Fixed assets are recorded at cost.  Property,  furniture  and equipment are
     depreciated  on a  straight-line  basis over their  estimated  useful lives
     which  range from  three to  fourteen  years.  Leasehold  improvements  are
     amortized  on a  straight-line  basis over the shorter of the lease term or
     the  estimated  lives of the related  assets.  Maintenance  and repairs are
     expensed as incurred.


                                      F-8
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     Intangible assets

     Intangible   assets   represent  the   Company's   rights  to  develop  and
     commercialize certain products derived from certain licensed  technologies.
     The assets are being  amortized over fifteen years. As of December 31, 1997
     and 1996, accumulated amortization was $748,518 and $701,994, respectively.
     Amortization  expense  amounted  to  $46,524  in  each of the  years  ended
     December 31, 1997, 1996 and 1995.

     As a result of the current period operating loss combined with a history of
     operating  losses,   management  assessed  whether  or  not  the  Company's
     intangible  assets were  recoverable.  As of December 31, 1997,  management
     estimates  that the net future  cash  inflows  expected  to result from the
     commercial marketing of the licensed  technologies will exceed the carrying
     amount of the Company's  intangible  assets and accordingly,  no impairment
     loss was recognized.

     On a periodic  basis,  the Company will assess whether there are conditions
     present  that  indicate an  impairment  of long lived assets and long lived
     assets to be  disposed  of. In the event  such an  impairment  is  present,
     management  will consider the  undiscounted  cash flows from such assets to
     quantify the amount of such impairment and the loss to be recorded.

     Research and development costs

     All research and development costs are expensed when incurred.  The Company
     has accounted for  reimbursements  of research and  development  costs as a
     reduction of research and development expense.

     Income taxes

     The Company  accounts for income taxes in accordance with the provisions of
     Statement of Financial Accounting Standards No. 109, "Accounting for Income
     Taxes"  ("SFAS  109").  Under the asset and  liability  method of SFAS 109,
     deferred  tax  assets and  liabilities  are  recognized  for the future tax
     consequences  attributable to differences  between the financial  statement
     carrying  amounts of existing assets and  liabilities and their  respective
     tax bases and  operating  loss and tax credit  carryforwards.  Deferred tax
     assets and  liabilities,  if any,  are  measured  using  enacted  tax rates
     expected to apply to taxable  income in the years in which those  temporary
     differences  are expected to be  recovered or settled.  Under SFAS 109, the
     effect on deferred tax assets and  liabilities  of a change in tax rates is
     recognized in income in the period that includes the enactment date.

     Foreign exchange

     The Company's foreign operations are principally conducted in U.S. dollars.
     Any  transactions  or balances in  currencies  other than U.S.  dollars are
     remeasured  and  any  resultant  gains  and  losses  are  included  in  the
     determination  of current  period income and loss. To date,  such gains and
     losses have been insignificant.

     Concentration of Credit Risk

     Financial   instruments   which   potentially   expose   the   Company   to
     concentrations   of  credit  risk  consist   primarily  of  cash  and  cash
     equivalents.  The Company  maintains  some of its cash balances in accounts
     which exceed federally insured limits. It has not experienced any losses to
     date resulting from this practice.

     Reclassifications

     Certain amounts for 1996 and 1995 have been  reclassified to conform to the
     fiscal 1997 presentation.  Such reclassifications did not have an impact on
     the Company's financial position or results of operations.


                                      F-9
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     Recent Accounting Standards

     Statement   of  Financial   Accounting   Standards   No.  130,   "Reporting
     Comprehensive Income" ("SFAS 130")

     On June 30, 1997, the FASB issued SFAS No. 130. This statement  establishes
     standards  for  reporting  and  display  of  comprehensive  income  and its
     components  (revenues,  expenses,  gains  and  losses)  in a  full  set  of
     general-purpose  financial  statements.  SFAS  No.  130  requires  that  an
     enterprise (a) classify items of other comprehensive income by their nature
     in a financial  statement and (b) display the accumulated  balance of other
     comprehensive  income  separately  from  retained  earnings and  additional
     paid-in capital in the equity section of a statement of financial position.

