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

**FORM            10-Q**
|   |                                                                                                                                      |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------|
| x      | **QUARTERLY REPORT                        PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF                        1934** |

**For the quarterly period            ended June 30, 2007**

**or**
|   |                                                                                                                                       |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
| o      | **TRANSITION REPORT                        PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF                        1934** |

**Commission            file number 0-11550**
|                                                                          |
|-------------------------------------------------------------------------------|
| **Pharmos                        Corporation**                                |
|                                                                               |
| (Exact name of                        registrant as specified in its charter) |
|                                                                                                         |   |                                          |
|--------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|
| **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)

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

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

Indicate by check mark whether            registrant is a large accelerated filer, an accelerated filer or a non-accelerated            filer (as defined in Rule 12b-2 of the Exchange Act).
|                                             |                                       |                                           |
|--------------------------------------------------|--------------------------------------------|------------------------------------------------|
| Large accelerated                        filer o | Accelerated filer                        o | Non-accelerated                        filer x |

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

As of August 1, 2007, the            Registrant had outstanding 25,603,759 shares of its $.03 par value Common            Stock.

1

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|                                                                                                                                                                                                                       |                                                                                                                                      |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------|
| **INDEX**                                                                                                                                                                                                                  |                                                                                                                                      |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| PART                        1                                                                                                                                                                                              | FINANCIAL                        INFORMATION                                                                                              |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| Item                        1.                                                                                                                                                                                             | Financial                        Statements                                                                                               |
|                                                                                                                                                                                                                       |                                                                                                                                      |
|                                        Consolidated Balance Sheets as of June 30, 2007 (unaudited) and December                        31, 2006 |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| Consolidated                        Statements of Operations (unaudited) for the three and six months ended                        June 30, 2007 and 2006                                                                  |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| Consolidated                        Statements of Cash Flows (unaudited) for the three and six months ended                        June 30, 2007 and 2006                                                                  |
|                                                                                                                                                                                                                       |                                                                                                                                      |
|                                        Notes to Consolidated Financial Statements (unaudited)                                                   |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| Item                        2.                                                                                                                                                                                             | Management’s                        Discussion and Analysis of Financial Condition and Results of                        Operations |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| Item                        3.                                                                                                                                                                                             | Quantitative                        and Qualitative Disclosures About Market Risk                                                         |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| Item                        4T.                                                                                                                                                                                            | Controls                        and Procedures                                                                                            |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| PART                        II                                                                                                                                                                                             | OTHER                        INFORMATION                                                                                                  |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| Item                        1.                                                                                                                                                                                             | Legal                        Proceedings                                                                                                  |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| Item                        6.                                                                                                                                                                                             | Exhibits                                                                                                                                  |
|                                                                                                                                                                                                                       |                                                                                                                                      |
| Signatures                                                                                                                                                                                                                 |                                                                                                                                      |

2

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**Part I.            Financial Information**

