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, 2001

                               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 311
                                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, 2002
held by those persons deemed to be non-affiliates was approximately $98,777,140.

   As of March 15, 2002, the Registrant had outstanding 56,573,792 shares of its
$.03 par value Common Stock.


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                                     PART I

Item 1.  Business

Introduction

Pharmos Corporation is a bio-pharmaceutical  company that discovers and develops
new drugs to treat a range of inflammatory  and  neurological  disorders such as
traumatic  brain  injury  and  stroke.  Although  we do not  currently  have any
approved  products,  we have an  extensive  portfolio of drug  candidates  under
development, as well as discovery,  preclinical and clinical capabilities. Prior
to  the  sale  of  our  existing  ophthalmic  product  line  to  Bausch  &  Lomb
Incorporated in October of last year, we had two successful  ophthalmic products
on the market.  To date, our principal sources of cash have been the sale of our
existing ophthalmic business, revenues from our ophthalmic product line, private
financings and research grants.

Dexanabinol,   Pharmos'  lead  central  nervous  system  product,  is  currently
undergoing a pivotal Phase III clinical trial for severe  traumatic brain injury
in Europe and Israel.  The study is expected to enroll a total of 860  patients,
including  patients in the U.S.  upon  receipt of necessary  FDA  authorization.
Fifty-four  centers are currently  participating in the trial,  which number may
ultimately  increase  to ninety by the end of the  year.  The Phase II  studies,
completed  in early  2000,  revealed  that the drug  inhibited  the  increase in
intracranial  pressure  above  25mmHg,  the  level of  pressure  above  which is
considered  to be a  prognostic  indicator  of poor  outcome.  This  result  was
statistically significant. The study also showed a trend of efficacy in the drug
treated  groups versus the placebo group and,  within the most severely  injured
patients,  a more than two-fold  increase in the  percentage of those  achieving
good recovery  (28.0% in the  dexanabinol  group vs. 11.7% in the placebo group)
was demonstrated. In addition,  neurological recovery appeared to be accelerated
in the  dexanabinol  treated  group,  such that the  percentage  of  dexanabinol
patients  achieving  good  recovery at one month after injury was  significantly
higher than in the placebo group.

Pharmos has identified several promising new compounds based upon its program to
develop synthetic  relatives of the active  ingredient in cannabis.  Preclinical
investigations are underway for compounds to treat stroke,  multiple  sclerosis,
neuropathic pain and Parkinson's disease.

On October 9, 2001,  Pharmos sold all of its rights to its  existing  ophthalmic
product  line to  Bausch  & Lomb  for cash and  assumption  of  certain  ongoing
obligations.  The disposition had two parts, one for its two products already on
the market, Lotemax(R) and Alrex(R), and the second part for a medication now in
Phase III clinical trials,  a product known as LE-T,  involving a combination of
loteprednol  etabonate and the antibiotic  tobramycin.  Based on meeting certain
new product  milestones for LE-T in the future,  the gross proceeds of the total
disposition may reach $49 million.

Pharmos  received  gross proceeds of  approximately  $25 million in cash for its
rights to Lotemax(R) and Alrex(R),  prescription  anti-inflammation  and allergy
products that have been  manufactured and marketed by Bausch & Lomb under a 1995
Marketing  Agreement with Pharmos and for the rights to any future extensions of
LE-T. Additionally, Pharmos may receive up to an additional $14 million in gross
proceeds,  adjusted  based on the date of FDA  approval of this new  combination
therapy.  An additional  milestone payment of up to $10 million could be paid to
Pharmos to the extent  certain  sales levels are exceeded in the first two years
following  commencement  of sales in the U.S.  Pharmos will pay the  loteprednol
etabonate patent  owner/licensor 11% of any such gross proceeds and 14.3% of any
such milestone  payment.  Pharmos agreed to pay up to $3.75 million of the costs
of developing LE-T based on the arrangement with Bausch & Lomb.


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Strategy

Pharmos' business is the discovery and development of new drugs to treat a range
of inflammatory  and  neurological  disorders such as traumatic brain injury and
stroke.  We seek to enter  into  collaborative  relationships  with  established
pharmaceutical  companies to complete  development and  commercialization of our
products.

Pharmos is applying its experience in rational drug design,  novel drug delivery
technology and high  through-put  screening in developing  products  directed at
several fields  including  neuroprotective  compounds for traumatic brain injury
and stroke,  and synthetic,  non-psychotropic  compounds related to cannabis for
neurological, vascular and other conditions involving inflammatory processes.

Products

Platform Technologies

Pharmos is developing two families of compounds based on scientific knowledge of
the medicinal  activities  of cannabis.  Since these  compounds  are  chemically
similar in several  ways to the main  active  component  of  cannabis,  they are
referred to as cannabinoids.  The company utilizes state-of-the-art technologies
to  synthesize,  evaluate  and develop new  cannabinoid  molecules  that exhibit
enhanced  therapeutic  benefit but do not display the undesirable,  psychotropic
effects seen with cannabis. Pharmos continues to expand its library of compounds
through a hybrid methodology combining the rational design of compounds based on
knowledge  of  detailed   molecular   requirements   for  drug   activity   with
combinatorial chemistry, a technique that utilizes randomized chemical reactions
to  synthesize  large  numbers  of  different  molecules.  In  contrast  to  the
conventional  random methods of  combinatorial  chemistry,  this hybrid approach
leads to a larger percentage of synthesized  compounds that demonstrate activity
in  screening  assays and  increases  the  potential  of  developing  potent and
selective drug candidates.

Pharmos'  chemical  library  consists  of two  chemically  distinct  cannabinoid
platforms,  tricyclic  dextrocannabinoids  and  bicyclic  cannabinoids.  The two
classes of synthetic cannabinoids have different mechanisms of action, but there
is   considerable   overlap  in  their   therapeutic   potential   for  treating
neurological, cardiovascular, autoimmune and inflammatory disorders.

Tricyclic dextrocannabinoids

The tricyclic dextrocannabinoids, for which dexanabinol is the prototype, do not
bind to either of the two known  classes of  cannabinoid  receptors.  Therefore,
this family of compounds does not show the  psychotropic and other negative side
effects seen with  naturally  occurring  cannabinoids.  Drug  candidates in this
family  display  biological  activity by  blocking  the  activation  of specific
channels in nerve cells and/or inhibiting several major inflammatory mechanisms.
Both activities may reduce the amount of sudden and programmed cell death caused
by certain disorders.

In addition to dexanabinol,  which is currently  undergoing a Phase III clinical
study   for   the   treatment   of   severe   head   injury,   other   tricyclic
dextrocannabinoids  are under  evaluation  in  preclinical  models  for  stroke;
neuropathic  pain,  which results from nerve damage or dysfunction;  nociceptive
pain, which is caused by activation of nerve sensors as a result of acute tissue
damage;  neurodegenerative disorders such as Parkinson's disease; and autoimmune
disorders such as multiple  sclerosis,  inflammatory  bowel disease,  rheumatoid
arthritis, etc.

Dexanabinol

Dexanabinol  is Pharmos' lead central  nervous  system product aimed at treating
severe  head  trauma.  It is a member  of the  tricyclic  family  of  compounds,
therefore  it is similar in  structure  to cannabis but is designed to


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avoid the unwanted  psychotropic and sedative effects while retaining properties
as an agent to reduce inflammation and pain.

In 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.  In late 1996,  Pharmos  commenced a
Phase II study  conducted  at six  medical  centers in Israel on  patients  with
severe head injury.  This trial was reviewed and approved by the American  Brain
Injury Consortium and the European Brain Injury Consortium.

In 1998,  Pharmos  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 a  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 Score 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.

In early 2000, Pharmos announced the results of the third cohort of the Phase II
Clinical Study.  The study concluded that the Phase II goals of establishing the
safety of dexanabinol in traumatic brain injury and the dosing  parameters for a
pivotal study were met. 101 patients in total were enrolled in the multi-center,
double-blind,  randomized  Phase II study,  which was  carried out in six trauma
centers  in  Israel  affiliated  with  the  American  Brain  Injury  Consortium.
Fifty-two of the patients were treated with  dexanabinol at three separate doses
and forty-nine  received a placebo. In the third cohort,  thirty-three  patients
received an  intravenous  injection of either 200 mg. of  dexanabinol  (N=21) or
placebo (N=12) within six hours of injury. Demographically,  these patients were
fairly  representative  of the  traumatic  brain injury  population,  comprising
mostly young men injured in motor vehicle  accidents.  However,  the dexanabinol
and placebo  groups  differed with respect to several  important  baseline entry
parameters  affecting the patients' prognosis;  for example,  injury severity as
determined  by the  Glasgow  Coma Scale was  significantly  worse in the treated
group  than in the  placebo  group.  In  addition,  the  patients'  Computerized
Tomography  classifications indicating the extent of the brain injury were worse
in the drug-treated group compared to placebo. Predictably, the strong trend for
better neurological  outcome in comparison with placebo that was observed in the
first two cohorts was not  repeated in this cohort.  Nevertheless,  intracranial
pressure  above a  threshold  of  25mmHg,  a major  risk  factor  affecting  the
prognosis of  traumatic  brain  injury,  was lower 40-70% of the time during the
first days after injury in the treated group vs. the placebo group.  This result
was  similar to those of the  previous  two  cohorts  (48mg.  and 150mg.  doses)
reported  in  1998.  An  analysis  of  patient   performance  on  the  Galveston
Orientation and Amnesia Test  demonstrated  significantly  better results in the
dexanabinol treated patients at 1, 3 and 6 months follow-up compared to placebo.
The Galveston  Orientation and Amnesia Test is a neurological test that measures
awareness of surroundings and ability to remember.

The 6 month outcome as measured by the Glasgow  Outcome Score was similar in the
treated  and  placebo  groups as a whole,  a  comparison  of outcome  within the
subgroup of very severe  (Glasgow Coma Scale 4-6) patients  revealed a more than
two-fold  increase in the percentage of those  achieving good recovery (28.0% in
the dexanabinol group vs. 11.7% in the placebo group). In addition, neurological
recovery appeared to be accelerated in the dexanabinol  treated group, such that
the percentage of  dexanabinol  patients  achieving  good


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recovery (measured by Glasgow Outcome Score) at 1 month was significantly higher
than in the placebo group (17% vs. 2%, p<0.02).

During January 2001,  Pharmos announced that its international  pivotal trial of
dexanabinol for severe  traumatic  brain injury  commenced in Europe and Israel.
The purpose of the Phase III study is to  determine  the safety and  efficacy of
dexanabinol in severe traumatic brain injury patients.  The study is expected to
enroll a total of 860 patients,  including  patients in the U.S. upon receipt of
necessary FDA authorization.  Fifty-four centers are currently  participating in
the trial.  Approximately 90 centers in Europe, the U.S. and Israel are expected
to  participate  in the study.  European  countries  participating  in the study
include Belgium,  Finland, France, Germany, Italy, the Netherlands and the U.K.,
along with  Israel.  Pharmos is  collaborating  with the  European  Brain Injury
Consortium  and the  American  Brain  Injury  Consortium  in a number  of areas,
including recruitment efforts with trauma centers.

Bicyclic cannabinoids

As with the  tricyclic  dextrocannabinoids,  the  bicyclic  cannabinoids  do not
display the unwanted  psychotropic  side effects seen with natural  cannabinoids
because  they do not  bind to  cannabinoid  receptors  known as CB1,  which  are
located  predominately  in the brain.  However,  the  molecular  activity of the
bicyclics is different  from the  tricyclics  in that the bicyclic  cannabinoids
bind with high affinity to cannabinoid receptors known as CB2, which are located
on immune and inflammatory  cells. Such binding of bicyclic  cannabinoids to CB2
receptors leads to the inhibition of certain intracellular  processes that would
normally  lead  to  activation  of  inflammatory  processes.  Therefore,  active
bicyclic   cannabinoids   may  help  prevent   certain  cells  from   activating
inflammation pathways.

Pharmaceuticals that activate CB2 receptors may be important in treating various
autoimmune,  inflammatory or  degenerative  disorders.  Several  candidates from
Pharmos'  bicyclic  cannabinoid  library have shown promise in animal models for
autoimmune  disorders including multiple sclerosis,  inflammatory bowel disease,
rheumatoid arthritis,  and insulin dependent diabetes mellitus;  for neuropathic
and nociceptive pain; and for neurodegeneration seen in Parkinson's disease.

Loteprednol Etabonate

Loteprednol  etabonate  is a  unique  steroid,  designed  to act in the  eye and
alleviate  inflammatory and allergic conditions,  and is quickly and predictably
reduced  into  inactive  particles  before it reaches  the inner eye or systemic
circulation.  This  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 intra-ocular pressure, 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.

LE-T,  a  loteprednol  etabonate-based  eye drug  combined  with the  antibiotic
tobramycin  that was sold to  Bausch & Lomb as part of the  ophthalmic  business
disposition  in October  2001,  is  undergoing a further  clinical  trial before
submitting the New Drug Application for FDA approval. Upon successful completion
of the clinical  trial,  Bausch & Lomb expects to file the New Drug  Application
with the FDA.

In  October  2001,  Pharmos  sold all of the assets of its  existing  ophthalmic
business to Bausch & Lomb.  Pharmos  retains no residual rights to Lotemax(R) or
Alrex(R), two commercially-available  products which were included in the assets
sold to Bausch & Lomb,  but may receive up to a maximum  gross $14 million based
on the date of FDA approval of LE-T,  and receive an additional fee of up to $10
million if the  following  occurs:  (a) net sales of LE-T in the first 12 months
after  commercial  launch are at least $7.5 million and (b) net sales of LE-T in
the second twelve  consecutive  months after commercial  launch (i) exceed $15.0
million and (ii) are greater than net sales in (a) above.  Future  payments will
be included in the Company's income when all


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contingencies  are  resolved.  In addition,  Pharmos has agreed to pay for up to
$3.75  million of the clinical  development  costs of LE-T,  depending  upon the
total  developmental costs for LE-T. There are several products currently on the
market  against which LE-T would  compete,  with Alcon's  Tobradex(R)  being the
largest selling product in the category.

SERM Platform

Pharmos has developed a library of new proprietary  compounds,  called Selective
Estrogen Receptor  Modulators  (SERM),  which have been synthesized and screened
primarily on the basis of their binding activity to estrogen receptors.  Pharmos
believes  these  compounds  may be  active  against  various  forms  of  cancer,
including some cancers that are not hormone  dependent such as pancreatic cancer
and malignant melanoma. In addition to its anti-cancer potential,  this platform
could provide drug candidates to treat various estrogen-related conditions, such
as post-menopausal  osteoporosis,  cardiovascular disease and mood and cognitive
disorders. This platform is at an early stage of discovery.

Competition

The  pharmaceutical  industry is highly  competitive.  Pharmos  competes  with a
number of pharmaceutical companies that have financial,  technical and marketing
resources  significantly  greater  than those of Pharmos.  Some  companies  with
established positions in the pharmaceutical industry may be better equipped than
Pharmos to develop  and market  products  in the  markets  Pharmos 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 Pharmos in  recruiting  highly
qualified scientific personnel.

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

Collaborative Relationships

Pharmos'  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 Pharmos'  products in  development  and  potential  future
products.  Depending on the availability of financial,  marketing and scientific
resources,  among other factors,  Pharmos 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  Pharmos'
flexibility in pursuing  alternatives for the commercialization of its products.
Due to the often unpredictable nature of the collaborative process, we cannot be
sure that we will be able to establish any additional collaborative arrangements
or that, if established, any such relationships will be successful.

Bausch & Lomb

In October 2001,  Pharmos sold to Bausch & Lomb all of its rights to manufacture
and market  Lotemax(R)  and Alrex(R) and the third  loteprednol  etabonate-based
product,  LE-T, which continues to be developed by Bausch & Lomb. As part of the
sale  agreement,  Pharmos will receive up to an additional  $14 million in gross
proceeds, based upon the date of


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FDA approval of the product, and a milestone payment of up to an additional $10
million if actual sales during the first two years following commercialization
exceed agreed-upon forecasted amounts. Pharmos agreed to pay up to $3.75 million
of the costs of developing LE-T based on the arrangement with Bausch & Lomb and
will have a passive role as a member of a joint committee overseeing the
development of LE-T.

Pharmos will pay Dr. Nicholas Bodor, the loteprednol  etabonate patent owner and
licensor,  who is also a former  director of and  consultant  to our company,  a
total of  approximately  $2.7 million  from the initial  proceeds of the sale of
Lotemax(R) and Alrex(R) in return for his consent to Pharmos'  assignment of its
rights under the license  agreement to Bausch & Lomb.  Pharmos will also pay Dr.
Bodor 11% of our LE-T proceeds due upon FDA approval and 14.3% of the payment we
will  receive in the event that  certain  sales levels are exceeded in the first
two years following commencement of sales in the U.S.

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  Pharmos'
technologies  may  depend,  in part,  upon the ability to obtain  strong  patent
protection.

Some of the technologies underlying Pharmos' potential products were invented or
are  owned  by  various  third  parties,  including  the  Hebrew  University  of
Jerusalem.  Pharmos 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. Pharmos generally maintains, at its expense, U.S.
and  foreign  patent  rights  with  respect  to both  the  licensed  and its own
technology and files and/or  prosecutes the relevant patent  applications in the
U.S. and foreign  countries.  Pharmos also relies upon trade secrets,  know-how,
continuing technological  innovations and licensing opportunities to develop its
competitive  position.  Pharmos'  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.  Pharmos  intends to file  additional  patent  applications,  when
appropriate,  relating to its technology,  improvements to its technology and to
specific products it develops.

The patent positions of pharmaceutical  firms,  including Pharmos, 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,  Pharmos 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,  Pharmos 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,  Pharmos 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  Pharmos,  even if the  eventual  outcome is  favorable  to
Pharmos. The results of the judicial process are often uncertain,  and we cannot
therefore  be sure  that a court  of  competent  jurisdiction  will  uphold  the
patents, if issued, 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 Pharmos'
fields.  If patents are issued to other  companies  that contain  competitive or
conflicting claims and such claims are ultimately  determined to be valid, it is
possible that Pharmos would not be able to obtain licenses to these patents at a
reasonable cost or be able to develop or obtain alternative technology.

Pharmos  also relies  upon trade  secret  protection  for its  confidential  and
proprietary  information.  It is always


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possible  that  others  will  independently  develop  substantially   equivalent
proprietary  information  and  techniques  or otherwise  gain access to Pharmos'
trade secrets.