     This statement is effective for fiscal years  beginning  after December 15,
     1997. Reclassification of financial statements for earlier periods provided
     for comparative purposes is required.  It is not expected that the adoption
     of SFAS No. 130 will have a material impact on the Company.

     Statement of Financial  Accounting  Standards  No. 131,  "Disclosure  about
     Segments of an Enterprise" ("SFAS 131")

     In June 1997,  the FASB issued SFAS No. 131. This  statement  requires that
     public  business  enterprises  report certain  information  about operating
     segments in complete sets of financial  statements of the enterprise and in
     condensed financial statements of interim periods to shareholders.  It also
     requires that enterprises  report certain  information about their products
     and services,  the  geographic  areas in which they operate and their major
     customers.  This  statement is effective for fiscal years  beginning  after
     December  15,  1997.  The effect of the  adoption of this  statement is not
     expected to have a significant impact on the Company.

4.   Collaborative Agreements

     In  June  1995,  the  Company  entered  into  a  marketing  agreement  (the
     "Marketing Agreement") with Bausch & Lomb Pharmaceuticals,  Inc. ("Bausch &
     Lomb")  to market  Lotemax,  on an  exclusive  basis in the  United  States
     following receipt of FDA approval.  The Marketing Agreement also covers the
     Company's  two  other  loteprednol  etabonate  based  products,  which  are
     referred to as Alrex and LE-T. Under the Marketing Agreement, Bausch & Lomb
     will purchase the active drug substance  (loteprednol  etabonate)  from the
     Company.  Through  December  31,  1997,  Bausch and Lomb has  provided  the
     Company  with  $5  million  in  cash  advances  against  future  sales.  An
     additional  $1 million is due upon the receipt of  regulatory  approval for
     LE-T in the  United  States.  Bausch & Lomb  will be  entitled  to  credits
     against future purchases or sales of the active drug substance based on the
     advances made, until all the advances have been repaid.  The Company may be
     obligated  to repay such  advances if it is unable to supply  Bausch & Lomb
     with certain specified quantities of the active drug substance. The portion
     of advances  expected  to be recouped by Bausch and Lomb in 1998,  based on
     management's  estimate of product sales to Bausch & Lomb in 1998,  has been
     presented  as a current  liability  in the  accompanying  balance  sheet at
     December 31, 1997.

     Bausch & Lomb also  collaborates  in the  development of products by making
     available  amounts up to 50% of the Phase III  clinical  trial  costs.  The
     Company has retained certain conditional  co-marketing rights to all of the
     products covered by the Marketing Agreement. Net reimbursements from Bausch
     & Lomb were  approximately  $.2  million,  $1.2 million and $0.1 million in
     1997,  1996 and 1995,  respectively,  and were offset against  research and
     development in the accompanying consolidated statements of operations.



                                      F-10
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     In December  1996,  the  Company and Bausch & Lomb signed an  international
     marketing agreement for the marketing of Lotemax, Alrex and LE-T in certain
     territories  outside  of  the  U.S.  The  Company  expects  to  receive  an
     additional  $1.6  million  of  advances  that will  follow  the  receipt of
     regulatory clearance in those markets.

5.   Fixed Assets

     Fixed assets consist of the following:

                                                             December 31,
                                                         1997           1996

Laboratory, pilot plant and other equipment          $ 1,339,688    $ 1,810,310
Leasehold improvements                                   240,462        402,936
Office furniture and fixtures                            107,251        235,663
Computer equipment                                        78,795        133,973
Vehicles                                                  53,307         52,873
                                                     -----------    -----------
                                                       1,819,503      2,635,755

Less-Accumulated depreciation and amortization        (1,116,075)    (2,006,342)
                                                     -----------    -----------
                                                     $   703,428    $   629,413
                                                     ===========    ===========

     Depreciation  and  amortization of fixed assets was $209,194,  $299,071 and
     $489,486 in 1997, 1996 and 1995, respectively.

