SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                AMENDMENT NO. 1
                                    FORM 10-K
    

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

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

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

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

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

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

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

                                      None
                                (Title of Class)

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

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

     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___.

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

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

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


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                                     PART I
Item 1.  Business

Introduction

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

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

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

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

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

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


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Strategy

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

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

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

Products

     Loteprednol Etabonate

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

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


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

     Dexanabinol (HU-211)

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

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

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

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

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


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<PAGE>


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

     Tamoxifen Analogs

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

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

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

Competition

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


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

Collaborative Relationships

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

     Bausch & Lomb

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

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

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

Patents, Proprietary Rights and Licenses

     Patents and Proprietary Rights


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

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

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

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

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


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

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

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

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

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

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


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

     Licenses

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

Government Regulation

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

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


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

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

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

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

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

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

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


                                       10


<PAGE>


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

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

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



                                       11


<PAGE>


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

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

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

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


                                       12


<PAGE>


Corporate History

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

Human Resources

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

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

Public Funding and Grants

   
     The Company's  subsidiary,  Pharmos Ltd., has received certain funding from
the Chief  Scientist  of the Israel  Ministry of Industry  and Trade (the "Chief
Scientist")  for research and  development  of SME  technology for injection and
nutrition as well as for research  relating to  pilocarpine,  dexamethasone  and
ophthalmic  formulations for dry eyes. The Company has received $1,827,192 under
such agreements  through  December 31, 1997. The Company will be required to pay
royalties to the Chief  Scientist from 2% to 5% of product  sales,  if any, as a
result of the research activities  conducted with such funds.  Aggregate royalty
payments are limited to the amount of funding received. Additionally, funding by
the Chief  Scientist  places  certain  legal  restrictions  on the  transfer  of
know-how  and the  manufacture  of  resulting  products  outside of Israel.  See
"Conditions in Israel."

     The Company has received  certain  funding of $925,780 from the Israel-U.S.
Binational Industrial Research and Development  Foundation ("BIRD-F") to develop
Lotemax and LE-T.  The  Company  will be  required  to pay  royalties  to BIRD-F
ranging from 2.5% to 5% of product sales, if any,
    

                                       13


<PAGE>


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

Conditions in Israel

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

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

Item 2. Properties

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

Item 3. Legal Proceedings

     None.

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

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


                                       14


<PAGE>


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

                                     PART II

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

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

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

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

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

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


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


                                       15


<PAGE>


commission, and may not necessarily represent actual transactions.

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

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

Item 6. Selected Financial Data

<TABLE>
<CAPTION>
                                                                      Year Ended December 31,
                                                                      -----------------------
                                                    1997             1996              1995              1994               1993
                                               ------------      ------------      ------------      ------------      ------------
<S>                                            <C>               <C>               <C>               <C>               <C>         
   
Revenues                                                 --                --      $     75,000      $      7,815      $     81,900
Operating expenses                               (8,563,019)       (8,354,991)       (8,253,666)      (13,036,461)       (9,594,091)
Loss Before Extraordinary                        (8,233,547)       (8,077,210)       (8,096,085)      (12,955,299)       (9,398,695)
Item
Extraordinary gain from
forgiveness of debt                                 416,248                --                --                --                --
Dividend embedded in
convertible preferred stock                      (1,952,767)               --                --                --                --
Preferred Stock dividends                          (240,375)               --                --                --                --
Net loss applicable to
common shareholders                            ($10,010,441)     ($ 8,077,210)     ($ 8,096,085)     ($12,955,299)     ($ 9,398,695)
                                               ============      ============      ============      ============      ============
Loss per share applicable
to common shareholders before 
extraordinary gain - basic                    ($      0.32)     ($      0.28)     ($      0.37)     ($      1.19)     ($      1.24)
                                               ------------      ------------      ------------      ------------      ------------

Extraordinary gain per share                   $       .01
                                               -----------

Net loss per share applicable
to common shareholders - basic                ($      0.31)     ($      0.28)     ($      0.37)     ($      1.19)     ($      1.24)
                                               ------------      ------------      ------------      ------------      ------------

Total assets                                   $  8,421,841      $  7,468,293      $  9,461,654      $  4,289,416      $ 10,608,458
                                               ------------      ------------      ------------      ------------      ------------
Long term obligations                          $  4,100,000      $  4,161,767      $  2,294,268      $     91,318      $    129,240
                                               ------------      ------------      ------------      ------------      ------------
Cash dividends declared                                  --                --                --                --                --
</TABLE>
    


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


                                       16
<PAGE>


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

Results of Operations

Years Ended December 31, 1997 and 1996

   
     Total operating expenses  increased by $208,028,  or 2.5 %, from $8,354,991
in 1996 to $8,563,019 in 1997.  Marketing  expenses  totaling  $598,385 which is
comprised of bulk material purchases of loteprednol etabonate ("LE"), the active
drug-stubstance  of Lotemax and Alrex, were principally  offset by reductions in
research  and  development,   net,  patents,   general  and  administrative  and
depreciation and amortization expenses.
    

