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**UNITED            STATES            SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549**

**FORM            10-K**
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| **x**                                                              | **Annual Report Pursuant to Section 13 or 15(d) of the                        Securities Exchange Act of 1934**                            |
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| For the Fiscal Year                        Ended December 31, 2007 |
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| **o**                                                              | **Transition Report                        Pursuant to Section 13 or 15(d) of the Securities Exchange Act of                        1934** |

Commission File            No. 0-11550

**Pharmos            Corporation**(Exact name of registrant as specified in its charter)
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| **Nevada**                                                                                                   | **36-3207413**                                |
| (State or other                        jurisdiction of                        incorporation or organization) | (IRS                        Employer Id. No.) |

**99 Wood Avenue            South, Suite 311            Iselin, NJ 08830**(Address of principal executive offices) (zip code)

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

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

**None**            (Title of Class)

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

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

          Indicate            by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405            of the Securities Act. o            Yes  x No

          Indicate            by check mark if the registrant is not required to file reports pursuant to Section 13            or Section 15(d) of the Act. o            Yes  x No

          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.            x Yes  o            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.            x

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          Indicate            by check mark whether registrant is a large accelerated filer, an accelerated filer, a            non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the            Act).

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| Large accelerated                        filer o |   | Accelerated filer                        o         |
|                                             |
| Non-accelerated                        filer o   |   | Smaller reporting                        company x |

          Indicate            by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of            the Act).o Yes  x            No

          The            aggregate market value of the registrant’s Common Stock at June 30, 2007 held by            those persons deemed to be non-affiliates was approximately $24,108,981.

          As            of February 20, 2008, the Registrant had outstanding 25,689,473 shares of its $.03 par            value Common Stock.

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          PART            I

*This report            contains information that may constitute “forward-looking statements.” The            use of words such as “believe,” “expect,” “intend,”            “estimate,” “anticipate,” “project,”            “will” and similar expressions identify forward-looking statements, which            generally are not historical in nature. All statements that address operating            performance, events or developments that we expect or anticipate will occur in the            future are forward-looking statements. As and when made, we believe that these            forward-looking statements are reasonable. However, caution should be taken not to            place undue reliance on any such forward-looking statements because such statements            speak only as of the date when made. We undertake no obligation to publicly update or            revise any forward-looking statements, whether as a result of new information, future            events or otherwise. In addition, forward-looking statements are subject to certain            risks and uncertainties that could cause actual results to differ materially from our            company’s historical experience and our present expectations or projections.            These risks and uncertainties include, but are not limited to, those described in Part            I, “Item 1A. Risk Factors” and elsewhere in this report and those described            from time to time in our future reports filed with the Securities and Exchange            Commission.*

*We do not            undertake to discuss matters relating to our ongoing clinical trials or our regulatory            strategies beyond those which have already been made public or discussed            herein.*

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**Item 1.            Business**

**RECENT            DEVELOPMENTS**

**Private Placement of            Convertible Debentures**

Pharmos            Corporation announced on January 3, 2008 that it completed an initial closing of a            private placement of its 10% Convertible Debentures due November 2012. At the initial            closing the Company issued $4,000,000 principal amount of the Debentures, at par, and            received gross proceeds in the same amount.

The purchasers            consisted of certain existing investors in the Company, namely Venrock Associates            (which is affiliated with Anthony B. Evnin), New Enterprise Associates (which is            affiliated with Charles W. Newhall, III), Lloyd I. Miller, III and Robert F.            Johnston.

The Debentures            mature the earlier of November 1, 2012 or the sale of the Company. The Debentures,            together with all accrued and unpaid interest thereon, may be repaid, without premium            or penalty, commencing on November 1, 2011.

Starting on            November 1, 2009 (or earlier sale of the Company), any outstanding Debenture may be            converted at the option of the holder. The conversion price is fixed equal to $0.70 per            share.

The Debentures            bear interest at the rate of 10% per annum, payable semi-annually either in cash or            common stock of the Company at the option of the Company.

Under the terms            of the offering, the Company may raise gross proceeds up to an aggregate of $8,000,000            from the sale of Debentures in the placement (including the Debentures issued at the            initial closing).

The proceeds            will be used for working capital, in particular for the ongoing Phase 2b trial for            dextofisopam.

The securities            issued and issuable in the offering have not been registered under the Securities Act            of 1933, as amended, and may not be offered or sold in the United States absent            registration or applicable exemption from registration requirements.

**Board and            Management Changes**

Pharmos            Corporation also announced the following changes in its Board of Directors and            Management, in January and February 2008:

**Board Changes**

Robert F.            Johnston has been elected to the Board as Executive Chairman effective January 3,            2008.

Haim Aviv,            Ph.D., David Schlachet and Mony Ben Dor (all effective January 3, 2008) and Abraham            Sartani (effective February 11, 2008) have retired from the Board.

The Pharmos            Board now consists of six directors -- Robert F. Johnston, Executive Chairman, Anthony            B. Evnin (Venrock), Charles W. Newhall, III (New Enterprise Associates), Srinivas            Akkaraju, M.D., Ph.D. (Panorama Capital), Lloyd I. Miller, III and Elkan Gamzu,            Ph.D.

**Management            Changes**

Effective            January 3, 2008 the Pharmos Board designated Mr. Robert F. Johnston to serve as            Executive Chairman of the Board and Mr. S. Colin Neill to serve as President, in            addition to his current roles as Chief Financial Officer, Treasurer and            Secretary.

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Also effective            January 3, 2008, Elkan Gamzu Ph.D., who had been Chief Executive Officer, retired from            that position and will remain on the Board.

**OVERVIEW**

Pharmos            Corporation (the Company or Pharmos) is a biopharmaceutical company that discovers and            develops novel therapeutics to treat a range of diseases of the nervous system,            including disorders of the brain-gut axis e.g., Irritable Bowel Syndrome (IBS), with a            focus on pain/inflammation, and autoimmune disorders. The Company’s most advanced            product, dextofisopam, produced a statistically significant greater number of months of            adequate relief over placebo in a Phase 2a clinical trial in IBS (n=141, p=0.033). On            June 20, 2007 the Company announced patient screening had commenced in its Phase 2b            clinical trial of dextofisopam, which is expected to enroll approximately 480 female            patients with diarrhea-predominant or alternating irritable bowel syndrome (d- and            a-IBS). IBS is a chronic and sometimes debilitating condition that affects roughly            10%-15% of U.S. adults and is two to three times more prevalent in women than in men.            With an absence of safe and effective therapies, dextofisopam’s novel            non-serotonergic activity holds the potential for a unique and innovative treatment            approach to d- and a-IBS.

The            Company’s core proprietary discovery platform focuses on synthetic cannabinoid            compounds. Cannabinor, the initial CB2-selective receptor agonist candidate, has            completed two Phase 2a clinical trials for pain relief with an intravenous (IV)            formulation. In January 2007, Pharmos reported that in the first of these studies            intravenous (i.v.) Cannabinor was generally safe and well tolerated, but failed to meet            the primary endpoint of reversing capsaicin-induced pain. However, that analysis of            additional endpoints of heat-induced and pressure-induced pain indicated that i.v.            Cannabinor does in fact exhibit a statistically significant systemic analgesic effect            compared to placebo. In April 2007, Pharmos reported that the lowest dose of Cannabinor            (12mg) produced a statistical significant decrease in pain versus placebo as in            subjects undergoing third molar dental extraction model, but that this effect was not            seen in the higher dose groups (24mg and 48 mg). This is an unexpected pattern of            results and as such the Company has determined that it will not continue with the            development of Cannabinor at this time, but will focus resources on other CB2 compounds            that have better potential. Cannabinor will be available for outlicensing.

The            Company’s NanoEmulsion (NE) drug delivery system, a proprietary asset derived            from our formulation expertise, completed a second Phase I trial in 2006 that confirmed            the safety, and tolerability as well as low systemic exposure of a more optimized NE            diclofenac cream formulation. On June 27, 2007 the Company announced that patient            screening had commenced in its Phase 2a clinical trial of its topical NanoEmulsion (NE)            drug delivery technology formulated with 3% diclofenac. The trial will compare the            safety and analgesic efficacy of the diclofenac NE cream with placebo in approximately            126 subjects with knee osteoarthritis (OA). OA affects approximately 12% of U.S.            adults, a significant portion of who are not treated pharmacologically due to side            effects associated with the commonly used oral treatments. A site-specific, topical            diclofenac product that could deliver a high drug concentration to the affected joint            with minimal systemic exposure could reduce the risk of treatment-limiting side effects            while maintaining the analgesic effect.

Pharmos’            cannabinoid research is geared toward development of selective and specific CB2            receptor agonists. Because they have little affinity for the CNS-located CB1 receptor,            CB2-selective and specific agonists lack the unwanted psychotropic side effects of many            natural cannabinoids. By activating CB2 receptors, CB2 agonists inhibit autoimmune and            inflammatory processes, and are likely to be useful for treating pain, autoimmune,            inflammatory and degenerative disorders.

For VPI-013, the            Company has completed a Phase IIa clinical trial whose data suggested that VPI-013 may            be effective in treating hypoactive sexual desire disorder. Further, preclinical data            suggested that VPI-013 may be effective in treating neuropathic pain. The company is            seeking to out-license this compound.

Tianeptine, a            potential follow-on product to Dextofisopam, has completed late-preclinical development            for the treatment of irritable bowel syndrome (IBS). Tianeptine, a racemic molecule,            has been marketed outside the United States since 1988 for the treatment of depression.            Preclinical studies support the potential utility of Tianeptine for the treatment of            functional gastrointestinal disorders and, in particular, IBS. Pharmos has

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established            patent rights for the use of Tianeptine and its enantiomers for the treatment of IBS            and functional dyspepsia. Tianeptine is available for out-licensing.

In October 2006,            Pharmos completed its acquisition of Vela Pharmaceuticals Inc. (Vela), which            specialized in the development of medicines related to diseases of the nervous system            including disorders of the “brain-gut axis.” The acquisition fulfilled            Pharmos’ strategic objective to expand its pipeline with later stage compounds,            in particular Dextofisopam, a promising and innovative new drug with positive Phase 2a            data for the treatment of diarrhea-predominant and alternating–type irritable            bowel syndrome (IBS). The Vela acquisition also included additional compounds in            preclinical and/or early clinical development for neuropathic pain, inflammation and            sexual dysfunction.

To date, our            principal sources of cash have been public and private financings, the sale of our            ophthalmic business, revenues from our ophthalmic product line prior to the sale,            research grants and the sale of a portion of our New Jersey State net operating loss            carryforwards. In December 2004, the Company’s former marketing partner, Bausch            & Lomb Incorporated (“Bausch & Lomb”), received approval from the            FDA of its New Drug Application (“NDA”) for Zylet® as an ophthalmic            anti-inflammatory antibiotic combination drug with respect to which the Company sold            its rights subject to certain payment milestones. In connection therewith, the Company            received net proceeds of approximately $9.1 million from Bausch & Lomb during the            first quarter of 2005. Management believes that cash, cash equivalents, and short term            investments of $11.2 million as of December 31, 2007 combined with our $4.0 million            private placement of convertible debentures in January 2008, will be sufficient to            support the Company’s continuing operations beyond December 31, 2008.

**STRATEGY**

Pharmos’            business is the discovery and development of new drugs to treat a range of indications            including pain, inflammation, autoimmunity and select CNS disorders, including            disorders of the “CNS-gut” axis. Our discovery program is focused on            capitalizing on our expertise in the biology, chemistry and manufacturing of            cannabinoid-based therapeutics, with the goal of developing increasingly potent,            drugable and selective cannabinoid receptor agonists and antagonists for the treatment            of a variety of human diseases. Modulation of these receptors in preclinical models of            disease suggests that potential areas for therapeutic intervention include the            treatment of chronic pain, autoimmune disease, osteoporosis, asthma, allergy,            atherosclerosis and obesity. Based on our advanced preclinical testing of drug            candidates, we are currently focused on the use of CB2-selective compounds for the            treatment of chronic pain and autoimmunity.

The            Company’s strategy has changed since the acquisition of Vela in October 2006. The            late stage clinical stage asset, Dextofisopam, is currently in a 480 patient Phase 2b            trial, following a successful Phase 2a trial. The Company has determined that the trial            is the principal shareholder value driver and consequently is optimizing the allocation            of cash resources to this program. The Company may also partner / out license            Dextofisopam to an appropriate strategic partner.

The Company is            currently seeking a partner who will take the lead in both operating and funding the            ongoing research programs in Israel, namely the CB2 receptor selective library of            compounds, including preclinical development of PRS-639,058 for neuropathic pain. Also            available for licensing or partnership is Pharmos’ proprietary 3% diclofenac            NanoEmulsion cream currently in Phase 2a clinical trial as topical treatment for            osteoarthritis pain. The study is conducted at several Israeli hospitals, completion of            subjects recruitment expected in mid-2008. To facilitate these efforts, the Company has            engaged a boutique life science investment bank.

The Company also            maintains a commitment to out-license proprietary technologies and products not            consistent with our primary corporate focus. Assets involved are Tianeptine to treat            IBS or functional dyspepsia and VPI-013 to treat hypoactive sexual desire disorder and            potentially neuropathic pain.

Pharmos’            lead product, Dextofisopam, has completed a double-blind, placebo-controlled            diarrhea-predominant or alternating IBS Phase 2a study with positive effect on primary            efficacy endpoint (n=141, p=0.033). In this study, Dextofisopam was well-tolerated and            demonstrated significant improvement over placebo, suggesting that

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Dextofisopam has            the potential to become a novel firstline treatment for IBS. The design of a larger,            Phase 2b, dose-ranging study was discussed at a 2005 meeting with FDA, and Pharmos            initiated a Phase 2b trial in February 2007 and in June 2007 the Company announced            patient screening had commenced. Dextofisopam is the R-enantiomer of racemic tofisopam,            a molecule marketed and used safely outside the United States for over three decades            for multiple indications including IBS. Unlike the two 5-HT3 or 5-HT4 IBS therapies            currently available, both of which have significant safety concerns,            Dextofisopam’s novel non-serotonergic activity offers a unique and innovative            approach to IBS treatment.

In research            efforts over the past decade, the Company has developed a significant expertise in            cannabinoid biology and chemistry, and has generated significant know-how and an            intellectual property estate pertaining to multiple areas of cannabinoid biology. The            Company is focusing its preclinical research efforts in CB2-selective cannabinoids, and            has generated both clinical-stage drugs and late preclinical compounds which appear            promising in preclinical testing.

The            Company’s core proprietary discovery platform focuses on synthetic cannabinoid            compounds. Cannabinor, the initial CB2-selective receptor agonist candidate, has            completed two Phase 2a clinical trials for pain relief with an intravenous (IV)            formulation. In January 2007, Pharmos reported that in the first of these studies            intravenous (i.v.) Cannabinor was generally safe and well tolerated, but failed to meet            the primary endpoint of reversing capsaicin-induced pain. However, analysis of            additional endpoints of heat-induced and pressure-induced pain looking at the non            capsaicin sensitized skin indicated that i.v. Cannabinor did in fact exhibit a            statistically significant systemic analgesic effect compared to placebo. In April 2007,            Pharmos reported that the lowest dose of Cannabinor (12mg) produced a statistical            significant decrease in pain versus placebo as in subjects undergoing third molar            dental extraction model, but that this effect was not seen in the higher dose groups            (24mg and 48 mg). This is an unexpected pattern of results and as such the Company has            determined that it will not continue with the development of Cannabinor at this time,            but will focus resources on other CB2 compounds that have better potential. Cannabinor            will be available for outlicensing.

Pharmos is            conducting a clinical program to develop its proprietary NanoEmulsion (NE) drug            delivery technology. Two Phase I studies in healthy volunteers have been completed and            confirmed the safety and tolerability as well as the low systemic exposure of a            diclofenac NE topical cream. The Company’s NanoEmulsion (NE) drug delivery            system, a proprietary asset derived from our formulation expertise, completed a second            Phase I trial in 2006 that confirmed the safety, and tolerability as well as low            systemic exposure of a more optimized 3% NE diclofenac cream formulation. On June 27,            2007 the Company announced that patient screening had commenced in its Phase 2a            clinical trial of its topical NanoEmulsion (NE) drug delivery technology formulated            with 3% diclofenac. The trial will compare the safety and analgesic efficacy of the            diclofenac NE cream with placebo in approximately 126 subjects with knee osteoarthritis            (OA). OA affects approximately 12% of U.S. adults, a significant portion of who are not            treated pharmacologically due to side effects associated with the commonly used oral            treatments. A site-specific, topical diclofenac product that could deliver a high drug            concentration to the affected joint with minimal systemic exposure could reduce the            risk of treatment-limiting side effects while maintaining the analgesic            effect.

**DRUG DISCOVERY            APPROACH**

Pharmos is            developing families of compounds based on its scientific knowledge of the medicinal            activities of cannabinoids, compounds with chemical structures or receptor-binding            properties related to the main active component of cannabis. The Company utilizes            state-of-the-art technologies to synthesize, evaluate and develop new cannabinoid            molecules that appear to exhibit enhanced therapeutic benefit. Pharmos has a library of            hundreds of well-characterized cannabinoids, and continues to expand its library of            compounds through a hybrid methodology combining the rational design of compounds based            on knowledge of detailed molecular requirements for drug activity            (“structure-activity relationships” or SAR) with combinatorial chemistry, a            technique that utilizes chemical reactions to synthesize large numbers of different            molecules. In contrast to random methods of combinatorial chemistry, this hybrid            approach leads to a larger percentage of synthesized compounds that demonstrate            activity in screening assays and increases the potential of developing potent and            selective drug candidates. Pharmos has developed screening paradigms to screen            compounds in its libraries

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for different            properties, including binding to CB1 and CB2 receptors and their functional activation.            Compounds that show potent activity in one or more of the screening assays are tested            in early ADMET (Absorption, Distribution, Metabolism, Excretion, Toxicology) screens.            The most promising compounds are then tested in validated animal models of human            chronic pain, including CFA-induced paw edema for inflammatory pain, and the chronic            sciatic nerve ligation (Bennett and Xie) model for neuropathic pain. Promising            molecules are further studied with additional models for neuropathic and chronic pain.            Selected molecules are also tested in animal models of autoimmune disease (rheumatoid            arthritis, multiple sclerosis and inflammatory bowel disease).

Pharmos’            chemical library consists of several chemically distinct classes of cannabinoid            compounds. The Company’s primary focuses for development are the families of            CB2-selective compounds which are cannabinoid receptor agonists that bind            preferentially to CB2 receptors. These receptors are found primarily in peripheral            neurons and immune cells. The compounds possess advantages such as a simple synthesis,            increased potency and improved drugability. Pharmos recognizes the potential            therapeutic promise of CB2 activation in such diverse disease entities as pain,            inflammation, autoimmunity, osteoporosis and atherosclerosis.

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**COMPOUNDS IN CLINICAL            DEVELOPMENT**

**Dextofisopam**

Dextofisopam, a            non-serotonergic agent currently being evaluated for the treatment of irritable bowel            syndrome (IBS), is the R-enantiomer of racemic tofisopam, a molecule marketed and used            safely outside the United States for over three decades for multiple indications            including IBS. Dextofisopam represents a novel, first-in-class opportunity with a            positive proof-of-concept study in an arena where there are few compounds with unique            approaches or positive efficacy results. By structure, Dextofisopam is a member of the            homophthalazine class; Dextofisopam binds to specific receptors in areas of the brain            affecting autonomic function, including gastrointestinal (GI) function. Unlike the two            5-HT3 or 5-HT4 mediated IBS therapies currently available, both with significant safety            concerns, Dextofisopam novel non-serotonergic activity offers a unique and innovative            approach to IBS treatment.

A double-blind,            placebo-controlled diarrhea-predominant or alternating IBS Phase 2a study has been            completed with positive effect on primary efficacy endpoint (n=141, p=0.033). In this            study, Dextofisopam was well-tolerated and demonstrated significant improvement over            placebo suggesting that Dextofisopam has the potential to become a novel firstline            treatment for IBS. The design of a larger, Phase 2b, dose-ranging study was discussed            at a 2005 meeting with FDA, and Pharmos initiated a Phase 2b trial in February 2007 and            the first patient was screened in June 2007.            An extensive patent estate is in place with Dextofisopam. This consists of an issued            composition-of-matter patent, an issued method-of-use patent, and numerous additional            pending patent applications in both the United States (including use of Dextofisopam            for inflammatory disorders and immunomodulation) and foreign counterparts.

**CB2-selective            cannabinoids**

Pharmos’            novel CB2-selective cannabinoids are synthetic compounds which belong to the class of            nonclassical cannabinoids. Compounds in this class have been demonstrated to possess            immunomodulatory and analgesic activities. Importantly, the CB2-selective cannabinoids            display fewer of the undesired psychotropic and cardiovascular side-effects seen with            some natural cannabinoids because they bind with high affinity to the peripheral            cannabinoid type two (CB2) receptor and with lower affinity to the cannabinoid type one            (CB1) receptor, located in the central nervous system. In contrast to CB1 receptors,            CB2 receptors are expressed mainly outside of the central nervous system, on immune and            inflammatory cells. CB2 activation also inhibits the release of pro-nociceptive peptide            from the periphery which may prevent activation of primary afferent neurons. CB2            activation also modulates T-cell activity, skewing the T-helper cell type 1            (Th1) responses to the T-helper cell type 2 (Th2) activity. Most            autoimmune diseases and models of autoimmunity in which susceptibility is associated            with the expression of specific MHC class II allotypes appear to be of the            Th1 type. Thus considerable emphasis has been placed on developing means of            altering the course of the autoimmune Th1 response to become that of a            Th2 response, with the goal of down regulating the autoimmune            pathogenesis

As noted earlier            (SEE: DRUG DISCOVERY APPROACH), several candidates from Pharmos’ CB2-selective            cannabinoid library have demonstrated promise in animal models for autoimmune            inflammatory disorders, such as multiple sclerosis and inflammatory bowel disease.            These compounds have also demonstrated efficacy in animal models of neuropathic,            inflammatory and chronic nociceptive pain. In selected preclinical models, these            compounds have demonstrated analgesic activity equivalent or better than            Gabapentin.

**Potential pharmaceutical            markets for Pharmos’ CB2-selective cannabinoids**

The development            of novel CB2-selective disease–modifying agents (DMA) that combine            anti-inflammatory, immunomodulatory and analgesics properties for the treatment of            inflammatory/autoimmune diseases is a major goal of Pharmos’ research and            discovery activity. Inflammation and immunodysregulation play a pivotal role in a            majority of chronic and debilitating autoimmune diseases such as rheumatoid arthritis            (RA), inflammatory bowel disease (IBD) and multiple sclerosis (MS). Treatment and            healthcare costs associated with these diseases have been estimated to exceed $500            billion annually. Recent products introduced in this market have been limited due to            lack of efficacy and/or severe side effect profile.

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In preclinical            models, Pharmos’ novel CB2-selective cannabinoids have also demonstrated            anti-inflammatory and analgesic properties, suggesting that they may be useful in the            treatment of neuropathic pain.

The analgesic            market where unmet medical needs remain can be categorized into five major syndromes:            cancer pain, back pain, HIV pain, neuropathies, and arthritic/osteoarthritic pain. The            incidence and prevalence of the major pain syndromes continues to increase with an            estimated patient potential in 2009 of over 368 million. In 2000, the global market for            analgesics was about $16 billion. Global analgesic sales increased to more than $22            billion for 2002 and are predicted to increase to $30 billion by 2009. In the US,            spending for drugs to treat neuropathic pain is anticipated to exceed $1 billion by            2009. At present, there is no specific or satisfactory analgesic for neuropathic pain.            Opioids and NSAIDs are only marginally effective in a minority of patients.            Pfizer’s Lyrica® (pregabalin) was recently FDA-approved for the treatment of            various forms of neuropathic pain. In controlled clinical trials, however, only 35% of            patients with neuropathic pain had a 50% reduction in pain score, and the most common            side effects of Lyrica® included dizziness, somnolence, dry mouth, peripheral            edema, blurred vision, weight gain and difficulty with concentration/attention.            Lyrica® is also designated as a controlled substance by the FDA. In the first year            after launch, the drug generated $291 million in sales, with an additional $639 million            in sales for Neurontin® (gabapentin), a closely-related drug widely used for the            treatment of neuropathic pain. Neuropathic pain occurs most commonly in diabetes,            cancer, multiple sclerosis, stroke, amyotrophic lateral sclerosis, HIV, trigeminal and            post-herpetic neuralgia, and after trauma (traumatic neuralgia, phantom limb surgery).            The main symptoms are spontaneous (i.e. not triggered by noxious stimuli), severe            shooting pains, hyperalgesia and allodynia (painful sensations evoked by light touch or            small changes in temperature that do not normally elicit pain).

These potential            markets are extremely attractive for analgesics that can effectively manage pain            experienced by patients suffering from any of these syndromes. The properties of our            CB2-selective cannabinioids place them in a good position for potential deployment in            several of these major pain syndromes.

Cannabinor and            other CB2 selective compounds in preclinical development demonstrate significant            immunomodulatory activity in autoimmune disease models of multiple sclerosis,            rheumatoid arthritis and inflammatory bowel disease. The total global market for            autoimmune disease therapeutics reached an estimated $11.3 billion in 2000. This was an            increase of 23.6% over an estimated $4.8 billion in 1996. Key market drivers at that            time included products such as Celebrex®, Vioxx®, Enbrel®, Avonex®,            Betaseron®, Rebif®, and Synthroid®. In 2006, the market is expected to            generate estimated revenues of $21.1 billion, reflecting a 15.9% increase from 2000 to            2006. The largest segment by disease area within the global autoimmune disease market            was the rheumatoid arthritis market, with 55.9% share in 2000.

More than two            million Americans suffer from Rheumatoid arthritis (RA), which causes stiffness,            swelling and limitation in the motion and function of multiple joints. RA is a chronic,            progressive disease, and if left untreated, patients can become disabled from joint            damage caused by the disease, limiting their ability to function. RA is associated with            substantial disability and economic losses, and one study showed that one-third of            patients in the United Kingdom who were employed became work-disabled within two years            of disease onset. Rheumatologic disorders also account for 25 percent of Social            Security disability payments in the United States. Radiographic changes occur within            two years of disease onset in 50 percent to 70 percent of RA patients. The American            College of Rheumatology suggests control of disease progression should start early to            limit joint damage in RA. Therapy for patients with RA has improved dramatically over            the past 25 years. Current treatments offer most patients good to excellent relief of            symptoms and the ability to continue to function at or near normal levels. Since there            is no cure for RA, the goal of treatment is to minimize patients’ symptoms and            disability by introducing appropriate drug therapy early in the course of the disease            before permanent damage to the joints has occurred. No one treatment is effective for            all patients, and many patients will need to change therapies during the course of            their disease. Successful management of RA requires early diagnosis and, at times,            aggressive treatment. Non-steroidal anti-inflammatory drugs (most commonly referred to            as NSAIDs, such as ibuprofen or naproxen) and/or corticosteroids (such as prednisone)            given orally at low doses or via injection into the joints may be used first with the            primary aim of quickly reducing joint inflammation. All RA patients with persistent            swelling in the joints are candidates for treatment with disease-modifying            anti-rheumatic drugs (called DMARDs for short) that are typically used in conjunction            with NSAIDs and/or low dose

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corticosteroids.            The DMARD class of drugs has greatly improved the symptoms and function as well as the            quality of life for the vast majority of patients with RA. DMARDs include: methotrexate            (Rheumatrex ® and Folex ®), hydroxychloroquine (Plaquenil ®), sulfasalazine            (Azulfidine ®), gold given orally (Auranofin ®) or intramuscularly (Myochrisine            ®), minocycline (Minocin ®, Dynacin ® and Vectrin ®), azothiaprine            (Imuran ®), cyclosporine (Sandimmune ® and Neoral ®), leflunomide (Arava            ®). The benefits from these medications may take weeks or months to be apparent.            Because they are associated with toxic side effects, frequent monitoring of blood tests            while on these medications is imperative. Another class of medications, referred to as            biologic disease response modifiers or “biologic agents” can specifically            target parts of the immune system that lead to joint and tissue damage in RA. FDA            approved treatments include agents etanercept (Enbrel ®), infliximab (Remicade            ®), adalimumab (Humira ®), and anakinra (Kineret ®). These drugs are            associated with variable degrees of immune suppression, and long-term use of            anti-TNF-alpha agents can lead to the development of autoantibodies. Anti-idiotype            antibodies may develop against the Fab portion of monoclonal antibodies. Antinuclear            antibodies and, less commonly, anti-double-stranded DNA antibodies have been noted with            anti-TNF-alpha therapy, but clinical lupus is rare. Demyelinating diseases such as            multiple sclerosis may also occur. With their unique mechanism of immunomodulation,            CB-2 agonists such as cannabinor could be viable therapeutic candidates for study in            patients with RA.

Multiple            sclerosis is a chronic and disabling disease, with healthcare costs disproportionate to            the numbers affected. In the US alone, costs are estimated to exceed $10 billion per            year. Estimates suggest that about 2.5 million people worldwide have MS, an            inflammatory disease of the nervous system characterized by recurrent relapses followed            by periods of remission. After trauma, it is the second most common neurological            disability to affect young and middle-aged adults. It affects twice as many women as            men, with the relapsing forms of MS the most common. Patients with MS display a range            of symptoms which arise from demyelination in the central nervous system, including the            brain, spinal cord and optic nerves. While symptoms vary between patients, they            commonly include blurred vision, slurred speech, numbness or tingling in the limbs and            problems with balance and coordination, due to the loss of control over vital functions            such as seeing, walking and talking.

Despite recent            advances in treatment, there remains a need for more efficacious drugs for MS and            especially for primary progressive MS, the most aggressive form of the disease.            Tysabri® (natalizumab) was recently introduced by Biogen-Idec as a potential            advance in the treatment of MS; however, cases of a neurological disease called            progressive multifocal leukoencephalopathy (PML) were reported in users of natalizumab.            The disease is most likely caused by a virus, and is associated with being            immunocompromised. The drug was withdrawn from the market. Prior to market withdrawal,            estimates of sales of up to $3 billion were projected. Tysabri® has subsequently            re-entered into the market, but is only available through a special distribution            program.

The introduction            of the first generation of disease-modifying drugs, which include interferon beta-1a            and 1b as well as glatiramer acetate, represented an important advance in the treatment            of MS when introduced into clinical practice. Approved for the treatment of relapsing            forms of MS, they reduce the frequency and severity of exacerbations as well as the            number of lesions seen on magnetic resonance imaging (MRI). However, while these agents            have an immunomodulatory effect that alters the course of the disease they do not            reverse the neurological damage that occurs in MS. Currently, no marketed treatments            for MS can produce remyelination and so treatment aims to:

|        |   |                                                                                 |
|--------|--------|--------------------------------------------------------------------------------------|
|   | • | Reduce relapse                        rates                                          |
|   |   |                                                                                 |
|   | • | Prevent fixed                        disability directly associated to relapse       |
|   |   |                                                                                 |
|   | • | Provide symptomatic                        management of fixed neurological deficits |
|   |   |                                                                                 |
|   | • | Prevent disability                        arising from disease progression           |

**Potential pharmaceutical            market for Dextofisopam**

The development            of Dextofisopam for the treatment of Irritable Bowel Syndrome (IBS) is a major goal of            Pharmos’ development activity. Direct medical costs associated with IBS have been            estimated at $8 billion annually in the U.S. It has been estimated that indirect costs            for IBS in the U.S. exceed $20 billion. The few recent products introduced in this            market have been limited by poor safety profiles.

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*Irritable Bowel Syndrome:            Disease Description and Diagnosis*

Irritable bowel            syndrome is defined by a constellation of symptoms that includes abdominal pain or            discomfort accompanied by diarrhea, constipation, or an alternation between the two.            IBS is classified as a functional disorder; it is diagnosed by symptom-based criteria            following exclusion of organic diseases that may produce abdominal pain and altered            bowel function.

Although the            etiology of IBS is not completely understood, five factors have been proposed as            playing a role in the development of IBS:

|   |   |                                                                                     |                                                                                                      |
|--------|--------|------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------|
|   | 1.     | Psychosocial                        factors                                              |
|   |   |                                                                                     |
|   |   | a.                                                                                       | impact of stress on                        motor function of the GI tract                                 |
|   |   |                                                                                     |                                                                                                      |
|   |   | b.                                                                                       | approximately 60% of                        patients seen at referral centers have psychiatric symptoms.  |
|   |   |                                                                                     |                                                                                                      |
|   | 2.     | Visceral                        hypersensitivity - lower threshold for abdominal pain    |
|   |   |                                                                                     |
|   | 3.     | Altered bowel motility                        - abnormal motility of the small intestine |
|   |   |                                                                                     |
|   | 4.     | Infection and                        inflammation                                        |
|   |   |                                                                                     |
|   | 5.     | Autonomic nervous                        system dysfunction                              |
|   |   |                                                                                     |
|   |   | a.                                                                                       | studies show that IBS                        patients have aberrant autonomic nervous system activity     |
|   |   |                                                                                     |                                                                                                      |
|   |   | b.                                                                                       | altering autonomic                        nervous system activity in volunteers produces symptoms of IBS. |

This perspective            on the pathophysiology of IBS suggests that a drug that improves altered bowel            motility, decreases visceral hypersensitivity reduces stress-related impact on GI            function, normalizes autonomic dysfunction, and possesses anti-inflammatory properties            may provide a superior, broad-spectrum approach to the treatment of IBS. In preclinical            studies, dextofisopam exhibits all of these properties.

The diagnostic            criteria for IBS have evolved over the years. Today, diagnosis for clinical trials and            regulatory purposes is defined by the Rome III Criteria. Diagnosis is based on the            patient having a) recurrent abdominal pain or discomfort for at least 6 months, and b)            at least two of the following three features on at least 3 days per month over the past            3 months:

|   |   |                                                                                |
|--------|--------|-------------------------------------------------------------------------------------|
|   | 1.     | Improvement with                        defecation                                  |
|   |   |                                                                                |
|   | 2.     | Onset associated with a                        change in frequency of stool         |
|   |   |                                                                                |
|   | 3.     | Onset associated with a                        change in form (appearance) of stool |

Based on the            clustering of symptoms, IBS patients are usually categorized as either            “diarrhea-predominant,” “constipation-predominant,” or            “alternating” (also termed “mixed”). For a diagnosis of IBS,            specific “red flag” symptoms are usually excluded. These “red            flag” symptoms may indicate the presence of organic disease, such as colon cancer            (especially if onset is rapid or occurs over the age of 40), ulcerative colitis (rectal            bleeding), or Crohn’s disease (weight loss, fever). For the diagnosis of IBS to            be made, normal results must have been obtained for blood and stool tests, x-rays,            endoscopy, and biopsies.

While not a            life-threatening disease, IBS can have a large negative impact on the quality of life            of patients. Even mild cases can be life-altering, and severe cases are often            debilitating, with the frequency and severity of episodes seriously affecting work,            school, and social schedules.

IBS is a leading            cause of physician visits, accounting for approximately 3,000,000 visits annually in            the U.S., representing 4% of all visits to office-based physicians and 49% of visits to            office-based gastroenterologists. The need to eliminate other possible diagnoses (colon            cancer, inflammatory bowel disease, other GI diseases) necessitates expensive in-office            procedures. As noted earlier, the annual direct medical costs for IBS in the U.S. have            been estimated at $8 billion.

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*Prevalence of            IBS*

IBS is a very            common disorder, with studies indicating prevalence in the range of 6-15% for North            America, Europe, and Japan. Based on a prevalence rate of 12.5%**,** approximately            36 million individuals in the United States meet diagnostic criteria for IBS.            Prevalence rates are similar in the major European markets (France, Germany, Italy,            Spain, and the United Kingdom). While prevalence rates for other countries are not well            established, published studies support the existence and recognition of IBS throughout            the world, including China and India.

The prevalence            of IBS varies with gender and age. Higher prevalence rates are consistently reported            for women than for men (two to three times greater). While IBS is observed in all age            groups, including pediatric and geriatric populations, it is more common in the age            range of 20 to 60 years for both genders

*Current Market*

Even with the            recent introduction of two new therapies - Lotronex® (alosetron), a            5-HT3 antagonist, and Zelnorm® (tegaserod), a            5-HT4 partial agonist - the IBS market is still largely served by older            products, with questionable efficacy and poor tolerability. These older products            include antispasmodics, laxatives, and antidiarrheal agents. While antispasmodics at            high doses may provide relief of specific symptoms, these drugs are poorly tolerated at            those doses. The estimated sales of IBS drugs in the U.S. market totaled $353.7 M in            2003.

Lotronex® was            introduced into the U.S. IBS market in March 2000, and was withdrawn from the market in            November 2000 due to safety issues. Lotronex® was subsequently            reintroduced in 2003 with a restricted marketing program (Physician Prescribing            Program). The utility of Lotronex® is severely hampered both by its            narrow indication (only for women with severe diarrhea-predominant IBS who have failed            to respond to conventional therapy) and a major safety issue (the risk of potentially            fatal ischemic colitis). Since its reintroduction, Lotronex® has had            minimal prescription volume.

Zelnorm® was            introduced into the U.S. IBS market in July 2002 for short-term use in women with            constipation-predominant IBS. In April 2004, a precautionary statement was added to            Zelnorm® labeling regarding post-marketing cases of ischemic colitis and            a warning for severe diarrhea. Despite these changes to the package insert, the strong            marketing and educational efforts supporting Zelnorm® appear to have            increased awareness and expanded utilization. Zelnorm® achieved U.S.            sales of $26 M in 2002, $132 M in 2003, $249 M in 2004, $357 M in 2005, and $488 M in            2006, with 2006 worldwide sales of $561 M. Zelnorm® is currently            approved in 30 countries, though not yet in major EU markets or in Japan.            Zelnorm® was voluntarily withdrawn from the market in March 2007 because            of side effects. It has been recently reintroduced with a black box warning            label.

*Market Potential (United            States and Rest of World)*

The market            potential for IBS is very large. IBS is a prevalent disorder for which there are            currently no safe and broadly effective treatments. Investment research analysts            projected a U.S. market worth $2.5 B by 2009. Market research reports project that the            current full worldwide (WW) market potential for IBS therapies could be as high as $15            B (over $6 B in the United States alone). Based on its current clinical profile,            dextofisopam may have the potential to capture a significant portion of the IBS            market.

**NanoEmulsion Drug Delivery            System**

Topical            application of drugs directly to pathological sites offers potential advantages over            systemic delivery by producing high drug concentration in the affected tissue while            avoiding unwanted side-effects due to high systemic drug levels. Topical preparations            of NSAIDs are commonly used as analgesics and anti-inflammatory agents to treat various            disorders such as arthropathies and myalgias. Many topical formulations employ chemical            penetration enhancers to improve dermal penetration of drugs. Chemical enhancers, which            are usually organic solvents, may cause skin irritation and sensitization. Pharmos            invented and owns a family of patents covering novel NanoEmulsion formulations as            vehicles for lipophilic drugs. NanoEmulsions are solvent-free, injection-

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free topical            vehicles based on drug entrapment in oil-in-water nanoemulsion droplets. Such vehicles            allow for high loading of water-insoluble drugs and offer enhanced skin penetration            over competing technologies. A topical application of the nanotechnology has already            demonstrated excellent targeted delivery of lipophilic drugs to muscle and joints in            animal models, and has undergone two Phase I testing in humans, demonstrating excellent            local safety and tolerability with low systemic exposure. Pharmos has formulated            several NSAIDs into this platform technology and initiated a Phase IIa clinical study            in 2007 in Osteoarthritis patients. This platform technology also offers the potential            for topical delivery of a wide variety of water-insoluble compounds in addition to            NSAIDs, and the possibility of incorporating other drug candidates into the delivery            system continue to be evaluated, either for internal development or for            out-licensing.

**Market for topical            NSAIDs**

Osteoarthritis            is the most common chronic disease in North America and afflicts an estimated 10% of            the world’s population. The active ingredient of the Company’s first            NanoEmulsion technology NSAID, diclofenac, has a long-standing and proven clinical            treatment record. With the Company’s enhanced proprietary delivery system, the            Company believes its clinical effectiveness will be significantly enhanced compared to            other topical preparations. The Company believes that NanoEmulsion NSAID delivery may            circumvent the significant GI side-effects commonly found with orally ingested NSAIDs            and will help to fill the void created by the withdrawal of products from the market or            requiring restrictive label indications based on safety concerns of the COX-2            inhibitors.

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**COMPETITION**

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

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

We know of            various programs using cannabinoid research in various stages that compete in            analgesia.

Dr Alexandros            Makriyannis from the University of Connecticut has filed several patents relating to            CB2 cannabinoid ligands and mimetics. MakScientific, a company founded by Dr.            Makriyannis in 2003, is developing technologies originating from AlexiPharma and the            University of Connecticut. In 2004, MakScientific has licensed its existing and future            preclinical library of compounds with selective CB2 agonist activity to Endo            Pharmaceuticals, for use in the fields of pain and selected CNS disorders. Other            University labs are carrying out academic research on CB2 agonists. According to recent            reports presented at scientific meetings, there are other companies pursuing the            development of synthetic cannabinoid derivatives with low psychotropic side effects for            the treatment of severe and chronic pain conditions. Indevus is developing IP 751, an            anti-inflammatory and analgesic compound, as a potential treatment for both acute and            chronic pain. A Phase II trial with IP 751, conducted by researchers in Germany and            published in the Journal of the American Medical Association (JAMA 2003; 290(13):            1757-1762), showed that patients treated with this compound experienced a significant            reduction in neuropathic pain. In addition, the drug was reported to be well tolerated,            with no major adverse psychological or physical effects observed. An IND has been filed            with the FDA, and an initial Phase I clinical trial designed to assess the safety of IP            751 demonstrated that it was well tolerated and showed no evidence of psychotropic            activity. Indevus is completing the scale-up and manufacturing of IP 751 in            anticipation of beginning additional Phase I trials starting in early 2005. Indevus            licensed exclusive worldwide rights to IP 751 from Manhattan Pharmaceuticals,            Inc.