**Item 1            Financial Statements**

**PHARMOS CORPORATION            (Unaudited)Consolidated Balance Sheets**

|                                                                                                                                                                                                                                                                                                                                                       |   |                                     |         |                                         |   |         |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|--------------|----------------------------------------------|--------|--------------|--------|
|                                                                                                                                                                                                                                                                                                                                                       |   | **June 30,                        2007** |         | **December 31,                        2006** |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                          |         |                                              |   |
| **Assets**                                                                                                                                                                                                                                                                                                                                                 |   |                                     |         |                                         |   |         |   |
| Cash and cash                        equivalents                                                                                                                                                                                                                                                                                                           |   | $                                        | 12,131,642   |                                         | $      | 12,757,013   |   |
| Short-term                        investments                                                                                                                                                                                                                                                                                                              |   |                                     | 5,114,366    |                                         |   | 13,172,673   |   |
| Restricted                        cash                                                                                                                                                                                                                                                                                                                     |   |                                     | 84,805       |                                         |   | 82,926       |   |
| Research and                        development grants receivable                                                                                                                                                                                                                                                                                          |   |                                     | 15,676       |                                         |   | 297,865      |   |
| Prepaid expenses and                        other current assets                                                                                                                                                                                                                                                                                           |   |                                     | 533,361      |                                         |   | 424,658      |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                          |              |                                         |        |              |   |
| **Total current                        assets**                                                                                                                                                                                                                                                                                                            |   |                                     | 17,879,850   |                                         |   | 26,735,135   |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                     |         |                                         |   |         |   |
| Fixed assets,                        net                                                                                                                                                                                                                                                                                                                   |   |                                     | 507,807      |                                         |   | 593,457      |   |
| Restricted                        cash                                                                                                                                                                                                                                                                                                                     |   |                                     | 64,487       |                                         |   | 63,922       |   |
| Severance pay                        funded                                                                                                                                                                                                                                                                                                                |   |                                     | 837,779      |                                         |   | 975,810      |   |
| Other assets                                                                                                                                                                                                                                                                                                                                               |   |                                     | 18,946       |                                         |   | 25,014       |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                          |              |                                         |        |              |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                     |         |                                         |   |         |   |
| **Total                        assets**                                                                                                                                                                                                                                                                                                                    |   | $                                        | 19,308,869   |                                         | $      | 28,393,338   |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                          |              |                                         |        |              |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                     |         |                                         |   |         |   |
| **Liabilities and                        Shareholders’ Equity**                                                                                                                                                                                                                                                                                      |   |                                     |         |                                         |   |         |   |
| Accounts                        payable                                                                                                                                                                                                                                                                                                                    |   | $                                        | 960,840      |                                         | $      | 663,192      |   |
| Accrued                        expenses                                                                                                                                                                                                                                                                                                                    |   |                                     | 595,082      |                                         |   | 889,783      |   |
| Warrant                        liability                                                                                                                                                                                                                                                                                                                   |   |                                     | —      |                                         |   | 11,435       |   |
| Accrued wages and other                        compensation                                                                                                                                                                                                                                                                                                |   |                                     | 668,145      |                                         |   | 1,002,572    |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                          |              |                                         |        |              |   |
| **Total current                        liabilities**                                                                                                                                                                                                                                                                                                       |   |                                     | 2,224,067    |                                         |   | 2,566,982    |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                     |         |                                         |   |         |   |
| Other                        liabilities                                                                                                                                                                                                                                                                                                                   |   |                                     | 18,960       |                                         |   | 77,682       |   |
| Severance                        pay                                                                                                                                                                                                                                                                                                                       |   |                                     | 1,203,275    |                                         |   | 1,320,624    |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                          |              |                                         |        |              |   |
| **Total                        liabilities**                                                                                                                                                                                                                                                                                                               |   |                                     | 3,446,302    |                                         |   | 3,965,288    |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                     |         |                                         |   |         |   |
| **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 and outstanding as of June 30, 2007 and December 31,                        2006, respectively |   |                                     | 768,112      |                                         |   | 766,973      |   |
| Paid-in capital in                        excess of par                                                                                                                                                                                                                                                                                                    |   |                                     | 205,523,907  |                                         |   | 204,700,030  |   |
| Accumulated                        deficit                                                                                                                                                                                                                                                                                                                 |   |                                     | (190,429,026 | )                                            |   | (181,038,527 | )      |
| Treasury stock, at                        cost, 2,838 shares                                                                                                                                                                                                                                                                                               |   |                                     | (426         | )                                            |   | (426         | )      |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                          |              |                                         |        |              |   |
| **Total                        shareholders’ equity**                                                                                                                                                                                                                                                                                                |   |                                     | 15,862,567   |                                         |   | 24,428,050   |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                     |         |                                         |   |         |   |
| **Total liabilities                        and shareholders’ equity**                                                                                                                                                                                                                                                                                |   | $                                        | 19,308,869   |                                         | $      | 28,393,338   |   |
|                                                                                                                                                                                                                                                                                                                                                       |   |                                          |              |                                         |        |              |   |

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

3

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**PHARMOS CORPORATION            (Unaudited)Consolidated Statements of Operations**