6.   Grants for Research and Development

     The Company has entered into agreements with U.S.  federal agencies and the
     State of Israel  which  provide  for grants for  research  and  development
     relating to certain projects. Amounts received pursuant to these agreements
     have been  reflected as a reduction of research  and  development  expense.
     Such  reductions  amounted to $418,245,  $245,302 and $331,546 during 1997,
     1996 and 1995,  respectively.  The agreements with agencies of the State of
     Israel place certain legal  restrictions  on the transfer of technology and
     manufacture  of  resulting  products  outside  Israel.  The Company will be
     required to pay royalties to such  agencies  from the sale of products,  if
     any, developed as a result of the research  activities carried out with the
     grant funds.

     As of December  31,  1997,  the total  amounts  received  under such grants
     amounted to $2,952,972,  of which $2,752,972 pertain to grants that contain
     royalty  provisions.  Aggregate future royalty payments related to sales of
     products developed,  if any, as a result of these grants will be limited to
     $3,215,862 based on grants received through December 31, 1997.

     In April 1997, the Company also signed an agreement with Consortium  Magnet
     for developing generic technologies for design and development of drugs and
     diagnostic kits, operated by the Office of the Chief Scientist.  Under such
     agreements the Company is entitled to a  non-refundable  grant amounting to
     approximately   60%  of  actual  research  and  development  and  equipment
     expenditures  on approved  projects.  No royalty  obligations  are required
     within the framework. The Company


                                      F-11
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     received grants totaling $200,000 in 1997 pursuant to this agreement.

7.   Licensing Arrangements

     The  Company  is  both  a  licensor  and   licensee  of  certain   research
     technologies.

     As a licensor,  the Company has entered into various agreements under which
     the rights to certain  of its  technologies  are  licensed  to others.  The
     Company is to be  compensated  by  receipt  of its share of defined  future
     product sales or royalties  earned by the licensee.  These  agreements have
     provided  for  funding  of  research,  either  in  whole  or in part by the
     licensee.

     As a  licensee,  the Company has  various  license  agreements  wherein the
     Company  has  acquired  exclusive  or  co-exclusive  rights to develop  and
     commercialize  certain  research  technologies.   These  agreements,  which
     include agreements related to Lotemax, generally require the Company to pay
     royalties on the sale of products developed from the licensed  technologies
     and fees on revenues from sublicenses, where applicable. The royalty rates,
     as defined in the respective license agreements, are customary and usual in
     the pharmaceutical  industry.  The royalties will be payable for periods up
     to fifteen years from the date of specified  events,  including the date of
     the  first  sale of  such  products,  or the  date  from  which  the  first
     registered patent from the developed  technologies is in force, or the year
     following the date on which  approval from the FDA received for a developed
     product.  No amounts have been recorded as a liability  with respect to any
     contingent royalties as of December 31, 1997.

     Certain of the  license  agreements  require  annual  payments  for periods
     extending through 2012. Minimum annual payments under licensing  agreements
     are $103,500. License fee expense amounted to approximately $103,500 during
     1997 and 1996, and $355,000 in 1995.

     In March 1997,  the  Company  paid a  licensor,  who is a former  director,
     $143,333. This payment represented prepaid royalties to the former director
     against  future  royalties  on  sales  of  LotemaxTM.  Prepayments  totaled
     $716,667 and $573,334 and are reflected as an asset on the balance sheet at
     December 31, 1997 and 1996, respectively.  The Company has agreed to prepay
     additional  royalties  based  on  future  advances  and  other  non-royalty
     payments from Bausch & Lomb or other  parties with whom the Company  enters
     into marketing or similar arrangements.