We know of a            number of programs in various stages that compete in the area of IBS.

Dextofisopam is            currently targeted for the treatment of diarrhea-predominant IBS and/or            alternating-type IBS. To the best of our knowledge, there are no competing compounds in            development specifically for the treatment of alternating-type IBS. Several compounds            are reported to be in development for the potential treatment of diarrhea-predominant            IBS. These include DDP-225, a mixed 5-HT3 antagonist/norepinephrine reuptake            blocker, reportedly in Phase 2 (Dynogen); rifaximin, an antibiotic marketed for the            treatment of traveler’s diarrhea (Salix); arverapamil, a compound with            5-HT3 antagonist and calcium channel blocking properties, reportedly in            Phase 2 (AGI); TRN-002, a chloride channel blocker reportedly in Phase 2 (Trine); and            LX1031, reportedly in Phase 1 (Lexicon Genetics). Several other compounds are reported            to be in development for the treatment of IBS. However, it is not clear if these            compounds are intended for a specific type of IBS, e.g., diarrhea-predominant,            constipation-predominant, or alternating-type IBS. Such compounds include a            glucagon-like peptide-1 agonist (Gastrotech) and asimadoline, a kappa opiate agonist            (Tioga), both reportedly in Phase 2. Several other compounds are reported to be in            development for the treatment of constipation-predominant IBS. While such compounds may            not directly compete with dextofisopam, it is possible that they may eventually be            developed for diarrhea-predominant or alternating-type IBS, or that dextofisopam may            eventually be developed

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for            constipation-predominant IBS. Such compounds include DDP-733, a 5-HT3            partial agonist reportedly in Phase 2 (Dynogen) and MD-1100, a guanylate cyclase C            agonist reportedly in Phase 2 (Microbia).

**Collaborative            Relationships**

Depending on the            availability of financial, marketing and scientific resources, among other factors,            Pharmos may license its technology or products to others and retain profit sharing,            royalty, manufacturing, co-marketing, co-promotion or similar rights. Any such            arrangements could limit Pharmos’ flexibility in pursuing alternatives for the            commercialization of its products. Due to the often unpredictable nature of the            collaborative process, Pharmos cannot be certain that it will be able to establish any            additional collaborative arrangements or that, if established, any of these            relationships will be successful.

**Bausch &            Lomb**

In 2001, Pharmos            sold to Bausch & Lomb all of its rights in the U.S. and Europe to manufacture and            market Lotemax® and Alrex® and Zylet®, the third loteprednol            etabonate-based product, which was submitted to the FDA for marketing approval in            September 2003. In December 2004, Bausch & Lomb received approval from the FDA of            its NDA for Zylet® as an ophthalmic anti-inflammatory/antibiotic combination            product.

At the time of            the sale in 2001, Pharmos received gross proceeds of approximately $25 million in cash            in 2001. During January 2005, an amended agreement was signed in regard to Zylet®            and Pharmos received additional gross proceeds of approximately $12.2 million from            Bausch & Lomb. Additionally, the Company may have received a milestone payment of            up to $10 million if actual sales during the first two years following Bausch &            Lomb’s commercialization were exceeding agreed-upon forecasted amounts.. A review            of Zylet sales provided by Bausch and Lomb indicated that no additional payments are            due the Company as actual sales of Zylet did not reach the agreed levels. Pharmos            agreed to pay up to $3.75 million of the costs of developing Zylet®, of which            $600,000 was deducted from the purchase price paid by Bausch & Lomb in October            2001. In July 2003, another $1.57 million was paid to Bausch & Lomb. Pharmos paid            the remaining balance of $1.56 million as its share of these research and development            related Zylet® expenses in January 2005. Pharmos has no further obligation for            payments to Bausch & Lomb.

Pharmos paid Dr.            Nicholas Bodor, the loteprednol etabonate patent owner and licensor, who is a former            director of and consultant to Pharmos, a total of approximately $2.7 million from the            initial proceeds of the sale of Lotemax® and Alrex® in return for his consent            to Pharmos’ assignment of its rights under the license agreement to Bausch &            Lomb. In January 2005, the Company paid Dr. Bodor approximately $1.3 million per the            agreement with respect to Zylet®. Pharmos owes Dr. Bodor an additional 14.3% of any            payments the Company may receive from Bausch & Lomb in the event that certain sales            levels are exceeded in the first two years following commencement of sales in the U.S.            As stated above, the required Zylet sales levels were not achieved during the            measurement period. In February 2005, the Company paid the Israel-U.S. Binational            Industrial Research and Development Foundation $211,712, which represented the maximum            amount the Company owed the foundation for Zylet®.

**Loteprednol            Etabonate**

Loteprednol            etabonate is a unique steroid that is designed to act in the eye and alleviate            inflammatory and allergic conditions. The drug is quickly and predictably reduced into            inactive particles before it reaches the inner eye or systemic circulation. This action            results in improved safety by avoiding the side effects related to exposure to most            ocular steroids. In the eye, the most unwanted side effect of steroids is the elevation            of intra-ocular pressure, which can be sight-threatening. While steroids, for lack of            an alternative, are regularly used for severe inflammatory conditions of the eye,            milder conditions such as allergies are preferentially treated with less effective            non-steroidal agents.

For Bausch &            Lomb’s ophthalmic product, Zylet®, in which we had a financial interest there            are competing products currently on the market including Tobradex® from Alcon,            which is the largest-selling product in its category, as well as Vexol® from Alcon            and Pred Forte® from Allergan.

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**Patents and Proprietary            Rights**

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

Some of the            technologies underlying Pharmos’ potential products were invented by or are owned            by various third parties, including Otsuka Pharmaceutical Co., Ltd and The Hebrew            University of Jerusalem. Pharmos is the licensee of these technologies under patents            held by the applicable owner, through licenses that generally remain in effect for the            life of the applicable patent. Pharmos generally maintains, at its expense, U.S. and            foreign patent rights with respect to both the licensed technology and its own            technology and files and/or prosecutes the relevant patent applications in the U.S. and            foreign countries. Pharmos also relies upon trade secrets, know-how, continuing            technological innovations and licensing opportunities to develop its competitive            position. Pharmos’ policy is to protect its technology by, among other things,            filing, or requiring the applicable licensor to file, patent applications for            technology that it considers important to the development of its business. Pharmos            intends to file additional patent applications, when appropriate, relating to its            technology, improvments to its technology and to specific products it            develops.

The patent            positions of pharmaceutical firms, including Pharmos, are uncertain and involve complex            factual questions. In addition, the coverage claimed in a patent application can be            significantly reduced before or after the patent is issued. Consequently, Pharmos does            not know whether any of the pending patent applications underlying the licensed            technology will result in the issuance of patents or, if any patents are issued,            whether they will provide significant proprietary protection or will be circumvented or            invalidated. Since patent applications in the U.S. and elsewhere publish only 18 months            after priority date, and since publication of discoveries in the scientific or patent            literature often lag behind actual discoveries, Pharmos cannot be certain that it or            its licensors, as the case may be, were the first creators of inventions covered by            pending and issued patents or that it or its licensors, as the case may be, were the            first to file patent applications for such inventions. Moreover, it may be necessary            for Pharmos to participate in interference proceedings declared by the U.S. Patent and            Trademark Office in order to determine priority of invention. Involvement in these            proceedings could result in substantial cost to Pharmos, even if the eventual outcomes            are favorable to Pharmos. Because the results of the judicial process are often            uncertain, we cannot be certain that a court of competent jurisdiction will uphold the            patents, if issued, relating to the licensed technology, or that a competitor’s            product will be found to infringe those patents.

Other            pharmaceutical and drug delivery companies and research and academic institutions may            have filed patent applications or received patents in Pharmos’ fields. If patents            are issued to other companies that contain competitive or conflicting claims and those            claims are ultimately determined to be valid, it is possible that Pharmos would not be            able to obtain licenses to these patents at a reasonable cost or be able to develop or            obtain alternative technology.

Pharmos also            relies upon trade secret protection for its confidential and proprietary information.            It is always possible that others will independently develop substantially equivalent            proprietary information and techniques or otherwise gain access to Pharmos’ trade            secrets.

It is            Pharmos’ policy to require its employees, consultants, outside scientific            collaborators, sponsored researchers and other advisors to execute confidentiality            agreements upon the commencement of employment or consulting or advisory relationships            with Pharmos. These agreements generally provide that all confidential information            developed or made known to the individual during the course of the individual’s            relationship with Pharmos is to be kept confidential and not disclosed to third parties            except in specific circumstances. Further, these agreements provide for the maintenance            of confidentiality following the termination of the individual’s relationship            with Pharmos. In the case of employees and certain consultants, the agreements provide            that all inventions conceived by the individual in the course of their employment or            consulting relationship shall be the exclusive property of Pharmos. Due to the vital            nature of trade secrets and the often uncertain results of the judicial process, we            cannot be sure, however, that these agreements will provide meaningful protection            or

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adequate            remedies for Pharmos’ trade secrets in the event of unauthorized use or            disclosure of such information. Pharmos’ patents and licenses underlying its            potential products described herein are summarized below.

Emulsion-based Drug Delivery            Systems. In the general category of SubMicron Emulsion technology, Pharmos holds            three patents. These patents and patent applications have been devised to protect a            group of formulation technologies devised by Pharmos and the inventors as they relate            to pharmaceutical and medicinal products. The most important of these relate to            submicron emulsions for improved topical and transdermal drug delivery. Two families            relate to dry solid lipid formulations for enhanced oral delivery of lipophilic            substances. The earliest patent filings for SubMicron Emulsion technology date from            1993 and the most recent are dated from 1997. These patents cover a broad range of new            formulations, which improve the absorption of drugs that are poorly soluble in            water.

Additional            Pharmos assets include dextofisopam (previously known as R-tofisopam) and tianeptine            for the treatment of irritable bowel syndrome and VPI-013 (previously known as            OPC-14523) for the treatment of depression.

*Dextofisopam to Treat            IBS*. Irritable bowel syndrome, or IBS, is a chronic, recurring condition with            symptoms that affect up to 15% of American adults, more often women than men. IBS is            characterized by multiple symptoms that include bowel dysmotility—diarrhea,            constipation, or alternating diarrhea and constipation—and abdominal discomfort.            Studies have shown that diarrhea-predominant IBS appears to be the most common subtype.            For patients with diarrhea-predominant and alternating-type IBS, there are no recently            approved treatments for any but the most severely affected women, and none for            men.

Dextofisopam is            a novel non-serotonergic agent in development for the treatment of IBS. Dextofisopam is            the R-enantiomer of racemic tofisopam. Pharmos holds an issued composition-of-matter            patent in the United States on dextofisopam which expires in 2019. Pharmos owns certain            counterpart foreign patents and patent applications, as well. Pharmos has filed            additional patent applications for the treatment of IBS in the United States, and            abroad.

*Tianeptine            to Treat IBS or Functional Dyspepsia.* Tianeptine is a racemic molecule marketed            and used outside the United States for the treatment of depression. Pharmos’            patent protection for tianeptine consists of a United States method-of-use patent            covering tianeptine and its two enantiomers for the treatment of IBS and non-ulcer            dyspepsia. This patent expires in 2024. Additional foreign patents related to this            United States patent are pending.

*VPI-013 to            Treat Neuropathic Pain.* Neuropathic pain is caused by a primary lesion or            dysfunction in the nervous system. The injury can be to the central nervous system            (brain and spinal cord) or the peripheral nervous system (nerves outside the brain and            spinal cord). Neuropathic pain is a component of many disorders, including infections,            diabetes, and lumbar disc disease. The current therapeutic market for neuropathic pain            is underserved, primarily by the off-label use of antidepressants and by the off-label            use of anticonvulsants. The anticonvulsant gabapentin (Neurontin®),            while not broadly approved for the treatment of neuropathic pain, is widely used            off-label for this indication. Treatment with gabapentin is limited by significant            side-effect issues, including high rates of dizziness and somnolence. Pfizer’s            Lyrica® (pregabalin) was recently FDA-approved for the treatment of various forms            of neuropathic pain, In controlled clinical trials, however, only 35% of patients with            neuropathic pain had a 50% reduction in pain score, and the most common side effects of            Lyrica® included dizziness, somnolence, dry mouth, peripheral edema, blurred            vision, weight gain and difficulty with concentration/attention. Lyrica® is also            designated as a controlled substance by the FDA.

Pharmos has            in-licensed North American and European rights (and rights in select additional            countries) to VPI-013 from Otsuka Pharmaceutical Co., Ltd. The VPI-013 patent estate            consists of a United States composition-of-matter patent (which expires in 2014), a            United States method-of-use patent, and foreign counterparts. The patents are owned by            Otsuka and are licensed exclusively to Pharmos in the geographic areas noted above.            Pharmos and Otsuka have jointly filed an international patent application covering the            treatment of neuropathic pain.

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**Licenses**

As discussed            above, Pharmos has licensed patents covering certain emulsion-based drug delivery            systems from the Hebrew University of Jerusalem.

Pharmos’            subsidiary, Pharmos Ltd., licensed its patents related to the oral delivery of            lipophilic substances in the limited field of use of nutraceuticals to Herbamed, Ltd.,            a company in Israel controlled by the former Chairman and Chief Executive Officer of            Pharmos. The terms of the license agreement are discussed in “Item 13. Certain            Relationships and Related Transactions.”

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

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**Government            Regulation**

**FDA and            Comparable Authorities in Other Countries**

Regulation by            governmental authorities in the U.S. and other countries is a significant factor in our            ongoing research and development activities and in the production and marketing of our            products. Pharmaceutical products intended for therapeutic use in humans are governed            in the U.S. by the Federal Food, Drug and Cosmetic Act (21 U.S.C. § 321 *et            seq.*) and by FDA regulations and by comparable agency regulations in other            countries. Specifically, in order to undertake clinical tests, and to produce and            market products for human therapeutic or diagnostic use, mandatory procedures and            safety standards established by the FDA and Department of Health and Human Services in            the U.S. and comparable agencies in other countries must be implemented and followed.            These standards include protection of human research subjects.

The following is            an overview of the steps that must be followed before a drug product may be marketed            lawfully in the U.S.:

|   |   |                                                                                                                                                                                         |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | (i)    | Preclinical studies                        including pharmacology, laboratory evaluation and animal studies to test                        for initial safety and efficacy;                  |
|   |   |                                                                                                                                                                                         |
|   | (ii)   | Submission to the FDA                        of an Investigational New Drug (IND) Application, which must become                        effective before human clinical trials may commence; |
|   |   |                                                                                                                                                                                         |
|   | (iii)  | Adequate and                        well-controlled human clinical trials to establish the safety and efficacy                        of the drug in its intended application;               |
|   |   |                                                                                                                                                                                         |
|   | (iv)   | Submission to the FDA                        of a New Drug Application (NDA), which application is not automatically                        accepted by the FDA for consideration; and       |
|   |   |                                                                                                                                                                                         |
|   | (v)    | FDA                        approval of the New Drug Application prior to any commercial sale or                        shipment of the drug.                                                 |

In addition to            obtaining FDA approval for each product, each drug-manufacturing establishment must be            registered or licensed by the FDA for each product sold within the US that is            manufactured at that facility. Manufacturing establishments are subject to inspections            by the FDA and by other national and local agencies and must comply with current Good            Manufacturing Practices (cGMPs), requirements that are applicable to the manufacture of            pharmaceutical drug products and their components.

Preclinical            studies include laboratory evaluation of product chemistry and animal studies to assess            the potential safety and efficacy of the product and its formulation. The results of            the preclinical studies are submitted to the FDA as part of an IND, and unless the FDA            objects, the application will become effective 30 days following its receipt by the            FDA. If the potential of addiction is found in the animal tests, then additional            regulatory requirements may be imposed by the FDA and DEA.

Clinical trials            involve the administration of the drug to healthy volunteers as well as to patients            under the supervision of a qualified “principal investigator,” who is a            medical doctor. Clinical trials in humans are necessary because effectiveness in humans            may not always be gleaned from findings of effectiveness in animals. They are conducted            in accordance with protocols that detail the objectives of the study, the parameters to            be used to monitor safety and the efficacy criteria to be evaluated. Each protocol is            submitted to the FDA as part of the application. Each clinical study is approved and            monitored by an independent Institutional Review Board (IRB) (Ethics Committee) at each            clinical site. The IRB must consider, among other things, the process of obtaining the            informed consents of each study subject, the safety of human subjects, the possible            liability of the institution conducting a clinical study, as well as various ethical            factors.

Clinical trials            typically are conducted in three sequential phases, although the phases may overlap. In            Phase I, the initial introduction of the drug to humans, the drug is tested in a small            group of healthy volunteers for safety and clinical pharmacology such as metabolism and            tolerance. Phase I trials may also yield preliminary

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information            about the product’s effectiveness and dosage levels. Phase II involves detailed            evaluation of safety and efficacy of the drug in patients with the disease or condition            being studied. It also involves a determination of optimal dosage and identification of            possible side effects in a larger patient group. Phase III trials consist of larger            scale evaluation of safety and efficacy and usually require greater patient numbers and            multiple clinical trial sites, depending on the clinical indications for which            marketing approval is sought.

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

The 1962            amendments to the Federal Food, Drug and Cosmetic Act required for the first time that            drug effectiveness be proven by adequate and well-controlled clinical trials. The FDA            interpretation of that requirement is that at least two such trials are necessary to            demonstrate effectiveness for approval of an NDA. This interpretation is based on the            scientific need for independent substantiation of study results. However, Section 115            of FDAMA revised Section 505 of the Act to read, in pertinent part that “based on            relevant science, data from one adequate and well-controlled clinical investigation and            confirmatory evidence ... are sufficient to establish effectiveness.” The            FDA has not issued comprehensive standards of testing conditions for pivotal trials.            The FDA maintains a preference for at least two adequate and well-controlled clinical            trials. Cannabinor and dexanabinol have been shown to be devoid of psychotropic            properties, and Pharmos believes that the potential of addictive properties is remote.            However, because cannabinor and dexanabinol are cannabinoids, the Company will conduct            a test to specifically evaluate any addictive potential. If the test shows the            possibility of addiction, additional regulatory requirements would have to be met which            could delay the NDA approval process.

Pharmos’            products will be subject to foreign regulatory approval before they may be marketed            abroad. Marketing beyond the US is subject to regulatory requirements that vary widely            from country to country. In the European Union, the general trend has been towards            coordination of the common standards for clinical testing of new drugs. Centralized            approval in the European Union is coordinated through the European Medicines Evaluation            Agency (EMEA). The time required to obtain regulatory approval from comparable            regulatory agencies in each country may be longer or shorter than that required for FDA            or EMEA approval. Further, in certain markets, reimbursement may be subject to            governmentally mandated prices.”

**Drug Enforcement            Administration**

In animal and            human testing, neither cannabinor nor dexanabinol have been shown to possess clinically            significant psychotropic properties at relevant therapeutic doses. As part of the            filing requirements with the FDA, Pharmos will study the addiction potential of its            drug candidates concurrent with late-stage clinical trials. If the potential of            addiction is found in animal tests, additional regulatory requirements may be imposed            by the FDA and Drug Enforcement Agency (DEA). The DEA regulates controlled substances            as Schedule I, II, III, IV or V substances, with Schedule I and II substances            considered to present the highest risk of substance abuse and Schedule V substances the            lowest risk. Should one of the Company’s products be classified as a controlled            substance, its manufacture, shipment, storage, sale and use would be subject to a high            degree of regulation. To meet its responsibilities, the DEA conducts periodic            inspections of registered establishments that handle controlled substances. Facilities            that conduct research, manufacture or distribute controlled substances must be            registered to perform these activities and have the security, control and accounting            mechanisms required by the FDA to prevent loss and diversion. Failure to maintain any            required compliance might result in regulatory action that could have a material            adverse event on our business. The FDA could seek civil penalties, refuse to renew            necessary registrations or initiate proceedings to revoke those registrations. In            certain circumstances, violations could give rise to criminal proceedings.

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**Corporate            History**

Pharmos            Corporation, (formerly known as Pharmatec, Inc.) a Nevada corporation, was incorporated            under the laws of the State of Nevada on December 20, 1982. On October 29, 1992,            Pharmatec, the Nevada Corporation, completed a merger with a privately held New York            corporation known as Pharmos Corporation founded by Dr. Aviv (the name of the            post-merger Nevada corporation was changed to Pharmos Corporation).

**Human            Resources**

As of December            31, 2007, Pharmos had 18 full-time employees, including 7 in the U.S. and 11in Israel.            Of the 18 employees, 7 hold doctorate or medical degrees.

Pharmos’            employees are not covered by a collective bargaining agreement. To date, Pharmos has            not experienced employment-related work stoppages and considers its employee relations            to be excellent.

**Public Funding and            Grants**

Pharmos’            subsidiary, Pharmos Ltd., has received certain funding from the Chief Scientist of the            Israel Ministry of Industry and Trade (the Chief Scientist) for: (1) research and            development of dexanabinol; (2) SubMicron Emulsion technology for injection and            nutrition; (3) research relating to pilocarpine, dexamethasone and ophthalmic            formulations for dry eyes; (4) research and development of CB2, including cannabinor.            As of December 31, 2007, the total amounts received under such grants amounted to            $17,827,499. Under the terms of the grant agreements, aggregate future royalty payments            related to sales of products developed, if any, as a result of the grants are limited            to $16,338,559 based on grants received through December 31, 2007. Pharmos will be            required to pay royalties to the Chief Scientist ranging from 3% to 5% of product            sales, if any, as a result of the research activities conducted with such funds.            Aggregate royalty payments per product are limited to the amount of funding received to            develop that product and interest. Additionally, funding by the Chief Scientist places            certain legal restrictions on the transfer of know-how and the manufacture of resulting            products outside of Israel. See “Conditions in Israel.”

Pharmos received            funding of $925,780 from the Israel-U.S. Binational Industrial Research and Development            Foundation to develop Lotemax® and Zylet®. Bausch & Lomb received approval            from the FDA for Zylet® in December 2004. In February 2005, the Company paid the            foundation $211,712, which represented the maximum amount the Company owed the            foundation.

Pharmos signed            an agreement with the Consortium Magnet, operated by the Office of the Chief Scientist,            for developing generic technologies and for the design and development of drug and            diagnostic kits. Under such agreement, Pharmos was entitled to a non-refundable grant            amounting to approximately 60% of the actual research and development and equipment            expenditures on approved projects. No royalty obligations were required within the            framework. As of December 31, 2005 Pharmos had received grants totaling $1,659,549 for            this program which was completed and closed.

During 2004, the            Company signed an agreement with Consortium Magnet to develop a supply of water-soluble            products of lipophilic compounds that improve their bioavailability and            biopharmaceutical properties. Under such agreement the Company is entitled to a            non-refundable grant amounting to approximately 60% of actual research and development            and equipment expenditures on approved projects. No royalty obligations are required            within the framework. As of December 31, 2006, the Company received grants totaling            $546,609 from this program which was completed and closed.

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**2005 Reverse Stock            Split**

On May 26, 2005,            Pharmos Corporation filed a Certificate of Change with the Nevada Secretary of State            which served to effect, as of May 31, 2005, a 1-for-5 reverse split of Pharmos’            common stock. As a result of the reverse stock split, every five shares of Pharmos            common stock were combined into one share of common stock; any fractional shares            created by the reverse stock split were rounded up to whole shares. The reverse stock            split affected all of Pharmos’ common stock, stock options and warrants            outstanding immediately prior to the effective date of the reverse stock split. The            reverse split reduced the number of shares of Pharmos’ common stock outstanding            at that time from 95,137,076 shares to 19,027,809 shares, and the number of authorized            shares of common stock was reduced from 150,000,000 shares to 30,000,000 shares. All            references to common share and per common share amounts for all periods presented have            been retroactively restated to reflect this reverse split. At the Annual Meeting in            September 2005, the shareholders voted to increase the number of authorized shares of            common stock to 60,000,000 shares.

**Availability of SEC            Filings**

All reports            filed by the Company with the SEC are available free of charge via EDGAR through the            SEC website at www.sec.gov. In addition, the public may read and copy materials            filed by the Company with the SEC at the SEC’s public reference room located at            100 F Street NE, Washington, D.C., 20549. The company also provides copies of its Forms            8-K, 10-K, 10-Q, Proxy and Annual Report at no charge available through its website at            www.pharmoscorp.com/investors as soon as reasonably practicable after filing            electronically such material with the SEC. Copies are also available, without charge,            from Pharmos Corporation, 99 Wood Avenue South, Suite 311, Iselin, NJ,            08830.

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**Item 1A. Risk            Factors**

**We have            certain obligations to indemnify our officers and directors.**

We have certain obligations to            indemnify our officers and directors and to advance expenses to such officers and            directors. Although we have purchased liability insurance for our directors and            officers, if our insurance carriers should deny coverage, or if the indemnification            costs exceed the insurance coverage, we may be forced to bear some or all of these            indemnification costs directly, which could be substantial and may have an adverse            effect on our business, financial condition, results of operations and cash flows. If            the cost of our liability insurance increases significantly, or if this insurance            becomes unavailable, we may not be able to maintain or increase our levels of insurance            coverage for our directors and officers, which could make it difficult to attract or            retain qualified directors and officers.

**We are at an early stage of            development.**

We are at an            early stage of development. Our lead product, dextofisopam, has completed Phase 2a            testing for irritable bowel syndrome (“IBS”), and patient screening            commenced for a Phase 2b study of dextofisopam for the treatment of IBS in June 2007.            We have determined that we will not continue with the development of Cannabinor at this            time, but will focus resources on other CB2 compounds that have better potential.            Cannabinor will be available for outlicensing. Apart from an ophthalmic product that            was sold to Bausch & Lomb Incorporated in October 2001, most of our other potential            products are early in the research and development phase, and product revenues may not            be realized from the sale of any such products for at least the next several years, if            at all. Many of our proposed products will require significant additional research and            development efforts prior to any commercial use, including extensive preclinical and            clinical testing, as well as lengthy regulatory approval. Because of the uncertain            nature of the process, we cannot be sure that our research and development efforts will            be successful, that our potential products will prove to be safe and effective in            clinical trials or that we will develop any other commercially successful            products.

**We have a history of            operating losses and expect to sustain losses in the future.**

We have            experienced significant operating losses since our inception. As of December 31, 2007,            we had an accumulated deficit of approximately $197 million. We expect to incur            operating losses over the next several years as our research and development efforts            and preclinical and clinical testing activities continue. Our ability to generate            revenues and achieve profitability depends in part upon our ability, alone or with            others, to successfully complete development of our proposed products, to obtain            required regulatory approvals and to manufacture and market our products.

**We may not be able to obtain            financing in the future.**

As of December 31, 2007, we had an            accumulated deficit of approximately $197 million. The development of our technology            and potential products will require a commitment of substantial funds to conduct the            costly and time-consuming research necessary to develop and optimize our technology,            and ultimately, to establish manufacturing and marketing capabilities. Our future            capital requirements will depend on many factors, including:

|   |   |                                                                                                                                             |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | continued scientific                        progress in the research and development of our technology and drug                        programs; |
|   |   |                                                                                                                                             |
|   | • | our ability to                        establish and maintain collaborative arrangements with others for drug                        development; |
|   |   |                                                                                                                                             |
|   | • | progress with                        preclinical and clinical trials;                                                                            |
|   |   |                                                                                                                                             |
|   | • | the time and costs                        involved in obtaining regulatory approvals;                                                            |
|   |   |                                                                                                                                             |
|   | • | the costs involved                        in preparing, filing, prosecuting, maintaining and enforcing patent                        claims;     |
|   |   |                                                                                                                                             |
|   | • | competing                        technological and market developments;                                                                          |
|   |   |                                                                                                                                             |
|   | • | changes in our                        existing research relationships; and                                                                       |
|   |   |                                                                                                                                             |
|   | • | effective product                        commercialization activities and arrangements.                                                          |

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We believe that            our cash and cash equivalents and short term investments as of December 31, 2007,            combined with our $4.0 million private placement of convertible debentures in January            2008 should be sufficient to fund our continuing operations beyond December 31,            2008.

We are also            continuing to actively pursue various funding options, including equity offerings,            strategic corporate alliances, business combinations and product-related research and            development limited partnerships, to obtain the additional financing which we require            to continue developing our products and ultimately bring them to market. We may not be            able to obtain additional financing when needed, if at all. If we are unable to raise            adequate financing in the future, our long term operations will need to be scaled-back            or discontinued.

**Our product            candidates may not successfully complete clinical trials required for            commercialization, and as a result our business may never achieve            profitability.**

To obtain regulatory approvals            needed for the sale of our drug candidates, we must demonstrate through testing and            clinical trials that each drug candidate is both safe and effective for the human            population that it was intended to treat. In general, two successful Phase III clinical            trials are required. The clinical trial process is complex and the regulatory            environment varies widely from country to country. Positive results from testing and            early clinical trials do not ensure positive results in the Phase III human clinical            trials. Many companies in our industry have suffered significant setbacks in Phase III,            potentially pivotal clinical trials, even after promising results in earlier trials.            The results from our trials, if any, may show that our drug candidates produce            undesirable side effects in humans or that our drug candidates are not safe or            effective or not safe or effective enough to compete in the marketplace. Such results            could cause us or regulatory authorities to interrupt, delay or halt clinical trials of            a drug candidate. Moreover, we, the FDA, or foreign regulatory authorities may suspend            or terminate clinical trials at any time if we or they believe the trial participants            face unacceptable health risks or that our drug candidates are not safe or effective            enough. Clinical trials are lengthy and expensive. They require adequate supplies of            drug substance and sufficient patient enrollment. Patient enrollment is a function of            many factors, including:

|   |                                                                                                                                                                          |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • | the size of the                        patient population,                                                                                                                    |
|   |                                                                                                                                                                          |
| • | the nature of the                        protocol (i.e., how the drug is given, and the size and frequency of the                        dose and use of placebo control),    |
|   |                                                                                                                                                                          |
| • | the proximity of                        patients to clinical sites, and                                                                                                       |
|   |                                                                                                                                                                          |
| • | the eligibility                        criteria for the clinical trial (i.e., age group, level of symptoms,                        concomitant diseases or medications etc.). |

Delays in            patient enrollment or negative trial outcomes can result in increased costs and longer            development times. Even if we successfully complete clinical trials, we may not be able            to file any required regulatory submissions in a timely manner and we may not receive            regulatory approval for the particular drug candidate that was tested.

In addition, if            the FDA or foreign regulatory authorities require additional clinical trials, we could            face increased costs and significant development delays. Changes in regulatory policy            or additional regulations adopted during product development and regulatory review of            information we submit could also result in delays or rejections.

**Our clinical trials depend on            third party investigators who are outside our control.**

We depend upon            the personnel of third party independent investigators to conduct our clinical trials.            Such personnel are not our employees, and we cannot control the amount of time or            resources that they devote to our programs. They may not assign as great a priority to            our programs or pursue them as diligently as we would if we were undertaking such            programs ourselves. If such third-party personnel fail to devote sufficient time and            resources to our clinical trials, or if their performance is substandard, the approval            of our FDA applications, if

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any, and our            introduction of new drugs, if any, will be delayed. Such third-party investigators may            also have relationships with other commercial entities that compete with us. If they            assist our competitors at our expense, our competitive position would be            harmed.

**We face            extensive governmental regulation and any failure to adequately comply could prevent or            delay product approval or cause the disallowance of our products after            approval.**

The FDA and            comparable agencies in foreign countries impose many requirements on the introduction            of new drugs through lengthy and detailed clinical testing procedures, and other costly            and time consuming compliance procedures. These requirements make it difficult to            estimate when any of our products in development will be available commercially, if at            all. In addition, the FDA or other comparable agencies in foreign countries may impose            additional requirements in the future that could further delay or even stop the            commercialization of our products in development.

Our proprietary            compounds in development require substantial clinical trials and FDA review as new            drugs. Even if we successfully enroll patients in our clinical trials, patients may not            respond to our potential drug products. We think it is prudent to expect setbacks and            possible product failures. Failure to comply with the regulations applicable to such            testing may delay, suspend or cancel our clinical trials, or the FDA might not accept            the test results. The FDA, or any comparable regulatory agency in another country, may            suspend clinical trials at any time if it concludes that the trials expose subjects            participating in such trials to unacceptable health risks. Further, human clinical            testing may not show any current or future product candidate to be safe and effective            to the satisfaction of the FDA or comparable regulatory agencies or the data derived            there from may be unsuitable for submission to the FDA or other regulatory            agencies.

We cannot predict with certainty            when we might submit any of our proposed products currently under development for            regulatory review. Once we submit a proposed product for review, the FDA or other            regulatory agencies may not issue their approvals on a timely basis, if at all. If we            are delayed or fail to obtain such approvals, our business may be damaged due to the            resulting inability to generate revenues from the sale of such product. If we fail to            comply with regulatory requirements, either prior to approval or in marketing our            products after approval, we could be subject to regulatory or judicial enforcement            actions. These actions could result in:

|   |   |                                                                                              |
|--------|--------|---------------------------------------------------------------------------------------------------|
|   | • | injunctions;                                                                                      |
|   |   |                                                                                              |
|   | • | criminal                        prosecution;                                                      |
|   |   |                                                                                              |
|   | • | refusals to approve                        new products and withdrawal of existing approvals; and |
|   |   |                                                                                              |
|   | • | enhanced exposure to                        product liabilities.                                  |

**We may need to find            collaborative partners.**

Our strategy for            the development, clinical testing, manufacture, marketing and commercialization of our            products includes the use of collaborations with corporate partners, licensors,            licensees and others.

Due to the often            unpredictable nature of the collaboration process, we cannot be sure that any present            or future collaborative agreements will be successful. To the extent we choose not to            or are not able to establish such arrangements, we would experience increased capital            requirements. In addition, we may encounter significant delays in introducing our            products currently under development into certain markets or find that the development,            manufacture, or sale of those products is hindered by the absence of collaborative            agreements due to the relatively small size of our company as compared with that of            some of our potential competitors.

**The value of            our research could diminish if we cannot protect or enforce our intellectual property            rights adequately.**

We actively            pursue both domestic and foreign patent protection for our proprietary products and            technologies. We have filed for patent protection for our technologies in all markets            we believe to be important for the

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development and            commercialization of our drug products; however, our patents may not protect us against            our competitors. We may have to file suit to protect our patents or to defend our use            of our patents against infringement claims brought by others. Because we have limited            cash resources, we may not be able to afford to pursue or defend against litigation in            order to protect our patent rights. As a result, while we currently have no specific            concerns about gaps in our intellectual property portfolio, we recognize that for            companies like ours, where intellectual property constitutes a key asset, there is            always a risk that a third party could assert a patent infringement claim or commence a            patent interference action. Defending against any such claims or actions could be very            costly to us, even if they were without merit.

We also rely on            trade secret protection for our unpatented proprietary technology. However, trade            secrets are difficult to protect. While we enter into proprietary information            agreements with our employees and consultants, these agreements may not successfully            protect our trade secrets or other proprietary information.

**We face large            competitors and our limited financial and research resources may limit our ability to            develop and market new products.**

The            pharmaceutical industry is highly competitive. We compete with a number of            pharmaceutical companies that have financial, technical and marketing resources that            are significantly greater than ours. Some companies with established positions in the            pharmaceutical industry may be better equipped than we are to develop, market and            distribute products in the global markets we seek 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. They may also market competitive commercial products on            their own or through joint ventures and may compete with us in recruiting highly            qualified scientific personnel. Further, these institutions may compete with us in            recruiting qualified patients for enrollment in their trials.

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

**We lack manufacturing            capability.**

Other than for            the production of clinical trial material, we currently do not have manufacturing            facilities. Should any of our products receive approval for marketing, we would likely            need to find third party manufacturers to assist in their production. If we should be            unable to find such manufacturers with which to work on commercially reasonable terms,            it could delay or restrict any potential revenues from such products.

**We use hazardous materials in            our research.**

As with most            other pharmaceutical companies, our research and development involves the controlled            use of hazardous materials. Our laboratories store and/or produce carbon monoxide,            nitric acid and ammonia. Although we believe that our safety procedures for handling            and disposing of these hazardous materials comply in all material respects with the            standards prescribed by government regulations, the risk of accidental contamination or            injury from these materials cannot be completely eliminated. In the event of an            accident, we could be held liable for any resulting damages which may or may not be            covered by insurance.

**We have            certain anti-takeover provisions and are also subject to certain Nevada anti-takeover            provisions that may make it difficult for a third party to acquire us or for            stockholders to replace or remove current management.**

We have adopted            a stockholder rights plan that imposes a significant penalty upon any person or group            that acquires 15% or more of our outstanding common stock without the approval of our            board. In addition, our by-laws provide for the division of our board into three            classes serving staggered terms and our charter documents

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authorize our            board to issue up to 1,250,000 shares of preferred stock. Moreover, certain provisions            of the Nevada General Corporation Law that limit our ability to enter into            “business combinations” with certain “interested shareholders”            and limit the voting rights of those stockholders who obtain “control            shares” may also act to inhibit a hostile acquisition of our company. All of            these provisions described above are likely to discourage potential acquisition            proposals and delay or prevent a transaction resulting in a change in            control.

In addition, the            existence of these provisions could prevent or frustrate stockholder attempts to            replace or remove current management, who serve at the pleasure of our board. Since the            “staggered” board provisions of our by-laws, as well as other by-law            provisions limiting the ability of our stockholders to call special meetings, make it            difficult to replace the majority of our board at once, stockholder efforts to change            the direction of our company, in the event of their dissatisfaction with the            board’s or management’s performance, could be hindered.

**Conditions in Israel continue            to be volatile.**

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

Since the            establishment of the State of Israel in 1948, a number of armed conflicts have taken            place between Israel and its Arab neighbors, as well as incidents of civil unrest. In            addition, Israel has in the past been the subject of an economic boycott, as have            companies doing business with Israel. Although Israel has entered into various            agreements with certain Arab countries and the Palestinian Authority, there has been an            increase in the unrest and terrorist activity that began in September 2000 and has            continued with varying levels of severity into 2008. We do not believe that the            political and security situation has had any material negative impact on our business            to date; however, the situation is volatile, and we cannot be sure that security and            political conditions will have no such effect in the future.

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

Pharmos Ltd. has            received funding from the Office of the Chief Scientist of the Israel Ministry of            Industry and Trade relating to various technologies for the design and development of            drugs and diagnostic kits. This funding prohibits the transfer or license of know-how            and the manufacture of resulting products outside of Israel without the permission of            the Chief Scientist. Although we believe that the Chief Scientist does not unreasonably            withhold this permission if the request is based upon commercially justified            circumstances and any royalty obligations to the Chief Scientist are sufficiently            assured, the matter is solely within his discretion and we cannot be sure that such            consent, if requested, would be granted upon terms satisfactory to us or granted at            all. Without such consent, we would be unable to manufacture any products developed by            this research outside of Israel, which may greatly restrict any potential revenues from            such products.

**The price of our Common Stock            may experience volatility**

The trading            price of our Common Stock could be subject to wide fluctuations in response to            variations in our quarterly operating results, the failure of trial results, the            failure to bring products to market, conditions in the industry, and the outlook for            the industry as a whole or general market or economic conditions. In addition, in            recent years, the stock market has experienced extreme price and volume fluctuations.            These fluctuations have had a substantial effect on the market prices for many            companies, often unrelated to the operating performance of the specific companies. Such            market fluctuations could have a material adverse effect on the market price for our            securities.

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**Nasdaq            Listing**

On September 26,            2007, we received notice from The Nasdaq Stock Market (“Nasdaq”) that the            minimum bid price of our common stock had fallen below $1.00 for 30 consecutive            business days and that we were therefore not in compliance with Nasdaq Marketplace Rule            4310(c)(4).

In accordance            with section 4310(c)(8)(D) of the Nasdaq Marketplace Rules, we have until March 24,            2008 (180 calendar days from September 26, 2007) to regain compliance. No assurance can            be given that we will regain compliance during that period.

We can regain            compliance with the minimum bid price rule if the bid price of our common stock closes            at $1.00 or higher for a minimum of 10 consecutive business days during the initial            180-day period, although Nasdaq may, in its discretion, require us to maintain a bid            price of at least $1.00 per share for a period in excess of ten consecutive business            days (but generally no more than 20 consecutive business days) before determining that            we have demonstrated the ability to maintain long-term compliance. If compliance is not            achieved by March 24, 2008, we will be eligible for another 180-day compliance period            (until September 20, 2008) if we meet the Nasdaq Capital Market initial listing            criteria as set forth in Nasdaq Marketplace Rule 4310(c) other than the minimum bid            price requirement. No assurance can be given that we will be eligible for the            additional 180-day compliance period or, if applicable, that we will regain compliance            during any additional compliance period. If we are not eligible for an additional            compliance period, or do not regain compliance during any additional compliance period,            Nasdaq will provide written notice to us that our securities will be delisted. At such            time, we would be able to appeal the delisting determination to a Nasdaq Listing            Qualifications Panel.

If our common            stock were to be delisted from Nasdaq, liquidity for our common stock could be            significantly decreased which could reduce the trading price and increase the            transaction costs of trading shares of our common stock.

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**Item 1B. Unresolved Staff            Comments**

None.

**Item 2.            Properties**

Pharmos is            headquartered in Iselin, New Jersey, where it leases its executive offices and            maintains clinical, regulatory and business development staff. The New Jersey lease            expires in 2009. Pharmos also leases facilities used in the operation of its research,            development and administrative activities in Rehovot, Israel. The facility in Rehovot            has been improved to meet the special requirements necessary for the operation of            Pharmos’ research and development activities. In the opinion of the management,            these facilities are sufficient to meet the current and anticipated future requirements            of Pharmos. In addition, management believes that it has sufficient ability to renew            its present leases related to these facilities or obtain suitable replacement            facilities. The monthly lease obligations for our office space in 2007 are $17,881 for            Iselin, New Jersey and $12,306 for Rehovot, Israel. The approximate square footage for            Iselin, New Jersey and Rehovot, Israel are 7,399 and 10,426, respectively. A portion of            the NJ offices are subleased; the net monthly lease obligations and approximate square            footage are $3,122 and 1,441 square feet, respectively.