|                                                           |   |                                                                          |       |                                                 |   |       |          |     |       |          |   |       |   |
|----------------------------------------------------------------|--------|-------------------------------------------------------------------------------|------------|------------------------------------------------------|--------|------------|---------------|----------|------------|---------------|--------|------------|--------|
|                                                           |   | **Three months                        ended                        June 30,** |       | **Six months ended                        June 30,** |   |
|                                                           |   |                                                                               |       |                                                      |   |
|                                                           |
|                                                           |   | **2007**                                                                      |       | **2006**                                             |   | **2007**   |          | **2006** |       |
|                                                           |   |                                                                               |       |                                                      |   |            |          |          |       |
| **Expenses**                                                   |   |                                                                          |       |                                                 |   |       |          |     |       |          |   |       |   |
| Research and                        development, gross         |   | $                                                                             | 3,667,030  |                                                 | $      | 2,381,974  |          | $        | 6,573,769  |          | $      | 4,249,088  |   |
| Grants                                                         |   |                                                                          | (194,308   | )                                          |   | (367,626   | )   |     | (530,949   | )   |   | (668,261   | )      |
|                                                           |   |                                                                               |            |                                                 |        |            |          |          |            |          |        |            |   |
| Research and                        development, net of grants |   |                                                                          | 3,472,722  |                                                 |   | 2,014,348  |          |     | 6,042,820  |          |   | 3,580,827  |   |
|                                                           |
| General and                        administrative              |   |                                                                          | 1,337,435  |                                                 |   | 2,495,322  |          |     | 3,798,131  |          |   | 4,308,543  |   |
| Depreciation and                        amortization           |   |                                                                          | 67,067     |                                                 |   | 86,394     |          |     | 136,635    |          |   | 164,878    |   |
|                                                           |   |                                                                               |            |                                                 |        |            |          |          |            |          |        |            |   |
| **Total operating                        expenses**            |   |                                                                          | 4,877,224  |                                                 |   | 4,596,064  |          |     | 9,977,586  |          |   | 8,054,248  |   |
|                                                           |   |                                                                               |            |                                                 |        |            |          |          |            |          |        |            |   |
|                                                           |
| **Loss from                        operations**                |   |                                                                          | (4,877,224 | )                                                    |   | (4,596,064 | )             |     | (9,977,586 | )             |   | (8,054,248 | )      |
|                                                           |   |                                                                               |            |                                                 |        |            |          |          |            |          |        |            |   |
|                                                           |   |                                                                          |       |                                                 |   |       |          |     |       |          |   |       |   |
| **Other income                        (expense)**              |   |                                                                          |       |                                                 |   |       |          |     |       |          |   |       |   |
| Interest                        income                         |   |                                                                          | 264,720    |                                                 |   | 458,626    |          |     | 594,878    |          |   | 924,330    |   |
| Change in value of                        warrants             |   |                                                                          | —    |                                                 |   | 7,624      |          |     | —    |          |   | 21,728     |   |
| Other (expense)                        income                  |   |                                                                          | (24,899    | )                                                    |   | 31,438     |          |     | (7,790     | )             |   | 7,128      |   |
|                                                           |   |                                                                               |            |                                                 |        |            |          |          |            |          |        |            |   |
| **Other income,                        net**                   |   |                                                                          | 239,821    |                                                 |   | 497,688    |          |     | 587,088    |          |   | 953,186    |   |
|                                                           |   |                                                                               |            |                                                 |        |            |          |          |            |          |        |            |   |
|                                                           |   |                                                                          |       |                                                 |   |       |          |     |       |          |   |       |   |
| **Net                        loss**                            |   | ($                                                                            | 4,637,403  | )                                                    | ($     | 4,098,376  | )             | ($       | 9,390,498  | )             | $      | (7,101,062 | )      |
|                                                           |   |                                                                               |            |                                                 |        |            |          |          |            |          |        |            |   |
|                                                           |
| **Net loss per                        share**                  |   |                                                                          |       |                                                 |   |       |          |     |       |          |   |       |   |
| - basic and                        diluted                     |   | ($                                                                            | 0.18       | )                                                    | ($     | 0.21       | )             | ($       | 0.37       | )             | ($     | 0.37       | )      |
|                                                           |   |                                                                               |            |                                                 |        |            |          |          |            |          |        |            |   |
|                                                           |   |                                                                          |       |                                                 |   |       |          |     |       |          |   |       |   |
| **Weighted average                        shares outstanding** |   |                                                                          |       |                                                 |   |       |          |     |       |          |   |       |   |
| - basic and                        diluted                     |   |                                                                          | 25,600,920 |                                                 |   | 19,062,389 |          |     | 25,582,247 |          |   | 19,050,077 |   |
|                                                           |   |                                                                               |            |                                                 |        |            |          |          |            |          |        |            |   |

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

4

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**Pharmos Corporation            (Unaudited)Consolidated Statements of Cash Flows**