It is Pharmos' 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 Pharmos. These agreements generally provide that all
confidential  information  developed or made known to the individual  during the
course of the individual's  relationship with Pharmos 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 Pharmos. Due to the vital nature
of trade secrets and the often  uncertain  results of the judicial  process,  we
cannot  be  sure,  however,   that  these  agreements  will  provide  meaningful
protection  or adequate  remedies  for  Pharmos'  trade  secrets in the event of
unauthorized  use or  disclosure  of  such  information.  Pharmos'  patents  and
licenses  underlying  its potential  products  described  herein are  summarized
below.

Neuroprotective  Agents.  Pharmos has  licensed  from the Hebrew  University  of
Jerusalem,  which is the  academic  affiliation  of the  inventor,  Dr.  Raphael
Mechoulam,  patents  covering new compounds  that have  demonstrated  beneficial
activity which may prevent damage or death to nerve cells resulting from various
diseases  and  disorders of the nervous  system while  appearing to be devoid of
most of the  deleterious  side  effects  usually  associated  with this class of
compounds.  Several  patents  have  been  designed  to  protect  this  family of
compounds  and their uses  devised by Pharmos and the  inventors.  The  earliest
patent  applications  resulted  in patents  issued in 1989,  and the most recent
patents  date  from  2000.  These  patents  cover  dexanabinol,  which  is under
development  for the  treatment  of head  trauma and other  conditions,  and new
molecules discovered by modifying the chemical structure of dexanabinol.

Site-Specific  Drugs. In the general  category of  site-specific  drugs that are
active  mainly  in the eye and  have  limited  systemic  side  effects,  Pharmos
licensed  several  patents from Dr. Nicholas Bodor. It assigned its rights under
the Bodor license to Bausch & Lomb in October 2001 in  connection  with its sale
of its existing ophthalmic business. The earliest patents date from 1984 and the
most recent from 1996. Some of these patents cover  loteprednol  etabonate-based
products and its formulations.

Selective  Estrogen  Receptor  Modulators  (SERM).   Pharmos  has  filed  patent
applications in the U.S., Israel,  Australia,  Canada,  Japan, Brazil, Korea and
the European Patent Office to protect certain  derivatives of tamoxifen,  a drug
approved by the FDA, and other steroid  hormones,  and molecules that oppose the
hormones' activities.  In July 1997, the U.S. Patent and Trademark Office issued
a patent with claims  covering the compounds  themselves and their use. A second
patent  issued  in July  2000  claims  the use of these  compounds  as agents to
inhibit  growth of new blood  vessels,  a potential  method of treating  various
cancers.  Pharmos  believes that these charged  derivatives  are superior to the
parent compounds in that they are devoid of central nervous system side effects.

Emulsion-based  Drug  Delivery  Systems.  In the general  category of  SubMicron
Emulsion technology,  Pharmos licensed two patents from the Hebrew University of
Jerusalem 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  Pharmos  and the
inventors as they relate to pharmaceutical and medicinal products.  The earliest
patent  filings for SubMicron  Emulsion  technology  date from 1986 and the most
recent from 1996. These patents cover a broad range of new  formulations,  which
improve the absorption of drugs that are poorly soluble in water.

Licenses

As discussed above, Pharmos licenses patents covering neuroprotective agents and
emulsion-based  drug delivery  systems from the Hebrew  University of Jerusalem.
Pharmos  assigned its rights as licensee of Dr.


                                       8
<PAGE>

Bodor's loteprednol  etabonate  ophthalmic compounds to Bausch & Lomb in October
2001.

Government Regulation

Regulation  by  governmental  authorities  in the U.S. and other  countries is a
significant factor in our ongoing research and development activities and in the
production and marketing of our products.  In order to undertake clinical tests,
to  produce  and  market  products  for human  therapeutic  or  diagnostic  use,
mandatory procedures and safety standards established by the FDA in the U.S. and
comparable agencies in other countries must be followed.

The standard process  required by the FDA before a  pharmaceutical  agent may be
marketed in the U.S. includes the following steps:

      (i)   Preclinical  studies  including  laboratory  evaluation  and  animal
            studies to test for initial safety and efficacy;

      (ii)  Submission to the FDA of an  Investigational  New Drug  Application,
            which  must  become  effective  before  human  clinical  trials  may
            commence;

      (iii) Adequate and well-controlled  human clinical trials to establish the
            safety and efficacy of the drug in its intended application;

      (iv)  Submission to the FDA of a New Drug  Application,  which application
            is not automatically accepted by the FDA for consideration; and

      (v)   FDA  approval of the New Drug  Application  prior to any  commercial
            sale or shipment of the drug.

In  addition  to  obtaining  FDA  approval  for  each  product,   each  domestic
drug-manufacturing  establishment  must be registered or licensed by the FDA for
each  product  that  is  manufactured  at  that  facility.   U.S.  manufacturing
establishments are subject to inspections by the FDA and by other Federal, state
and local  agencies and must comply with current Good  Manufacturing  Practices,
requirements applicable to the production of pharmaceutical drug products.

Preclinical  studies  include  laboratory  evaluation  of product  chemistry and
animal  studies to assess the  potential  safety and efficacy of the product and
its formulation. The results of the preclinical studies are submitted to the FDA
as part of an Investigational New Drug Application,  and unless the FDA objects,
the application will become effective 30 days following its receipt by the FDA.

Clinical  trials involve the  administration  of the drug to healthy  volunteers
and/or to patients under the supervision of a qualified principal  investigator.
Clinical  trials are  conducted in  accordance  with  protocols  that detail the
objectives of the study,  the  parameters  to be used to monitor  safety and the
efficacy criteria to be evaluated. Each protocol is submitted to the FDA as part
of the  application.  Each  clinical  study  is  approved  and  monitored  by an
independent Institutional Review Board or Ethics Committee at each clinical site
who will consider,  among other things, ethical factors,  informed consents, the
safety  of  human  subjects  and  the  possible  liability  of  the  institution
conducting a clinical study.

Clinical trials typically are conducted in three sequential phases, although the
phases may overlap. In Phase I, the initial  introduction of the drug to humans,
the drug is tested for  safety and  clinical  pharmacology  such as  metabolism.
Phase II  involves  detailed  evaluation  of safety and  efficacy of the drug in
patients with the disease or condition  being studied.  Phase III trials consist
of larger scale  evaluation of safety and efficacy and usually  require  greater
patient  numbers and multiple  clinical  trial sites,  depending on the clinical
indications for which


                                       9
<PAGE>

marketing approval is sought.

The process of completing  clinical testing and obtaining FDA approval for a new
product  is  likely to take a number of years and  require  the  expenditure  of
substantial resources. The FDA may grant an unconditional approval of a drug for
a  particular   indication  or  may  grant   approval   conditioned  on  further
post-marketing  testing.  The FDA also may conclude  that the  submission is not
adequate to support an approval and may require further clinical and preclinical
testing,  re-submission of the New Drug  Application,  and further review.  Even
after initial FDA approval has been obtained, further studies may be required to
provide  additional  data on safety or to gain approval for the use of a product
for  clinical  indications  other than those for which the product was  approved
initially.  Also,  the FDA may  require  post-market  testing  and  surveillance
programs to monitor the drug's efficacy and side effects.

Marketing  of  pharmaceutical  products  outside  of the  U.S.  are  subject  to
regulatory  requirements  that vary  widely  from  country  to  country.  In the
European  Union,  the general trend has been towards  coordination of the common
standards  for  clinical  testing  of new  drugs.  Centralized  approval  in the
European Union is coordinated through the European Medicines  Evaluation Agency,
or EMEA.

The level of regulation  outside of the U.S. varies widely. The time required to
obtain regulatory  approval from comparable  regulatory agencies in each country
may be longer  or  shorter  than  that  required  for FDA or EMEA  approval.  In
addition,  in certain markets,  reimbursement  may be subject to  governmentally
mandated prices.

Corporate History

Pharmos Corporation,  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,  Pharmos,  the Nevada  Corporation,  completed a merger with a
privately held New York corporation  known as Pharmos  Corporation,  and in 1992
acquired all of the outstanding  shares of Xenon Vision,  Inc., a privately held
Delaware corporation.

Human Resources

As of January 1, 2002,  Pharmos had 70 employees (62 full-time and 8 part-time),
including 11 in the U.S. (2 part-time) and 59 in Israel (6  part-time),  of whom
approximately 29 hold doctorate or medical degrees.

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

Public Funding and Grants

Pharmos'  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,  SubMicron  Emulsion  technology for
injection  and  nutrition  as  well as for  research  relating  to  pilocarpine,
dexamethasone and ophthalmic  formulations for dry eyes. Pharmos has received an
aggregate of $3,348,189 under such agreements through December 31, 2001. Pharmos
will be required to pay royalties to the Chief  Scientist  ranging from 2% to 5%
of product sales, if any, as a result of the research activities  conducted with
such funds.  Aggregate royalty payments per product are limited to the amount of
funding  received to develop that  product.  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."

Pharmos received funding of $925,780 from the Israel-U.S.  Binational Industrial
Research and Development  Foundation to develop Lotemax(R) and LE-T. Pharmos was
required to pay royalties to this  foundation on product sales, if any, of 2.5%,
through  September  1999,  then  5%  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


                                       10
<PAGE>

received,  linked to the  exchange  rate of the U.S.  dollar and the New Israeli
Shekel.  During October 2001, in connection with the sale of Pharmos's  existing
ophthalmic business, Pharmos paid the foundation royalties of approximately $1.0
million for Lotemax(R) which concluded  Pharmos'  obligation to pay royalties to
the foundation for Lotemax(R).

In April 1997, Pharmos 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,   Pharmos  was  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 were required within
the framework.  As of December 31, 2001,  Pharmos had received  grants  totaling
$1,734,037 pursuant to this agreement.

Conditions in Israel

A  significant  part of our  operations  is  conducted  in  Israel  through  our
wholly-owned subsidiary, Pharmos Ltd., and we are directly affected by economic,
political and military conditions there.

Since  the  establishment  of the  State of  Israel  in 1948,  a number of armed
conflicts  have taken place between  Israel and its Arab  neighbors,  as well as
incidents of civil unrest. In addition, Israel and companies doing business with
Israel  have,  in the past,  been the subject of an economic  boycott.  Although
Israel has entered into various  agreements  with certain Arab countries and the
Palestinian  Authority,  there has been an increase in the unrest and  terrorist
activity that began in September  2000 and has continued  with varying levels of
severity into 2002. We do not believe that the political and security  situation
has had any  material  negative  impact on our  business to date;  however,  the
situation  is  volatile  and we  cannot  be sure  that  security  and  political
conditions will have no such effect in the future.

Many of our employees in Israel are obligated to perform  military reserve duty.
In the event of severe unrest or other conflict,  individuals  could be required
to serve in the military for extended  periods of time. Our operations  could be
disrupted  by the  absence  for a  significant  period  of  time  of some of our
employees due to military service. Such disruption could harm our operations.

In addition, since 1997 Pharmos Ltd. has received funding from the Office of the
Chief Scientist of the Israel Ministry of Industry and Trade relating to generic
technologies  for the  design  and  development  of drugs and  diagnostic  kits.
Through 2001, we have received an aggregate of $1,443,335 from these grants, and
may receive future grants,  the amounts of which would be determined at the time
of application.  This 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 we believe 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,  the matter is solely within his discretion and we cannot
be  sure  that  such  consent,  if  requested,   would  be  granted  upon  terms
satisfactory to us or granted at all.  Without such consent,  we would be unable
to manufacture any products developed by this research outside of Israel,  which
may greatly restrict any potential revenues from such products.

Item 2. Properties

Pharmos is  headquartered  in Iselin,  New Jersey where it leases its  executive
offices and  maintains  clinical,  regulatory  and business  development  staff.
Pharmos  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 Pharmos' research and development activities.  In
the  opinion of the  management  these  facilities  are  sufficient  to meet the
current and anticipated future requirements of Pharmos. In addition,  management
believes that it has  sufficient  ability to renew its present leases related to
these facilities or obtain suitable  replacement  facilities.  The monthly lease
obligations


                                       11
<PAGE>

for our office  space in 2002 are $9,548 for Iselin,  New Jersey and $10,607 for
Rehovot, Israel.


Item 3. Legal Proceedings

None.

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

At the  Company's  Annual  Meeting of  Stockholders  held on July 12, 2001,  the
stockholders  of the Company  elected the following  persons as directors of the
Company to serve until the next annual meeting of  stockholders  and until their
successors are duly elected and qualified:  Haim Aviv, Elkan R. Gamzu, Samuel D.
Waksal, David Schlachet, Mony Ben Dor and Georges Anthony Marcel. The results of
the voting were as follows:

                                     VOTES FOR     VOTES WITHHELD
     Haim Aviv                       42,272,069       431,763
     Elkan R. Gamzu                  42,279,742       424,090
     Samuel D. Waksal                42,183,724       520,108
     David Schlachet                 42,283,942       419,890
     Mony Ben Dor                    42,281,039       422,793
     Georges Anthony Marcel          42,282,922       421,010

Also at the Annual  Meeting,  the  stockholders  approved  the  adoption  of the
Company's  2001 Employee Stock Purchase  Plan,  with  41,594,111  votes cast for
approval 1,030,636 votes cast against and 79,085 abstentions.  Stockholders also
ratified the appointment by the Board of Directors of PricewaterhouseCoopers LLP
as the  independent  auditors of the Company for the fiscal year ending December
31, 2001.



                                       12
<PAGE>

                                     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, 2001                       HIGH             LOW
---------------------                              ----            -----

1st Quarter...........................            $2.88            $1.50
2nd Quarter...........................             3.80             1.87
3rd Quarter...........................             3.85             1.84
4th Quarter...........................             2.76             1.97

Year ended December 31, 2000                       HIGH             LOW
---------------------                              ----            -----

1st Quarter...........................           $15.38            $1.75
2nd Quarter...........................             6.75             2.38
3rd Quarter...........................             4.56             2.94
4th Quarter...........................             3.59             1.47

The high and low bid  prices for the Common  Stock  during the first  quarter of
2002 (through  March 15, 2002) were $2.55 and $1.75,  respectively.  The closing
price on March 15, 2002 was $1.80.

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

On March 15, 2002,  there were  approximately  511 record  holders of the Common
Stock of the Company and  approximately  19,800  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.




                                       13
<PAGE>

Item 6.  Selected Financial Data

<TABLE>
<CAPTION>

                                                                 Year Ended December 31,
                                                                 -----------------------
                                                2001              2000              1999              1998               1997
                                             ------------      ------------      ------------      ------------      ------------

<S>                                          <C>               <C>               <C>               <C>               <C>
Revenues                                     $  4,298,441      $  5,098,504      $  3,279,397      $  1,539,941                --

Gross Margin                                    3,029,852         3,222,549         2,284,780         1,102,228                --

Operating expenses                            (13,789,291)       (9,969,879)       (6,999,136)       (6,109,809)     $ (8,563,091)
Income (Loss) Before Income Taxes and
Extraordinary Item                              4,819,822*       (7,984,202)**     (4,618,190)       (4,663,347)       (8,233,547)

Extraordinary gain from
forgiveness of debt                                    --                --                --                --           416,248
Dividend embedded in
convertible preferred stock                            --                --                --          (642,648)       (1,952,767)
Preferred Stock dividends                              --                --           (22,253)         (242,295)         (240,375)
                                             ------------      ------------      ------------      ------------      ------------

Net income (loss) applicable to
common shareholders                          $  5,045,855*     ($ 7,984,202)**    ($4,640,443)     ($ 5,548,290)     ($10,010,441)
                                             ============      ============      ============      ============      ============

Income(loss) per share applicable
to common shareholders before
extraordinary gain - basic & diluted         $       0.09      ($      0.15)     ($      0.11)     ($      0.15)     ($      0.32)

Extraordinary gain per share                           --                --                --                --              0.01
                                             ------------      ------------      ------------      ------------      ------------

Net loss per share applicable
to common shareholders - basic & diluted     $       0.09      ($      0.15)     ($      0.11)     ($      0.15)     ($      0.31)
                                             ============      ============      ============      ============      ============


Total assets                                 $ 44,262,991      $ 30,783,109      $  7,791,294      $  8,066,670      $  8,421,841
                                             ============      ============      ============      ============      ============


Long term obligations                        $  5,847,951      $  7,680,872      $  1,277,565      $  2,691,023      $  4,100,000
                                             ============      ============      ============      ============      ============


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

*    includes a $16.3  million  gain on sale of the ophthalmic  product  line in
     October 2001

**   includes a beneficial conversion future charge of $1.8 million.

                                       14
<PAGE>

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

This  discussion  and  analysis  of  our  financial  condition  and  results  of
operations   contains   forward-looking   statements   that  involve  risks  and
uncertainties.  We have based these  forward-looking  statements  on our current
expectations  and  projections of future  events.  Such  statements  reflect our
current  views with respect to future  events and are subject to unknown  risks,
uncertainty  and other factors that may cause results to differ  materially from
those  contemplated  in  such  forward  looking  statements.  In  addition,  the
following discussion should be read in conjunction with the audited consolidated
financial  statements and the related notes thereto  included  elsewhere in this
report.

During  2000 and  through  the end of the third  quarter  of 2001,  the  Company
generated  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 had not been  profitable
from  inception  through 2000 and has  incurred a  cumulative  net loss of $85.5
million through December 31, 2001.  Losses have resulted  principally from costs
incurred  in  research  activities  aimed  at  identifying  and  developing  the
Company's  product  candidates,  clinical  research  studies,  the  write-off of
purchased research and development, and general and administrative expenses. The
Company  expects to incur  additional  losses over the next several years as the
Company's  research and  development and clinical trial programs  continue.  The
Company's  ability to  achieve  profitability  is  dependent  on 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  contract  to  develop  or  acquire  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."

Critical Accounting Policies

The Company considers certain  accounting  policies related to the tax valuation
allowance and revenue  recognition to be critical policies due to the estimation
process involved in each.

Revenue

The Company  earns license fees from the transfer of drug  candidate  technology
and the related  preclinical  research  data.  License fee revenue is recognized
when all  performance  obligations  are completed and the amounts are considered
collectible.  Up-front  license  fees  are  deferred  and  recognized  when  all
performance obligations are completed.

Royalty  revenue is recognized upon the sale of the related  products,  provided
the royalty  amounts are fixed or  determinable  and the amounts are  considered
collectible.  The Company has not  recognized  any royalty  revenue during 2001,
2000 and 1999.

Tax Valuation Allowance

The Company has assessed the future  taxable  income and has  determined  that a
100%  deferred tax  valuation  allowance is deemed  necessary.  In the event the
Company  were to  determine  that it would be able to realize its  deferred  tax
asset,  an  adjustment  to the deferred tax asset would  increase  income in the
period such determination is made.