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

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

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

                                       17


<PAGE>


University.

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

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

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

   
Interest  and other  income,  net of interest and other  expenses,  increased by
$51,692,  or 19%, from $277,782 in 1996 to $329,472 in 1997.  Interest and other
income,  net,  increased as a result of higher  average cash  balances,  and net
foreign  exchange gains. 
    

Years Ended December 31, 1996 and 1995

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

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

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

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


                                       18


<PAGE>


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

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

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

Liquidity and Capital Resources

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

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

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


                                       19


<PAGE>


The Year 2000

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

Item 8. Financial Statements and Supplementary Data

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

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

     None.


                                       20


<PAGE>


                                    PART III

Item 10. Directors and Executive Officers of the Registrant

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


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

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


                                       21


<PAGE>


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

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

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

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

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

                                       22


<PAGE>


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

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

   
     David  Schlachet,  a Director of the Company since  December 15, 1994,  has
served as the Chairman of Elite  Industries  Ltd.  from July 1997.  From January
1996 to June 1997,  Mr.  Schlachet  served as the Vice  President of the Strauss
Group and Chief Executive  Officer of Strauss Holdings Ltd. The Strauss Group is
Israel's  largest  privately  owned food  manufacturer.  Mr.  Schlachet was Vice
President of Finance and  Administration at the Weizmann Institute of Science in
Rehovot,  Israel from 1990 to December,  1995. Mr. Schlachet was responsible for
the Institute's  administration and financial  activities,  including personnel,
budget and finance,  funding,  investments,  acquisitions and collaboration with
the industrial and business  communities.  From 1989 to 1990, Mr.  Schlachet was
President and Chief Executive Officer of YEDA Research and Development Co. Ltd.,
a marketing  and  licensing  company at the Weizmann  Institute of Science.  Mr.
Schlachet  is  a  Director  of  Taya   Investment   Company   Ltd.,  an  Israeli
publicly-held investment company.
    

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

   
     Mony Ben Dor, a Director of the Company since September 1997, has been Vice
President of The Israel  Corporations,  Ltd.  since May 1, 1997, and chairman of
two publicly  traded  subsidiaries:  H.L.  Finance and Leasing and Albany Bonded
International  Trade. He is also a director of a number of subsidiary  companies
of Israel  Chemicals  Ltd. From 1992 to 1997,  Mr. Ben Dor was Vice President of
Business  Development  for Clal  Industries  Ltd. (a subsidiary of Clal Israel),
which  is one of the  leading  investment  groups  in  Israel.  He was  actively
involved in the acquisition of
    


                                       23


<PAGE>


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

Section 16 Filings

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


                                       24


<PAGE>


Item 11. Executive Compensation

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

Summary Compensation Table

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

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


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


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


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


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

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

3)   Consists of non-employee compensation.

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

                                       25


<PAGE>


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


Option Grants for the Year
Ended December 31, 1997:

     None.(1)(2)(3)

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

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

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


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

<TABLE>
<CAPTION>
                                                                                             Value of Unexercised
                      Number of                            Number of Unexercised           In-the-Money Options at
                       Shares                              Options at December 31,            December 31, 1997
                     Acquired on        Value          --------------------------------  -----------------------------
Name                  Exercise         Realized                    1997                  Exercisable     Unexercisable
----                  --------         --------                    ----                  -----------     -------------
                                                        Exercisable      Unexercisable  
                                                        -----------      -------------  
<S>                      <C>              <C>             <C>                <C>           <C>              <C>    
Haim Aviv,                                                                              
Ph.D.                    0                0               255,376            69,000        $72,000           $48,000
                                                                                        
Gad                                                                                     
Riesenfeld,              0                0               57,466             21,867        $48,000          $32,000
Ph.D.                                                                                   
                                                                                        
Anat Biegon,             0                0               34,426             16,107        $36,000          $24,000
Ph.D.                                                                                   
                                                                                       
</TABLE>


                                       26


<PAGE>


Stock Option Plans

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

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

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

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

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

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

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

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


                                       27


<PAGE>


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

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

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

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

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

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


                                       28


<PAGE>


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

1997 Employees and Directors Warrants Plan

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

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


Employment/Consulting Contracts/Directors' Compensation

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


                                       29


<PAGE>


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

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


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

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


                                       30


<PAGE>


Item 12. Security Ownership of Certain Beneficial Owners and Management

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


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

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


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


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


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


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


                                       31


<PAGE>


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

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


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

----------

*    Indicates ownership of less than 1%.