|                                                                                                                                    |   |                                             |       |   |   |        |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|------------|--------|--------|-------------|--------|
|                                                                                                                                    |   | Six                        months ended June 30, |       |
|                                                                                                                                    |   | 2007                                             |       | 2006   |   |
|                                                                                                                                    |   |                                                  |       |        |   |
| Cash flows from                        operating activities                                                                             |   |                                             |       |   |   |        |   |
| Net income                        (loss)                                                                                                |   | $                                                | (9,390,498 | )      | $      | (7,101,062  | )      |
|                                                                                                                                    |   |                                             |       |   |   |        |   |
| Adjustments to                        reconcile net income (loss) loss to net cash used in operating                        activities: |   |                                             |       |   |   |        |   |
| Depreciation and                        amortization                                                                                    |   |                                             | 136,635    |   |   | 164,878     |   |
| Provision for severance                        pay                                                                                      |   |                                             | (117,349   | )      |   | 175,051     |   |
| Change in the value of                        warrants                                                                                  |   |                                             | (11,435    | )      |   | (21,728     | )      |
| Stock based                        compensation                                                                                         |   |                                             | 719,172    |   |   | 499,014     |   |
| Amortization of                        restricted shares issuance                                                                       |   |                                             | 105,845    |   |   | 317,658     |   |
| Gain of disposition of                        fixed assets                                                                              |   |                                             | (14,699    | )      |   | —     |   |
| Changes in operating                        assets and liabilities:                                                                     |   |                                             |       |   |   |        |   |
| Research and                        development grants receivable                                                                       |   |                                             | 282,189    |   |   | 295,407     |   |
| Prepaid expenses and                        other current assets                                                                        |   |                                             | (108,703   | )      |   | (188,696    | )      |
| Other assets                                                                                                                            |   |                                             | 6,068      |   |   | —     |   |
| Accounts                        payable                                                                                                 |   |                                             | 297,648    |   |   | 192,496     |   |
| Accrued                        expenses                                                                                                 |   |                                             | (294,701   | )      |   | 353,557     |   |
| Accrued wages and other                        compensation                                                                             |   |                                             | (334,427   | )      |   | (201,563    | )      |
| Other                        liabilities                                                                                                |   |                                             | (58,724    | )      |   | (74,374     | )      |
|                                                                                                                                    |   |                                                  |            |        |        |             |        |
|                                                                                                                                    |   |                                             |       |   |   |        |   |
| Net cash used in                        operating activities                                                                            |   |                                             | (8,782,979 | )      |   | (5,589,362  | )      |
|                                                                                                                                    |   |                                                  |            |        |        |             |        |
|                                                                                                                                    |   |                                             |       |   |   |        |   |
| Cash flows from                        investing activities                                                                             |   |                                             |       |   |   |        |   |
| Purchases of fixed                        assets                                                                                        |   |                                             | (131,775   | )      |   | (130,303    | )      |
| Proceeds from                        disposition of fixed assets                                                                        |   |                                             | 95,489     |   |   | —     |   |
| Costs associated with                        acquisition of Vela Pharmaceuticals                                                        |   |                                             | —    |   |   | (832,924    | )      |
| Purchase of short-term                        investments                                                                               |   |                                             | (6,661,286 | )      |   | (14,468,196 | )      |
| Proceeds from sale of                        short-term investments                                                                     |   |                                             | 14,719,593 |   |   | 25,218,816  |   |
| Severance pay                        funding                                                                                            |   |                                             | 138,031    |   |   | (97,744     | )      |
| Increase in restricted                        cash                                                                                      |   |                                             | (2,444     | )      |   | (2,039      | )      |
|                                                                                                                                    |   |                                                  |            |        |        |             |        |
|                                                                                                                                    |   |                                             |       |   |   |        |   |
| Net cash provided by                        investing activities                                                                        |   |                                             | 8,157,608  |   |   | 9,687,610   |   |
|                                                                                                                                    |   |                                                  |            |        |        |             |        |
|                                                                                                                                    |   |                                             |       |   |   |        |   |
| Cash flows from                        financing activities                                                                             |   |                                             | —    |   |   | —     |   |
|                                                                                                                                    |   |                                                  |            |        |        |             |        |
|                                                                                                                                    |   |                                             |       |   |   |        |   |
| Net (decrease)/increase                        in cash and cash equivalents                                                             |   |                                             | (625,371   | )      |   | 4,098,248   |   |
|                                                                                                                                    |   |                                             |       |   |   |        |   |
| Cash and cash                        equivalents at beginning of year                                                                   |   |                                             | 12,757,013 |   |   | 10,289,127  |   |
|                                                                                                                                    |   |                                                  |            |        |        |             |        |
|                                                                                                                                    |   |                                             |       |   |   |        |   |
| Cash and cash                        equivalents at end of period                                                                       |   | $                                                | 12,131,642 |   | $      | 14,387,375  |   |
|                                                                                                                                    |   |                                                  |            |        |        |             |        |
|                                                                                                                                    |   |                                             |       |   |   |        |   |
|                                                                                                                                         |   |                                                  |

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

5

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**Notes to            Consolidated Financial Statements (unaudited)**

**Basis of            Presentation**

The accompanying            unaudited interim financial statements have been prepared in accordance with accounting            principles generally accepted in the United States of America for interim financial            information pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X.            Accordingly, they do not include all of the information and footnotes required by            accounting principles generally accepted in the United States of America for complete            financial statements. In the opinion of management, all adjustments, consisting of            normal recurring accrual adjustments, considered necessary for a fair statement have            been included. Operating results and cash flows for the six month period ended June 30,            2007 are not necessarily indicative of the results that may be expected for the year            ending December 31, 2007. The year-end consolidated balance sheet was derived from            audited financial statements but does not include all disclosures required by            accounting principles generally accepted in the United States of America and included            in the Form 10-K filing.

**1. The            Company**

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 men. With            an absence of safe and effective available therapies, dextofisopam’s novel            non-serotonergic brain-gut mechanism holds the potential for a unique and innovative            treatment approach to d- and a-IBS.

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.

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. The Company subsequently            noted 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.

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.

Other compounds in            Pharmos’ pipeline are in pre-clinical studies and are targeted as potential            treatments for inflammatory bowel disease, pain, multiple sclerosis, rheumatoid            arthritis and other disorders.

As described in more detail            under Item 2, Management’s Discussion and Analysis of Financial Condition and            Results of Operations, on August 6, 2007 the Board of Pharmos approved a detailed            restructuring and cost reduction plan for the Company’s operations in Israel. The            plan involves a workforce reduction from 41 employees to 23 employees. Certain key            functions that were previously conducted on site will be outsourced and certain            equipment will be sold or leased to third parties.

6

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The Company has corporate            offices in Iselin, New Jersey and conducts research, discovery and development through            its wholly owned subsidiary, Pharmos, Ltd., in Rehovot, Israel.

**2. Liquidity            and Business Risks**

The Company was            not profitable from 2002 through June 30, 2007. At June 30, 2007, the Company had an            accumulated deficit of $190 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 $17 million as of            June 30, 2007, will be sufficient to support the Company’s continuing operations            beyond June 30, 2008.

The Company            routinely actively pursues various funding options, including equity offerings,            equity-like financing, 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.

**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 Acquisition Corp. All significant intercompany            balances and transactions are eliminated in consolidation. The functional currency for            Pharmos Ltd. is the US dollar.

***Reclassifications***

The consolidated statement of            cash flows for the six months ended June 30, 2006 includes in cash flows from investing            activities $(97,744), for the funding of severance payments. In prior filings such            payments were included in cash flow used in operating activities. This reclass was            recorded in the nine month period ended September 30, 2006 and had no impact on the            Consolidated Balance Sheet or Consolidated Statement of Operations for any            period.