8.   Common and Preferred Stock Transactions

     1997 transactions

     On February 12, 1997, the Company issued  warrants to purchase an aggregate
     of 955,000  shares of common stock at an exercise  price of $1.59 per share
     to 14 employees of the Company. Prior to December 31, 1997, 65,000 of these
     warrants were canceled in connection  with the  termination of 2 employees.
     Such warrants become  exercisable in increments of 25% each on February 12,
     1998,  February 12, 1999,  February 12, 2000 and February 12, 2001.  All of
     such warrants expire on February 12, 2007.  Also, on February 12, 1997, the
     Company  issued  warrants  to purchase an  aggregate  of 115,000  shares of
     common stock at an exercise  price of $1.59 per share to the Company's five
     outside  directors  and  one  outside  consultant.  These  warrants  become
     exercisable  on the same basis as the  warrants  issued to  employees,  but
     expire on February 12, 2003. Upon  termination of employment or termination
     as a director,  all warrants held by such employee or director will expire,
     except that any warrant  that was  exercisable  on the date of  termination
     may, to the extent then  exercisable,  be  exercised  within  three  months
     thereafter  (or one year  thereafter  if the  termination  is the result of
     death or permanent disability of such employee or director).



                                      F-12
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     In March 1997,  the Company  issued  warrants to purchase an  aggregate  of
     75,000 shares of common stock at an exercise price of $1.66 per share to an
     employee of the Company.  Such warrants become exercisable in increments of
     25% each on March 1, 1998,  March 1, 1999, March 1, 2000 and March 1, 2001.
     All of  such  warrants  expire  on  March  1,  2007.  Upon  termination  of
     employment, all warrants held by such employee will expire, except that any
     warrant that was exercisable on the date of termination  may, to the extent
     then exercisable,  be exercised within three months thereafter (or one year
     thereafter  if  the  termination  is  the  result  of  death  or  permanent
     disability of such employee).

     On  March  31,  1997,  the  Company  completed  a  private  placement  with
     institutional  investors  of  Series  B  Convertible  Preferred  Stock  and
     warrants to purchase common stock, generating gross proceeds of $6 million.
     The Series B preferred  stock carries a 5% dividend rate payable in cash or
     common stock, at the option of the Company,  and is convertible into common
     shares of the Company  based on the share  price at the time of  conversion
     less discounts  ranging from 17% to 20%. Until converted into common stock,
     the preferred  stock has no voting rights.  The 159,000  warrants issued to
     the investors  are  exercisable  at a price of $1.75 per share,  commencing
     March 31, 1998, for a three year period.  The Company also issued  warrants
     to purchase an aggregate  of 239,473  shares of common stock at an exercise
     price of $1.38 per share to certain  parties who assisted in the completion
     of the private placement.  The warrants are exercisable from March 31, 1998
     and will expire in 2007.

     On April 30, 1997, the Company issued  warrants to purchase an aggregate of
     15,000 shares of common stock at an exercise price of $1.22 per share to an
     outside  consultant of the Company.  Such warrants  became  exercisable  on
     April 30, 1998 and expire on April 30, 2003.

     During 1997, the Company issued  3,493,158  shares of its common stock upon
     conversion  of  5,145  shares  of  the  Company's  Series  A and  Series  B
     Convertible  Preferred Stock. The shares were issued with conversion prices
     ranging  from $.93 per share to $2.04 per share.  The  Company  also issued
     133,455  shares of common stock in payment of dividends on the Series A and
     Series B Convertible  Preferred  Stock.  As of the date of such  issuances,
     these dividends are valued at $197,709. The Company issued 37,500 shares of
     its common  stock upon  exercise  of  warrants  to  purchase  shares of the
     Company's common stock at $1.80 per share.

     As of December 31, 1997,  cumulative  dividends in arrears on the Company's
     outstanding Series B Convertible Preferred Stock were $42,666.

     In  connection  with  the  issuances  of  the  Series  A and B  convertible
     preferred  stock,  the Company was required to recognize in the calculation
     of earnings  per share  (EPS),  the value of the  conversion  discount as a
     dividend to the preferred stockholders. The dividend has been recognized in
     the EPS  calculation  on a pro rata basis over the  period  beginning  with
     issuance to the earliest date that conversion can occur. For the year ended
     December  31,  1997,  the Company  recorded a preferred  stock  dividend of
     $1,952,767  on  the  outstanding  shares  of  Series  A and  B  convertible
     preferred stock in connection with the conversion discount.

