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, 1998

                               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)

                         99 Wood Avenue South, Suite 301
                                Iselin, NJ 08830
               (Address of principal executive offices) (zip code)

       Registrant's telephone number, including area code: (732) 452-9556

           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 15, 1999
held by those persons deemed to be non-affiliates was approximately $50,673,356.

     As of March 15, 1999, the Registrant had outstanding  40,538,685  shares of
its $.03 par value Common Stock.


<PAGE>


                                     PART I

Item 1.  Business

Introduction

Pharmos Corporation (the "Company") is a pharmaceutical  company specializing in
the modification of existing molecules through proprietary  techniques to reduce
undesirable  side effects  and/or  enhance  efficacy.  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.   In  March  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,  Lotemax(R)  (loteprednol  etabonate  ophthalmic  suspension 0.5%) and
Alrex(TM)   (loteprednol   etabonate  ophthalmic  suspension  0.2%).  BLP  began
marketing  Lotemax and Alrex in the second  quarter of 1998.  Product  shipments
also began in the second quarter of 1998, when the Company  received its initial
product revenues from the sales of these products.

Lotemax  is a  topical,  site-specific  steroid  that is used to  treat  steroid
responsive  inflammatory eye conditions.  The prescription eye drop is also used
for  post-operative  eye inflammations  such as experienced  following  cataract
surgery.  The novel  chemical  structure of Lotemax  allows it to be predictably
transformed by enzymes in the eye to an inactive metabolite,  thereby increasing
its safety profile.  The safety profile of Lotemax was  demonstrated in clinical
trials by a low  incidence of  elevation  in  intraocular  pressure  ("IOP"),  a
significant side effect of ophthalmic steroid use. In addition,  Lotemax has the
broadest range of approved indications of any ophthalmic steroid on the market.

Alrex is a specially developed formula of loteprednol  etabonate that is 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 in the United  States 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
final 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
severe head trauma and stroke,  is  currently  in the third cohort of a Phase II
clinical trial for severe head trauma. On October 7, 1998, the Company announced
the  results  of the first  two of the three  cohort  Phase II  Clinical  Study.
Highlights  of the  study  included  a  significant  reduction  in  intracranial
pressure, a 26% reduction in mortality, and a higher percentage of patients able
to resume a normal life ("Good Neurological Outcome") among the treated group.

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  that 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 IOP by


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<PAGE>


steroids, or are drugs that 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.

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 for the treatment of cancer.

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  alleviate  inflammatory  and
allergic  conditions,  and is quickly  hydrolyzed  into a  predictable  inactive
metabolite  before  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  steroids,  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, including 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.  The final clinical
trial for LE-T  reached  full  enrollment  in January  1999 and an NDA filing is
expected this year.

In June 1995, the Company  entered into an agreement with BLP to market Lotemax,
Alrex and LE-T in the U.S. A second agreement, covering Europe, Canada and other
selected  countries,  was signed in December 1996.  Both agreements give BLP the
right to purchase the active  component LE 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  PPG-Sipsy,  a unit of PPG Industries,
Inc., for exclusive manufacturing of LE for sale to the Company.

Following FDA approval of Lotemax and Alrex, BLP commenced  product shipments in
April 1998, providing the Company with its initial product revenues.

Dexanabinol (HU-211)

Dexanabinol  (HU-211) is the Company's lead synthetic  cannabinoid compound in a
family of non psychotic  cannabinoid  molecules originally designed to avoid the
psychotropic and sedative  spectrum of  cannabinometic  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.   More
importantly,  it  is a  stereo  selective,  non-competitive  antagonist  of  the
glutamate NMDA receptor  channel,  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 time points of
the neurotoxic process in head trauma, stroke and potentially other indications.


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<PAGE>


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  and other  members of this family of  compounds  for these  chronic
indications are 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  resulted  in  a  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 1999. This
study,  conducted at six medical  centers in Israel on patients with severe head
injury, was reviewed and approved by the American Brain Injury Consortium (ABIC)
and the European Brain Injury Consortium (EBIC).

On October 7, 1998,  the Company  announced the results of the first two cohorts
of the three cohort  Phase II Clinical  Study  involving  67 patients.  Clinical
endpoints  established  an excellent  safety  profile of the drug in the treated
patients.  There were no unexpected adverse experiences  reported for either the
drug treated or placebo  group.  Intracranial  pressure  above a threshold of 25
mmHg, an important risk factor and a predictor of poor neurological outcome, was
significantly  reduced in the  drug-treated  patients  through  the third day of
treatment,  without  concomitant  reduction  in  systolic  blood  pressure.  The
mortality rate of 10% (3/30) in the dexanabinol group compared  favorably with a
13.5%  rate in the  placebo  group  (5/37).  The  investigators  concluded  that
dexanabinol  was  shown to be safe and well  tolerated  in  severe  head  trauma
patients.

Neurological  outcomes in the study,  assessed periodically up to 6 months after
injury,  established  a strong trend of  efficacy.  The  percentage  of patients
achieving Good Neurological Outcome, the highest score on the five level Glasgow
Outcome Scale used to assess the recovery of head trauma patients, was higher in
the  drug-treated  group at each  measurement.  Among the most severely  injured
patients in the study, a better outcome was consistently observed among the drug
treated  group  than among the  placebo  treated  group.  Patients  received  an
intravenous  injection of either  dexanabinol  or placebo  within 6 hours of the
injury.  Demographically,  all 67  patients  were fairly  representative  of the
characteristics describing severe head trauma.

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 approved 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 autoimmune  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 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.

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


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<PAGE>


Competition

The pharmaceutical  industry is highly competitive.  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.

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 Pharmaceuticals, Inc.

On June  30,  1995,  the  Company  signed  a  definitive  agreement  with BLP 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 BLP. A second  agreement  signed  December 12, 1996,  extends  BLP's
rights to market these products in Europe,  Canada and other selected  countries
pending regulatory approval.

Under the  agreements,  BLP will  purchase  the active drug  substance  from the
Company.  As of March 1999,  BLP has  provided  the  Company  with a total of $5
million  in cash  advances  and is  entitled  to recoup the  advances  by way of
credits from sales of Lotemax,  Alrex and line  extension  products.  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 by BLP will
be payable to the Company following  receipt of regulatory  clearance in certain
markets  outside of the United States.  BLP  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.  As of December
31, 1998,  the company had repaid $ .6 million of the cash  advances from BLP by
way of credits from sales of Lotemax and Alrex during 1998.

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


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Patents, Proprietary Rights and Licenses

Patents and Proprietary Rights

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 that 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 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 a court of competent
jurisdiction,  if issued,  will  uphold the  patents  relating  to the  licensed
technology,  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  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


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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 that 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 its formulations.

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 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
July 1997,  a patent was issued by the U.S.  Patent and  Trademark  Office  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  filed  ten  patent  applications  that  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,


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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,
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 FDA,
under a series of regulations called the Good Laboratory  Practice  regulations,
regulates the conduct of preclinical  studies.  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.

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


                                        8
<PAGE>


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 of  $272,000  (for  Fiscal  Year  1999).
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 Alrex 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
maintenance  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").  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.

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,  numerous foreign authorities would regulate any future  international
sales.

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  payers  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.


                                       9
<PAGE>


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.

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.

Human Resources

As of March 15, 1999, the Company had 40 full time employees,  6 in the U.S. and
34 in Israel, of whom approximately 14 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  Dexanabinol,  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
$2,203,199 under such agreements  through December 31, 1998. The Company will be
required to pay royalties to the Chief Scientist from 2% to 5% of product sales,
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 is required to pay  royalties  to BIRD-F of 2.5%,
through September 1999, then 5% of product sales thereafter,  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.

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


                                       10
<PAGE>


within the framework. To date, the Company has received grants totaling $543,587
pursuant to this agreement.

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 SME Technology and with respect to 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  Shareholder  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 (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).

At its  Shareholder  Meeting held on September 17, 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  (27,980,414  votes for and 261,339 votes
against),  Stephen C. Knight  (27,763,994  votes for and 357,089 votes against),
David Schlachet (27,960,644 votes for and 251,089 votes against), Marvin P. Loeb
(27,960,664  votes for and 251,089 votes  against),  E. Andrews  Grinstead,  III
(27,859,994 votes for and 261,089 votes against), Mony Ben Dor (27,869,794 votes
for and 251,289 votes against) and Georges Anthony Marcel  (27,882,664 votes for
and 359,089  votes  against).  The  stockholders  of the  Company  also voted to
approve the issuance of certain  shares of Common Stock upon  conversion  of the
Company's Series C Convertible Participating Preferred Stock (6,869,765 voted in
favor,  1,097,044  voted  against  and  301,089  abstained).  In  addition,  the
stockholders  of the Company  voted to amend the  Company's  1997  Incentive and
Non-Qualified Stock Option


                                       11
<PAGE>


Plan to increase  the number of shares of Common Stock  issuable  under the plan
from 600,000 to 1,000,000  (27,045,129  voted for,  1,026,621  voted against and
178,518 abstained).