***Research            and development grants receivable***

As of June 30,            2007 and December 31, 2006, research and development grant receivables consist of            grants for research and development from the office of the Chief Scientist in Israel            (OCS) relating to certain projects. Research and development grants are recognized as a            reduction of research and development expenses.

***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 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.

7

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|                                                   |   |                                                        |      |                                     |   |       |   |
|--------------------------------------------------------|--------|-------------------------------------------------------------|-----------|------------------------------------------|--------|------------|--------|
|                                                   |   | June                        30,                        2007 |      | December 31,                        2006 |   |
|                                                   |   |                                                             |      |                                          |   |
| Securities greater                        than 90 days |   | $                                                           | 2,714,366 |                                     | $      | 5,172,673  |   |
| Auction Rate                        Securities         |   |                                                        | 2,400,000 |                                     |   | 8,000,000  |   |
|                                                   |   |                                                             |           |                                     |        |            |   |
| Total Short Term                        Investments    |   | $                                                           | 5,114,366 |                                     | $      | 13,172,673 |   |
|                                                   |   |                                                             |           |                                     |        |            |   |

***Restricted            cash***

Both short term            and long term restricted cash represents deposits held for or by landlords.

***Tax            Provision***

No tax provision            is required at this time since the Company expects to be in a tax loss position at            year-end December 31, 2007 and has net operating losses from previous years. The            Company has established a 100% valuation allowance against the deferred tax            asset.

***Accounting            for Uncertainty in Income Taxes* (“FIN 48”)**

In June 2006,            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 June 30, 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 (expense) income. To date, such gains            and losses have been insignificant.

***Equity            based compensation***

During the six            months ended June 30, 2007 and 2006, the Company recognized equity based compensation            expense of $719,172 and $499,014, respectively, for stock options which was recognized            in the Statement of Operations. As of June 30, 2007, the total compensation costs            related to non-vested awards not yet recognized is $2.2 million which will be            recognized over the next three and one-quarter years.

During the six            months ended June 30, 2007 and 2006, employees and outside directors of the Company            were granted stock options under the Pharmos 2000 Stock Option Plan per the table            below:

|                                 |   |                                 |    |                                                                          |   |                                                                      |   |   |   |   |
|--------------------------------------|--------|--------------------------------------|---------|-------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------|--------|--------|--------|--------|
| Period Ended                         |   | Grants                        Issued |    | Weighted                        Average                        Exercise Price |   | Weighted                        Average                        Fair Value |   |
|                                      |   |                                      |    |                                                                               |   |                                                                           |   |
|                                 |
| June 30,                        2007 |   |                                 | 870,000 |                                                                          | $      | 1.70                                                                      |   | $      | 1.23   |   |
| June 30,                        2006 |   |                                 | 676,000 |                                                                          | $      | 2.15                                                                      |   | $      | 1.67   |   |

The 2007 option grants include            200,000 options granted contingent upon the approval by the Company’s            shareholders of an increased number of authorized shares in the 2000 Amended and            Restated Stock Option Plan.

***Recent            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-

8

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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.

**4. Vela Pharmaceuticals,            Inc.**

The            Company’s 2006 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 six months ended June 30, 2006,            as though the Vela acquisition was completed as of the beginning of the            period.

|                                                                           |   |                                 |       |   |
|--------------------------------------------------------------------------------|--------|--------------------------------------|------------|--------|
|                                                                           |   | June                        30, 2006 |       |
|                                                                           |   |                                      |       |
|                                                                           |   |                                 |
| Net loss                        attributable to common shareholders            |   | $                                    | (9,695,545 | )      |
|                                                                           |   |                                      |            |   |
|                                                                           |   |                                 |       |   |
| Net loss per share                        attributable to common shareholders: |   |                                 |       |   |
|                                                                           |   |                                 |       |   |
| Basic and                        diluted                                       |   | $                                    | (0.38      | )      |
|                                                                           |   |                                      |            |   |
|                                                                           |   |                                 |       |   |
| Weighted average                        shares outstanding                     |   |                                 | 25,550,077 |   |
|                                                                           |   |                                      |            |   |

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).

9

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The remaining milestones are as            follows:

|   |   |                                                                                                                                               |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | $1 million cash + 2                        million shares of Pharmos common stock: Final patient enrolled in Phase 2b                        trial |
|   |   |                                                                                                                                               |
|   | • | $2 million cash +                        2.25 million shares: Successful completion of Phase 2b                                                    |
|   |   |                                                                                                                                               |
|   | • | $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   |

**5. 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. For            the periods ending June 30, 2007 and 2006, other potential common stock has been            excluded from the calculation of diluted net loss per common share, as their inclusion            would be anti-dilutive. In accordance with the requirements of Statement of Financial            Accounting Standards No. 128, it was determined that no stock options or warrants as of            June 30, 2007 and 2006 were “in the money” and therefore none were            considered other potential common stock to be included in the calculation of diluted            net loss per share.