In February 2007            Pharmos Ltd. signed a new four-year lease for its Rehovot facilities. There is an early            termination date on January 31, 2009 with no penalty to Pharmos if the company elects            to notify of early termination 150 days prior to the early termination date. About            11,180 square feet of the facility in Rehovot were subleased between October 1, 2007 to            January 31, 2008. On January 31, 2008 we terminated 11,180 square feet and on February            1, 2008 subleased 5,036 square feet; the net monthly lease obligations and approximate            square footage from February 1, 2008 are $6,363 and 5,391 square feet respectively. The            sublease of the 5,036 square feet will terminate on January 31, 2009, the early            termination date.

**Item 3. Legal            Proceedings**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | The                        Company and certain current officers were named as defendants in several                        purported shareholder class action lawsuits alleging violations of federal                        securities laws. These lawsuits were filed beginning in January 2005 in the                        U.S. District Court for the District of New Jersey. These lawsuits assert                        claims under Sections 10(b) and 20(a) of the Securities Exchange Act of                        1934 and Rule 10b-5 hereunder. The complaints allege generally that the                        defendants knowingly or recklessly made false or misleading statements                        regarding the effectiveness of dexanabinol in treating TBI (Traumatic Brain                        Injury) which had the effect of artificially inflating the price of the                        Company’s common stock. These class actions have been consolidated by                        order of the court and lead plaintiffs and lead plaintiffs’ counsel                        have been appointed. An amended complaint was filed in September                        2005. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | On                        May 31, 2007, the Company entered into an agreement with plaintiffs to                        settle the class action lawsuits that commenced starting in January 2005                        and are currently pending in the U.S. District Court for the District of                        New Jersey. The lawsuits relate to statements purportedly made by Pharmos                        and its officers regarding the effectiveness of dexanabinol in treating                        traumatic brain injury.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | The                        settlement, which is covered in its entirety by Pharmos’ insurance,                        has been reached with no admission of liability by any party and has been                        entered into to avoid costly and time consuming litigation by all parties.                        The parties agreed to seek the required court approvals of the settlement                        and filed the settlement documents with the Court on June 4, 2007. On July                        18, 2007, the Court granted preliminary approval of the                        settlement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | Both                        of the previously disclosed derivative lawsuits (which alleged, generally,                        breaches of fiduciary duty and other state law violations arising from the                        same set of underlying facts as the class actions) have been settled, court                        approval has been obtained, the settlements are final and the cases have                        been dismissed with prejudice.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

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

At the Pharmos Annual Meeting of            Stockholders held on October 24, 2007, our stockholders elected the following persons            as Class I Directors to serve until the 2008 annual meeting of stockholders and until            their successors are duly elected and qualified: Charles Newhall III, David Schlachet            and Abraham Sartani, MD. The results of the voting were as follows:

|                                       |   |                                 |   |                                      |
|--------------------------------------------|--------|--------------------------------------|--------|-------------------------------------------|
|                                       |   | **VOTES                        FOR** |   | **VOTES                        WITHHELD** |
|                                       |   |                                 |   |                                      |
| Charles Newhall                        III |   | 18,477,113                           |   | 581,585                                   |
|                                       |   |                                 |   |                                      |
| David                        Schlachet     |   | 17,463,594                           |   | 1,565,104                                 |
|                                       |   |                                 |   |                                      |
| Abraham Sartani,                        MD |   | 18,376,959                           |   | 651,739                                   |

Also at the Annual Meeting, the            stockholders approved the amendment of the Company’s 2000 Stock Option Plan            authorizing the issuance of an additional 2,000,000 shares under such plan, thereby            increasing the aggregate number of shares issuable under the plan from 2,700,000 to            4,700,000, with 9,111,467 votes for approval, 468,144 votes against approval and 31,868            abstentions.

Further, the stockholders            ratified the Board’s selection of PricewaterhouseCoopers LLP as Pharmos’s            independent registered public accounting firm for the fiscal year ended December 31,            2007, with 18,277,488 votes for ratification, 320,660 votes against ratification,            430,549 abstentions.

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**PART            II**

**Item 5.            Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer            Purchases of Equity Securities**

The            Company’s Common Stock is traded on the Nasdaq Capital Market under the symbol            “PARS.” The following table sets forth the range of high and low sales            prices per share for the Common Stock as reported on Nasdaq during the periods            indicated.

|                                                    |   |     |   |    |   |   |   |
|---------------------------------------------------------|--------|----------|--------|---------|--------|--------|--------|
| **Year ended                        December 31, 2007** |   | **HIGH** |   | **LOW** |   |
|                                                         |   |          |   |         |   |
|                                                    |
| 4th                        Quarter                      |   | $        | .96    |    | $      | .31    |   |
| 3rd                        Quarter                      |   |     | 1.45   |    |   | .79    |   |
| 2nd                        Quarter                      |   |     | 2.28   |    |   | 1.33   |   |
| 1st                        Quarter                      |   |     | 1.88   |    |   | 1.36   |   |

|                                                    |   |     |   |    |   |   |   |
|---------------------------------------------------------|--------|----------|--------|---------|--------|--------|--------|
| **Year ended                        December 31, 2006** |   | **HIGH** |   | **LOW** |   |
|                                                         |   |          |   |         |   |
|                                                    |
| 4th                        Quarter                      |   | $        | 2.22   |    | $      | 1.68   |   |
| 3rd                        Quarter                      |   |     | 2.14   |    |   | 1.55   |   |
| 2nd                        Quarter                      |   |     | 2.70   |    |   | 2.01   |   |
| 1st                        Quarter                      |   |     | 2.93   |    |   | 2.00   |   |
|                                                    |   |     |   |    |   |   |   |

The high and low            sales prices for the Common Stock from January 1, 2008 through February 26, 2008 were            $.95 and $.30, respectively. The closing price on February 26, 2008 was            $.94.

On February 20,            2008, there were approximately 493 record holders of the Common Stock of the Company            and approximately 16,347 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.

**PERFORMANCE            GRAPH**

The following            graph compares the Company’s cumulative stockholder’s return for the five            year period ended December 31, 2007 with the cumulative total return of the Nasdaq            Equity Market Index and the Nasdaq Pharmaceuticals Index over the same            period.

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**Item 6.            Selected Financial Data**

|                                                                                                 |   |                                               |        |                         |    |        |                         |     |       |                         |   |        |                         |    |        |                         |
|------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------|-------------|------------------------------|---------|-------------|------------------------------|----------|------------|------------------------------|--------|-------------|------------------------------|---------|-------------|------------------------------|
|                                                                                                 |   | **Year Ended December                        31,** |        |
|                                                                                                 |   |                                                    |        |
|                                                                                                 |   | **2007**                                           |        | **2006**                     |    | **2005**    |                         | **2004** |       | **2003**                     |   |
|                                                                                                 |   |                                                    |        |                              |    |             |                         |          |       |                              |   |
| Revenues                                                                                             |   |                                               | —     |                         |    | —     |                         |     | —    |                         |   | —     |                         |    | —     |                         |
| Operating                        expenses                                                            |   | ($                                                 | 17,579,259  | )                            | ($      | 37,542,519  | )                        (1) | ($       | 15,708,888 | )                            | ($     | 19,880,151  | )                            | ($      | 16,034,146  | )                            |
| Other income (expense),                        net                                                   |   |                                               | 997,652     |                         |    | 1,792,775   |                         |     | 12,288,382 | (2)                          |   | (2,532,390  | )                            |    | (2,679,517  | )                            |
| Loss before income                        taxes                                                      |   |                                               | (16,581,607 | )                            |    | (35,749,744 | )                            |     | (3,420,506 | )                            |   | (22,412,541 | )                            |    | (18,713,663 | )                            |
| Net loss                                                                                             |   |                                               | (15,625,825 | )                            |    | (35,136,969 | )                            |     | (2,929,872 | )                            |   | (21,967,767 | )                            |    | (18,485,865 | )                            |
| Net loss applicable to                        common shareholders                                    |   | ($                                                 | 15,625,825  | )                        (3) | ($      | 35,136,969  | )                        (3) | ($       | 2,929,872  | )                        (3) | ($     | 21,967,767  | )                        (3) | ($      | 18,485,865  | )                        (3) |
|                                                                                                 |   |                                                    |             |                         |         |             |                         |          |            |                         |        |             |                         |         |             |                         |
| Net loss per share                        applicable to common shareholders –basic and diluted |   | ($                                                 | 0.61        | )                            | ($      | 1.74        | )                            | ($       | 0.15       | )                            | ($     | 1.22        | )                            | ($      | 1.37        | )                            |
|                                                                                                 |   |                                                    |             |                         |         |             |                         |          |            |                         |        |             |                         |         |             |                         |
|                                                                                                 |   |                                               |        |                         |    |        |                         |     |       |                         |   |        |                         |    |        |                         |
| Total assets                                                                                         |   |  $                                            | 12,374,959  |                         |  $ | 28,393,338  |                         |  $  | 48,990,772 |                         | $      | 57,664,842  |                         |  $ | 69,622,482  |                         |
|                                                                                                 |   |                                                    |             |                         |         |             |                         |          |            |                         |        |             |                         |         |             |                         |
| Long term                        obligations                                                         |   |  $                                            | 410,594     |                         |  $ | 1,388,306   |                         |  $  | 1,125,551  |                         | $      | 1,236,451   |                         |  $ | 5,772,344   |                         |
|                                                                                                 |   |                                                    |             |                         |         |             |                         |          |            |                         |        |             |                         |         |             |                         |
|                                                                                                 |
| Cash dividends                        declared                                                       |   |                                               | —     |                         |    | —     |                         |     | —    |                         |   | —     |                         |    | —     |                         |
|                                                                                                 |   |                                               |        |                         |    |        |                         |     |       |                         |   |        |                         |    |        |                         |
| Average shares                        outstanding - basic and diluted                                |   |                                               | 25,591,660  |                         |    | 20,249,714  |                         |     | 18,974,175 |                         |   | 18,033,358  |                         |    | 13,479,435  |                         |

|   |                                                                                                                                                                                                                                     |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 1.     | The                        Company acquired in-process research and development in the Vela                        acquisition in October 2006. Vela results are consolidated from October 26,                        2006 forward.      |
|   |                                                                                                                                                                                                                                     |
| 2.     | Includes a $10.7                        million milestone payment received in 2005 related to the sale of the                        ophthalmic product line in October 2001.                                                            |
|   |                                                                                                                                                                                                                                     |
| 3.     | Includes benefit of                        sales of Pharmos NJ Net Operating Loss in 2007, 2006, 2005, 2004 and 2003                        of $955,782, $612,775, $490,634, $444,744 and $227,798,                        respectively. |

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

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

**Executive            Summary**

The results for the year ended            December 31, 2007 and 2006 were a net loss of $15.6 million and $35.1 million or a loss            per share of $.61 and $1.74, respectively.

The operating            expenses for 2007 were $17.6 million, primarily comprised of $10.6 million research and            development expenses primarily relating to the commencement of the dextofisopam Phase            2b clinical trial, and $6.7 million of general and administration expenses.

In 2007 the            Company commenced the dextofisopam Phase 2b clinical trial with 72 randomized patients            enrolled as of December 31, 2007 of an anticipated 480 patient trial.

General and            administrative expenses included severance payments aggregations $1,014,732 relating to            the departure of three senior executives.

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**Critical Accounting            Policies**

The preparation            of our consolidated financial statements in conformity with accounting principles            generally accepted in the U.S. requires management to make estimates and assumptions            that affect the amounts reported in our consolidated financial statements and            accompanying notes. Future events and their effects cannot be determined with absolute            certainty. Therefore, the determination of estimates requires the exercise of judgment.            Actual results inevitably will differ from those estimates, and such differences may be            material to the financial statements. The listing below is not intended to be a            comprehensive list of all of our accounting policies. The Company considers certain            accounting policies related to stock-based compensation, tax valuation allowance and            asset impairments to be critical policies due to the estimation process involved in            each.

**Equity based            compensation**

Effective January 1, 2006, the            Company adopted the provisions of Statement of Financial Accounting Standards No. 123R,            “Share-Based Payment” (“SFAS 123R”), which establishes the            financial accounting and reporting standards for stock-based compensation plans. SFAS            123R requires the measurement and recognition of compensation expense for all            stock-based awards made to employees and directors, including employee stock options            and restricted stock units, and employee stock purchases related to the ESPP. Under the            provisions of SFAS 123R, stock-based compensation cost is measured at the grant date,            based on the fair value of the award, and is recognized as an expense over the            requisite service period of the entire award (generally the vesting period of the            award). The Company has elected to expense these awards on a straight line basis over            the life of the awards. As a result of adopting SFAS 123R, the Company’s net loss            before income taxes and net loss for the years ended December 31,2007 and 2006 were            $1,076,606 and $939,500 more than if the Company had continued to account for            stock-based compensation under Accounting Principles Board Opinion No. 25,            “Accounting for Stock Issued to Employees” (“APB 25”) and its            related interpretations. Basic and diluted net loss per share for the years ended            December 31, 2007 and 2006 of $(0.61) and $(1.74) are $0.04 and $0.05 more as a result            of adopting SFAS 123R.

The Company elected to use the            modified prospective transition method as permitted by SFAS 123R and, therefore,            financial results for prior periods have not been restated. Under this transition            method, stock-based compensation expense for the years ended December 31, 2007 and 2006            include expense for all equity awards granted prior to, but not yet vested as of            January 1, 2006, based on the grant date fair value estimated in accordance with the            original provisions of SFAS No. 123, “Accounting for Stock-Based            Compensation” (“SFAS 123,”) as amended by SFAS 148, “Accounting            for Stock-Based Compensation—Transition and Disclosure.” Compensation            expense for all stock-based compensation awards granted subsequent to January 1, 2006            was based on the grant-date fair value determined in accordance with the provisions of            SFAS 123R. During the years ended December 31, 2007 and 2006, the Company recognized            compensation expense of $1,076,606 and $939,500 for stock options which were recognized            in the Consolidated Statement of Operations. As of December 31, 2007 and 2006, the            total compensation costs related to non-vested awards not yet recognized is $510,000            which will be recognized over the next three and one-quarter years.

Prior to January            1, 2006, the Company accounted for stock-based compensation in accordance with APB 25            and also followed the disclosure requirements of SFAS 123. Under APB 25, the Company            accounted for stock-based awards to employees and directors using the intrinsic value            method as allowed under SFAS 123.

The following            table illustrates the effect on net loss and loss per share if the Company had applied            the fair value recognition provisions of SFAS No. 123 to stock-based employee            compensation. The estimated fair value of each option is calculated using the            Black-Scholes option-pricing model.

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|                                                                                                                                                          |   |                                                                       |       |   |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------|------------|--------|--------|
|                                                                                                                                                          |   | Year                        Ended                        December 31, 2005 |       |
|                                                                                                                                                          |   |                                                                            |       |
| Net loss as                        reported                                                                                                                   |   | ($                                                                         | 2,929,872  | )      |   |
| Add: Stock-based                        employee compensation expense included in reported net loss                                                           |   |                                                                       | 1,171,728  |   |   |
|                                                                                                                                                          |   |                                                                       |       |   |   |
| Deduct: Total                        stock-based employee compensation expense determined under fair value based                        method for all awards |   |                                                                       | (4,578,359 | )      |   |
|                                                                                                                                                          |   |                                                                            |            |   |   |
| Pro forma net                        loss                                                                                                                     |   | ($                                                                         | 6,336,503  | )      |   |
|                                                                                                                                                          |   |                                                                            |            |   |   |
|                                                                                                                                                          |   |                                                                       |       |   |   |
| Loss per                        share:                                                                                                                        |   |                                                                       |       |   |   |
| Basic and diluted, as                        reported                                                                                                         |   | ($                                                                         | 0.15       | )      |   |
| Basic and diluted, pro                        forma                                                                                                           |   | ($                                                                         | 0.33       | )      |   |

For disclosure            purposes under SFAS No. 123, the fair value of each option grant was estimated on the            date of grant using the Black-Scholes option valuation model with the following            weighted-average assumption:

|                                             |   |   |                            |   |   |
|--------------------------------------------------|--------|--------|---------------------------------|--------|--------|
|                                             |   | 2005   |                            |   |
|                                             |   |        |                            |   |
| Risk-free interest                        rate   |   |   | 3.71-4.45%                      |   |   |
| Expected lives (in                        years) |   |   | 5                               |   |   |
| Dividend                        yield            |   |   | 0%                              |   |   |
| Expected                        volatility       |   |   | 99                        -107% |   |   |

On June 28,            2005, the Company accelerated the vesting of unvested stock options awarded under its            stock option plans that had exercise prices greater than $9.00; the closing price was            $2.43 on June 28, 2005. Unvested options to purchase approximately 200,000 shares            became exercisable as a result of the vesting acceleration. Typically, the Company            grants stock options that vest over a four-year period. The purpose of the accelerated            vesting was to enable the Company to avoid recognizing, in its consolidated statement            of operations, compensation expense associated with these options in future periods,            upon adoption of SFAS 123R (Share-Based Payment) in January 2006. The impact of this            acceleration resulted in a $2.6 million increase in proforma stock-based compensation            expense in 2005.

Options issued            to non-employees other than directors are accounted for under the fair value method in            accordance with SFAS 123 and EITF Issue No. 96-18, “Accounting for Equity            Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction            with Selling Goods or Services.” Under the fair value method, compensation cost            is measured at the grant date of the option based on the value of the award using the            Black-Scholes method. Compensation cost is periodically remeasured as the underlying            options vest in accordance with EITF Issue No. 96-18 and is recognized over the service            period.

On September 6,            2004, the Board of Directors approved the Retention Award Agreements and Pharmos            entered into Retention Award Agreements with each of Dr. Haim Aviv, its then Chairman            and Chief Executive Officer, and Dr. Gad Riesenfeld, its then President and Chief            Operating Officer. The Company granted retention awards consisting of cash and            restricted stock units to Dr. Aviv. The Company granted retention awards consisting of            cash and restricted stock to Dr. Riesenfeld (the “Awards”). Under the            agreement, one-half of the Awards vested on December 31, 2005 and the balance shall            vest and become non-forfeitable on June 30, 2007, subject to certain accelerated            vesting provisions. Under the terms of Dr. Riesenfeld’s severance agreement, the            balance of his Awards vested on his departure from the Company on April 2, 2006 and the            expense of those awards was accelerated through April 2, 2006. The fair value of the            restricted shares was based on the fair value of the stock on the issuance date. The            aggregate fair value of the restricted stock awards totaled $2 million. For financial            reporting purposes, the cash awards and the fair value of the restricted stock awards,            which totaled $2,500,000, will be expensed pro rata over the vesting periods. Per the            Awards, only Dr. Riesenfeld was issued the restricted stock; Dr. Aviv received            restricted stock units.

**Impairment of            Long-Lived Assets**

We review            long-lived assets for impairment whenever events or changes in business circumstances            indicate that the carrying amount of the assets may not be fully recoverable or that            the useful lives of these assets are no longer appropriate. Each impairment test is            based on a comparison of the undiscounted cash flow to the recorded value of the asset.            Subsequent impairment assessments could result in future impairment charges.            Any

35

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impairment            charge would result in the reduction in the carrying value of long-lived assets and            would increase our net loss in the period in which the charge arose.

**Tax Valuation            Allowance**

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

**Results of            Operations**

                      *Years Ended December 31, 2007 and 2006*

The Company            recorded no product sales revenue and cost of sales during 2007 and 2006.

During 2007, the            Company increased its expenditures on research and development activities. In 2006, the            Company completed its acquisition of Vela Pharmaceuticals, Inc. which included            $20,608,000 of in-process research and development costs. The Vela operations have been            integrated into Pharmos and the Company currently operates as one operating segment.            Thus research and development expenditures in 2007 were greater than in 2006. From the            Vela acquisition, the Company initiated a large Phase 2b study of Dextofisopam for the            treatment of IBS in the first half of 2007.

The acquisition            of Vela resulted in the Company acquiring three potential drug candidates in various            stages of development. The Company initiated a large scale Phase IIb trial involving            approximately 480 patients with Dextofisopam for irritable bowel syndrome (IBS) in June            2007. The second drug acquired through Vela was VPI-013 for female sexual dysfunction            and neuropathic pain. This drug candidate has completed Phase IIa testing and the            Company intends to seek to license this to a partner. The Company also intends to            license out the third drug candidate, Tianeptine, also for IBS which has completed            pre-clinical testing. Significant additional clinical testing and related expenses will            be needed before these drugs reach the market if at all. The additional expenses cannot            be quantified at this time.

A Phase 2a            clinical trial with the Company’s NanoEmulsion delivery technology for topical            application of analgesic and anti-inflammatory agents commenced in June 2007 targeting            126 patients. Completion is expected in mid 2008.

During the first            half of 2007 the Company completed two Phase 2a proof of principle trials for            Cannabinor with the iv formulation, a drug candidate for treating pain. Cannabinor is a            CB2 selective agonist and is the first of the CB2 molecules tested in            humans.

During 2007 the            Company focused on lowering its general and administrative costs. During 2006, the            Company incurred higher professional fees primarily in connection with legal fees            related to the proxy contest including the coverage of Lloyd Miller’s legal            costs, higher investor relation costs related to the acquisition and proxy            preparation.

Included in the            2007 general and administrative costs are costs relating to the departure of three            senior executives. These payments were made under contractual agreements. After            including these expenses in 2007, the aggregate general and administrative costs are            lower than in 2006 due in part to cost management efforts and the scaling back of            activities not core to the Company’s research and development efforts.

The Company is            currently dependent upon external financing, interest income, and research and            development contracts to pursue its intended business activities. The Company has not            been profitable since its inception, except for 2001. During 2007, the Company funded            the majority of its expenses and other capital requirements with $13 million of common            stock issued in conjunction with the Vela acquisition, utilization of cash and short            term investments available from external financing in earlier years, income from grants            received from the Office

36

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of the Chief            Scientist of Israel and the sale of NJ Net Operating Losses. At December 31, 2007, the            Company has an accumulated deficit of $197 million and expects to continue to incur            losses going forward. Losses have resulted principally from costs incurred in research            activities aimed at identifying and developing the Company’s product candidates,            clinical research studies, the write-off of purchased research and development, and            general and administrative expenses. The Company expects to incur additional losses            over the next several years as the Company’s research and development and            clinical trial programs continue. The Company’s ability to achieve profitability,            if ever, is dependent on its ability to develop and obtain regulatory approvals for its            product candidates, to enter into agreements for product development and            commercialization with strategic corporate partners and contract to develop or acquire            the capacity to manufacture and sell its products. See “Management’s            Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity            and Capital Resources.”

Research efforts            in 2007 and 2006 have been focused on the identification of new, potentially more            potent CB2 agonists, completion of preclinical toxicology and safety pharmacology            studies of an oral formulation of Cannabinor, scale-up manufacturing, technology            transfer to the active ingredient supplier, and clinical trial finished material at            Pharmos’ facility in Rehovot, Israel. The major increase in year-to-date            operating expenses year–over-year reflects the shift from primarily in-house            research & development activities in 2005 to preclinical and clinical trials in            2006.

The Company            considers major research & development projects to be those projects that have            reached at least Phase II level of clinical development. In June 2007 the Company            announced that patient screening had commenced in the Phase 2b trial for Dextofisopam            for IBS with a target of 480 patients. Through December 31, 2007 expenditures on this            trial amounted to $5,188,539.

The Cannabinor            expenditures for the two Phase 2a trials amounted to $1,180,952 and the costs of the            NanoEmulsion Phase 2a trial aggregated $313,038 in 2007.

Gross expenses            for other research and development projects in early stages of development for the year            ended December 31, 2007 and 2006 were $4,350,348 and $ 6,477,805, respectively.            Research & development (R&D) gross expenses increased by $2,500,745 or 28% from            $8,956,821 in 2006 to $11,457,566 in 2007 due to the commencement of the Dextofisopam            Phase 2b clinical trial and a $1.0 million milestone payment made by Pharmos upon the            study’s commencement. The Company recorded research and development grants            received from the Office of the Chief Scientist of Israel’s Ministry of Industry            and Trade of $812,042 and $1,445,513 during 2007 and 2006, respectively, which reduced            research and development expenses. The decrease in grants is directly related to the            decrease in the underlying eligible activity for the grants in 2007 over 2006 as the            Company focused more research funds on the US based Phase 2b clinical trial of            Dextofisopam. Total research and development expenses, net of grants, increased by            $3,134,216 or 42% from $7,511,308 in 2006 to $10,645,524 in 2007.

In process            acquired research and development costs decreased by $20,607,575 from $$20,607,575 in            2006 to $0 in 2007. The in process acquired research and development costs were            acquired in conjunction with the acquisition of Vela in 2006.

General and            administrative expenses decreased by $2,410,266 or 26%, from $9,108,867 in 2006 to            $6,698,601 in 2007. The decrease in general and administrative expenses is due to            lower, professional fees, investor relations and insurance costs by $1,933,000,            $358,000, and $348,000 respectively, in 2007 compared to 2006. These decreases were            offset in part by an increase in salary and benefit costs of $547,000 in 2007 as            compared to 2006. The lower professional fees in 2007 are due to non-recurring legal            and consulting fees that were incurred in 2006 related to the Vela acquisition and            business development. The decrease in investor relation costs is primarily related to            2006 non recurring proxy printing and distribution costs associated with the Vela            acquisition. The decline in insurance costs reflect favorable renewal rates and reduced            policy coverage limits. The increase in salary and benefit costs is primarily            attributed to severance costs associated with the departure of several            executives.

37

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*          Years            Ended December 31, 2006 and 2005*

The Company            recorded no product sales revenue and cost of sales during 2006 and 2005.

Total operating            expenses increased by $21,833,631 or 139%, to $37,542,519 in 2006 from $15,708,888 in            2005. In 2006, the Company completed its acquisition of Vela Pharmaceuticals, Inc.            which included $20,608,000 of in-process research and development costs. The Vela            operations have been integrated into Pharmos and the Company currently operates as one            operating segment. From the Vela acquisition, the Company expects to initiate a large            Phase 2b study of Dextofisopam for the treatment of IBS in the first half of 2007.            During 2006, the Company has completed the Phase I trial and one of two            proof-of-principle Phase IIa testing for its lead candidate for treating pain, a CB-2            selective agonist, Cannabinor with the IV formulation and is scheduled to complete the            second proof-of-principle Phase IIa testing and for a Phase I testing with the oral            formulation during 2007. The Company’s NanoEmulsion delivery technology for            topical application of analgesic and anti-inflammatory agents has completed in 2006 the            second Phase I trial with Diclofenac cream and is scheduled in 2007 for a Phase IIa            clinical trial in Osteoarthritis patients. During 2006, the Company incurred higher            professional fees primarily in connection with legal fees related to the proxy contest            including the coverage of Lloyd Miller’s legal costs, higher investor relation            costs related to the acquisition and proxy preparation, higher costs for the clinical            trial activity for Cannabinor and NanoEmulsion and higher salaries costs for severance            for a number of executives and the 2006 implementation of the equity based compensation            of SFAS 123R.

During 2006,            Pharmos completed the Phase I trial and one of two proof-of-principle Phase IIa testing            for its lead candidate for treating pain from its proprietary platform of CB2-selective            synthetic cannabinoid compounds, Cannabinor with IV formulation as well as the            preclinical toxicology and safety pharmacology studies of an oral formulation of            Cannabinor. Cannabinor and other platform compounds were designed to reduce the side            effects caused by natural cannabinoids. In a number of animal models, these compounds            have demonstrated efficacy as analgesics to treat moderate to severe pain, as            anti-inflammatory agents, and immunomodulation agents to treat diseases such as            multiple sclerosis, rheumatoid arthritis and inflammatory bowel disease. The            preliminary results of one of two proof-of-principle Phase IIa testing of Cannabinor in            capsaicin-induced pain model of neuropathic pain didn’t meet the primary endpoint            defined by analgesic effects compared to placebo, but confirmed safety and tolerability            observed in previous studies. The Company expects in 2007 to complete the analysis of            the Cannabinor proof-of-principle Phase IIa testing in capsaicin-induced pain model of            neuropathic pain results, to complete the proof-of-principle Phase IIa testing            Cannabinor in patients experiencing nociceptive pain from 3rd molar extraction and to            conduct a Phase I safety study with the Cannabinor oral formulation.

During 2006,            Pharmos completed the second Phase I study with its proprietary NanoEmulsion drug            delivery technology in healthy volunteers that confirmed the safety and tolerability as            well as the low systemic exposure of a Diclofenac NE topical cream. The Company plans            to initiate a Phase IIa clinical trial in Osteoarthritis patients in 2007.

The acquisition            of Vela resulted in the Company acquiring three potential drug candidates in various            stages of development. The Company is planning to initiate a large scale Phase IIb            trial involving approximately 480 patients with Dextofisopam for irritable bowel            syndrome (IBS). The second drug acquired through Vela VPI-013 for female sexual            dysfunction and neuropathic pain. This drug candidate has completed Phase IIa testing            and the Company intends to seek to license this to a partner. The Company also intends            to license out the third drug candidate, Tianeptine, also for IBS, which has completed            pre-clinical testing. Significant additional clinical testing and related expenses will            be needed before these drugs reach the market, if at all. The additional expenses            cannot be quantified at this time.

The Company is            currently dependent upon external financing, interest income, and research and            development contracts to pursue its intended business activities. The Company has not            been profitable since its inception, except for 2001. During 2006, the Company funded            the majority of its expenses and other capital requirements with $13 million of common            stock issued in conjunction with the Vela acquisition, utilization of cash and short            term investments available from external financing in earlier years, income from grants            received from the Office of the Chief Scientist of Israel and the sale of NJ Net            Operating Losses. At December 31, 2006, the Company

38

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has an            accumulated deficit of $181 million and expects to continue to incur losses going            forward. Losses have resulted principally from costs incurred in research activities            aimed at identifying and developing the Company’s product candidates, clinical            research studies, the write-off of purchased research and development, and general and            administrative expenses. The Company expects to incur additional losses over the next            several years as the Company’s research and development and clinical trial            programs continue. The Company’s ability to achieve profitability, if ever, is            dependent on its ability to develop and obtain regulatory approvals for its product            candidates, to enter into agreements for product development and commercialization with            strategic corporate partners and contract to develop or acquire the capacity to            manufacture and sell its products. See “Management’s Discussion and            Analysis of Financial Condition and Results of Operations -- Liquidity and Capital            Resources.”

Research efforts            in 2006 have been focused on the identification of new, potentially more potent CB2            agonists, completion of preclinical toxicology and safety pharmacology studies of an            oral formulation of Cannabinor, scale-up manufacturing, technology transfer to the            active ingredient supplier, and clinical trial finished material at Pharmos’            facility in Rehovot, Israel. The major increase in year-to-date operating expenses            year–over-year reflects the shift from primarily in-house research &            development activities in 2005 to preclinical and clinical trials in 2006.

The Company            considers major research & development projects to be those projects that have            reached at least Phase II level of clinical development. The Company’s Phase II            project is the development of Cannabinor. During 2006, the gross cost of development            and review was approximately $2.5 million. Total costs since the Cannabinor project            entered Phase II development in 2006 through December 31, 2006 were $2.5            million,

Gross expenses            for other research and development projects in early stages of development for the year            ended December 31, 2006 and 2005 were $6,477,805 and $ 6,257,498, respectively: 75% in            2006 and 87% in 2005 of the spending was related to cannabinor and other CB2 compounds.            Research & development (R&D) gross expenses decreased by $611,472 or 6% from            $9,568,293 in 2005 to $8,956,821 in 2006 due to a reduction in clinical activity that            was related to Dexanabinol. The Company recorded research and development grants            received from the Office of the Chief Scientist of Israel’s Ministry of Industry            and Trade of $1,445,513 and $1,406,508 during 2006 and 2005, respectively, which            reduced research and development expenses. The increase in grants is directly related            to the increase in the underlying eligible activity for the grants for 2006 over 2005.            Total research and development expenses, net of grants, decreased by $650,477 or 8%            from $8,161,785 in 2005 to $7,511,308 in 2006.

In process            acquired research and development costs increased by $20,607,575 from $0 in 2005 to            $20,607,575 in 2006. The in process acquired research and development costs were            acquired in conjunction with the acquisition of Vela.

General and            administrative expenses increased by $1,943,576 or 27%, from $7,165,291 in 2005 to            $9,108,867 in 2006. The increase in general and administrative expenses is due to            higher compensation, professional fees, and investor relations by $1,086,000, $695,000,            and $304,000 respectively, in 2006 compared to 2005. There were also decreases in            general and administrative expenses related to lower consultant expenses of $239,000.            The increase in compensation is attributed to severance costs, and the cost of stock            based compensation awards associated with the adoption of FAS 123R. The higher            professional fees in 2006 are attributed to legal fees related to the proxy and the            Vela acquisition. The increase in investor relation costs is primarily related to costs            associated with the printing and distribution of the proxy.

Depreciation and            amortization expenses decreased by $67,043, or 18%, from $381,812 in 2005 to $314,769            in 2006. The decrease is due to fixed assets which have become fully            depreciated.

Other income            net, decreased by $10,495,607 from income of $12,288,382 in 2005 to income of            $1,792,775 in 2006. Income of $10,725,688 was recognized for the net payment received            from B&L in the first quarter of 2005. Interest expense decreased by $166,322 from            $166,322 in 2005 to $0 in 2006. The decrease in 2005 interest expense is a result of            the substantially reduced average outstanding balance and maturity at March 31, 2005 of            the September 2003 Convertible Debentures. This debt was fully repaid as of March 31,            2005. Interest income increased by $263,164, or 17%, from $1,514,878 in 2005 to            $1,778,042 in 2006 as a result of higher

39

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interest rates.            During 2006, the Company recorded in other income royalties of $5,177 compared with            $24,670 in 2005 per the licensing agreement with Herbamed Ltd, a company controlled by            Dr. Haim Aviv, the Company’s CEO.

No tax provision            is required at this time since the company is in a tax loss position at year-end            December 31, 2006 and has net operating losses from previous years. The Company has            established a 100% valuation allowance against the deferred tax asset. The Company had            an increase in income tax benefit by $122,141 from $490,634 in 2005 to $612,775. The            income tax benefit represents funds derived from the sale of Pharmos’ New Jersey            State net operating losses.

**Liquidity and            Capital Resources**

The Company was            not profitable from 2004 through 2007. During 2007, the Company funded the majority of            its expenses and other capital requirements with the utilization of cash and short term            investments available from external financing in earlier years, income from grants            received from the Office of the Chief Scientist of Israel and the sale of NJ Net            Operating Losses. At December 31, 2007, the Company had an accumulated deficit of $197            million and expects to continue to incur losses going forward. Such losses have            resulted principally from costs incurred in research and development and from general            and administrative expenses. 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, grants from the Office of the Chief Scientist of            Israel, research contracts, the sale of a portion of its New Jersey net operating loss            carryforwards, and interest income. Management believes that the current cash, cash            equivalents and short term investments, totaling of $11.2 million as of December 31,            2007,combined with our $4.0 million private placement of convertible debentures in            January 2008, will be sufficient to support the Company’s continuing operations            beyond December 31, 2008.

The Company            expects to incur additional losses over the next several years as the Company’s            research and development and clinical trial programs continue. The Company expects cash            expenditures in research and development to increase in 2008 due primarily to the            ongoing dextofisopam Phase 2b clinical trial. The Company’s ability to achieve            profitability, if ever, is dependent on its ability to develop and obtain regulatory            approvals for its product candidates, to enter into agreements for product development            and commercialization with strategic corporate partners and contract to develop or            acquire the capacity to manufacture and sell its products.

The following            table describes the Company’s liquidity and financial position on December 31,            2007, and on December 31, 2006:

|                                                                           |   |                                     |   |                                     |   |   |   |   |       |   |   |
|--------------------------------------------------------------------------------|--------|------------------------------------------|--------|------------------------------------------|--------|--------|--------|--------|------------|--------|--------|
|                                                                           |   | December 31,                        2007 |   | December 31,                        2006 |   |
|                                                                           |   |                                          |   |                                          |   |
| Working                        capital                                         |   |                                     | $      | 9,504,348                                |   |   |   | $      | 24,168,153 |   |   |
| Cash and cash                        equivalents                               |   |                                     | $      | 7,481,741                                |   |   |   | $      | 12,757,013 |   |   |
| Short term                        investments                                  |   |                                     | $      | 3,686,568                                |   |   |   | $      | 13,172,673 |   |   |
| Total cash, cash                        equivalents and short term investments |   |                                     | $      | 11,168,309                               |   |   |   | $      | 25,929,686 |   |   |

**Current            working capital position**

As of December            31, 2007, the Company had working capital of $9.5 million consisting of current assets            of $11.5 million and current liabilities of $2.0 million. This represents a decrease of            $14.7 million from its working capital of $24.2 million on current assets of $26.7            million and current liabilities of $2.5 million as of December 31, 2006.

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**Current and future liquidity            position**

Management            believes that cash, cash equivalents and short term investments, totaling $11.2 million            as of December 31, 2007 combined with our $4.0 million private placement of convertible            debentures in January 2008, will be sufficient to support the Company’s            continuing operations beyond December 31, 2008. The Company is continuing to actively            pursue various funding options, including additional equity offerings, strategic            corporate alliances, business combinations and the establishment of product related            research and development limited partnerships to obtain additional financing to            continue the development of its products and bring them to commercial markets. Should            the Company be unable to raise adequate financing or generate revenue in the future,            long-term operations will need to be scaled back or discontinued.

**Cash**

At December 31,            2007, cash and cash equivalents totaled $7.5 million. At December 31, 2006 cash and            cash equivalents totaled $12.8 million. This net decrease in cash of $5.3 million was            due to the utilization of cash for operating activities. The cash and cash equivalents,            in combination with the short term investments, will be used to finance future            operating expenses.

The Company has            a lease agreement for the premises it occupies in New Jersey. The lease agreement            expires in 2009. The lease agreement is secured by a letter of credit of $65,031. This            amount is included in restricted cash at December 31, 2007.

In addition, the            Company’s subsidiary, Pharmos Ltd., has a lease agreement for the premises it            occupies in Israel. The lease agreement expired in November 2006 and was renewed for a            four year term in February 2007. There is an early termination date on January 31, 2009            with no penalty to Pharmos if the company elects to notify of early termination 150            days prior to the early termination date. The lease agreement is secured by a letter of            guarantee in the amount of $177,016 based on the Israeli consumer price index. A            deposit of $86,695 is included in restricted cash at December 31, 2007.

**Operating            activities**

Net cash used in            operating activities for 2007 was $15.4 million compared to $19.7 million for 2006. The            decrease is primarily attributed to lower research and development costs and general            and administrative expenses incurred in 2007.

**Capital            expenditures**

Our capital            expenditures for property, plant and equipment for 2007, 2006 and 2005 totaled            approximately $177,000, $165,000 and $137,000 respectively for normal replacements and            improvements.

**Investing            activities**

In 2007, the            Company purchased short term investments that were typically auction rate securities            and investments that mature between 90 days and one year. Short term investments are            reinvested upon maturity to the extent that the funds are not needed to meet operating            activity cash flow needs. In 2007, the Company received $16.4 million in short term            investment proceeds and reinvested $6.9 million in short term investments.

The Company            considers all investments that are not considered cash equivalents and with a maturity            of less than one year from the balance sheet date to be short-term investments. The            Company considers all investments with a maturity of greater than one year to be            long-term investments. All investments are considered as held-to-maturity and are            carried at amortized cost, as the Company has both the positive intent and ability to            hold them to maturity. The Company invests in a variety of instruments such as            commercial paper, US Government securities and corporate securities with an effective            maturity of less than one year. Some of the Company’s investments are in            auction-rate securities (ARS) that are held as investments available for sale. Auction            rate securities are instruments with long-term underlying maturities, but for which an            auction is conducted periodically, as specified, to reset the interest rate and allow            investors to buy or sell the instruments. Because auctions generally occur more often            than annually, and because the Company holds these instruments in order to

41

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meet short-term            liquidity needs, the auction rate securities are classified as short-term investments            in the Consolidated Balance Sheet. Interest income includes interest, amortization of            investment purchases premiums and discounts, and realized gains and losses on sales of            securities. Realized gains and losses on sales of investment securities are determined            based on the specific identification method. The Consolidated Statement of Cash Flows            reflects the gross amount of the purchases of short term investments and the proceeds            from maturities of short term securities and sales of auction rate            securities.

At December 31,            2007 we held $2,650,000 in Auction Rate Securities (“ARS”). At February 11,            2008 we had only one remaining ARS. The one remaining ARS, issued by George Washington            University, is for $1,000,000. The reset auction for this security failed to clear on            February 13, 2008. An auction failure occurs when the parties wishing to sell            securities could not. This ARS, a general obligation of George Washington University,            was reset at the maximum rate, as defined and is backed by student loans.

If the issuers            are unable to successfully close future auctions and their credit ratings. deteriorate,            we may in the future be required to record an impairment charge on these investments.            We believe we will be able to liquidate our investment without significant loss within            the next year, and currently believe this security is not impaired, primarily due to            insurance covering the investment, however, it could take until the final maturity of            the underlying note (up to 30 years) to realize our investment’s recorded value.            Based on our current cash balances, and other potential sources of cash, we do not            anticipate the potential lack of liquidity on this investment will affect our ability            to execute our current business plan.