     1996 transactions

     In January 1996,  the Company issued 89,286 shares of its common stock as a
     result of the exercise of certain warrants.  Of this amount,  75,000 shares
     were issued at an exercise  price of $.52 per share and 14,286  shares were
     issued at an exercise price of $.84 per share.

     On September 30, 1996, the Company  completed a private placement of Series
     A convertible


                                      F-13
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     preferred stock and warrants to purchase common stock,  with  institutional
     investors generating gross proceeds of $1.9 million. The Series A preferred
     stock carries a 5% dividend  rate payable in cash or common  stock,  at the
     option of the Company, and is convertible into common shares of the Company
     based on the share price at the time of conversion  less discounts  ranging
     from 17% to 20%. Until converted into common stock, the preferred stock has
     no  voting  rights.  The  50,000  warrants  issued  to  the  investors  are
     exercisable  at a price of $1.75 per share,  commencing  one year after the
     closing for a three year period.  The investors were granted limited rights
     to approve certain financing by the Company for 180 days from closing.

     In December 1996, the Company issued 10,000 shares of its common stock as a
     result of the  exercise of warrants  to  purchase  shares of the  Company's
     common stock.  The 10,000  shares were issued at an exercise  price of $.75
     per share.

     In December 1996, Bausch & Lomb purchased  1,479,200 shares of common stock
     from the Company for $2 million in a private placement.  The purchase price
     of $1.35 per share was equal to the average  closing price for the prior 15
     days.

     During 1996,  the Company issued  warrants to consultants  who assisted the
     Company on various business and financial  matters as follows:  warrants to
     purchase  15,000  shares at an  exercise  price of $2.31 per  share,  which
     expire in March 2002;  warrants to purchase  65,000 shares of the Company's
     common  stock at an  exercise  price of $1.34 per  share,  which  expire in
     September 2007;  warrants to purchase 10,000 shares at an exercise price of
     $1.39 per share,  which  expire in November  2006.  The Company  recognized
     compensation expense of $12,000 related to warrants in 1996.

     1995 transactions

     On January 18, 1995, the Company's stockholders  authorized an amendment to
     the Company's  Restated  Articles of  Incorporation  which  provided for an
     increase in the number of shares of authorized common stock from 20 million
     shares to 50 million shares, and the elimination of the Class B convertible
     common stock.

     In February  1995, the Company  completed the sale of $1,270,000  principal
     amount convertible debentures in a private placement transaction to several
     accredited investors, including a large institutional shareholder. A member
     of the Company's Board of Directors  purchased  $70,000 of such debentures.
     During 1995, all of the debentures were converted into 2,442,309  shares of
     the  Company's  common  stock at an  exchange  price of $.52 per share.  In
     connection  with this  transaction  the Company issued warrants to purchase
     150,000  shares of common  stock at an  exercise  price of $.52 per  share.
     During 1995,  warrants to purchase  75,000  shares were  exercised  and the
     remaining 75,000 warrants were exercised in January 1996.

     The Company  issued  6,000,000  shares of its common  stock and warrants to
     purchase  500,000 shares of common stock in connection with the acquisition
     of Oculon.

     On  September  14,  1995,  the  Company  completed  a private  offering  of
     6,000,000  units at $1.50 per unit.  The proceeds of the private  offering,
     net of costs of $900,000, were $8,100,000. Each unit consisted of one share
     of the  Company's  common  stock and one warrant to  purchase  0.075 of one
     share of common stock  (450,000  shares).  In addition  the Company  issued
     warrants to purchase  450,000 shares of common stock to the two finders who
     assisted in this  transaction.  Both  groups of  warrants  have an exercise
     price of $1.80 per share and may be exercised commencing September 14, 1996
     and expire on September 14, 2000.