The following            table sets forth the number of potential shares of common stock that have been excluded            from diluted loss per share because the exercise price was greater than the average            market price of our common stock, and therefore, the effect on diluted income (loss)            per share would have been anti-dilutive.

|                                                                                      |   |                                     |      |                                     |   |      |   |
|-------------------------------------------------------------------------------------------|--------|------------------------------------------|-----------|------------------------------------------|--------|-----------|--------|
|                                                                                      |   | **June 30,                        2007** |      | **June 30,                        2006** |   |
|                                                                                      |   |                                          |      |                                          |   |
|                                                                                      |   |                                     |      |                                     |   |      |   |
| Stock                        options                                                      |   |                                     | 2,537,211 |                                     |   | 1,776,361 |   |
| Warrants                                                                                  |   |                                     | 297,739   |                                     |   | 1,176,310 |   |
| Restricted stock -                        non vested                                      |   |                                     | —   |                                     |   | 63,292    |   |
|                                                                                      |   |                                          |           |                                     |        |           |   |
|                                                                                      |   |                                     |      |                                     |   |      |   |
| Total potential                        dilutive securities not included in loss per share |   |                                     | 2,834,950 |                                     |   | 3,015,963 |   |
|                                                                                      |   |                                          |           |                                     |        |           |   |

**6. Collaborative            Agreements**

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 Chairman and former    Chief Executive Officer of Pharmos. In the three and six months ending June    30, 2007, the Company recorded in other income royalties of $1,155 and $2,052    compared with $657 and $1,648 for the same periods in 2006, respectively,    per the licensing agreement with Herbamed.

**7. Common Stock            Transactions**

In the six            months ended June 30, 2007 there were no shares of common stock issued pursuant to the            Pharmos Corporation 2001 Employee Stock Purchase Plan or options exercised under the            Company’s Stock Option Plans.

During the first            quarter of 2007, the Company incurred a non-cash charge of $328,057 for the            acceleration of unvested options for Dr. Haim Aviv, Chairman and former Chief Executive            Officer.

On September 6,            2004, the Board of Directors approved, and Pharmos entered into, a Retention Award            Agreement with Dr. Haim Aviv, Chairman and former Chief Executive Officer. The Company            granted a retention award of $300,000 cash and 75,950 restricted stock units to Dr.            Aviv (the “Awards”). Under the agreement, one-half of the Awards vested on            December 31, 2005 and the balance of Dr. Aviv’s Awards were to vest and become            non-forfeitable on June 30, 2007, subject to certain accelerated vesting provisions.            The Company accelerated the vesting of Dr. Aviv’s remaining unvested Awards to            March 31, 2007 in connection with his retirement on that date as Chief Executive            Officer. 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

10

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purposes, the            cash awards and the fair value of the restricted stock awards, which totaled            $2,500,000, were expensed pro rata over the vesting periods. During the three month            period ended March 31, 2007, the Company recorded an expense of approximately $105,844            in connection with the Awards.

On March 4,            2003, the Company raised $4.3 million from the placement of common stock and warrants.            The private placement offering was completed by issuing 1,011,765 shares of common            stock at a price of $4.25 per share and approximately 200,000 warrants at an exercise            price of $6.25 per share. Additionally, the remaining balance of the September 2000            Convertible Debenture offering was redeemed for cash. The original face amount of $3.5            million was redeemed for approximately $4.0 million, which included accrued and unpaid            interest. According to EITF 00-19, the issued warrants meet the requirements of and are            being accounted for as a liability since registered shares must be delivered upon            settlement. The Company calculated the initial value of the warrants, including the            placement agent warrants, as being approximately $394,000 under the Black-Scholes            option-pricing method (assumption: volatility 75%, risk free rate 2.88% and zero            dividend yield). The value of the warrants were being marked to market each reporting            period as a gain/loss until exercised or expiration and amounted to $11,435 of income            through March 31, 2007. Upon exercise of each of the warrants, the related liability is            reduced by recording an adjustment to additional paid-in-capital.

The fair value            of the warrants were being marked to market using the Black-Scholes option-pricing            model with the same assumptions as used for the stock options.

**8. Segment and            Geographic Information**

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

Geographic information for the            three and six months ending June 30, 2007 and 2006 are as follows:

|                                            |   |                                                   |       |                                                 |   |       |   |     |       |   |   |       |   |
|-------------------------------------------------|--------|--------------------------------------------------------|------------|------------------------------------------------------|--------|------------|--------|----------|------------|--------|--------|------------|--------|
|                                            |   | **Three months ended                        June 30,** |       | **Six months ended                        June 30,** |   |
|                                            |   |                                                        |       |                                                      |   |
|                                            |   | **2007**                                               |       | **2006**                                             |   | **2007**   |   | **2006** |       |
|                                            |   |                                                        |       |                                                      |   |            |   |          |       |
| **Net (loss)                        income**    |   |                                                   |       |                                                 |   |       |   |     |       |   |   |       |   |
| United                        States            |   | $                                                      | (4,311,033 | )                                                    | $      | (4,082,194 | )      | $        | (9,041,901 | )      | $      | (7,010,335 | )      |
| Israel                                          |   |                                                   | (326,370   | )                                                    |   | (16,182    | )      |     | (348,597   | )      |   | (90,727    | )      |
|                                            |   |                                                        |            |                                                 |        |            |   |          |            |   |        |            |   |
|                                            |   | $                                                      | (4,637,403 | )                                                    | $      | (4,098,376 | )      | $        | (9,390,498 | )      | $      | (7,101,062 | )      |
|                                            |   |                                                        |            |                                                 |        |            |   |          |            |   |        |            |   |
|                                            |   |                                                   |       |                                                 |   |       |   |     |       |   |   |       |   |
| **Capital                        Expenditures** |   |                                                   |       |                                                 |   |       |   |     |       |   |   |       |   |
| United                        States            |   | $                                                      | 2,914      |                                                 | $      | —    |   | $        | 9,100      |   | $      | —    |   |
| Israel                                          |   |                                                   | 38,826     |                                                 |   | 34,206     |   |     | 122,675    |   |   | 130,303    |   |
|                                            |   |                                                        |            |                                                 |        |            |   |          |            |   |        |            |   |
|                                            |   | $                                                      | 41,740     |                                                 | $      | 34,206     |   | $        | 131,775    |   | $      | 130,303    |   |
|                                            |   |                                                        |            |                                                 |        |            |   |          |            |   |        |            |   |

Geographic            information as of June 30, 2007 and December 31, 2006 are as follows:

|                                              |   |     |       |     |   |       |   |
|---------------------------------------------------|--------|----------|------------|----------|--------|------------|--------|
|                                              |   | **2007** |       | **2006** |   |
|                                              |   |          |       |          |   |
| **Total                        Assets**           |   |     |       |     |   |
| United                        States              |   | $        | 16,112,136 |     | $      | 25,245,098 |   |
| Israel                                            |   |     | 3,196,733  |     |   | 3,148,240  |   |
|                                              |   |          |            |     |        |            |   |
|                                              |   | $        | 19,308,869 |     | $      | 28,393,338 |   |
|                                              |   |          |            |     |        |            |   |
|                                              |   |     |       |     |   |       |   |
| **Long Lived                        Assets, net** |   |     |       |     |   |       |   |
| United                        States              |   | $        | 30,499     |     | $      | 38,368     |   |
| Israel                                            |   |     | 477,308    |     |   | 555,089    |   |
|                                              |   |          |            |     |        |            |   |
|                                              |   | $        | 507,807    |     | $      | 593,457    |   |
|                                              |   |          |            |     |        |            |   |

**9. Legal            Proceedings**

Class Action            Lawsuits

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.

11

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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.            The settlement is subject to final court approval. There is no assurance that the            settlement will be approved by the Court.

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.

**10. Related Party            Transaction**

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.

**Item 2.            Management’s Discussion and Analysis of Financial Condition and Results of            Operations**

*This report            on Form 10-Q 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” of our            Form 10-K for the year ended December 31, 2006 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.*

***Executive            Summary of 2007 Strategy and Operating Plan***

Pharmos’            business is the discovery and development of novel therapeutics to treat a range of            indications including specific diseases of the nervous system such as disorders of the            “brain-gut” axis, pain/inflammation and autoimmune disorders. The            Company’s core proprietary technology platform focuses on discovery and            development of synthetic cannabinoid compounds with a focus on cannabinoid2 (CB2)            receptor-selective agonists. The Company has a portfolio of drug candidates and            compounds in various development stages, including clinical, preclinical and discovery.            Pharmos is also working to commercialize its proprietary NanoEmulsion (NE) drug            delivery system, which is in clinical-stage development for topical application of            analgesic and anti-inflammatory agents. To complement our own drug development            platforms, the Company periodically evaluates expanding its portfolio of internally            developed products with either in-licensed products or acquisitions in selected related            therapeutic areas. Also, we seek to enter into targeted strategic alliances/scientific            collaborations with established pharmaceutical companies to

12

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complete            development and commercialization of selected products. The Company also maintains a            commitment to out-license proprietary technologies and products not consistent with our            primary corporate focus.

Pharmos’            lead product, dextofisopam (previously known as R-tofisopam) is in Phase II clinical            development as a treatment for irritable bowel syndrome (IBS). Dextofisopam is the            R-enantiomer of racemic tofisopam, a nonsedating agent that has been marketed and used            safely outside the U.S. for over three decades for multiple indications including IBS.            Dextofisopam binds to specific receptors in areas of the brain affecting autonomic            function, including gastrointestinal function. Unlike 5-HT3 or 5-HT4 IBS therapies            currently available, both of which have significant safety concerns,            dextofisopam’s novel non-serotonergic, brain-gut mechanism offers a unique and            innovative approach to IBS treatment. On June 20, 2007 the Company announced it had            commenced a Phase IIb clinical trial of dextofisopam, which is expected to enroll            approximately 480 female patients with diarrhea-predominant or alternating IBS (d- and            a-IBS) in up to 70 U.S. centers. The double-blind, randomized, placebo-controlled study            will evaluate the clinical safety, tolerability and efficacy of multiple doses of            dextofisopam. The estimated duration of the enrollment period for the study is 18            months. The Phase IIb IBS study follows a successful Phase IIa study in 141 IBS            patients in which dextofisopam demonstrated a statistically significant improvement            over placebo on the primary endpoint of adequate overall relief (p = 0.033). In the            Phase IIa trial, dextofisopam was well tolerated and did not cause significant            constipation. Dextofisopam also provided benefit on a variety of secondary endpoints.            Importantly, the beneficial effects on stool frequency were observable after two days            and maintained for the 12 weeks of treatment. Overall, similar rates of adverse events            were seen with dextofisopam and placebo. Importantly, diarrhea and constipation            occurred at a very low rate. Dextofisopam has also been evaluated in three randomized,            double-blind, placebo-controlled Phase 1 trials comprising healthy volunteers in which            dextofisopam appeared to be safe and well tolerated at doses up to 600 mg BID. 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 men. With an absence of            safe and effective available therapies, dextofisopam’s novel non-serotonergic            brain-gut mechanism holds the potential for a unique and innovative treatment approach            to d- and a-IBS.