                                     PART II

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

The  Company's  Common  Stock is traded on the  Nasdaq  SmallCap  Marketsm.  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, 1998                               HIGH            LOW
----------------------------                               -----           -----

1st Quarter ....................................           $3.56           $1.63
2nd Quarter ....................................            3.28            2.47
3rd Quarter ....................................            2.75            1.44
4th Quarter ....................................            2.25            1.47

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


The foregoing represent inter-dealer prices,  without retail mark-up,  mark-down
or commission, and may not necessarily represent actual transactions.

On March 15,  1999,  there  were 462 record  holders of the Common  Stock of the
Company and  approximately  6,700  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.


                                       12
<PAGE>


Item 6.  Selected Financial Data
<TABLE>
<CAPTION>
                                                                    Year Ended December 31,
                                                                    -----------------------
                                         1998               1997                1996                 1995               1994
                                     ------------        ------------        ------------        ------------        ------------
<S>                                  <C>                 <C>                 <C>                 <C>                 <C>  
Revenues                             $  1,539,941                  --                  --        $     75,000        $      7,815

Gross Margin                            1,102,228                  --                  --                  --                  --

Operating expenses                     (6,109,809)         (8,563,091)         (8,354,991)         (8,253,666)        (13,036,461)

Loss Before Extraordinary Item         (4,663,347)         (8,233,547)         (8,077,210)         (8,096,085)        (12,955,299)

Extraordinary gain from
forgiveness of debt                            --             416,248                  --                  --                  --

Dividend embedded in
convertible preferred stock              (642,648)         (1,952,767)                 --                  --                  --
Preferred Stock dividends                (242,295)           (240,375)                 --                  --                  --

Net loss applicable to
common shareholders                  ($ 5,548,290)       ($10,010,441)       ($ 8,077,210)       ($ 8,096,085)       ($12,955,299)
                                     ============        ============        ============        ============        ============

Loss per share applicable
to common shareholders before
extraordinary gain - basic           ($      0.15)       ($      0.32)       ($      0.28)       ($      0.37)       ($      1.19)

Extraordinary gain per share                   --               (0.01)                 --                  --                  --
                                     ------------        ------------        ------------        ------------        ------------
Net loss per share applicable
to common shareholders - basic       ($      0.15)       ($      0.31)       ($      0.28)       ($      0.37)       ($      1.19)
                                     ============        ============        ============        ============        ============

Total assets                         $  8,066,670        $  8,421,841        $  7,468,293        $  9,461,654        $  4,289,416
                                     ============        ============        ============        ============        ============

Long term obligations                $  2,691,023        $  4,100,000        $  4,161,767        $  2,294,268        $     91,318
                                     ============        ============        ============        ============        ============

Cash dividends declared                        --                  --                  --                  --                  --
</TABLE>


                                       13
<PAGE>


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

During 1998,  the Company  began to generate  revenues from product  sales,  but
continues to be 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  $77,779,075  through  December  31,  1998.  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.  See "Management's  Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."

Results of Operations

Years Ended December 31, 1998 and 1997

During the year ended December 31, 1998, the Company reported revenues from sale
of product for the first  time.  Product  sales  commenced  in April  1998,  and
revenues totaled $1,188,278 for the period.  Additionally,  the Company recorded
license income of $351,663 for the year ended December 31, 1998 ($0 for the year
ended  December 31, 1997).  The license  income was primarily  generated  from a
non-recurring  payment  received by the Company in exchange  for the transfer of
certain drug technology.

Cost of goods sold for the year ended December 31, 1998 totaled  $437,713.  Cost
of goods  sold  includes  the cost of the  active  drug  substance  and  royalty
payments.

Total operating expenses decreased $2,453,210 or 29%, from $8,563,019 in 1997 to
$6,109,809  in 1998.  The decrease in operating  expenses is primarily  due to a
decrease in research and development expenses.

Net research and  development  expenses  decreased by  $1,972,125  or 36%,  from
$5,463,508  in 1997 to  $3,491,383  in 1998.  The  decrease  in R&D  expense  is
primarily due to the closure of the company's R&D  facilities in Florida  during
the fourth  quarter of 1997,  a lower than  anticipated  level of  research  and
development expenditures at the Company's Israel facility and reduced regulatory
expenses  resulting from the granting of waivers for fees previously paid to the
FDA.

Selling,  general and administrative expenses decreased by $495,837 or 19%, from
$2,632,477 in 1997 to $2,136,640 in 1998. The decrease is primarily due to costs
incurred by the Company during 1997 under marketing  agreements to supply Bausch
& Lomb  Pharmaceuticals,  Inc.  ("BLP") with  certain  specified  quantities  of
loteprednol  etabonate ("LE").  These quantities of LE, totaling $598,385,  were
purchased during 1997 for use in testing,  manufacturing  and various  marketing
activities,  and were charged to results of  operations in 1997. No such amounts
were incurred in 1998.

Patent expenses  increased by $2,626,  or 1 %, from $211,316 in 1997 to $213,942
in 1998.  This  increase is due to the timing of  completion  of certain  patent
applications.

Depreciation  and  amortization  expenses  increased  by  $12,125,  or 5 %, from
$255,718 in 1997 to $267,844 in 1998,  reflecting a higher level of purchases of
fixed assets during 1998.

Interest  and other  income,  net of interest and other  expenses,  increased by
$14,762, or 4.5 %, from $329,472 in


                                       14
<PAGE>


1997 to $344,234 in 1998. Interest and other income, net, increased  principally
as a result of higher average cash balances during 1998.

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.  Marketing  expenses  totaling  $598,385,  which is
comprised of bulk material purchases of LE, the active drug-substance of Lotemax
and Alrex,  were  principally  offset by reductions in research and development,
net,  patents,  general and  administrative  and  depreciation  and amortization
expenses.

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 that  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 accordance with its obligations under the Marketing  Agreements to supply BLP
with  specified  quantities  of LE  (the  active  drug-substance),  the  Company
purchased  quantities of LE and smaller quantities of a key reagent required for
the  manufacture of LE, in the amount of $2,403,012.  Certain  quantities of LE,
totaling  $598,385,  that were purchased  during 1997,  for use in testing,  and
marketing  activities  (principally  producing free samples of the product) were
charged  to  results  of  operations  in  1997.  Purchases  of LE  that  totaled
$1,804,627 and were made subsequent to the Company being advised by the FDA that
LE was an approvable drug have been recorded as inventory at December 31, 1997.

In  September  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 accounts payable due the University.

General  and  administrative  expense  increased  by  $509,079,  or 24  %,  from
$2,123,392 in 1996 to $2,632,471 in 1997. The increase is primarily due to costs
incurred to supply BLP with LE,  totaling  $598,385,  partially  offset by lower
expenses  associated  with the  completion of the Company's NDAs for Lotemax and
Alrex as well as the closure of its Florida.

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.

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,  and net
foreign exchange gains.

Years Ended December 31, 1996 and 1995

Total revenues decreased by $75,000 from 1995 to $-0- in 1996. The 1995 revenues
resulted  from the  sublicensing  of  certain  technologies  that 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.


                                       15
<PAGE>


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.  BLP net  reimbursements  for  clinical  trials  totaled $1.2
million during 1996, thereby reducing research and development  expenses by this
amount.

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.

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  that  were no  longer  being  pursued.
Further,  the Company's  in-house  patent  counsel now executes work  previously
undertaken by external patent attorneys.

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  had no sources of  recurring  revenues  until the  commencement  of
product  sales in April  1998,  and has  incurred  operating  losses  since  its
inception.  At December  31,  1998,  the Company has an  accumulated  deficit of
$77,779,095.  The Company has  financed its  operations  with public and private
offerings  of  securities,  advances and other  funding  pursuant to a marketing
agreement with BLP, research contracts,  license fees,  royalties and sales, and
interest income.

The  Company  had  working  capital  of $2.3  million,  including  cash and cash
equivalents  of $3.5 million,  as of December 31, 1998. On February 4, 1998, the
Company  completed  a  private  placement  of  convertible  preferred  stock and
warrants that generated $5 million in gross proceeds.  On December 10, 1998, the
Company obtained a $10 million equity line of credit with a single institutional
investor.  During 1998, the Company received  additional  equity of $1.7 million
from the exercise of warrants to purchase the Company's common stock.

Management  believes  that the  equity  line of credit,  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
BLP will be sufficient to support operations through the first half of 2000. 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 the Company will be successful in obtaining  additional financing
or commercializing its product candidates, or that Lotemax or Alrex will achieve
market acceptance.