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

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

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

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

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

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


Item 13. Certain Relationships and Related Transactions


             None.


                                       32


<PAGE>


                                     PART IV


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

     (a)  Financial Statements and Exhibits

          (1)  FINANCIAL STATEMENTS

               Report of Independent Accountants

               Consolidated Balance Sheets at December 31, 1997 and 1996

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

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

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

               Notes to Consolidated Financial Statements

          (2)  FINANCIAL STATEMENT SCHEDULES

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

          (3)  EXHIBITS; EXECUTIVE COMPENSATION PLANS

Exhibits

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

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


                                       33


<PAGE>


3 Articles of Incorporation and By-Laws

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

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

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

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

4 Instruments defining the rights of security holders, including indentures

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

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

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

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

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

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

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


                                       34


<PAGE>


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

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

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

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

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

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

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

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

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

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

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


                                       35


<PAGE>


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

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

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

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

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

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

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

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

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

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

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


                                       36


<PAGE>


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

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

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

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

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

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

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

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

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

10  Material Contracts

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

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


                                       37


<PAGE>


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

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

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

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

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

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

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

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

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

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

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


                                       38


<PAGE>


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

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

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

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

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

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

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

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

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

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


                                       39
<PAGE>


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

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

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

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

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

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

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

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

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

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


                                       40


<PAGE>


21 Subsidiaries of the Registrant

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

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

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

Executive Compensation Plans and Arrangements

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

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

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

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

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

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

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

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

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


                                       41


<PAGE>


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

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

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

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

     (b)  Reports on Form 8-K

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

     (c)  Exhibits

          None.

     (d)  Financial Statement Schedules

          See Item 14(a)(2) above


                                       42


<PAGE>


                                   SIGNATURES


     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                              PHARMOS CORPORATION


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

   
                                 Date: May 13, 1998
    

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

<TABLE>
<CAPTION>
   
Signature                             Title                                           Date
---------                             -----                                           ----
<S>                                   <C>                                             <C> 
/s/ Robert Cook                       Chief Financial Officer (Principal              May 13, 1998
----------------------------
Robert Cook                           Financial and Accounting Officer),
                                      and Secretary
/s/ Dr. Gad Riesenfeld                President, Chief Operating Officer              May 13, 1998
----------------------------
Dr. Gad Riesenfeld
/s/ Marvin P. Loeb                    Director                                        May 13, 1998
------------------
Marvin P. Loeb
/s/ E. Andrews Grinstead III          Director                                        May 13, 1998
----------------------------
E. Andrews Grinstead III
/s/ Stephen C. Knight                 Director                                        May 13, 1998
----------------------------
Stephen C. Knight
/s/ David Schlachet                   Director                                        May 13, 1998
----------------------------
David Schlachet
/s/ Fredric D. Price                  Director                                        May 13, 1998
----------------------------
Fredric D. Price
/s/ Mony Ben Dor                      Director                                        May 13, 1998
----------------------------
Mony Ben Dor
</TABLE>
    



                                       43



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



<PAGE>




                               Pharmos Corporation
                   Index to Consolidated Financial Statements


Report of Independent Accountants                                          F - 2

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

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

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

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

Notes to consolidated financial statements                           F - 7 - F21






                                      F-1

<PAGE>


                        Report of Independent Accountants


March 16, 1998

To the Board of Directors and
Shareholders of Pharmos Corporation

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

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


                                      F-2
<PAGE>


Pharmos Corporation

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

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

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

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

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

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

Shareholders' (deficit) equity:

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

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



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

                                       F-3

<PAGE>


Pharmos Corporation

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

   
<TABLE>
<CAPTION>
                                                                          Year Ended December 31,
                                                                    1997             1996           1995

<S>                                                            <C>              <C>             <C>       
Revenues:

License fees, royalties, net                                   $       --      $       --      $     75,000

Expenses:

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

Other income (expenses):