**Bausch &            Lomb**

In October 2001,            Bausch & Lomb purchased all rights to the Company’s loteprednol etabonate            (LE) ophthalmic product line for cash and assumption of certain ongoing obligations.            The Company received gross proceeds of approximately $25 million in cash for its rights            to Lotemax® and Alrex®, prescription products that are made and marketed by            Bausch & Lomb under a 1995 Marketing Agreement with the Company; in addition,            Bausch & Lomb also acquired future extensions of LE formulations including            Zylet®, a product that was submitted to the FDA for marketing approval in September            2003. In December 2004, Bausch & Lomb received approval from the FDA of its New            Drug Application for Zylet® as an ophthalmic anti-inflammatory/antibiotic            combination product. During January 2005, the Company received gross proceeds of            approximately $12.2 million from Bausch & Lomb. An additional milestone payment of            up to $10 million could be paid to the Company to the extent sales of the new product            exceed an agreed-upon forecast in the first two years. A review of Zylet sales provided            by Bausch and Lomb indicated that no additional payments are due the Company as actual            sales of Zylet did not reach the agreed levels. The Company had a passive role as a            member of a joint committee overseeing the development of Zylet® and had an            obligation to Bausch & Lomb to fund up to a maximum of $3.75 million of the LE-T            development cost, of which $600,000 was deducted from the purchase price paid by Bausch            & Lomb to Pharmos in October 2001. In July 2003, the Company paid Bausch & Lomb            $1.57 million of its liability for the development of Zylet®. As of December 31,            2004, Pharmos owed an additional $1.56 million as its share of these research and            development related Zylet® expenses and represents the maximum amount Pharmos owes            Bausch & Lomb. Pharmos paid Bausch & Lomb the remaining research and            development related expenses in January 2005. The Company incurred transaction and            royalty costs of approximately $2 million. The Company also compensated the LE patent            owner approximately $2.7 million ($1.5 million paid upon closing and $1.2 million paid            in October 2002) from the proceeds of the sale of Lotemax® and Alrex® in return            for his consent to the Company’s assignment of its rights under the license            agreement to Bausch & Lomb. During January 2005, the Company paid Dr. Bodor            approximately $1.3 million per the agreement with respect to Zylet®. Pharmos owes            Dr. Bodor an additional 14.3% of the payment the Company will receive from Bausch &            Lomb in the event that certain sales levels are exceeded in the first two years            following commencement of sales in the U.S.

**Common Stock            Transactions**

At the closing            of the Vela Pharmaceuticals Inc. acquisition on October 25, 2006, the Company issued            6.5 million shares of common stock and paid $6 million to Vela shareholders. Pharmos            also agreed to reimburse

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Vela for            $679,000 of operating expenses from July 1, 2006 through closing. The amended Merger            Agreement also includes additional performance-based milestone payments to the Vela            stockholders related to the development of dextofisopam, aggregating up to an            additional $8 million in cash and the issuance of up to an additional 13,500,000 shares            of Pharmos common stock. In the event that such shares or payments are issued or funded            in future periods, a determination will then be made as to whether the values are to be            written off as in-process research and development and charged to results of            operations; any such future charge could be material. None of the conditions requiring            issuance of these contingent shares or funding these payments had been met as of            December 31, 2007 except for a $1.0 million milestone payment made by Pharmos due upon            the study’s commencement.

On January 3,            2008, the Company entered into an Amendment to the Merger Agreement relating to its            acquisition of Vela. The Amendment defers the payment by the Company of certain cash            milestones payable by the Company to the former stockholders of Vela upon (A) the            enrollment of the final patient in the Company’s current Phase 2b clinical trial            for dextofisopam ($1 million payment obligation) and (B) the successful completion of            such Phase 2b trial ($2 million payment obligation). Payment of such cash milestones            will be deferred until such time as (X) the Company has successfully entered into a            strategic collaboration or licensing agreement with a third party for the development            of dextofisopam resulting in an upfront cash fee of at least $10 million, or a            financing with net proceeds of at least such amount, and (Y) payment of one or both of            the cash milestones would still leave the Company with at least one year’s            operating cash. Additionally, the Company’s obligations to issue to the former            Vela stockholders 2 million share of Common Stock after final patient enrollment in the            dextofisopam Phase 2b clinical trial and 2.25 million shares of Common Stock after a            successful Phase 2b trial are deferred until November 2, 2009.

**Other**

In 2007, 2006,            and 2005, the Company sold $12,136,911, $7,781,267, and $6,413,522, respectively, of            its State Net Operating Loss carryforwards under the State of New Jersey’s            Technology Business Tax Certificate Transfer Program (the Program). The Program allows            qualified technology and biotechnology businesses in New Jersey to sell unused amounts            of net operating loss carryforwards and defined research and development tax credits            for cash. The proceeds from the sale in 2007, 2006, and 2005 were $955,782, $612,775            and $490,634, respectively and such amounts were recorded as a tax benefit in the            consolidated statements of operations. The State renews the Program annually and limits            the aggregate proceeds to $10,000,000. We cannot be certain if we will be able to sell            any of our remaining or future carryforwards under the Program.

Under Internal            Revenue Code Section 382 rules, a change in ownership can occur whenever there is a            shift in ownership by more than 50 percentage points by one or more five-percent            shareholders within a three-year period. When a change of ownership is triggered, the            Company’s net operating losses (NOL) asset may be impaired. The Company believes            that substantially all of its Federal NOL generated since 1995 are not impaired, except for approximately $60 million relating to Vela’s results of operations prior to Vela’s acquisition by Pharmos. The Company            requests that all investors contact the Company prior to allowing their ownership            interest to reach a five-percent level.

**Commitments            and Long Term Obligations**

|                                                                               |   |                                          |    |                                                           |   |                                                            |    |                                                            |   |                                                            |    |                                  |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |
|------------------------------------------------------------------------------------|--------|-----------------------------------------------|---------|----------------------------------------------------------------|--------|-----------------------------------------------------------------|---------|-----------------------------------------------------------------|--------|-----------------------------------------------------------------|---------|---------------------------------------|--------|--------|---------|--------|--------|--------|--------|---------|--------|--------|--------|--------|---------|--------|--------|
|                                                                               |   | Payments Due by                        Period |    |
|                                                                               |   | Total                                         |    | Less                        than                        1 Year |   | 1                        – 3                        Years |    | 3                        – 5                        Years |   | More                        Than                        5 Years |    | Undetermined                        * |   |
|                                                                               |   |                                               |    |                                                                |   |                                                                 |    |                                                                 |   |                                                                 |    |                                       |   |
| Operating                        Leases                                            |   | $                                             | 548,356 |                                                           |   | $                                                               | 311,801 |                                                            |   | $                                                               | 236,555 |                                  |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |
| Other long-term                        liabilities reflected on our balance sheet* |   |                                          | 358,706 |                                                           |   |                                                            | — |                                                            |   |                                                            | — |                                  |   |   | — |   |   |   |   | — |   |   |   |   | 358,706 |   |   |
|                                                                               |   |                                               |         |                                                           |   |                                                                 |         |                                                            |   |                                                                 |         |                                  |   |        |         |   |   |   |        |         |   |   |   |        |         |   |   |
| Total                                                                              |   | $                                             | 907,062 |                                                           |   | $                                                               | 311,801 |                                                            |   | $                                                               | 236,555 |                                  |   | $      | — |   |   |   | $      | — |   |   |   | $      | 358,706 |   |   |
|                                                                               |   |                                               |         |                                                           |   |                                                                 |         |                                                            |   |                                                                 |         |                                  |   |        |         |   |   |   |        |         |   |   |   |        |         |   |   |

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|   |                                                                                                                                                                                                                                                                                                   |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *      | Consists of severance                        benefits payable under Israeli law. Because these benefits are paid only                        upon termination of employment, it is not possible to allocate the                        liability across future years. The Company has funded $264,934. |

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

In connection            with the acquisition of Vela Pharmaceuticals which closed on October 25, 2006 the            Company is obligated to pay certain performance based milestones connected to the            development of dextofisopam.

The $1.0 million            cash milestone payable when the first patient enrolled in the Phase 2b trial was paid            on June 26, 2007 as that milestone was achieved in the second quarter of 2007. Such            amount was included in research and development expense (net).

The remaining            milestones are as follows:

|   |   |                                                                                                                                                                          |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | $1                        million cash + 2 million shares of Pharmos common stock: Final patient                        enrolled in Phase 2b                        trial (1) |
|   |   |                                                                                                                                                                          |
|   | • | $2                        million cash + 2.25 million shares: Successful completion of Phase                        2b(1)                                                     |
|   |   |                                                                                                                                                                          |
|   | • | $2                        million + 2 million shares: NDA submission                                                                                                          |
|   |   |                                                                                                                                                                          |
|   | • | $2                        million cash +2.25 million shares: FDA approval                                                                                                     |
|   |   |                                                                                                                                                                          |
|   | • | 1                        million shares: Approval to market in Europe or Japan                                                                                                |
|   |   |                                                                                                                                                                          |
|   | • | 4                        million shares: $100 million sales of dextofisopam, when and if approved,                        in any 12-month period                              |

(1)            The above milestones have been amended and deferred as a condition of the convertible            debentures issued January 3, 2008. If the respective milestone is achieved, payment of            these milestones will be deferred until such time as 1). the Company has successfully            entered into a strategic collaboration or licensing agreement with a third party for            the development of dextofisopam resulting in an upfront cash fee or at least $10            million, and 2). Payment of one or both of the cash milestones would still leave the            Company with at least one year’s operating cash. Additionally, the Vela            acquisition agreement has been amended to defer the equity milestones issuable to the            Vela shareholders related to such Phase 2b events until November 1, 2009 at the            earliest.

Management            believes that cash, cash equivalents, and short term investments of $11.2 million as of            December 31, 2007, combined with our $4.0 million private placement of convertible            debentures in January 2008, will be sufficient to support the Company’s            continuing operations beyond December 31, 2008. The Company is continuing to actively            pursue various funding options, including additional equity offerings, strategic            corporate alliances, business combinations and the establishment of product related            research and development limited partnerships to obtain additional financing to            continue the development of its products and bring them to commercial            markets.

The Company has            assessed its vulnerability to certain market risks, including interest rate risk            associated with financial instruments included in cash and cash equivalents, short term            investments, restricted cash and the currency impact in Israel. Due to the relatively            short-term nature of these investments the Company has determined that the risks            associated with interest rate fluctuations related to these financial instruments do            not pose a material risk to us. The value of the warrant liability is based upon the            Company’s stock price, which has historically shown wide fluctuations.

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**New            accounting pronouncements**

In September            2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS            157”). SFAS 157 establishes a single authoritative definition of fair value, sets            out a framework for measuring fair value, and requires additional disclosures about            fair-value measurements. SFAS 157 applies only to fair value measurements that are            already required or permitted by other accounting standards (except for measurements of            share-based payments) and is expected to increase the consistency of those            measurements. Accordingly, SFAS 157 does not require any new fair value measurements.            However, for some entities, the application of SFAS 157 will change current practice.            SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim            periods within those fiscal years. The Company does not expect the adoption of SFAS 157            to have a material impact on our consolidated financial statements.

In February            2007, the FASB issued Statement of Financial Accounting Standards “(FAS) No.            159”, “The Fair Value Option for Financial Assets and Financial            Liabilities, Including an Amendment of FASB Statement No. 115” “(FAS No.            159)”, which is effective for financial statements issued for fiscal years            beginning after November 15, 2007 and interim periods within those fiscal years. SFAS            No. 159 permits entities to measure eligible financial assets, financial liabilities            and firm commitments at fair value, on an instrument-by-instrument basis, that are            otherwise not permitted to be accounted for at fair value under other generally            accepted accounting principles. The fair value measurement election is irrevocable and            subsequent changes in fair value must be recorded in earnings. The Company is currently            evaluating the impact that SFAS No. 159 will have on its consolidated financial            statements.

On June 27,            2007, the FASB reached a final consensus on Emerging Issues Task Force Issue 07-3,            “Accounting for Advance Payments for Goods or Services to Be Used in Future            Research and Development Activities” (“EITF 07-03”). Currently, under            FASB Statement No. 2, “Accounting for Research and Development Costs”,            nonrefundable advance payments for future research and development activities for            materials, equipment, facilities, and purchased intangible assets that have no            alternative future use are expensed as incurred. EITF 07-03 addresses whether such            non-refundable advance payments for goods or services that have no alternative future            use and that will be used or rendered for research and development activities should be            expensed when the advance payments are made or when the research and development            activities have been performed. The consensus reached by the FASB requires companies            involved in research and development activities to capitalize such non-refundable            advance payments for goods and services pursuant to an executory contractual            arrangement because the right to receive those services in the future represents a            probable future economic benefit. Those advance payments will be capitalized until the            goods have been delivered or the related services have been performed. Entities will be            required to evaluate whether they expect the goods or services to be rendered. If an            entity does not expect the goods to be delivered or services to be rendered, the            capitalized advance payment will be charged to expense. The consensus on EITF 07-03 is            effective for financial statements issued for fiscal years beginning after December 15,            2007, and interim periods within those fiscal years. Earlier application is not            permitted. Entities are required to recognize the effects of applying the guidance in            EITF 07-03 prospectively for new contracts entered into after the effective date. The            Company is in the process of evaluating the expected impact of EITF 07-03 on its            financial position and results of operations following adoption.

**Item 7A.            Quantitative and Qualitative Disclosures About Market Risk**

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

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**Item 8.            Financial Statements and Supplementary Data**

The information            called for by this Item 8 is included following the “Index to Consolidated            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.

**Item 9A.            Controls and Procedures**

***Evaluation            of Disclosure Controls and Procedures***

Our management,            with the participation of our principal executive officer and principal financial            officer, has evaluated the effectiveness of the design and operation of our disclosure            controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act            of 1934, as amended (the “Act”) as of the end of the period covered by this            annual report on Form 10-K. Based on this evaluation, our principal executive officer            and principal financial officer concluded that these disclosure controls and procedures            were effective as of such date, at a reasonable level of assurance, in ensuring that            the information required to be disclosed by our company in the reports we file or            submit under the Act is (i) accumulated and communicated to our management (including            the principal executive officer and principal financial officer) in a timely manner,            and (ii) recorded, processed, summarized and reported within the time periods specified            in the SEC’s rules and forms.

***Internal            Control Over Financial Reporting***

Management is            responsible for establishing and maintaining adequate internal control over financial            reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the            supervision and with the participation of our management, including our Chief Executive            Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of            Pharmos’s internal control over financial reporting based on the criteria in            Internal Control – Integrated Framework issued by the Committee of Sponsoring            Organizations of the Treadway Commission. Based on our evaluation, management has            concluded that Pharmos’s internal control over financial reporting was effective            as of December 31, 2007. This annual report does not include an attestation report            of our registered public accounting firm regarding internal control over financial            reporting pursuant to temporary rules of the Securities and Exchange            Commission.

***Changes in            Internal Control Over Financial Reporting***

There was no            change in our internal control over financial reporting (as defined in Rule 13a-15(f)            under the Securities Exchange Act of 1934, as amended) during our last fiscal quarter            that has materially affected, or is reasonably likely to materially affect, our            internal control over financial reporting.

**Item 9B.            Other Information**

None.

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**PART            III**

**Item 10.            Directors, Executive Officers and Corporate Governance**

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

|                                                |   |    |   |                                                                               |
|-----------------------------------------------------|--------|---------|--------|------------------------------------------------------------------------------------|
| **Name**                                            |   | **Age** |   | **Position**                                                                       |
|                                                     |   |         |   |                                                                                    |
| Robert F.                        Johnston           |   | 71      |   | Executive Chairman of                        the Board of Directors                |
| S.                        Colin Neill               |   | 61      |   | President, Chief                        Financial Officer, Secretary and Treasurer |
| Srinivas Akkaraju, MD,                        Ph.D* |   | 39      |   | Director                                                                           |
| Anthony B. Evnin,                        Ph.D*      |   | 67      |   | Director                                                                           |
| Lloyd Miller                        III*            |   | 54      |   | Director                                                                           |
| Elkan R. Gamzu,                        Ph.D         |   | 65      |   | Director                                                                           |
| Charles W. Newhall                        III       |   | 63      |   | Director                                                                           |

|   |                                                  |
|--------|-------------------------------------------------------|
| *      | Members of the Audit                        Committee |

Robert F.            Johnston became Executive Chairman of the Board of Directors of Pharmos in January            2008. Mr. Johnston, a venture capitalist, is President of Johnston Associates which he            founded in 1968 to provide financing for emerging companies in the biotechnology and            healthcare fields. Mr. Johnston was a founder and Chairman of Vela Pharmaceuticals,            Inc., which merged into Pharmos in late 2006, and has founded numerous public companies            including Sepracor, Cytogen, I-STAT, Ecogen, Genex and Envirogen. He also played an            active and key role in the early formations of private companies such as Sonomed,            Immunicon, PharmaStem (formerly Biocyte), ExSAR and Targent. Mr. Johnston served as CEO            of Cytogen from July 1988 to April 1989. He is also a member of the Advisory Council of            the Department of Molecular Biology at Princeton University and the Executive Committee            of the Friends of the Institute for Advanced Study in Princeton, as well as Founder and            President of Educational Ventures, a foundation focused on funding improvements in the            educational system; and Vice-Chairman of Center for Education Reform (CER) an advocate            for charter schools. Mr. Johnston received his B.A. from Princeton University and his            M.B.A. from New York University.

S. Colin Neill            became President of Pharmos in January 2008, and has served as Chief Financial Officer,            Secretary, and Treasurer of Pharmos since October 2006. Prior to becoming President, he            also served as Senior Vice President from October 2006 to January 2008. From September            2003 to October 2006, Mr. Neill served as Chief Financial Officer, Treasurer and            Secretary of Axonyx Inc., a biopharmaceutical company that develops products and            technologies to treat Alzheimer’s disease and other central nervous system            disorders, where he played an integral role in the merger between Axonyx and            TorreyPines Therapeutics Inc., a privately-held biopharmaceutical company. Mr. Neill            served as Senior Vice President, Chief Financial Officer, Secretary and Treasurer of            ClinTrials Research Inc., a $100 million publicly traded global contract research            organization in the drug development business, from 1998 to its successful sale in            2001. Following that sale from April 2001 to September 2003 Mr. Neill served as an            independent consultant assisting small start-up and development stage companies in            raising capital. Earlier experience was gained as Vice President Finance and Chief            Financial Officer of BTR Inc., a $3.5 billion US subsidiary of BTR plc, a British            diversified manufacturing company, and Vice President Financial Services of The BOC            Group Inc., a $2.5 billion British owned industrial gas company with substantial            operations in the health care field. Mr. Neill served four years with American Express            Travel Related Services, first as chief internal auditor for worldwide operations and            then as head of business planning and financial analysis. Mr. Neill began his career in            public accounting with Arthur Andersen LLP in Ireland and later with Price Waterhouse            LLP as a senior manager in New York City. He also served with Price Waterhouse for two            years in Paris, France. Mr. Neill graduated from Trinity College, Dublin with a first            class honors degree in Business/Economics and he holds a masters degree in Accounting            and Finance from the London School of Economics. He is a Certified Public Accountant in            New York State and a Chartered Accountant in Ireland. Mr. Neill serves on the board of            OXIS International, Inc. and Pro Pharmaceuticals, Inc.

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Elkan R. Gamzu,            Ph.D., a Director of the Company since February 2000 and Chief Executive Officer            between March 2007 and January 2008, is a consultant to the biotechnology and            pharmaceutical industries, a Principal of enERGetics Biopharmaceutical Consultancy,            LLC, and was a founding partner of the due diligence company BioPharmAnalysis, LLC.            From December 1, 2004 until February 24, 2005, Dr. Gamzu was the interim CEO of XTL            Biopharmaceuticals, Ltd. Prior to becoming a consultant, Dr. Gamzu held a number of            senior executive positions in the biotechnology and pharmaceutical companies, including            President and Chief Executive Officer of Cambridge Neuroscience, Inc. from 1994 until            1998. Dr. Gamzu also served as President and Chief Operating Officer and Vice President            of Development for Cambridge Neuroscience, Inc. from 1989 to 1994. Previously, Dr.            Gamzu held a variety of senior positions with Warner-Lambert where he was Vice            President, Development and Hoffmann-La Roche, Inc. In 2001 and 2002, Dr. Gamzu was            part-time Interim VP, Product Management Leadership for Millennium Pharmaceuticals,            Inc. Dr. Gamzu is a member of the Board of Directors of three other biotechnology            companies: the privately held biotechnology companies Neurotech Inc., NeuroHealing            Pharmaceuticals Inc. and AviTx Inc., for which he also serves as President.

Srinivas            Akkaraju, M.D., Ph.D., a director since October 2006, is a Managing Director of            Panorama Capital, LLC, a private equity firm founded by the former venture capital            investment team of J.P. Morgan Partners, LLC, a private equity division of JPMorgan            Chase & Co. Panorama Capital is advising J.P. Morgan Partners as to its investment            in the Company. Prior to August 1, 2006, Dr. Akkaraju was a Partner with J.P. Morgan            Partners, LLC which he joined in April 2001. Prior to JPMorgan Partners, LLC, from            October 1998 to April 2001, Dr. Akkaraju was in the Business and Corporate Development            group at Genentech, Inc. where he served in various capacities, most recently as Senior            Manager and project team leader for one of Genentech’s clinical development            products. Dr. Akkaraju is currently a member of the Board of Directors of Barrier            Therapeutics, Inc., Seattle Genetics, Inc., and several private biotechnology            companies. Dr. Akkaraju received his undergraduate degrees in Biochemistry and Computer            Science from Rice University and his M.D. and Ph.D. in Immunology from Stanford            University.

Anthony B.            Evnin, Ph.D., a director since October 2006, is a General Partner of Venrock, a venture            capital firm, where he has been a Partner since 1975. He is currently a member of the            Board of Directors of Icagen, Inc., Infinity Pharmaceuticals, Inc., Memory            Pharmaceuticals Corp., Renovis, Inc., and Sunesis Pharmaceuticals, Inc., as well as            being on the Board of Directors of a number of private companies. He was formerly a            director of IDEC Pharmaceuticals Corporation, Dianon Systems, Inc., BioSurface            Technologies, Inc., Sepracor, Inc., IDEXX Laboratories, Inc., Athena Neurosciences,            Inc., Genetics Institute, Inc., SUGEN, Inc., Axys Pharmaceuticals, Inc., Centocor,            Inc., Ribozyme Pharmaceuticals, Inc., Triangle Pharmaceuticals, Inc., Caliper Life            Sciences, Inc., and Sonic Innovations, Inc. Dr. Evnin received an A.B. in Chemistry            from Princeton University and a Ph.D. in Chemistry from the Massachusetts Institute of            Technology.

Lloyd I. Miller,            III, a director since October 2006, is a registered investment advisor and has been a            member of the Chicago Board of Trade since 1978 and a member of the Chicago Stock            Exchange since 1996. Mr. Miller is currently a director of Stamps.com, American            BankNote Corporation and Synergy Brands Inc. Mr. Miller previously served on the board            of directors of several other companies, including Anacomp, Denny’s Corporation,            Vulcan International, Celeritek, Inc., Dynabazaar, Inc. (formerly FairMarket, Inc.),            American Controlled Industries and Aldila Inc. Mr. Miller’s principal occupation            is investing assets held by Mr. Miller on his own behalf and on behalf of his family.            Mr. Miller graduated from Brown University in 1977 with a Bachelor’s            Degree.

Charles W.            Newhall III, a director since October 2006, co-founded New Enterprise Associates (NEA).            Founded in 1978, Baltimore-based NEA is one of the largest Venture Capital firms in the            United States. To date Mr. Newhall has served as a director of over 40 venture            backed companies. Many have gone public and have been acquired. Several of these            companies achieved market capitalizations in excess of $1 billion. He also started            several healthcare information technology companies like PatientKeeper, TargetRx, and            LifeMetrix. Some of his current board memberships include Vitae Pharmaceuticals,            Supernus Pharmaceuticals, Co-Genesys, Bravo Health, Hospital Partners of America,            TargetRx, and Sensors for Medicine and Science.

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In 1986 he            founded the Mid-Atlantic Venture Capital Association (MAVA), which now has over 80            venture capital firms that are members, and is one of the most active regional venture            associations in the country. He is Chairman Emeritus of MAVA. Before NEA, Mr. Newhall            was a Vice President of T. Rowe Price. He served in Vietnam commanding an independent            platoon including an initial reconnaissance of Hamburger Hill. His decorations include            the Silver Star and Bronze Star V (1st OLC.) He received an MBA from Harvard Business            School, and an Honors Degree in English from the University of Pennsylvania.

**Role of the Board; Corporate            Governance Matters**

It is the            paramount duty of the Board of Directors to oversee the Chief Executive Officer and            other senior management in the competent and ethical operation of the Company on a            day-to-day basis and to assure that the long-term interests of the shareholders are            being served. To satisfy this duty, the directors set standards to ensure that the            Company is committed to business success through maintenance of the highest standards            of responsibility and ethics.

Members of the            Board bring to the Company a wide range of experience, knowledge and judgment. The            governance structure in the Company is designed to be a working structure for            principled actions, effective decision-making and appropriate monitoring of both            compliance and performance. The key practices and procedures of the Board are outlined            in the Company’s Code of Ethics and Business Conduct, which is available on the            Company’s website at www.pharmoscorp.com. Click “Investors,”            and then “Corporate Governance.”

**Board            Committees**

The Board has a            standing Compensation Committee, Governance and Nominating Committee and Audit            Committee.

The Compensation            Committee is primarily responsible for reviewing the compensation arrangements for the            Company’s executive officers, including the Chief Executive Officer, and for            administering the Company’s stock option plans. Members of the Compensation            Committee are Messrs. Newhall and Evnin.

The Governance            and Nominating Committee, created by the Board in February 2004, assists the Board in            identifying qualified individuals to become directors, determines the composition of            the Board and its committees, monitors the process to assess Board effectiveness and            helps develop and implement the Company’s corporate governance guidelines.            Members of the Governance and Nominating Committee are Messrs. Miller, Newhall and            Evnin.

The Audit            Committee is primarily responsible for overseeing the services performed by the            Company’s independent registered public accounting firm and evaluating the            Company’s accounting policies and its system of internal controls. Consistent            with the Nasdaq audit committee structure and membership requirements, the Audit            Committee is comprised of three members: Messrs. Evnin, Miller and Akkaraju, all of            whom are independent directors. While more than one member of the Company’s Audit            Committee qualifies as an “audit committee financial expert” under Item            407(d)(5) of Regulation S-K, Mr. Miller, the Committee chairperson, is the designated            audit committee financial expert. Mr. Miller is considered “independent”            under applicable Nasdaq rules.

The Audit            Committee, Compensation Committee and Governance and Nominating Committee each operate            under written charters adopted by the Board. These charters are available on the            Company’s website at www.pharmoscorp.com. Click “Investors,” and then            “Corporate Governance.”

**Code of Ethics**

As part of our            system of corporate governance, our Board of Directors has adopted a Code of Ethics and            Business Conduct that is applicable to all employees and specifically applicable to our            chief executive officer,

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president, chief            financial officer and controllers. The Code of Ethics and Business Conduct is available            on the Company’s website at www.pharmoscorp.com. Click “Investors,”            and then “Corporate Governance.” We intend to disclose any changes in or            waivers from our Code of Ethics and Business Conduct by filing a Form 8-K or by posting            such information on our website.

**Section 16(a) Beneficial            Ownership Reporting Compliance**

No person who,            during the fiscal year ended December 31, 2007, was a “Reporting Person”            defined as 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”), 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.

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**Item 11. Executive            Compensation**

**COMPENSATION            DISCUSSION AND ANALYSIS**

**General Executive            Compensation Policy**

The Compensation            and Stock Option Committee of the Board of Directors establishes the general            compensation policies of the Company, the compensation plans and specific compensation            levels for executive officers, and administers the Company’s 2001 Employee Stock            Purchase Plan, as well as the 2000, 1997 and 1992 Incentive and Non-Qualified Stock            Option Plans. The Compensation and Stock Option Committee is composed of two            independent, non-employee Directors who have no interlocking relationships as defined            by the Securities and Exchange Commission.

The Compensation            and Stock Option Committee, being responsible for overseeing and approving executive            compensation and grants of stock options, is in a position to appropriately balance the            current cash compensation considerations with the longer-range incentive-oriented            growth outlook associated with stock options. The main objectives of the            Company’s compensation structure include rewarding individuals for their            respective contributions to the Company’s performance, establishing executive            officers with a stake in the long-term success of the Company and providing            compensation policies that will attract and retain qualified executive            personnel.

The Compensation            and Stock Option Committee uses no set formulas and may accord different weight to            different factors for each executive. The Committee looks toward the progress of the            Company’s research and development programs and its clinical programs, its            ability to gain support for those programs, either internally or externally, its            ability to attract, motivate and retain talented employees and its ability to secure            capital sufficient for its product development to achieve rapid and effective            commercialization as may be practicable.

The Compensation            and Stock Option Committee believes that the chief executive officer’s            compensation should be heavily influenced by Company performance. Although the officers            existing employment agreement with the Company (see “Employment Contracts”)            provides for a base level of compensation, the Committee determines the appropriate            level of bonuses and increases, if any, based in large part on Company performance. The            Committee also considers the salaries of CEOs of comparably-sized companies and their            performance. Stock options are granted to the CEO, as to other executives, primarily            based on the executive’s ability to influence the Company’s long-term            growth.

The Compensation            and Stock Option Committee has adopted similar policies with respect to compensation of            other officers of the Company. The Committee establishes base salaries that are within            the range of salaries for persons holding positions of similar responsibility at other            companies. In addition, the Committee considers factors such as relative Company            performance, the executive’s past performance and future potential in            establishing the base salaries of executive officers.

As with the CEO,            the number of options granted to the other officers is determined by the subjective            evaluation of the executive’s ability to influence the Company’s long-term            growth. All options are granted at no less than the current market price. Since the            value of an option bears a direct relationship to the Company’s stock price, it            is an effective incentive for managers to create value for shareholders. The Committee            therefore views stock options as an important component of its long-term,            performance-based compensation philosophy.

**Executive Officers’            Compensation Paid in 2007**

***Cash            Compensation.*** During 2005, the Company redirected its efforts to drug discovery            activities, to the development of early stage drug candidates and to business            development activities involving potential strategic alliances, product acquisitions            and mergers and acquisitions. As a result, the Company significantly reduced its            operating expenses in 2005. Consistent with this retrenchment and refocusing of            efforts, and following the unfavorable clinical trial results in December 2004 for            dexanabinol which was tested as an agent to treat severe traumatic brain injury, the            Compensation and Stock Option Committee determined in January 2006 not to            award

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any cash bonus            to the Company’s Chief Executive Officer, Dr. Haim Aviv who was awarded a cash            bonus of $50,000 for his 2006 performance. The Committee increased his annual base            compensation 3%, effective January 1, 2007, from $322,396 for 2006 to $332,068 for            2007.

Dr. Elkan R            Gamzu was hired February 26, 2007 as Chief Executive Officer. Dr. Gamzu separated from            the Company effective January 3, 2008. Dr. Gamzu’s 2007 compensation of $452,500            includes $252,500 in salary and $200,000 in accrued severance compensation in            accordance with his employment agreement.

Under the terms            of his employment contract, Alan Rubino, the Company’s Former President and Chief            Operating Officer, received a cash bonus of $100,000 in January 2007 for his            performance in 2006, and an increase of 3% in his base compensation effective January            1, 2007 from $315,000 for 2006 to $324,450 for 2007. Mr. Rubino separated from the            Company effective December 18, 2007, and in accordance with his employment contract            received $486,675 in severance compensation.

Under the terms            of his employment contract, Colin Neill, the Company’s President and Chief            Financial Officer, received a cash bonus of $18,750 in January 2007 for his performance            in 2006. Pursuant to the terms of his employment agreement, Mr. Neill’s base            salary in 2007 was $265,000.

***Stock            Options.*** The Committee in January 2007 awarded Dr. Aviv 60,000 stock options,            Alan Rubino 50,000 stock options and Colin Neill 40,000 stock options under the            Company’s 2000 Stock Plan, with 25% vesting on the first anniversary of the date            of grant and the remainder vesting in twelve equal quarterly installments over the next            three years, and exercisable at the fair market value of the Company’s Common            Stock as of the date of grant. These grants were similar to grants made to the            Company’s officers in earlier years and continue to incentivize management to            create value for shareholders.

Dr. Haim            Aviv’s unvested existing stock option grants were vested and the exercise term            was extended to the original grant term in accordance with his employment and            employment termination agreements.

Alan            Rubino’s unvested existing stock option grants were vested and the exercise term            was extended to the original grant term in accordance with his employment and            employment termination agreements.

The Committee            also awarded 150,000 and 200,000 stock options to Dr. Elkan Gamzu in conjuction with            his employment agreement in February 2007 under the Company’s 2000 Stock Plan            with 25% vesting on the first anniversary of the date of grant and the remainder            vesting in twelve equal quarterly installments over the next three years, and            exercisable at the fair market value of the Company’s Common Stock as of the date            of grant. Subsequently, in accordance with Dr. Elkan’s separation agreement, 25%            of these options will vest with an exercise life through January 3, 2009. The balance            of the February 2007 grants are forfeited effective January 3, 2008.

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**Bonuses for 2007 and            Compensation Determinations for 2008**

***Cash            Compensation****.* In January, 2008, the Compensation and Stock Option            Committee decided, based on his performance in 2007, to award Colin Neill a cash bonus            of $50,000. The Committee increased his annual base compensation 13%, effective January            1, 2008, from $265,000 for 2007 to $300,000 for 2008 reflecting his increased            responsibilities and duties as President and Chief Financial Officer.

***Equity            Compensation****.* Mr. Neill also received a portion of his bonus for 2007 in            the form of 75,000 shares of common stock. Seeking to base a significant part of their            respective compensation on future performance, the Committee in January 2008 awarded            350,000 ten-year stock options to Mr. Johnston and 130,000 ten-year stock options to            Mr. Neill all under the Company’s 2000 Stock Plan. Mr. Johnston will also be            eligible for an additional grant of 100,000 ten-year stock options on October 1, 2008            if certain performance-based milestones are achieved prior to that date in the areas of            corporate development and clinical product trials.

**March 2007 Chief Executive            Officer Transition**

On February 26,            2007, Elkan Gamzu, Ph.D., was appointed by the Board of Directors to become Chief            Executive Officer, effective March 31, 2007. Dr. Aviv retired as Chief Executive            Officer and Chief Scientist on that date, but remained as Chairman of the            Board.

**December 2007 and January            2008 Officer Transitions**

On December 12,            2007 Alan Rubino resigned as President and Chief Operating Officer of the Company. On            January 3, 2008, the Company announced that Elkan Gamzu, Ph.D., who had been Chief            Executive Officer, retired from that position and will remain on the Board. Robert F.            Johnston was named as the Company’s new Executive Chairman of the Board of            Directors, and Colin Neill was named to serve as President in addition to his            responsibilities as Chief Financial Officer, Treasurer and Secretary.

**COMPENSATION            AND STOCK OPTION COMMITTEE REPORT**

The Compensation            and Stock Option Committee of Pharmos Corporation has reviewed and discussed the            Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with            management and, based on such review and discussions, the Compensation and Stock Option            Committee has recommended to the Board that the Compensation Discussion and Analysis be            included in this Annual Report on Form 10-K.

|   |                                           |
|--------|------------------------------------------------|
|   | THE COMPENSATION                        AND    |
|   | STOCK OPTION                        COMMITTEE  |
|   | Anthony B.                        Evnin        |
|   | Charles W. Newhall,                        III |

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**SUMMARY            COMPENSATION TABLE**

|                                                                                                                                                                                                                                                                                                                                                 |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| The                        following table summarizes the total compensation of the Chief Executive                        Officer of the Company in 2007 and the two previous years, as well as all                        other executive officers of the Company who received compensation in excess                        of $100,000 for 2007. |

|                                                |   |   |   |   |    |   |   |   |   |    |                                 |        |                                                                 |    |   |                                      |   |    |   |   |   |   |   |      |   |   |
|-----------------------------------------------------|--------|--------|--------|--------|---------|--------|--------|--------|--------|---------|--------------------------------------|--------|----------------------------------------------------------------------|---------|--------|-------------------------------------------|--------|---------|--------|--------|--------|--------|--------|-----------|--------|--------|
| Name/Principal                        Position      |   | Year   |   | Salary |    |   |   | Bonus  |   |         | Option                        Awards |   | All                        Other                        Compensation |    |   | Total                        Compensation |   |
|                                                     |   |        |   |        |    |   |   |        |   |         |                                      |   |                                                                      |    |   |                                           |   |
|                                                |   |   |   |   |    |   |   |   |   |    |                                 |        |                                                                 |    |   |                                      |   |    |   |   |   |   |   |      |   |   |
| Haim Aviv, Ph.D.                        former      |   | 2007   |   | $      | 362,533 | (1)    |   |   | $      | 120,073 |                                 |        | $                                                                    | 571,777 |   |                                      | $      | 211,142 | (2)    |   |   |   | $      | 1,265,525 |   |   |
| Chairman, Chief                        Executive    |   | 2006   |   | $      | 322,396 |   |   |   | $      | 170,000 |                                 |        | $                                                                    | 78,379  |   |                                      | $      | 34,692  | (2)    |   |   |   | $      | 605,467   |   |   |
| Officer and Chief                        Scientist  |   | 2005   |   | $      | 308,497 |   |   |   |   |    |                                 |        |                                                                 |    |   |                                      | $      | 37,412  | (2)    |   |   |   | $      | 345,909   |   |   |
|                                                |        |        |        |        |         |        |        |        |        |         |                                      |        |                                                                      |         |        |                                           |        |         |        |        |        |        |        |           |        |        |
| Elkan R. Gamzu,                        Ph.D,        |   | 2007   |   | $      | 452,500 | (3)    |   |   |   |    |                                 |        | $                                                                    | 18,346  |   |                                      | $      | 6,750   | (4)    |   |   |   | $      | 477,596   |   |   |
| Director and former                        Chief    |   | 2006   |   |   |    |   |   |   |   |    |                                 |        |                                                                 |    |   |                                      |   |    |   |   |   |   |   |      |   |   |
| Executive                        Officer            |   | 2005   |   |   |    |   |   |   |   |    |                                 |        |                                                                 |    |   |                                      |   |    |   |   |   |   |   |      |   |   |
|                                                |        |        |        |        |         |        |        |        |        |         |                                      |        |                                                                      |         |        |                                           |        |         |        |        |        |        |        |           |        |        |
| Alan L.                        Rubino               |   | 2007   |   | $      | 797,606 | (6)    |   |   |   |    |                                 |        | $                                                                    | 185,520 |   |                                      | $      | 32,895  | (5)    |   |   |   | $      | 1,016,021 |   |   |
| Former President                        & Chief |   | 2006   |   | $      | 315,000 |   |   |   | $      | 160,000 |                                 |        | $                                                                    | 136,800 |   |                                      | $      | 24,454  | (5)    |   |   |   | $      | 636,254   |   |   |
| Operating                        Officer            |   | 2005   |   | $      | 41,761  | (6)    |   |   | $      | 52,500  |                                 |        |                                                                 |    |   |                                      | $      | 1,277   | (5)    |   |   |   | $      | 95,538    |   |   |
|                                                |        |        |        |        |         |        |        |        |        |         |                                      |        |                                                                      |         |        |                                           |        |         |        |        |        |        |        |           |        |        |
| S. Colin                        Neill               |   | 2007   |   | $      | 265,000 |   |   |   | $      | 75,000  | (8)                                  |        | $                                                                    | 31,036  |   |                                      | $      | 20,712  | (9)    |   |   |   | $      | 391,748   |   |   |
| President,                                          |   | 2006   |   | $      | 62,938  | (7)    |   |   | $      | 38,750  |                                 |        | $                                                                    | 40,199  |   |                                      | $      | 2,800   | (9)    |   |   |   | $      | 144,687   |   |   |
| Chief Financial                        Officer,     |   | 2005   |   |   |    |   |   |   |   |    |                                 |        |                                                                 |    |   |                                      |   |    |   |   |   |   |   |      |   |   |
| Secretary &                        Treasurer    |   |   |   |   |    |   |   |   |   |    |                                 |        |                                                                 |    |   |                                      |   |    |   |   |   |   |   |      |   |   |

54

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|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1)    | Dr.                        Haim Aviv served as Chief Executive Officer through March 31, 2007. His                        compensation consists of compensation paid in the US and Israel. 2007                        compensation includes $250,418 in consulting income paid to Dr. Aviv in                        accordance with his severance agreement. Dr. Aviv resigned from the Board                        of Directors in January 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (2)    | In                        2007, consists of deferred payment obligations of the Company equal to the                        cost of premiums that would otherwise have been payable to maintain a split                        dollar life insurance policy for $96,945, $105,844 in insurance premiums                        and/or car allowance and $8,353 in retirement benefits. In 2006, consists                        of deferred payment obligations of the Company equal to the cost of                        premiums that would otherwise have been payable to maintain a split dollar                        life insurance policy for $18,537, $10,782 in insurance premiums and/or car                        allowance and $5,373 in retirement benefits. In 2005, consists of deferred                        payment obligations of the Company equal to the cost of premiums that would                        otherwise have been payable to maintain a split dollar life insurance                        policy for $17,125 and $20,287 in insurance premiums and/or car                        allowance. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (3)    | Dr.                        Gamzu served as Chief Executive Officer from March 2007 to January 2008.                        Dr. Gamzu’s compensation consists of $252,500 in salary and $200,000                        in employment contract severance payments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (4)    | Consists of 401k                        employer contribution.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (5)    | Consists of                        contributions to insurance premiums and/or car allowance and 401k employer                        contribution.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (6)    | Mr.                        Rubino joined Pharmos Corporation in November 2005 and served as President                        and Chief Operating Officer through December 12, 2007. Mr. Rubino’s                        2007 compensation consists of $310,931 in salary and $486,675 in severance                        payments in accordance with his employment contract.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (7)    | Mr.                        Neill joined Pharmos Corporation in October 2006. He became President in                        January 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (8)    | Consists of $50,000 in cash and                    75,000 shares of common stock valued at $25,000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (9)    | In                        2007, consists of $6,750 in 401k employer contribution, 4,962 in life                        insurance and $9,000 in automobile allowance. In 2006, consists of $662 in                        401k employer contribution and $2,138 in automobile allowance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

|                                                                                                                              |   |                              |   |                                                                                                                                                                                                                                  |   |                                                                                         |   |                                                                                                                                             |   |   |   |   |   |    |   |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|---------|--------|--------|
| **GRANTS OF PLAN-BASED                        AWARDS IN 2007**                                                                    |
|                                                                                                                              |
|                                                                                                                                   |
|                                                                                                                              |   |                              |   |                                                                                                                                                                                                                                  |   |                                                                                         |   |                                                                                                                                             |   |   |   |   |
| Name                                                                                                                              |   | Grant                        Date |   | All                        other                        Option                        Awards:                        Number of                        Securities                        Underlying                        Options (#) |   | Exercise or Base Price                        of                        Option Awards ($/Sh) |   | Grant                        Date Fair                        Value of Stock                        and Option                        Awards ($) |   |
|                                                                                                                                   |   |                                   |   |                                                                                                                                                                                                                                       |   |                                                                                              |   |                                                                                                                                                  |   |
|                                                                                                                              |   |                              |   |                                                                                                                                                                                                                                  |   |                                                                                         |   |                                                                                                                                             |   |   |   |   |   |    |   |   |
| Haim Aviv, PhD                        (1)                                                                                         |   | 1/17/2007                         |   | 60,000                                                                                                                                                                                                                                |   |                                                                                         |   | $                                                                                                                                                | 1.84   |   |   |   | $      | 71,316  |   |   |
|                                                                                                                              |   |                              |   |                                                                                                                                                                                                                                  |   |                                                                                         |   |                                                                                                                                             |   |   |   |   |   |    |   |   |
|                                                                                                                              |   |                              |   |                                                                                                                                                                                                                                  |   |                                                                                         |   |                                                                                                                                             |   |   |   |   |   |    |   |   |
| Elkan R. Gamzu,                        Ph.D, (2)                                                                                  |   | 1/17/2007                         |   | 20,000                                                                                                                                                                                                                                |   |                                                                                         |   | $                                                                                                                                                | 1.84   |   |   |   | $      | 26,659  |   |   |
|                      (3) |   | 2/26/2007                         |   | 150,000                                                                                                                                                                                                                               |   |                                                                                         |   | $                                                                                                                                                | 1.55   |   |   |   | $      | 168,343 |   |   |
|                      (4) |   | 3/31/2007                         |   | 200,000                                                                                                                                                                                                                               |   |                                                                                         |   | $                                                                                                                                                | 1.46   |   |   |   | $      | 210,808 |   |   |
|                                                                                                                              |   |                              |   |                                                                                                                                                                                                                                  |   |                                                                                         |   |                                                                                                                                             |   |   |   |   |   |    |   |   |
|                                                                                                                              |   |                              |   |                                                                                                                                                                                                                                  |   |                                                                                         |   |                                                                                                                                             |   |   |   |   |   |    |   |   |
| Alan L. Rubino                        (5)                                                                                         |   | 1/17/2007                         |   | 50,000                                                                                                                                                                                                                                |   |                                                                                         |   | $                                                                                                                                                | 1.84   |   |   |   | $      | 66,647  |   |   |
|                                                                                                                              |   |                              |   |                                                                                                                                                                                                                                  |   |                                                                                         |   |                                                                                                                                             |   |   |   |   |   |    |   |   |
| S. Colin Neill                        (6)                                                                                         |   | 1/17/2007                         |   | 40,000                                                                                                                                                                                                                                |   |                                                                                         |   | $                                                                                                                                                | 1.84   |   |   |   | $      | 53,317  |   |   |

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1)                        25% of the options granted to Dr. Aviv were to vest upon the first                        anniversary of the grant with the remaining 75% of the grant vesting                        ratably on a quarterly basis over the three years following the first                        anniversary of the grant. This grant was accelerated and fully vested in                        accordance with Dr. Aviv’s separation agreement in March                        2007. |

55

----

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)                        25% of the options granted to Dr. Gamzu vest upon the first anniversary of                        the grant with the remaining 75% of the grant vesting ratably on a                        quarterly basis over the three years following the first anniversary of the                        grant.                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (3)                        25% of the options granted to Dr. Gamzu vest upon the first anniversary of                        the grant with the remaining 75% of the grant vesting ratably on a                        quarterly basis over the three years following the first anniversary of the                        grant.                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (4)                        25% of the options granted to Dr. Gamzu vest upon the first anniversary of                        the grant with the remaining 75% of the grant vesting ratably on a                        quarterly basis over the three years following the first anniversary of the                        grant.                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (5)                        25% of the options granted to Mr. Rubino were to vest upon the first                        anniversary of the grant with the remaining 75% of the grant vesting                        ratably on a quarterly basis over the three years following the first                        anniversary of the grant. This grant was accelerated and fully vested in                        accordance with Mr. Rubino’s separation agreement in December                        2007. |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (6)                        25% of the options granted to Mr. Neill vest upon the first anniversary of                        the grant with the remaining 75% of the grant vesting ratably on a                        quarterly basis over the three years following the first anniversary of the                        grant.                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| All                        option grants in 2007 were made under the Company’s 2000 Stock Option                        Plan. The Company made no equity or non-equity incentive plan awards in                        2007.                                                                                                                                                                                                                                                                               |

|                                                                 |   |                                                                                                           |   |                                                                         |   |                                                                                   |   |                                                                       |   |   |    |   |   |
|----------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------|--------|--------|---------|--------|--------|
| **OPTION EXERCISES AND                        STOCK VESTED IN 2007** |   |
|                                                                      |   |
|                                                                 |   |                                                                                                           |   |                                                                         |   |
|                                                                 |   | Option                        Awards                                                                           |   | Stock                        Awards                                          |   |
|                                                                 |   |                                                                                                                |   |                                                                              |   |
|                                                                 |   |                                                                                                           |   |                                                                         |   |                                                                                   |   |                                                                       |   |
| Name                                                                 |   | Number of                        Shares                        Acquired on                        Exercise (#) |   | Value                        Realized                        on Exercise ($) |   | Number of                        Shares Acquired                        on Vesting (#) |   | Value                        Realized on                        Vesting($) |   |
|                                                                      |   |                                                                                                                |   |                                                                              |   |                                                                                        |   |                                                                            |   |
|                                                                 |   |                                                                                                           |   |                                                                         |   |                                                                                   |   |                                                                       |   |   |    |   |   |
| Haim Aviv,                        PhD                                |   | —                                                                                                        |   | $ —                                                               |   | 37,975                                                                                 | (1)    |                                                                       |   | $      | 105,841 |   |   |
| Elkan R. Gamzu,                        PhD.                          |   | —                                                                                                        |   | $ —                                                               |   | —                                                                                |   |                                                                       |   | $      | — |   |   |
| Alan L.                        Rubino                                |   | —                                                                                                        |   | $ —                                                               |   | —                                                                                |   |                                                                       |   | $      | — |   |   |
| S. Colin                        Neill                                |   | —                                                                                                        |   | $ —                                                               |   | —                                                                                |   |                                                                       |   | $      | — |   |   |

|   |                                                                                                                                                                                                                                                                                          |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1)    | Dr.                        Aviv received an award of 75,950 shares of restricted stock in September                        2004, 37,975 shares of which vested in December 2005. The remaining 37,975                        shares vested upon his departure from the Company in March 2007. |

56

----

|                                                                         |   |                                                                                                                                                                                   |   |                                                                                                                                                                                     |    |                                                                                                                                                                                                                                                                                   |   |                                                                    |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------|------------|--------|--------|--------|--------|--------|
| **OUTSTANDING EQUITY                        AWARDS AT 2007 FISCAL YEAR-END** |
|                                                                              |
|                                                                         |   |                                                                                                                                                                                   |   |                                                                                                                                                                                     |    |                                                                                                                                                                                                                                                                                   |   |                                                                    |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |
|                                                                         |   |                                                                                                                                                                                   |   |                                                                                                                                                                                     |    |                                                                                                                                                                                                                                                                                   |   | Option                        Awards                                    |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   | Stock                        Awards |       |
|                                                                         |   |                                                                                                                                                                                        |        |                                                                                                                                                                                          |         |                                                                                                                                                                                                                                                                                        |        |                                                                         |        |                                                                      |        |                                                                                                                                                                                                   |        |                                                                                                                                                                                                             |   |                                     |            |
| Name                                                                         |   | Number of                        securities                        underlying                        unexercised                        options (#)                        Exercisable |   | Number of                        securities                        underlying                        unexercised                        options (#)                        Unexercisable |    | Equity                        Incentive Plan                        awards:                        Number of                        securities                        underlying                        unexercsied                        Unearned                        Options (#) |   | Option                        Exercise                        Price ($) |   | Option                        Expiration                        Date |   | Number                        of Shares                        or Units                        of Stock                        That Have                        Not                        Vested |   | Market                        Value of                        Shares or                        Units of                        Stock That                        have not                        vested ($) |   |
|                                                                              |   |                                                                                                                                                                                        |   |                                                                                                                                                                                          |    |                                                                                                                                                                                                                                                                                        |   |                                                                         |   |                                                                      |   |                                                                                                                                                                                                   |   |                                                                                                                                                                                                             |   |
|                                                                         |   |                                                                                                                                                                                   |   |                                                                                                                                                                                     |    |                                                                                                                                                                                                                                                                                   |   |                                                                    |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |
| Haim Aviv,                        PhD                                        |   | 60,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 60,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 1.84   |                                                                                                                                                                                                        |   |                                | 1/17/2017  |   |   |   |   |   |
|                                                                         |   | 325,000                                                                                                                                                                                |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 325,000                                                                 |   |                                                                 |   | $                                                                                                                                                                                                 | 2.15   |                                                                                                                                                                                                        |   |                                | 1/24/2016  |   |   |   |   |   |
|                                                                         |   | 38,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 38,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 3.85   |                                                                                                                                                                                                        |   |                                | 2/15/2015  |   |   |   |   |   |
|                                                                         |   | 38,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 38,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 21.20  |                                                                                                                                                                                                        |   |                                | 2/12/2014  |   |   |   |   |   |
|                                                                         |   | 37,500                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 37,500                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 5.10   |                                                                                                                                                                                                        |   |                                | 2/18/2013  |   |   |   |   |   |
|                                                                         |   | 30,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 30,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 9.50   |                                                                                                                                                                                                        |   |                                | 3/5/2012   |   |   |   |   |   |
|                                                                         |   | 20,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 20,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 9.38   |                                                                                                                                                                                                        |   |                                | 4/2/2011   |   |   |   |   |   |
|                                                                         |   | 20,001                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 20,001                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 20.15  |                                                                                                                                                                                                        |   |                                | 6/6/2010   |   |   |   |   |   |
|                                                                         |   | 13,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 13,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 6.25   |                                                                                                                                                                                                        |   |                                | 4/16/2009  |   |   |   |   |   |
|                                                                         |   | 20,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 20,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 13.91  |                                                                                                                                                                                                        |   |                                | 5/18/2008  |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                        |        |                                                                                                                                                                                          |         |                                                                                                                                                                                                                                                                                        |        |                                                                         |        |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   | 601,501                                                                                                                                                                                |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 601,501                                                                 |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                        |        |                                                                                                                                                                                          |         |                                                                                                                                                                                                                                                                                        |        |                                                                         |        |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                              |   |                                                                                                                                                                                   |   |                                                                                                                                                                                     |    |                                                                                                                                                                                                                                                                                   |   |                                                                    |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
| Elkan R. Gamzu,                        PhD.                                  |   | 0                                                                                                                                                                                      |   |                                                                                                                                                                                     | 200,000 | (1)                                                                                                                                                                                                                                                                                    |   | 200,000                                                                 |   |                                                                 |   | $                                                                                                                                                                                                 | 1.46   |                                                                                                                                                                                                        |   |                                | 1/03/2009  |   |   |   |   |   |
|                                                                         |   | 0                                                                                                                                                                                      |   |                                                                                                                                                                                     | 150,000 | (2)                                                                                                                                                                                                                                                                                    |   | 150,000                                                                 |   |                                                                 |   | $                                                                                                                                                                                                 | 1.55   |                                                                                                                                                                                                        |   |                                | 1/03/2009  |   |   |   |   |   |
|                                                                         |   | 0                                                                                                                                                                                      |   |                                                                                                                                                                                     | 20,000  | (3)                                                                                                                                                                                                                                                                                    |   | 20,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 1.84   |                                                                                                                                                                                                        |   |                                | 1/17/2017  |   |   |   |   |   |
|                                                                         |   | 8,750                                                                                                                                                                                  |   |                                                                                                                                                                                     | 12,250  | (4)                                                                                                                                                                                                                                                                                    |   | 20,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 2.15   |                                                                                                                                                                                                        |   |                                | 1/24/2016  |   |   |   |   |   |
|                                                                         |   | 3,437                                                                                                                                                                                  |   |                                                                                                                                                                                     | 1,563   | (5)                                                                                                                                                                                                                                                                                    |   | 5,000                                                                   |   |                                                                 |   | $                                                                                                                                                                                                 | 3.85   |                                                                                                                                                                                                        |   |                                | 2/15/2015  |   |   |   |   |   |
|                                                                         |   | 5,000                                                                                                                                                                                  |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 5,000                                                                   |   |                                                                 |   | $                                                                                                                                                                                                 | 21.20  |                                                                                                                                                                                                        |   |                                | 2/12/2014  |   |   |   |   |   |
|                                                                         |   | 2,250                                                                                                                                                                                  |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 2,250                                                                   |   |                                                                 |   | $                                                                                                                                                                                                 | 5.10   |                                                                                                                                                                                                        |   |                                | 2/18/2013  |   |   |   |   |   |
|                                                                         |   | 4,000                                                                                                                                                                                  |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 4,000                                                                   |   |                                                                 |   | $                                                                                                                                                                                                 | 9.50   |                                                                                                                                                                                                        |   |                                | 3/5/2012   |   |   |   |   |   |
|                                                                         |   | 1,250                                                                                                                                                                                  |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 1,250                                                                   |   |                                                                 |   | $                                                                                                                                                                                                 | 9.38   |                                                                                                                                                                                                        |   |                                | 4/2/2011   |   |   |   |   |   |
|                                                                         |   | 3,000                                                                                                                                                                                  |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 3,000                                                                   |   |                                                                 |   | $                                                                                                                                                                                                 | 20.15  |                                                                                                                                                                                                        |   |                                | 6/6/2010   |   |   |   |   |   |
|                                                                         |   | 3,000                                                                                                                                                                                  |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 3,000                                                                   |   |                                                                 |   | $                                                                                                                                                                                                 | 12.03  |                                                                                                                                                                                                        |   |                                | 1/20/2010  |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                        |        |                                                                                                                                                                                          |         |                                                                                                                                                                                                                                                                                        |        |                                                                         |        |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   | 30,687                                                                                                                                                                                 |   |                                                                                                                                                                                     | 383,813 |                                                                                                                                                                                                                                                                                   |   | 413,500                                                                 |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                        |        |                                                                                                                                                                                          |         |                                                                                                                                                                                                                                                                                        |        |                                                                         |        |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                   |   |                                                                                                                                                                                     |    |                                                                                                                                                                                                                                                                                   |   |                                                                    |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
| Alan                        Rubino                                           |   | 50,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 50,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 1.84   |                                                                                                                                                                                                        |   |                                | 1/17/2017  |   |   |   |   |   |
|                                                                         |   | 225,000                                                                                                                                                                                |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 225,000                                                                 |   |                                                                 |   | $                                                                                                                                                                                                 | 2.18   |                                                                                                                                                                                                        |   |                                | 11/14/2015 |   |   |   |   |   |
|                                                                         |   | 100,000                                                                                                                                                                                |   |                                                                                                                                                                                     | 0       |                                                                                                                                                                                                                                                                                   |   | 100,000                                                                 |   |                                                                 |   | $                                                                                                                                                                                                 | 2.18   |                                                                                                                                                                                                        |   |                                | 11/14/2015 |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                        |        |                                                                                                                                                                                          |         |                                                                                                                                                                                                                                                                                        |        |                                                                         |        |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   | 375,000                                                                                                                                                                                |   |                                                                                                                                                                                     |    |                                                                                                                                                                                                                                                                                   |   | 375,000                                                                 |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                        |        |                                                                                                                                                                                          |         |                                                                                                                                                                                                                                                                                        |        |                                                                         |        |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                   |   |                                                                                                                                                                                     |    |                                                                                                                                                                                                                                                                                   |   |                                                                    |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
| S. Colin                        Neill                                        |   | 0                                                                                                                                                                                      |   |                                                                                                                                                                                     | 40,000  | (6)                                                                                                                                                                                                                                                                                    |   | 40,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 1.84   |                                                                                                                                                                                                        |   |                                | 1/17/2017  |   |   |   |   |   |
|                                                                         |   | 35,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 55,000  | (7)                                                                                                                                                                                                                                                                                    |   | 90,000                                                                  |   |                                                                 |   | $                                                                                                                                                                                                 | 1.75   |                                                                                                                                                                                                        |   |                                | 10/5/2016  |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                        |        |                                                                                                                                                                                          |         |                                                                                                                                                                                                                                                                                        |        |                                                                         |        |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   | 35,000                                                                                                                                                                                 |   |                                                                                                                                                                                     | 95,000  |                                                                                                                                                                                                                                                                                   |   | 130,000                                                                 |   |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |
|                                                                         |   |                                                                                                                                                                                        |        |                                                                                                                                                                                          |         |                                                                                                                                                                                                                                                                                        |        |                                                                         |        |                                                                 |   |                                                                                                                                                                                              |   |                                                                                                                                                                                                        |   |                                |       |   |   |   |   |   |

(1) 25% of the            options were scheduled to vest upon the first anniversary of the grant date March 31,            2007 with the remaining 75% of the grant vesting ratably on a quarterly basis over the            three years following the first anniversary of the grant. Due to the officer’s            separation agreement of January 2008, 50,000 options will vest in January 2008 with the            balance of the grants options cancelled.

(2) 25% of the            options were scheduled to vest upon the first anniversary of the grant date February            26, 2007 with the remaining 75% of the grant vesting ratably on a quarterly basis over            the three years following the first

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anniversary of            the grant. Due to the officer’s separation agreement of January 2008, 37,500            options will vest in January 2008 with the balance of the grants options            cancelled.

(3) 5,000 of            these options vested on January 3, 2008, 3,750 vest on January 17, 2008 and the            remaining options are scheduled to vest in twelve equal increments on a quarterly basis            beginning on April 17, 2008.

(4) 2,813 of            these options vested on January 3, 2008, the remaining options are scheduled to vest in            nine equal increments on a quarterly basis beginning on January 24, 2008.

(5) 391 of these            options vested on January 3, 2008, the remaining options are scheduled to vest in five            equal increments on a quarterly basis beginning on February 15, 2008.

(6) 25% of the            options granted to Mr. Neill vest upon the first anniversary of the grant date of            January 17, 2007 with the remaining 75% of the grant vesting ratably on a quarterly            basis over the three years following the first anniversary of the grant.

(7) The            remaining options are scheduled to vest in eleven equal increments on a quarterly basis            beginning on January 5, 2008

The Company made            no equity plan incentive awards in 2007.

**Stock Option            Plans**

It is currently            the Company’s policy that all full time key employees are considered annually for            the possible grant of stock options, depending upon employee performance. The criteria            for the awards are experience, uniqueness of contribution to the Company and level of            performance shown during the year. Stock options are intended to generate greater            loyalty to the Company and help make each employee aware of the importance of the            business success of the Company.

As of December            31, 2007, 2,420,386 options to purchase shares of the Company’s Common Stock were            outstanding under various option plans. During 2007, the Company granted 870,000            options to purchase shares of its Common Stock to employees, directors and            consultants.

A summary of the            various established stock option plans is as follows:

***1992            Plan.*** The maximum number of shares of the Company’s Common Stock            available for issuance under the 1992 Plan is 150,000 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            would again be available for options to be issued under the 1992 Plan. As of December            31, 2007, there were no options outstanding to purchase the Company’s Common            Stock under this plan. The Company does not plan to issue any additional options from            the 1992 Plan.

***1997 Plan            and 2000 Plan.*** The 1997 Plan and the 2000 Plan are each administered by a            committee appointed by the Board of Directors (the “Compensation            Committee”). The Compensation Committee will designate the persons to receive            options, the number of shares subject to the options and the terms of the options,            including the option price and the duration of each option, subject to certain            limitations. All stock options grants during 2006 were made from the 2000 Plan. The            Company does not plan to issue any additional options from the 1997 Plan.

The maximum            number of shares of Common Stock available for issuance under the 1997 Plan is 300,000            shares, as amended, and under the 2000 Plan, as amended, is 4,700,000 shares. Each plan            is subject to adjustment in the event of stock splits, stock dividends, mergers,            consolidations and the like. Common Stock subject to options granted under the 1997            Plan and the 2000 Plan that expire or terminate will again be available for options to            be issued under each Plan.

The price at            which shares of Common Stock may be purchased upon exercise of an incentive stock            option must be at least 100% of the fair market value of Common Stock on the date the            option is granted (or at least 110%

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of fair market            value in the case of a person holding more than 10% of the outstanding shares of Common            Stock (a “10% Stockholder”).

The aggregate            fair market value (determined at the time the option is granted) of Common Stock with            respect to which incentive stock options are exercisable for the first time in any            calendar year by an optionee under the 1997 Plan, the 2000 Plan or any other plan of            the Company or a subsidiary, shall not exceed $100,000. The Compensation Committee will            fix the time or times when, and the extent to which, an option is exercisable, provided            that no option for annual option grants 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 to the Company. However,            the Board of Directors may grant a loan to an employee, other than an executive            officer, pursuant to the loan provision of the 1997 Plan or the 2000 Plan, for the            purpose of exercising an option or may permit the option price to be paid in shares of            Common Stock at the then current fair market value, as defined in the 1997 Plan or the            2000 Plan.

Under the 1997            Plan, upon termination of an optionee’s employment or consultancy, all options            held by such optionee will terminate, except that any option that was exercisable on            the date employment or consultancy terminated may, to the extent then exercisable, be            exercised within three months thereafter (or one year thereafter if the termination is            the result of permanent and total disability of the holder), and except such three            month period may be extended by the Compensation Committee in its discretion. If an            optionee dies while he is an employee or a consultant or during such three-month            period, the option may be exercised within one year after death by the decedent’s            estate or his legatees or distributees, but only to the extent exercisable at the time            of death. The 2000 Plan provides that the Compensation Committee may in its discretion            determine when any particular stock option shall expire. A stock option agreement may            provide for expiration prior to the end of its term in the event of the termination of            the optionee’s service to the Company or death or any other            circumstances.

The 1997 Plan            and the 2000 Plan each provides that outstanding options shall vest and become            immediately exercisable in the event of a “sale” of the Company, including            (i) the sale of more than 75% of the voting power of the Company in a single            transaction or a series of transactions, (ii) the sale of substantially all assets of            the Company, (iii) approval by the stockholders of a reorganization, merger or            consolidation, as a result of which the stockholders of the Company will own less than            50% of the voting power of the reorganized, merged or consolidated company.

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

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

Under current            federal income tax law, the grant of incentive stock options under the 1997 Plan or the            2000 Plan will not result in any taxable income to the optionee or any deduction for            the Company at the time the options are granted. The optionee recognizes no gain upon            the exercise of an option. However the amount by which the fair market value of Common            Stock at the time the option is exercised exceeds the option price is an “item of            tax preference” of the optionee, which may cause the optionee to be subject to            the alternative minimum tax. If the optionee holds the shares of Common Stock received            on exercise of the option at least one year from the date of exercise and two years            from the date of grant, he will be taxed at the time of sale at long-term            capital

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gains rates, if            any, on the amount by which the proceeds of the sale exceed the option price. If the            optionee disposes of the Common Stock before the required holding period is satisfied,            ordinary income will generally be recognized in an amount equal to the excess of the            fair market value of the shares of Common Stock at the date of exercise over the option            price, or, if the disposition is a taxable sale or exchange, the amount of gain            realized on such sale or exchange if that is less. If, as permitted by the 1997 Plan or            the 2000 Plan, the Board of Directors permits an optionee to exercise an option by            delivering already owned shares of Common Stock valued at fair market value) the            optionee will not recognize gain as a result of the payment of the option price with            such already owned shares. However, if such shares were acquired pursuant to the            previous exercise of an option, and were held less than one year after acquisition or            less than two years from the date of grant, the exchange will constitute a            disqualifying disposition resulting in immediate taxation of the gain on the already            owned shares as ordinary income. It is not clear how the gain will be computed on the            disposition of shares acquired by payment with already owned shares.

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

The total number            of shares reserved for issuance under the 2001 Plan is 100,000 shares. Under the 2001            Plan, for any given calendar year, a participating employee can only be granted Rights            to purchase that number of shares which, when multiplied by the exercise price of the            Rights, does not exceed more than 10% of the employee’s base pay. To date, the            Company has issued 12,560 shares of its common stock under the 2001 Plan. The Company            did not issue any shares under the 2001 Plan in 2007.

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

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

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

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

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

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

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

**1997            Employees and Directors Warrants Plan**

The 1997            Employees and Directors Warrants Plan was approved by the Stock Option Committee as of            February 12, 1997 and March 19, 1997. 206,000 Warrants to purchase 206,000 shares of            Common Stock were granted to certain employees of the Company. Of such warrants,            191,000 were granted at an exercise price of $7.95 per share and 15,000 were granted            and an exercise price of $8.30 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. 20,000 Warrants to purchase 20,000 shares of Common Stock were            granted to directors of the Company at an exercise price of $7.95 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, 2007. At            December 31, 2007, there were no employee warrants outstanding.

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

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**Employment            Contracts**

*Haim Aviv,            Ph.D.* Dr. Aviv retired as CEO on March 31, 2007. In April 2001, the Compensation            and Stock Option Committee of the Board of Directors recommended, and the Board            approved, a one-year employment/consulting agreement for Dr. Aviv, as Chairman of the            Board and Chief Executive Officer of the Company. Dr. Aviv has agreed to devote a            majority of his business time to the Company and to Pharmos Ltd. The agreement provides            for automatic one year renewals unless either the Company terminates the agreement at            least 180 days prior to the scheduled expiration date during the initial one year term            (and 90 days for subsequent terms) or Dr. Aviv terminates the agreement at least 60            days in advance of termination. Dr. Aviv’s base compensation for 2006 was            $322,396 and for 2007 was $362,533, and is allocated between the Company and is paid in            US dollars and Pharmos Ltd which is paid in shekels and may result in exchange rate            differences. The Company also agreed to make available for Dr. Aviv’s benefit            following his death, termination of employment for disability or retirement at the age            of at least 62 an amount equal to the cost of insurance premiums the Company would            otherwise have incurred to obtain and maintain a “split-dollar” life            insurance policy on his life (approximately $10,000 per year, accruing interest at 8%            per year). In addition, the Company agreed to pay, in lieu of contributing to other            benefits plans on his behalf, an amount equal to an aggregate of approximately 21% of            his base compensation toward the “Management Insurance Scheme” managed by            the government of Israel for members of management of Israeli companies.

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

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

The Board of            Directors of the Company also agreed at its January 25, 2006 meeting, based upon the            recommendation of the Compensation Committee, to clarify the Employment Agreement of            the Company’s Chairman and CEO, Dr. Haim Aviv, dated as of April 2, 2001, to            confirm that the calculation of any severance payments to be received by him upon a            termination of employment in certain circumstances shall be based on the aggregate            annual compensation he had been receiving at the time of termination, both in the form            of base salary as an employee of the Company’s Pharmos Ltd. subsidiary and in the            form of an annual consulting fee paid directly by the Company to an entity owned by Dr.            Aviv.

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

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On September 6,            2004, the Board of Directors approved, and Pharmos entered into, a Retention Award            Agreement with Dr. Aviv. The Company granted a retention award of $300,000 cash and            75,950 restricted stock units to Dr. Aviv (the Award). Under the agreement, one-half of            the Award vested on December 31, 2005 and the balance was scheduled to vest and become            non-forfeitable on June 30, 2007, subject to certain accelerated vesting provisions.            Under the terms of Dr. Aviv’s retirement agreement, the balance of his Award            vested on his retirement as CEO on March 31, 2007.

*Elkan R.            Gamzu.* Dr. Gamzu resigned on January 3, 2008.In February 2007, the Compensation and            Stock Option Committees of the Board of Directors recommended, and the Board approved,            an employment agreement for Dr. Gamzu as full time Chief Executive Officer of the            Company. Dr. Gamzu’s base compensation for 2007, effective February 26, was            $300,000. Dr. Gamzu’s agreement allows for an annual bonus of up to 25% of his            base salary upon the attainment of agreed upon goals and milestones. In subsequent            years, the bonus is to range from minimum of 25% of base salary to target of 50% of            base salary, with no maximum limit, based on milestones and determined by the CEO and            Compensation Committee. The other provisions of Dr. Gamzu’s employment agreement            relating to benefits, severance arrangements, automatic renewal and confidentiality and            non-competition obligations are substantially similar to the those included in Dr.            Aviv’s employment agreement, as described above, except that Mr. Rubino does not            participate in the “Management Insurance Scheme” of Pharmos Ltd.

*Alan L.            Rubino.* Mr. Rubino resigned on December 12, 2007.In November 2005, the Compensation            and Stock Option Committees of the Board of Directors recommended, and the Board            approved, a three-year employment agreement for Mr. Rubino as full time President and            Chief Operating Officer of the Company. Mr. Rubino’s base compensation for 2005,            effective November 14, was $315,000, $315,000 for 2006 and $324,450 for 2007. Mr.            Rubino received a sign-on bonus of $40,000 in November 2005. Mr. Rubino received a            performance bonus for 2005 (pro rated) of $12,500 and received a performance bonus for            fiscal year 2006 of $160,000 (including a special bonus of $60,000 in recognition of            his performance during the negotiation and consummation of the Vela acquisition,            including the proxy fight and related settlement). In subsequent years, the bonus is to            range from minimum of 25% of base salary to target of 50% of base salary, with no            maximum limit, based on milestones and determined by the CEO and Compensation            Committee. The other provisions of Mr. Rubino’s employment agreement relating to            benefits, severance arrangements, automatic renewal and confidentiality and            non-competition obligations are substantially similar to the those included in Dr.            Aviv’s employment agreement, as described above, except that Mr. Rubino does not            participate in the “Management Insurance Scheme” of Pharmos Ltd.

*S. Colin            Neill.* In October 2006, the Compensation and Stock Option Committees of the Board            of Directors recommended, and the Board approved, a one year employment agreement for            Mr. Neill as full time Senior Vice President, Chief Financial Officer, Secretary and            Treasurer of the Company. Mr. Neill’s initial base compensation is $265,000. The            other provisions of Mr. Neill’s employment agreement relating to benefits,            severance arrangements, automatic renewal and confidentiality and non-competition            obligations are substantially similar to the those included in Dr. Aviv’s            employment agreement, as described above, except that Mr. Neill does not participate in            the “Management Insurance Scheme” of Pharmos Ltd. Mr. Neill received a            sign-on bonus of $20,000 in October 2006, and a performance bonus for 2006 (pro rated)            of $18,750 in January 2007.

**Compensation            of Directors**

On January 25,            2006, the Board of Directors of Pharmos and its Compensation and Stock Option Committee            approved a change in the compensation arrangements for its independent directors. In            lieu of paying fees for each meeting attended, the Board authorized the payment of an            annual fee of $30,000 for service on the Board. Also, in consideration of the            additional work they perform for the Company, the Board authorized payment of            additional compensation in the amount of $5,000 to each of the Chairmen of the            Board’s Audit Committee, Compensation Committee, Governance and Nominating and            Committee and Clinical Development and Scientific Committee, and $15,000 to the Lead            Director (the Lead Director does not receive any additional fees for also serving as            committee chair). Payment of such fees to any director is subject to attendance by such            director at a minimum of least 70% of the combined number of meetings of the full Board            and any Committees on which such director sits. Any director attending fewer than 70%            of the meetings in a given year will have

63

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his or her            aggregate annual fees reduced on a percentage basis by the same percentage of that            year’s meetings not attended by such director (e.g., a director who did not            attend 45% of the meetings in a given year would have his or her aggregate fees reduced            by 45% for such year).

Also, on January            25, 2006, the Board approved the annual grant to each of the non-employee directors of            20,000 ten-year stock options, with 25% vesting on the first anniversary of the date of            grant and the remainder vesting in twelve equal quarterly installments over the next            three years, and exercisable at the fair market value of the Company’s Common            Stock as of the date of grant.

On October 18,            2006, the Board of Directors approved payment of a fee of $50,000 to Mony Ben Dor for            his service as chair of the Board’s Proxy Contest Steering Committee.

No fees or stock            option awards were paid in 2006 to the four directors (Akkaraju, Evnin, Miller and            Newhall) who joined the Board upon completion of the Company’s acquisition of            Vela Pharmaceuticals on October 25, 2006.

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**DIRECTOR            COMPENSATION FOR 2007**

The table below            summarizes the compensation paid by the Company to non-employee Directors for the            fiscal year ended December 31, 2007:

|                                                  |   |                                                                          |      |                                        |   |                             |   |   |
|-------------------------------------------------------|--------|-------------------------------------------------------------------------------|-----------|---------------------------------------------|--------|----------------------------------|--------|--------|
| Name                                                  |   | Fees                        Earned                        or Paid in Cash ($) |      | Option                        Awards ($)(1) |   | Total                        ($) |
|                                                       |   |                                                                               |      |                                             |   |                                  |
|                                                  |   |                                                                          |      |                                        |   |                             |
| Srinivas Akkaraju,                        M.D., Ph.D. |   | 30,000                                                                        |      |                                        | 6,665  |                             |   | 36,665 |
|                                                  |   |                                                                          |      |                                        |   |                             |   |   |
| Mony                        Ben Dor                   |   | 45,000                                                                        |  (4) |                                        | 17,530 |                             |   | 62,530 |
|                                                  |   |                                                                          |      |                                        |   |                             |   |   |
| Anthony B. Evnin,                        Ph.D.        |   | 30,000                                                                        |      |                                        | 6,665  |                             |   | 36,665 |
|                                                  |   |                                                                          |      |                                        |   |                             |   |   |
| Elkan R. Gamzu,                        Ph.D.          |   | 5,833                                                                         |  (2) |                                        | 17,712 |                             |   | 23,545 |
|                                                  |   |                                                                          |      |                                        |   |                             |   |   |
| Lloyd I. Miller,                        III           |   | 35,000                                                                        |  (3) |                                        | 6,665  |                             |   | 41,665 |
|                                                  |   |                                                                          |      |                                        |   |                             |   |   |
| Charles W. Newhall,                        III        |   | 30,000                                                                        |      |                                        | 6,665  |                             |   | 36,665 |
|                                                  |   |                                                                          |      |                                        |   |                             |   |   |
| Abraham Sartani,                        M.D.          |   | 33,334                                                                        |      |                                        | 18,348 |                             |   | 51,682 |
|                                                  |   |                                                                          |      |                                        |   |                             |   |   |
| David                        Schlachet                |   | 35,000                                                                        |  (5) |                                        | 17,530 |                             |   | 52,530 |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1)    | Reflects the dollar                        amount recognized for financial statement reporting purposes for the fiscal                        year ended December 31, 2007 in accordance with FAS 123(R), and thus                        includes amounts from awards granted in and prior to 2007. All options                        awarded to Directors in 2007 remained outstanding at fiscal                        year-end. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (2)    | Reflects partial fee                        due to the resignation from board upon accepting Chief Executive Officer                        position in February 2007.                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (3)    | Includes $5,000 fee as                        Chair of the Governance Committee.                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (4)    | Includes $10,000 fee as                        Lead Director and $5,000 fee as chair of the Compensation                        Committee.                                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (5)    | Includes $5,000 fee as                        chair of the Audit Committee.                                                                                                                                                                                                                                                                                                                                                          |

**Director            Retirements and New Director Appointment in 2008**

On January 3,            2008, the Company announced the retirement of Haim Aviv, Ph.D., David Schlachet and            Mony Ben Dor from the Board of Directors. On that date, the Board appointed Robert F.            Johnston to the Board to serve as Executive Chairman. On February 11, 2008, Abraham            Sartani retired from the Board of Directors.

**Change in            Director Compensation for 2008**

Director            compensation for 2008 will be as follows:

|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 1.     | At the                        election of each Director, either (i) 20,000 ten-year stock options granted                        in January and 20,000 fully vested ten-year stock options to be granted on                        July 1, or (ii) a cash payment of $6,000 in January and $6,000 on July 1;                        and                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   | 2.     | The                        Chairman of the Audit Committee will be granted an additional 5,000 fully                        vested ten-year stock options in January and 5,000 fully vested ten-year                        stock options to be granted on July 1; and the Chairmen of the Compensation                        and the Governance and Nominating Committees will each be granted an                        additional 2,500 fully vested ten-year stock options in January and 2,500                        fully vested ten-year stock options to be granted on July 1. |

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**Compensation            Committee Interlocks and Insider Participation**

The members of            the Compensation and Stock Option Committee in 2007 were Mony Ben Dor, Anthony B. Evnin            and Elkan Gamzu (until his appointment as CEO in March). There were no interlocks on            the Compensation and Stock Option Committee in 2007.

**Item 12.****Security Ownership of Certain Beneficial Owners and Management and Related            Stockholder Matters**

**EQUITY            COMPENSATION PLAN INFORMATION**

The table below            provides certain information concerning our equity compensation plans as of December            31, 2007.

|                                                                              |   |                                                                                                                                                                                    |   |                                                                                                                                             |        |                                                                                                                                                                                                                                                                                 |   |      |   |
|-----------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|-------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------|--------|
| ***Plan                        Category***                                        |        | Number of securities                        to be                        issued upon exercise of                        outstanding options,                        warrants and rights |        | Weighted average                        exercise                        price of outstanding                        options, warrants and rights |             | Number of                        securities                        remaining available for                        future issuance under equity                        compensation plans                        (excluding securities                        reflected in column (a) |
|                                                                              |        | (a)                                                                                                                                                                                     |        | (b)                                                                                                                                              |             | (c)                                                                                                                                                                                                                                                                                  |
|                                                                                   |        |                                                                                                                                                                                         |        |
| Equity compensation                        plans approved by security holders     |   | 2,458,361                                                                                                                                                                               |   |                                                                                                                                             | $ 4.17 |                                                                                                                                                                                                                                                                                 |   | 2,153,137 |   |
| Equity compensation                        plans not approved by security holders |   | N/A                                                                                                                                                                                     |   |                                                                                                                                             | N/A         |                                                                                                                                                                                                                                                                                 |   | N/A       |   |
|                                                                                   |        |                                                                                                                                                                                         |        |                                                                                                                                                  |             |                                                                                                                                                                                                                                                                                      |        |           |        |
| Total                                                                             |   | 2,458,361                                                                                                                                                                               |   |                                                                                                                                             | $ 4.17 |                                                                                                                                                                                                                                                                                 |   | 2,153,137 |   |
|                                                                                   |        |                                                                                                                                                                                         |        |                                                                                                                                                  |             |                                                                                                                                                                                                                                                                                      |        |           |        |

**SECURITY            OWNERSHIP OF CERTAIN BENEFICIAL OWNERS**

The following            table sets forth certain information with respect to the beneficial ownership of the            Company’s Common Stock as of February 20, 2008, except as set forth in the            footnotes, by (i) each person who was known by the Company to own beneficially more            than 5% of any class of the Company’s Stock, (ii) each of the Company’s            executive officers who served during 2007 and 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.

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|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|--------|----------------------------------------------------|
| **Name and Address of                        Beneficial Owner**                                                                                                                                                 |   | **Amount of                        Beneficial                        Ownership** |   | **Percentage                        of Total (1)** |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| Robert F. Johnston                        (2)                        c/o Pharmos Corporation                        99 Wood Avenue South, Suite 311                        Iselin, NJ 08830                     |   | 864,102                                                                          |   |   3.4%                                   |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| Srinivas Akkaraju,                        M.D., Ph.D. (3)                        c/o Panorama Management, LLC                        2440 Sand Hill Road, Suite 302                        Menlo Park, CA 94025 |   | 2,851,410                                                                        |   | 11.1%                                              |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| Anthony B. Evnin                        (4)                        c/o Venrock Associates                        30 Rockefeller Plaza, Room 5508                        New York, NY 10112                      |   | 1,289,462                                                                        |   |   5.0%                                   |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| Elkan R. Gamzu, Ph.D.                        (5)                        enERGetics                        99 Wells Avenue, Suite 302                        Newton, MA 02459                                    |   | 138,563                                                                          |   | *                                                  |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| Lloyd I. Miller, III                        (6)                        4550 Gordon Drive                        Naples, FL 34102                                                                                |   | 1,971,525                                                                        |   |   7.7%                                   |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| Charles W. Newhall, III                        (7)                        1119 St. Paul Street                        Baltimore, MD 21202                                                                       |   | 1,887,074                                                                        |   |   7.4%                                   |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| S. Colin Neill (8)                        c/o Pharmos Corporation                        99 Wood Avenue South, Suite 311                        Iselin, NJ 08830                                                |   | 132,500                                                                          |   | *                                                  |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| All Current Directors                        and                        Executive Officers as a group                        (seven persons) (9)                                                                |   | 9,134,636                                                                        |   | 35.2%                                              |
|                                                                                                                                                                                                                 |        |                                                                                  |        |                                                    |
|                                                                                                                                                                                                            |        |                                                                             |        |                                               |
| Haim Aviv, Ph.D.                        (10)                        c/o Pharmos Ltd, Kiryat Weizmann                        Rehovot 76326, Israel                                                               |        | 1,038,978                                                                        |        |   4.1%                                   |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| Alan L. Rubino (11)                        c/o Pharmos Corporation                        99 Wood Avenue South, Suite 311                        Iselin, NJ 08830                                               |        | 376,000                                                                          |        |   1.5%                                   |
|                                                                                                                                                                                                                 |        |                                                                                  |        |                                                    |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| JP Morgan Partners BHCA                        LLP (12)                        c/o JP Morgan Partners, LLC                        270 Park Avenue, 39th Floor                        New York, NY 10017         |   | 2,845,160                                                                        |   | 11.1%                                              |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| New Enterprise                        Associates 10, LP (13)                        1119 St. Paul Street                        Baltimore, MD 21202                                                             |   | 1,880,824                                                                        |   |   7.3%                                   |
|                                                                                                                                                                                                            |   |                                                                             |   |                                               |
| Venrock Associates                        (14)                                                                                                                                                                  |   | 1,283,212                                                                        |   |   5.0%                                   |
| Venrock Associates III                        LP                                                                                                                                                                |   |                                                                             |   |                                               |
| Venrock Entrepreneurs                        Fund III LP                        30 Rockefeller Plaza, Room 5508                        New York, NY 10112                                                       |   |                                                                             |   |                                               |

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* Less than            1%.

(1) Based on            25,603,759 shares of common stock outstanding, plus each individual’s warrants or            options which are either currently exercisable or will be exercisable within 60 days of            the date set forth above. Assumes that no other individual will exercise any warrants            and/or options.

(2) Consists of            747,435 outstanding shares  and 116,667 shares issuable upon exercise of currently            exercisable options. 

(3) Consists of            shares beneficially owned by JP Morgan Partners BHCA LLP and 6,250 shares issuable upon            exercise of currently exercisable warrants and/or options.

(4) Consists of            shares beneficially owned by Venrock Associates, Venrock Associates III LP and Venrock            Entrepreneurs Fund III LP and 6,250 shares issuable upon exercise of currently            exercisable warrants and/or options.

(5) Consists of            2,000 outstanding shares and 136,563 shares issuable upon exercise of currently            exercisable warrants and/or options.

(6) Of such            shares beneficially owned by Mr. Miller, 1,603,097 shares are held by Milfam II, LP,            352,178 shares are held by Trust A-4, 10,000 shares are held directly by Mr. Miller and            6,250 shares issuable upon exercise of currently exercisable warrants and/or            options.

(7) Consists of            shares beneficially owned by New Enterprise Associates 10, LP and 6,250 shares issuable            upon exercise of currently exercisable warrants and/or options.

            (8) Consists of 75,000 outstanding shares and 57,500 shares issuable upon exercise of            currently exercisable warrants and/or options.

            (9) Consists of 8,798,906 outstanding shares and 335,730 shares issuable upon exercise            of currently exercisable warrants and/or options.

            (10) Consists of 268,970 outstanding shares and 770,008 shares issuable upon exercise            of currently exercisable warrants and/or options. Dr. Aviv retired as CEO in March 2007            and retired from the Board in January 2008.

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(11) Consists of            1,000 outstanding shares and 375,000 shares issuable upon exercise of currently            exercisable options. Mr. Rubino resigned as President and Chief Operating Officer in            December 2007.

(12) As of            January 25, 2008, based on a Form 4 filed with the SEC.

(13) As of            October 25, 2006, based on a Schedule 13D filed with the SEC.

(14) As of            January 3, 2008, based on a Schedule 13D filed with the SEC.

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**Item 13.            Certain Relationships, Related Transactions and Director Independence**

***Herbamed            License Agreement.*** The Company’s subsidiary, Pharmos Ltd., is party to a            License Agreement with Herbamed, Ltd., a company controlled by Dr. Haim Aviv, the            Company’s former Chairman and Chief Executive Officer. The License Agreement            licenses to Herbamed the Company’s patent rights for the oral delivery of            lipophilic substances in the limited field of nutraceuticals, which include food and            dietary supplements, food additives, vitamins and herbs. Under the terms of the revised            License Agreement, Herbamed will pay to Pharmos Ltd. royalties of 3% on net sales.            During 2007 and 2006, the Company recognized royalties of $4,992 and $5,177,            respectively.

Neither the            Company nor its Pharmos Ltd. subsidiary is involved in the field of nutraceuticals            generally, and specifically in developing improved oral delivery of nutraceuticals.            Pharmos Ltd., therefore, licensed its technology in this narrow non-pharmaceutical            field of use to Dr. Aviv’s company as a way of seeking to benefit from a            potential stream of royalty payments without having to devote any resources to the            development of an application it otherwise would not have pursued. In addition, if the            technology proves to be successful for the delivery of nutraceuticals, Pharmos hopes            that it could be able to interest potential strategic partners in licensing the            technology for pharmaceuticals applications.

Dr. Aviv was not            involved with either party in negotiating the terms of the License Agreement with            Herbamed. Pharmos Ltd. concluded that the royalty rates and other terms of the License            Agreement are commercially reasonable to it, and the Board of the Company ratified the            License Agreement.

The Herbamed            License Agreement was approved by Pharmos’ Board of Directors and subsequently            ratified by the Audit Committee.

***CEO            Retirement Agreement.*** Pursuant to the retirement agreement with the Company,            the Chairman and former CEO acquired his corporate automobile on June 30, 2007 for            $31,008. The automobile’s fair market value as of June 2007 was $64,599 and            its depreciated cost as of the June 30, 2007 was $68,278. The discounted            benefit of $33,591 was included in general and administrative            expenses.

***Director            Independence.*** The Company has determined that seven of the nine Directors            serving at December 31, 2007 (Srinivas Akkaraju, Mony Ben Dor, Anthony B. Evnin, Lloyd            I. Miller, III, Charles W. Newhall, III, Abraham Sartani and David Schlachet), were            independent under applicable Nasdaq rules.

**Item 14.            Principal Accounting Fees and Services**

**Audit            fees**

Aggregate fees            for professional services rendered by PricewaterhouseCoopers LLP in connection with its            audit of the Company’s consolidated financial statements as of and for the years            ended December 31, 2007 and 2006, its reviews of the Company’s unaudited            consolidated interim financial statements, and for SEC filings were $257,000 and            $441,000, respectively.

**Audit-related            fees**

There were no            audit—related fees in 2007. Aggregate fees for professional services rendered by            PricewaterhouseCoopers LLP in connection with Vela acquisition due diligence services            in 2006 were $43,000.

**Tax            fees**

Aggregate fees            for professional services rendered by PricewaterhouseCoopers LLP in connection with its            income tax compliance and related tax services for the years ended December 31, 2007,            and 2006 were $0 and $35,000, respectively.

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**All other            fees**

A fee of $1,500            was incurred in each of 2007 and 2006 in relation to subscription services for            accounting related topics. The Company also licenses Automated Disclosure Checklist -            Client Assist from PricewaterhouseCoopers LLP at no cost.

**Policy on            Audit Committee Pre-Approval of Audit and Non-Audit Services of Independent            Auditor**

The charter of            the Audit Committee requires that the Committee review and pre-approve all audit,            review or attest engagements of, and non-audit services to be provided by, the            independent registered public accounting firm (other than with respect to the de            minimis exception permitted by the Sarbanes-Oxley Act of 2002 and the SEC rules            promulgated thereunder). The Audit Committee pre-approved all auditing services and            permitted non-audit services rendered by PricewaterhouseCoopers LLP in 2007.

The pre-approval            duty may be delegated to one or more designated members of the Audit Committee, with            any such pre-approval reported to the Committee at its next regularly scheduled            meeting. Any such designated member(s) of the Committee shall also have the authority            to approve non-audit services already commenced by the independent registered public            accounting firm if (i) the aggregate amount of all such services provided constitutes            no more than five percent (5%) of the total amount of revenues paid by the Company to            the independent registered public accounting firm during the fiscal year in which the            services are provided, (ii) such services were not recognized by the Company at the            time of the engagement to be non-audit services, and (iii) such services are promptly            brought to the attention of the Committee and approved by such designated member(s)            prior to the completion of the audit.

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**PART            IV**

**Item 15.            Exhibits and Financial Statement Schedules**

|                                                                                                                                                                |                                                     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------|
| (a)                                                                                                                                                                 | Financial Statements                        and Exhibits |
|                                                                                                                                                                |                                                     |
| (1)                                                                                                                                                                 | FINANCIAL                        STATEMENTS              |
|                                                                                                                                                                |                                                     |
| Report of Independent                        Registered Public Accounting Firm                                                                                      |
| Consolidated balance                        sheets as of December 31, 2006 and 2005                                                                                 |
| Consolidated statements                        of operations for the years ended                        December 31, 2006, 2005 and 2004                            |
| Consolidated statements                        of changes in shareholders’ equity                        for the years ended December 31, 2006, 2005 and 2004 |
| Consolidated statements                        of cash flows for the years ended                        December 31, 2006, 2005, and 2004                           |
| Notes to consolidated                        financial statements                                                                                                   |

|   |                                                 |
|--------|------------------------------------------------------|
| (2)    | FINANCIAL STATEMENT                        SCHEDULES |

          All            schedules have been omitted because the information required to be set forth therein is            not applicable or is shown in the financial statements or notes thereto.

|   |                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|--------|-------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (3)    | EXHIBITS                                                                                                                      |
|   |                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 2      | Plan                        of purchase, sale, reorganization, arrangement, liquidation, or                        succession |
|   |                                                                                                                          |
|   | 2(a)                                                                                                                          | Agreement and Plan of                        Merger by and among Pharmos Corporation, Vela Acquisition Corporation and                        Vela Pharmaceuticals Inc. dated March 14, 2006 (Incorporated by reference                        to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed                        March 15, 2006).                                                                                     |
|   |                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 2(b)                                                                                                                          | Amendment to Agreement                        and Plan of Merger by and among Pharmos Corporation, Vela Acquisition                        Corporation and Vela Pharmaceuticals Inc. dated August 31, 2006                        (incorporated by reference to Exhibit 2.1 of the registrant’s Current                        Report on Form 8-K filed September 5, 2006).                                                                 |
|   |                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 2(c)                                                                                                                          | Amendment No.2 to                        Agreement and Plan of Merger by and among Pharmos Corporation, Vela                        Acquisition Corporation, Vela Acquisition No.2 Corporation and Vela                        Pharmaceuticals Inc. dated September 29, 2006 (incorporated by reference to                        Exhibit 2.1 of the registrant’s Current Report on Form 8-K filed                        October 5, 2006). |
|   |                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 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)                                                                                                                                                   |
|   |                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 3(b)                                                                                                                          | Certificate of                        Amendment of Restated Articles of Incorporation dated January 30, 1995                        (Incorporated by reference to Annual Report on Form 10-K for the year ended                        December 31, 1994).                                                                                                                                                                                        |
|   |                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 3(c)                                                                                                                          | Certificate of                        Amendment of Restated Articles of Incorporation dated January 16, 1998                        (Incorporated by reference to the Company’s Current Report on Form                        8-K, dated February 6, 1998).                                                                                                                                                                                 |
|   |                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 3(d)                                                                                                                          | Certificate of                        Amendment of Restated Articles of Incorporation dated October 21, 1999                        (Incorporated by reference to exhibit 4(e) to the Form S-3 Registration                        Statement of the Company filed September 28, 2000 (No.                        333-46818)).                                                                                                                     |

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|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|--------|--------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 3(e)                                                                                             | Certificate of                        Amendment of Restated Articles of Incorporation dated July 19, 2002                        (Incorporated by reference to Exhibit 3 to the Company’s Report on                        Form 10-Q for the quarter ended June 30, 2002).                                                                                         |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 3(f)                                                                                             | Certificate of                        Amendment of Restated Articles of Incorporation dated July 7, 2004                        (Incorporated by reference to Exhibit 3.1 to the Company’s Report on                        Form 10-Q for the quarter ended June 30, 2004).                                                                                        |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 3(g)                                                                                             | Certificate of                        Amendment to Articles of Incorporation dated September 23, 2005                        (Incorporated by reference to exhibit 3.1 to the Company’s Quarterly                        Report on Form 10-Q for the quarter ended September 30, 2005).                                                                            |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 3(h)                                                                                             | Amended and Restated                        By-Laws (Incorporated by reference to Exhibit 3.1 to the Company’s                        Quarterly Report on Form 10-Q for the quarter ended September 30,                        2007.                                                                                                                               |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
| 4      | Instruments defining                        the rights of security holders, including indentures |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(a)                                                                                             | Form                        of Employee Warrant Agreement, dated April 11, 1995, between the Company                        and Oculon Corporation (Incorporated by reference to the Company’s                        Current Report on Form 8-K, dated April 11, 1995, as amended).                                                                               |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(b)                                                                                             | 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                        (c)                                                                     | Form                        of Stock Purchase Warrant dated as of March 31, 1997 between the Company                        and the Investor (Incorporated by reference to Form S-3 Registration                        Statement of the Company dated March 5, 1998 [No. 333-47359]).                                                                                   |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(d)                                                                                             | Form                        of Common Stock Purchase Warrant exercisable until September 1, 2005                        (Incorporated by reference to Exhibit 4.4 to the Company’s Current                        Report on Form 8-K filed on September 11, 2000).                                                                                                 |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(e)                                                                                             | Form                        of placement agent warrant with Ladenburg Thalmann & Co. Inc.                        (Incorporated by reference to Form S-3 Registration Statement of the                        Company dated September 28, 2000 (No. 333-46818).                                                                                                       |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(f)                                                                                             | Form                        of placement agent warrant with SmallCaps OnLine LLC (Incorporated by                        reference to Form S-3 Registration Statement of the Company dated September                        28, 2000 (No. 333-46818).                                                                                                                    |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(g)                                                                                             | Form                        of consulting warrant with SmallCaps OnLine LLC (Incorporated by reference                        to Form S-3 Registration Statement of the Company dated September 28, 2000                        (No. 333-46818).                                                                                                                         |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(h)                                                                                             | Certificate of                        Designation, Rights Preferences and Privileges of Series D Preferred Stock                        of the Company (Incorporated by reference to Exhibit 99.3 to the                        Company’s Current Report on Form 8-K filed on October 24,                        2002).                                            |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(i)                                                                                             | Rights Agreement dated                        as of October 23, 2002 between the Company and American Stock Transfer                        & Trust Company, as Rights Agent (Incorporated by reference to Exhibit                        99.2 to the Company’s Current Report on Form 8-K filed on October 24,                        2002).                  |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(j)                                                                                             | Form                        of Investor Warrant dated March 4, 2003 (Incorporated by reference to                        Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on                        March 4, 2003).                                                                                                                                  |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(k)                                                                                             | Form                        of Placement Agent’s Warrant dated March 4, 2003 (Incorporated by                        reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K                        filed on March 4, 2003).                                                                                                                   |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(l)                                                                                             | Registration Rights                        Agreement dated as of May 30, 2003 between the Company and the purchasers.                        (Incorporated by reference to Exhibit 4.2 to the Company’s Current                        Report on Form 8-K filed on June 3, 2003).                                                                                  |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(m)                                                                                             | Form                        of Investor Warrant dated June 2, 2003 (Incorporated by reference to                        Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on June                        3, 2003).                                                                                                                                     |
|   |                                                                                             |                                                                                                                                                                                                                                                                                                                                                                     |
|   | 4(n)                                                                                             | Securities Purchase                        Agreement dated as of September 26, 2003 between the Company and the                        purchasers identified on the signature pages thereto 2003 (Incorporated by                        reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K                        filed on September 30, 2003). |

73

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|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|--------|-------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 4(o)                                      | Form                        of 4% convertible debenture due March 31, 2005 (Incorporated by reference                        to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on                        September 30, 2003).                                                                                                      |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 4(p)                                      | Registration Rights                        Agreement dated as of September 26, 2003 between the Company and the                        purchasers signatory thereto (Incorporated by reference to Exhibit 4.3 to                        the Company’s Current Report on Form 8-K filed on September 30,                        2003).             |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 4(q)                                      | Form                        of Common Stock Purchase Warrant (Incorporated by reference to Exhibit 4.4                        to the Company’s Current Report on Form 8-K filed on September 30,                        2003).                                                                                                                    |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 4(r)                                      | Escrow Agreement dated                        as of September 26, 2003 between the Company, the purchasers signatory                        thereto and Feldman Weinstein LLP (Incorporated by reference to Exhibit 4.5                        to the Company’s Current Report on Form 8-K filed on September 30,                        2003).   |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 4(s)                                      | Form                        of Placement Agent Common Stock Purchase Warrant (Incorporated by reference                        to Exhibit 4.6 to the Company’s Current Report on Form 8-K filed on                        September 30, 2003).                                                                                                    |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 4(t)                                      | Rights Agreement                        Amendment, dated October 23, 2006, between Pharmos Corporation and American                        Stock Transfer & Trust Co. (Incorporated by reference to Exhibit 4.1 to                        the Company’s Current Report on Form 8-K filed on October 27,                        2006).         |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 4(u)                                      | Registration Rights                        Agreement, dated as of October 25, 2006, by and among Pharmos Corporation                        and the Representatives named therein (Incorporated by reference to Exhibit                        4.1 to the Company’s Current Report on Form 8-K filed on October 31,                        2006). |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
| 10     | Material                        Contracts |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(a)                                     | Employment Agreement                        dated as of April 2, 2001, between Pharmos Corporation and Haim Aviv                        (Incorporated by reference to Exhibit 10(n) to the Company’s Annual                        Report on Form 10-K for the year ended December 31, 2001).**                                                   |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(b)                                     | Amendment of Employment                        Agreement with Haim Aviv, dated as of January 25, 2006 (Incorporated by                        reference to Exhibit 10.1 to the Company’s Quarterly Report on Form                        10-Q for the quarter ended March 31, 2006).**                                                            |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(c)                                     | Employment Agreement                        dated as of April 2, 2001, between Pharmos Corporation and Gad Riesenfeld                        (Incorporated by reference to Exhibit 10(o) to the Company’s Annual                        Report on Form 10-K for the year ended December 31, 2001).**                                              |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(d)                                     | Amendment of Employment                        Agreement dated as of April 23, 2001, between Pharmos Corporation and Gad                        Riesenfeld (Incorporated by reference to Exhibit 10(p) to the                        Company’s Annual Report on Form 10-K for the year ended December 31,                        2001).**         |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(e)                                     | Amendment of Employment                        Agreement dated as of February 16, 2005 between Pharmos Corporation and Gad                        Riesenfeld (Incorporated by reference to Exhibit 10(w) to the                        Company’s Annual Report on Form 10-K for the year ended December 31,                        2004).**       |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(f)                                     | Employment Agreement                        dated as of July 19, 2004 between Pharmos Corporation and James A. Meer                        (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly                        Report on Form 10-Q for the quarter ended September 30, 2004).**                                          |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(g)                                     | Employment Agreement                        dated as of November 7, 2005, between Pharmos Corporation and Alan L.                        Rubino (Incorporated by reference to exhibit 10.1 to the Company’s                        Quarterly Report on Form 10-Q for the quarter ended September 30,                        2005).**              |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(h)                                     | Employment Agreement                        between Pharmos Corporation and S. Colin Neill, dated as of October 5, 2006                        (Incorporated by reference to Exhibit 10.1 to the Company’s Current                        Report on Form 8-K filed on October 6, 2006).**                                                         |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(i)                                     | Retention Award                        Agreement dated as of September 6, 2004 between Pharmos Corporation and Dr.                        Haim Aviv (Incorporated by reference to Exhibit 10.1 to the Company’s                        Current Report on Form 8-K filed on September 10, 2004).**                                                 |
|   |                                      |                                                                                                                                                                                                                                                                                                                                                    |
|   | 10(j)                                     | Retention Award                        Agreement dated as of September 6, 2004 between Pharmos Corporation and Dr.                        Gad Riesenfeld (Incorporated by reference to Exhibit 10.2 to the                        Company’s Current Report on Form 8-K filed on September 10,                        2004).**                     |

74

----

|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|--------|----------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10(k)    | Consulting Agreement                        between Pharmos Corporation and Dr. Georges Anthony Marcel, dated October                        17, 2006 (Incorporated by reference to Exhibit 10.1 to the Company’s                        Current Report on Form 8-K filed on October 20, 2006).**                                                                                                                                           |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(l)    | Consulting Agreement                        between Pharmos Corporation and Dr. Lawrence F. Marshall, dated October 17,                        2006 (Incorporated by reference to Exhibit 10.2 to the Company’s                        Current Report on Form 8-K filed on October 20, 2006).**                                                                                                                                             |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(m)    | 1997                        Incentive and Non-Qualified Stock Option Plan (Annexed as Appendix B to the                        Proxy Statement on Form 14A filed November 5, 1997).**                                                                                                                                                                                                                                                             |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(n)    | Amended and Restated                        2000 Incentive and Non-Qualified Stock Option Plan.**                                                                                                                                                                                                                                                                                                                                                 |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(o)    | Amendment to the 2000                        Stock Option Plan (incorporated by reference to Appendix D to the                        Company’s Definitive Proxy Statement on Schedule 14A filed on                        September 10, 2007).**                                                                                                                                                                                           |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(p)    | 2001                        Employee Stock Purchase Plan (Incorporated by reference to Exhibit B to the                        Company’s Definitive Proxy Statement on Form 14A filed on June 6,                        2001).**                                                                                                                                                                                                            |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(q)(1) | Agreement between                        Avitek Ltd. (“Avitek”) and Yissum Research Development Company                        of the Hebrew University of Jerusalem (“Yissum”) dated November                        20, 1986 (Incorporated by reference to Annual Report on Form 10-K, as                        amended by Form10-K/A, for year ended December 31, 1992). (1)                                          |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(q)(2) | 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(q)(3) | 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(r)(1) | 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(r)(2) | 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(r)(3) | 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(s)(1) | 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(s)(2) | 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(s)(3) | Amendment No.1 to                        Research, Development and License Agreement between Pharmos Corporation,                        Pharmos Ltd. and Yissum Research Development Company of the Hebrew                        University of Jerusalem, dated May 31, 2006 (incorporated by reference to                        exhibit 99.1 to the registrant’s Current Report on Form 8-K filed                        June 6, 2006). |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(t)    | License Assignment and                        Amendment Agreement dated as of October 9, 2001 by and among Dr. Nicholas                        S. Bodor, Pharmos Corporation and Bausch & Lomb Incorporated                        (Incorporated by reference to Exhibit 2.2 to the Company’s Current                        Report on Form 8-K filed on October 16, 2001).                                                             |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(u)    | Asset Purchase                        Agreement between Bausch & Lomb Incorporated and Pharmos Corporation                        dated October 9, 2001 (Incorporated by reference to Exhibit 2.1 to the                        Company’s Current Report on Form 8-K filed on October 16,                        2001).                                                                                                                 |
|   |     |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | 10(v)    | Amendment No. 1 to                        Asset Purchase Agreement dated as of December 28, 2001 between Bausch &                        Lomb Incorporated and Pharmos Corporation (Incorporated by reference to                        Exhibit 10(v) to the Company’s Annual Report on Form 10-K for the                        year ended December 31, 2001).                                                                         |

75

----

|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|--------|----------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10(w)                                                          | Amendment No. 2 to                        Asset Purchase Agreement dated as of December 30, 2004 between Bausch &                        Lomb Incorporated and Pharmos Corporation (Incorporated by reference to                        Exhibit 10(v) to the Company’s Annual Report on Form 10-K for the                        year ended December 31, 2004).           |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 10(x)                                                          | License Agreement dated                        as of December 18, 2001 between Pharmos Ltd. and Herbamed Ltd.                        (Incorporated by reference to Exhibit 10(p) to the Annual Report on Form                        10-K for year ended December 31, 2002).                                                                                                        |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 10(y)                                                          | Amendment No. 1, dated                        as of June 30, 2005, to the License Agreement by and between Pharmos Ltd.                        and Herbamed Ltd., dated as of December 18, 2001 (Incorporated by reference                        to exhibit 99.1 to the Company’s Quarterly Report on Form 10-Q for                        the quarter ended June 30, 2005). |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 10(z)                                                          | Settlement Agreement                        between the Company and Lloyd I. Miller, III dated August 31, 2006                        (incorporated by reference to Exhibit 10.1 of the registrant’s                        Current Report on Form 8-K filed September 5, 2006).                                                                                              |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 10(aa)                                                         | Voting Agreement and                        Waiver by and among the Company, Lloyd I. Miller, III, Trust A-4 - Lloyd I.                        Miller, Milfam II L.P. and Milfam LLC dated August 31, 2006 (incorporated                        by reference to Exhibit 10.2 of the registrant’s Current Report on                        Form 8-K filed September 5, 2006).  |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 10(bb)                                                         | Employment Agreement                        between Pharmos Corporation and Elkan R. Gamzu, dated as of March 20, 2007                        (incorporated by reference to Exhibit 10.1 of the registrant’s                        Current Report on Form 8-K filed March 26, 2007).                                                                                         |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 10(cc)                                                         | Letter of Agreement                        between Pharmos Corporation and Haim Aviv, dated March 20, 2007                        (incorporated by reference to Exhitit 10.2 of the registrant’s                        Current Report on Form 8-K filed March 26, 2007.                                                                                                      |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
| 21     | Subsidiaries of the                        Registrant          |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 21(a)                                                          | Subsidiaries of the                        Registrant (Incorporated by reference to Annual Report on Form 10-K, as                        amended by Form 10-K/A, for year ended December 31, 1992).                                                                                                                                                                                |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
| 23     | Consents of Experts and                        Counsel         |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 23(a) ***                                                      | Consent of                        PricewaterhouseCoopers LLP                                                                                                                                                                                                                                                                                                                        |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
| 31     | Rule                        13a-14(a)/15d-14(a) Certifications |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 31(a)***                                                       | Rule                        13a-14(a)/15d-14(a) Certification of Principal Executive Officer                                                                                                                                                                                                                                                                                        |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 31(b)***                                                       | Rule                        13a-14(a)/15d-14(a) Certification of Chief Financial Officer                                                                                                                                                                                                                                                                                            |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
| 32     | Section 1350                        Certifications             |
|   |                                                           |                                                                                                                                                                                                                                                                                                                                                                                |
|   | 32(a)***                                                       | Section 1350                        Certification of Principal Executive Officer and Chief Financial                        Officer                                                                                                                                                                                                                                                 |

|   |                                                                                                                                       |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
| (1)    | Confidential                        information is omitted and identified by a * and filed separately with the                        SEC. |
|   |                                                                                                                                       |
| (**)   | This                        document is a management contract or compensatory plan or                        arrangement.                  |
|   |                                                                                                                                       |
| (***)  | Filed                        herewith                                                                                                      |

76

----

**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/ Robert F. Johnston    |
|                                                                                                       |                                                      |
|                                                                                                       | Robert F.                        Johnston            |
|                                                                                                       | Executive                        Chairman            |
|                                                                                                       | (Principal Executive                        Officer) |
|                                                                                                       |                                                 |
|           Date:                        February 29, 2008 |

          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:

|                                               |   |                                                                                                                             |      |                                     |                                     |
|----------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------|-----------|------------------------------------------|------------------------------------------|
| **Signature**                                      |   |                                                                                                                             | **Title** |                                     | **Date**                                 |
|                                                    |   |                                                                                                                             |           |                                     |                                          |
|                                               |   |                                                                                                                             |      |                                     |                                     |
| /s/                        S. Colin Neill          |   |                                                                                                                             |      |                                     |                                     |
|                                                    |   |                                                                                                                             |      |                                     |                                     |
| S.                        Colin Neill              |   | President and Chief                        Financial Officer                        (Principal Financial and Accounting Officer) |      | February 29,                        2008 |
| /s/ Srinivas Akkaraju                              |   |                                                                                                                             |      |                                     |                                     |
|                                                    |   |                                                                                                                             |      |                                     |                                     |
| Srinivas Akkaraju, MD,                        Ph.D |   | Director                                                                                                                         |      |                                     | February 29,                        2008 |
|                                               |   |                                                                                                                             |      |                                     |                                     |
| /s/                        Anthony B. Evnin        |   |                                                                                                                             |      |                                     |                                     |
|                                                    |   |                                                                                                                             |      |                                     |                                     |
| Anthony B. Evnin,                        Ph.D      |   | Director                                                                                                                         |      |                                     | February 29,                        2008 |
|                                               |   |                                                                                                                             |      |                                     |                                     |
| /s/                        Elkan R. Gamzu, Ph.D    |   |                                                                                                                             |      |                                     |                                     |
|                                                    |   |                                                                                                                             |      |                                     |                                     |
| Elkan R. Gamzu,                        Ph.D        |   | Director                                                                                                                         |      |                                     | February 29,                        2008 |
| /s/ Lloyd I. Miller                           |   |                                                                                                                             |      |                                     |                                     |
|                                                    |   |                                                                                                                             |      |                                     |                                     |
| Lloyd I. Miller,                        III        |   | Director                                                                                                                         |      |                                     | February 29,                        2008 |
|                                               |   |                                                                                                                             |      |                                     |                                     |
| /s/                        Charles W. Newhall, III |        |                                                                                                                                  |           |                                          |                                          |
|                                                    |   |                                                                                                                             |      |                                     |                                     |
| Charles W. Newhall,                        III     |   | Director                                                                                                                         |      |                                     | February 29,                        2008 |

77

----

**Pharmos            Corporation            Index to Consolidated Financial Statements**

|                                                                                                                                                                |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Report of                        Independent Registered Public Accounting Firm                                                                                      | F-2    |
| Consolidated                        balance sheets as of December 31, 2007 and 2006                                                                                 | F-3    |
| Consolidated                        statements of operations for the years ended December 31, 2007, 2006 and                        2005                            | F-4    |
| Consolidated                        statements of changes in shareholders’ equity for the years ended                        December 31, 2007, 2006 and 2005 | F-5    |
| Consolidated                        statements of cash flows for the years ended December 31, 2007, 2006, and                        2005                           | F-6    |
| Notes to                        consolidated financial statements                                                                                                   | F-7    |

F-1

----

**Report of            Independent Registered Public Accounting Firm**

To the Board of Directors            and            Shareholders of Pharmos Corporation:

In our opinion,            the consolidated financial statements listed in the index appearing under Item 15(a)(1)            present fairly, in all material respects, the financial position of Pharmos Corporation            and its subsidiaries at December 31, 2007 and December 31, 2006, and the results of            their operations and their cash flows for each of the three years in the period ended            December 31, 2007 in conformity with accounting principles generally accepted in the            United States of America. These financial statements are the responsibility of the            Company’s management. Our responsibility is to express an opinion on these            financial statements based on our audits. We conducted our audits of these statements            in accordance with the standards of the Public Company Accounting Oversight Board            (United States). Those standards 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 our opinion.

As discussed in Note 3 to the            consolidated financial statements, the Company changed the manner in which it accounts            for share-based compensation in 2006, and adopted FIN 48, Accounting for Uncertainty in            Income Taxes, effective January 1, 2007.

/s/ PricewaterhouseCoopers            LLP

PricewaterhouseCoopers LLP            New York, NY            February 27, 2008

F-2

----

**PHARMOS CORPORATIONConsolidated Balance Sheets**

|                                                                                                                                                                      |   |                                    |         |     |   |         |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------------|----------|--------|--------------|--------|
|                                                                                                                                                                      |   | **December                        31,** |         |
|                                                                                                                                                                      |   |                                         |         |
|                                                                                                                                                                      |   | **2007**                                |         | **2006** |   |
|                                                                                                                                                                      |   |                                         |         |
| **Assets**                                                                                                                                                                |   |                                    |         |
| Current                        Assets                                                                                                                                     |   |                                    |         |     |   |         |   |
| Cash and cash                        equivalents                                                                                                                          |   | $                                       | 7,481,741    |     | $      | 12,757,013   |   |
| Short-term                        investments                                                                                                                             |   |                                    | 3,686,568    |     |   | 13,172,673   |   |
| Restricted                        cash                                                                                                                                    |   |                                    | 86,695       |     |   | 82,926       |   |
| Research and                        development grants receivable                                                                                                         |   |                                    | 3,859        |     |   | 297,865      |   |
| Prepaid expenses and                        other current assets                                                                                                          |   |                                    | 225,185      |     |   | 424,658      |   |
|                                                                                                                                                                      |   |                                         |              |     |        |              |   |
| **Total current                        assets**                                                                                                                           |   |                                    | 11,484,048   |     |   | 26,735,135   |   |
|                                                                                                                                                                      |   |                                    |         |     |   |         |   |
| Fixed assets,                        net                                                                                                                                  |   |                                    | 424,458      |     |   | 593,457      |   |
| Restricted                        cash                                                                                                                                    |   |                                    | 65,031       |     |   | 63,922       |   |
| Severance pay                        funded                                                                                                                               |   |                                    | 264,934      |     |   | 975,810      |   |
| Other assets                                                                                                                                                              |   |                                    | 136,488      |     |   | 25,014       |   |
|                                                                                                                                                                      |   |                                         |              |     |        |              |   |
|                                                                                                                                                                      |   |                                    |         |     |   |         |   |
| **Total                        assets**                                                                                                                                   |   | $                                       | 12,374,959   |     | $      | 28,393,338   |   |
|                                                                                                                                                                      |   |                                         |              |     |        |              |   |
|                                                                                                                                                                      |   |                                    |         |     |   |         |   |
| **Liabilities and                        Shareholder’s Equity**                                                                                                     |   |                                    |         |     |   |         |   |
| Current                        liabilities                                                                                                                                |   |                                    |         |     |   |         |   |
| Accounts                        payable                                                                                                                                   |   | $                                       | 768,768      |     | $      | 663,192      |   |
| Accrued                        expenses                                                                                                                                   |   |                                    | 404,937      |     |   | 889,783      |   |
| Warrant                        liability                                                                                                                                  |   |                                    |         |     |   | 11,435       |   |
| Accrued wages and other                        compensation                                                                                                               |   |                                    | 805,995      |     |   | 1,002,572    |   |
|                                                                                                                                                                      |   |                                         |              |     |        |              |   |
| **Total current                        liabilities**                                                                                                                      |   |                                    | 1,979,700    |     |   | 2,566,982    |   |
|                                                                                                                                                                      |   |                                    |         |     |   |         |   |
| Other                        liability                                                                                                                                    |   |                                    | 51,888       |     |   | 77,682       |   |
| Severance                        pay                                                                                                                                      |   |                                    | 358,706      |     |   | 1,320,624    |   |
|                                                                                                                                                                      |   |                                         |              |     |        |              |   |
| **Total                        liabilities**                                                                                                                              |   |                                    | 2,390,294    |     |   | 3,965,288    |   |
|                                                                                                                                                                      |   |                                         |              |     |        |              |   |
|                                                                                                                                                                      |   |                                    |         |     |   |         |   |
| Commitments and                        contingencies                                                                                                                      |   |                                    |         |     |   |         |   |
|                                                                                                                                                                      |   |                                    |         |     |   |         |   |
| **Shareholders’                        Equity**                                                                                                                     |   |                                    |         |     |   |         |   |
| Preferred stock, $.03                        par value, 1,250,000 shares authorized, none issued and                        outstanding                                   |   |                                    | —      |     |   | —      |   |
| Common stock, $.03 par                        value; 60,000,000 shares authorized, 25,603,759 and 25,565,784 issued in                        2007 and 2006, respectively |   |                                    | 768,112      |     |   | 766,973      |   |
| Paid-in capital in                        excess of par                                                                                                                   |   |                                    | 205,881,331  |     |   | 204,700,030  |   |
| Accumulated                        deficit                                                                                                                                |   |                                    | (196,664,352 | )        |   | (181,038,527 | )      |
|                                                                                                                                                                      |   |                                    |         |     |   |         |   |
| Treasury stock, at                        cost, 2,838 shares                                                                                                              |   |                                    | (426         | )        |   | (426         | )      |
|                                                                                                                                                                      |   |                                         |              |     |        |              |   |
| **Total                        shareholders’ equity**                                                                                                               |   |                                    | 9,984,665    |     |   | 24,428,050   |   |
|                                                                                                                                                                      |   |                                         |              |     |        |              |   |
|                                                                                                                                                                      |   |                                    |         |     |   |         |   |
| **Total liabilities                        and shareholders’ equity**                                                                                               |   | $                                       | 12,374,959   |     | $      | 28,393,338   |   |
|                                                                                                                                                                      |   |                                         |              |     |        |              |   |

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

F-3

----

**PHARMOS CORPORATIONConsolidated Statements of Operations**

|                                                                |   |                                               |        |     |   |        |   |   |        |   |
|---------------------------------------------------------------------|--------|----------------------------------------------------|-------------|----------|--------|-------------|--------|--------|-------------|--------|
|                                                                |   | **Year ended December                        31,** |        |
|                                                                |   |                                                    |        |
|                                                                |   | **2007**                                           |        | **2006** |   | **2005**    |   |
|                                                                |   |                                                    |        |          |   |             |   |
| **Expenses**                                                        |   |                                               |        |     |   |        |   |   |        |   |
| Research and                        development, gross              |   | $                                                  | 11,457,566  |     | $      | 8,956,821   |   | $      | 9,568,293   |   |
| Grants                                                              |   |                                               | (812,042    | )        |   | (1,445,513  | )      |   | (1,406,508  | )      |
|                                                                |   |                                                    |             |     |        |             |   |        |             |   |
| Research and                        development, net of grants      |   |                                               | 10,645,524  |     |   | 7,511,308   |   |   | 8,161,785   |   |
| In-process acquired                        research and development |   |                                               | —     |     |   | 20,607,575  |   |   | —     |   |
|                                                                |   |                                               |        |     |   |        |   |   |        |   |
| General and                        administrative                   |   |                                               | 6,698,601   |     |   | 9,108,867   |   |   | 7,165,291   |   |
| Depreciation and                        amortization                |   |                                               | 235,134     |     |   | 314,769     |   |   | 381,812     |   |
|                                                                |   |                                                    |             |     |        |             |   |        |             |   |
|                                                                |   |                                               |        |     |   |        |   |   |        |   |
| **Total operating                        expenses**                 |   |                                               | 17,579,259  |     |   | 37,542,519  |   |   | 15,708,888  |   |
|                                                                |   |                                                    |             |     |        |             |   |        |             |   |
|                                                                |   |                                               |        |     |   |        |   |   |        |   |
| **Loss from                        operations**                     |   |                                               | (17,579,259 | )        |   | (37,542,519 | )      |   | (15,708,888 | )      |
|                                                                |   |                                               |        |     |   |        |   |   |        |   |
| **Other income                        (expense)**                   |   |                                               |        |     |   |        |   |   |        |   |
|                                                                |   |                                               |        |     |   |        |   |   |        |   |
| Bausch & Lomb                        payment, net               |   |                                               | —     |     |   | —     |   |   | 10,725,688  |   |
| Interest                        income                              |   |                                               | 938,312     |     |   | 1,778,042   |   |   | 1,514,878   |   |
| Interest                        expense                             |   |                                               | —     |     |   | —     |   |   | (166,322    | )      |
| Change in value of                        warrants                  |   |                                               | 11,435      |     |   | 27,445      |   |   | 259,075     |   |
| Other (expense)                        income                       |   |                                               | 47,905      |     |   | (12,712     | )      |   | (44,937     | )      |
|                                                                |   |                                                    |             |     |        |             |   |        |             |   |
| **Other income,                        net**                        |   |                                               | 997,652     |     |   | 1,792,775   |   |   | 12,288,382  |   |
|                                                                |   |                                                    |             |     |        |             |   |        |             |   |
|                                                                |   |                                               |        |     |   |        |   |   |        |   |
| **Loss before income                        taxes**                 |   | $                                                  | (16,581,607 | )        | $      | (35,749,744 | )      | $      | (3,420,506  | )      |
| Income tax                        benefit                           |   |                                               | (955,782    | )        |   | (612,775    | )      |   | (490,634    | )      |
|                                                                |   |                                                    |             |     |        |             |   |        |             |   |
|                                                                |   |                                               |        |     |   |        |   |   |        |   |
| **Net                        loss**                                 |   | $                                                  | (15,625,825 | )        | $      | (35,136,969 | )      | ($     | 2,929,872   | )      |
|                                                                |   |                                                    |             |     |        |             |   |        |             |   |
|                                                                |   |                                               |        |     |   |        |   |   |        |   |
| **Net loss per                        share**                       |   |                                               |        |     |   |        |   |   |        |   |
| - basic and                        diluted                          |   | ($                                                 | 0.61        | )        | ($     | 1.74        | )      | ($     | 0.15        | )      |
|                                                                |   |                                               |        |     |   |        |   |   |        |   |
| **Weighted average                        shares outstanding**      |   |                                               |        |     |   |        |   |   |        |   |
| - basic and                        diluted                          |   |                                               | 25,591,660  |     |   | 20,249,714  |   |   | 18,974,175  |   |