Results of Operations


                                       15
<PAGE>

Years Ended December 31, 2001 and 2000

Revenues  from sales  decreased by $800,063 or 16%,  from  $5,098,504 in 2000 to
$4,298,441 in 2001. The decrease is due to the sale of the Company's  ophthalmic
product line to Bausch & Lomb in October  2001.  Bausch & Lomb was the Company's
marketing partner for its ophthalmic product line. Product revenues for the year
ended  December  31,  2000  included a full year of  revenue,  while the product
revenues  for the year ended  December 31, 2001  included  revenues for only the
first three fiscal quarters. Additionally, License Fee revenues were $225,000 in
2000 compared to $80,000 in 2001.

Cost of goods sold  decreased  by $607,366 or 32%,  from  $1,875,955  in 2000 to
$1,268,589 in 2001. The decrease reflects the decrease in product revenue due to
the sale of the  Company's  ophthalmic  product line to Bausch & Lomb in October
2001.  Cost of goods sold  includes  the cost of the active drug  substance  and
royalty payments to the licensor.

Total operating expenses increased by $3,819,412 or 38%, from $9,969,879 in 2000
to $13,789,291  in 2001. The increase in operating  expenses is primarily due to
increased   research  and   development   expenses  as  the  Company   increased
expenditures  related to the  development  of  dexanabinol  for the treatment of
traumatic  brain injury and to increased  activity in the Company's  cannabinoid
program  to  treat  various  central   nervous  system  and   inflammation-based
conditions.

The Company considers major research & development projects to be those projects
that have  reached at least  Phase II level of  clinical  development.  The only
major project of the Company is the development of dexanabinol for the treatment
of traumatic brain injury,  which is currently  involved in Phase III testing in
Europe and Israel.  During the periods ending  December 31, 2001, 2000 and 1999,
the costs of this project  were $6.2  million,  $2.9  million and $1.9  million,
respectively. Total costs since the project entered Phase II development in 1996
through December 31, 2001 are $14.7 million. Enrollment in the current Phase III
trial is expected  to continue  until the end of 2003.  The  principal  costs of
completing  the  project  include  patient  enrollment,  production  of the drug
product,  collection  and evaluation of the data, and management of the project.
The primary uncertainties in the completion of the project are the time required
to enroll sufficient  numbers of patients in the study, the results of the study
upon its conclusion,  and the Company's ability to produce sufficient quantities
of drug product under current Good Manufacturing Practice conditions. Should the
uncertainties  delay  completion  of the project on the current  timetable,  the
Company may experience additional costs that cannot be accurately estimated.  If
the Phase III trial of dexanabinol  for the treatment of traumatic  brain injury
is successfully completed, the Company can expect to begin to earn revenues upon
marketing  approval  as early as 2005;  however,  should our  product  candidate
experience set backs or should a product fail to achieve FDA approval and market
acceptance  for any  reason,  it would  have a  material  adverse  affect on our
business.

Expenses  for  other  research  &  development  projects  in  earlier  stages of
development  for the years  ended  December  31,  2001,  2000 and 1999 were $2.9
million,  $2.4  million  and  $1.9  million,  respectively.   Total  research  &
development  expenses for the years ended December 31, 2001,  2000 and 1999 were
$9.1 million, $5.3 million and $3.8 million, respectively.

Selling,  general and administrative  expenses decreased by $378,574 or 9%, from
$5,283,397  in 2000 to  $3,666,293  in 2001.  The decrease is primarily due to a
reallocation of employee  resources to research and development from general and
administrative areas.

Depreciation  and  amortization  expenses  increased by $292,249,  or 61%,  from
$481,724 in 2000 to $773,973 in 2001, reflecting increased  depreciation expense
related to laboratory equipment purchases.

Other  income  (expense),  net of  interest  and other  expenses,  increased  by
$16,816,133 from expense of


                                       16
<PAGE>

$1,236,872 in 2000 to income of  $15,579,261  in 2000. The increase is primarily
due to a gain of $16.3 million from the sale of the Company's ophthalmic product
line to Bausch & Lomb in October 2001.  The reported  gain  includes  charges of
$3.75 million representing the Company's maximum liability for the completion of
the  clinical  development  of  LE-T,  the  final  product  resulting  from  the
ophthalmic  marketing  relationship  with  Bausch & Lomb.  Should  LE-T gain FDA
approval,  the Company will receive additional gross proceeds up to a maximum of
$14 million  depending on the date of FDA approval and up to an  additional  $10
million based upon the achievement of certain sales goals.  Also contributing to
the increase in other income was a lower level of interest expense primarily due
to  non-cash  charges  related  to the  Company's  convertible  debt  financing,
completed in the third  quarter of 2000.  Partially  offsetting  the increase in
other income is decreased  interest  income as a result of lower market interest
rates on the Company's cash balances in 2001.

Years Ended December 31, 2000 and 1999

Revenues from sales  increased  $1,819,107  or 55%,  from  $3,279,397 in 1999 to
$5,098,504 in 2000. The increase primarily resulted from increased market shares
for the  Company's  products.  Additionally,  License Fee revenues were $225,000
compared to zero in 1999.  The license  income was primarily  generated from the
licensing of a technology of the Company for use in Japan.

Cost  of  goods  sold  increased  $881,338  or  89%,  from  $994,617  in 1999 to
$1,875,955  in 2000.  The increase  reflects  the high product  revenue for 2000
compared  to 1999.  Cost of goods  sold  includes  the cost of the  active  drug
substance  and  royalty  payments  to the  licensor.  Cost of goods in 2000 grew
faster than product revenues as a result of higher expenses for product samples,
higher LE product license expenses and higher royalties.

Total operating expenses increased $2,970,743 or 42%, from $6,999,136 in 1999 to
$9,969,879  in 2000.  The  increase in operating  expenses is  primarily  due to
increases  in  selling,   general  &  administrative   expenses,   research  and
development expenses and depreciation.

Net research and  development  expenses  increased by  $1,456,396  or 38%,  from
$3,827,001  in 1999 to  $5,283,397  in 2000.  The  increase  in R&D  expense  is
primarily  due  to  increased   expenditures,   including   increased   employee
headcounts,  related to the  development  of  dexanabinol  for the  treatment of
traumatic  brain injury and to increased  activity in the Company's  cannabinoid
program  to  treat  various  central   nervous  system  and   inflammation-based
conditions.

Selling,  general and  administrative  expenses  increased by $1,432,697 or 55%,
from  $2,612,170 in 1999 to $4,044,867 in 2000. The increase is primarily due to
higher staffing levels and increased investor relations activities.

Depreciation  and  amortization  expenses  increased by $135,680,  or 39%,  from
$346,044 in 1999 to $481,724 in 2000, reflecting increased  depreciation expense
related to laboratory equipment purchases.

Other  income  (expense),  net of  interest  and other  expenses,  decreased  by
$1,333,038  from income of $96,166 in 1999 to expense of  $1,236,872  in 2000. A
higher level of interest  expense was primarily due to non-cash  charges related
to the Company's  convertible debt financing,  completed in the third quarter of
2000, of approximately $2.4 million.  The increased expense was partially offset
by increased  interest income of  approximately  $1.1 million a result of higher
average cash balances in 2000.

Liquidity and Capital Resources

While the Company  received  revenues since 1998 until the third quarter of 2001
from the sale of its approved  products,  it has incurred  cumulative  operating
losses since its  inception and had an  accumulated  deficit of  $85,448,454  at
December 31,  2001.  The Company has  financed  its  operations  with public and
private  offerings  of  securities,  advances  and other  funding  pursuant to a
marketing agreement with Bausch & Lomb, research


                                       17
<PAGE>

contracts, license fees, royalties and sales, and interest income.

The  Company  had  working  capital of $25.7  million as of  December  31,  2001
(excluding  restricted cash of $2.3 million).  Included in the current assets of
$39.2 million is $35.3 million related to cash and cash equivalents.

In October 2001, Bausch & Lomb purchased all rights to the Company's loteprednol
etabonate  (LE)  ophthalmic  product  line for cash and  assumption  of  certain
ongoing  obligations.  The Company received gross proceeds of approximately  $25
million in cash for its rights to Lotemax(R) and Alrex(R), prescription products
that are made and  marketed  by Bausch & Lomb under a 1995  Marketing  Agreement
with the Company; in addition,  Bausch & Lomb also acquired future extensions of
LE formulations including LE-T, a product currently in Phase III clinical trial.
The Company had no product sales beginning in the fourth quarter of 2001. Bausch
& Lomb will pay the Company up to an additional  maximum  gross  proceeds of $14
million, with the actual payment price based on the date of FDA approval of this
new combination  therapy.  An additional  milestone payment of up to $10 million
could be paid to the Company to the extent  sales of the new  product  exceed an
agreed-upon forecast in the first two years. The Company has a passive role as a
member  of a joint  committee  overseeing  the  development  of LE-T  and has an
obligation to Bausch & Lomb to fund up to a maximum of $3.75 million of the LE-T
development  cost. As a result of this  transaction,  the Company recorded a net
gain of $16.3  million.  The  company  recorded  an  accrual  of  $3.75  million
representing  the  Company's  maximum  obligation  in  the  continuing  clinical
development  of LE-T.  The Company  incurred  transaction  and royalty  costs of
approximately  $2 million.  The Company  also  compensated  the LE patent  owner
approximately  $2.7 million  ($1.5 million paid upon closing and $1.2 million of
this  amount is to be paid in  October  2002) from the  proceeds  of the sale of
Lotemax and Alrex in return for his consent to the  Company's  assignment of its
rights under the license  agreement to Bausch & Lomb.  Additionally,  the patent
owner will  receive 11% of the  proceeds  payable to the Company  following  FDA
approval of LE-T, as well as 14.3% of its milestone payment, if any.

In September  2000,  the Company  completed a private  placement of  Convertible
Debentures,  common stock and  warrants to purchase  shares of common stock with
institutional   investors,   generating  gross  proceeds  of  $11  million.  The
Convertible  Debentures,  which generated gross proceeds of $8 million, were due
in  February  2002 and  carried a 6% interest  payable  semiannually  in cash or
common stock. In connection with the Convertible  Debenture,  the  institutional
investors also received  warrants for the purchase of 276,259 common shares with
a relative fair value of $725,000.  The Convertible  Debentures were convertible
into common shares of the Company at the conversion price of $3.83 per share (or
2,088,775 common shares) and were convertible  beginning October 31. 2000. Under
certain limited anti-dilutive conditions, the conversion price may change. Until
converted into common stock or the outstanding principal is repaid, the terms of
the  Convertible  Debentures  require  the  Company  to deposit $4 million in an
escrow  account.  The  escrowed  capital  is  shown  as  Restricted  Cash on the
Company's balance sheet and will be released to the Company in proportion to the
amount  of  Convertible  Debentures  converted  into  common  shares or upon the
repayment of the debt.

In December  2001,  the holders of the  Convertible  Debentures  and the Company
agreed to modify the repayment and conversion terms. The holders of $5.8 million
convertible debt (book value on December 31, 2001,  including  accrued interest)
extended  the  maturity  date to June 2003 in exchange  for a  reduction  in the
conversion  price from $3.83 to $2.63 for half of the outstanding  balance and $
2.15 for the other half of the outstanding  balance. The convertible debt with a
maturity  date of June 2003 is  convertible  beginning  December 31,  2001.  The
holder of the  remaining  outstanding  debt of $1.9 million  (including  accrued
interest)  changed the maturity  date from February 28, 2002 to January 31, 2002
in exchange for  lowering the  conversion  price for the other  holders.  As the
modification was not significant in accordance with EITF 96-19 the change in the
fair value between the original  convertible  debt and the modified  convertible
debt will be accreted over the  remaining  term of the  convertible  debt with a
corresponding charge into interest expense.

Emerging Issues Task Force Issue No. 98-5, Accounting for Convertible Securities
with  Beneficial  Conversion  Features  or  Contingently  Adjustable  Conversion
Ratios, require the Company to compute the Beneficial Conversion Feature ("BCF")
of the  convertible  debt from the private  placement of September 2000. The BCF
must be capitalized  and amortized from the closing date until the earliest date
that the investors  have the right to convert the debt into common  shares.  The
BCF was computed at approximately $1.8 million,  all of which has been amortized
and  included  as  interest  expense  in the  year  ending  December  31,  2000.
Additionally,  the  discount  on  the  Convertible  Debenture  of  approximately
$800,000  will be amortized to interest  expense over the life of the debt.  For
the year ending December 31, 2001, $533,932 has been amortized.

During 2001,  the Company paid $589,819 and issued  182,964 shares of the common
stock of the Company to the investors in the convertible debenture.  The payment
of  cash  and  stock  were  the  option  chosen  by the  Company  and  represent
adjustments  to the pricing  based upon the  Company's  stock  price  during the
adjustment period. Under the terms of the agreements, no further adjustments are
due.

One investor in the September 2000 private placement had an option, in the form
of a warrant, to purchase an additional $2 million of common shares for a period
of one year provided that the future purchase price is greater than the initial
closing price of $3.65 per share. During the third quarter of 2001, the investor
exercised this option and, accordingly, the Company issued 542,299 shares to the
investor. The Private Placement provided certain conditions under which the
number of shares issued for this option could be adjusted and, accordingly, the
Company issued 281,659 shares to the investor in the fourth quarter of 2001 as
an adjustment to the warrant.

The  issuance  costs  related to the Private  Placement  of  approximately  $1.4
million were  capitalized and amortized over the life of the debt. For the years
ending December 31, 2001 and 2000, $682,464 and $224,691 have been amortized and
included as interest expense, respectively.


                                       18
<PAGE>

Commitments and Long Term Obligations

As of December 31, 2001, we had the following commitments and long term
obligations:

<TABLE>
<CAPTION>

                               2002          2003          2004          2005          Thereafter        Total
                               ----          ----          ----          ----          ----------        -----

<S>                         <C>            <C>            <C>            <C>            <C>            <C>
Operating Leases            $  284,419     $  184,473     $  158,617     $  156,615     $  202,336     $  986,460
Convertible debentures,
excluding interest           1,949,317      5,847,951                                                   7,797,268
R&D commitments                761,748        190,437                                                     952,185
                            ----------     ----------     ----------     ----------     ----------     ----------
     Grand total            $2,995,484     $6,222,861     $  158,617     $  156,615     $  202,336     $9,735,913
</TABLE>

The convertible  debenture  commitment  excludes interest that will accrue until
the maturity date in June 2003. The principal  amount of the debentures plus any
accrued  interest is  convertible  into  common  shares and may  ultimately  not
require a cash outlay. In January 2002, the convertible  debenture commitment of
approximately  $2  million  was  repaid  in  cash.  Additionally,  $2.6  million
(including  accrued interest of $0.1million) was converted into 1,217,485 common
shares,  thus leaving $3.9 million  (including accrued interest of $0.4 million)
outstanding  as of March 15, 2002.  After the  repayment  and  conversion,  $3.6
million was released from restricted cash.

The R&D commitments  represent scheduled  professional fee payments for clinical
services  relating  the  phase III  clinical  study  for  dexanabinol.  Upon the
completion of certain agreed upon milestones,  additional fees will be paid. The
fees that  Pharmos is  obligated  to pay upon the  reaching  of the agreed  upon
milestones  is not included in the above table due to  uncertainties  in timing.
The maximum amount that could be paid is approximately $4.6 million.

The Company has entered into various employment  agreements.  The terms of these
employment agreements include one-year renewable terms and do not represent long
term commitments of the Company.

Management  believes  that cash and cash  equivalents  of $35.3  million and the
total  restricted  cash balance of $5.4 million as of December 31, 2001, will be
sufficient to support the Company's  continuing  operations through at least the
middle of 2004.  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 additional financing to continue the
development of its products and bring them to commercial markets.

Item 7a.  Quantitative and Qualitative Disclosure About Market Risk

We assessed our vulnerability to certain market risks,  including  interest rate
risk   associated  with  financial   instruments   included  in  cash  and  cash
equivalents,  restricted cash, and convertible debentures. Due to the short-term
nature of the cash and cash  equivalent  investments,  restricted  cash, and the
fixed interest rate on the  convertible  debt, we have determined that the risks
associated   with  interest  rate   fluctuations   related  to  these  financial
instruments do not pose a material risk to us.

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.


                                       19
<PAGE>

PART III

Item 10.  Directors and Executive Officers of the Registrant

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

<TABLE>
<CAPTION>

Name                                  Age             Position
-----                                 ----            -------
<S>                                    <C>            <C>
Haim Aviv, Ph.D.                       62             Chairman, Chief Executive Officer,
                                                           Chief Scientist and Director
Gad Riesenfeld, Ph.D.                  58             President, Chief Operating Officer
Robert W. Cook                         46             Executive Vice President and
                                                           Chief Financial Officer
David Schlachet                        56             Director
Mony Ben Dor                           56             Director
Georges Anthony Marcel, M.D., Ph.D.    61             Director
Elkan R. Gamzu, Ph.D.                  59             Director
Samuel D. Waksal, Ph.D.                53             Director
</TABLE>

Haim Aviv, Ph.D., is Chairman,  Chief Executive  Officer,  Chief Scientist and a
Director of the Company. In 1990, he co-founded 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 a variety of Pharmaceutical  and Biotechnology
business  activities  relating  to  the  development  and  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  pharmaceutical
company involved in extracorporeal  blood therapy.  Dr. Riesenfeld holds a Ph.D.
degree from the Hebrew University of Jerusalem and held a scientist position, as
a post doctorate, at the Cedars Sinai Medical Center in Los Angeles, California.

Robert W. Cook was elected Vice President Finance and Chief Financial Officer of
Pharmos in January 1998 and became  Executive  Vice  President in February 2001.
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.

David  Schlachet,  a Director of the Company from December  1994,  served as the
Chairman  of Elite  Industries


                                       20
<PAGE>

Ltd.  from July 1997 until June 30th 2000.  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, one of Israel's  largest  privately owned food
manufacturers.  He was Vice  President  of  Finance  and  Administration  at the
Weizmann Institute of Science in Rehovot, Israel from 1990 to December 1995, and
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.  Today Mr.  Schlachet  serves as Chairman of Harel Capital
Markets  (Israeli  broker,  underwriter  and  asset  management  firm)  and as a
Director of Israel Discount Bank Ltd., Hapoalim Capital Markets Ltd, Teldor Ltd.
(software  and computer  company),  Proseed Ltd., a Venture  Capital  investment
company,  Compugen Ltd. and Taya  Investment  Company  Ltd.,  and also serves as
Managing Partner in Biocom, a V.C. Fund in the field of Life Science.