    Interest income                                                 330,453         323,097         209,584
    Other income (expenses), net                                     16,365          (9,393)           --
    Interest expense                                                (17,346)        (35,923)       (127,003)
                                                               ------------    ------------    ------------
          Other income (expense), net                               329,472         277,781          82,581
                                                               ============    ============    ============
Loss before extraordinary item                                   (8,233,547)     (8,077,210)     (8,096,085)

Extraordinary gain from forgiveness of debt,
    net of $0 of income taxes (Note 3)                              416,248            --              --
                                                               ------------    ------------    ------------
Net loss                                                         (7,817,299)     (8,077,210)     (8,096,085)
                                                               ------------    ------------    ------------
Less:  Dividend embedded in convertible preferred
             stock (Note 9)                                      (1,952,767)           --              --
          Preferred stock dividends                                (240,375)           --              --
                                                               ------------    ------------    ------------
Net loss applicable to common shareholders                     $(10,010,441)   $ (8,077,210)   $ (8,096,085)
                                                               ============    ============    ============
Net loss per share applicable to common shareholders
    before extraordinary gain - basic                                  (.32)           (.28)           (.37)

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


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

                                       F-4
<PAGE>


Pharmos Corporation

Consolidated Statement of Changes in Shareholders' (Deficit) Equity (Note 9)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                       Series A Convertible  Series B Convertible
                                                                    Common Stock          Preferred Stock      Preferred Stock  
                                                                 Shares         Amount   Shares     Amount    Shares      Amount 
<S>                                                           <C>          <C>           <C>       <C>          <C>      <C>
December 31, 1994                                             14,631,726   $  438,952      --      $   --        --      $  --   
                                                                                                   --------   -------    -------
Issuance of common stock to purchase Oculon Corp.              6,000,000      180,000      --          --        --         --   
Conversion of debentures to common stock                       2,442,309       73,269      --          --        --         --   
Warrant exercise                                                  75,000        2,250      --          --        --         --   
Issuance of common stock, net of offering costs
     of $900,000                                               6,000,000      180,000      --          --        --         --   
Warrant grant to consultants                                        --           --        --          --        --         --   
Share adjustment for reverse split                                     4         --        --          --        --         --   
Net loss                                                            --           --        --          --        --         --   
                                                              ----------   ----------  --------    --------   -------    -------

December 31, 1995                                             29,149,039      874,471      --          --        --         --   

Warrant exercise                                                  99,286        2,978      --          --        --         --   
Issuance of Series A preferred stock, net of offering costs
     of $18,000                                                     --           --       1,900          57      --         --   
Private placement of common stock                              1,479,200       44,376      --          --        --         --   
Warrant grant to consultants                                        --           --        --          --        --         --   
Net loss                                                            --           --        --          --        --         --   
                                                              ----------   ----------  --------    --------   -------    -------

December 31, 1996                                             30,727,525      921,825     1,900          57      --         --   

Issuance of Series B preferred stock,
    net of offering costs of $260,000                               --           --        --          --       6,000        180
Warrant exercises                                                 37,500        1,125      --          --        --         --   
Conversion of Series A preferred stock                         1,492,943       44,788    (1,900)        (57)     --         --   
Preferred stock dividend paid with common stock                  133,455        4,004      --          --        --         --   
Conversion of Series B preferred stock                         2,000,215       60,006      --          --      (3,245)       (97)
Dividend embedded in convertible preferred stock                    --           --        --          --        --         --   
Net loss                                                            --           --        --          --        --         --   
                                                              ----------   ----------  --------    --------   -------    -------

December 31, 1997                                             34,391,638   $1,031,748      --      $   --       2,755    $    83
                                                              ==========   ==========  ========    ========   =======    =======
<CAPTION>
                                                                                                                         Total 
                                                                Additonal                   Treasury                  Shareholders'
                                                                 Paid-in      Accumulated    Stock                      (Deficit)  
                                                                 Capital        Deficit      Shares        Amount        Equity    
                                                              ------------  ------------  -----------   ------------   ------------
<S>                                                           <C>           <C>                <C>      <C>            <C>          
December 31, 1994                                             $ 46,669,890  $(45,928,657)      18,356   $    (551)     $  1,179,634 
                                                                 2,892,426          --           --          --                --   
Issuance of common stock to purchase Oculon Corp.                1,196,731          --           --          --           3,072,426 
Conversion of debentures to common stock                            36,750          --           --          --           1,270,000 
Warrant exercise                                                      --            --           --          --              39,000 
Issuance of common stock, net of offering costs                                                                                     
     of $900,000                                                 7,920,000          --           --          --           8,100,000 
Warrant grant to consultants                                        48,000          --           --          --              48,000 
Share adjustment for reverse split                                    --            --           --          --                --   
Net loss                                                              --      (8,096,085)        --          --          (8,096,085)
                                                              ------------  ------------  -----------   ---------      ------------ 
December 31, 1995                                               58,763,797   (54,024,742)      18,356        (551)        5,612,975 
                                                                                                                                    
Warrant exercise                                                    55,522          --           --          --              58,500 
Issuance of Series A preferred stock, net of offering costs                                                                         
     of $18,000                                                  1,881,943          --           --          --           1,882,000 
Private placement of common stock                                1,955,624          --           --          --           2,000,000 
Warrant grant to consultants                                        12,000          --           --          --              12,000 
Net loss                                                              --      (8,077,210)        --          --          (8,077,210)
                                                              ------------  ------------  -----------   ---------      ------------ 
December 31, 1996                                               62,668,886   (62,101,952)      18,356        (551)        1,488,265 
                                                                                                                                    
Issuance of Series B preferred stock,                                                                                               
    net of offering costs of $260,000                            5,739,820          --           --          --           5,740,000 
Warrant exercises                                                   66,375          --           --          --              67,500 
Conversion of Series A preferred stock                             (44,731)         --           --          --                --   
Preferred stock dividend paid with common stock                    193,705      (197,709)        --          --                --   
Conversion of Series B preferred stock                             (59,909)         --           --          --                --   
Dividend embedded in convertible preferred stock                 1,952,767    (1,952,767)        --          --                --   
Net loss                                                              --      (7,817,299)        --          --          (7,817,299)
                                                              ------------  ------------  -----------   ---------      ------------ 
December 31, 1997                                             $ 70,516,913  $(72,069,727)      18,356   $    (551)     $   (521,534)
                                                              ============  ============  ===========   =========      ============ 
</TABLE> 


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

                                       F-5

<PAGE>

Pharmos Corporation

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

   
<TABLE>
<CAPTION>
                                                                                           Year Ended December 31,
                                                                                     1997            1996            1995
                                                                                 ------------    ------------    ------------
<S>                                                                              <C>             <C>             <C>          
Cash flows from operating activities:
    Net loss                                                                     $ (7,817,299)   $ (8,077,210)   $ (8,096,085)
    Adjustments to reconcile net loss to net
       cash flow used in operating activities:
          Depreciation and amortization                                               255,718         345,595         536,010
          Loss on disposal of fixed assets                                             41,560            --              --
          Warrant grant to consultants                                                   --            12,000          48,000
          Extraordinary gain from forgiveness of debt                                (416,248)
    Changes in operating assets and liabilities, net of effects of acquisition
       in 1995:
          Inventories                                                              (1,804,627)           --              --
          Grants receivable                                                           121,364        (254,758)        158,389
          Prepaid expenses and other current assets                                    76,064         239,000         202,240
          Advanced royalties                                                         (143,333)       (573,334)           --
          Other assets                                                                114,958            --              --
          Accounts payable                                                          2,145,801         108,059      (1,180,748)
          Accrued expenses                                                            312,248         (18,413)         89,219
          Accrued wages and other compensation                                         43,304         152,645            --
          Other liabilities                                                            48,881        (184,360)           --
                                                                                 ------------    ------------    ------------
          Net cash used in operating activities                                    (7,021,609)     (8,250,776)     (8,242,975)
                                                                                 ------------    ------------    ------------
Cash flows from investing activities:
    Purchases of fixed assets, net                                                   (324,769)        (73,028)        (56,647)
                                                                                 ------------    ------------    ------------
          Net cash used in investing activities                                      (324,769)        (73,028)        (56,647)
                                                                                 ------------    ------------    ------------
Cash flows from financing activities:
          Advances against future sales                                             1,000,000       2,122,859       1,877,141
    Proceeds from issuance of common stock
       and exercise of warrants, net                                                   67,500       2,058,500       8,139,000
    Proceeds from issuance of preferred stock, net                                  5,740,000       1,882,000            --
    Proceeds from issuance of convertible debentures                                     --              --         1,270,000
    Proceeds from acquisition of Oculon, net                                             --              --         3,072,426
    Payments of loans payable                                                        (170,639)        (49,440)       (480,219)
                                                                                 ------------    ------------    ------------
          Net cash provided by financing activities                                 6,636,861       6,013,919      13,878,348
                                                                                 ------------    ------------    ------------
Net (decrease) increase in cash and cash equivalents                               (1,542,013)     (2,309,885)      5,578,726