                                       16
<PAGE>


During 1997, the Company  raised 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 BLP 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 BLP as of
December 31, 1998 totaled $5 million.  BLP is entitled to recoup the advances by
withholding  certain  amounts  from the  proceeds  payable  to the  Company  for
purchases of the active drug substance used in the production of Lotemax,  Alrex
and line extension products.  As of December 31, 1998, the outstanding  advances
from BLP  amounted to $4.4  million.  The Company may be obligated to repay such
advances if it is unable to supply BLP with certain specified  quantities of the
active drug substance.

The Year 2000

The Company has  completed its  assessment  of the potential  impact of the year
2000  on the  ability  of the  Company's  computerized  information  systems  to
accurately process information that may be date sensitive.  Any of the Company's
programs that  recognize a date using "00" as the year 1900 rather than the year
2000 could result in errors or systems failures.  The Company currently believes
that the costs of addressing this issue will not have a material  adverse impact
on the Company's financial  position.  The Company has not been able to complete
an assessment of any year 2000 issues that may effect third  parties,  including
the Company's current and prospective suppliers. The Company plans to devote all
resources  required to resolve any significant  third-party year 2000 compliance
problems in a timely manner.  Any year 2000 compliance  problems of the Company,
its customers or vendors could have a material  adverse  effect on the Company's
business, results of operations and financial condition.

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.


                                       17
<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.               59       Chairman, Chief Executive Officer,
                                          Chief Scientist and Director
Gad Riesenfeld, Ph.D.          55       President, Chief Operating Officer
Robert W. Cook                 43       Vice President Finance and
                                          Chief Financial Officer
Anat Biegon, Ph.D.             45       Vice President/Research and Development
Marvin P. Loeb                 72       Director
E. Andrews Grinstead III       53       Director
Stephen C. Knight, M.D.        39       Director
David Schlachet                53       Director
Mony Ben Dor                   53       Director
George Anthony Marcelt, 
     M.D., Ph.D.               57       Director
Stephan Guttmann, Ph.D.        71       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 in October 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 biopharmaceutical and venture capital companies.

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 1977 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 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 director of 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


                                       18
<PAGE>


University Medical Center.  From 1988 to 1990, she was an Associate Professor in
the Department of Neurobiology at the Weizmann Institute of Science.  Dr. Biegon
resigned  from her  position  effective  April  1999 in order  to  pursue  other
interests.  She will, however,  continue to support the dexanabinol  development
program and will be working with the Company through 1999.

Marvin P. Loeb, a Director, was Chairman of the Board of the Company (then known
as Pharmatec,  Inc.) from December 1982 through October 1992, and has remained a
Director of the Company since 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 and
Chairman of Automedix  Sciences,  Inc.  from  September  1980 until August 1997.
Automedix Sciences,  Inc. changed its name to COMC, Inc. in August 1997 and is a
publicly held voice and data  transmission  company.  Chairman of  Cardiomedics,
Inc.,  a privately  held  company  engaged in the  development  of heart  assist
devices,  since May 1986.  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 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 1994, is Chief
Financial Officer, 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.,  where he  specialized  in R&D
valuations,  and mergers and acquisitions 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 MBA from the Yale School of
Organization and Management.

David  Schlachet,  a Director of the Company since  December 1994, has served as
the Chairman of Elite  Industries Ltd. from July 1997. From January 1996 to June
1997, Mr.  Schlachet served as the Vice President of the Strauss Group and Chief
Executive Officer of Strauss Holdings 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.


                                       19
<PAGE>


Mony Ben Dor, a Director  of the Company  since  September  1997,  has been Vice
President of The Israel  Corporations,  Ltd. since May 1997, 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 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.

Georges Anthony Marcel,  M.D.,  Ph.D., a Director of the Company since September
1998,  is  President  and Chief  Executive  Officer of TMC  Development  S.A., a
biopharmaceutical  consulting firm based in Paris, France. Prior to founding TMC
Development in 1992, Dr. Marcel held a number of senior  executive  positions in
the pharmaceutical industry, including Chief Executive Officer of Amgen's French
subsidiary,  Vice President of Marketing for Rhone-Poulenc Sante and Director of
Development  for  Roussel-Uclaf.  Dr. Marcel  teaches  biotechnology  industrial
issues and European regulatory affairs at the Faculties of Pharmacy of Paris and
Lille. Dr. Marcel is also a member of the Gene Therapy Advisory Committee at the
French Medicines Agency.

Stephan Guttmann,  Ph.D., a Director of the Company since December 1998, retired
as Senior Vice  President of Research  and  Development  at Sandoz  Pharma Ltd.,
which merged with  Ciba-Geigy in 1997 to form  Novartis.  Earlier in his career,
Dr. Guttmann lead Sandoz'  Worldwide Pharma Research and  Development.  Prior to
that, at the Sandoz  Pharmaceutical  Chemical Research Department,  Dr. Guttmann
held a variety of positions including head of the Pharmaceutical Development and
Preclinical  Research  departments.  Dr.  Guttmann  has  served  on the board of
Systemix and the  Scientific  Advisory Board of Sequana  Pharmaceuticals  and is
currently on the boards of Modex Pharmaceuticals.

Section 16 Filings

No person who,  during the fiscal year ended  December 31, 1998, 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.

Item 11.  Executive Compensation

The following  table  summarizes the total  compensation  of the Chief Executive
Officer of the Company for 1998 and the two previous years, as well as all other
executive  officers  of the  Company  who  received  compensation  in  excess of
$100,000 for 1998.


                                       20
<PAGE>


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>    
Haim Aviv, Ph.D
Chairman, Chief                     1998         $236,347                             $  4,197(1)                         100,000
Executive Officer, and              1997         $227,471         $ 40,000            $ 16,119(1)                          
Chief Scientist                     1996         $236,453                             $ 27,435(1)                          
                                                                                                                     
Gad Riesenfeld, Ph.D                                                                                                 
President and                       1998         $175,000         $ 25,000            $ 50,728(2)                          80,000
Chief Operating Officer             1997         $175,000                             $ 44,948(2)                          
                                    1996         $150,000                             $ 43,798(2)                          
                                                                                                                     
Robert W. Cook                                                                                                       
Vice President Finance              1998         $165,000         $ 20,000            $  4,800(1)                         150,000
and Chief Financial Officer                                                                                          
                                                                                                                     
Anat Biegon, Ph.D                                                                                                    
Vice President of                   1998         $ 88,830         $ 14,396            $ 23,490(1)                          60,000
Research and                        1997         $ 81,873         $ 20,456            $ 27,860(1)                          
Development                         1996         $ 85,516                             $ 26,565(1)                          
                                                                                                    
</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.

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 YearEnded December 31, 1998

<TABLE>
<CAPTION>
                               Common Stock
                                Underlying          % of Total Options
                                 Options               Granted to         Exercise Price
                                 Granted                Employees            per Share       Expiration Date
                              ------------          ------------------    --------------     ---------------
<S>                              <C>                       <C>                <C>                 <C> 
Haim Aviv, Ph.D                  100,000                   15.2%              $  2.78             5/18/08

Gad Riesenfeld, Ph.D              80,000                   12.2%              $  2.78             5/18/08

Robert W. Cook                   100,000                   15.2%              $  2.00              1/1/08
                                  50,000                    7.6%              $  2.78             5/18/08

Anat Biegon, Ph.D                 60,000                    9.1%              $  2.78             5/18/08
</TABLE>


                                       21
<PAGE>


Aggregated Option Exercises
for the Year Ended December 31, 1998
and Option Values as of December 31, 1998:

<TABLE>
<CAPTION>
                                                                                                           Value of Unexercised
                                                                                                         In-the-Money Options at
                                       Number of                          Number of Unexercised              December 31, 1998
                                        Shares                         Options at December 31, 1998      -----------------------
                                       Acquired on      Value          ------------------------------
Name                                   Exercise        Realized         Exercisable     Unexercisable    Exercisable   Unexercisable
----                                   -----------    --------         ------------     -------------    -----------   -------------
<S>                                        <C>        <C>                 <C>              <C>              <C>            <C>  
Haim Aviv, Ph.D                            0                0             312,376          112,000          $  --          $  --


Gad Riesenfeld, Ph.D                       0          $60,022(1)           71,333           88,000          $  --          $  --


Robert W. Cook                             0                0              25,000          125,000          $  --          $  --


Anat Biegon, Ph.D                          0                0              44,533           66,000          $  --          $  --

(1) Represents 43,750 shares
</TABLE>

Stock Option Plans

It is  currently  the  Company's  policy  that all full time key  employees  are
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.

As of December 31, 1998, the Company has 1,551,101 options to purchase shares of
the Company's Common Stock  outstanding  under various option plans,  536,765 of
which are  non-qualified  options.  A summary of the various  established  stock
option plans is as follows:

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, 1998,  there were options to purchase  701,166  shares of the
Company's  Common  Stock  outstanding  under  this  plan.  Each  option  granted
outstanding  under the 1992 plan as of December 31, 1998 expire by January 2008.
It is anticipated that future grants of stock options will not be made from this
plan.