Mony Ben Dor, a director of the Company since  September 1997, has been managing
partner of Biocom,  a V.C Fund in the field of Life Science  since April   2000.
Prior to that he was Vice  President  of the Israel  Corporation  Ltd.  from May
1997, and Chairman of two publicly traded subsidiaries: H.L. Finance and Leasing
and Albany  Bonded  International  Trade.  He was also a Director of a number of
subsidiary  companies such as Israel  Chemicals  Ltd., Zim Shipping  Lines,  and
Tower Semi Conductors. From 1992-1997 Mr. Ben Dor was Vice President of Business
Development for Clal Industries Limited,  which is one of the leading investment
groups in Israel.  He was  actively  involved in the  acquisition  of  companies
including a portfolio of pharmaceutical companies Pharmaceutical Resources Inc.,
Finetech Ltd., BioDar Ltd., to name a few. 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, 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 Chairman 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.

Elkan R. Gamzu,  Ph.D.,  a Director of the Company  since  February  2000,  is a
consultant to the biotechnology and pharmaceutical industries. Prior to becoming
a  consultant,  Dr.  Gamzu held a number of senior  executive  positions  in the
biotechnology  and  pharmaceutical  industries,  including  President  and Chief
Executive  Officer of Cambridge  Neuroscience,  Inc.  from 1994 until 1998.  Dr.
Gamzu also served as President and Chief Operating Officer and Vice President of
Development for Cambridge Neuroscience,  Inc. from 1989 to 1994. Previously, Dr.
Gamzu held a variety of senior  positions with  Warner-Lambert  and  Hoffmann-La
Roche,  Inc.  Dr.  Gamzu is a member of the Board of  Directors  of three  other
biotechnology companies: the publicly traded XTL Biopharmaceuticals Ltd. and the
privately  held  biotechnology  companies  Neurotech  S.A.  of Evry,  France and
Hypnion,  Inc.  of  Worcester,  MA.  He is also on the  Board  of  Directors  of
Rho-ADDS,  sas, a Paris-based  provider of biostatistics and data management for
the biopharmaceutical  industry. Since February 2001, Dr. Gamzu has been acting,
on a  part-time  basis,  as  Interim  VP,  Development  Product  Leadership  for
Millennium Pharmaceuticals, Inc.

Samuel D.  Waksal,  Ph.D.,  a Director  of the Company  since  March 2000,  is a
founder of ImClone Systems Incorporated and has been its Chief Executive Officer
and a Director  since August 1985 and President  since March 1987.  From 1982 to
1985,  Dr. Waksal was a member of the faculty of Mt. Sinai School of Medicine as
Associate  Professor of Pathology and Director of the Division of  Immunotherapy
within the Department of Pathology.  He has served as visiting  Investigator  of
the National Cancer  Institute,  Immunology  Branch,  Research  Associate of the
Department of Genetics,  Stanford University Medical School, Assistant Professor
of


                                       21
<PAGE>

pathology at Tufts  University  School of Medicine and Senior  Scientist for the
Tufts Cancer Research  Center.  Dr. Waksal was a scholar of the Leukemia Society
of America  from 1979 to 1984.  Dr.  Waksal  currently  serves on the  Executive
Committee of the New York Biotechnology  Association,  the Board of Directors of
Cadus Pharmaceutical Corporation and is Chairman of the New York Council for the
Humanities.


                                       22
<PAGE>

Section 16 Filings

No person who,  during the fiscal year ended  December 31, 2001, 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 2001 and the two previous years, as well as all other
executive  officers  of the  Company  who  received  compensation  in  excess of
$100,000 for 2001.

<TABLE>
<CAPTION>

                               Annual Compensation                                  Long Term Compensation
                               -------------------                                  ----------------------
                                                                                                  Stock
Name/                                                                              Restricted   Underlying
Principal Position               Year     Salary         Bonus         Other          Stock       Options
-----------------                ----      ----          -----        -------       --------    -----------
<S>                             <C>      <C>          <C>          <C>               <C>         <C>
Haim Aviv, Ph.D
Chairman, Chief                 2001     $268,000     $ 80,000     $  2,844                      100,000
Executive Officer, and          2000     $244,662     $ 74,044     $  2,925                      100,000
Chief Scientist                 1999     $236,418     $ 29,906     $  2,829                       65,000

Gad Riesenfeld, Ph.D
President and                   2001     $209,790     $ 42,000     $ 56,556 (2)                   50,000
Chief Operating Officer         2000     $194,250     $ 20,000     $ 71,125 (2)                   60,000
                                1999     $185,000     $ 20,000     $ 53,860 (2)                   50,000

Robert W. Cook
Executive Vice President        2001     $198,450     $ 40,000     $ 15,338 (1)                   40,000
and Chief Financial Officer     2000     $183,750     $ 40,000     $  4,800 (1)                   45,000
                                1999     $175,000     $ 20,000     $  4,800 (1)                   40,000
</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.



                                       23
<PAGE>

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

Option Grants for the Year Ended December 31, 2001

                       Common
                        Stock      % of Total
                      Underlying     Options       Exercise
                       options      Granted to     Price per
                       Granted      Employees       Share     Expiration Date
                       -------      ---------       -----     ---------------

Haim Aviv, Ph.D        100,000        19.6 %       $ 1.875    April 2, 2011

Gad Riesenfeld, Ph.D.   50,000         9.8 %       $ 1.875    April 2, 2011


Robert W. Cook          40,000         7.8 %       $ 1.875    April 2, 2011

Aggregated Option Exercises
for the Year Ended December 31, 2001
and Option Values as of December 31, 2001:

<TABLE>
<CAPTION>

                                                                                   Value of Unexercised
                         Number of                    Number of Unexercised       In-the-Money Options at
                           Shares                  Options at December 31, 2001      December 31, 2001
                        Acquired on     Value      ---------------------------------------------------------
Name                      Exercise    Realized     Exercisable    Unexercisable   Exercisable  Unexercisable
----                      --------    --------     -----------    -------------   -----------  -------------

<S>                           <C>         <C>         <C>            <C>          <C>            <C>
Haim Aviv, Ph.D               0           0           331,876        232,500      $ 60,500       $ 83,250

Gad Riesenfeld, Ph.D.         0           0           179,333        140,000       $ 44,000      $ 51,250

Robert W. Cook                0           0           118,750        106,250       $ 39,500      $ 41,000
</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 generate  greater  loyalty to the Company and help
make each  employee  aware of the  importance  of the  business  success  of the
Company.

As of December 31, 2001, the Company had 2,452,030 options to purchase shares of
the Company's Common Stock  outstanding  under various option plans,  437,192 of
which are  non-qualified  options.  During  2001,  the Company  granted  610,500
options to purchase shares of its Common Stock to employees,  and directors,  of
which 100,000 are non-qualified  options.  A summary of the various  established
stock option plans is as follows:

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, 2001,  there were options to purchase  385,792  shares of the
Company's  Common  Stock  outstanding  under  this  plan.  Each  option  granted
outstanding  under the 1992 plan as of December  31, 2000 expires on October 31,
2005.


                                       24
<PAGE>

1997 Plan and 2000 Plan.  The 1997 Plan and the 2000 Plan are each  administered
by  a  committee   appointed  by  the  Board  of  Directors  (the  "Compensation
Committee").  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, and under the 2000 Plan is 1,500,000 shares each, 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 and the 2000 Plan that expire or terminate will again be available for
options to be issued under each Plan.

The price at which shares of Common Stock may be purchased  upon  exercise of an
incentive  stock option must be at least 100% of the fair market value of Common
Stock on the date the option is granted (or at least 110% of fair  market  value
in the case of a person  holding  more  than 10% of the  outstanding  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, the
2000 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 or the 2000 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 or the 2000 Plan.

Under  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
2000  Plan  provides  that  the  Compensation  Committee  may in its  discretion
determine  when  any  particular  stock  option  shall  expire.  A stock  option
agreement may provide for  expiration  prior to the end of its term in the event
of the  termination  of the  optionee's  service to the  Company or death or any
other circumstances.

The 1997 Plan and the 2000 Plan each  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
therefore  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


                                       25
<PAGE>

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.

The Board of Directors may amend, suspend or discontinue the 2000 Plan, but it
must obtain stockholder approval to (i) increase the number of shares subject to
the 2000 Plan or (ii) change the designation of the class of persons eligible to
receive options.

Under current federal income tax law, the grant of incentive stock options under
the 1997  Plan or the 2000 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 or the 2000  Plan,  the Board of
Directors permits an optionee to exercise an option by delivering  already owned
shares of Common  Stock  valued at fair  market  value)  the  optionee  will not
recognize  gain as a result of the payment of the option price with such already
owned shares.  However,  if such shares were  acquired  pursuant to the previous
exercise  of an option,  and were held less than one year after  acquisition  or
less than two years  from the date of grant,  the  exchange  will  constitute  a
disqualifying  disposition  resulting in  immediate  taxation of the gain on the
already  owned shares as ordinary  income.  It is not clear how the gain will be
computed on the  disposition  of shares  acquired by payment with already  owned
shares.

2001 Employee  Stock  Purchase  Plan. The 2001 Plan is intended to qualify as an
employee stock purchase plan under Section 423 of the Code. All employees of the
Company,  its Pharmos Ltd.  subsidiary or any other  subsidiaries  or affiliated
entities  who  have  completed  180  consecutive  days  of  employment  and  who
customarily  work at least 20 hours per week will be eligible to  participate in
the 2001 Plan,  except  for any  employee  who owns five  percent or more of the
total  combined  voting power or value of all classes of stock of the Company or
any subsidiary on the date a grant of a right to purchase  shares under the 2001
Plan (Right) is made.  There  currently  are no such  employees  with such large
holdings.  Participation  by officers in the 2001 Plan will be on the same basis
as that of any other employee. No employee will be granted a Right which permits
such  employee to purchase  shares  under the 2001 Plan at a rate which  exceeds
$25,000 of fair market value of such shares  (determined  at the time such Right
is granted)  for each  calendar  year in which such Right is  outstanding.  Each
Right will expire if not  exercised by the date  specified  in the grant,  which
date will not exceed 27 months  from the date of the grant.  Rights  will not be
assignable or transferable by a participating employee, other than in accordance
with certain qualified  domestic relations orders, as defined in the Code, or by
will or the laws of descent and distribution.

The total number of shares  reserved for issuance under the 2001 Plan is 500,000
shares.  Under the 2001  Plan,  for any given  calendar  year,  a  participating
employee  can only be granted  Rights to purchase  that number of shares  which,
when  multiplied by the exercise price of the Rights,  does not exceed more than
10% of the employee's base pay. The Company contemplates that payroll deductions
generally will be used by participating  employees to acquire the shares covered
by their Rights.

From time to time, the Board of Directors may fix a date or a series of dates on
which the Company will grant Rights to purchase shares of Common Stock under the
2001 Plan at prices not less than 85% of the lesser of (i) the fair market value
of the shares on the date of grant of such Right or (ii) the fair  market  value
of the shares on the date such Right is exercised.


                                       26
<PAGE>

The 2001 Plan also provides that any shares of Common Stock  purchased  upon the
exercise of Rights cannot be sold for at least six months following exercise, to
avoid potential violations of the "short swing" trading provisions of Section 16
of the Securities Exchange Act of 1934, as amended.

The Board of Directors or a committee to which it delegates its authority  under
the 2001 Plan will  administer,  interpret and apply all  provisions of the 2001
Plan.  The Board has  delegated  such  authority to the  Compensation  and Stock
Option Committee.

The Board of Directors may amend,  modify or terminate the 2001 Plan at any time
without notice, provided that no such amendment, modification or termination may
adversely affect any existing Rights of any participating employee,  except that
in the case of a participating  employee of a foreign subsidiary of the Company,
the 2001 Plan may be varied to conform with local laws. In addition,  subject to
certain  appropriate  adjustments  to give  effect to  relevant  changes  in the
Company's  capital  stock,  no  amendments  to the 2001 Plan may be made without
stockholder approval if such amendment would increase the total number of shares
offered under the 2001 Plan or would render Rights "unqualified" for special tax
treatment under the Code.

No taxable income will be recognized by a participant either at the time a Right
is granted under the 2001 Plan or at the time the shares are purchased. Instead,
tax  consequences  are generally  deferred  until a participant  disposes of the
shares (e.g., by sale or gift). The federal income tax consequences of a sale of
shares  purchased  under  the 2001 Plan  will  depend on the  length of time the
shares  are held  after  the  relevant  date of grant and date of  exercise,  as
described below.

If shares  purchased  under the 2001 Plan are held for more than one year  after
the  date of  purchase  and more  than two  years  from the date of  grant,  the
participant generally will have taxable ordinary income on a sale or gift of the
shares to the extent of the lesser of: (i) the amount (if any) by which the fair
market value of the stock at the date of grant  exceeds the exercise  price paid
by the  participant;  or (ii) the amount by which the fair  market  value of the
shares  on the  date of sale or gift  exceeds  the  exercise  price  paid by the
participant  for the shares.  In the case of a sale, any additional gain will be
treated  as  long-term  capital  gain.  If the shares are sold for less than the
purchase price,  there will be no ordinary income, and the participant will have
a long-term  capital loss for the difference  between the purchase price and the
sale price.

If the stock is sold or gifted within either one year after the date of purchase
or two  years  after  the  date of grant (a  "disqualifying  disposition"),  the
participant  generally will have taxable ordinary income at the time of the sale
or gift to the  extent  that the fair  market  value of the stock at the date of
exercise was greater than the exercise price. This amount will be taxable in the
year of sale or  disposition  even if no gain is realized  on the sale,  and the
Company would be entitled to a corresponding  deduction. A capital gain would be
realized upon the sale of the shares to the extent the sale proceeds  exceed the
fair market value of those shares on the date of purchase.  A capital loss would
be realized to the extent the sales price of the shares disposed of is less than
the fair  market  value of such  shares  on the date of  purchase.  Special  tax
consequences may follow from dispositions other than a sale or gift.

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


                                       27
<PAGE>

and shall expire on February 12, 2003. At December 31, 2001,  there were 491,500
1997 Employees  Warrants at $1.59, no 1997 Employees Warrants at $1.66 and 5,000
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 renewed for additional one-year periods unless either the
Company  or Dr.  Aviv  terminated  the  agreement  at least  90 days  prior to a
scheduled  expiration date. The agreement was renewed on an annual basis and was
to have expired on May 3, 2001.  Under the  agreement,  Dr. Aviv was 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 was required to render
certain consulting services to the Company.


The Company's subsidiary,  Pharmos Ltd., employs Dr. Aviv as its Chief Executive
Officer under an employment  agreement  with Dr. Aviv.  Dr. Aviv was 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.

In April 2001,  the  Compensation  and Stock  Option  Committee  of the Board of
Directors    recommended,    and   the   Board   approved,    a   new   one-year
employment/consulting agreement for Dr. Aviv, as Chairman of the Board and Chief
Executive  Officer of the  Company.  Dr. Aviv has agreed to devote a majority of
his business time to the Company and to Pharmos Ltd. The agreement  provides for
automatic one year renewals  unless either the Company  terminates the agreement
at least 180 days prior to the scheduled  expiration date during for the initial
one year term (and 90 days for  subsequent  terms) or Dr.  Aviv  terminates  the
agreement at least 60 days prior to the scheduled  expiration  date.  Dr. Aviv's
base compensation for 2001,  effective January 1, was $268,000,  to be allocated
between  the  Company  and Pharmos  Ltd.,  and his base  compensation  for 2002,
effective  January 1, is  $281,400,  to be  allocated  between  the  Company and
Pharmos Ltd. The Company also agreed to make  available for Dr.  Aviv's  benefit
following his death,  termination  of employment for disability or retirement at
the age of at least 62 an amount  equal to the cost of  insurance  premiums  the
Company would  otherwise  have incurred to obtain and maintain a  "split-dollar"
life  insurance  policy on his life  (approximately  $10,000 per year,  accruing
interest at 8% per year).  In  addition,  the Company  agreed to pay, in lieu of
contributing  to other  benefits  plans on his  behalf,  an  amount  equal to an
aggregate of approximately 21% of his base  compensation  toward the "Management
Insurance  Scheme" managed by the government of Israel for members of management
of Israeli companies.

Dr. Aviv's new  employment  agreement  also  provides that if his  employment is
terminated  within one year  following a "change of  control,"  he will  receive
severance pay of 18 months of base salary for the then-current year, accelerated
vesting of all unvested stock options and extended  exercisability  of all stock
options until their respective  expiration dates. A "change of control" involves
an acquisition of at least 50% of the voting power of the Company's  securities,
a change in at least 51% of the  composition  of the current Board of Directors,
or  approval  by the Board of  Directors  or  stockholders  of the  Company of a
transaction  where such  change of voting  control or  composition  of the Board
would occur, where the Company would be liquidated or where all or substantially
all of its assets would be sold.


                                       28
<PAGE>

If Dr. Aviv's employment is terminated by the Company,  after notice, other than
for a change in control,  death,  disability  or for  "cause," as defined in his
employment  agreement,  or if he terminates his employment  within one year of a
change in control or otherwise for "good  reason," as defined in his  employment
agreement,  he will  receive  severance  pay of 12 months of base salary for the
then-current  year,  accelerated  vesting  of all  unvested  stock  options  and
extended  exercisability of all stock options until their respective  expiration
dates.

The  new  employment  agreement  also  contains  customary  confidentiality  and
non-competition undertakings by Dr. Aviv.


Gad Riesenfeld,  Ph.D. In October 1992, the Company's predecessor entered into a
one-year  employment  agreement  with Dr.  Riesenfeld,  which was  automatically
renewable for  successive  one-year  terms unless either party gave three months
prior notice of non-renewal.  Under the Agreement,  Dr.  Riesenfeld  devoted his
full time to serving as President and Chief Operating Officer of the Company.

In April 2001,  the  Compensation  and Stock  Option  Committee  of the Board of
Directors  recommended,  and  the  Board  approved,  a new one  year  employment
agreement for Dr. Riesenfeld, as full-time President and Chief Operating Officer
of the Company.  The Committee also increased his base salary,  as of January 1,
2001,  by 8%, to  $209,790.  In March 2002,  the  Committee  increased  his base
salary, effective January 1, 2002, by 12% to $234,965.

The other provisions of Dr.  Riesenfeld's new employment  agreement  relating to
benefits,   severance   arrangements  and  confidentiality  and  non-competition
obligations  are  substantially  similar  to the those  included  in Dr.  Aviv's
employment agreement, as described above, except that the Company's contribution
to the "Management Insurance Scheme" on Dr. Riesenfeld's behalf is approximately
16%. In addition, the Compensation Committee and the Board of Directors in April
2001 also authorized an amendment to Dr.  Riesenfeld's new employment  agreement
to  provide  that  if the  Company  hires a new  Chief  Executive  Officer,  Dr.
Riesenfeld  will be  awarded,  at the  time of  commencement  of  employment,  a
one-time  stock option grant equal to the highest  grant he received  during the
previous  three  years,  in  addition  to his annual  stock  option  awards.  In
addition,   any   termination  by  the  Company  within  12  months  after  such
commencement  of employment  will require 180 days' prior written  notice to Dr.
Riesenfeld  and will  entitle  him to  severance  pay equal to 12 months of base
salary.  In such  circumstances,  any  resignation by Dr.  Riesenfeld  within 12
months  thereafter,  other than for "good reason" (as defined in his  employment
agreement) will require 90 days' prior written notice by Dr. Riesenfeld and will
entitle  him to 12  months  of base  salary.  The  amendment  to his  employment
agreement also provides that Dr.  Riesenfeld will act as an unpaid consultant to
the Company for a one year period following any such termination or resignation.


Robert W. Cook. In January 1998, the Company entered into a one-year  employment
agreement  with Mr. Cook,  which was  automatically  renewable  for a successive
one-year term unless either party gave three months prior notice of non-renewal.
Under the Agreement, Mr. Cook devoted his full time to serving as Vice President
Finance and Chief Financial Officer of the Company.

In April 2001,  the  Compensation  and Stock  Option  Committee  of the Board of
Directors  recommended,  and  the  Board  approved,  a new one  year  employment
agreement for Mr. Cook, as full-time Vice President  Finance and Chief Operating
Officer of the Company.  The Committee  also  increased  his base salary,  as of
January 1, 2001,  by 8%, to $198,450  and the Board  ratified  his  promotion to
Executive  Vice  President.  In March 2002,  the  Committee  increased  his base
salary, effective January 1, 2002, by 12% to $222,264.

The  other  provisions  of Mr.  Cook's  new  employment  agreement  relating  to
benefits,   severance   arrangements  and  confidentiality  and  non-competition
obligations  are  substantially  similar  to the those  included  in Dr.  Aviv's
employment  agreement,  as  described  above,  except  that  Mr.  Cook  does not
participate  in the  "Management  Insurance  Scheme"  of the  Company's  Israeli
subsidiary,  and  that in lieu of  investing  life  insurance  premiums  for his
benefit,  the  Company  has  actually  obtained a $500,000  "split-dollar"  life
insurance policy for the benefit of Mr. Cook.


                                       29
<PAGE>

Elkan R. Gamzu,  Ph.D.  In January 2000,  the Company  entered into a consulting
agreement  with Dr.  Gamzu  with a term of one year  (subject  to  extension  by
written agreement of the Company and Dr. Gamzu), pursuant to which Dr. Gamzu may
provide  certain  assistance and consulting  services to the Company as and when
needed.  The  agreement  provides  for  compensation  on a  per  diem  basis  in
connection with the provision of such assistance and consulting  services at the
rate of $3,000 per day. In 2001, the Company paid $ 23,580 to Dr. Gamzu pursuant
to the consulting agreement.

Directors' Compensation. In 2001, Directors did not receive any compensation for
service on the Board or for attending Board  meetings.  In March 2002, the Board
of  Directors  of the Company  adopted a  compensation  policy  with  respect to
outside members of the Board. Specifically, the board approved:

Cash Compensation

      1)    Two  payments of $2,500 each per annum,  the first due on January 1,
            and the  second  immediately  after the  earlier  of the  director's
            initial  appointment  to the board or election by the  shareholders;
            and

      2)    $1,000 per each board or committee  meeting attended in person or by
            conference call; no payment for a committee  meeting if it occurs on
            the same day as the board meeting.

Stock Compensation

      1)    An initial grant of 30,000 options,  awardable on the earlier of the
            director's  initial  appointment  to the  board or  election  by the
            shareholders; and

      2)    20,000 options annually thereafter,  awardable on the earlier of the
            date of the director's  re-election by the  shareholders or the date
            on which a general  option  grant is made by the Company for its key
            employees and directors; and

      3)    Special,  one-time  awards  may be  granted  for  attaining  certain
            corporate achievements at the recommendation of the Chairman.


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, 2002, by (i)
each person who was known by the Company to own beneficially more than 5% of any
class of the Company's Common Stock, (ii) each of the Company's  Directors,  and
(iii) all current  Directors and  executive  officers of the Company as a group.
Except  as  otherwise  noted,  each  person  listed  below has sole  voting  and
dispositive power with respect to the shares listed next to such person's name.

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

Haim Aviv, Ph.D. (2)                   1,267,995          2.2%
c/o Pharmos Ltd.
Kiryat Weitzman
Rehovot, Israel

David Schlachet (3)                       21,250             *
BioCom (Management) Limited
40 Einstein St., Ramat Aviv Tower
Tel-Aviv 69102, Israel


                                       30
<PAGE>

Mony Ben Dor (3)                          18,125             *
BioCom (Management) Limited
40 Einstein St., Ramat Aviv Tower
Tel-Aviv 69102, Israel

Georges Anthony Marcel M.D., Ph.D.(3)     13,750             *
TMC Development
9, rue de Magdebourg
77116 Paris France

Elkan R. Gamzu, Ph.D. (3)                 11,250             *
enERGetics
199 Wells Avenue, Suite 302
Newton, MA 02459

Samuel D. Waksal, Ph.D.                    3,750             *
ImClone Systems Incorporated
180 Varick Street
New York, NY  10014

All Directors and                      1,697,603          3.0%
Executive Officers as a group
(8 persons)(4)
----------

* Indicates ownership of less than 1%.

(1)   Based  on  56,573,792  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 and warrants
      to purchase 557,063 shares of Common Stock.

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

(4)   Based on the number of shares of Common  Stock  outstanding,  plus 956,021
      currently  exercisable  warrants  and options  held by the  Directors  and
      executive officers.

Item 13.  Certain Relationships and Related Transactions

In January 2000, the Company entered into a consulting agreement with one of our
Directors,  Dr.  Elkan  Gamzu,  for a term of one year  (subject to extension by
written agreement of the Company and Dr. Gamzu), pursuant to which Dr. Gamzu may
provide  certain  assistance and consulting  services to the Company as and when
needed.  The  agreement  provides  for  compensation  on a  per  diem  basis  in
connection with the provision of such assistance and consulting  services at the
rate of $3,000 per day. In 2001, the Company paid $ 23,580 to Dr. Gamzu pursuant
to the consulting agreement.




                                       31
<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, 2001 and 2000

         Consolidated  Statements of Operations for the years ended December 31,
         2001, 2000 and 1999

         Consolidated  Statements  of  Changes in  Shareholders'  Equity for the
         years ended December 31, 2001, 2000 and 1999

         Consolidated  Statements of Cash Flows for the years ended December 31,
         2001, 2000 and 1999

         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


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
                  dated  January 30, 1995  (Incorporated  by reference to Annual
                  Report on Form 10-K for the year ended December 31, 1994).

         3(c)     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).

         3(d)     Certificate of Amendment of Restated Articles of Incorporation
                  dated October 21, 1999  (Incorporated by reference to Form S-3
                  Registration Statement of the Company dated September 28, 2000
                  (No. 333-46818).

         3(e)     Amended and  Restated  By-Laws  (Incorporated  by reference to
                  Form S-3 Registration Statement of the Company dated September
                  28, 2000 (No. 333-46818).


                                       32
<PAGE>

4     Instruments defining the rights of security holders, including indentures


         4(a)     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(b)     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(c)     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(d)     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(e)     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(f)     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(g)     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(h)     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(i)     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(j)     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(k)     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(l)     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(m)     Stock Purchase Agreement, dated December 12, 1996, between the
                  Company and Bausch &


                                       33
<PAGE>

                  Lomb  Pharmaceuticals,  Inc.  (Incorporated  by  reference  to
                  Annual Report on Form 10-K dated March 29, 1997).

         4(n)     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(o)     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(p)     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(q)     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(r)     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(s)     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(t)     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).

         4(u)     Purchase  Agreement between the Company,  Millennium  Partners
                  LP,  Strong River  Investments  Inc. and St.  Albans  Partners
                  Ltd., dated as of September 1, 2000 (Incorporated by reference
                  to Exhibit  4.1 to the  Company's  Current  Report on Form 8-K
                  filed on September 11, 2000).

         4(v)     Form  of  6%  convertible  debenture  due  February  28,  2002
                  (Incorporated  by  reference  to Exhibit 4.2 to the  Company's
                  Current Report on Form 8-K filed on September 11, 2000).

         4(w)     Registration Rights Agreement between the Company,  Millennium
                  Partners LP,  Strong  River  Investments  Inc. and St.  Albans
                  Partners Ltd., dated as of September 1, 2000  (Incorporated by
                  reference to Exhibit 4.3 to the  Company's  Current  Report on
                  Form 8-K filed on September 11, 2000).

         4(x)     Form  of  Common  Stock  Purchase  Warrant  exercisable  until
                  September 1, 2005 (Incorporated by reference to Exhibit 4.4 to
                  the  Company's  Current  Report on Form 8-K filed on September
                  11, 2000).

         4(y)     Escrow Agreement between the company,  Millennium Partners LP,
                  Strong River  Investments  Inc., St. Albans  Partners Ltd. and
                  Kleinberg  Kaplan  Wolff & Cohen PC,  dated as of September 1,
                  2000   (Incorporated  by  reference  to  Exhibit  4.5  to  the
                  Company's  Current  Report on Form 8-K filed on September  11,
                  2000).


                                       34
<PAGE>

         4(z)     Common  Stock  Investment   Agreement   between  the  Company,
                  Millennium  Partners  LP,  Strong River  Investments  Inc. and
                  Laterman & Co. LP, dated as of September 1, 2000 (Incorporated
                  by reference to Exhibit 4.6 to the Company's Current Report on
                  Form 8-K filed on September 11, 2000).

         4(aa)    Registration Rights Agreement between the Company,  Millennium
                  Partners LP, Strong River  Investments Inc. and Laterman & Co.
                  LP, dated as of September 1, 2000  (Incorporated  by reference
                  to Exhibit  4.7 to the  Company's  Current  Report on Form 8-K
                  filed on September 11, 2000).

         4(bb)    Form of Common  Stock  Adjustment  Warrant  exercisable  until
                  November 1, 2001  (Incorporated by reference to Exhibit 4.8 to
                  the  Company's  Current  Report on Form 8-K filed on September
                  11, 2000).

         4(cc)    Form of Call  Warrant  exercisable  until  September  1,  2001
                  (Incorporated  by  reference  to Exhibit 4.9 to the  Company's
                  Current Report on Form 8-K filed on September 11, 2000).

         4(dd)    Form of Optional Adjustment Warrant exercisable until February
                  28, 2002  (Incorporated  by  reference  to Exhibit 4.10 to the
                  Company's  Current  Report on Form 8-K filed on September  11,
                  2000).

         4(ee)    Form of placement agent warrant with Ladenburg  Thalmann & Co.
                  Inc.  (Incorporated  by  reference  to Form  S-3  Registration
                  Statement  of  the  Company  dated  September  28,  2000  (No.
                  333-46818).

         4(ff)    Form of  placement  agent  warrant with  SmallCaps  OnLine LLC
                  (Incorporated by reference to Form S-3 Registration  Statement
                  of the Company dated September 28, 2000 (No. 333-46818).

         4(gg)    Form  of  consulting   warrant  with   SmallCaps   OnLine  LLC
                  (Incorporated by reference to Form S-3 Registration  Statement
                  of the Company dated September 28, 2000 (No. 333-46818).

         4(hh)    Form of 6% convertible  debenture due June 30, 2003 with $2.15
                  exercise  price  (Incorporated  by reference to Exhibit 4.2 to
                  the Company's  Current  Report on Form 8-K filed on January 4,
                  2002).

         4(ii)    Form of 6% convertible  debenture due June 30, 2003 with $2.63
                  exercise  price  (Incorporated  by reference to Exhibit 4.3 to
                  the Company's  Current  Report on Form 8-K filed on January 4,
                  2002).

10    Material Contracts

         10(a)    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  Form10-K/A,  for
                  year ended December 31, 1992). (1)

         10(a)(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)


                                       35
<PAGE>

         10(a)(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(b)    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(b)(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(b)(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(c)    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(c)(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(d)    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(e)    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(f)    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(g)    Marketing  Agreement,  dated as of December 12, 1996,  between
                  the Company and Bausch & Lomb Pharmaceuticals, Inc. (1)

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

         10(i)    1997 Incentive and Non-Qualified Stock Option Plan (Annexed as
                  Appendix B to the Proxy  Statement on Form 14A filed  November
                  5, 1997). **

         10(j)    2000 Incentive and Non-Qualified Stock Option Plan (Annexed as
                  Appendix A to the Proxy  Statement  on Form 14A filed June 19,
                  2000).**

         10(k)    Agreement dated as of January 21, 2000 between the Company and
                  Dr. Elkan R. Gamzu (Incorporated by reference to Exhibit 10(n)
                  to the  Company's  Annual  Report  for the  fiscal  year ended
                  December 31, 2000).**

         10(l)    Agreement  dated as of April 7, 2000  between  the Company and
                  Dr.  Stephen C. Knight


                                       36
<PAGE>

                  (Incorporated  by reference to Exhibit  10(o) to the Company's
                  Annual Report for the fiscal year ended December 31, 2000).**

         10(m)    Agreement  dated as of April 14, 2000  between the Company and
                  Mr. Marvin P. Loeb (Incorporated by reference to Exhibit 10(p)
                  to the  Company's  Annual  Report  for the  fiscal  year ended
                  December 31, 2000).**

         10(n)*** Employment  Agreement  dated  as of  April  2,  2001,  between
                  Pharmos Corporation and Haim Aviv.**

         10(o)*** Employment  Agreement  dated  as of  April  2,  2001,  between
                  Pharmos Corporation and Gad Riesenfeld.**

         10(p)*** Amendment of Employment  Agreement dated as of April 23, 2001,
                  between Pharmos Corporation and Gad Riesenfeld.**

         10(q)*** Employment  Agreement  dated  as of  April  2,  2001,  between
                  Pharmos Corporation and Robert W. Cook.**

         10(r)    2001 Employee Stock Purchase Plan  (Incorporated  by reference
                  to Exhibit B to the Company's  Definitive  Proxy  Statement on
                  Form 14A filed on June 6, 2001).**

         10(s)    Asset Purchase  Agreement  between Bausch & Lomb  Incorporated
                  and Pharmos Corporation dated October 9, 2001 (Incorporated by
                  reference to Exhibit 2.1 to the  Company's  Current  Report on
                  Form 8-K filed on October 16, 2001).

         10(t)    License Assignment and Amendment Agreement dated as of October
                  9,  2001  by  and  among  Dr.   Nicholas  S.  Bodor,   Pharmos
                  Corporation and Bausch & Lomb  Incorporated  (Incorporated  by
                  reference to Exhibit 2.2 to the  Company's  Current  Report on
                  Form 8-K filed on October 16, 2001).

         10(u)    Amendment  Agreement between Pharmos  Corporation,  Millennium
                  Partners LP and St. Albans Partners Ltd., dated as of December
                  31,  2001  (Incorporated  by  reference  to Exhibit 4.1 to the
                  Company's  Current  Report  on Form 8-K  filed on  January  4,
                  2002).

         10(v)*** Amendment  No.  1 to  Asset  Purchase  Agreement  dated  as of
                  December  28,  2001  between  Bausch & Lomb  Incorporated  and
                  Pharmos Corporation


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 Consents of Experts and Counsel

         23(a)    *** Consent of PricewaterhouseCoopers, LLP

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

(**)        This  document  is a  management  contract or  compensatory  plan or
            arrangement.

(***)       Filed herewith.

(b)   Reports on Form 8-K


                                       37
<PAGE>

         1.       Current  Report  filed on October  16,  2001 (date of earliest
                  event reported October 9, 2001); Item 2 was reported.

         2.       Current  Report  filed on January  4, 2002  (date of  earliest
                  event reported December 31, 2001); Item 5 was reported.




                                       38
<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: April 11, 2002

   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      April 11, 2002
----------------------------------------------     Financial and Accounting Officer),
Robert W. Cook                                     and Secretary

/s/ David Schlachet                                Director                                April 11, 2002
----------------------------------------------
David Schlachet

/s/ Mony Ben Dor                                   Director                                April 11, 2002
----------------------------------------------
Mony Ben Dor

/s/ Georges Anthony Marcel                         Director                                April 11, 2002
---------------------------------------
Georges Anthony Marcel, M.D.,Ph.D.

/s/ Elkan R. Gamzu                                 Director                                April 11, 2002
---------------------------------------------
Elkan R. Gamzu, Ph.D.

/s/ Samuel D. Waksal                               Director                                April 11, 2002
--------------------------------------------
Samuel D. Waksal, Ph.D.
</TABLE>



                                       39
<PAGE>

<TABLE>
<CAPTION>

                                                          Pharmos Corporation
                                              Index to Consolidated Financial Statements


<S>                                                                                                   <C>
Report of Independent Accountants                                                                     F-2

Consolidated balance sheets as of December 31, 2001 and 2000                                          F-3

Consolidated statements of operations for the years ended
      December 31, 2001, 2000 and 1999                                                                F-4

Consolidated statements of changes in shareholders' equity
        for the years ended December 31, 2001, 2000 and 1999                                          F-5

Consolidated statements of cash flows for the years ended
        December 31, 2001, 2000 and 1999                                                              F-6

Notes to consolidated financial statements                                                            F-7
</TABLE>





                                       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' equity and of
cash flows present fairly, in all material  respects,  the financial position of
Pharmos  Corporation  and its  subsidiary at December 31, 2001 and 2000, and the
results of their  operations and their cash flows for each of the three years in
the period ended  December 31, 2001 in  conformity  with  accounting  principles
generally accepted in the United States of America.  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  audits.  We
conducted our audits of these  statements in accordance with auditing  standards
generally  accepted in the United  States of America  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.


 /s/ PricewaterhouseCoopers LLP
   New York, New York
   February 8, 2002






                                      F-2
<PAGE>

<TABLE>
<CAPTION>

Pharmos Corporation
Consolidated Balance Sheets
-------------------------------------------------------------------------------------------------------------------
                                                                                             December 31,
                                                                                   --------------------------------
                                                                                       2001               2000
                                                                                   -------------      -------------
<S>                                                                                <C>                <C>
Assets
Current assets
  Cash and cash equivalents                                                        $  35,269,114      $  22,480,777
  Restricted cash                                                                      2,275,251                 --
  Inventories                                                                                 --            796,550
  Receivables                                                                            690,067          1,188,502
  Prepaid royalties                                                                           --              6,591
  Prepaid expenses and other current assets                                              997,695            281,109
                                                                                   -------------      -------------
    Total current assets                                                              39,232,127         24,753,529
Fixed assets, net                                                                      1,918,281          1,681,390
Prepaid royalties, net of current portion                                                     --            143,000
Intangible assets, net                                                                        --            151,690
Restricted cash                                                                        3,090,550          4,035,414
Other assets                                                                              22,033             18,086
                                                                                   -------------      -------------
      Total assets                                                                 $  44,262,991      $  30,783,109
                                                                                   =============      =============

Liabilities and Shareholders' Equity
Current liabilities
  Accounts payable                                                                 $   2,197,299      $     458,504
  Accrued expenses (Note 6)                                                            5,809,642          1,162,098
  Accrued wages and other compensation                                                 1,317,934            768,975
  Convertible debentures, net                                                          1,949,317                 --
  Advances against future sales                                                               --            619,702
                                                                                   -------------      -------------
      Total current liabilities                                                       11,274,192          3,009,279

Advances against future sales, net of current portion                                         --          1,000,000
Convertible debentures, net                                                            5,847,951          6,580,872
Other liabilities                                                                             --            100,000
                                                                                   -------------      -------------
    Total liabilities                                                                 17,122,143         10,690,151
                                                                                   -------------      -------------

Commitments and Contingencies (Note 14)

Shareholders' equity
  Preferred stock, $.03 par value, 1,250,000 shares authorized,
       none issued and outstanding
  Common stock, $.03 par value; 80,000,000 shares authorized, 55,356,307 and
      54,063,897 shares outstanding (excluding $551 (18,356 shares)
      in 2001 and 2000, held in Treasury) in 2001 and 2000, respectively               1,660,688          1,621,916
    Deferred compensation                                                               (223,144)                --
    Paid in capital                                                                  111,151,758        108,965,351
    Accumulated deficit                                                              (85,448,454)       (90,494,309)
                                                                                   -------------      -------------
      Total shareholders' equity                                                      27,140,848         20,092,958
                                                                                   -------------      -------------
      Total liabilities and shareholders' equity                                   $  44,262,991      $  30,783,109
                                                                                   =============      =============
</TABLE>

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


                                      F-3
<PAGE>

<TABLE>
<CAPTION>

Pharmos Corporation
Consolidated Statements of Operations
--------------------------------------------------------------------------------------------------------
                                                                    Year Ended December 31,
                                                        ------------------------------------------------
                                                            2001              2000              1999
                                                        ------------      ------------      ------------
<S>                                                     <C>               <C>               <C>
Revenues
       Product sales                                    $  4,218,441      $  4,873,504      $  3,279,397
       License fee                                            80,000           225,000                --
                                                        ------------      ------------      ------------

Total Revenues                                             4,298,441         5,098,504         3,279,397

Cost of Goods Sold                                         1,268,589         1,875,955           994,617
                                                        ------------      ------------      ------------

Gross Margin                                               3,029,852         3,222,549         2,284,780
                                                        ------------      ------------      ------------

Expenses
        Research and development, net                      9,085,266         5,283,397         3,827,001
        Selling, general and administrative                3,666,293         4,044,867         2,612,170
        Patents                                              263,759           159,891           213,921
        Depreciation and amortization                        773,973           481,724           346,044
                                                        ------------      ------------      ------------

                    Total operating expenses              13,789,291         9,969,879         6,999,136
                                                        ------------      ------------      ------------

Loss from operations                                     (10,759,439)       (6,747,330)       (4,714,356)
                                                        ------------      ------------      ------------

Other income (expense)
        Interest income                                      979,234         1,133,439           129,481
        Other income (expense), net                           28,509           (10,226)           (2,790)
        Interest expense                                  (1,713,806)       (2,360,085)          (30,525)
       Gain from sale of LE product line (Note 4)         16,285,324                --                --
                                                        ------------      ------------      ------------

                    Other income (expense), net           15,579,261        (1,236,872)           96,166
                                                        ------------      ------------      ------------

Income (loss) before income taxes                          4,819,822        (7,984,202)       (4,618,190)
Income tax benefit                                          (226,033)               --                --
                                                        ------------      ------------      ------------

Net Income (loss)                                          5,045,855        (7,984,202)       (4,618,190)


Less: Preferred stock dividends                                   --                --           (22,253)
                                                        ------------      ------------      ------------

Net income (loss) applicable to common shareholders     $  5,045,855      $ (7,984,202)     $ (4,640,443)
                                                        ============      ============      ============
Net income (loss) per share applicable to common
         shareholders - basic                           $        .09      $       (.15)     $       (.11)
                                                        ============      ============      ============
Net income (loss) per share applicable to common
         shareholders - diluted                         $        .09      $       (.15)     $       (.11)
                                                        ============      ============      ============
Weighted average shares outstanding - basic               54,678,932        52,109,589        42,725,157
                                                        ============      ============      ============
 Weighted average shares outstanding - diluted            55,298,063        52,109,589        42,725,157
                                                        ============      ============      ============
</TABLE>

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


                                      F-4
<PAGE>

<TABLE>
<CAPTION>

Pharmos Corporation
Consolidated Statements of Changes in Shareholders' Equity (Notes 9 & 10)
For the Years ended December 31, 2001, 2000 and 1999
---------------------------------------------------------------------------------------------------------------------
                                                                                                            Series C
                                                                                                           Convertible
                                                           Common Stock            Deferred              Preferred Stock
                                                     Shares            Amount      Compensation       Shares         Amount
                                                     ------            ------      ------------       ------         ------

<S>                                                  <C>         <C>            <C>                  <C>             <C>
December 31, 1998                                    39,800,112  $   1,194,003  $           0           1,500              45

Warrant and option exercises                            150,000          4,500                        121,500
Conversion of Series C preferred stock                1,270,058         38,102                         (1,500)            (45)
Common Stock Dividend upon conversion of P/S,
      Series C                                           76,066          2,282
Issuance of Common Stock and warrants - equity
       credit line, net of fees of $199,197           4,128,165        123,845
Preferred Stock Dividends
Net loss
                                                  -------------  -------------  -------------   -------------   -------------
December 31, 1999                                    45,424,401      1,362,732              0               0               0

Warrant and option exercises                          2,615,003         78,450
Warrant issuances for consultant compensation           243,449                                                       243,449
Issuance of Common Stock and warrants - equity
      credit line, net of fees of $77,831               518,424         15,552
Issuance of Common Stock - private equity sales,
      net of fees of $382,000                         5,524,425        165,733
Net loss
                                                  -------------  -------------  -------------   -------------   -------------
December 31, 2000                                    54,082,253      1,622,467              0               0               0

Warrant and option exercises                          1,109,446         33,283
Warrant issuances for consultant compensation                                   ($     50,175)
Stock option issuances below fair market value                                       (172,969)
Issuance of Common Stock and adjustments in
      connection with private equity sale, net
      of fees of $5,924                                 182,964          5,489
Net income
                                                  -------------  -------------  -------------   -------------   -------------
December 31, 2001                                    55,374,663  $   1,661,239  ($    223,144)              0   $           0
                                                  =============  =============  =============   =============   =============

<CAPTION>


                                                    Paid-in                                                           Total
                                                   Capital in       Accumulated             Treasury Stock         Shareholders'
                                                  Excess of Par      Deficit             Shares        Amount         Equity
                                                  -------------      -------             ------        ------         ------

<S>                                               <C>             <C>                  <C>       <C>             <C>
December 31, 1998                                 $  78,051,783   ($ 77,779,075)         18,356  ($        551)  $   1,466,205

Warrant and option exercises                                                            126,000
Conversion of Series C preferred stock                  (38,057)                                                             0
Common Stock Dividend upon conversion of P/S,
      Series C                                           88,307         (90,589)                                             0
Issuance of Common Stock and warrants - equity
      credit line, net of fees of $199,197            5,126,956                                                      5,250,801
Preferred Stock Dividends                                22,253         (22,253)                                             0
Net loss                                                             (4,618,190)                                    (4,618,190)
                                                  -------------   -------------   -------------  -------------   -------------
December 31, 1999                                    83,372,742     (82,510,107)         18,356           (551)      2,224,816

Warrant and option exercises                          4,754,443                                                      4,832,893
Warrant issuances for consultant compensation
Issuance of Common Stock and warrants - equity
      credit line, net of fees of $77,831             2,130,352                                                      2,145,904
Issuance of Common Stock - private equity sales,
      net of fees of $382,000                        18,464,365                                                     18,630,098
Net loss                                                             (7,984,202)                                    (7,984,202)
                                                  -------------   -------------   -------------  -------------   -------------
December 31, 2000                                   108,965,351     (90,494,309)         18,356           (551)     20,092,958

Warrant and option exercises                          2,384,259                                                      2,417,542
Warrant issuances for consultant compensation           189,893                                                        139,718
Stock option issuances below fair market value          207,563                                                         34,594
Issuance of Common Stock and adjustments in
      connection with private equity sale, net
      of fees of $5,924                                (595,308)                                                      (589,819)
Net income                                                            5,045,855                                      5,045,855
                                                  -------------   -------------   -------------  -------------   -------------
December 31, 2001                                 $ 111,151,758   ($ 85,448,454)         18,356  ($        551)  $  27,140,848
                                                  =============   =============   =============  =============   =============
</TABLE>

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


                                       F-5
<PAGE>

<TABLE>
<CAPTION>

Pharmos Corporation
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------------------------------------------
                                                                               Year Ended December 31,
                                                                      2001              2000             1999
                                                                  ------------      ------------      ------------
<S>                                                               <C>               <C>               <C>
Cash flows from operating activities
   Net income (loss)                                              $  5,045,855      $ (7,984,202)     $ (4,618,190)
   Adjustments to reconcile net income (loss) to net
     cash flow used in operating activities
       Depreciation and amortization                                   773,973           481,724           346,044
       Amortization of Beneficial Conversion Feature                        --         1,796,344                --
       Amortization of Debt Discount and Issuance costs              1,216,398           449,053                --
       Option issuances - consultant compensation                      139,718           243,449                --
       Stock options issued below fair market value                     34,594                --                --
       Gain from sale of LE product line                           (16,285,324)               --                --

   Changes in operating assets and liabilities
       Inventories                                                     322,620         1,041,201          (110,655)
      Receivables                                                     (862,542)         (226,733)         (411,712)
      Prepaid expenses and other current assets                       (116,586)          (58,718)          (15,598)
      Prepaid royalties                                                  6,591           301,079           174,970
      Other assets                                                      (3,947)               --            60,314
      Accounts payable                                                (113,179)         (221,550)         (256,846)
      Accrued expenses                                                  25,820           450,909            31,452
      Accrued wages                                                    548,959           219,433            92,967
      Other liabilities                                               (100,000)               --                --
                                                                  ------------      ------------      ------------

      Net cash used in operating activities                         (9,367,050)       (3,508,011)       (4,707,254)
                                                                  ------------      ------------      ------------

Cash flows from investing activities:
     Purchases of fixed assets                                        (859,174)         (932,731)         (302,350)
     Proceeds from sale of LE business,net                          23,136,930                --                --
                                                                  ------------      ------------      ------------

         Net cash  provided by (used in) investing activities       22,277,756          (932,731)         (302,350)
                                                                  ------------      ------------      ------------

Cash flows from financing activities:
        Advances against future sales, net                            (619,702)       (1,567,863)       (1,239,689)
        Proceeds from issuance of common stock
              and exercise of options and warrants, net              2,417,542        23,462,991           126,000
        Proceeds from issuance of convertible debentures, net               --         4,335,475                --
        Pricing adjustments for private placement, net                (589,819)               --                --
        Proceeds from exercise of equity credit line                        --         2,145,904         5,250,803
        (Increase) in restricted cash                               (1,330,390)       (4,035,414)               --
        (Decrease) increase in notes payable, net                           --          (338,128)          338,128
                                                                  ------------      ------------      ------------

         Net cash (used in) provided by financing activities          (122,369)       24,002,965         4,475,242
                                                                  ------------      ------------      ------------

Net increase (decrease) in cash and cash equivalents                12,788,337        19,562,223          (534,362)
Cash and cash equivalents at beginning of year                      22,480,777         2,918,554         3,452,916
                                                                  ------------      ------------      ------------

Cash and cash equivalents at end of year                          $ 35,269,114      $ 22,480,777      $  2,918,554
                                                                  ============      ============      ============

Supplemental Information:
Interest paid                                                     $    243,983      $      3,210      $      1,944
                                                                  ============      ============      ============

</TABLE>

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


                                      F-6
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

1.    The Company

      Pharmos Corporation (the "Company") is a  bio-pharmaceutical  company that
      discovers  and  develops  new drugs to treat a range of  inflammatory  and
      neurological disorders such as traumatic brain injury and stroke. Although
      we do not  currently  have any  approved  products,  we have an  extensive
      portfolio of drug  candidates  under  development,  as well as  discovery,
      preclinical and clinical  capabilities.  The Company has executive offices
      in Iselin,  New Jersey and conducts  research and development  through its
      wholly owned subsidiary, Pharmos, Ltd., in Rehovot, Israel.

      In  October  2001,  the  Company  sold its  ophthalmic  product  line that
      included  Lotemax and Alrex,  two  products  that were being  marketed and
      future  extensions of  loteprednol  etabonate (see Note 4). As a result of
      the sale, the Company is  exclusively  in the drug  candidate  development
      stage.

2.    Liquidity and Business Risks

      The Company incurred operating losses since its inception through the year
      ended  December  31,  2000.  At  December  31,  2001,  the  Company has an
      accumulated   deficit  of  $85.5   million.   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 the current cash and cash  equivalents  of $35.3
      million and restricted  cash of $5.4 million as of December 31, 2001, will
      be sufficient to support the Company's  continuing  operations  through at
      least the middle of 2004.

      The Company is  continuing to actively  pursue  various  funding  options,
      including  additional equity  offerings,  strategic  corporate  alliances,
      business combination and the establishment of product related research and
      development  limited  partnerships,  to  obtain  additional  financing  to
      continue the  development  of its  products  and bring them to  commercial
      markets.

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 the  consolidated  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.  The most significant  estimates
      and  assumptions  related to revenue  recognition  and  recoverability  of
      inventories. Actual results could differ from those estimates.

      Net income (loss) per common share

      Basic net income  (loss) per common  share is  computed  by  dividing  net
      income  (loss) for the period,  reduced by any preferred  stock  dividends
      (declared or in arrears),  by the sum of the  weighted  average  number of
      shares of common


                                      F-7
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      stock issued and  outstanding.  Diluted  earnings per share is computed by
      dividing  net  income  (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 that are
      dilutive are converted.

      A reconciliation of the basic and diluted earnings per share  computations
      for net income for the year ended December 31, 2001 is as follows:

<TABLE>
<CAPTION>

                                                                                                 Earnings
                                                          Income              Shares             per Share
                                                       --------------     ---------------     --------------
<S>                                                     <C>                 <C>                 <C>

      Net income                                        $5,045,855

      Basic EPS Income applicable to common
      shareholders                                       5,045,855          54,678,932          $   .09

      Effect of Dilutive Securities:
          Warrants                                                             314,738
          Options                                                              304,393
                                                        ----------          ----------          -------

      Dilutive EPS Income applicable to common
      shareholders plus assumed conversion              $5,045,855          55,298,063          $   .09
                                                        ==========          ==========          =======
</TABLE>

      In accordance  with FASB 128 "Earnings per Share,"  1,811,961  options and
      warrants and the  convertible  debt were not  included in the  calculation
      above as the results of the  exercise of such would be  antidilutive.  For
      the years ended  December  31,  2000 and 1999,  there were  5,005,240  and
      5,890,273,   respectively,   of  outstanding   options  and  warrants  and
      convertible  debt (in 2000)  which were  excluded  from the  dilutive  EPS
      calculation due to the fact that the results of the exercise of such would
      be antidilutive.

      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 2001 and 2000.

      Revenue recognition

      The Company  earns license fees from the transfer of drug  technology  and
      the related  preclinical  research data. License fee revenue is recognized
      when  all  performance  obligations  are  completed  and the  amounts  are
      considered collectible.  Up-front license fees are deferred and recognized
      when all performance obligations are completed.

      Royalty  revenue  is  recognized  upon the sale of the  related  products,
      provided the royalty amounts are fixed or determinable and the amounts are
      considered collectible. The Company has not recognized any royalty revenue
      during 2001, 2000 and 1999.

      Accounts Receivable


                                      F-8
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      As of December 31, 2001,  accounts receivable consists primarily of grants
      for research and development relating to certain projects.  In addition to
      grants for research  and  development,  as of December  31, 2000  accounts
      receivable  also  consisted of  receivables  from the sales of  ophthalmic
      products.



                                      F-9
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      Inventories

      As of December 31, 2000, 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.

      Fixed assets

      Fixed assets are recorded at cost.  Property,  furniture and equipment are
      depreciated on a straight-line  basis over their  estimated  useful lives.
      The Company uses the following estimated useful lives:

<TABLE>
<S>                                                                           <C>
                Laboratory, pilot plant and other equipment                   7 years to 14 years
                Leasehold improvements                                        5 years to 14 years
                Office furniture and fixtures                                 3 years to 17 years
                Computer equipment                                            3 years
                Vehicles                                                      7 years
</TABLE>

      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.

      Intangible assets

      Intangible   assets   represent  the  Company's   rights  to  develop  and
      commercialize certain products derived from certain licensed technologies.
      The assets have been  amortized  over their  estimated  useful life. As of
      December 31, 2001, the intangible assets have been fully amortized.  As of
      December 31, 2001 and 2000,  accumulated  amortization  was $1,039,780 and
      $888,090, respectively.  Amortization expense amounted to $151,690 for the
      year  ended  December  31,  2001 and  $46,524  in each of the years  ended
      December 31, 2000 and 1999. The increase in  amortization  expense in 2001
      is a result of a change in the estimated useful life.

      Long-lived assets

      The Company periodically evaluates potential impairments of its long-lived
      assets,  including intangible assets. When the Company determines that the
      carrying value of long-lived  assets may not be recoverable based upon the
      existence of one or more indicators of impairment,  the Company  evaluates
      the  projected  undiscounted  cash  flows  related to the assets and other
      factors.  If these  cash  flows  are less than the  carrying  value of the
      assets, the Company measures the impairment using discounted cash flows or
      other methods of determining fair value.

      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


                                      F-10
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      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   that   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
      that exceed federally insured limits.  The Company has not experienced any
      losses to date resulting from this practice.

      Substantially  all  product  sales  have been to a single  customer,  as a
      result of the Company's marketing agreement with that customer.

      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  operating
      results and pro forma 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. Warrants issued to
      non-employees  are valued using the fair value  methodology under SFAS No.
      123.

      Reclassifications

      Certain amounts for 2000 and 1999 have been reclassified to conform to the
      fiscal 2001 presentation. Such reclassifications did not have an impact on
      the Company's financial position or results of operations.

      Recent Accounting Pronouncements

      In August 2001,  the Financial  Accounting  Standards  Board (FASB) issued
      Statement No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal
      of Long-Lived  Assets." This statement  supersedes FASB Statement No. 121,
      "Accounting for the Impairment of Long-Lived  Assets and Long-Lived Assets
      to be  Disposed  of"  and  certain  provisions  of  APB  Opinion  No.  30,
      "Reporting  the Results of  Operations - Reporting the Effects of Disposal
      of a Segment of a Business, and Extraordinary, Unusual and Infrequently


                                      F-11
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      Occurring  Events and  Transactions,"  for the  disposal of a segment of a
      business (as previously  defined in that Opinion).  The provisions of SFAS
      144 are effective for fiscal years  beginning after December 15, 2001. The
      Company  does not  anticipate  that the  adoption  of SFAS 144 will have a
      material impact on the consolidated financial statements.

      In June 2001, the FASB issued Statement No. 143 ("SFAS 143"),"  Accounting
      for Asset Retirement  Obligations" SFAS 143 addresses financial accounting
      and reporting for  obligations  associated with the retirement of tangible
      long-lived  assets and the associated asset retirement  costs. SFAS 143 is
      effective for financial statements issued for fiscal years beginning after
      June 15, 2002. The Company does not  anticipate  that the adoption of SFAS
      143 will have a material impact on the consolidated financial statements.

      In July 2001,  the FASB issued  Statement No. 141 ("SFAS 141"),  "Business
      Combinations",  and No. 142 ("SFAS 142"),  "Goodwill and Other  Intangible
      Assets."  SFAS  141  addresses  financial  accounting  and  reporting  for
      business combinations and supersedes APB16,  "Business  Combinations." The
      provisions  of SFAS 141  were  required  to be  adopted  July 1,  2001 for
      acquisitions  initiated after June 30, 2001. The most significant  changes
      made by  SFAS  141  were:  (1)  requiring  that  the  purchase  method  of
      accounting be used for all business combinations  initiated after June 30,
      2001, (2) establishing specific criteria for the recognition of intangible
      assets  separately  from goodwill and (3) requiring  unallocated  negative
      goodwill to be written off immediately as an extraordinary  gain. SFAS 142
      primarily   addresses   accounting  for  goodwill  and  intangible  assets
      subsequent  to  their  acquisition  and  supersedes  APB  17,  "Intangible
      Assets." The  provisions  of SFAS 142 are required to be adopted in fiscal
      years beginning after December 15, 2001. The most significant changes made
      by SFAS 142 are: (1) goodwill and indefinite-lived  intangible assets will
      no longer be  amortized,  (2) goodwill  will be tested for  impairment  at
      least annually at the  reporting-unit  level, (3) intangible assets deemed
      to have an indefinite life will be tested for impairment at least annually
      and (4) the  amortization  period of  intangible  assets with finite lives
      will no longer be limited to forty years.  The Company does not anticipate
      that the  adoption of SFAS 141 and 142 will have a material  impact on the
      consolidated financial statements.

4.    Collaborative Agreements

      In  June  1995,  the  Company  entered  into a  marketing  agreement  (the
      "Marketing Agreement") with Bausch & Lomb Pharmaceuticals, Inc. ("Bausch &
      Lomb"),  a shareholder of the Company,  to market Lotemax and Alrex, on an
      exclusive  basis in the United States  following  receipt of FDA approval.
      The  Marketing  Agreement  also covered the  Company's  other  loteprednol
      etabonate based product,  LE-T.  Under the Marketing  Agreement,  Bausch &
      Lomb purchased 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").
      In October 2001, the Company sold its ophthalmic  product line,  including
      the Company's rights under the above agreements to Bausch & Lomb.

      Through  October 2001,  Bausch & Lomb provided the Company with $5 million
      in cash  advances  against  future  sales.  Bausch & Lomb was  entitled to
      recoup the advances by withholding a certain percentage of payments to the
      Company against payments for purchases of the active drug substance.  With
      the completion of the sale of the ophthalmic  business to Bausch & Lomb in
      October 2001,  all the advances have been repaid.  The portion of advances
      expected to be recouped  by Bausch & Lomb in 2001,  based on  management's
      estimate of product  sales to Bausch & Lomb in 2001,  was  presented  as a
      current liability in the accompanying balance sheet at December 31, 2000.

      Total  receivables from Bausch & Lomb as of December 31, 2001 and December
      31, 2000 were $0 and


                                      F-12
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      $870,043, respectively.

      Sale of Ophthalmic Product line

      In October  2001,  Bausch & Lomb  purchased  all  rights to the  Company's
      loteprednol etabonate (LE) ophthalmic product line for cash and assumption
      of certain  ongoing  obligations.  The Company  received gross proceeds of
      approximately  $25  million  in cash  for its  rights  to  Lotemax(R)  and
      Alrex(R),  prescription  products that were  manufactured  and marketed by
      Bausch & Lomb under a 1995 Marketing Agreement with the Company.  Bausch &
      Lomb also acquired future extensions of LE formulations  including LE-T, a
      product  candidate  currently in Phase III clinical  trial.  Bausch & Lomb
      will pay the Company  additional  fees depending on the approval date with
      the FDA as  follows:  If the  earlier  of (a)  commercial  launch or (b) 6
      months after FDA approval of LE-T (the  "Triggering  Event") occurs before
      January 1, 2002 the Company will receive $15.4  million.  This amount will
      be reduced by $90,000  for each month  thereafter  to a minimum  amount of
      $13.3 million (if the  Triggering  Event occurs on December 31, 2003).  If
      the Triggering  Event occurs after December 31, 2003, then the Company and
      Bausch & Lomb will  negotiate  in good  faith to agree  upon the amount of
      additional  consideration  that Bausch & Lomb will pay the Company but not
      to exceed  $13.3  million.  The patent owner of LE-T is entitled to 11% of
      the  additional  fees  that  the  Company  receives  as a  result  of  the
      contingent  payment,  which  will  be  net  against  any  additional  gain
      recorded. The Company estimates its gross proceeds to be approximately $14
      million.

      Pharmos  will  receive  an  additional  fee  of up to $10  million  if the
      following  occurs:  (a) net  sales of LE-T in the  first 12  months  after
      commercial  launch are at least $7.5  million and (b) net sales of LE-T in
      the second twelve  consecutive  months after commercial  launch (i) exceed
      $15.0  million  and (ii) are greater  than net sales in (a) above.  Future
      payments will be included in the Company's  income when all  contingencies
      are resolved. The patent owner is also entitled to 14.3% of the additional
      fees that the Company receives as a result of these contingent payments.

      The Company's only future obligation to Bausch & Lomb after the sale is to
      pay up to $3.75 million in research and development cost relating to LE-T,
      of which $600,000 was withheld from the sales  proceeds.  The entire $3.75
      million was netted  against the gain on sale  recorded.  The Company has a
      passive  role  as a  member  of a joint  committee,  with  Bausch  & Lomb,
      overseeing the development of LE-T.

      As a result of this  transaction,  the  Company  recorded  a gain of $16.3
      million.   The  Company   incurred   transaction   and  royalty  costs  of
      approximately $2 million. The Company also compensated the LE patent owner
      approximately  $2.7  million  ($1.5  million  paid upon  closing  and $1.2
      million of this amount is to be paid in October 2002) from the proceeds of
      the sale of Lotemax and Alrex in return for his  consent to the  Company's
      assignment of its rights under the license agreement to Bausch & Lomb.

5.    Fixed Assets

      Fixed assets consist of the following:

<TABLE>
<CAPTION>

                                                                   December 31,
                                                                   ------------

                                                               2001             2000
                                                           -----------      -----------

<S>                                                        <C>              <C>
      Laboratory, pilot plant and other equipment          $ 2,826,727      $ 2,400,221
      Leasehold improvements                                   623,607          467,444
      Office furniture and fixtures                            397,745          249,480
      Computer equipment                                       704,316          582,396



                                      F-13
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements


      Vehicles                                                  38,742           38,742
                                                           -----------      -----------

                                                             4,591,137        3,738,283
      Less - Accumulated depreciation and amortization      (2,672,857)      (2,056,893)
                                                           -----------      -----------

                                                           $ 1,918,281      $ 1,681,390
                                                           ===========      ===========
</TABLE>

      Depreciation and  amortization of fixed assets was $622,283,  $435,200 and
      $299,520 in 2001, 2000 and 1999, respectively.



                                      F-14
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

 6.   Accrued expenses

      Accrued expenses consist of the following:

<TABLE>
<CAPTION>

                                                                             December 31,
                                                                             ------------

                                                                        2001                2000
                                                                     ----------          ----------

<S>                                                                  <C>                 <C>
      Accrued expenses, other                                        $  814,910          $1,162,098
      Research & development cost relating to LE-T (Note 4)           3,750,000                  --
      Accrued fee due to the LE patent owner (Note 4)                 1,244,732                  --
                                                                     ----------          ----------

      Total accrued expenses                                         $5,809,642          $1,162,098
                                                                     ==========          ==========
</TABLE>

7.    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 $1,336,566,  $326,438 and $138,102
      during 2001, 2000 and 1999, respectively.  The agreements with agencies of
      the State of Israel place  certain legal  restrictions  on the transfer of
      the technology and manufacture of resulting  products outside Israel.  The
      Company will be required to pay royalties, at rates ranging from 3% 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, 2001,  the total  amounts  received  under such grants
      amounted to $4,853,657, of which $4,273,969 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
      $3,142,551 based on grants received through December 31, 2001.

      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
      $281,453,  $543,807  and  $418,074 in 2001,  2000 and 1999,  respectively,
      pursuant to this agreement.

8.    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  generally  require  the  Company  to pay
      royalties on the sale of products developed and contingent royalties based
      upon milestones 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 is  received  for a  developed
      product.  No amounts have been recorded as a liability with respect to any
      contingent royalties as of December 31, 2001.


                                      F-15
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      Certain of the license  agreements,  which include  agreements  related to
      Lotemax and Alrex,  required 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 2001, 2000,
      and 1999.  With the completion of the sale of the  ophthalmic  business to
      Bausch & Lomb in October 2001, the obligations under these agreements have
      been assumed by Bausch & Lomb.

      The  Company  has  paid a  licensor,  who is a  former  director,  prepaid
      royalties  against  future  royalties  on  sales  of  Lotemax  and  Alrex.
      Outstanding  prepaid  royalties totaled $ 0 and $149,591 and are reflected
      as an  asset  on the  balance  sheets  at  December  31,  2001  and  2000,
      respectively.

9.    Private Placement

      In  September  2000,  the  Company   completed  a  private   placement  of
      convertible  debentures,  common stock and warrants to purchase  shares of
      common stock with  institutional  investors,  generating gross proceeds of
      $11 million.

      Convertible Debentures

      The Convertible Debentures,  which generated gross proceeds of $8 million,
      were due in February 2002 and carried a 6% interest  payable  semiannually
      in cash or common stock. In connection with the Convertible Debenture, the
      institutional investors also received warrants for the purchase of 276,259
      common  shares with a relative  fair value of  $725,000.  The  Convertible
      Debentures  were  convertible  into  common  shares of the  Company at the
      conversion  price of $3.83 per share (or 2,088,775 common shares) and were
      convertible   beginning   October  31,   2000.   Under   certain   limited
      anti-dilutive conditions, the conversion price may change. Until converted
      into common stock or the outstanding principal is repaid, the terms of the
      Convertible  Debentures  require  the  Company to deposit $4 million in an
      escrow  account.  The escrowed  capital is shown as Restricted Cash on the
      Company's  balance sheet and will be released to the Company in proportion
      to the amount of  Convertible  Debentures  converted into common shares or
      upon the repayment of the debt.

      During 2001,  the Company paid $589,819 and issued  182,964  shares of the
      common stock of the Company to the investors in the convertible debenture.
      The  payment of cash and stock were the option  chosen by the  Company and
      represent  adjustments to the pricing based upon the Company's stock price
      during  the  adjustment  period.  Additional  shares  were  issued  for no
      additional  consideration  resulting  in an  increase  in common  stock of
      $5,489 and a corresponding decrease in additional paid in capital.

      Emerging  Issues Task Force Issue No.  98-5,  Accounting  for  Convertible
      Securities with Beneficial Conversion Features or Contingently  Adjustable
      Conversion   Ratios,   require  the  Company  to  compute  the  Beneficial
      Conversion  Feature  ("BCF")  on the  convertible  debt due to the  spread
      between the fair market  value of the common stock at the date of issuance
      of the convertible debt and the conversion price taking into consideration
      the relative fair value of the warrants  issued in  conjunction  with this
      financing. The BCF is netted out of the proceeds and is amortized from the
      closing date until the earliest date that the investors  have the right to
      convert the debt into common shares. The BCF was computed at approximately
      $1.8  million,  all of which has been  amortized  and included as interest
      expense in the year ending December 31, 2000.  Additionally,  the discount
      on the Convertible Debenture due to the warrants issued in connection with
      the convertible  debenture of approximately  $800,000 will be amortized to
      interest  expense over the life of the debt.  For the years ended December
      31,  2001  and  2000,  $533,932  and  $177,976,   respectively,  has  been
      amortized.


                                      F-16
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      In  December  2001,  the  holders of the  Convertible  Debentures  and the
      Company agreed to modify the repayment and conversion  terms.  The holders
      of $5.8  million  convertible  debt  (book  value on  December  31,  2001,
      including  accrued  interest)  extended the maturity  date to June 2003 in
      exchange for a reduction in the  conversion  price from $3.83 to $2.63 for
      half of the  outstanding  balance  and  $2.15  for the  other  half of the
      outstanding  balance.  The  convertible  debt with a maturity date of June
      2003 is  convertible  beginning  December  31,  2001.  The  holder  of the
      remaining  outstanding debt of $1.9 million  (including  accrued interest)
      changed the  maturity  date from  February  28,2002 to January 31, 2002 in
      exchange for lowering the conversion  price for the other holders.  As the
      modification  was not significant in accordance with EITF 96-19 the change
      in the fair value between the original  convertible  debt and the modified
      convertible  debt  will  be  accreted  over  the  remaining  term  of  the
      convertible debt with a corresponding charge to interest expense.

      Common Stock

      The Company issued 1,024,425  common shares in the private  placement that
      generated   gross  proceeds  of  $3  million.   Under  the  terms  of  the
      transaction, 821,515 shares were issued at closing. In accordance with the
      terms of the agreement,  since the average  closing price of the Company's
      common stock during the 30 business days  following the effective  date of
      the registration statement relating to the shares purchased did not exceed
      110% of the initial  closing price of $3.65 per share,  the Company issued
      an additional  202,910  shares,  calculated  in accordance  with the stock
      purchase  agreement.  The  additional  shares  were  issued in the  fourth
      quarter of 2000 for no additional consideration,  resulting in an increase
      in common stock of $6,087 and a corresponding  decrease in additional paid
      in capital.

      One common stock investor has an option ("Call Warrant"), in the form of a
      warrant,  to  purchase  an  additional  $2 million of common  shares for a
      period of one year  (September  2002)  provided  that the future  purchase
      price is greater than the initial  closing  price of $3.65 per share.  The
      maximum  number of shares that can be issued from this  warrant is 547,945
      and is part of the maximum number of warrants issued for the total private
      placement  of  1,115,730,  including  placement  agent  warrants at prices
      ranging  from $3.65 to $6.08 per share.  The  warrants to the one investor
      for the purchase of an  additional  $2 million of common stock were valued
      using the Black Scholes  option-pricing model (assumptions:  volatility of
      78%, risk free rate of 5.89% and a zero dividend  yield).  The warrants to
      the placement  agents were valued using the Black  Scholes  option-pricing
      model using the same  assumptions  as above.  Both warrant  issuances were
      recorded  upon  issuance  as  additional  paid-in-capital.   The  investor
      exercised the Call Warrant in the third quarter of 2001,  with the Company
      issuing  542,299  common  shares.  During the fourth  quarter  the Company
      issued  281,659 shares as an adjustment to the pricing of the Call Warrant
      based upon the  Company's  stock  price  during the  adjustment  period as
      defined in the Call Warrant agreement.

      The issuance costs related to the Private Placement of approximately  $1.4
      million,  included the value of 187,929 warrants to purchase common shares
      (included in the total warrants of 1,115,780 issued in connection with the
      private  placement)  at prices  ranging from $4.34 to $4.56.  The issuance
      costs relating to the Convertible  Debenture of $981,000 will be amortized
      over the life of the debt. For the year ending December 31, 2001 and 2000,
      $682,464 and $224,691,  respectively,  has been  amortized and included as
      interest  expense.  The  issuance  costs  related to the  common  stock of
      $382,000 were netted against the proceeds.

      Of the warrants issued in connection with the private placement,  warrants
      for the purchase of 567,785 common shares at exercise  prices ranging from
      $4.34 to $6.08 per share and an expiration date of September 2005,  remain
      outstanding at December 31, 2001.

      The warrants  that were issued in  connection  with the private  placement
      noted above were valued using the Black-Scholes  option pricing model with
      the following  assumption:  volatility  78%, risk free rate 5.89% and zero
      dividend yield.


                                      F-17
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

10.   Common and Preferred Stock Transactions

      2001 Transactions

      The Company issued  1,109,446 shares of its common stock upon the exercise
      of stock options and warrants, and received consideration of $2,417,542.

      On January 1, 2001 the Company terminated the employment  contract for two
      employees and they became independent consultants.  In accordance with the
      incentive  option  plan,  all  terminated  employees  who are  extended  a
      consulting  contract  may  continue  to  vest  their  options.  Since  the
      employees  became   consultants  on  a  prospective   basis,  the  options
      outstanding on the date of  termination  are marked to market each quarter
      until the options vest. The Company is recording the value of the services
      being  received  based on the fair market  value of the options  using the
      Black-Scholes option-pricing model, which was more reliable than the value
      of the  services  provided.  The  fair  value of  these  options  has been
      estimated based on the following weighted average assumptions:  volatility
      of 78%,  risk free rate of 5.89% and a zero dividend  yield.  For the year
      ended December 31, 2001 the Company recorded professional fees relating to
      these terminated employees of $139,718.

      As of December 31, 2001, the Company had reserved  2,534,089 common shares
      for the possible conversion of the convertible  debentures,  2,452,030 for
      outstanding stock options and 2,297,277 for outstanding warrants.

      2000 Transactions

      During  2000,  the Company  issued  1,024,425  shares of common stock in a
      private placement transaction that generated gross proceeds of $3 million.
      Additionally,  the Company  issued  warrants  to purchase up to  1,115,730
      shares of common stock at prices ranging from $3.65 to $6.08 per share and
      expiring  in 2001 and 2005 in  connection  with the private  placement  of
      convertible debt and common stock described in Note 9.

      The Company issued  2,615,003 shares of its common stock upon the exercise
      of stock options and warrants, and received consideration of $4,832,893.

      During the first quarter of 2000, the Company issued 4,500,000  registered
      shares  of its  common  stock  under a  "shelf"  registration  to  several
      investors, and received consideration, net of offering costs and expenses,
      of $12,648,383.


                                      F-18
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      During  2000,  under terms of the Credit  Agreement,  the  Company  issued
      518,424 shares of its Common Stock and warrants to purchase  51,162 shares
      of its Common Stock to the Investor for  consideration of $2,145,904,  net
      of fees.  The warrants have exercise  prices  ranging from $2.19 to $16.80
      per share and expire in 2003.  The proceeds from the common stock issuance
      were allocated to the common stock and warrants based on the fair value of
      the  securities.   The  warrants  were  valued  using  the   Black-Scholes
      option-pricing  model  (assumptions:  volatility of 78%, risk free rate of
      5.89% and a zero  dividend  yield)  and  recorded  as  additional  paid in
      capital.  As of December 31, 2000, $1.7 million  remained  available under
      the equity line of credit.

      During 2000, the Company issued  warrants to purchase 32,000 shares of its
      common  stock  (4000   warrants  each  month   through   August  2000)  as
      compensation to a consultant.  The warrants were immediately  exercisable,
      have an exercise price of $1.19 per share and expire by 2005. The warrants
      were valued using the  Black-Scholes  option-pricing  model  (assumptions:
      volatility of 78%, risk free rate of 5.89% and a zero dividend  yield) and
      recorded as additional paid in capital.

      1999 Transactions

      In October 1999, the  shareholders of the Company approved the increase in
      the  number of  authorized  shares  of common  stock  from  60,000,000  to
      80,000,000  and  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 1,000,000 to 1,500,000.

      During  1999,  the Company  issued  1,346,124  shares of common stock upon
      conversion of its Series C convertible preferred stock. These transactions
      completed  the  conversion of the Series C  convertible  preferred  stock,
      leaving no preferred stock outstanding at December 31, 1999.

      The Company entered into this 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 1999, under terms of
      the Credit  Agreement,  the Company issued  4,128,165 shares of its Common
      Stock and warrants to purchase  348,495  shares of its Common Stock to the
      Investor for  consideration of $5,250,803,  net of fees. The warrants have
      exercise  prices  ranging  from  $1.41 to $2.38 per  share  and  expire by
      December  2002. The proceeds from the common stock issuance were allocated
      to the common stock and warrants base on the fair value of the securities.
      The warrants  were valued using the  Black-Scholes  option  pricing  model
      (assumptions:  volatility  of 50%,  risk free rate of 6.5%,  zero dividend
      yield) and recorded as additional paid in capital.


                                      F-19
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

11.   Warrants

      Some of the warrants  issued in connection  with various equity  financing
      and related  transactions  during 1991 through 2001 contain  anti-dilution
      provisions requiring adjustment. The following table summarizes the common
      shares issuable upon exercise of warrants outstanding at December 31, 2001
      as adjusted for the events which have triggered  anti-dilution  provisions
      contained in the respective warrant agreements:

<TABLE>
<CAPTION>

                                                                               Common Shares
                                                                                 Issuable         Exercise
             Issuance Date                  Expiration Date                    Upon Exercise       Price
             -------------                  ---------------                    -------------      --------
<S>                                         <C>                                 <C>               <C>
             April 1995                     April 2005                            341,600         $ 2.75
                                            April 2005                             10,000         $  .78
             February 1997                  February 2007                          45,000         $ 1.59
                                            February 2007                         404,000         $ 1.59
             March 1997                     March 2008                            171,052         $ 1.38
                                            March 2007                             10,000         $ 1.66
             January 1998                   October 2005                            7,000         $ 2.22
             February 1998                  January 2003                          531,081         $ 2.51
                                            January 2003                          157,185         $ 2.18
             November 1999                  November 2004                           4,000         $ 1.19
             December 1999                  December 2004                           4,000         $ 1.19
             January 2000                   January 2005                            4,000         $ 1.19
             February 2000                  February 2005                           4,000         $ 1.19
             March 2000                     March 2005                              4,000         $ 1.19
             April 2000                     April 2005                              4,000         $ 1.19
             May 2000                       May 2005                                4,000         $ 1.19
             June 2000                      June 2005                               4,000         $ 1.19
                                            June 2003                              12,574         $ 5.00
             July 2000                      July 2005                               4,000         $ 1.19
             August 2000                    August 2005                             4,000         $ 1.19
             September 2000                 September 2005                         95,843         $ 4.56
                                            September 2005                         92,086         $ 4.34
                                            September 2005                        379,856         $ 6.08
                                                                                  -------         ------
               Total shares and average
                    exercise price                                              2,297,277         $ 2.99
                                                                                =========         ======
</TABLE>


                                      F-20
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

12.  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, generally
      expire  ten  years  from  the  date of  grant  and  vest  in  four  annual
      installments of 25% each.

      The  following  table  summarizes  activity  in approved  incentive  stock
      options approved by the Company's Board of Directors:

                                            Under        Weighted Average
                                           Option        Exercise Price
                                           ------        --------------

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

Granted                                     312,000           $   1.25
Cancelled                                   (14,000)          $   2.05
                                         ----------           --------

Options Outstanding at 12/31/99           1,312,336           $   2.19
                                         ----------           --------

Granted                                     449,252           $   4.03
Exercised                                  (214,167)          $   2.31
Cancelled                                   (27,583)          $   2.65
                                         ----------           --------

Options Outstanding at 12/31/00           1,519,838           $   2.71
                                         ----------           --------

Granted at fair market value                 57,000           $   2.56
Granted below fair market value             453,500               1.88
Exercised                                   (12,500)              1.25
Cancelled                                    (3,000)              4.03
                                         ----------           --------

Options Outstanding at 12/31/01           2,014,838           $   2.53
                                         ==========           ========

Options exercisable at 12/31/01             898,399           $   2.47
                                         ==========           ========

Options exercisable at 12/31/00             602,836           $   2.29
                                         ==========           ========

Options exercisable at 12/31/99             581,836           $   2.32
                                         ==========           ========

Additional  information with respect to the outstanding  incentive stock options
as of December 31, 2001 is as follows:

<TABLE>
<CAPTION>

                                               Options Outstanding                            Options Exercisable
                          ---------------------------------------------------    -------------------------------------------
                                             Weighted
                                              Average           Weighted
     Range of Exercise       Options         Remaining          Average                                  Weighted Average
           Prices          Outstanding    Contractual Life   Exercise Price      Options Exercisable      Exercise Price
    --------------------- --------------- ----------------- -----------------    --------------------- ---------------------
<S>                          <C>             <C>                 <C>                   <C>                    <C>
       $1.25 - $1.88         741,000         8.7 years           $ 1.63                136,500                $ 1.25
       $1.94 - $2.78         815,586         5.7 years           $ 2.50                650,336                $ 2.46
       $3.68 - $4.03         458,252         8.5 years           $ 4.02                111,563                $ 4.03
                          --------------- ----------------- -----------------    --------------------- ---------------------
                            2,014,838        7.4 years           $ 2.53                898,399                $ 2.47
</TABLE>


                                      F-21
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      All  incentive  stock option grants during 2001 were made from the Pharmos
      Corporation  2000  Incentive  and  Non-Qualified  Stock Option Plan. As of
      December  31, 2001,  there were 802,500  shares  remaining  available  for
      issuance under this plan.

      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:

                                           Under          Weighted Average
                                          Option          Exercise Price
                                          ------          --------------

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

Granted                                    80,000           $   1.25
                                         --------           --------

Options Outstanding at 12/31/99           616,765           $   2.31
                                         --------           --------

Granted                                   190,748           $   3.81
Exercised                                (283,333)          $   2.23
Cancelled                                 (20,000)          $   1.25
                                         --------           --------

Options Outstanding at 12/31/00           504,180           $   2.97
                                         --------           --------

Granted below fair market value           100,000           $   1.88
Exercised                                (136,988)          $   2.20
Cancelled                                 (30,000)          $   2.77
                                         --------           --------

Options Outstanding at 12/31/01           437,192           $   2.97
                                         ========           ========

Options exercisable at 12/31/01           184,756           $   3.18
                                         ========           ========

Options exercisable at 12/31/00           287,807           $   2.77
                                         ========           ========

Options exercisable at 12/31/99           616,765           $   2.31
                                         ========           ========

Additional  information  with  respect  to the  outstanding  nonqualified  stock
options as of December 31, 2001 is as follows:

<TABLE>
<CAPTION>

                                            Options Outstanding                               Options Exercisable
                          ---------------------------------------------------    -------------------------------------------
                                              Weighted
                                              Average           Weighted
     Range of Exercise       Options         Remaining          Average                                  Weighted Average
           Prices          Outstanding    Contractual Life   Exercise Price      Options Exercisable      Exercise Price
    --------------------- --------------- ----------------- -----------------    --------------------- ---------------------
<S>                          <C>             <C>                 <C>                    <C>                   <C>
       $1.25 - $1.88         165,000         8.4 years           $ 1.74                 36,875                $ 1.58
       $2.41 - $2.50          83,194         4.6 years           $ 2.48                 71,944                $ 2.50
       $4.00 - $5.20         188,998         6.5 years           $ 4.25                 75,937                $ 4.61
                          --------------- ----------------- -----------------    --------------------- ---------------------
                             437,192         6.6 years           $ 2.97                184,756                $ 3.18
</TABLE>

      All  incentive  stock option grants during 2001 were made from the Pharmos
      Corporation  2000  Incentive


                                      F-22
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      and  Non-Qualified  Stock Option Plan. As of December 31, 2001, there were
      889,500 shares remaining available for issuance under this plan.

      During 2000, the Company modified the terms of certain  nonqualified stock
      options granted to two of the Company's  former Directors who entered into
      consulting  relationships with the Company. The modifications included the
      immediate  vesting  of the  nonqualified  options  and,  accordingly,  the
      Company expensed the value of these options as consultant compensation for
      the year ended December 31, 2000.

      The Company applies Accounting Principles Board Opinion No. 25, Accounting
      for Stock Issued to Employees,  and related  interpretations in accounting
      for its plans.  During 2001, the Company issued  453,500  incentive  stock
      options and 100,000 non-qualified stock options to employees and directors
      at an exercise price of $1.875 per share. The exercise price of $1.875 was
      representative  of the average  price  during the month the  options  were
      granted,  but was below the closing market price on the date of the grant.
      Accordingly,  the  Company  recorded  compensation  expense of $34,594 and
      deferred  compensation  expense  of  $172,969  to reflect  the  difference
      between the exercise price and the closing market price on the date of the
      grant.  The  deferred  compensation  expense  will be  amortized  over the
      remaining three-year vesting period.

      All other  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,  thus no compensation  expense has been recognized
      for those  stock-based  compensation  plans. Had compensation cost for the
      Company's stock option plans been determined  based upon the fair value at
      the  grant  date  for  awards  under  these  plans   consistent  with  the
      methodology  prescribed under Statement of Financial  Accounting Standards
      No. 123, Accounting for Stock-Based Compensation, the Company's net income
      and income per share would have been decreased by approximately  $923,000,
      or $.02 per  share in 2001 and net  loss  and loss per  share  would  have
      increased  by  approximately  $798,000,  or $.02  per  share  in 2000  and
      $560,000,  or $.01 per share in 1999.  The weighted  average fair value of
      options and warrants  granted to employees,  officers,  and directors from
      1999 through 2001 are  estimated at $ 0.783 to $2.697 on the date of grant
      using  the   Black-Scholes   option-pricing   model  with  the   following
      assumptions:  dividend yield 0%, volatility of 78% in 2000and 2001 and 50%
      in 1999,  risk-free interest rate ranging between 3.90% and 4.94% in 2001,
      5.89%  in 2000 and 6.5% in 1999,  assumed  forfeiture  rate of 3%,  and an
      expected life of 1 to 5 years.

13.   Income Taxes

      No provision for federal income taxes was recorded for the two years ended
      December 31, 2000 due to net operating losses  incurred.  No provision for
      income taxes was  recorded for the year ended  December 31, 2001 since the
      Company will be able to utilize its net operating  loss  carryforwards  to
      offset any tax due. Net operating loss carryforwards for U.S. tax purposes
      of approximately $64,000,000 expire from 2002 through 2021.

      During 2001,  the Company  sold a portion of its New Jersey net  operating
      loss  carryforwards  to a third party under the New Jersey  Technology Tax
      Certificate Program and, as a result, recorded a tax benefit of $226,033.

      The Company's  gross deferred tax assets of $26,900,000 and $28,300,000 at
      December 31, 2001 and 2000,  respectively,  represented  primarily the tax
      effect of both the net operating loss carryforwards ($22.4 million in 2001
      and $23.1 million in 2000),  deferred research and development costs ($2.4
      million in 2001 and $3.0 million in 2000) and research and development tax
      credit carryforwards ($1.9 million in 2001 and $1.5 million in 2000). As a
      result of


                                      F-23
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

      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 due to  management's  uncertainty of the
      recoverability of the deferred tax assets.




                                      F-24
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

14.  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.

      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.

      At December 31, 2001, the future minimum lease commitments with respect to
      non-cancelable  operating leases  (including  office and equipment leases)
      with initial terms in excess of one year are as follows:

                                                          Lease
                                                        Commitments
                                                        -----------
                  2002                                  $ 284,419
                  2003                                    184,473
                  2004                                    158,617
                  2005                                    156,516
                  2006                                    156,516
                  thereafter                               45,820
                                                         --------
                                                        $ 986,361
                                                        =========

      Rent expense during 2001 2000 and 1999 amounted to $353,793,  $329,246 and
      $323,469,  respectively. Rent expense in 2001, 2000 and 1999 is net of $0,
      $0 and $86,454 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,  2001,  2000 or 1999.  The Company does not
      intend to pay a cash dividend in the foreseeable future.

15.   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 $39,637,
      $26,570 and $11,333 in 2001, 2000 and 1999, respectively.


                                      F-25
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

16.   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.  The  estimated  fair market value of the
      convertible  debt is $9.5 million,  or $1.7 million  greater than the book
      value of $7.8 million at December 31, 2001.

17.   Segment and Geographic Information

      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, 2001, 2000 and
      1999 are as follows:

<TABLE>
<CAPTION>

                                      2001                 2000                 1999
                                  ------------         ------------         ------------
<S>                               <C>                  <C>                  <C>
      Net revenues
        United States             $  4,298,441         $  5,098,504         $  3,279,397
        Israel                              --                   --                   --
                                  ------------         ------------         ------------
                                  $  4,298,441         $  5,098,504         $  3,279,397
                                  ============         ============         ============
      Net income (loss)
        United States             $  5,564,634         ($ 7,597,846)        ($ 4,343,289)
        Israel                        (518,779)            (386,356)            (274,901)
                                  ------------         ------------         ------------
                                  $  5,045,855         ($ 7,984,202         ($ 4,618,190)
                                  ============         ============         ============
      Total assets
        United States             $ 40,648,880         $ 28,073,517         $  5,728,624
        Israel                       3,614,111            2,709,592            2,062,670
                                  ------------         ------------         ------------
                                  $ 44,262,991         $ 30,783,109         $  7,791,294
                                  ============         ============         ============
      Capital expenditures, net
        United States             $    138,424         $     54,746         $     23,448
        Israel                         720,750              877,985              278,902
                                  ------------         ------------         ------------
                                  $    859,174         $    932,731         $    302,350
                                  ============         ============         ============






</TABLE>



                                      F-26
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements

18.        Quarterly Information (Unaudited)

<TABLE>
<CAPTION>

         Year ended
      December 31, 2001                 1st Quarter        2nd Quarter       3rd Quarter       4th Quarter
      -----------------                 -----------        -----------       -----------       -----------

<S>                                     <C>               <C>               <C>               <C>
    Revenues                            $  1,105,058      $  1,480,737      $  1,712,646                --***

    Gross Margin                             693,717         1,026,829         1,309,306                --***

    Operating Expenses                     3,350,345         3,189,482         3,093,611      $  4,155,853

    Loss from Operations                  (2,656,628)       (2,162,653)       (1,784,305)       (4,155,853)

    Other Income (Expense), net              (93,475)         (204,092)         (212,741)       16,089,569*

    Net income (loss) applicable to
    common shareholders                 $ (2,750,103)     $ (2,366,745)     $ (1,997,046)     $ 12,159,749*

    Net income (loss)
     per share - basic & diluted        $       (.05)     $       (.04)     $       (.04)     $        .22
</TABLE>

*-    Other  Income  (Expense),  net and the Net Loss for the fourth  quarter of
      2001  include  the gain from the sale of the  ophthalmic  product  line to
      Bausch & Lomb in October 2001.

***-  As a result of the sale to  Bausch & Lomb in  October  2001,  there was no
      revenue or gross margin during the fourth quarter of 2001.


<TABLE>
<CAPTION>

      Year ended
   December 31, 2000                        1st Quarter      2nd Quarter        3rd Quarter        4th Quarter
   -----------------                        -----------      -----------        -----------        -----------

<S>                                         <C>              <C>                <C>                <C>
    Revenues                                $   663,580      $ 1,414,837        $ 1,761,735        $ 1,258,352

    Gross Margin                                383,051          937,675          1,181,533            720,290

    Operating Expenses                        2,425,064        2,075,209          2,576,618          2,892,988

    Loss from Operations                     (2,042,013)      (1,137,534)        (1,395,085)        (2,172,698)

    Other Income (Expense), net
                                                146,869          287,602           (136,074)**      (1,535,269)**

    Net loss applicable to common
    shareholders                            $(1,895,144)     $  (849,932)       $(1,531,159)**     $(3,707,967)**

    Net loss per share -basic & diluted
                                            $      (.04)     $      (.02)       $      (.03)       $      (.07)
</TABLE>


                                      F-27
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements


**-  Other  Income  (Expense),  net and the Net Loss for the  third  and  fourth
quarter of 2000 include the  amortization of the Beneficial  Conversion  Feature
from the Private Placement as discussed in Note 9.




                                      F-28
<PAGE>

Pharmos Corporation
Notes to Consolidated Financial Statements


19.   Subsequent event

      In January 2002, the convertible  debenture commitment of approximately $2
      million was repaid in cash. Additionally,  $2.6 million (including accrued
      interest of $0.1 million) was converted into 1,217,485 common shares, thus
      leaving  $3.9  million  (including  accrued  interest of $0.4  million) as
      outstanding as of March 15, 2002. After the repayment and conversion, $3.6
      million was released from restricted cash.





                                      F-29