Cash and cash equivalents at beginning of year                                      5,132,906       7,442,791       1,864,065
                                                                                 ------------    ------------    ------------
Cash and cash equivalents at end of year                                         $  4,423,389    $  5,132,906    $  7,442,791
                                                                                 ============    ============    ============
</TABLE>
    

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


                                      F-6

<PAGE>


Pharmos Corporation

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

1.     The Company

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

2.     Liquidity and Business Risks

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

3.     Significant Accounting Policies

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

                                      F-7
<PAGE>

Pharmos Corporation

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

       Use of Estimates

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

       Net loss per common share

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

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

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

       Cash and cash equivalents

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

       Revenue recognition

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

       Inventories

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


                                      F-8

<PAGE>

Pharmos Corporation

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

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

       Fixed assets

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

       Intangible assets

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

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

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

       Research and development costs

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

       Income taxes

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


                                      F-9

<PAGE>

Pharmos Corporation

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

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

       Concentration of Credit Risk

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

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

       Reclassifications

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

       Recent Accounting Standards

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

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


                                      F-10

<PAGE>

Pharmos Corporation

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

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

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

4.     Collaborative Agreements

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

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

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



                                      F-11

<PAGE>

Pharmos Corporation

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

5.     Fixed Assets

       Fixed assets consist of the following:

                                                             December 31,
                                                         1997           1996

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

                                                        1,819,503    2,635,755

       Less - Accumulated depreciation and amortization (1,116,075)  (2,006,342)
                                                       -----------  -----------

                                                       $   703,428  $   629,413
                                                       ===========  ===========


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

6.     Grants for Research and Development

   
       The Company has entered into  agreements with U.S.  federal  agencies and
       the State of Israel which provide for grants for research and development
       relating  to  certain  projects.   Amounts  received  pursuant  to  these
       agreements have been reflected as a reduction of research and development
       expense.  Such  reductions  amounted to  $418,245,  $245,302 and $331,546
       during 1997, 1996 and 1995, respectively. The agreements with agencies of
       the State of Israel place certain legal  restrictions  on the transfer of
       technology and  manufacture of resulting  products  outside  Israel.  The
       Company will be required to pay  royalties,  at rates  ranging from 2% to
       5%, to such  agencies from the sale of products,  if any,  developed as a
       result of the research activities carried out with the grant funds.

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

       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

                                      F-12

<PAGE>

Pharmos Corporation

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

       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  $200,000 in
       1997 pursuant to this agreement.

7.     Licensing Arrangements

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

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

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

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

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

8.     Common and Preferred Stock Transactions

       1997 transactions

   
       On  February  12,  1997,  the  Company  issued  warrants  to  purchase an
       aggregate of 955,000 shares of common stock at an exercise price of $1.59
       per  share,  the fair  market  value of the  common  stock on the date of
       grant, to 14 employees of the Company. Prior to December 31, 1997, 65,000
       of these warrants were canceled in connection  with the  termination of 2
       employees.  Such warrants become exercisable in increments of 25% each on
       February 12, 1998,  February 12, 1999, February 12, 2000 and February 12,
       2001. All of such warrants expire on February 12, 2007. Also, on February
       12, 1997, the 
    


                                      F-13

<PAGE>

Pharmos Corporation

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

       Company  issued  warrants to purchase an aggregate  of 115,000  shares of
       common  stock at an  exercise  price of $1.59 per share to the  Company's
       five outside directors and one outside consultant.  These warrants become
       exercisable  on the same basis as the warrants  issued to employees,  but
       expire  on  February  12,  2003.   Upon   termination  of  employment  or
       termination as a director, all warrants held by such employee or director
       will expire,  except that any warrant that was exercisable on the date of
       termination  may, to the extent then  exercisable,  be  exercised  within
       three months thereafter (or one year thereafter if the termination is the
       result of death or permanent disability of such employee or director).

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

       On March  31,  1997,  the  Company  completed  a private  placement  with
       institutional  investors  of  Series B  Convertible  Preferred  Stock and
       warrants  to  purchase  common  stock,  generating  gross  proceeds of $6
       million.  The Series B preferred stock carries a 5% dividend rate payable
       in cash or common stock, at the option of the Company, and is convertible
       into common shares over a period  ranging from 90 to 270 days  subsequent
       to March 31, 1997. The conversion  price will be based on the share price
       at the time of conversion  less discounts  ranging from 17% to 20%. Until
       converted  into common stock,  the preferred  stock has no voting rights.
       The 159,000  warrants  issued to the investors are exercisable at a price
       of $1.75 per share,  commencing  March 31, 1998, for a three year period.
       The Company  also issued  warrants  to purchase an  aggregate  of 239,473
       shares of common stock at an exercise price of $1.38 per share to certain
       parties who  assisted in the  completion  of the private  placement.  The
       warrants are exercisable from March 31, 1998 and will expire in 2007.
    

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

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

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


                                      F-14

<PAGE>

Pharmos Corporation

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

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

       1996 transactions

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

   
       On  September  30,  1996,  the Company  completed a private  placement of
       Series A  convertible  preferred  stock and  warrants to purchase  common
       stock,  with  institutional  investors  generating gross proceeds of $1.9
       million.  The Series A preferred stock carried a 5% dividend rate payable
       in  cash  or  common  stock,  at the  option  of  the  Company,  and  was
       convertible  into common shares over a period ranging from 80 days to 360
       days subsequent to September 30, 1996. The conversion  price was based on
       the share price at the time of conversion less discounts ranging from 17%
       to 20%.  Until  converted into common stock,  the preferred  stock had no
       voting  rights.   The  50,000   warrants  issued  to  the  investors  are
       exercisable at a price of $1.75 per share,  commencing one year after the
       closing for a three year  period.  The  investors  were  granted  limited
       rights to approve  certain  financing  by the  Company  for 180 days from
       closing.
    

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

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

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

       1995 transactions

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


                                      F-15

<PAGE>

Pharmos Corporation

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

   
       In February 1995, the Company completed the sale of $1,270,000  principal
       amount  convertible  debentures  in a private  placement  transaction  to
       several   accredited   investors,   including   a   large   institutional
       shareholder.  A member  of the  Company's  Board of  Directors  purchased
       $70,000 of such  debentures.  During  1995,  all of the  debentures  were
       converted  into  2,442,309  shares of the  Company's  common  stock at an
       exchange price of $.52 per share.  Imputed  interest  associated with the
       below  market  conversion  price  was not  recorded  as it did not have a
       material  impact on the results of operations in 1995. In connection with
       this  transaction the Company issued warrants to purchase  150,000 shares
       of common  stock at an  exercise  price of $.52 per share.  During  1995,
       warrants  to purchase  75,000  shares were  exercised  and the  remaining
       75,000 warrants were exercised in January 1996.
    

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

       On  September  14,  1995,  the Company  completed  a private  offering of
       6,000,000 units at $1.50 per unit. The proceeds of the private  offering,
       net of costs of $900,000,  were  $8,100,000.  Each unit  consisted of one
       share of the Company's  common stock and one warrant to purchase 0.075 of
       one share of common  stock  (450,000  shares).  In  addition  the Company
       issued  warrants to purchase  450,000  shares of common  stock to the two
       finders who assisted in this transaction. Both groups of warrants have an
       exercise  price  of  $1.80  per  share  and may be  exercised  commencing
       September  14, 1996 and expire on September  14, 2000.  During 1995,  the
       Company  issued  warrants  to  consultants  who  assisted  the Company on
       various business and financial  matters as follows:  warrants to purchase
       10,000  shares at an exercise  price of $1.88 per share,  which expire on
       October 31, 2001;  warrants to purchase  10,000  shares of the  Company's
       common  stock at an  exercise  price of $.78 per share,  which  expire on
       April 10, 2005; warrants to purchase 75,000 shares,  25,000 each of which
       have an exercise price of $.75, $1.00 and $1.50 per share,  respectively,
       and may be exercised  beginning May 1, 1996 and expire on April 30, 2000.
       The  Company  recognized  compensation  expense  of  $48,000  related  to
       warrants in 1995.


                                      F-16

<PAGE>


Pharmos Corporation

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

9.     Warrants

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

   
                                                              Shares  
                                                             Issuable 
Issuance Date                                 Expiration       Upon     Exercise
                                                 Date        Exercise    Price 
November 1991                                                                  
                                              March 1998      269,490  $   2.01
                                              March 1998      303,338      2.50
August 1993                                   March 1998      361,844      1.52
September 1994                               August 1998      454,121      2.67
October 1994                                September 1999     65,044      2.26
April 1995                                   October 1999     200,000       .84
                                              April 2005      500,000      2.75
                                              April 2005       10,000       .78
                                              April 2000       15,000       .75
                                              April 2000       25,000      1.00
September 1995                                April 2000       25,000      1.50
October 1995                                September 2000    862,500      1.80
March 1996                                   October 2001      10,000      1.88
September 1996                                March 2002       15,000      2.31
                                            September 2000     50,000      1.75
November 1996                               September 2007     65,000      1.34
February 1997                               November 2006      10,000      1.39
                                            February 2003     115,000      1.59
March 1997                                  February 2007     890,000      1.59
                                              March 2001      159,000      1.75
                                              March 2007       75,000      1.66
April 1997                                    March 2007      239,473      1.38
                                              April 2003       15,000      1.22
                                            --------------  ---------  --------
  Total shares and average exercise price                   4,734,810   $  1.90
                                                            ---------  --------
    
                                      F-17

<PAGE>

Pharmos Corporation

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

10.    Stock Option Plans

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

                                                        Under    Exercise
                                                        Option     Price

          Options outstanding at 12/31/95               544,186    $2.20  
          Granted                                         4,000     2.28  
          Expired                                       (34,933)    2.18  
                                                       --------    -----  
                                                                          
          Options Outstanding at 12/31/96               513,253     2.13  
          Expired                                       (86,834)    1.74  
                                                       --------    -----  
                                                                          
          Options outstanding at 12/31/97               426,419    $2.21  
                                                       --------    -----  
                                                                          
          Options exercisable at 12/31/97               306,935    $2.26  
                                                       --------    -----  
                                                       
       The Company's Board of Directors approved  nonqualified stock options for
       key  employees,  directors  and  certain  non-employee  consultants.  The
       following table summarizes activity in Board-approved  nonqualified stock
       options:

                                                        Under    Exercise
                                                        Option     Price

          Options outstanding at 12/31/95              442,182    $ 3.10
          Expired                                      (10,000)     1.94
                                                       -------    ------
          Options Outstanding at 12/31/96              432,182      3.12
          Expired                                      (25,000)    10.50
                                                       -------    ------
          Options outstanding at 12/31/97              407,182    $ 2.67
                                                       -------    ------
          Options exercisable at 12/31/97              357,566    $ 2.65
                                                       -------    ------

   
       The  Company  applies   Accounting   Principles  Board  Opinion  No.  25,
       Accounting for Stock Issued to Employees,  and related interpretations in
       accounting  for  its  plans.  As all  options  and  warrants  granted  to
       employees  were granted with  exercise  prices equal to the fair value of
       the common stock on the
    


                                      F-18
<PAGE>

Pharmos Corporation

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


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

11.    Long Term Debt

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

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

12.    Income Taxes

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

       The Company's gross deferred tax assets of $25,087,000 and $22,870,000 at
       December 31, 1997 and 1996,  respectively,  represented primarily the tax
       effect of both the net operating loss carryforwards and deferred research
       and   development   costs,   and  research  and  development  tax  credit
       carryforwards.  As a result of previous business combinations and changes
       in stock ownership,  substantially  all of these net operating losses and
       tax credit  carryforwards  are subject to  significant  restriction  with
       regard  to  annual  utilization.  A full  valuation  allowance  has  been
       established with regard to the gross deferred tax assets.

13.    Commitments and Contingencies

       Leases

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

                                      F-19

<PAGE>

Pharmos Corporation

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

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

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

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

                                             Lease            Sublease
                                           Commitments        Rentals

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

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

       Consulting contracts and employment agreements

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

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

14.    Employee Benefit Plan

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


                                      F-20

<PAGE>

Pharmos Corporation

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


15.   Estimated Fair Value of Financial Instruments

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

   
16.    Subsequent Events
    

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

   
       On February  4, 1998,  the Company  completed  a private  placement  with
       institutional  investors  of  Series C  Convertible  Preferred  Stock and
       warrants to purchase  650,000  shares of common stock,  generating  gross
       proceeds of $5 million. The preferred stock carries a 5% dividend payable
       in common stock and is convertible into common shares of the Company,  60
       days  subsequent to the date of issuance.  For the period ending 180 days
       after the date of issuance, the conversion price is 90% of the average of
       the low trade prices of the Common Stock for the five consecutive trading
       days  ending on the day  immediately  prior to the  conversion  date (the
       "Variable Conversion Price"). Following such period, the conversion price
       is the lower of the Variable  Conversion  Price or 120% of the average of
       the closing bid prices of the Common Stock for the trading days beginning
       on the date which is 151 days,  and ending on the date which is 180 days,
       following the date of issuance.  Until  converted into common stock,  the
       preferred  stock  has  no  voting  rights.  The  warrants  issued  to the
       investors  are  exercisable  at prices  ranging  from  $2.28 to $2.67 per
       share, commencing one year after the closing for a three year period.
    

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


                                      F-21