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

F-4

----

|                                                                                        |
|---------------------------------------------------------------------------------------------|
| **Pharmos                        Corporation**                                              |
| **Consolidated                        Statements of Changes in Shareholders’ Equity** |
| **For the Years                        ended December 31, 2007, 2006 and 2005**             |
|                                                                                             |

|                                                                                                                                  |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   |        |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   |        |   |   |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|--------------|-------------|--------|--------|----------------------------------------------|--------|---------------------------------------------------------|--------|--------------------------------------------|--------|--------|----------------|--------|-------------|--------------------------------------------------------------------------------|--------|--------|--------------|--------|--------|---------|--------|--------|--------|--------|--------|--------|-------------|--------|--------|
|                                                                                                                                  |   | Common Stock |        |   |   |                                         |   |                                                    |   |                                       |   |   | Treasury Stock |   |        |                                                                           |   |
|                                                                                                                                  |   | Shares       |        | Amount |   | Deferred                        Compensation |   | Paid-in Capital in                        Excess of Par |   | Accumulated                        Deficit |   | Shares |           | Amount |        | Total                        Stockholders’                        Equity |   |
|                                                                                                                                  |   |              |        |        |   |                                              |   |                                                         |   |                                            |   |        |           |        |        |                                                                                |   |
| December 31,                        2004                                                                                              |   |         | 95,137,076  |   | $      | 2,854,112                                    |   |                                                    | $      | (1,701,122                                 | )      |   |           | $      | 188,809,955 |                                                                           |   | $      | (142,971,686 | )      |   | 14,189  |   | $      | (426   | )      |   | $      | 46,990,833  |   |   |
|                                                                                                                                  |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   |        |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   |        |   |   |
| Option issuance for                        consultant compensation                                                                    |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   | 1,244       |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   | 1,244       |   |   |
| Amortization of stock                        option issuance below fair market value                                                  |   |         |        |   |   |                                         |   |                                                    |   | 68,772                                     |   |   |           |   |        |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   | 68,772      |   |   |
| Amortization of                        Retention Award Agreements                                                                     |   |         |        |   |   |                                         |   |                                                    |   | 1,102,957                                  |   |   |           |   |        |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   | 1,102,957   |   |   |
| Effect of Stock Split                        (1:5)                                                                                    |   |         | (76,109,267 | )      |   | (2,283,278                                   | )      |                                                    |   |                                       |   |   |           |   | 2,283,278   |                                                                           |   |   |         |   |   | (11,351 | )      |   |   |   |   |   | —     |   |   |
| Issuance of Retention                        Award Shares                                                                             |   |         | 37,975      |   |   | 1,139                                        |   |                                                    |   |                                       |   |   |           |   | (1,139      | )                                                                              |   |   |         |   |   |    |   |   |   |   |   |   |        |   |   |
| Net Loss                                                                                                                              |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   |        |                                                                           |   |   | (2,929,872   | )      |   |    |   |   |   |   |   |   | (2,929,872  | )      |   |
|                                                                                                                                  |   |              |             |        |        |                                              |        |                                                         |        |                                            |        |        |                |        |             |                                                                                |        |        |              |        |        |         |        |        |        |        |        |        |             |   |   |
| December 31,                        2005                                                                                              |   |         | 19,065,784  |   |   | 571,973                                      |   |                                                    |   | (529,393                                   | )      |   |           |   | 191,093,338 |                                                                           |   |   | (145,901,558 | )      |   | 2,838   |   |   | (426   | )      |   |   | 45,233,934  |   |   |
|                                                                                                                                  |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   |        |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   |        |   |   |
| Stock and option                        issuance for employee compensation and amortization of retention                        award |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   | 1,363,092   |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   | 1,363,092   |   |   |
| Issuance of Common                        Stock for Vela Acquisition, net of direct costs of $32,007                                  |   |         | 6,500,000   |   |   | 195,000                                      |   |                                                    |   |                                       |   |   |           |   | 12,772,993  |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   | 12,967,993  |   |   |
| Reclassify deferred                        Compensation to Paid in Capital                                                            |   |         |        |   |   |                                         |   |                                                    |   | 529,393                                    |   |   |           |   | (529,393    | )                                                                              |   |   |         |   |   |    |   |   |   |   |   |   |        |   |   |
|                                                                                                                                  |
| Net loss                                                                                                                              |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   |        |                                                                           |   |   | (35,136,969  | )      |   |    |   |   |   |   |   |   | (35,136,969 | )      |   |
|                                                                                                                                  |   |              |             |        |        |                                              |        |                                                         |        |                                            |        |        |                |        |             |                                                                                |        |        |              |        |        |         |        |        |        |        |        |        |             |   |   |
| December 31,                        2006                                                                                              |   |         | 25,565,784  |   |   | 766,973                                      |   |                                                    |   | 0                                          |   |   |           |   | 204,700,030 |                                                                           |   |   | (181,038,527 | )      |   | 2,838   |   |   | (426   | )      |   |   | 24,428,050  |   |   |
|                                                                                                                                  |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   |        |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   |        |   |   |
| Stock and option                        issuance for employee compensation and amortization of retention                        award |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   | 1,182,440   |                                                                           |   |   |         |   |   |    |   |   |   |   |   |   | 1,182,440   |   |   |
| Issuance of Retention                        Award Shares                                                                             |   |         | 37,975      |   |   | 1,139                                        |   |                                                    |   |                                       |   |   |           |   | (1,139      | )                                                                              |   |   |         |   |   |    |   |   |   |   |   |   |        |   |   |
| Net Loss                                                                                                                              |   |         |        |   |   |                                         |   |                                                    |   |                                       |   |   |           |   |        |                                                                           |   |   | (15,625,825  | )      |   |    |   |   |   |   |   |   | (15,625,825 | )      |   |
|                                                                                                                                  |   |              |             |        |        |                                              |        |                                                         |        |                                            |        |        |                |        |             |                                                                                |        |        |              |        |        |         |        |        |        |        |        |        |             |   |   |
| December 31,                        2007                                                                                              |   |         | 25,603,759  |   | $      | 768,112                                      |   |                                                    | $      | 0                                          |   |   |           | $      | 205,881,331 |                                                                           |   | $      | (196,664,352 | )      |   | 2,838   |   | $      | (426   | )      |   | $      | 9,984,665   |   |   |
|                                                                                                                                  |   |              |             |        |        |                                              |        |                                                         |        |                                            |        |        |                |        |             |                                                                                |        |        |              |        |        |         |        |        |        |        |        |        |             |   |   |

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

F-5

----

**Pharmos CorporationConsolidated Statements of Cash Flows**

|                                                                                                                                 |   |                                               |        |     |   |        |   |   |        |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------|-------------|----------|--------|-------------|--------|--------|-------------|--------|
|                                                                                                                                 |   | **Year Ended December                        31,** |        |
|                                                                                                                                 |   | **2007**                                           |        | **2006** |   | **2005**    |   |
|                                                                                                                                 |   |                                                    |        |          |   |             |   |
|                                                                                                                                 |   |                                               |        |     |   |        |   |   |        |   |
| Cash flows from                        operating activities                                                                          |   |                                               |        |     |   |        |   |   |        |   |
|                                                                                                                                 |   |                                               |        |     |   |        |   |   |        |   |
| Net loss                                                                                                                             |   | $                                                  | (15,625,825 | )        | $      | (35,136,969 | )      | $      | (2,929,872  | )      |
| Adjustments to                        reconcile net loss to net cash used in operating activities:                                   |   |                                               |        |     |   |        |   |   |        |   |
| Depreciation and                        amortization                                                                                 |   |                                               | 235,134     |     |   | 314,769     |   |   | 381,812     |   |
| Provision for severance                        pay                                                                                   |   |                                               | (961,918    | )        |   | 305,977     |   |   | (182,392    | )      |
| Change in the value of                        warrants                                                                               |   |                                               | (11,435     | )        |   | (27,445     | )      |   | (259,074    | )      |
| Amortization of debt                        discount and issuance costs                                                              |   |                                               | —     |     |   | —     |   |   | 126,256     |   |
| Share-based                        compensation                                                                                      |   |                                               | 1,182,441   |     |   | 1,363,092   |   |   | 1,172,973   |   |
| Non cash portion of                        in-process research and development charge                                                |   |                                               | —     |     |   | 13,000,000  |   |   | —     |   |
| Income from Bausch                        & Lomb milestone payment, net                                                          |   |                                               | —     |     |   | —     |   |   | (10,725,688 | )      |
| Gain on disposition of                        fixed assets                                                                           |   |                                               | (12,383     | )        |   | —     |   |   | —     |   |
| Changes in operating                        assets and liabilities:                                                                  |   |                                               |        |     |   |        |   |   |        |   |
| Research and                        development grants receivable                                                                    |   |                                               | 294,006     |     |   | 436,372     |   |   | 803,545     |   |
| Prepaid expenses and                        other current assets                                                                     |   |                                               | 199,473     |     |   | 118,451     |   |   | (280,299    | )      |
| Other assets                                                                                                                         |   |                                               | (111,474    | )        |   | 3,482       |   |   | 450         |   |
| Accounts                        payable                                                                                              |   |                                               | 105,576     |     |   | 143,788     |   |   | (410,230    | )      |
| Accrued                        expenses                                                                                              |   |                                               | (484,846    | )        |   | 314,561     |   |   | (580,191    | )      |
| Accrued wages and other                        compensation                                                                          |   |                                               | (196,577    | )        |   | (495,209    | )      |   | 741,293     |   |
| Other                        liabilities                                                                                             |   |                                               | (25,794     | )        |   | (43,222     | )      |   | 71,492      |   |
|                                                                                                                                 |   |                                                    |             |     |        |             |   |        |             |   |
| Net cash used in                        operating activities                                                                         |   |                                               | (15,413,622 | )        |   | (19,702,353 | )      |   | (12,069,925 | )      |
|                                                                                                                                 |   |                                                    |             |     |        |             |   |        |             |   |
| Cash flows from                        investing activities                                                                          |   |                                               |        |     |   |        |   |   |        |   |
| Purchases of fixed                        assets                                                                                     |   |                                               | (176,592    | )        |   | (165,366    | )      |   | (137,222    | )      |
| Proceeds from                        disposition of fixed assets                                                                     |   |                                               | 122,839     |     |   | —     |   |   | —     |   |
| Proceeds from Bausch                        & Lomb milestone payment                                                             |   |                                               | —     |     |   | —     |   |   | 12,275,000  |   |
| Payment to Bausch &                        Lomb related to sale of ophthalmic business                                           |   |                                               | —     |     |   | —     |   |   | (1,532,528  | )      |
| Royalty payment and                        grant reimbursement related to Bausch & Lomb milestone                        payment |   |                                               | —     |     |   | —     |   |   | (1,549,312  | )      |
| Purchase of short-term                        investments                                                                            |   |                                               | (6,933,488  | )        |   | (23,312,980 | )      |   | (41,748,343 | )      |
| Proceeds from sale of                        short-term investments                                                                  |   |                                               | 16,419,593  |     |   | 45,888,650  |   |   | 6,000,000   |   |
| Severance pay                        funding                                                                                         |   |                                               | 710,876     |     |   | (203,611    | )      |   | 39,727      |   |
| Decrease (increase) in                        restricted cash                                                                        |   |                                               | (4,878      | )        |   | (4,447      | )      |   | 4,843,348   |   |
|                                                                                                                                 |   |                                                    |             |     |        |             |   |        |             |   |
| Net cash provided by                        (used in) investing activities                                                           |   |                                               | 10,138,350  |     |   | 22,202,246  |   |   | (21,809,330 | )      |
|                                                                                                                                 |   |                                                    |             |     |        |             |   |        |             |   |
| Cash flows from                        financing activities                                                                          |   |                                               |        |     |   |        |   |   |        |   |
| Costs from registration                        of common stock issued with Vela Acquisition                                          |   |                                               | —     |     |   | (32,007     | )      |   | —     |   |
| Repayment of                        convertible debentures                                                                           |   |                                               | —     |     |   | —     |   |   | (4,846,148  | )      |
|                                                                                                                                 |   |                                                    |             |     |        |             |   |        |             |   |
| Net cash (used in)                        financing activities                                                                       |   |                                               | —     |     |   | (32,007     | )      |   | (4,846,148  | )      |
|                                                                                                                                 |   |                                                    |             |     |        |             |   |        |             |   |
|                                                                                                                                 |
| Net increase (decrease)                        in cash and cash equivalents                                                          |   |                                               | (5,275,272  | )        |   | 2,467,886   |   |   | (38,725,403 | )      |
|                                                                                                                                 |   |                                               |        |     |   |        |   |   |        |   |
| Cash and cash                        equivalents at beginning of year                                                                |   |                                               | 12,757,013  |     |   | 10,289,127  |   |   | 49,014,530  |   |
|                                                                                                                                 |   |                                               |        |     |   |        |   |   |        |   |
|                                                                                                                                 |   |                                                    |             |     |        |             |   |        |             |   |
| Cash and cash                        equivalents at end of year                                                                      |   | $                                                  | 7,481,741   |     | $      | 12,757,013  |   | $      | 10,289,127  |   |
|                                                                                                                                 |   |                                                    |             |     |        |             |   |        |             |   |
| Supplemental                        information:                                                                                     |   |                                               |        |     |   |        |   |   |        |   |
| Interest                        paid                                                                                                 |   |                                               | —     |     |   | —     |   | $      | 32,086      |   |
| Supplemental disclosure                        of non-cash investing and financing activities:                                       |   |                                               |        |     |   |        |   |   |        |   |
| Common stock issued                        with Vela acquisition                                                                     |   |                                               | —     |     | $      | 13,000,000  |   |   | —     |   |

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

|   |
|--------|
|        |

F-6

----

**Pharmos CorporationNotes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 1.     | The                        Company                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | Pharmos Corporation                        (the “Company” or “Pharmos”) is a specialty                        pharmaceutical company that discovers and develops new novel therapeutic                        drugs to treat a range of indicators including pain, inflammatory,                        auto-immune and select CNS disorders. The Company has executive offices in                        Iselin, New Jersey and certain discovery, research and development                        activities are conducted through its wholly owned subsidiary, Pharmos,                        Ltd., in Rehovot, Israel.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.     | Liquidity and                        Business Risks                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | Except for 2001, the                        Company has experienced operating losses every year since inception in                        funding the research, development and clinical testing of our drug                        candidates. As of December 31, 2007, the Company’s accumulated                        deficit was approximately $197 million. The Company expects to incur                        additional losses over the next several years as the Company’s                        research and development and clinical trial programs continue. The Company                        has funded its operations through the use of cash obtained principally from                        third party financing, milestone payments from Bausch and Lomb, and                        government grants. Management believes that the cash, cash equivalents and                        short term investments of $11.2million as of December 31, 2007, combined                        with the $4.0 million private placement of convertible debentures that                        closed in January 2008 will be sufficient to support the Company’s                        continuing operations beyond December 31, 2008. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | The                        Company regularly pursues various funding options, including additional                        equity offerings, strategic corporate alliances, business combinations and                        the establishment of product related research and development limited                        partnerships to obtain additional financing to continue the development of                        its products and bring them to commercial markets. Should the Company be                        unable to raise adequate financing in the future, long-term projects will                        need to be scaled back or discontinued.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.     | Significant                        Accounting Policies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | *Basis of                        consolidation*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | The                        accompanying consolidated financial statements include the accounts of the                        Company and its wholly owned subsidiaries: Pharmos Ltd. and Vela                        Pharmaceuticals. All significant intercompany balances and transactions are                        eliminated in consolidation. The functional currency for Pharmos Ltd is the                        US dollar.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | *Use of                        estimates*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | The                        preparation of the consolidated financial statements in conformity with                        generally accepted accounting principles requires the Company to make                        estimates and assumptions that affect the reported amounts of assets and                        liabilities, disclosure of contingent assets and liabilities at the date of                        the financial statements and the reported amounts of revenues, costs and                        expenses during the reporting period. The most significant estimates and                        assumptions related to stock based compensation asset impairments,                        including estimates of commitments and contingencies, and the tax valuation                        allowance. Actual results could differ from those estimates.                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | *Net loss per                        common share*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | Basic and diluted net                        loss per common share was computed by dividing the net loss for the period                        by the weighted average number of shares of common stock issued and                        outstanding. In accordance with the requirements of Statement of Financial                        Accounting Standards No. 128, potential shares of common stock have been                        excluded from the calculation of diluted net loss per common share, as                        their inclusion would be antidilutive.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | The                        following table summarized the equivalent number of potential common shares                        assuming the related securities that were outstanding as of December 31,                        2007 and 2006 had been converted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

F-7

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|                                                                                      |   |      |   |      |   |
|-------------------------------------------------------------------------------------------|--------|-----------|--------|-----------|--------|
|                                                                                      |   | 2007      |   | 2006      |   |
|                                                                                      |   |           |   |           |   |
| Stock                        options                                                      |   | 2,420,386 |   | 1,924,622 |   |
| Warrants                                                                                  |   | 297,739   |   | 424,769   |   |
| Restricted stock                        – non vested                                |   | —   |   | 37,975    |   |
|                                                                                      |   |           |   |           |   |
| Total potential                        dilutive securities not included in loss per share |   | 2,718,125 |   | 2,387,366 |   |
|                                                                                      |   |           |   |           |   |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | *Cash and cash                        equivalents*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | The                        Company considers all highly liquid 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 at December                        31, 2007 and 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | *Investments*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | The Company                        considers all investments that are not considered cash equivalents and with                        a maturity of less than one year from the balance sheet date to be                        short-term investments. The Company considers all investments with a                        maturity of greater than one year to be long-term investments except for                        auction-rate securities as discussed below. All investments are considered                        as held-to-maturity and are carried at amortized cost, as the Company has                        both the positive intent and ability to hold them to maturity. The Company                        invests in a variety of instruments such as commercial paper, US Government                        securities and corporate securities with an effective maturity of less than                        one year. Some of the Company’s investments are in auction-rate                        securities (ARS) that are held as investments available for sale. Auction                        rate securities are instruments with long-term underlying maturities, but                        for which an auction is conducted periodically, as specified, to reset the                        interest rate and allow investors to buy or sell the instruments. Because                        auctions generally occur more often than annually, and because the Company                        holds these instruments in order to meet short-term liquidity needs, the                        auction rate securities are classified as short-term investments in the                        Consolidated Balance Sheet. Interest income includes interest, amortization                        of investment purchases premiums and discounts, and realized gains and                        losses on sales of securities. Realized gains and losses on sales of                        investment securities are determined based on the specific identification                        method. The Consolidated Statement of Cash Flows reflects the gross amount                        of the purchases of short term investments and the proceeds from maturities                        of short term securities and sales of auction rate securities. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | Realized gains and                        losses on sales of investment securities are determined based on the                        specific identification method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

|                                                   |   |   |      |   |   |       |   |
|--------------------------------------------------------|--------|--------|-----------|--------|--------|------------|--------|
|                                                   |   | 2007   |      | 2006   |   |
|                                                   |   |        |      |        |   |
| Securities greater                        than 90 days |   | $      | 1,036,568 |   | $      | 5,172,673  |   |
| Auction Rate                        Securities         |   |   | 2,650,000 |   |   | 8,000,000  |   |
|                                                   |   |        |           |   |        |            |   |
| Total Short Term                        Investments    |   | $      | 3,686,568 |   | $      | 13,172,673 |   |
|                                                   |   |        |           |   |        |            |   |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Since December 31, 2007                        the Company liquidated certain Auction Rate Securities. At February 11,                        2008 the Company had one remaining Auction Rate Security. The one remaining                        ARS, issued by George Washington University, is for $1,000,000. The reset                        auction for this security failed to clear on February 13, 2008. An auction                        failure occurs when the parties wishing to sell securities could not. This                        ARS, a general obligation of George Washington University, was reset at the                        max rate as defined and is backed by student loans. Additionally the ARS is                        insured and as a result no impairment charge has been deemed necessary.                        Based on the Company’s current cash balances, and other potential                        sources of cash, the Company does not anticipate the potential lack of                        liquidity on these investments will affect its ability to execute on the                        current business plan. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | *Revenue                        recognition*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | The                        Company’s policy with respect to license fees is to recognize revenue                        when all performance obligations are completed. The Company had no product                        sales revenue during 2007, 2006, or 2005 and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |

F-8

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                              |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | does                        not expect product sale revenues for the next few years and may never have                        such sales if products currently under development fail to be                        commercialized.                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                              |
|   | *Research and                        development costs*                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                              |
|   | All                        research and development costs are expensed when incurred. The Company                        accounts for reimbursements of research and development costs as a                        reduction of research and development expenses as the underlying expenses                        are incurred. |

F-9

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | *Research and                        development grants receivable*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | As                        of December 31, 2007 and 2006, research and development grant receivables                        consist of grants for research and development relating to certain                        projects. Research and development grants are recognized as a reduction of                        research and development expenses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | *Restricted                        cash*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | The                        Company has a lease agreement for the premises it occupies in New Jersey.                        The lease agreement expires in 2009. The lease agreement is secured by a                        letter of credit of $65,031. This amount is included in restricted cash at                        December 31, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | In                        addition, the Company’s subsidiary, Pharmos Ltd., has a lease                        agreement for the premises it occupies in Israel. The lease agreement                        expired in January 2007. In February 2007 the Company renewed the lease for                        a four year term. There is an early termination date on January 31, 2008                        and January 31, 2009 with no penalty to Pharmos if the company elects to                        notify an early termination 150 days prior to one of the early termination                        dates. The lease agreement is secured by a letter of guarantee in the                        amount of $177,016 based on the Israeli consumer price index. A deposit of                        $86,695 is included in restricted cash (current) at December 31,                        2007. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | *Fixed                        assets*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | Fixed assets are                        recorded at cost and are depreciated on a straight-line basis over their                        estimated useful lives. The Company uses the following estimated useful                        lives:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

|   |                                                               |                                       |
|--------|--------------------------------------------------------------------|--------------------------------------------|
|   | Laboratory, pilot                        plant and other equipment | 7 years to 14                        years |
|   | Leasehold                        improvements                      | 5 years to 14                        years |
|   | Office furniture and                        fixtures               | 3 years to 17                        years |
|   | Computer                        equipment                          | 3 years to 4                        years  |
|   | Vehicles                                                           | 5 years to 7                        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.                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | *Long-lived                        assets*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | The                        Company periodically evaluates potential impairments of its long-lived                        assets. When the Company determines that the carrying value of long-lived                        assets may not be recoverable based upon the existence of one or more                        indicators of impairment, the Company evaluates the projected undiscounted                        cash flows related to the assets and other factors. If these cash flows are                        less than the carrying value of the assets, the Company measures the                        impairment using discounted cash flows or other methods of determining fair                        value. |

F-10

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | *Severance                        pay*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | The                        Company’s liability for severance pay is calculated pursuant to                        Israel’s Severance Pay Law on the most recent salary of the employees                        multiplied by the number of years of employment, as of the balance sheet                        date. Employees are entitled to one month’s salary for each year of                        employment or a portion thereof. The Company’s liability for all of                        its Israeli employees is fully provided by monthly deposits with insurance                        policies and by an accrual. The value of these policies is recorded as an                        asset in the Company’s balance sheet.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | The                        deposited funds may be withdrawn only upon the fulfillment of the                        obligation pursuant to Israel’s Severance Pay Law or labor                        agreements. The value of the deposited funds is based on the cash surrender                        value of these policies, and includes immaterial profits accumulated up to                        the balance sheet date.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | Severance expenses in                        Israel for the years ended December 31, 2007, 2006 and 2005 amounted to                        $267,879, $396,826, and $102,962, respectively and have been included in                        the appropriate R&D and G&A expense categories.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | *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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | Effective January 1,                        2007, the Company adopted, the Financial Accounting Standards Board issued                        Interpretation No. 48, *Accounting for Uncertainty in Income                        Taxes* (“FIN 48”). This Interpretation clarifies the                        accounting for uncertainty in income taxes recognized in an entity’s                        financial statements and prescribes a recognition threshold of                        more-likely-than-not to be sustained upon examination. Measurement of the                        tax uncertainty occurs if the recognition threshold has been met.                        This Interpretation also provides guidance on derecognition,                        classification, interest and penalties, accounting in interim periods,                        disclosure, and transition. Pharmos conducts business in the US and Israel                        and, as a result, files US, New Jersey and Israeli income tax returns. In                        the normal course of business the Company is subject to examination by                        taxing authorities. At present, there are no ongoing audits or unresolved                        disputes with the various tax authorities that the Company files with.                        Given the Company’s substantial net operating loss carryforwards                        (“NOLs”, which are subject to a full valuation allowance) as                        well as the historical operating losses, the adoption of FIN 48 on January                        1, 2007 did not have any effect on our financial position, results of                        operations or cash flows as of December 31, 2007. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | *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 other                        income (expense). To date, such gains and losses have been                        insignificant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | *Concentration of                        credit risk*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | Financial instruments                        that potentially expose the Company to concentrations of credit risk                        consist primarily of cash, cash equivalents and short term investments. The                        Company maintains most of its cash balances in                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

F-11

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                        |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | accounts that exceed                        federally insured limits. The Company has not experienced any losses to                        date resulting from this practice.                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                        |
|   | *Fair value of                        financial instruments*                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                        |
|   | The                        carrying amounts of the Company’s financial instruments, including                        cash and cash equivalents, investments, other receivables, other assets,                        accounts payable and accrued liabilities which approximate fair value due                        to their short term maturities. |

F-12

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | *Share based                        compensation*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | The Company has                        stock-based compensation plans under which employees and outside directors                        receive stock options and other equity-based awards. The plans provide for                        the granting of stock options, restricted stock awards, and other stock                        unit awards. The maximum number of shares of Common Stock available for                        issuance under the 2000 Plan, as amended, is 4,700,000 shares. At December                        31, 2007, awards relating to 2,420,386 shares were outstanding. Pharmos                        stock options are granted with an exercise price equal to 100% of the                        market value of a share of common stock on the date of the grant, generally                        have 10 year terms, and vest no later than four years from the date of                        grant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | Under the terms of                        the Pharmos Employee Stock Purchase Plan (ESPP), all full-time and                        part-time employees of the Company who have completed a minimum of 6 months                        of employment are eligible to participate. The price of the Common Stock is                        calculated at 85% of the lower of either the mean between the highest and                        lowest prices at which Pharmos common stock trades on the first business                        day of the month, or the mean between the highest and lowest trading prices                        on the day of exercise (the last day of the month). A participant can                        purchase shares not to exceed 10% of one’s annualized base pay;                        $25,000; or 5% or more of shares outstanding. The total number of shares                        reserved for issuance under the 2001 Plan is 100,000 shares. During the                        year ended December 31, 2007, no shares were purchased under the ESPP and                        87,440 shares remain for issuance under the 2001 Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | Effective January 1,                        2006, the Company adopted the provisions of Statement of Financial                        Accounting Standards No. 123R, “Share-Based Payment”                        (“SFAS 123R”), which establishes the financial accounting                        and reporting standards for stock-based compensation plans. SFAS 123R                        requires the measurement and recognition of compensation expense for all                        stock-based awards made to employees and directors, including employee                        stock options and restricted stock units, and employee stock purchases                        related to the ESPP. Under the provisions of SFAS 123R, stock-based                        compensation cost is measured at the grant date, based on the fair value of                        the award, and is recognized as an expense over the requisite service                        period of the entire award (generally the vesting period of the award). The                        Company has elected to expense these awards on a straight line basis over                        the life of the awards. As a result of adopting SFAS 123R, the                        Company’s net loss before income taxes and net loss for the years                        ended December 31,2007 and 2006 were $1,076,606 and $939,500 more than if                        the Company had continued to account for stock-based compensation under                        Accounting Principles Board Opinion No. 25, “Accounting for                        Stock Issued to Employees” (“APB 25”) and its related                        interpretations. Basic and diluted net loss per share for the years ended                        December 31, 2007 and 2006 of $(0.61) and $(1.74) are $0.04 and $0.05 more                        as a result of adopting SFAS 123R. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | The Company elected                        to use the modified prospective transition method as permitted by SFAS 123R                        and, therefore, financial results for prior periods have not been restated.                        Under this transition method, stock-based compensation expense for the                        years ended December 31, 2007 and 2006 include expense for all equity                        awards granted prior to, but not yet vested as of January 1, 2006, based on                        the grant date fair value estimated in accordance with the original                        provisions of SFAS No. 123, “Accounting for Stock-Based                        Compensation” (“SFAS 123,”) as amended by SFAS 148,                        “Accounting for Stock-Based Compensation—Transition and                        Disclosure.” Compensation expense for all stock-based compensation                        awards granted subsequent to January 1, 2006 was based on the grant-date                        fair value determined in accordance with the provisions of SFAS 123R.                        During the years ended December 31, 2007 and 2006, the Company recognized                        compensation expense of $1,076,606 and $939,500 for stock options which                        were recognized in the Consolidated Statement of Operations. As of December                        31, 2007 and 2006, the total compensation costs related to non-vested                        awards not yet recognized is $510,000 which will be recognized over the                        next three and one-quarter years.                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | Prior to January 1,                        2006, the Company accounted for stock-based compensation in accordance with                        APB 25 and also followed the disclosure requirements of SFAS 123.                        Under APB 25, the Company accounted for stock-based awards to employees and                        directors using the intrinsic value method as allowed under SFAS 123. The                        following table sets forth the computation of basic and diluted loss per                        share for the year ended December 31, 2005 and illustrates the effect on                        net loss and loss per share as if the Company had applied                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

F-13

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                           |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | the                        fair value recognition provisions of SFAS 123 to its stock plans. The                        estimated fair value of each option is calculated using the Black-Scholes                        option-pricing model: |

|                                                                                                                                                          |   |                                                                                              |   |                                                                           |   |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|--------|--------|
|                                                                                                                                                          |   | Year                        Ended                        December 31,                        2005 |   |
|                                                                                                                                                          |   |                                                                                                   |   |
| Net loss as                        reported                                                                                                                   |   |                                                                                              |   | ($   2,929,872                                                  | )      |   |
| Add: Stock-based                        employee compensation expense included in reported net loss                                                           |   |                                                                                                   |   | 1,171,728                                                                      |        |   |
| Deduct: Total                        stock-based employee compensation expense determined under fair value based                        method for all awards |   |                                                                                              |   | (4,578,359                                                                     | )      |   |
|                                                                                                                                                          |   |                                                                                                   |   |                                                                                |        |   |
| Pro forma net                        loss                                                                                                                     |   |                                                                                                   |   | ($   6,336,503                                                  | )      |   |
|                                                                                                                                                          |   |                                                                                                   |   |                                                                                |        |   |
| Loss per                        share:                                                                                                                        |   |                                                                                              |   |                                                                           |   |   |
| As reported - basic and                        diluted                                                                                                        |   |                                                                                                   |        | ($            0.15 | )      |   |
| Pro forma - basic and                        diluted                                                                                                          |   |                                                                                              |   | ($            0.33 | )      |   |

|   |                                                                                                                                                                                                                                                                                   |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | For                        disclosure purposes under SFAS No. 123, the fair value of each option grant                        was estimated on the date of grant using the Black-Scholes option valuation                        model with the following weighted-average assumption: |

|   |                                             |                            |
|--------|--------------------------------------------------|---------------------------------|
|   |                                             | 2005                            |
|   |                                             |                                 |
|   | Risk-free interest                        rate   | 3.71-4.45%                      |
|   | Expected lives (in                        years) | 5                               |
|   | Dividend                        yield            | 0%                              |
|   | Expected                        volatility       | 99                        -107% |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | *Recently Issued                        Accounting Pronouncements*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | In                        September 2006, the FASB issued SFAS No. 157, “Fair Value                        Measurements” (“SFAS 157”). SFAS 157 establishes a single                        authoritative definition of fair value, sets out a framework for measuring                        fair value, and requires additional disclosures about fair-value                        measurements. SFAS 157 applies only to fair value measurements that are                        already required or permitted by other accounting standards (except for                        measurements of share-based payments) and is expected to increase the                        consistency of those measurements. Accordingly, SFAS 157 does not require                        any new fair value measurements. However, for some entities, the                        application of SFAS 157 will change current practice. SFAS 157 is effective                        for fiscal years beginning after November 15, 2007, and interim periods                        within those fiscal years. The Company does not expect the adoption of SFAS                        157 to have a material impact on our consolidated financial                        statements. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | In                        February 2007, the FASB issued Statement of Financial Accounting Standards                        “(FAS) No. 159”, “The Fair Value Option for Financial                        Assets and Financial Liabilities, Including an Amendment of FASB Statement                        No. 115” “(FAS No. 159)”, which is effective for                        financial statements issued for fiscal years beginning after November 15,                        2007 and interim periods within those fiscal years. SFAS No. 159 permits                        entities to measure eligible financial assets, financial liabilities and                        firm commitments at fair value, on an instrument-by-instrument basis, that                        are otherwise not permitted to be accounted for at fair value under other                        generally accepted accounting principles. The fair value measurement                        election is irrevocable and subsequent changes in fair value must be                        recorded in earnings. The Company is currently evaluating the impact that                        SFAS No. 159 will have on its consolidated financial statements.                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | On                        June 27, 2007, the FASB reached a final consensus on Emerging Issues Task                        Force Issue 07-3, “Accounting for Advance Payments for Goods or                        Services to Be Used in Future Research and Development                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |

F-14

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Activities”                        (“EITF 07-03”). Currently, under FASB Statement No. 2,                        “Accounting for Research and Development Costs”, nonrefundable                        advance payments for future research and development activities for                        materials, equipment, facilities, and purchased intangible assets that have                        no alternative future use are expensed as incurred. EITF 07-03 addresses                        whether such non-refundable advance payments for goods or services that                        have no alternative future use and that will be used or rendered for                        research and development activities should be expensed when the advance                        payments are made or when the research and development activities have been                        performed. The consensus reached by the FASB requires companies involved in                        research and development activities to capitalize such non-refundable                        advance payments for goods and services pursuant to an executory                        contractual arrangement because the right to receive those services in the                        future represents a probable future economic benefit. Those advance                        payments will be capitalized until the goods have been delivered or the                        related services have been performed. Entities will be required to evaluate                        whether they expect the goods or services to be rendered. If an entity does                        not expect the goods to be delivered or services to be rendered, the                        capitalized advance payment will be charged to expense. The consensus on                        EITF 07-03 is effective for financial statements issued for fiscal years                        beginning after December 15, 2007, and interim periods within those fiscal                        years. Earlier application is not permitted. Entities are required to                        recognize the effects of applying the guidance in EITF 07-03 prospectively                        for new contracts entered into after the effective date. The Company is in                        the process of evaluating the expected impact of EITF 07-03 on its                        financial position and results of operations following adoption. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.     | Acquisition of Vela                        Pharmaceuticals, Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | In                        March 2006, the Company announced an agreement to acquire Vela                        Pharmaceuticals, Inc. (“Vela”), which has a Phase II product                        candidate, dextofisopam, in development to treat irritable bowel syndrome.                        The Company intends to dedicate substantial resources to complete clinical                        development of this product candidate. The Vela acquisition also includes                        additional compounds in preclinical and/or clinical development for                        neuropathic pain, inflammation and sexual dysfunction. The final merger                        agreement, as amended, was announced on September 5, 2006 and approved by                        the Company’s shareholders on October 25, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | Under the amended                        Merger Agreement, the Company issued 6.5 million shares of common stock and                        paid $6 million to Vela shareholders at closing. Pharmos also agreed to                        reimburse Vela for $679,000 of operating expenses from July 1, 2006 through                        closing. The amended Merger Agreement also includes additional                        performance-based milestone payments to the Vela stockholders related to                        the development of dextofisopam, aggregating up to an additional $8 million                        in cash and the issuance of up to an additional 13,500,000 shares of                        Pharmos common stock. In the event that such shares or payments are issued                        or funded in future periods, a determination will then be made as to                        whether the values are to be written off as in - process research and                        development and charged to results of operations; such future charge could                        be material. None of the conditions requiring issuance of these contingent                        shares or funding these payments were met at December 31, 2007 except for a                        $1.0 million milestone payment made by Pharmos due upon the study’s                        commencement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | In                        addition, the Company’s additional paid in capital was reduced by                        $32,007 for registration costs related to the issuance of the common shares                        issued to Vela’s shareholders.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | The                        combined value of the acquisition purchase price was approximately $19.7                        million, plus direct expenses. The fair value ascribed to the 6.5 million                        shares of Company common stock ($13 million) was determined using the                        closing price of Pharmos common stock on October 25, 2006, which was the                        shareholder approval date of the acquisition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | The purchase price                        is as follows (in thousands):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

|                                                                  |   |   |   |   |
|-----------------------------------------------------------------------|--------|--------|--------|--------|
| Fair value of                        Pharmos shares issued at closing |   | $      | 13,000 |   |
| Cash and advances                        paid                         |   |   | 6,679  |   |
|                                                                  |   |        |        |   |
|                                                                  |   |   | 19,679 |   |
| Transaction costs                        incurred by Pharmos          |   |   | 1,422  |   |
|                                                                  |   |        |        |   |
| Purchase                        price                                 |   | $      | 21,101 |   |
|                                                                  |   |        |        |   |

F-15

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                           |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | The                        purchase price has been allocated based on a valuation of Vela’s                        tangible and intangible assets and liabilities and their following fair                        values (in thousands): |

|                                                                                          |   |   |   |   |
|-----------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Proceeds receivable                        from sale of New Jersey State net operating losses |   | $      | 493    |   |
| In-process research                        and development                                    |   |   | 20,608 |   |
|                                                                                          |   |        |        |   |
| Total                                                                                         |   | $      | 21,101 |   |
|                                                                                          |   |        |        |   |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | A                        substantial portion of the purchase price was considered to represent                        in-process research and development (“IPR&D) costs as the                        products have not, at the acquisition date, reached technological                        feasibility and may not have an alternate future use. Accordingly, such                        value was written off as a charge to operations for the quarter and year                        ended December 31, 2006. The value of the IPR&D charge was determined                        based on a discounted forecast of the estimated net future cash flows for                        each project, adjusted for the estimated probability of technical success                        and regulatory approvals. The discount rate applied was 23%. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   | The                        Company’s 2006 consolidated statement of operations includes the                        results of operations from Vela from October 26, 2006 forward. The                        following table presents unaudited pro forma consolidated results of                        operations for Pharmos for the years ended December 31, 2006 and 2005, as                        though the Vela acquisition was completed as of the beginning of each                        period.                                                                                                                                                                                                                                                                                                                                                     |

|                                                                           |   |                                         |        |                                         |   |        |   |
|--------------------------------------------------------------------------------|--------|----------------------------------------------|-------------|----------------------------------------------|--------|-------------|--------|
|                                                                           |   | **December                        31, 2006** |        | **December                        31, 2005** |   |
|                                                                                |   |                                              |        |                                              |   |
| Net loss attributable                        to common shareholders            |   | $                                            | (37,760,577 | )                                            | $      | (11,545,665 | )      |
|                                                                           |   |                                              |             |                                         |        |             |   |
| Net loss per share                        attributable to common shareholders: |   |                                         |        |                                         |   |        |   |
| Basic and                        diluted                                       |   | $                                            | (1.48       | )                                            | $      | (0.45       | )      |
| Weighted average shares                        outstanding                     |   |                                         | 25,565,783  |                                         |   | 25,474,175  |   |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 5.     | Bausch & Lomb                        Collaborative Agreement                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | Pharmos sold to Bausch                        & Lomb all of its rights in the U.S. and Europe to manufacture and                        market Lotemax® and Alrex® and Zylet®, the third loteprednol                        etabonate-based product, which was submitted to the FDA for marketing                        approval in September 2003. In December 2004, Bausch & Lomb received                        approval from the FDA of its New Drug Application for Zylet as an                        ophthalmic anti-inflammatory/antibiotic combination product.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | During January 2005, an                        amended agreement was signed in regard to Zylet and the Company received                        gross proceeds of approximately $12.2 million from Bausch & Lomb.                        Additionally, the Company may receive a milestone payment of up to $10                        million if actual sales during the first two years following Bausch &                        Lomb’s commercialization exceed agreed-upon forecasted amounts. A                        review of Zylet sales provided by Bausch and Lomb indicated that no                        additional payments are due the Company as actual sales of Zylet did not                        reach the agreed levels. Pharmos agreed to pay up to $3.75 million of                        Bausch & Lomb’s costs of developing Zylet, of which $600,000 was                        deducted from the purchase price paid by Bausch & Lomb in October 2001.                        In July 2003, another $1.57 million was paid to Bausch & Lomb. As of                        December 31, 2004, Pharmos owed an additional $1.56 million as its share of                        these research and development related Zylet expenses, which was included                        in accounts payable and represents the final amount Pharmos owes Bausch                        & Lomb for their project development under the terms of the agreement.                        This amount was paid to Bausch & Lomb in January 2005. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | Pharmos paid Dr.                        Nicholas Bodor, the loteprednol etabonate patent owner and licensor, who is                        also a former director of and consultant to Pharmos, a total of                        approximately $2.7 million from the initial proceeds of the sale of                        Lotemax® and Alrex® in return for his consent to Pharmos’                        assignment of its rights under the license agreement to Bausch & Lomb                        ($1.5 million paid at closing and $1.2 million paid in                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |

F-16

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | October 2002). During                        January 2005, the Company paid Dr. Bodor approximately $1.3 million per the                        agreement with respect to Zylet. Pharmos owes Dr. Bodor an additional 14.3%                        of any payments the Company may receive from Bausch & Lomb in the event                        that certain sales levels are exceeded in the first two years following                        commencement of sales in the U.S. Pharmos has no further obligations for                        payments to Bausch & Lomb. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 6.     | Fixed                        Assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | Fixed assets consist                        of the following:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

|                                                               |   |                                    |       |     |   |       |   |
|--------------------------------------------------------------------|--------|-----------------------------------------|------------|----------|--------|------------|--------|
|                                                               |   | **December                        31,** |       |
|                                                               |   |                                         |       |
|                                                               |   | **2007**                                |       | **2006** |   |
|                                                               |   |                                         |       |          |   |
|                                                               |   |                                    |       |     |   |       |   |
| Laboratory, pilot                        plant and other equipment |   | $                                       | 2,727,055  |     | $      | 3,053,556  |   |
| Leasehold                        improvements                      |   |                                    | 839,713    |     |   | 812,070    |   |
| Office furniture and                        fixtures               |   |                                    | 288,965    |     |   | 299,759    |   |
| Computer                        equipment                          |   |                                    | 822,835    |     |   | 1,192,439  |   |
| Vehicles                                                           |   |                                    | —    |     |   | 49,489     |   |
|                                                               |   |                                         |            |     |        |            |   |
|                                                               |   |                                    | 4,678,568  |     |   | 5,407,313  |   |
| Less - Accumulated                        depreciation             |   |                                    | (4,254,110 | )        |   | (4,813,856 | )      |
|                                                               |   |                                         |            |     |        |            |   |
| Total Fixed                        Assets                          |   | $                                       | 424,458    |     | $      | 593,457    |   |
|                                                               |   |                                         |            |     |        |            |   |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Depreciation of fixed                        assets was $235,134, $314,769, and $381,812 in 2007, 2006 and 2005,                        respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 7.     | Grants for Research                        and Development                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | During 2007, 2006 and                        2005, gross research and development costs amounted to $11,457,566,                        $8,956,821, and $9,568,293 respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | The                        Company has entered into agreements with 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                        $812,042, $1,445,513 and $1,406,508 during 2007, 2006 and 2005,                        respectively. The agreements with agencies of the State of Israel place                        certain legal restrictions on the transfer of the technology and                        manufacture of resulting products outside Israel. The Company will be                        required to pay royalties, at rates ranging from 3% to 5%, to such agencies                        from the sale of products, if any, developed as a result of the research                        activities carried out with the grant funds up to the amount received and                        interest. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | As                        of December 31, 2007, the total amounts received under such grants amounted                        to $17,827,499. Aggregate future royalty payments related to sales of                        products developed, if any, as a result of these grants are limited to                        $16,338,559, exclusive of interest, based on grants received through                        December 31, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | The                        Company signed an agreement with Consortium Magnet for developing generic                        technologies for design and development of drugs and diagnostic kits which                        consortium is operated by the Office of the Chief Scientist (OCS) of                        Israel. Under such agreements the Company is entitled to a non-refundable                        grant amounting to approximately 60% of actual research and development and                        equipment expenditures on approved projects. No royalty obligations are                        required within the framework. As of December 31, 2005, the Company                        received cumulative grants totaling $1,659,549 for this program which was                        completed and closed.                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | The                        Company signed an agreement with Consortium Magnet to develop a supply of                        water-soluble prodrugs of lipophilic compounds that improve their                        bioavailability and biopharmaceutical properties. Under such agreement the                        Company is entitled to a non-refundable grant amounting to approximately                        60% of actual research and development and equipment expenditures on                        approved projects. No royalty obligations are required within the                        framework. As of December 31, 2006, the Company received cumulative grants                        totaling $546,609 for this program. On December 31, 2006, the OCS closed                        the magnet program.                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

F-17

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 8.     | Private Placement of                        Convertible Debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | On                        September 26, 2003, the Company completed a private placement of                        convertible debentures and warrants to six institutional investors,                        generating total gross proceeds of $21.0 million. Five million dollars of                        the proceeds was to be used for working capital purposes, and $16.0 million                        would be available to fund acquisitions upon the approval of the investors.                        The convertible debentures were convertible into common stock of the                        Company at a fixed price of $20.20, 205% above the closing bid price of the                        stock for the five days preceding the closing date. The debentures, which                        bore an interest rate of 4%, were redeemed in 13 substantially equal                        monthly increments beginning March 31, 2004. In general, amounts converted                        into shares of Pharmos common stock reduced the monthly redemption amount                        proportionately. The $16.0 million earmarked for acquisition activity was                        held in escrow until repaid. The debentures were fully repaid during March                        2005; As of December 31, 2005, there are no remaining funds in the escrow                        account. In connection with the financing, the Company also issued                        1,102,941 three-year warrants (including 102,941 placement agent warrants)                        to purchase 1,102,941 shares of common stock at an exercise price of $10.20                        per share. Total issuance costs related to the financing were approximately                        $1,229,000 in cash and $434,000 for the value of the placement agent                        warrants. The issuance costs allocated to the warrants were recorded as a                        reduction to additional paid in capital. The placement agent warrants were                        capitalized and were amortized over the life of the debt. The Company                        calculated the value of the warrants at the date of the transaction,                        including the placement agent warrants, being approximately $4,652,877                        under the Black-Scholes option-pricing method (assumption: volatility 75%,                        risk free rate 1.59% and zero dividend yield). The Company allocated the                        $19.34 million in net proceeds between the convertible debentures and the                        warrants based on their relative fair values. The Company has reported the                        debt discount of approximately $3.5 million as a direct reduction to the                        face amount of the debt in accordance with APB 21. The discount accreted                        over the life of the outstanding debentures. Total accretion of the debt                        discount from inception through December 31, 2005 was $3,284,041. The                        issuance costs allocated to the convertible debentures of approximately                        $1.4 million had been being deferred and amortized to interest expense over                        the life of the debt. Total amortization of the debt issuance costs from                        inception through December 31, 2005 was $1,309,075. During the first                        quarter of 2004, one of the investors converted a total of $2 million plus                        interest into 99,533 shares of common stock. In conjunction with this                        conversion, the relating unamortized debt discount and issuance costs                        totaling $267,912 was reclassified to additional paid in capital. As of                        December 31, 2005, all the debentures had been either repaid or converted                        into common stock of the Company. As of December 31, 2005, 351,400 of the                        total warrants issued were exercised totaling approximately $3,584,280.                        There were no warrants exercised during 2005, 2006 or 2007. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 9.     | Shareholders Equity                        Transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | *2007                        Transactions*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | On                        March 31, 2007, 37,975 shares were issued to Haim Aviv for shares which                        vested, according to the terms of his Retention Award Agreement and his                        severance agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | During 2007, 2006 and                        2005, there were no shares of common stock issued pursuant to the Pharmos                        Corporation 2001 Employee Stock Purchase Plan. All full-time and part-time                        employees of the Company who have completed a minimum of 6 months of                        employment are eligible to participate. The price of the Common Stock is                        calculated at 85% of the lower of either the mean between the highest and                        lowest prices at which Pharmos common stock trades on the first business                        day of the month, or the mean between the highest and lowest trading prices                        on the day of exercise (the last day of the month). A participant can                        purchase shares not to exceed 10% of one’s annualized base pay;                        $25,000; or 5% or more of shares outstanding. The total number of shares                        reserved for issuance under the 2001 Plan is 100,000 shares. As of December                        31, 2007, there were 87,440 shares remaining for issuance under the 2001                        Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   | For                        the year ended December 31, 2007, there were no options exercised under the                        Company’s Stock Option Plans. For the year ended December 31, 2007,                        the Company incurred a non-cash charge of $1,076,606 for stock options to                        employees and directors.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

F-18

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | As                        of December 31, 2007, the Company had reserved 2,420,386 for outstanding                        stock options and 297,739 for outstanding warrants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | *2006                        Transactions*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | On                        October 25, 2006 Pharmos issued 6,500,000 shares of its common stock to                        Vela’s shareholders in conjunction with the acquisition of                        Vela.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | For                        the year ended December 31, 2006, there were no options exercised under the                        Company’s Stock Option Plans. For the year ended December 31, 2006,                        the Company incurred a non-cash charge of $939,500 for issuing stock                        options to employees.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | As                        of December 31, 2006, the Company had reserved 1,987,914 for outstanding                        stock options and 424,769 for outstanding warrants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | *2005                        Transactions*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | For                        the year ended December 31, 2005, there were no options exercised under the                        Company’s Stock Option Plans. For the year ended December 31, 2005,                        the Company incurred a non-cash charge of $1,244 for issuing stock options                        to consultants who have since become employees. In addition, the                        amortization of the remaining balance for options which had been issued                        below fair market value in 2004 and charged to deferred compensation has                        been expensed in the amount of $48,000 during 2005 as a result of the                        acceleration of vested options above $9.00 which included these shares. The                        total amortization for all shares issued below fair market value recognized                        during 2005 was $68,772.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | During 2005, the                        Company recorded an expense of approximately $1,103,000 in connection with                        the Retention Awards granted to Dr Aviv and Dr. Riesenfeld. Per the Awards,                        only Dr. Riesenfeld was issued shares of restricted stock. Dr. Aviv                        received restricted stock units and will be issued shares of stock when                        vested. On December 31, 2005, 37,975 shares were issued to Haim Aviv for                        shares which vested, according the terms of his Retention Award Agreement.                        Dr. Riesenfeld’s shares had already been issued at the time of the                        approval of the Retention Award Agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | In                        September 2005, the shareholders of the Company approved the increase in                        the number of authorized shares of the Company’s Common Stock to                        60,000,000 from 30,000,000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | On                        May 26, 2005, Pharmos Corporation filed a Certificate of Change with the                        Nevada Secretary of State which served to effect, as of May 31, 2005, a                        1-for-5 reverse split of Pharmos’ common stock. As a result of the                        reverse stock split, every five shares of Pharmos common stock were                        combined into one share of common stock; any fractional shares created by                        the reverse stock split were rounded up to whole shares. The reverse stock                        split affected all of Pharmos’ common stock, stock options,                        restricted shares and warrants outstanding immediately prior to the                        effective date of the reverse stock split. The reverse split reduced the                        number of shares of Pharmos’ common stock outstanding from 95,137,076                        shares to 19,027,809 shares, and the number of authorized shares of common                        stock was reduced from 150,000,000 shares to 30,000,000 shares. All                        references to common share and per common share amounts for all periods                        presented have been retroactively restated to reflect this reverse split.                        At the Annual Meeting in September 2005, the shareholders voted to increase                        the number of authorized shares of common stock to 60,000,000                        shares. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | As                        of December 31, 2005, the Company had reserved 1,261,591 for outstanding                        stock options and 1,176,310 for outstanding warrants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

F-19

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.    | Warrants                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   | Some                        of the warrants issued in connection with various equity financing and                        related transactions contain anti-dilution provisions requiring adjustment.                        The following table summarizes the common shares issuable upon exercise of                        warrants outstanding at December 31, 2007 as adjusted for the events which                        have triggered anti-dilution provisions contained in the respective warrant                        agreements: |

|                                                    |   |         |      |                                                                              |   |   |   |   |   |
|---------------------------------------------------------|--------|--------------|-----------|-----------------------------------------------------------------------------------|--------|--------|--------|--------|--------|
|                                                    |   | **Warrants** |      | **Weighted                        Average                        Exercise Price** |   |
|                                                    |   |              |      |                                                                                   |   |
|                                                    |   |         |      |                                                                              |   |   |   |   |   |
| Warrants Outstanding                        at 12/31/04 |   |         | 1,383,188 |                                                                              |   | $      | 10.35  |   |   |
|                                                    |   |         |      |                                                                              |   |   |   |   |   |
| Cancelled                                               |   |         | (206,878  | )                                                                                 |   | $      | 8.90   |   |   |
|                                                    |   |              |           |                                                                              |   |   |   |   |   |
| Warrants Outstanding                        at 12/31/05 |   |         | 1,176,310 |                                                                              |   | $      | 9.05   |   |   |
|                                                    |   |         |      |                                                                              |   |   |   |   |   |
| Cancelled                                               |   |         | (751,541  | )                                                                                 |   | $      | 2.04   |   |   |
|                                                    |   |              |           |                                                                              |   |   |   |   |   |
| Warrants Outstanding                        at 12/31/06 |   |         | 424,769   |                                                                              |   | $      | 7.02   |   |   |
|                                                    |   |         |      |                                                                              |   |   |   |   |   |
| Cancelled                                               |   |         | (127,030  | )                                                                                 |   | $      | 7.10   |   |   |
|                                                    |   |              |           |                                                                              |   |   |   |   |   |
| Warrants Outstanding                        at 12/31/07 |   |         | 297,739   |                                                                              |   | $      | 6.99   |   |   |
|                                                    |   |              |           |                                                                              |   |   |   |   |   |
|                                                    |   |         |      |                                                                              |   |   |   |   |   |
| Warrants Exercisable                        at 12/31/07 |   |         | 297,739   |                                                                              |   | $      | 6.99   |   |   |
|                                                    |   |              |           |                                                                              |   |        |        |   |   |
|                                                    |   |         |      |                                                                              |   |   |   |   |   |
| Warrants Exercisable                        at 12/31/06 |   |         | 424,769   |                                                                              |   | $      | 7.02   |   |   |
|                                                    |   |              |           |                                                                              |   |        |        |   |   |
|                                                    |   |         |      |                                                                              |   |   |   |   |   |
| Warrants Exercisable                        at 12/31/05 |   |         | 1,176,310 |                                                                              |   | $      | 9.05   |   |   |
|                                                    |   |              |           |                                                                              |   |        |        |   |   |

|   |                                                    |
|--------|---------------------------------------------------------|
|   | Schedule of warrants                        expiration: |

|                                   |   |                                                        |
|----------------------------------------|--------|-------------------------------------------------------------|
| Expiration                        Date |   | Common Shares                        Issuable Upon Exercise |
|                                        |   |                                                             |
| 2008                                   |   | 297,739                                                     |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 11.    | Stock Option                        Plans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | The                        Company’s shareholders have approved incentive stock option plans for                        officers and employees. The Company’s shareholders have approved                        nonqualified stock options for key employees, directors and certain                        non-employee consultants. Options granted are generally exercisable over a                        specified period, not less than one year from the date of grant, generally                        expire ten years from the date of grant and vest evenly over four                        years. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | A                        summary of the various established stock options plans are as                        follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | 1997                        Plan and 2000 Plan. The 1997 Plan was and the 2000 Plan is administered by                        a committee appointed by the Board of Directors (the “Compensation                        Committee”). The Compensation Committee will designate the persons to                        receive options, the number of shares subject to the options and the terms                        of the options, including the option price and the duration of each option,                        subject to certain limitations.                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | The                        maximum number of shares of Common Stock available for issuance under the                        1997 Plan was 300,000 shares, as amended, and under the 2000 Plan is                        4,700,000 shares, as amended. Each plan is subject to adjustment in the                        event of stock splits, stock dividends, mergers, consolidations and the                        like.                                                                                                                                                                                                |

F-20

----

**Pharmos            Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                          |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Common Stock subject to                        options granted under the 1997 Plan and the 2000 Plan that expire or                        terminate will again be available for options to be issued under each                        Plan. |
|   |                                                                                                                                                                                                                                          |
|   | All                        stock option grants during 2007 were made from the Pharmos Corporation 2000                        Incentive and Non-Qualified Stock Option Plan.                                                                  |
|   |                                                                                                                                                                                                                                          |
|   | The                        following table summarizes activity in stock options approved by the                        Company’s Board of Directors:                                                                                    |

|                                                   |   |       |          |                                                                              |   |   |   |   |   |
|--------------------------------------------------------|--------|------------|---------------|-----------------------------------------------------------------------------------|--------|--------|--------|--------|--------|
|                                                   |   | **Option** |          | **Weighted                        Average                        Exercise Price** |   |
|                                                   |   |            |          |                                                                                   |   |
|                                                   |
| Options Outstanding at                        12/31/04 |   |       | 791,992       |                                                                              |   | $      | 13.65  |   |   |
|                                                   |   |       |          |                                                                              |   |   |   |   |   |
| Granted                                                |   |       | 575,310       |                                                                              |   | $      | 2.88   |   |   |
| Cancelled                                              |   |       | (169,003      | )                                                                                 |   | $      | 12.21  |   |   |
|                                                   |   |            |               |                                                                              |   |   |   |   |   |
| Options Outstanding at                        12/31/05 |   |       | 1,198,299     |                                                                              |   | $      | 8.63   |   |   |
|                                                   |   |       |          |                                                                              |   |   |   |   |   |
| Granted                                                |   |       | 881,000       |                                                                              |   | $      | 2.09   |   |   |
| Cancelled                                              |   |       | (154,677      | )                                                                                 |   | $      | 8.82   |   |   |
|                                                   |   |            |               |                                                                              |   |   |   |   |   |
| Options Outstanding at                        12/31/06 |   |       | 1,924,622     |                                                                              |   | $      | 5.62   |   |   |
|                                                   |   |            |               |                                                                              |   |   |   |   |   |
|                                                   |
| Granted                                                |   |       | 870,000       |                                                                              |   | $      | 1.70   |   |   |
| Cancelled                                              |   |       | (374,236      | )                                                                                 |   | $      | 7.06   |   |   |
|                                                   |   |            |               |                                                                              |   |   |   |   |   |
| Options Outstanding at                        12/31/07 |   |       | **2,420,386** |                                                                              |   | $      | 3.99   |   |   |
|                                                   |   |            |               |                                                                              |   |   |   |   |   |
|                                                   |
| Options exercisable at                        12/31/07 |   |       | 1,606,763     |                                                                              |   | $      | 5.12   |   |   |
|                                                   |   |            |               |                                                                              |   |        |        |   |   |
|                                                   |
| Options exercisable at                        12/31/06 |   |       | 879,467       |                                                                              |   | $      | 9.62   |   |   |
|                                                   |   |            |               |                                                                              |   |        |        |   |   |
|                                                   |
| Options exercisable at                        12/31/05 |   |       | 622,333       |                                                                              |   | $      | 13.81  |   |   |
|                                                   |   |            |               |                                                                              |   |        |        |   |   |

|   |                                                                                                                                                      |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Additional information                        with respect to the outstanding stock options as of December 31, 2007 is as                        follows: |

|                                                                       |   |                                           |   |                                                                                                                 |   |                                                                              |   |                                           |   |                                                                              |   |   |      |   |   |   |   |   |   |   |
|----------------------------------------------------------------------------|--------|------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|--------|-----------|--------|--------|--------|--------|--------|--------|--------|
|                                                                       |   | **Options                        Outstanding** |   | **Options                        Exercisable**                                                                       |   |
|                                                                       |   |                                                |   |                                                                                                                      |   |
| **Range of                        Exercise                        Prices** |   | **Options                        Outstanding** |   | **Weighted                        Average                        Remaining                        Contractual Life** |   | **Weighted                        Average                        Exercise Price** |   | **Options                        Exercisable** |   | **Weighted                        Average                        Exercise Price** |   |
|                                                                       |   |                                                |   |                                                                                                                      |   |                                                                                   |   |                                                |   |                                                                                   |   |
| $1.46                        - $2.01                                       |   | 945,000                                        |   |                                                                                                                 |   | 5.4                        years                                                  |   |                                           | $      | 1.71                                                                              |   |   | 238,749   |   |   |   | $      | 1.83   |   |   |
|                                                                       |   |                                           |   |                                                                                                                 |   |                                                                              |   |                                           |   |                                                                              |   |   |      |   |   |   |   |   |   |   |
| $2.15                        - $3.95                                       |   | 1,072,062                                      |   |                                                                                                                 |   | 7.4                        years                                                  |   |                                           | $      | 2.41                                                                              |   |   | 964,690   |   |   |   | $      | 2.42   |   |   |
|                                                                       |   |                                           |   |                                                                                                                 |   |                                                                              |   |                                           |   |                                                                              |   |   |      |   |   |   |   |   |   |   |
| $5.10                        - $8.75                                       |   | 93,774                                         |   |                                                                                                                 |   | 4.2                        years                                                  |   |                                           | $      | 5.41                                                                              |   |   | 93,774    |   |   |   | $      | 5.41   |   |   |
|                                                                       |   |                                           |   |                                                                                                                 |   |                                                                              |   |                                           |   |                                                                              |   |   |      |   |   |   |   |   |   |   |
| $9.38                        - $21.20                            |   | 309,550                                        |   |                                                                                                                 |   | 4.2                        years                                                  |   |                                           | $      | 15.98                                                                             |   |   | 309,550   |   |   |   | $      | 15.98  |   |   |
|                                                                       |   |                                                |   |                                                                                                                 |   |                                                                              |   |                                           |   |                                                                              |   |   |           |   |   |   |   |   |   |   |
|                                                                       |
|                                                                       |   | 2,420,386                                      |   |                                                                                                                 |   | 6.1                        years                                                  |   |                                           | $      | 3.99                                                                              |   |   | 1,606,763 |   |   |   | $      | 5.12   |   |   |
|                                                                       |   |                                                |   |                                                                                                                 |   |                                                                              |   |                                           |   |                                                                              |   |   |           |   |   |   |   |   |   |   |

F-21

----

**Pharmos            Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | On                        September 6, 2004, the Board of Directors approved the Retention Award                        Agreements and Pharmos entered into Retention Award Agreements with each of                        Dr. Haim Aviv, Chairman and Chief Executive Officer, and Dr. Gad                        Riesenfeld, its then President and Chief Operating Officer. The Company                        granted retention awards of 75,949 restricted stock units to Dr. Aviv and                        50,633 shares of restricted stock to Dr. Riesenfeld (the Awards). Under the                        agreement, one-half of the Awards vested on December 31, 2005 and the                        balance shall vest and become non-forfeitable on June 30, 2007, subject to                        certain accelerated vesting provisions. Under the terms of Dr.                        Riesenfeld’s severance agreement, the balance of his Awards vested on                        his departure from the Company on April 2, 2006 and the expense of those                        awards was accelerated on April 2, 2006. Under the terms of Dr.                        Aviv’s severance agreement, the balance of his Awards vested on his                        departure from the Company on March 31, 2007 and the expense of those                        awards was accelerated at March 31, 2007. The fair value of the restricted                        shares was based on the fair value of the stock on the issuance date. The                        Awards of restricted stock are not included in the above stock option                        table. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | *Fair value of                        options:*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | The                        fair value of each option grant was estimated on the date of grant using                        the Black-Scholes option valuation model with the following                        weighted-average assumptions:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

|                                             |   |   |                           |   |   |                           |   |
|--------------------------------------------------|--------|--------|--------------------------------|--------|--------|--------------------------------|--------|
|                                             |   | 2007   |                           | 2006   |   |
|                                             |   |        |                           |        |   |
| Risk-free interest                        rate   |   |   | 4.20-4.75%                     |   |   | 4.35-4.69%                     |   |
| Expected lives (in                        years) |   |   | 6.16                           |   |   | 5                              |   |
| Dividend                        yield            |   |   | 0%                             |   |   | 0%                             |   |
| Expected                        volatility       |   |   | 79                        -80% |   |   | 80                        -84% |   |
| Fair                        value                |   |   | $1.28                          |   |   | $1.60                          |   |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | *Expected                        Volatility.* The Company calculates the expected volatility of its stock                        options using historical volatility of weekly stock prices.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | *Expected Term.*                        The expected term is based on historical observations of employee exercise                        patterns during the Company’s history.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | *Risk-Free Interest                        Rate*. The interest rate used in valuing awards is based on the yield at                        the time of grant of a U.S. Treasury security with an equivalent remaining                        term.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | *Dividend Yield*.                        The Company has never paid cash dividends, and does not currently intend to                        pay cash dividends, and thus has assumed a 0% dividend yield.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | *Pre-Vesting                        Forfeitures*. Estimates of pre-vesting option forfeitures are based on                        Company experience. The Company will adjust its estimate of forfeitures                        over the requisite service period based on the extent to which actual                        forfeitures differ, or are expected to differ, from such estimates. Changes                        in estimated forfeitures will be recognized through a cumulative catch-up                        adjustment in the period of change and will also impact the amount of                        compensation expense to be recognized in future periods.                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | During the years                        ended December 31, 2007, 2006 and 2005, employees and outside directors of                        the Company were granted stock options under the Pharmos 2000 Stock Option                        Plan in the amount of 870,000 or a fair value of $1,117,347, 881,000                        options, or a fair value of $1,412,443, and 575,310 options, or a fair                        value of $949,900, respectively. The fair value of options that vested                        during the years ended December 31, 2007, 2006 and 2005, without                        considering forfeitures, was $1,018,539, $1,046,956 and $4,939,943,                        respectively. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 12.    | Related                        Parties                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | The                        Company’s Pharmos Ltd. subsidiary renewed a License Agreement with                        Herbamed, Ltd., a company controlled by the Company’s Chairman and                        Chief Executive Officer. The License Agreement licenses to Herbamed the                        Company’s patent rights for the oral delivery of lipophilic                        substances in the limited field of                                                                                                                                                                                                                                                                                |

F-22

----

**Pharmos            Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | nutraceuticals, which                        include food and dietary supplements, food additives, vitamins and herbs.                        Under the terms of the revised License Agreement, Herbamed will pay to                        Pharmos Ltd. royalties of 3% on net sales. During 2007, 2006 and 2005, the                        Company recognized other income of $4,992, $5,177, and $24,670,                        respectively, under terms of the licensing agreement with                        Herbamed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   | ***CEO Retirement                        Agreement.*** Pursuant to the retirement agreement with the Company,                        the Chairman and former CEO acquired his corporate automobile on June 30,                        2007 for $31,008. The automobile’s fair market value as of June 2007                        was $64,599 and its depreciated cost as of the June 30, 2007 was $68,278.                        The discounted benefit of $33,591 was included in general and                        administrative expenses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 13.    | Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   | For                        2007, 2006 and 2005, the Company has not recorded a tax benefit on the                        operating losses generated by U.S and Israeli operations. After an                        assessment of all available evidence, including historical and forecasted                        operating results, management has concluded that realization of the                        Company’s net operating loss carryforwards (“NOLs”),                        which includes Vela’s historical NOLs and research tax credits                        generated through the acquisition date, and other deferred tax assets could                        not be considered more likely than not. Based on this assessment, the                        Company has increased the valuation allowance established on deferred tax                        assets by approximately $3,177,000, $40,510,000, and $1,617,000 in 2007,                        2006 and 2005, respectively. A substantial portion of the increase in the                        December 31, 2006 valuation allowance related to the acquired NOLs and tax                        credits of Vela.                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   | In                        2007, 2006, and 2005, the Company sold $12,136,911, $7,781,267 and                        $6,413,522, respectively, of its State Net Operating Loss carryforwards                        under the State of New Jersey’s Technology Business Tax Certificate                        Transfer Program (the “Program”). The Program allows qualified                        technology and biotechnology businesses in New Jersey to sell unused                        amounts of net operating loss carryforwards and defined research and                        development tax credits for cash. The proceeds from the sale in 2007, 2006,                        and 2005, net of commissions, were $955,782, $612,775 and $490,634,                        respectively, and such amounts were recorded as a tax benefit in the                        accompanying statements of operations. In December 2006, the Company                        received $493,000 related to the sale of Vela net operating losses. In                        accounting for the Vela acquisition, such amount was allocated to the                        purchase price and, accordingly, is not reflected in the accompanying 2006                        statement of operations. The State renews the Program annually and                        currently limits the aggregate proceeds to $60,000,000. We cannot be                        certain if we will be able to sell any of our remaining or future New                        Jersey loss carryforwards or tax credits under the Program. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   | For                        2007, 2006 and 2005, the Company’s recorded tax benefit differs from                        the benefit calculated by applying the statutory U.S. federal income tax                        rate due to the valuation allowances established on deferred tax assets in                        those periods and non-deductible charges, including the in - process                        research and development charge, offset by the aforementioned tax benefits                        from the sale of New Jersey NOLs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   | At                        December 31, 2007 and 2006, the Company’s deferred tax assets are                        comprised of the following:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

|                                                                 |   |   |        |   |   |        |   |
|----------------------------------------------------------------------|--------|--------|-------------|--------|--------|-------------|--------|
|                                                                 |   | 2007   |        | 2006   |   |
|                                                                 |   |        |        |        |   |
| Domestic                        NOLs                                 |   | $      | 75,906,000  |   | $      | 72,883,000  |   |
| Israeli                        NOLs                                  |   |   | 877,000     |   |   | 818,000     |   |
| Research and                        Development Credit Carryforwards |   |   | 6,831,000   |   |   | 7,080,000   |   |
| In Process Research                        and Development           |   |   | 8,231,000   |   |   | 8,231,000   |   |
| Accrued expenses,                        compensation and other      |   |   | 1,204,000   |   |   | 860,000     |   |
|                                                                 |   |        |             |   |        |             |   |
| Net Deferred Tax                        Assets                       |   |   | 93,049,000  |   |   | 89,801,000  |   |
| Valuation                        allowance                           |   |   | (93,049,000 | )      |   | (89,801,000 | )      |
|                                                                 |   |        |             |   |        |             |   |
|                                                                 |   | $      | —     |   | $      | —     |   |
|                                                                 |   |        |             |   |        |             |   |

F-23

----

**Pharmos            Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | At                        December 31, 2007 the Company had net operating losses of approximately                        $207 million and $92 million for U.S and New Jersey tax return purposes,                        respectively. Of these amounts, approximately $60 million and $42 million,                        respectively, relate to Vela’s results of operations prior to the                        acquisition. Management believes that Vela’s State of New Jersey NOL                        will not qualify to be available for sale under the Program. Net operating                        losses for Israel tax return purposes approximated $3 million at December                        31, 2007. As a result of previous business combinations and changes in its                        ownership, there is a substantial amount of U.S. NOLs that may be subject                        to annual limitations on utilization. The remaining U.S. NOLs begin to                        expire in 2008 and continue to expire through 2027. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | The                        Vela acquisition has been regarded as a tax free reorganization, although                        no assurances can be given to this treatment, within the meaning of Section                        368(a) of the Internal Revenue Code.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 14.    | Commitments and                        Contingencies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | *Leases*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | The                        Company leases research and office facilities in Israel and New Jersey. The                        facilities in Israel are used in the operation of the Company’s                        research and development activities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   | All                        of the leases 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, 2007, the future gross minimum lease commitments with respect                        to non-cancelable operating leases (including office and equipment leases)                        with initial terms in excess of one year are as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

|   |   |                                         |   |    |
|--------|--------|----------------------------------------------|--------|---------|
|   |   | **Lease                        Commitments** |   |
|   |
|   |   |                                              |   |
| 2008   |   |                                         | $      | 311,801 |   |   |
| 2009   |   |                                         |   | 233,810 |   |   |
| 2010   |   |                                         |   | 2,745   |   |   |
| 2011   |   |                                         |   | — |   |   |
| 2012   |   |                                         |   | — |   |   |
|   |   |                                         |        |         |   |   |
|   |   |                                         | $      | 548,356 |   |   |
|   |   |                                         |        |         |   |   |

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Rent                        expense during 2007, 2006 and 2005 amounted to $447,316, $623,165, and                        $544,013, respectively. In 2007, 2006 and 2005, rent expense is net of                        sublease income of $100,713, $128,850, and $97,630, respectively. A                        sublease agreement expired on March 31, 2007 and was at an annual rate of                        $97,630. A second sublease entered into March 2006 is for $37,466 annually                        and expires on December 2009. The Israel facility entered into a sub-lease                        agreement for a portion of the leased space in 2007. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   | *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, 2007, 2006 or 2005.                                                                                                                                                                                                                                                                                                    |

F-24

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**Pharmos            Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | *Litigation*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | The                        Company and certain current officers have been named as defendants in                        several purported shareholder class action lawsuits alleging violations of                        federal securities laws. These lawsuits were filed beginning in January                        2005 and are pending in the U.S. District Court for the District of New                        Jersey. These lawsuits assert claims under Sections 10(b) and 20(a) of the                        Securities Exchange Act of 1934 and Rule 10b-5 hereunder. The complaints                        allege generally that the defendants knowingly or recklessly made false or                        misleading statements regarding the effectiveness of dexanabinol in                        treating TBI (Traumatic Brain Injury) which had the effect of artificially                        inflating the price of the Company’s common stock. These class                        actions have been consolidated by order of the court and lead plaintiffs                        and lead plaintiffs’ counsel have been appointed. An amended                        complaint was filed in September 2005. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | On                        May 31, 2007, the Company entered into an agreement with plaintiffs to                        settle the class action lawsuits that commenced starting in January 2005                        and are currently pending in the U.S. District Court for the District of                        New Jersey. The lawsuits relate to statements purportedly made by Pharmos                        and its officers regarding the effectiveness of dexanabinol in treating                        traumatic brain injury.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | The                        settlement, which is covered in its entirety by Pharmos’ insurance,                        has been reached with no admission of liability by any party and has been                        entered into to avoid costly and time consuming litigation by all parties.                        The parties agreed to seek the required court approvals of the settlement                        and filed the settlement documents with the Court on June 4, 2007. On July                        18, 2007, the Court granted preliminary approval of the                        settlement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | Both                        of the previously disclosed derivative lawsuits (which alleged, generally,                        breaches of fiduciary duty and other state law violations arising from the                        same set of underlying facts as the class actions) have been settled, court                        approval has been obtained, the settlements are final and the cases have                        been dismissed with prejudice.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 15.    | Employee Benefit                        Plans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | The                        Company has a 401-K defined contribution profit-sharing plan covering                        its’ U.S. employees. Contributions to the plan are based on 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 this plan                        amounted to $39,204, $46,080, and $49,132 in 2007, 2006 and 2005,                        respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | Pharmos Ltd.                        participates in various contribution severance plans and makes regular                        deposits with pension funds or insurance companies to allow some severance                        rights to most of its employees. The custody and management of the amounts                        so deposited are independent of the Company. The Company is required by                        Israeli labor laws to pay upon dismissal or retirement each employee one                        month of salary for each year of service. The Company generally funds this                        liability by purchasing insurance policies directly in the name of each                        employee.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 16.    | Segment and Geographic                        Information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | The                        Company is active in one business segment: designing, developing, selling                        and marketing pharmaceutical products. The Company maintains development                        operations in the United States and Israel. The Company’s                        administration operations are maintained in the United States. The                        Company’s chief operating decision makers use measurements aggregated                        at the entity-wide level to manage the business. Reflected in the amounts                        below are intercompany billings from Israel to the United States for                        research and development activity.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

F-25

----

**Pharmos            Corporation            Notes to Consolidated Financial Statements**

|   |                                                                                                                                      |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------|
|   | Geographic information                        for the years ended December 31, 2007, 2006 and 2005 are as                        follows: |

|                                             |   |     |                                |     |   |        |   |   |       |   |
|--------------------------------------------------|--------|----------|-------------------------------------|----------|--------|-------------|--------|--------|------------|--------|
|                                             |   | **2007** |                                | **2006** |   | **2005**    |   |
|                                             |   |          |                                |          |   |             |   |
| Net loss                                         |   |     |                                |     |   |        |   |   |       |   |
| United                        States             |   | $        | (15,                        553,864 | )        | $      | (34,848,770 | )      | $      | (2,709,593 | )      |
| Israel                                           |   |     | (71,961                             | )        |   | (288,199    | )      |   | (220,279   | )      |
|                                             |   |          |                                     |     |        |             |   |        |            |   |
|                                             |   | $        | (15,625,825                         | )        | $      | (35,136,969 | )      | $      | (2,929,872 | )      |
|                                             |   |          |                                     |     |        |             |   |        |            |   |
| Total                        assets              |   |     |                                |     |   |        |   |   |       |   |
| United                        States             |   | $        | 10,827,747                          |     | $      | 25,245,098  |   | $      | 45,752,574 |   |
| Israel                                           |   |     | 1,547,212                           |     |   | 3,148,240   |   |   | 3,238,198  |   |
|                                             |   |          |                                     |     |        |             |   |        |            |   |
|                                             |   | $        | 12,374,959                          |     | $      | 28,393,338  |   | $      | 48,990,772 |   |
|                                             |   |          |                                     |     |        |             |   |        |            |   |
| Long lived assets,                        net    |   |     |                                |     |   |        |   |   |       |   |
| United                        States             |   | $        | 18,280                              |     | $      | 38,368      |   | $      | 86,505     |   |
| Israel                                           |   |     | 406,178                             |     |   | 555,089     |   |   | 656,355    |   |
|                                             |   |          |                                     |     |        |             |   |        |            |   |
|                                             |   | $        | 424,458                             |     | $      | 593,457     |   | $      | 742,860    |   |
|                                             |   |          |                                     |     |        |             |   |        |            |   |
| Capital                        expenditures, net |   |     |                                |     |   |        |   |   |       |   |
| United                        States             |   | $        | 9,100                               |     | $      | 1,155       |   | $      | 8,401      |   |
| Israel                                           |   |     | 167,492                             |     |   | 164,211     |   |   | 128,821    |   |
|                                             |   |          |                                     |     |        |             |   |        |            |   |
|                                             |   | $        | 176,592                             |     | $      | 165,366     |   | $      | 137,222    |   |
|                                             |   |          |                                     |     |        |             |   |        |            |   |

F-26

----

**Pharmos Corporation            Notes to Consolidated Financial Statements**

17. Quarterly Information            (Unaudited)

|                                                                 |   |                                   |       |                                   |   |                                   |   |                                   |       |   |   |       |   |
|----------------------------------------------------------------------|--------|----------------------------------------|------------|----------------------------------------|--------|----------------------------------------|--------|----------------------------------------|------------|--------|--------|------------|--------|
| **Year ended                        December 31, 2007**              |   | **1st                        Quarter** |       | **2nd                        Quarter** |   | **3rd                        Quarter** |   | **4th                        Quarter** |       |
|                                                                      |   |                                        |       |                                        |   |                                        |   |                                        |       |
| Operating                        Expenses                            |   | $                                      | 5,100,362  |                                   | $      | 4,877,224                              |   | $                                      | 3,732,191  |   | $      | 3,869,482  |   |
| Loss from                        Operations                          |   |                                   | (5,100,362 | )                                      |   | (4,877,224                             | )      |                                   | (3,732,191 | )      |   | (3,869,482 | )      |
| Other                        income                                  |   |                                   | 347,267    |                                   |   | 239,821                                |   |                                   | 193,636    |   |   | 216,928    |   |
| Net loss                        2                                    |   | $                                      | (4,753,095 | )                                      | $      | (4,637,403                             | )      | $                                      | (3,538,555 | )      | $      | (2,696,772 | )      |
| Net loss per share                        – basic and diluted* |   | $                                      | (.19       | )                                      | $      | (.18                                   | )      | $                                      | (.14       | )      | $      | (.11       | )      |

|                                                                 |   |                                   |       |                                   |   |                                   |   |                                   |       |   |   |        |   |
|----------------------------------------------------------------------|--------|----------------------------------------|------------|----------------------------------------|--------|----------------------------------------|--------|----------------------------------------|------------|--------|--------|-------------|--------|
| **Year ended                        December 31, 2006**              |   | **1st                        Quarter** |       | **2nd                        Quarter** |   | **3rd                        Quarter** |   | **4th                        Quarter** |       |
|                                                                      |   |                                        |       |                                        |   |                                        |   |                                        |       |
| Operating                        Expenses1                           |   | $                                      | 3,458,184  |                                   | $      | 4,596,064                              |   | $                                      | 4,730,287  |   | $      | 24,757,984  |   |
| Loss from                        Operations                          |   |                                   | (3,458,184 | )                                      |   | (4,596,064                             | )      |                                   | (4,730,287 | )      |   | (24,757,984 | )      |
| Other                        income                                  |   |                                   | 455,498    |                                   |   | 497,688                                |   |                                   | 488,734    |   |   | 350,855     |   |
| Net loss                        2                                    |   | $                                      | (3,002,686 | )                                      | $      | (4,098,376                             | )      | $                                      | (4,241,553 | )      | $      | (23,794,354 | )      |
| Net loss per share                        – basic and diluted* |   | $                                      | (.16       | )                                      | $      | (.21                                   | )      | $                                      | (.22       | )      | $      | (1.00       | )      |

* The addition of earnings            (loss) per share by quarter may not equal total earnings (loss) per share for the            year.

|   |                                                                                                                                                                                                                                                                                                                                      |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 1.     | Fluctuations within                        operating expenses are primarily related to expenses with clinical trials                        and the timing of the receipt of grants and the acquisition of Vela in                        process research and development expenses in the fourth quarter of                        2006. |
|   |                                                                                                                                                                                                                                                                                                                                      |
| 2.     | Includes the sale of                        the NJ Net Operating Losses in the fourth quarters of 2007 and 2006 of                        $955,782, and $612,775, respectively.                                                                                                                                                           |

**SUBSEQUENT            EVENTS**

**Private            Placement of Convertible Debentures**

Pharmos            Corporation announced on January 3, 2008 that it completed an initial closing of a            private placement of its 10% Convertible Debentures due November 2012. At the initial            closing the Company issued $4,000,000 principal amount of the Debentures, at par, and            received gross proceeds in the same amount.

The purchasers            consisted of certain existing investors in the Company, namely Venrock Associates            (which is affiliated with Anthony B. Evnin), New Enterprise Associates (which is            affiliated with Charles W. Newhall, III), Lloyd I. Miller, III and Robert F.            Johnston.

The Debentures            mature the earlier of November 1, 2012 or the sale of the Company. The Debentures,            together with all accrued and unpaid interest thereon, may be repaid, without premium            or penalty, commencing on November 1, 2011.

A condition of            closing was the amendment of the 2006 Vela acquisition agreement to defer the cash            milestones payable by the Company to the former stockholders of Vela Pharmaceuticals            Inc. upon (A) the enrollment of the final patient in the Company’s current Phase            2b clinical trial for dextofisopam ($1 million) and (B) the successful completion of            such Phase 2b ($2 million). Payment will be deferred until such time as (X) the Company            has successfully entered into a strategic collaboration or licensing agreement with a            third party for the development of dextofisopam resulting in an upfront cash fee or at            least $10 million, and (Y) Payment of one or both of the cash milestones would still            leave the Company with at least one year’s operating cash.

F-27

----

**Pharmos            Corporation            Notes to Consolidated Financial Statements**

Additionally,            the Vela acquisition agreement was amended to defer the equity milestones issuable to            the Vela shareholders related to such Phase 2b events until November 1,            2009.

Starting on            November 1, 2009 (or earlier sale of the Company), any outstanding Debenture may be            converted at the option of the holder. The conversion price is fixed equal to $0.70 per            share. The Debentures bear interest at the rate of 10% per annum, payable semi-annually            either in cash or common stock of the Company at the option of the Company.

Under the terms            of the offering, the Company may raise gross proceeds up to an aggregate of $8,000,000            from the sale of Debentures in the placement (including the Debentures issued at the            initial closing). The proceeds will be used for working capital, in particular for the            ongoing Phase 2b trial for dextofisopam. The securities issued and issuable in the            offering have not been registered under the Securities Act of 1933, as amended, and may            not be offered or sold in the United States absent registration or applicable exemption            from registration requirements.

**Board and            Management Changes**

Pharmos            Corporation also announced the following changes in its Board of Directors and            Management, in January and February 2008:

**Board            Changes**Robert F. Johnston has been elected to the Board as Executive Chairman effective            January 3, 2008.

Haim Aviv,            Ph.D., David Schlachet and Mony Ben Dor (all effective January 3, 2008) and Abraham            Sartani (effective February 11, 2008) have retired from the Board.

The Pharmos            Board now consists of six directors — Robert F. Johnston, Executive Chairman,            Anthony B. Evnin (Venrock), Charles W. Newhall, III (New Enterprise Associates),            Srinivas Akkaraju, M.D., Ph.D. (Panorama Capital), Lloyd I. Miller, III and Elkan            Gamzu, Ph.D.

**Management            Changes**Effective January 3, 2008 the Pharmos Board designated Mr. Robert F. Johnston to            serve as Executive Chairman of the Board and Mr. S. Colin Neill to serve as President,            in addition to his current roles as Chief Financial Officer, Treasurer and            Secretary.

Also effective            January 3, 2008, Elkan Gamzu Ph.D., who had been Chief Executive Officer, retired from            that position and will remain on the Board.

F-28

----