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, as amended,  is 1,000,000 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.


                                       22
<PAGE>


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  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 "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


                                       23
<PAGE>


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.  At December 31, 1998,
there were  845,750  1997  Employees  Warrants at $1.59,  10,000 1997  Employees
Warrants at $1.66 and 95,000 1997 Directors Warrants at $1.59 outstanding.

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 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, 1999. 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  and  Chief  Operating   Officer  of  the  Company.   Dr.
Riesenfeld's annual gross salary is $185,000.

Robert W. Cook In January 1998, the Company  entered into a one-year  employment
agreement  with  Mr.  Cook,  which is  automatically  renewable  for  successive
one-year   terms  unless  either  party  gives  three  months  prior  notice  of
non-renewal.  Under the Agreement,  Mr. Cook devotes his full time to serving as
Vice President  Finance and Chief Financial  Officer of the Company.  Mr. Cook's
annual gross salary is $175,000.

Directors' Compensation. In 1998, Directors did not receive any compensation for
service on the Board or for attending Board meetings.


                                       24
<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 15, 1999, 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.

<TABLE>
<CAPTION>
                                                 Amount of
Name and Address of                              Beneficial             Percentage of
Beneficial Ownership                              Ownership               Total (1)
--------------------                             ----------             -------------
<S>                                               <C>                     <C> 
Haim Aviv, Ph.D.(2)                               1,349,305               3.3%
c/o Pharmos Ltd.
Kiryat Weitzman
Rehovot, Israel

Marvin P. Loeb(3)                                   305,646                  *
Trimedyne, Inc.
2810 Barranca Road
Irvine, CA 92714

E. Andrews Grinstead III(4)                         115,738                  *
Hybridon, Inc.
One Innovation Drive
Worcester, MA 01605

Stephen C. Knight, M.D.(4)                            8,333                  *
Epix Medical, Inc.
71 Rogers Street
Cambridge, MA 02142

David Schlachet(4)                                   20,000                  *
Strauss Ltd.
16 Bazel Street
Petach-Tikva, Israel 49510

Mony Ben Dor(4)                                       1,875                  *
The Israel Corporation
4 Weizman St
Tel-Aviv 61336, Israel

Georges Anthony Marcel, M.D., Ph.D                        0                  *
c/o TMC Development
9, rue de Magdebourg
75116 Paris France

Stephan Guttmann, Ph.D.                                   0                  *
Hegenheimermattweg
CH-4123 Allschwil
Switzerland

All Directors and                                 2,083,013               5.0%
Executive Officers as a group
(11 persons)(5)
</TABLE>


                                       25
<PAGE>

----------

*    Indicates ownership of less than 1%.

(1)  Based  on  40,538,685  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 437,376
     shares of Common Stock.

(3)  Held jointly with his wife. Also includes currently exercisable options and
     warrants to purchase 60,000 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)  Based on the number of shares of Common  Stock  outstanding,  plus  915,438
     currently  exercisable  warrants  and  options  held by the  Directors  and
     executive officers.

Item 13.  Certain Relationships and Related Transactions

     None.

 
                                       26
<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, 1998 and 1997

               Consolidated   Statements  of  Operations  for  the  years  ended
               December 31, 1998, 1997 and 1996

               Consolidated  Statements of Changes in  Shareholders'  Equity for
               the years ended December 31, 1998, 1997 and 1996

               Consolidated  Statements  of  Cash  Flows  for  the  years  ended
               December 31, 1998, 1997 and 1996

               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).

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)).


                                       27
<PAGE>


     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).

     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).


                                       28
<PAGE>


     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).

     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 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


                                       29
<PAGE>


               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 4, 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 4, 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 4, 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]).

     4(a)(l)   Private Equity Line of Credit  Agreement dated as of December 10,
               1998  between  the  Company  and the  Investor  (Incorporated  by
               reference to the Company's  Current  Report 8-K filed on December
               23, 1998).

     4(a)(m)   Amendment  Agreement  dated as of December  18, 1998  between the
               Company  and  Dominion   Capital  Fund,  Ltd.   (Incorporated  by
               reference to the Company's  Current  Report 8-K filed on December
               23, 1998).

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


                                       30
<PAGE>


     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)

     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  


                                       31
<PAGE>


               (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)

     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]).


                                       32
<PAGE>


     10(a)(a)  Employment  Agreement,  dated  December  15,  1997,  between  the
               Company and Robert W. Cook (  Incorporated  by  reference  to the
               Company's  Annual Report on Form 10-K for the year ended December
               31, 1997).

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).

23   Consent of Experts

     23(a)     Consent of PricewaterhouseCoopers LLP**

27   Financial Data Schedule**

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

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


(b)  Reports on Form 8-K

     Since  October  1, 1998,  the  Company  has one  report on Form 8-K,  dated
December 23, 1998.


                                       33
<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, 1999

   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 W. Cook                Chief Financial Officer (Principal      March 30, 1999
-----------------------------     Financial and Accounting Officer), 
Robert W. Cook                    and Secretary                      
                                  

/s/ Gad Riesenfeld                President, Chief Operating Officer      March 30, 1999
-----------------------------
Gad Riesenfeld


/s/ Marvin P. Loeb                Director                                March 30, 1999
-----------------------------
Marvin P. Loeb


/s/ E. Andrews Grinstead III      Director                                March 30, 1999
-----------------------------
E. Andrews Grinstead III


/s/ Stephen C. Knight             Director                                March 30, 1999
-----------------------------
Stephen C. Knight


/s/ David Schlachet               Director                                March 30, 1999
-----------------------------
David Schlachet


/s/ Mony Ben Dor                  Director                                March 30, 1999
-----------------------------
Mony Ben Dor


/s/ Georges Anthony Marcel        Director                                March 30, 1999
-----------------------------
Georges Anthony Marcel


/s/ Stephan Guttmann              Director                                March 30, 1999
-----------------------------
Stephan Guttmann
</TABLE>





                                       34
<PAGE>


                               Pharmos Corporation
                   Index to Consolidated Financial Statements


Report of Independent Accountants                                           F-2

Consolidated balance sheets as of December 31, 1998 and 1997                F-3

Consolidated statement of operations for the years ended
      December 31, 1998, 1997 and 1996                                      F-4

Consolidated statement of changes in shareholders' (deficit) equity
        for the years ended December 31, 1998, 1997 and 1996                F-5

Consolidated statement of cash flows for the years ended
        December 31, 1998, 1997 and 1996                                    F-6

Notes to consolidated financial statements                                  F-7


                                      F-1
<PAGE>


                        Report of Independent Accountants


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, 1998 and
1997,  and the results of their  operations and their cash flows for each of the
three years in the period ended  December 31, 1998 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, 1998 has an  accumulated  deficit of
$77,779,075  that  raises  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.

/s/ PricewaterhouseCoopers  LLP
New York, New York
March 1, 1999


                                      F-2
<PAGE>


Pharmos Corporation
Consolidated Balance Sheets
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                                                               December 31,
                                                                                   ----------------------------------
                                                                                        1998                  1997
                                                                                   ------------          ------------
Assets
Current assets:
<S>                                                                                <C>                   <C>         
  Cash and cash equivalents                                                        $  3,452,916          $  4,423,389
  Inventories                                                                         1,727,096             1,804,627
  Grants  and other receivables                                                         550,057               237,655
  Prepaid royalties                                                                     259,488               143,333
  Prepaid expenses and other current assets                                             206,793               171,299
                                                                                   ------------          ------------
    Total current assets                                                              6,196,350             6,780,303
Fixed assets, net                                                                     1,181,030               703,428
Prepaid royalties, net of current portion                                               366,152               573,334
Intangible assets, net                                                                  244,738               291,262
Other assets                                                                             78,400                73,514
                                                                                   ------------          ------------
      Total assets                                                                 $  8,066,670          $  8,421,841
                                                                                   ============          ============

Liabilities and Shareholders' (Deficit) Equity
Current liabilities:
  Long term debt, current portion                                                  $         --          $     55,253
  Accounts payable                                                                      936,899             2,576,968
  Accrued expenses                                                                      679,737               809,869
  Accrued wages and other compensation                                                  456,575               401,285
  Advances against future sales                                                       1,836,231             1,000,000
                                                                                   ------------          ------------
      Total current liabilities                                                       3,909,442             4,843,375

Advances against future sales, net of current portion                                 2,591,023             4,000,000
Other liabilities                                                                       100,000               100,000
                                                                                   ------------          ------------
    Total liabilities                                                                 6,600,465             8,943,375

Shareholders' (deficit) equity:
  Preferred stock, $.03 par value, 1,250,000 shares authorized:
    Series B convertible, 0 and 2,755 shares outstanding, respectively
      (liquidation preference of $0 and $2,755,000, respectively)                            --                    83
    Series C convertible, 1,500 and 0 shares outstanding, respectively
      (liquidation preference of $1,500,000 and $0, respectively)                            45                    --
    Common stock, $.03 par value; 60,000,000 shares authorized,
      39,800,112 and 34,391,638 shares issued and
      outstanding (excluding $551 in 1998 and 1997,
      held in Treasury) in 1998 and 1997, respectively                                1,193,452             1,031,197
    Paid in capital                                                                  78,051,783            70,516,913
    Accumulated deficit                                                             (77,779,075)          (72,069,727)
                                                                                   ------------          ------------
      Total shareholders' (deficit) equity                                            1,466,205              (521,534)
                                                                                   ------------          ------------

Commitments and contingencies
      Total liabilities and shareholders' (deficit) equity                         $  8,066,670          $  8,421,841
                                                                                   ============          ============
</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,
                                                                             ------------------------------------------------------
                                                                                 1998                 1997                 1996
                                                                             ------------         ------------         ------------
<S>                                                                          <C>                  <C>                  <C>         
Revenues:
       Product sales                                                         $  1,188,278         $         --         $         --
       License fee                                                                351,663                   --
                                                                             ------------         ------------         ------------
Total Revenues                                                                  1,539,941                   --                   --

Cost of Goods Sold                                                                437,713                   --                   --
                                                                             ------------         ------------         ------------
Gross Margin                                                                    1,102,228                   --                   --
                                                                             ------------         ------------         ------------
Expenses:
        Research and development, net                                           3,491,383            5,463,508            5,604,592
        Selling, general and administrative                                     2,136,640            2,632,477            2,123,392
        Patents                                                                   213,942              211,316              281,412
        Depreciation and amortization                                             267,844              255,718              345,595
                                                                             ------------         ------------         ------------

                    Total operating expenses                                    6,109,809            8,563,019            8,354,991
                                                                             ------------         ------------         ------------

Loss from operations                                                           (5,007,581)          (8,563,019)          (8,354,991)
Other income (expenses):
        Interest income                                                           315,336              330,453              323,097
        Other income (expenses), net                                               38,844               16,365               (9,393)
        Interest expense                                                           (9,946)             (17,346)             (35,923)
                                                                             ------------         ------------         ------------
                    Other income (expenses), net                                  344,234              329,472              277,781
                                                                             ------------         ------------         ------------
Loss before extraordinary item                                                 (4,663,347)          (8,233,547)          (8,077,210)
Extraordinary gain from forgiveness of debt,
        net of $0 of income taxes (Note 4)                                             --              416,248                   --
                                                                             ------------         ------------         ------------

Net loss                                                                       (4,663,347)          (7,817,299)          (8,077,210)

Less:  Dividend embedded in convertible preferred
                    stock (Note 8)                                               (642,648)          (1,952,767)                  --
           Preferred stock dividends                                             (242,295)            (240,375)                  --
                                                                             ------------         ------------         ------------
Net loss applicable to common shareholders                                   $ (5,548,290)        $(10,010,441)        $ (8,077,210)
                                                                             ============         ============         ============
Loss per share applicable to common shareholders
        before extraordinary gain - basic and diluted                        $       (.15)        $       (.32)        $       (.28)
Extraordinary gain per share                                                           --                  .01                   --
                                                                             ------------         ------------         ------------
Net loss per share applicable to common
         shareholders - basic and diluted                                    $       (.15)        $       (.31)        $       (.28)
                                                                             ============         ============         ============
Weighted average shares outstanding - basic and diluted                        37,277,186           32,442,981           29,291,401
                                                                             ============         ============         ============
</TABLE>

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

                                      F-4
<PAGE>

Pharmos Corporation
Consolidated Statements of Changes in Shareholders' Equity (Note 8)
================================================================================
<TABLE>
<CAPTION>
                                                                                                           Series A Convertible     
                                                                                 Common Stock                  Preferred Stock      
                                                                           Shares          Amount         Shares          Amount    
                                                                        ------------    ------------   ------------    ------------ 
<S>                                                                       <C>               <C>               <C>               <C> 
December 31, 1995                                                         29,149,039        $874,471                                

Warrant exercise                                                              99,286           2,978                                
Issuance of preferred stock, net of offering costs                                                            1,900             $57 
     of $18,000
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 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)
Common Stock Dividend upon conversion of P/S                                  47,265           1,418                                
Conversion of Series B preferred stock                                     2,000,215          60,006                                
Common Stock Dividend upon conversion of P/S                                  86,190           2,586                                
Dividend embedded in convertible preferred stock                                                                                    
Net loss                                                                                                                            
                                                                        ------------    ------------   ------------    ------------ 
December 31, 1997                                                         34,391,638       1,031,748              0               0 

Issuance of C preferred stock, net of offering costs                                                                                
     of $411,135                                                             
Warrant and option exercises                                                 970,728          29,122                                
Conversion of Series B preferred stock                                     1,704,978          51,149                                
Common Stock Dividend upon conversion of P/S,                                 34,904           1,047                                
Conversion of Series C preferred stock                                     2,230,010          66,900                                
Common Stock Dividend upon conversion of P/S,                                 69,947           2,098                                
Issuance of Common Stock - equity credit line, net                           397,907          11,938                                
Dividend embedded in convertible preferred stock                                                                                    
Preferred Stock Dividends                                                                                                           
Net loss                                                                                                                            
                                                                        ------------    ------------   ------------    ------------ 
December 31, 1998                                                         39,800,112      $1,194,003              0              $0 
                                                                        ============    ============   ============    ============ 

<CAPTION>
                                                                             Series B Convertible          Series C Convertible     
                                                                                Preferred Stock               Preferred Stock       
                                                                             Shares          Amount        Shares         Amount    
                                                                         ------------    ------------   ------------   ------------ 
<S>                                                                            <C>                <C>         <C>              <C> 
December 31, 1995                                                                                                                   

Warrant exercise                                                                                                                    
Issuance of preferred stock, net of offering costs                                                                                  
     of $18,000
Private placement of common stock                                                                                                   
Warrant grant to consultants                                                                                                        
Net loss                                                                                                                            
                                                                         ------------    ------------   ------------   ------------ 
December 31, 1996                                                                   0              $0              0             $0 

Issuance of preferred stock, net of offering costs
     of $260,000                                                                6,000             180                               
Warrant exercises                                                                                                                   
Conversion of Series A preferred stock                                                                                              
Common Stock Dividend upon conversion of P/S                                                                                        
Conversion of Series B preferred stock                                         (3,245)            (97)                              
Common Stock Dividend upon conversion of P/S                                                                                        
Dividend embedded in convertible preferred stock                                                                                    
Net loss                                                                                                                            
                                                                         ------------    ------------   ------------   ------------ 
December 31, 1997                                                               2,755              83              0              0 

Issuance of C preferred stock, net of offering costs                                                           5,000            150 
     of $411,135                                                       
Warrant and option exercises                                                            
Conversion of Series B preferred stock                                         (2,755)            (83)                              
Common Stock Dividend upon conversion of P/S,                                                                                       
Conversion of Series C preferred stock                                                                        (3,500)          (105)
Common Stock Dividend upon conversion of P/S,                                                                                       
Issuance of Common Stock - equity credit line, net                                                                                  
Dividend embedded in convertible preferred stock                                                                                    
Preferred Stock Dividends                                                                                                           
Net loss                                                                                                                            
                                                                         ------------    ------------   ------------   ------------ 
December 31, 1998                                                                   0              $0          1,500            $45 
                                                                         ============    ============   ============   ============ 

<CAPTION>
                                                                           Paid-in                                                  
                                                                          Capital in    Accumulated           Treasury Stock        
                                                                         Excess of Par    Deficit          Shares         Amount    
                                                                         -------------  ------------    ------------   ------------ 
<S>                                                                       <C>           <C>                   <C>         <C>   
December 31, 1995                                                         $58,763,797   $(54,024,742)         18,356          $(551)

Warrant exercise                                                               55,522                                               
Issuance of preferred stock, net of offering costs                          1,881,943                                               
     of $18,000
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)         18,356           (551)

Issuance of preferred stock, net of offering costs
     of $260,000                                                            5,739,820                                               
Warrant exercises                                                              66,375                                               
Conversion of Series A preferred stock                                        (44,731)                                              
Common Stock Dividend upon conversion of P/S                                   59,345        (60,763)                               
Conversion of Series B preferred stock                                        (59,909)                                              
Common Stock Dividend upon conversion of P/S                                  134,360       (136,946)                               
Dividend embedded in convertible preferred stock                            1,952,767     (1,952,767)                               
Net loss                                                                                  (7,817,299)                               
                                                                         ------------   ------------    ------------   ------------ 
December 31, 1997                                                          70,516,913    (72,069,727)         18,356           (551)

Issuance of C preferred stock, net of offering costs                        4,588,715                                               
     of $411,135                                                       
Warrant and option exercises                                                1,649,212                                               
Conversion of Series B preferred stock                                        (51,067)                                              
Common Stock Dividend upon conversion of P/S,                                  53,724         (54,771)                              
Conversion of Series C preferred stock                                        (66,795)                                              
Common Stock Dividend upon conversion of P/S,                                 104,189        (106,287)                              
Issuance of Common Stock - equity credit line, net                            371,949                                               
Dividend embedded in convertible preferred stock                              642,648        (642,648)                              
Preferred Stock Dividends                                                     242,295        (242,295)                              
Net loss                                                                                  (4,663,347)                               
                                                                         ------------   ------------    ------------   ------------ 
December 31, 1998                                                         $78,051,783   $(77,779,075)         18,356          $(551)
                                                                         ============   ============    ============   ============ 

<CAPTION>
                                                                                Total
                                                                            Shareholders'
                                                                               Equity
                                                                            ------------
<S>                                                                           <C>       
December 31, 1995                                                             $5,612,975

Warrant exercise                                                                  58,500
Issuance of preferred stock, net of offering costs                             1,882,000
     of $18,000
Private placement of common stock                                              2,000,000
Warrant grant to consultants                                                      12,000
Net loss                                                                      (8,077,210)
                                                                            ------------
December 31, 1996                                                              1,488,265

Issuance of preferred stock, net of offering costs
     of $260,000                                                               5,740,000
Warrant exercises                                                                 67,500
Conversion of Series A preferred stock                                                 0
Common Stock Dividend upon conversion of P/S                                           0
Conversion of Series B preferred stock                                                (0)
Common Stock Dividend upon conversion of P/S                                           0
Dividend embedded in convertible preferred stock                                       0
Net loss                                                                      (7,817,299)
                                                                            ------------
December 31, 1997                                                               (521,534)

Issuance of C preferred stock, net of offering costs                           4,588,865
     of $411,135                                                       
Warrant and option exercises                                                   1,678,334
Conversion of Series B preferred stock                                                 0
Common Stock Dividend upon conversion of P/S,                                          0
Conversion of Series C preferred stock                                                 0
Common Stock Dividend upon conversion of P/S,                                          0
Issuance of Common Stock - equity credit line, net                               383,887
Dividend embedded in convertible preferred stock                                       0
Preferred Stock Dividends                                                              0
Net loss                                                                      (4,663,347)
                                                                            ------------
December 31, 1998                                                             $1,466,205
                                                                            ============
</TABLE>


<PAGE>

Pharmos Corporation
Consolidated Statement of Cash Flows
------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                           Year Ended December 31,
                                                                                  1998                 1997                 1996
                                                                              -----------          -----------          -----------
<S>                                                                           <C>                  <C>                  <C>         
Cash flows from operating activities:
   Net loss                                                                   $(4,663,347)         $(7,817,299)         $(8,077,210)
   Adjustments to reconcile net loss to net
     cash flow used in operating activities:
      Depreciation and amortization                                               267,844              255,718              345,595
      Loss on disposal of fixed assets                                                 --               41,560                   --
      Warrant grant to consultants                                                     --                   --               12,000
      Extraordinary gain from forgiveness of debt                                      --             (416,248)
   Changes in operating assets and liabilities
      Inventory                                                                    77,531           (1,804,627)                  --
      Grants and other receivables                                               (312,402)             121,364             (254,758)
      Prepaid expenses and other current assets                                   (35,494)              76,064              239,000
      Advanced royalties                                                           91,027             (143,333)            (573,334)
      Other assets                                                                 (4,887)             114,958                   --
      Accounts payable                                                         (1,640,069)           2,145,801              108,059
      Accrued expenses                                                           (130,132)             312,248              (18,413)
      Accrued wages and other compensation                                         55,290               43,304              152,645
      Other liabilities                                                                --               48,881             (184,360)
                                                                              -----------          -----------          -----------
      Net cash used in operating activities                                    (6,294,639)          (7,021,609)          (8,250,776)
                                                                              -----------          -----------          -----------
Cash flows from investing activities:
     Purchases of fixed assets, net                                              (698,921)            (324,769)             (73,028)
                                                                              -----------          -----------          -----------
         Net cash used in investing activities                                   (698,921)            (324,769)             (73,028)
                                                                              -----------          -----------          -----------
Cash flows from financing activities:
        Advances against future sales                                            (572,746)           1,000,000            2,122,859
        Proceeds from issuance of common stock
              and exercise of warrants and options, net                         1,678,334               67,500            2,058,500
        Proceeds from issuance of preferred stock, net                          4,588,865            5,740,000            1,882,000
        Proceeds from exercise of equity credit line                              383,887                   --                   --
        Payments of loans payable                                                 (55,253)            (170,639)             (49,440)
                                                                              -----------          -----------          -----------
         Net cash provided by financing activities                              6,023,087            6,636,861            6,013,919
                                                                              -----------          -----------          -----------
Net (decrease) increase in cash and cash equivalents                             (970,473)            (709,517)          (2,309,885)
Cash and cash equivalents at beginning of year                                  4,423,389            5,132,906            7,442,791
                                                                              -----------          -----------          -----------
Cash and cash equivalents at end of year                                      $ 3,452,916          $ 4,423,389          $ 5,132,906
                                                                              ===========          ===========          ===========
</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   pharmaceutical   company
     specializing in the modification of existing molecules through  proprietary
     techniques to reduce undesirable side effects and/or enhance efficacy.  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.  The Company
     has administrative  offices in Iselin,  New Jersey and conducts  operations
     through its wholly owned subsidiary, Pharmos, Ltd., in Rehovot, Israel.

     In March 1998,  the Company  received  approval for three separate New Drug
     Applications  ("NDA") from the U.S. Food and Drug  Administration  ("FDA").
     These  approvals  were  for  Lotemax(R)  and  Alrex(TM).  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.

2.   Liquidity and Business Risks

     While the Company has  generated  revenue  through the sale of its approved
     products  in the  market,  it  has  incurred  operating  losses  since  its
     inception.  At December 31, 1998, the Company has an accumulated deficit of
     $77,779,075.  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 $3.5 million as of December 31, 1998,  combined  with
     anticipated  cash inflows from  revenues  derived from sales of Lotemax and
     Alrex and the obtaining of a $10 million  equity line of credit on December
     10, 1998 (see note 8) will be sufficient to support operations into 2000.

     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,
     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.  Actual  results could differ from
     those estimates.

                                       F-7


<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements

     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 applicable
     to common  shareholders  for the  period,  reduced by 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, 1998,  1,500  outstanding  shares of Series C  Convertible
     Preferred  Stock,  convertible  into  1,114,818  shares of common stock and
     outstanding  options and  warrants to purchase  5,634,842  shares of common
     stock,  with exercise  prices  ranging from $ .75 to $ 5.20 per share 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 1998 and 1997.

     Revenue recognition

     Sales  revenue is recognized  upon shipment of products to customers,  less
     allowances for estimated returns and discounts.  License fees and royalties
     are recognized  when earned in accordance  with the underlying  agreements.
     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.

     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  etabonate,  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 their estimated  useful life of fifteen
     years.  As of December  31,  1998 and 1997,  accumulated  amortization  was
     $795,042  and  $748,518,  respectively.  Amortization  expense  amounted to
     $46,524 in each of the years ended December 31, 1998, 1997 and 1996.

     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, 1998,  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.


                                      F-9
<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements


     Equity based compensation

     The Company accounts for its employee stock option plans in accordance with
     the provisions of Accounting  Principles Board Opinion No. 25,  "Accounting
     for Stock  Issued to  Employees",  and  related  interpretations.  As such,
     compensation expense related to employee stock options is recorded only if,
     on the date of grant,  the fair value of the  underlying  stock exceeds the
     exercise  price.  The Company adopted the  disclosure-only  requirements of
     SFAS No. 123,  "Accounting  for  Stock-Based  Compensation",  which  allows
     entities  to  continue  to apply the  provisions  of APB Opinion No. 25 for
     transactions  with employees and provide pro forma net income and pro forma
     earnings per share  disclosures  for employee stock grants made in 1996 and
     future years as if the  fair-value-based  method of  accounting in SFAS No.
     123 had been applied to these transactions.

     Reclassifications

     Certain amounts for 1997 and 1996 have been  reclassified to conform to the
     fiscal 1998 presentation.  Such reclassifications did not have an impact on
     the Company's financial position or results of operations.

     Comprehensive income

     Effective  January 1, 1998, the Company adopted the provisions of Statement
     of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
     ("SFAS 130").  SFAS 130 establishes  standards for reporting  comprehensive
     income,  defined as all changes in equity from non-owner sources.  Adoption
     of SFAS 130 did not  have a  material  effect  on the  Company's  financial
     position or results of operations.

     Segment and geographic information

     Effective  January 1, 1998, the Company adopted the provisions of Statement
     of Financial Accounting  Standards No. 131,  "Disclosures about Segments of
     an Enterprise and Related  Information"  (SFAS 131").  SFAS 131 establishes
     standards for the way public enterprises report information about operating
     segments in annual financial  statements and requires those  enterprises to
     report selected  information about operating  segments in interim financial
     reports  issued to  stockholders.  See Note 16 for  additional  disclosures
     related to segment and geographic information.

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 and Alrex,  on an  exclusive  basis in the United
     States  following  receipt of FDA approval.  The Marketing  Agreement  also
     covers the Company's other loteprednol etabonate based product, LE-T. Under
     the  Marketing  Agreement,  Bausch & Lomb will  purchase  the  active  drug
     substance  (loteprednol  etabonate) from the Company.  A second  agreement,
     covering  Europe,  Canada  and  other  selected  countries,  was  signed in
     December 1996 ("the New Territories Agreement").

     Through December 31, 1998, Bausch and Lomb has provided the Company with $5
     million in cash advances against future sales, of which  approximately $4.4
     million was  outstanding  at December 31, 1998. An additional $1 million is
     due from Bausch & Lomb upon the receipt of regulatory  approval for LE-T in
     the United  States.  Bausch & Lomb is  entitled  to recoup the  advances by
     withholding  certain amounts against  payments for future  purchases 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 1999, based on management's estimate of product sales to
     Bausch & Lomb in 1999,  has been  presented  as a current  liability in the
     accompanying balance sheet at December 31, 1998.

     Bausch & Lomb also  collaborates  in the  development of products by making
     available  amounts up to 50% 


                                      F-10
<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements


     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 and the New Territories Agreement.

     In  September  1997,  the  Company  entered  into  an  agreement  with  the
     University of Florida Research Foundation (the  "University").  Under terms
     of the agreement,  the Company  returned rights to technologies the Company
     previously  ceased  developing,  and in  exchange  the  University  forgave
     $416,248 of debts owed by the Company during 1997. During 1998, the Company
     received a  non-recurring  license  fee of  $350,000  in  exchange  for the
     transfer of certain drug technology to the University under the agreement.


5.   Fixed Assets

     Fixed assets consist of the following:

<TABLE>
<CAPTION>
                                                               December 31,
                                                            1998           1997
                                                        -----------    -----------

<S>                                                     <C>            <C>        
     Laboratory, pilot plant and other equipment        $ 1,916,804    $ 1,339,688
     Leasehold improvements                                 255,451        240,462
     Office furniture and fixtures                          143,714        107,251
     Computer equipment                                     145,449         78,795
     Vehicles                                                53,307         53,307
                                                        -----------    -----------
                                                          2,514,725      1,819,503
     Less - Accumulated depreciation and amortization    (1,333,695)    (1,116,075)
                                                        -----------    -----------
                                                        $ 1,181,030    $   703,428
                                                        ===========    ===========
</TABLE>

     Depreciation  and  amortization of fixed assets was $221,320,  $209,194 and
     $299,071 in 1998, 1997 and 1996, 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 $513,931,  $418,245 and $245,302 during 1998,
     1997 and 1996,  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, at rates ranging from 2% to 5%, 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,  1998,  the total  amounts  received  under such grants
     amounted to $3,672,566,  of which $3,128,979 relates to grants that contain
     royalty  provisions.  Aggregate future royalty payments related to sales of
     products  developed,  if any,  as a result of these  grants are  limited to
     $3,591,869 based on grants received through December 31, 1998.


                                      F-11
<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements


     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 received grants totaling $343,587 in 1998
     pursuant to this agreement.

     7.  Licensing Arrangements

     The Company is a licensee of certain research  technologies and 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
     and Alrex,  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, 1998.

     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
     1998, 1997 and 1996.

     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 Lotemax and Alrex. Outstanding prepaid
     royalties  totaled $ 625,640 and $ 716,667 and are reflected as an asset on
     the balance sheets at December 31, 1998 and 1997, 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

     1998 Transactions

     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.

     In May 1998,  the  Company,  under  provisions  of the 1997  Incentive  and
     Non-Qualified  Stock Option Plan,  issued options to employees,  directors,
     consultants  and other key personnel for the purchase of 500,000  shares of
     common stock.  The options are exercisable  over a ten-year period and will
     expire on May 18, 2008.  The options will vest in four annual  installments
     of 25% each on May 18, 1999, 2000, 2001 and 2002, respectively. The options
     are exercisable at a strike price of $2.781 per share, which represents the
     closing  market  value of the  common  stock on the date the  options  were
     awarded.

     In September 1998, the  shareholders of the Company approved an increase in
     the number of shares of common stock  reserved for issuance  under the 1997
     Incentive and Non-Qualified Stock Option Plan from 600,000 to 1,000,000.


                                      F-12
<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements


     During the first quarter of 1998,  the Company issued  1,704,978  shares of
     its common stock upon conversion of 2,755 shares of the Company's  Series B
     convertible  preferred stock. The shares were issued with conversion prices
     ranging  from $1.41 per share to $1.78 per share.  The Company  also issued
     34,904  shares of common  stock in  payment  of  dividends  of the Series B
     convertible  preferred  stock.  As of the  date  of such  issuances,  these
     dividends were valued at $68,624.

     On  February  4, 1998,  the  Company  completed  a private  placement  with
     institutional  investors of Series C Redeemable Convertible Preferred Stock
     ("Series C convertible  preferred  stock") and warrants to purchase 650,000
     shares of common stock, generating gross proceeds of $5 million. The Series
     C convertible preferred stock carries a 5% premium payable in common stock,
     and is convertible  into common shares of the Company 60 days subsequent to
     the date of  issuance.  For the  period  ending  180 days after the date of
     issuance,  the  conversion  price is the lower of 90% of the average of the
     low trade prices of the Common Stock for the five consecutive  trading days
     ending on the day  immediately  prior to the conversion date (the "Variable
     Conversion  Price") or $2.89 per share.  Until converted into common stock,
     the Series C convertible preferred stock has no voting rights. The warrants
     issued to the investor and the finders are  exercisable  at prices  ranging
     from $2.28 to $2.67 per share,  commencing  one year after the  closing for
     four and five year periods. Under certain circumstances, the holders of the
     Series C convertible  preferred  stock were  initially  able to require the
     Company  to  redeem  the  outstanding  shares of the  Series C  convertible
     preferred  stock.  In December 1998,  the Company  received a waiver of the
     redemption  features from the holder of the Series C convertible  preferred
     stock.

     During  1998,  the Company  issued  2,299,957  shares of common  stock upon
     conversion of 3,500 shares of its Series C convertible preferred stock.

     As of December  31, 1998 and 1997,  cumulative  dividends in arrears on the
     Company's  outstanding  Series B and C  convertible  preferred  stock  were
     $173,671 and $42,666,  respectively.  The  dividends  are payable in common
     stock of the Company.

     During 1998, the Company issued 970,728 shares of its common stock upon the
     exercise of warrants, and received consideration of $1,678,334.

     In  connection  with the  issuances  of the  Series A, B and C  convertible
     preferred stock, the Company was required to recognize, in its earnings per
     share  ("EPS")  calculation,  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.  The  Company
     recorded a preferred  stock  dividend of $642,648  and  $1,952,767  for the
     years ended December  31,1998 and 1997,  respectively,  on the  outstanding
     shares of  convertible  preferred  stock in connection  with the conversion
     discount.

     The Company has entered into a Private Equity Line of Credit Agreement (the
     "Credit Agreement") as of December 10, 1998, and as amended on December 18,
     1998, with Dominion  Capital Fund, Ltd. (the  "Investor").  Pursuant to the
     terms of the Credit Agreement,  the Company may, from time to time during a
     specified  term,  cause the  Investor  to purchase  up to an  aggregate  of
     $10,000,000  of the Company's  common stock,  par value $.03 per share (the
     "Common  Stock").  The price  per  share of Common  Stock to be paid by the
     Investor is to be determined  at the time of each  purchase  according to a
     specified  formula which is based upon the average closing bid price of the
     Common  Stock on the  principal  trading  exchange or market for the Common
     Stock (the "Principal  Market") over a prescribed,  five-day  period.  With
     each  purchase of Common  Stock,  the Investor is also to receive  warrants
     exercisable  for a number of shares of Common Stock equal to ten percent of
     the number of shares of Common  Stock  purchased  at an exercise  price per
     share  equal to 125% of the  closing  bid price of the Common  Stock on the
     Principal Market on a specified date.

     During  1998,  under  terms of the Credit  Agreement,  the  Company  issued
     397,907  shares of its Common Stock and warrants to purchase  39,791 shares
     of its Common Stock to the Investor for  consideration of $383,887,  net of
     fees.  The warrants have exercise  prices ranging from $ 1.95 to $ 2.11 per
     share and expire in December 2001.


                                      F-13
<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements

     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,
     the fair  market  value of the  common  stock on the date of  grant,  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).

     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,  the
     fair market value of the common stock on the date of grant,  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 over a period  ranging from 90 to 270 days  subsequent  to March 31,
     1997. The conversion  price will be 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 were 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.

     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.


                                      F-14
<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements


     On September 30, 1996, the Company  completed a private placement of Series
     A convertible  preferred stock and warrants to purchase common stock,  with
     institutional  investors  generating  gross  proceeds of $1.9 million.  The
     Series A  preferred  stock  carried a 5% dividend  rate  payable in cash or
     common stock, at the option of the Company, and was convertible into common
     shares  over a  period  ranging  from  80 days to 360  days  subsequent  to
     September 30, 1996.  The  conversion  price was 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 had 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.


                                      F-15
<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements

9.   Warrants

     Many of the warrants issued in connection with various equity financing and
     related  transactions  during  1991  through  1998  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,  1998 as  adjusted  for the events  which have  triggered
     anti-dilution provisions contained in the respective warrant agreements:

<TABLE>
<CAPTION>
                                                                      Shares Issuable   Exercise
           Issuance Date              Expiration Date                  Upon Exercise      Price
           -------------              ---------------                  -------------    --------
<S>                                   <C>                                <C>             <C>   
           February 1992              February 1999                         87,979       $ 2.44
           August 1993                August 1999                          466,832       $ 2.60
           October 1993               September 1999                        65,044       $ 2.26
           June 1994                  October 1999                         150,000       $  .84
           April 1995                 April 2005                           500,000       $ 2.75
                                      April 2005                            10,000       $  .78
           May 1995                   April 2000                             7,119       $  .75
                                      April 2000                            17,119       $ 1.00
                                      April 2000                            17,119       $ 1.50
           September 1995             September 2000                       821,489       $ 1.80
           October 1995               October 2001                          10,000       $ 1.88
           March 1996                  March 2002                           15,000       $ 2.31
           September 1996             September 2007                        50,000       $ 1.75
                                      September 2007                        65,000       $ 1.34
           November 1996              November 2002                         10,000       $ 1.39
           February 1997              September 1999                        20,000       $ 1.59
                                      February 2003                         90,000       $ 1.59
                                      February 2007                        845,750       $ 1.59
           March 1997                 March 2001                           159,000       $ 1.75
                                      March 2007                            10,000       $ 1.66
                                      March 2008                           239,473       $ 1.38
           April 1997                 April 2003                            15,000       $ 1.22
           January 1998               October 2005                          22,000       $ 2.22
           February 1998              January 2003                         502,314       $ 2.66
                                      January 2003                         150,566       $ 2.28
           December 1998              December 2001                         18,824       $ 1.95
                                      December 2001                         18,113       $ 2.11
                                                                         ---------       ------

           Total shares and average
                exercise price                                           4,383,741       $ 2.01
                                                                         =========       ======
</TABLE>




                                      F-16
<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements

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:

<TABLE>
<CAPTION>
                                                                             Under          Weighted Average
                                                                             Option          Exercise Price
                                                                             ------          --------------

<S>                                                                         <C>                    <C>  
     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

     Granted                                                                  627,917              $2.63
     Exercised                                                                 (6,000)             $1.94
     Expired                                                                  (34,000)             $2.27
                                                                            ---------              -----

     Options Outstanding at 12/31/98                                        1,014,336              $2.47
                                                                            =========              =====

     Options exercisable at 12/31/98                                          382,086              $2.24
                                                                            =========              =====
</TABLE>

     The exercise prices of outstanding  incentive stock options at December 31,
     1998  range  from $ 1.94 to $ 2.78 per share and have an  weighted  average
     remaining contractual life of 8.3 years.

     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:

<TABLE>
<CAPTION>
                                                                             Under            Weighted Average
                                                                             Option            Exercise Price
                                                                             ------            --------------

<S>                                                                          <C>                    <C>   
     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

     Exercised                                                                (6,667)               $ 1.94
     Granted                                                                 136,250                $ 1.74
                                                                            --------                ------

     Options Outstanding at 12/31/98                                         536,765                $ 2.47
                                                                            ========                ======

     Options exercisable at 12/31/98                                         441,440                $ 2.62
                                                                            ========                ======
</TABLE>

     The exercise prices of outstanding  nonqualified  stock options at December
     31, 1998 range from $ 1.75 to $ 5.20 per share and have an weighted average
     remaining contractual life of 6.0 years.

     The Company has 500,000 options available for grant at December 31, 1998.



                                      F-17
<PAGE>


Pharmos Corporation
Notes to Consolidated Financial Statements

     The Company applies Accounting  Principles Board Opinion No. 25, Accounting
     for Stock Issued to Employees,  and related  interpretations  in accounting
     for its plans.  As all  options  and  warrants  granted to  employees  were
     granted with exercise prices equal to the fair value of the common stock on
     the respective grant dates, no compensation expense has been recognized for
     its stock-based compensation plans. Had compensation cost for the Company's
     stock option plans and warrant grants 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  $478,000, or
     $ .01 per  share  in 1998  and  $305,000,  or $.01  per  share  in 1997 and
     $203,000  or $.01 per  share in 1996  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 1996 through 1998 are
     estimated  at $.51 to $1.44 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, 1998,  Pharmos  Limited has an unused line of credit of
     $50,000 denominated in New Israeli Shekels.

12.  Income Taxes

     No  provision  for income  taxes was  recorded  for the three  years  ended
     December 31, 1998 due to net operating losses incurred.  Net operating loss
     carryforwards  for U.S. tax purposes of  approximately  $60,956,000  expire
     from 2000 through 2013.

     The Company's  gross deferred tax assets of $26,900,000  and $25,087,000 at
     December 31, 1998 and 1997,  respectively,  represented  primarily  the tax
     effect of both the net operating loss carryforwards,  deferred research and
     development costs and research and development tax credit 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 February 2004. The research and  development  facility in Israel
     is leased under an agreement which expires in May 2000.

     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-18
<PAGE>



     At December 31, 1998,  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:

<TABLE>
<CAPTION>
                                                   Lease                 Sublease
                                                Commitments               Rentals
                                                 --------               ----------

<S>                                              <C>                    <C>     
          1999                                   $447,395               $146,950
          2000                                    213,854                 36,738
          2001                                     89,119                     --
                                                 --------               --------
                                                 $750,368               $183,688
                                                 --------               --------
</TABLE>
                                    
                
     Rent expense during 1998, 1997 and 1996 amounted to $292,035,  $410,856 and
     $371,526  respectively.  Rent  expense  in  1998,  1997  and 1996 is net of
     $146,950, $308,608 and $499,106 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,  1998,  1997 or 1996.  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 $5,504, $10,090 and $11,363 in 1998,
     1997 and 1996, 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 $4,427,254 at December
     31, 1998.  The  estimated  fair values of all other  financial  instruments
     approximate, or are not materially different, than their carrying values.


                                      F-19
<PAGE>


16.  Segment and Geographic Information

     In 1998, the Company  adopted SFAS 131,  "Disclosures  about Segments of an
     Enterprise and Related  Information".  SFAS 131  establishes  standards for
     reporting  information regarding operating segments and related disclosures
     about products and services, geographic areas and major customers.

     The  Company  is active in one  business  segment:  designing,  developing,
     selling  and  marketing  pharmaceutical  products.  The  Company  maintains
     development  operations  in the United  States and  Israel.  The  Company's
     selling operations are maintained in the United States.

     Geographic  information  for the years ending  December 31, 1998,  1997 and
     1996 are as follows:

                                    1998              1997              1996
                                -----------       -----------       -----------
      Net revenues
        United States           $ 1,539,941                --                --
        Israel                           --                --                -- 
                                -----------       -----------       -----------
                                $ 1,539,941                --                -- 
                                -----------       -----------       -----------
      Net loss
        United States           ($4,480,022)      ($7,660,521)      ($7,865,918)
        Israel                     (183,325)         (156,778)         (211,292)
                                -----------       -----------       -----------
                                ($4,663,347)      ($7,817,299)      ($8,077,210)
                                -----------       -----------       -----------
      Total assets
        United States           $ 6,478,552       $ 7,058,724       $ 6,684,973
        Israel                    1,588,118         1,363,119           783,320
                                -----------       -----------       -----------
                                $ 8,066,670       $ 8,421,843       $ 7,468,293
                                ===========       ===========       ===========


                                      F-20