                                      F-14
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     During 1995,  the Company issued  warrants to consultants  who assisted the
     Company on various business and financial  matters as follows:  warrants to
     purchase  10,000  shares at an  exercise  price of $1.88 per  share,  which
     expire on October  31,  2001;  warrants to  purchase  10,000  shares of the
     Company's common stock at an exercise price of $.78 per share, which expire
     on April 10, 2005; warrants to purchase 75,000 shares, 25,000 each of which
     have an exercise  price of $.75,  $1.00 and $1.50 per share,  respectively,
     and may be  exercised  beginning  May 1, 1996 and expire on April 30, 2000.
     The Company recognized  compensation expense of $48,000 related to warrants
     in 1995.

9.   Warrants

     Many of the warrants issued in connection with various equity financing and
     related  transactions  during  1991  through  1997  contain   anti-dilution
     provisions requiring  adjustment,  if at a later date securities are issued
     at prices below the  respective  warrant's  exercise  price.  The following
     table summarizes the shares issuable upon exercise of warrants  outstanding
     at  December  31,  1996 as  adjusted  for the events  which have  triggered
     anti-dilution provisions contained in the respective warrant agreements:

<TABLE>
<CAPTION>
                                                                                    Shares
                                                                                    Issuable
                                                               Expiration             Upon             Esercise
     Issuance Date                                                Date              Exercise             Price
     -------------                                                ----              --------             -----
<S>                                                             <C>               <C>                  <C>
November 1991                                                   March 1998           269,490           $ 2.01
                                                                March 1998           303,338             2.50
                                                                March 1998           361,844             1.52
August 1993                                                    August 1998           454,121             2.67
September 1994                                                 September 1999         65,044             2.26
October 1994                                                   October 1999          200,000              .84
April 1995                                                      April 2005           500,000             2.75
                                                                April 2005            10,000              .78
                                                                April 2000            15,000              .75
                                                                April 2000            25,000             1.00
                                                                April 2000            25,000             1.50
Scptember 1995                                                 September 2000        862,500             1 80
October 1995                                                   October 2001           10,000             1.88
March 1996                                                      March 2002            15,000             2.31
September 1996                                                 Septemher 2000         50,000             1.75
                                                               September 2007         65,000             1.34
November 1996                                                  November 2006          10,000             1.39
February 1997                                                  February 2003         115,000             1.59
                                                               Februaly 2007         890,000             1.59
March 1997                                                      March 2001           159,000             1.75
                                                                March 2007            75,000             1.66
                                                                March 2007           239,473             1.38
April 1997                                                      April 2003            15,000             1.22
                                                               --------------    -----------           ------
     Total shares and average exercise price                                     $ 4,734,810           $ 1.90
                                                                                 ===========           ======
</TABLE>

10.  Stock Option Plans

     The Company's  shareholders have approved  incentive stock option plans for
     officers and employees.  Options granted are generally  exercisable  over a
     specified  period,  not  less  than one year  from the date of  grant,  and
     generally  expire ten years  from the date of grant.  The  following  table
     summarizes  activity in approved  incentive  stock options  approved by the
     Company's Board of Directors:

                                                  Shares              Average
                                                  Under               Exercise
                                                  Option              Price
                                                  ------              -----
Options outstanding at 12/31/95                   544,186              $2.20
Granted                                             4,000               2.28
Expired                                           (34,933)              2.18
                                                  -------              -----
Options outstanding at 12/31/96                   513,253               2.13
Expired                                           (86,834)              1.74
                                                  -------              -----
Options outstanding at 12/31/97                   426,419               2.21
                                                  =======              =====
Options exercisable at 12/31/97                   306,935               2.26
                                                  =======              =====

     The Company's Board of Directors  approved  nonqualified  stock options for
     key  employees,   directors  and  certain  non-employee  consultants.   The
     following table summarizes  activity in Board-approved  nonqualified  stock
     options:



                                      F-15
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

                                                  Shares              Average
                                                  Under               Exercise
                                                  Option              Price
                                                  ------              -----
Options outstanding at 12/31/95                    442,182           $ 3.10
Expired                                            (10,000)            1.94
                                                  --------           ------
Options outstanding at 12/31/96                    432,182             3.12
Expired                                            (25,000)           10.50
                                                  --------           ------
Options outstanding at 12/31/97                    407,182           $ 2.67
                                                  ========           ======
Options exercisable at 12/31/97                    357,566           $ 2.65
                                                  ========           ======

     The Company applies Accounting  Principles Board Opinion No. 25, Accounting
     for Stock Issued to Employees,  and related  interpretations  in accounting
     for its plans. Accordingly, no compensation expense has been recognized for
     its  stock-based  compensation  plans other than for  restricted  stock and
     performance-based  awards.  Had  compensation  cost for the Company's other
     stock option plans been  determined  based upon the fair value at the grant
     date  for  awards  under  these  plans   consistent  with  the  methodology
     prescribed  under  Statement of  Financial  Accounting  Standards  No. 123,
     Accounting for  Stock-Based  Compensation,  the Company's net loss and loss
     per share would have been increased by approximately $305,000, or $.01. per
     share in 1997 and $203,000,  or $.01 per share in 1996 and $320,000 or $.01
     per share in 1995 before  deducting  the value of stock  options  that were
     canceled  in 1995.  The fair  value of  options  and  warrants  granted  to
     employees,  officers, and directors from 1995 through 1997 are estimated at
     $.51 to $1.17 on the date of grant using the  Black-Scholes  option-pricing
     model with the following assumptions: dividend yield 0%, volatility of 50%,
     risk-free  interest  rate of 6.5%,  assumed  forfeiture  rate of 3%, and an
     expected life of 3 to 5 years.

11.  Long Term Debt

     As of December  31, 1997,  Pharmos  Limited has an unused line of credit of
     $50,000 denominated in New Israeli Shekels.

     In 1996,  the  Company  incurred a  liability  relating  to the  negotiated
     buy-out of a lease  obligation.  The  termination  agreement  provides  for
     monthly  installment  payments of $4,375 through December 1998. At December
     31, 1997, the outstanding  balance was $52,233 and has been classified as a
     current liability in the accompanying balance sheet.


12.  Income Taxes

     No  provision  for income  taxes was  recorded  for the three  years  ended
     December 31, 1997 due to net operating losses incurred.  Net operating loss
     carryforwards for U.S. tax purposes of  approximately  $50,485,000  expire
     from 2000 through 2012.

     The Company's  gross deferred tax assets of $25,087,000  and $22,870,000 at
     December 31, 1997 and 1996,  respectively,  represented  primarily  the tax
     effect of both the net operating loss  carryforwards  and deferred research
     and   development   costs,   and  research  and   development   tax  credit

                                      F-16
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     carryforwards. As a result of previous business combinations and changes in
     stock  ownership,  substantially  all of these net operating losses and tax
     credit carryforwards are subject to significant  restriction with regard to
     annual  utilization.  A full valuation  allowance has been established with
     regard to the gross deferred tax assets.

13.  Commitments and Contingencies

     Leases

     The Company leases research and office facilities in Israel and New Jersey.
     The  facilities  in  Israel  are  used in the  operation  of the  Company's
     research  and  administration  activities.  The New Jersey  facility  which
     serves as the  corporate  headquarters  is leased under an agreement  which
     expires in September 1998 and contains  unlimited one year renewal options.
     The  research  and  development  facility  in  Israel  is  leased  under an
     agreement which expires in May 1998.

     The Company  also has a long term lease on office  facilities  in New York,
     which  previously  served as the Company's  executive  headquarters,  which
     expires in March  2000.  The  Company  has  entered  into a  non-cancelable
     sublease agreement for this facility which expires in March 2000.

     All of the  leases and  subleases  described  above call for base  rentals,
     payment of certain building maintenance costs (where applicable) and future
     increases based on the consumer price indices.


                                      F-17
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     At December 31, 1997,  the future  minimum lease  commitments  and sublease
     rental  receivables  with respect to  non-cancelable  operating leases with
     initial terms in excess of one year are as follows:

                                                  Lease               Sublease
                                               Commitments             Rentals

1998                                             $279,347              $145,834
1999                                              145,834               145,834
2000                                               36,458                36,458
                                                 --------              --------
                                                 $461,639              $328,126
                                                 ========              ========

     Rent expense during 1997, 1996 and 1995 amounted to $410,856,  $371,526 and
     $542,885,  respectively.  Rent  expense  in  1997,  1996 and 1995 is net of
     $308,608, $499,106 and $88,698 of sublease income, respectively.

     Consulting contracts and employment agreements

     In the normal course of business, the Company enters into annual employment
     and consulting contracts with various employees and consultants.

     Dividend restrictions

     Dividends may be paid by the Company's  subsidiary,  Pharmos Limited,  only
     out of retained  earnings as  determined  for Israeli  statutory  purposes.
     There are no retained  earnings in Israel  available  for  distribution  as
     dividends  as of December  31,  1997,  1996 or 1995.  The Company  does not
     intend to pay a cash dividend in the foreseeable future.

14.  Employee Benefit Plan

     The Company has a 401-K defined  contribution  profit-sharing plan covering
     certain employees. Contributions to the plan are based on salary reductions
     by the participants,  matching employer  contributions as determined by the
     Company, and allowable  discretionary  contributions,  as determined by the
     Company's Board of Directors, subject to certain limitations. Contributions
     by the Company to the plan amounted to $10,090,  $11,363 and $10,731 and in
     1997, 1996 and 1995, respectively.

15.  Estimated Fair Value of Financial Instruments

     The  carrying  amounts  of cash  and cash  equivalents,  grants  and  other
     receivables, accounts payable and accrued expenses are reasonable estimates
     of their  fair  values.  Due to the  uncertainty  of the  timing  of future
     product  sales it is not  practical  to estimate the fair value of advances
     against  future sales which have a carrying value of $5,000,000 at December
     31, 1997.  The  estimated  fair values of all other  financial  instruments
     approximate, or are not materially different, than their carrying values.

16.  Legal Proceedings

     Management  has reviewed with counsel all actions and  proceedings  pending
     against or  involving  the Company.  Although the ultimate  outcome of such
     actions and  proceedings  cannot be predicted  with certainty at this time,
     management  believes  that  losses,  if any, in excess of amounts  accrued,

                                      F-18
<PAGE>

Pharmos Corporation

Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

     resulting  from those  actions  will not have a  significant  impact on the
     Company's financial position or results of operations.

17.  Subsequent Events

     In January 1998, the  shareholders of the Company  approved the increase in
     the  number of  authorized  shares  of  common  stock  from  50,000,000  to
     60,000,000  and adopted the 1997 Incentive and  Non-Qualified  Stock Option
     Plan,  which has reserved for issuance up to 600,000 shares of common stock
     upon the exercise of stock options to be granted to  employees,  directors,
     consultants and other key personnel.

     On  February  4, 1998,  the  Company  completed  a private  placement  with
     institutional  investors  of  Series  C  Convertible  Preferred  Stock  and
     warrants to  purchase  650,000  shares of common  stock,  generating  gross
     proceeds of $5 million.  The  preferred  stock  carries a 5% dividend  rate
     payable  in cash or common  stock,  at the  option of the  Company,  and is
     convertible  into common  shares of the Company based on the share price at
     the time of conversion  less a discount of 10%. Until converted into common
     stock, the preferred stock has no voting rights. The warrants issued to the
     investors are  exercisable at prices ranging from $2.28 to $2.67 per share,
     commencing one year after the closing for a three year period.

     On March 10,  1998,  the Company  received  approval,  from the FDA, of its
     NDA's for Lotemax and Alrex.



                                      F-19