Pharmos’            proprietary NE drug delivery technology is in Phase II clinical development as a local            anti-inflammatory drug delivery agent, and is potentially applicable to Pharmos’            CB2 receptor-selective molecules. The NE drug delivery system consists of an efficient            solvent-free topical vehicle based on drug entrapment in stable, submicron particles of            oil-in-water emulsions with a mean droplet size between 100 and 200 nm that are            uniformly dispersed in an aqueous phase. One of the unique characteristics of the NE            technology is the relatively high percentage of total particle volume occupied by the            internal hydrophobic oil core of the droplets, which provides high solubilization            capacity for lipophilic compounds compared to other lipoidal vehicles such as            liposomes. Another unique characteristic of Pharmos’ NE technology is that it            does not employ the chemical penetration enhancers commonly used in other topical drug            delivery vehicles, which may cause skin irritation and sensitization. On June 27, 2007            the Company announced that it had commenced a Phase IIa clinical trial of the NE drug            delivery technology formulated with 3% diclofenac, an approved and widely-used            non-steroidal anti-inflammatory drug (NSAID). Up to eight sites in Israel will            participate in the double-blind, randomized, placebo-controlled, parallel group study.            The trial will compare the safety and analgesic efficacy of the diclofenac NE cream            with placebo in approximately 126 subjects with osteoarthritis (OA) of the knee. OA            affects approximately 12% of U.S. adults, a significant portion of whom 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. Two            Phase I studies in healthy volunteers have been completed and confirmed the safety and            tolerability as well as the low systemic exposure of diclofenac NE topical            cream.

Our discovery            program is focused on capitalizing on our expertise in the biology, chemistry and            manufacturing of synthetic cannabinoid therapeutics, an area in which Pharmos has            generated significant know-how and amassed a rich intellectual property estate covering            multiple areas of cannabinoid biology. Modulation of the CB2 receptors in preclinical            models of disease suggests that potential areas for therapeutic intervention include            the treatment of pain, autoimmune disease, OA, asthma, allergy, atherosclerosis and            obesity. Pharmos’ research efforts are currently focused on the use of            cannabinoid compounds that selectively bind to the CB2 receptors (CB2-selective) for            the treatment of pain and autoimmune diseases. These efforts have produced increasingly            more potent, drugable and selective CB2 receptor agonists and antagonists for these            indications as well as others. Cannabinor, the most advanced CB2-selective compound            from Pharmos’ library, has completed two Phase IIa clinical studies in an            intravenous formulation. In January 2007, Pharmos reported that in the first of the            Phase IIa studies to be completed, an experimentally induced pain model, cannabinor            failed to meet the primary endpoint of reducing capsaicin-induced pain. The Company            subsequently noted that analysis of additional endpoints of pressure-induced and            heat-induced pain indicates that cannabinor does exhibit a statistically significant            systemic analgesic effect compared to placebo. In April 2007, Pharmos reported that in            the separate Phase IIa trial of i.v. cannabinor in acute nociceptive pain in patients            undergoing 3rd molar extraction, an analgesic effect was observed at the 12mg dose;            however, there was no effect at the higher doses (24mg and 48mg). In both Phase 2a            trials, cannabinor was generally well tolerated with no serious adverse events. 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

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resources on            other CB2 compounds that have greater potential from multiple aspects. Cannabinor will            be available for outlicensing.

The results for            the three and six months ended June 30, 2007 and 2006 were a net loss of $4.6 and $4.1            million and a net loss of $9.4 million and $7.1 million, respectively. On a loss per            share basis, this equates to $(0.18) and $(0.21) for the quarter and $(0.37) and            $(0.37) for the first half, respectively.

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 June 30, 2007,            the Company’s accumulated deficit was approximately $190.4 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’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.

On August 6,            2007 the board of Pharmos approved a detailed restructuring and cost reduction plan for            the Company’s operations in Israel. The plan involves a workforce reduction from            41 employees to 23 employees. Certain key functions that were previously conducted on            site will be outsourced and certain equipment will be sold or leased to third            parties.

The            restructuring plan will enable the Company to continue its scientific research and            development programs and better manage existing cash resources.

The focus of the            Company’s operations in Israel will now be: