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EX-23.A - CONSENT OF FRIEDMAN LLP - PHARMOS CORPex23a.htm
EX-31.A - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - PHARMOS CORPex31a.htm
EX-31.B - CERTIFICATION OF CHIEF FINANCIAL OFFICER - PHARMOS CORPex31b.htm
EX-32.A - SECTION 1350 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND CHIEF FINANCIAL OF - PHARMOS CORPex32.htm




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

FORM 10-K

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

For the Fiscal Year Ended December 31, 2010

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

Commission File No. 0-11550

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

Nevada
36-3207413
(State or other jurisdiction of
(IRS Employer Id. No.)
incorporation or organization)
 
   
99 Wood Avenue South, Suite 302
Iselin, NJ 08830
(Address of principal executive offices) (zip code)

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

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

None
(Title of Class)

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

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

 
    Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  [  ] Yes   [X] No
 
    Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  [  ] Yes   [X] No

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

    Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   [  ] Yes    [  ] No

 
 

 


    Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [X]
 
    Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Act).
 
Large accelerated filer [  ]                                                      Accelerated filer [  ]
 
Non-accelerated filer [  ]                                                      Smaller reporting company [X]

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

    The aggregate market value of the registrant’s Common Stock at June 30, 2010 held by those persons deemed to be non-affiliates was approximately $1,436,730.

    As of February 17, 2011, the Registrant had outstanding 59,732,332 shares of its $.03 par value Common Stock.


 
 

 

PART I


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

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

Item 1.  Business

OVERVIEW OF BUSINESS

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), with a focus on pain/inflammation, and autoimmune disorders. The Company's most advanced product is Dextofisopam for the treatment of irritable bowel syndrome (IBS). IBS is a chronic and sometimes debilitating condition that affects roughly 10%-15% of U.S. adults and is two to three times more prevalent in women than in men. With an absence of safe and effective therapies, Dextofisopam’s novel non-serotonergic activity holds the potential for a unique and innovative treatment approach to IBS with diarrhea predominant and alternating patients.

As described below, the Phase 2b Dextofisopam trial did not meet its primary endpoint. During 2010 the Company conducted minimal research and development activity. The Company’s focus was on further understanding the Dextofisopam Phase 2b results and discussing these with a wide variety of potential pharmaceutical partners and investment funds to participate in a Phase 2c clinical trial as the next development stage for Dextofisopam. The Company estimates that the cost of such a trial would be in the $8 million to $10 million range. Therefore to proceed with development the Company needs to secure a partner and /or funding source.

During 2010 the Company explored initiating proof of concept clinical studies in other therapeutic areas with its compounds and conferred with clinical and scientific experts as to the best opportunity.

The Company’s operations in Israel were closed effective October 2008 and the Company has been actively seeking to sell and license the CB2 selective agonist program that had been developed in Israel.

Summary of Dextofisopam development through Phase 2b

On September 14, 2009, the Company announced the results of its Phase 2b Dextofisopam clinical trial to evaluate safety and efficacy of the compound in irritable bowel syndrome.


 
1

 

Although the primary efficacy variable (% of weeks responding for adequate overall relief of IBS symptoms) did not reach statistical significance, the percentage responding for the Dextofisopam 200 mg group was higher than that observed for the Phase 2a trial. However, the placebo response rate was also higher than expected compared to the Phase 2a placebo response.

This result was similarly demonstrated across all other secondary efficacy variables associated with the adequate overall relief question. In all cases except in the first month, the response rates for the Dextofisopam 200 mg group were essentially the same as or in most cases better than the response rates observed for the Phase 2a trial.

Also, secondary response variables of adequate relief of abdominal pain and discomfort and overall IBS symptoms ratings showed statistical significance and trends favoring the Dextofisopam 200 mg group compared to placebo.

The Phase 2b double-blind, randomized, placebo-controlled study evaluated the clinical safety, tolerability and efficacy of multiple doses of Dextofisopam. Female outpatients with diarrhea predominant and alternating diarrhea and constipation IBS (according to Rome III Criteria for IBS) were randomized into each of four treatment groups: 100mg, 200mg, and 300mg twice a day (BID) Dextofisopam or placebo. A total of 324 patients were enrolled using approximately 70 US centers. The patients participated for up to 19 weeks, including a screening period, a 12-week treatment period, and a 28-day post treatment period. The primary endpoint was “adequate overall relief” of IBS symptoms during the 12-week treatment period.

In the Phase 2b study, of the 324 patients randomized, 311 (96%) were evaluated in the Intent to Treat (ITT) analysis. Patients who completed the full study numbered 225 (69%), a similar percentage to the Phase 2a study, and 99 (31%) patients discontinued the study. The majority of patients who discontinued did so due to withdrawal of consent or a non serious adverse event.

Demographics and baseline calculations were comparable among the four treatment groups. The mean age was between 44 and 45 years of age. The duration of IBS disease symptoms ranged from 9 to 11 years, and the majority of patients were white.

The most bothersome IBS symptom reported at baseline was abdominal pain and discomfort, followed by a sense of urgency and stool frequency.

This Phase 2b study followed a successful 141-patient Phase 2a study in which Dextofisopam with a dose of 200 mg BID demonstrated a statistically significant improvement over placebo on the primary endpoint of adequate overall relief ( p=0.033). In the Phase 2a 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 12 weeks of treatment. Overall, similar rates of adverse events were seen with Dextofisopam and placebo. Diarrhea and constipation as adverse events occurred at a very low rate.

Additionally, Dextofisopam has been evaluated in three randomized, double-blind, placebo-controlled Phase 1 trials comprising healthy volunteers. Clinical data from the Phase 1 studies demonstrated that Dextofisopam appears to be safe and well tolerated at doses up to 600 mg BID.

The Company’s strategy is to seek a pharmaceutical partner with the appropriate GI clinical and scientific expertise for further development of Dextofisopam.

The Company’s primary focus is on the development and partnering of Dextofisopam and to that end cash resources are being conserved and targeted for that program. On August 29, 2008 the Company announced that effective October 31, 2008 it would cease operations in Rehovot, Israel, and manage those activities out of the Company’s US headquarters in Iselin, New Jersey. The voluntary liquidation of the Company’s subsidiary in Israel, Pharmos Ltd. was completed in May of 2010.

 
2

 

The CB2 selective receptor agonist program

Substantial development work was conducted on the CB2 selective agonist program in Israel from 2002 through 2008. The Company expended approximately $15 million on this development program.

Pharmos’ cannabinoid research was geared toward development of selective and specific CB2 receptor agonists. 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.  Although progress has been made, the early stage of this work and resource limitations have resulted in termination of these programs. Pharmos’ strategy is to sell or out license the technology developed around the cannabinoid research.  Pharmos had developed these compounds in preclinical testing for neuropathic pain.

In November 2009 the Company entered into a Material Transfer Agreement whereby a European company will perform certain experiments with samples of our synthetic selective cannabinoid receptor CB2 agonist.

Tianeptine

During 2010 the Company decided not to continue to pursue Tianeptine in order to conserve its cash resources. Tianeptine, a potential follow-on product to Dextofisopam, had completed late-preclinical development for the treatment of irritable bowel syndrome (IBS). Tianeptine, a racemic molecule, has been marketed outside the United States since 1988 for the treatment of depression. Preclinical studies support the potential utility of Tianeptine for the treatment of functional gastrointestinal disorders and, in particular, IBS. Pharmos has established patent rights for the use of Tianeptine and its enantiomers for the treatment of IBS and functional dyspepsia. Tianeptine is available for out-licensing.

S-Tofisopam

The Company owns the rights to both R and S Tofisopam. Dextofisopam is the R enantiomer of racemic tofisopam and is being developed for IBS as described above. During 2010 the Company examined the data from earlier Phase 1 studies using S-Tofisopam and determined that the lowering of uric acid observed in two Phase 1 studies supported considering S-Tofisopam as a potential therapy to treat patients with gout. Work has been conducted with various academic and research centers to explore a proof of concept trial using S-Tofisopam in gout patients. It is expected that the Company will initiate a trial in 2011.

Company trades on the pink sheets

On March 13, 2009 the Company was officially delisted from the Nasdaq Capital Market, and is currently trading on the OTCBB pink sheets under the symbol “PARS.PK”. The Company was not in compliance with the minimum $2,500,000 stockholders’ equity requirement for continued listing and was unable to comply during the grace period extended by NASDAQ. As a result of trading on the OTCBB pink sheets, liquidity for the Company’s common stock may be significantly decreased which could reduce trading price and increase the transaction costs of trading shares of the Company’s common stock.


 
3

 

Liquidity and funding needs

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. The Company had an accumulated deficit of $211.4 million as of December 31, 2010 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. Previously the Company had financed its operations with public and private offerings of securities, advances and other funding pursuant to an earlier 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 (NOL’s), and interest income. During 2010 the Company was awarded a cash grant of $244,000 under the Federal Qualifying Therapeutic Discovery Project for the further development of Dextofisopam. The Company had approximately $3.1 million of cash and cash equivalents at December 31, 2010. However, the Company’s ability to continue as a going concern is largely dependent upon achieving a collaboration with a pharmaceutical partner or raising additional capital to either advance its lead compound, Dextofisopam, for the treatment of IBS or to advance other earlier stage intellectual property assets.   The Company has in the past pursued various funding and financing options; however management believes that future funding or financing options may be challenging because of the current environment.
 
As the Company does not currently have the finances and resources to complete full clinical trials for its lead compound, Dextofisopam, it may decide to embark on smaller clinical trials for Dextofisopam or commence pre-clinical development on its other intellectual property assets which could further reduce the company’s current resources.
 
As such these factors raise substantial doubt as to the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from this uncertainty.

The Company has corporate offices in Iselin, New Jersey.

STRATEGY

Pharmos’ most advanced compound is  Dextofisopam, which  has completed a double-blind, placebo-controlled diarrhea-predominant or alternating IBS Phase 2a study with positive effect on primary efficacy endpoint (n=141, p=0.033). In this study, Dextofisopam was well-tolerated and demonstrated significant improvement over placebo, suggesting that Dextofisopam has the potential to become a novel first line treatment for IBS. Pharmos initiated a Phase 2b trial in February 2007 and in June 2007 the Company announced patient screening had commenced. Dextofisopam is the R-enantiomer of racemic tofisopam, a molecule marketed and used safely outside the United States for over three decades for multiple indications including IBS. Unlike the two 5-HT3 or 5-HT4 IBS therapies recently introduced into the market, and subsequently withdrawn because of safety concerns, Dextofisopam’s novel non-serotonergic activity offers a unique and innovative approach to IBS treatment.

The results of a Phase 2b study were announced in September 2009. The primary endpoint of overall adequate relief was not met due to a high placebo response, but drug activity was observed in all drug cohorts, especially the 200 mg dose.

The Company now is seeking a pharmaceutical partner with clinical, scientific and financial capabilities to further develop Dextofisopam.

 
4

 
In research efforts over the past decade, the Company has developed a significant expertise in cannabinoid biology and chemistry, and has generated significant know-how and an intellectual property estate pertaining to multiple areas of cannabinoid biology.  With the decision to focus resources on Dextofisopam and with the closure of the Company’s operations in Israel effective October 31, 2008, no further development work is being performed on the cannabinoid assets and the focus is to partner or sell these assets.

In November 2009 the Company entered into a Material Transfer Agreement whereby a European company will perform certain experiments with samples of our synthetic selective cannabinoid receptor CB2 agonist.

The Company continues to seek, sell or license other CB2 assets, including Cannabinor which was the only CB2 asset to enter human clinical trials.

The Company owns the rights to both R and S Tofisopam. Dextofisopam is the R enantiomer of racemic tofisopam and is being developed for IBS as described above. During 2010 the Company examined the data from earlier Phase 1 studies using S-Tofisopam and determined that the lowering of uric acid observed in two Phase 1 studies supported considering S-Tofisopam as a potential therapy to treat patients with gout. Work has been conducted with various academic and research centers to explore a proof of concept trial using S-Tofisopam in gout patients. It is expected that the Company will initiate a trial in 2011. The Company’s strategy would be to seek a partner after the completion of a proof of concept trial.
 
The Company has explored the concept of a merger or reverse merger with another life science company in order to build greater pipeline critical mass. Several possible candidates were examined during 2010, but were not pursed after preliminary scientific diligence.

COMPOUND IN CLINICAL DEVELOPMENT
 
Pharmos currently has only one compound in clinical development – Dextofisopam.  Dextofisopam, a non-serotonergic agent currently being evaluated for the treatment of irritable bowel syndrome (IBS), is the R-enantiomer of racemic tofisopam, a molecule marketed and used safely outside the United States for over three decades for multiple indications including IBS. Dextofisopam represents a novel, first-in-class opportunity with a positive proof-of-concept study in an arena where there are few compounds with unique approaches or positive efficacy results. By structure, Dextofisopam is a member of the homophthalazine class; Dextofisopam binds to specific receptors in areas of the brain affecting autonomic function, including gastrointestinal (GI) function. Unlike the two 5-HT3 or 5-HT4 mediated IBS therapies recently introduced into the market, and subsequently withdrawn because of safety concerns, Dextofisopam novel non-serotonergic activity offers a unique and innovative approach to IBS treatment.
 
A double-blind, placebo-controlled diarrhea-predominant or alternating IBS Phase 2a study has been completed with positive effect on primary efficacy endpoint (n=141, p=0.033). In this study, Dextofisopam was well-tolerated and demonstrated significant improvement over placebo suggesting that Dextofisopam has the potential to become a novel first line treatment for IBS.

On September 14, 2009, the Company announced the results of its Phase 2b Dextofisopam clinical trial to evaluate safety and efficacy of the compound in irritable bowel syndrome.

Although the primary efficacy variable (% of weeks responding for adequate overall relief of IBS symptoms) did not reach statistical significance, the percentage responding for the Dextofisopam 200 mg group was higher than that observed for the Phase 2a trial. However, the placebo response rate was also higher than expected compared to the Phase 2a placebo response.
 
An extensive patent estate is in place with Dextofisopam. This consists of an issued composition-of-matter patent, an issued manufacturing patent, and several additional pending patent applications in both the United States (including use of Dextofisopam for inflammatory disorders and immunomodulation) and foreign counterparts.


 
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Potential pharmaceutical market for Dextofisopam

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

Irritable Bowel Syndrome:  Disease Description and Diagnosis

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

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

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

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

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

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

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

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


 
6

 

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

Prevalence of IBS

IBS is a very common disorder, with studies indicating prevalence in the range of 6-15% for North America, Europe, and Japan. Based on a prevalence rate of 12.5%, approximately 36 million individuals in the United States meet diagnostic criteria for IBS.  Prevalence rates are similar in the major European markets (France, Germany, Italy, Spain, and the United Kingdom). While prevalence rates for other countries are not well established, published studies support the existence and recognition of IBS throughout the world, including China and India.
 
Irritable bowel syndrome, or IBS, is a chronic, recurring condition with symptoms that affect more often women than men.  IBS is characterized by multiple symptoms that include bowel dysmotility—diarrhea, constipation, or alternating diarrhea and constipation—and abdominal discomfort.  Studies have shown that diarrhea-predominant IBS appears to be the most common subtype.  For patients with diarrhea-predominant and alternating-type IBS, there are no recently approved treatments for any but the most severely affected women, and none for men.

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

Current and Recent Therapies

Even with the introduction of two new therapies - Lotronex® (alosetron), a 5-HT3 antagonist, and Zelnorm® (tegaserod), a 5-HT4 partial agonist - the IBS market is still largely served by older products, with questionable efficacy and poor tolerability. These older products include antispasmodics, laxatives, and antidiarrheal agents. While antispasmodics at high doses may provide relief of specific symptoms, these drugs are poorly tolerated at those doses. The estimated sales of IBS drugs in the U.S. market totaled $348 M in 2009.

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

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


 
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Market Potential (United States and Rest of World)

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

COMPOUNDS AVAILABLE FOR LICENSING OR SALE

Pharmos is not currently performing any research or discovery work. The focus of the Company is to secure a pharmaceutical partnership arrangement for Dextofisopam. However, the Company is exploring a small proof of concept trial using S-Tofisopam for patients with gout.

Dextofisopam

As described above the Company has completed both a Phase 2a and Phase 2b trials of Dextofisopam for IBS. The results of the Phase 2b trial were reported in September 2009. The Company has spent considerable time during 2010 seeking a pharmaceutical partner for the further development of Dextofisopam.

CB2-selective cannabinoids

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

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

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

Pharmos closed its operations in Israel in late 2008 and has ceased any discovery or development work on CB2 selective cannabinoid program. However these assets are available for licensing and / or sale. There has been limited interest to date. In November 2009 Pharmos entered into a Material Transfer Agreement whereby a European company will perform certain experiments with samples of our synthetic selective cannabinoid receptor agonist.


 
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COMPETITION

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

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

We know of a number of programs in various stages that compete in the area of IBS.
 
Salix Pharmaceuticals is developing rifaximin, an antibiotic marketed for the treatment of traveler’s diarrhea. Salix is conducting clinical development studies to assess the utility of rifaximin for the treatment of irritable bowel disease. Ocera Therapeutics is developing AST-120 for a number of conditions, including IBS; Lexicon Genetics is developing LX1031, which has completed a Phase 2 clinical trial. LX1031 is an orally-delivered small molecule designed to regulate gastrointestinal (GI) function by reducing the amount of serotonin available for receptor activation in the GI tract without affecting serotonin levels in the brain. Serotonin is a key regulator of GI function, and is associated with the most common symptoms of IBS: problems of bowel motility and GI discomfort. Several other compounds are reported to be in development for the treatment of IBS.  However, it is not clear if these compounds are intended for a specific type of IBS, e.g., diarrhea-predominant, constipation-predominant, or alternating-type IBS.  Such compounds include a glucagon-like peptide-1 agonist (Gastrotech) and asimadoline, a kappa opiate agonist (Tioga), both reportedly in Phase 2.  Several other compounds are reported to be in development for the treatment of constipation-predominant IBS.  While such compounds may not directly compete with Dextofisopam, it is possible that they may eventually be developed for diarrhea-predominant or alternating-type IBS, or that Dextofisopam may eventually be developed for constipation-predominant IBS.  Such compounds include MD-1100, a guanylate cyclase C agonist reportedly in Phase 3 (Ironwood).

Dextofisopam is currently targeted for the treatment of diarrhea-predominant IBS and/or alternating-type IBS.  To the best of our knowledge, there are no competing compounds in development specifically for the treatment of alternating-type IBS.  However, the alternating results have been mixed between the Phase 2a and Phase 2b trials and the numbers of patients were small.  Several compounds are reported to be in development for the potential treatment of diarrhea-predominant IBS. 

The IBS area remains a difficult development area. During the past year some of our potential competition has reported disappointing or failed clinical trials. However, as IBS represents a large unmet medical need, we expect other competition to emerge.

Collaborative Relationships

The Company’s principal focus is to seek a pharmaceutical partner with the appropriate GI clinical and scientific expertise for further development of Dextofisopam.


 
9

 

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

Patents and Proprietary Rights

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

Pharmos generally maintains, at its expense, U.S. and foreign patent rights with respect to both the licensed technology and its own technology and files and/or prosecutes the relevant patent applications in the U.S. and foreign countries. Pharmos also relies upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop its competitive position. Pharmos' policy is to protect its technology by, among other things, filing, or requiring the applicable licensor to file, patent applications for technology that it considers important to the development of its business. Pharmos intends to file additional patent applications, when appropriate, relating to its technology, improvements to its technology and to specific products it develops.

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

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

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


 
10

 

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

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

Government Regulation

FDA and Comparable Authorities in Other Countries

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

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

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

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


 
11

 

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

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

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

Clinical trials typically are conducted in three sequential phases, although the phases may overlap. In Phase I, the initial introduction of the drug to humans, the drug is tested in a small group of healthy volunteers for safety and clinical pharmacology such as metabolism and tolerance. Phase I trials may also yield preliminary information about the product’s effectiveness and dosage levels. Phase II involves detailed evaluation of safety and efficacy of the drug in patients with the disease or condition being studied. It also involves a determination of optimal dosage and identification of possible side effects in a larger patient group. Phase III trials consist of larger scale evaluation of safety and efficacy and usually require greater patient numbers and multiple clinical trial sites, depending on the clinical indications for which marketing approval is sought.

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

The 1962 amendments to the Federal Food, Drug and Cosmetic Act required for the first time that drug effectiveness be proven by adequate and well-controlled clinical trials. The FDA interpretation of that requirement is that at least two such trials are necessary to demonstrate effectiveness for approval of an NDA. This interpretation is based on the scientific need for independent substantiation of study results. However, Section 115 of FDAMA revised Section 505 of the Act to read, in pertinent part that “based on relevant science, data from one adequate and well-controlled clinical investigation and confirmatory evidence … are sufficient to establish effectiveness.”  The FDA has not issued comprehensive standards of testing conditions for pivotal trials.  The FDA maintains a preference for at least two adequate and well-controlled clinical trials.


 
12

 

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

Corporate History

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

Human Resources

As of December 31, 2010, Pharmos had 2 full-time employees in the U.S. The Company uses an outsourcing model for the conduct of its development work and has a pool of experienced pharmaceutical and drug development experts available.

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

Public Funding and Grants

In November 2010 the Company was awarded a cash grant under the Federal Qualifying Therapeutic Discovery Project , which was provided under new section 48D of the Internal Revenue Service, as enacted as part of the Patient Protection and Affordable Care Act of 2010. In December 2010 the Company received $244,479 under this program.

Until its closure in 2008, Pharmos’ subsidiary, Pharmos Ltd., has received certain funding from the Chief Scientist of the Israel Ministry of Industry and Trade (the Chief Scientist) for: (1) research and development of dexanabinol; (2) SubMicron Emulsion technology for injection and nutrition; (3) research relating to pilocarpine, dexamethasone and ophthalmic formulations for dry eyes; (4) research and development of CB2, including cannabinor. As of December 31, 2009, the total amounts received under such grants amounted to $17,897,830. Under the terms of the grant agreements, aggregate future royalty payments related to sales of products developed, if any, as a result of the grants are limited to $16,408,890 based on grants received through December 31, 2009. Pharmos will be required to pay royalties to the Chief Scientist ranging from 3% to 5% of product sales, if any, as a result of the research activities conducted with such funds.  Aggregate royalty payments per product are limited to the amount of funding received to develop that product and interest.  Additionally, funding by the Chief Scientist places certain legal restrictions on the transfer of know-how and the manufacture of resulting products outside of Israel.  With the closure of the Israel location, the Company will not be eligible for further OCS grants and received none in 2009 or 2010.

The Company closed its operations in Israel effective October 31, 2008 and has subsequently reconciled and repaid a Chief Scientist grant that was overpaid. All obligations of the Company have been settled except the requirement to pay royalties should any of the related technologies be licensed out and further developed.


 
13

 

Availability of SEC Filings

All reports filed by the Company with the SEC are available free of charge via EDGAR through the SEC website at www.sec.gov. In addition, the public may read and copy materials filed by the Company with the SEC at the SEC’s public reference room located at 100 F Street NE, Washington, D.C., 20549. The company also provides copies of its Forms 8-K, 10-K, 10-Q, Proxy and Annual Report at no charge available through its website at http://investors.pharmoscorp.com/sec.cfm as soon as reasonably practicable after filing electronically such material with the SEC. Copies are also available, without charge, from Pharmos Corporation, 99 Wood Avenue South, Suite 302, Iselin, NJ, 08830.

Item 1A.  Risk Factors

We are very largely dependent upon the success of our lead drug candidate, Dextofiosopam, currently being developed for Irritable Bowel Syndrome, for diarrhea predominant patients.

We currently have one product candidate, Dextofisopam, that has completed Phase 2b clinical trials. Our other drug candidate assets are in earlier stages of development and are not currently being developed. Our primary focus is on the development and partnering of Dextofisopam and we need to secure a partnership arrangement for Dextofisopam with a pharmaceutical company with greater scientific and financial resources than we have. If we fail to secure a partnership arrangement, or raise additional capital, our operations will need to be scaled back or discontinued.

We closed our operations in Israel in late 2008 and those earlier stage assets are available for licensing.

We are at an early stage of development.

We are at an early stage of development. Our sole product candidate, Dextofisopam, has completed a Phase 2b trial for the treatment of Irritable Bowel Syndrome (IBS).  While the trial did not meet the primary endpoint, the drug treatment group at 200 mg demonstrated activity and secondary response variables of adequate relief of abdominal pain and discomfort, and overall IBS symptoms ratings showed statistical significance and trends favoring the Dextofisopam group compared to placebo.  Although the primary efficacy variable did not reach statistical significance, the percentage responding for the Dextofisopam 200 mg group was higher than that observed in the successful Phase 2a trial.  However, the placebo was also higher than the Phase 2a trial.  We plan to seek a pharmaceutical partner with the appropriate GI clinical and scientific expertise for further development of Dextofisopam; however, there can be no assurance that we will be able to find such a partner.  We have no other products in development.

We will need to raise additional capital.

Our ability to operate as a going concern is dependent upon raising adequate financing or securing a partnership arrangement for Dextofisopam. 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. The Company had an accumulated deficit of $211.4 million as of December 31, 2010 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. Previously the Company had financed its operations with public and private offerings of securities, advances and other funding pursuant to an earlier 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 (NOL’s), and interest income. During 2010 the Company was awarded a cash grant of $244,000 under the Federal Qualifying Therapeutic Discovery Project for the further development of Dextofisopam. The Company had approximately $3.1 million of cash and cash equivalents at December 31, 2010. However, the Company’s ability to continue as a going concern is largely dependent upon achieving a collaboration with a pharmaceutical partner or raising additional capital to either advance its lead compound, Dextofisopam, for the treatment of IBS or to advance other earlier stage intellectual property assets. The Company has in the past pursued various funding and financing options; however management believes that future funding or financing options may be challenging because of the current environment.

 
14

 

As the Company does not currently have the finances and resources to complete full clinical trials for its lead compound, Dextofisopam, it may decide to embark on smaller clinical trials for Dextofisopam or commence pre-clinical development on its other intellectual property assets which could further reduce the company’s current resources.

As such these factors raise substantial doubt as to the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from this uncertainty.

We have been delisted from Nasdaq.

On March 13, 2009, the Company was officially delisted from the Nasdaq Capital Market, and is currently trading on the OTCBB pink sheets. The Company was not in compliance with the minimum $2,500,000 stockholders’ requirement for continued listing and was unable to comply during the grace period extended by Nasdaq. As a result of trading on the OTCBB pink sheets, liquidity for our common stock may be significantly decreased which could reduce trading price and increase the transaction costs of trading shares of the company’s common stock.

The price of our Common Stock may experience volatility.

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

We have certain obligations to indemnify our officers and directors.

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

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

We have experienced significant operating losses since our inception. As of December 31, 2010, we had an accumulated deficit of approximately $211 million. We expect to incur operating losses over the next several years as our research and development efforts and preclinical and clinical testing activities continue. Our ability to generate revenues and achieve profitability depends in part upon our ability, alone or with others, to successfully complete development of our proposed products, to obtain required regulatory approvals and to manufacture and market our products.


 
15

 

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

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

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

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

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

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

We depend upon the personnel of third party independent investigators to conduct our clinical trials. Such personnel are not our employees, and we cannot control the amount of time or resources that they devote to our programs. They may not assign as great a priority to our programs or pursue them as diligently as we would if we were undertaking such programs ourselves. If such third-party personnel fail to devote sufficient time and resources to our clinical trials, or if their performance is substandard, the approval of our FDA applications, if any, and our introduction of new drugs, if any, will be delayed. Such third-party investigators may also have relationships with other commercial entities that compete with us. If they assist our competitors at our expense, our competitive position would be harmed.

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

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

 
16

 


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

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

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

We need to find collaborative partners.

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

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

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

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

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


 
17

 

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

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

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

We lack manufacturing capability.

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

We use hazardous materials in our research.

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

We have certain anti-takeover provisions and are also subject to certain Nevada anti-takeover provisions that may make it difficult for a third party to acquire us or for stockholders to replace or remove current management.  Further, the board controls a majority of the outstanding shares.

After the equity financing in April 2009, the current board represents 60% of the outstanding shares and on a fully diluted basis a total of 68% as of December 31, 2010.

Additionally, we have adopted a stockholder rights plan that imposes a significant penalty upon any person or group that acquires 15% or more of our outstanding common stock without the approval of our board. Moreover, certain provisions of the Nevada General Corporation Law that limit our ability to enter into “business combinations” with certain “interested shareholders” and limit the voting rights of those stockholders who obtain “control shares” may also act to inhibit a hostile acquisition of our company. All of these provisions described above are likely to discourage potential acquisition proposals and delay or prevent a transaction resulting in a change in control.
 

 
18

 

Item 1B.  Unresolved Staff Comments

None.

Item 2.  Properties

Pharmos is headquartered in Iselin, New Jersey, where it leases its executive offices from which the Company is managed.  The New Jersey lease expired on June 2010. In November 2010 the Company relocated to smaller office space within the same building. A lease was executed with the landlord through December 31, 2011 and the Company’s rent was reduced from an annual cost of $86,400 to $25,548.

In the opinion of management, the New Jersey facilities are sufficient to meet the current requirements of Pharmos.  In addition, management believes that because of the high level of available commercial office space it has sufficient ability to renew its present New Jersey lease or obtain suitable replacement facilities.

Item 3.  Legal Proceedings

None

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

None

PART II

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

The Company’s Common Stock is traded on the Over the Counter Pink Sheets ( OTCBB) under the symbol “PARS.PK”. The Company was delisted from the Nasdaq Capital Market in March 2009 as it did not meet the requirements for continued listing.

The following table sets forth the range of high and low sales prices per share for the Common Stock as reported on Nasdaq and OTCBB respectively during the periods indicated.

Year ended December 31, 2010
 
HIGH
   
LOW
 
             
4th Quarter
  $ .12     $ .09  
3rd Quarter
    .14       .05  
2nd Quarter
    .09       .06  
1st Quarter
    .12       .07  
                 
Year ended December 31, 2009
 
HIGH
   
LOW
 
                 
4th Quarter
  $ .17     $ .06  
3rd Quarter
    .48       .15  
2nd Quarter
    .30       .06  
1st Quarter
    .14       .03  


 
19

 


The high and low sales prices for the Common Stock from January 1, 2011 through February 10, 2011 were $.11 and $.08, respectively.  The closing price on February 10, 2011 was $.08.

On January 21, 2011, there were approximately 260 record holders of the Common Stock of the Company and approximately 9,608 beneficial owners of the Common Stock of the Company, based upon the number of shares of Common Stock held in “street name”.

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

PERFORMANCE GRAPH

The following graph compares the Company's cumulative stockholder's return for the five year period ended December 31, 2010 with the cumulative total return of the Nasdaq Equity Market Index and the Nasdaq Pharmaceuticals Index over the same period.

Performance Graph

Item 6.  Selected Financial Data – not required for a smaller reporting company

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

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


 
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Executive Summary

The results for the year ended December 31, 2010 and 2009 were a net loss of $1.5 million and $3.1 million or a loss per share of $.03 and $.06, respectively.

The gross operating expenses for 2010 were $1.7 million, primarily comprised of $0.5 million research and development expenses and $1.2 million of general and administration expenses.

The net operating expenses for 2010 were $1.4 million, primarily comprised of $0.2 million research and development expenses and $1.2 million of general and administration expenses. During 2010 the Company was awarded a cash grant of $244,000 under the Federal Qualifying Therapeutic Discovery Project for the further development of Dextofisopam.

In 2009, the majority of the Company’s research and development expenditures were spent on the advancement of the Dextofisopam Phase 2b clinical trial which concluded in September of 2009.  In 2010, the majority of the Company’s expenditures were spent on general and administrative efforts for a licensing deal or funding for a future trial. During 2010 the Company explored initiating proof of concept clinical studies in other therapeutic areas with its compounds and conferred with clinical and scientific experts as to the best opportunity.

Going Concern Considerations

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. The Company had an accumulated deficit of $211.4 million as of December 31, 2010 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. Previously the Company had financed its operations with public and private offerings of securities, advances and other funding pursuant to an earlier 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 (NOL’s), and interest income. During 2010 the Company was awarded a cash grant of $244,000 under the Federal Qualifying Therapeutic Discovery Project for the further development of Dextofisopam. The Company had approximately $3.1 million of cash and cash equivalents at December 31, 2010. However, the Company’s ability to continue as a going concern is largely dependent upon achieving a collaboration with a pharmaceutical partner or raising additional capital to either advance its lead compound, Dextofisopam, for the treatment of IBS or to advance other earlier stage intellectual property assets. The Company has in the past pursued various funding and financing options; however management believes that future funding or financing options may be challenging because of the current environment.

As the Company does not currently have the finances and resources to complete full clinical trials for its lead compound, Dextofisopam it may decide to embark on smaller clinical trials for Dextofisopam or commence pre-clinical development on its other intellectual property assets which could further reduce the company’s current resources.  In addition, work has been conducted with various academic and research centers to explore a proof of concept trial using S-Tofisopam in gout patients.  It is expected that the Company will initiate a trial in 2011.
 
As such these factors raise substantial doubt as to the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from this uncertainty.

Critical Accounting Policies

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

 
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Equity based compensation

The Company follows the provisions of FASB Topic 718 on stock based compensation. Effective January 1, 2006, the Company adopted the provisions which established the financial accounting and reporting standards for stock-based compensation plans. This required the measurement and recognition of compensation expense for all stock-based awards made to employees and directors, including employee stock options and restricted stock units, and employee stock purchases related to the ESPP. Under the provisions of ASC Topic 718, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period of the entire award (generally the vesting period of the award). As of December 31, 2010, the total compensation costs related to non-vested awards not yet recognized is $284,104 which will be recognized over the next two and one-half years.

Options issued to non-employees other than directors are accounted for under the fair value method in accordance with ASC Topic 718 “Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services.” Under the fair value method, compensation cost is measured at the grant date of the option based on the value of the award using the Black-Scholes method. Compensation cost is periodically remeasured as the underlying options vest in accordance with ASC Topic 718 and is recognized over the service period.

Tax Valuation Allowance

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

Sale of New Jersey Net Operating Losses and Grants

The Company participates in the State of New Jersey’s Technology Business Tax Certificate Transfer Program (the “Program”) administered by the New Jersey Economic Development Authority. The Program allows qualified technology and biotechnology businesses located in New Jersey to sell unused amounts of net operating loss carryforwards and defined research and development tax credits for cash. In 2009 the Company received net proceeds of $3,914,481 from the sale of New Jersey Net Operating Losses for the years 2004 through 2008 and there is $6,890,533 left from 2008 of operating losses to sell in future years, which at the 9% state tax rate equates to $620,148. For the year 2010 the State of New Jersey modified the eligibility requirements to be based on a minimum number of employees. Based on this modification, the Company did not qualify to participate in the program for 2010.

The Company has applied for a cash grant under the Federal Qualifying Therapeutic Discovery Project, which was provided under new section 48D of the Internal Revenue Service, as enacted as part of the Patient Protection and Affordable Care Act of 2010. In December the Company received $244,479 under this program.

The proceeds will enable the Company to continue operations with its main focus on seeking a pharmaceutical partner to further the development of Dextofisopam.


 
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Results of Operations

Years Ended December 31, 2010 and 2009

The Company recorded no product sales revenue and cost of sales or licensing revenue during 2010 and 2009.

The Phase 2b Dextofisopam trial, which was completed in September 2009, did not meet its primary endpoint. During 2010 the Company conducted minimal research and development activity. The Company’s focus was on further understanding the Dextofisopam Phase 2b results and discussing these with a wide variety of potential pharmaceutical partners and investment funds to participate in a Phase 2c clinical trial as the next development stage for Dextofisopam. The Company estimates that the cost of such a trial would be in the $8 million to $10 million range. Therefore to proceed with development the Company needs to secure a partner and /or funding source.

The Company considers major research & development projects to be those projects that have reached at least Phase II level of clinical development. In June 2007 the Company announced that patient screening had commenced in the Phase 2b trial for Dextofisopam for IBS. Through December 31, 2010 expenditures on this trial, from inception, amounted to $15,787,563.

During 2010 the Company explored initiating proof of concept clinical studies in other therapeutic areas with its compounds and conferred with clinical and scientific experts as to the best opportunity. Consequently research and development expenses were minimal.

During 2009 and 2010 the Company lowered its general and administrative costs by streamlining operations, focusing on reducing all non core costs.

Net Research & development (R&D) expenses decreased by $4,169,144 or 94% from $4,422,600 in 2009 to $253,456 in 2010 due to the curtailment of research and development activities on the Dextofisopam Phase IIb trial. The decline reflects decreases in virtually every research and development category. The primary reductions include a $198,000 reduction in payroll, a $147,000 reduction in professional fees and consulting, a $3,451,000 reduction in clinical fees and a reduction of $129,000 in various facility related expenses. An additional reduction occurred when the Company received a $244,000 cash grant under the Federal Qualifying Therapeutic Discovery Project for work completed on Dextofisopam in 2009.

In process research and development costs which were related to the Vela milestone decreased by $180,000 from $180,000 in 2009 to $0 in 2010. On April 9, 2009 the last patient was enrolled in the Phase 2b trial thus triggering the following milestone: $1 million cash and 2 million shares of Pharmos common stock: Final patient enrolled in Phase 2b trial. The expense of the milestone of $180,000 was reflected in the Q1 2009 results while the payment of the cash portion of the milestone was deferred under an amendment to the acquisition agreement. Under the terms of the Vela acquisition agreement as amended, the 2 million shares were issued on November 2, 2009. The cash portion was also expensed in Q1 2009 but was reversed in Q4 2009 since it is not probable that the amended terms will be met in the foreseeable future, which includes receipt of at least $10 million cash upfront payment. Since the trial results were not successful, no other milestones have been achieved.

General and administrative expenses decreased by $349,135 or 23%, from $1,536,470 in 2009 to $1,187,335 in 2010.  The decrease in general and administrative expenses is due to a reduction in expenses in every expense category.  Significant reductions occurred in salaries and benefits $128,000, professional & consulting fees $171,000, facility related expenses $150,000 and were offset by an increase to the miscellaneous expenses of $100,000 when comparing 2010 to 2009.  The majority of the decline in the salaries and benefits were attributable to no bonuses paid out which were partially offset by higher stock compensation expenses.  Lower professional & consulting fees in 2010 are due to reductions in the utilization of outside counsel, a change in auditors which resulted in a significant reduction and lower overall consulting expenses for the year. The Company also incurred lower investor relations expenses and reduced rent expenses as the majority of the facility related reductions. Finally we incurred an increase in miscellaneous expenses in 2010 over 2009 as credits against miscellaneous expenses were greater in 2009 than in 2010. In 2009 we reduced our expenses of $100,000 for an accrued marketing expense that will not be paid.

 
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Other expense net, decreased by $718,029 from an expense of $821,431 in 2009 to an expense of $103,402 in 2010. Interest expense decreased by $114,591 from $225,335 in 2009 to $110,744 in 2010. The decrease in 2010 interest expense results from the retirement of convertible debentures in April 2009. Debt conversion expense decreased by $596,104 from $596,104 in 2009 to $0 in 2010 was attributable to the convertible debentures retired in April 2009. The conversion of the debentures at a reduced conversion price resulted in a debt conversion expense of $596,104 as the original conversion price of $0.70 was reduced to $0.275.

The Company had a decrease in income tax benefit by $3,914,481 from $3,914,481 in 2009 to $0 in 2010. The income tax benefit represents funds derived from the sale of Pharmos’ New Jersey State net operating losses in 2009. In 2010 the Company did not qualify to participate in sale of net operating losses to the State of New Jersey because it did not meet the minimum number of employees.

Liquidity and Capital Resources

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. The Company had an accumulated deficit of $211.4 million as of December 31, 2010 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. Previously the Company had financed its operations with public and private offerings of securities, advances and other funding pursuant to an earlier 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 (NOL’s), and interest income. During 2010 the Company was awarded a cash grant of $244,000 under the Federal Qualifying Therapeutic Discovery Project for the further development of Dextofisopam. The Company had approximately $3.1 million of cash and cash equivalents at December 31, 2010. However, the Company’s ability to continue as a going concern is largely dependent upon achieving a collaboration with a pharmaceutical partner or raising additional capital to either advance its lead compound, Dextofisopam, for the treatment of IBS or to advance other earlier stage intellectual property assets. The Company has in the past pursued various funding and financing options; however management believes that future funding or financing options may be challenging because of the current environment.

For the year 2010 the State of New Jersey modified the eligibility requirements for the net operating loss sale program to be based on a minimum number of employees. Based on this modification, the Company did not qualify to participate in the program for 2010 and it is not known if the Company will again be eligible in the future.
 
As the Company does not currently have the finances and resources to complete full clinical trials for its lead compound, Dextofisopam it may decide to embark on smaller clinical trials for Dextofisopam or commence pre-clinical development on its other intellectual property assets which could further reduce the company’s current resources.  In addition, work has been conducted with various academic and research centers to explore a proof of concept trial using S-Tofisopam in gout patients.  It is expected that the Company will initiate a trial in 2011.
 
As such these factors raise substantial doubt as to the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from this uncertainty.

 
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The following table describes the Company’s liquidity and financial position on December 31, 2010, and December 31, 2009:

   
December 31, 2010
   
December 31, 2009
 
Working capital
  $ 3,015,068     $ 4,238,033  
Cash and cash equivalents
  $ 3,139,347     $ 4,629,486  
Convertible debenture, due 2012
  $ 1,000,000     $ 1,000,000  

Current working capital position

As of December 31, 2010, the Company had working capital of $3.0 million consisting of current assets of $3.2 million and current liabilities of $0.2 million. This represents a decrease from its working capital of $4.2 million on current assets of $4.6 million and current liabilities of $0.4 million as of December 31, 2009.

Current and future liquidity position

At December 31, 2010 the Company had approximately $3.1 million of cash and cash equivalents, which at current operating levels should be sufficient to continue operations at least through December 31, 2011, excluding clinical trial requirements which may be necessary to facilitate a pharmaceutical partnership for the advancement of its compounds. The Company’s ultimate ability to continue as a going concern is largely dependent upon achieving a pharmaceutical partnership for the advancement of its lead compound, Dextofisopam for the treatment of IBS which, to date, has not occurred. Further, the Company may embark on smaller clinical trials, the expense of which would further reduce cash resources available.

The Company has in the past pursued various funding options, including additional equity offerings, strategic corporate alliances, and business combinations, as well as grants and the sale of some of its New Jersey net operating loss carry forwards. Future equity financings will be challenging because of the low market capitalization of the Company and the move from the Nasdaq market to trading on the over the counter Pink Sheets in March 2009 and the sale of New Jersey operating loss carryfowards has been limited.

As such these factors raise substantial doubt as to the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from this uncertainty.

Cash

At December 31, 2010, cash and cash equivalents totaled $3.1 million. At December 31, 2009 cash and cash equivalents totaled $4.6 million. This net decrease in cash of $1.5 million was due to the utilization of cash for operating activities offset by the proceeds from the Federal Qualifying Therapeutic Discovery Program Grant. The cash and cash equivalents will be used to finance future operating expenses.

Operating activities

Net cash used in operating activities for 2010 was $1.5 million compared to $2.3 million for 2009. The decrease is primarily attributed to lower research and development expenses and general and administrative expenses incurred in 2010. Research and development expenses declined from $4.4 million in 2009 to $0.3 million in 2010 while general and administrative expenses declined from $1.5 million in 2009 to $1.2 million in 2010.


 
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Capital expenditures

Our capital expenditures for property, plant and equipment for 2010 and 2009 totaled approximately $5,785 and $0 respectively for normal replacements and improvements.

Investing activities

In 2009 the only significant activity was the cash received related to the disposition of certain fixed assets in Israel.

Financing activities

In April 2009 the proceeds from the issuance of common stock and warrants, net of issuance costs, were recorded in the amount of $1,779,777.

Common Stock Transactions

At the closing of the Vela Pharmaceuticals Inc. acquisition on October 25, 2006, the Company issued 6.5 million shares of common stock and paid $6 million to Vela shareholders.  Pharmos also agreed to reimburse Vela for $679,000 of operating expenses from July 1, 2006 through closing.  The amended Merger Agreement also includes additional performance-based milestone payments to the Vela stockholders related to the development of Dextofisopam, aggregating up to an additional $5 million in cash and the issuance of up to an additional 9,250,000 shares of Pharmos common stock.  In the event that such shares or payments are issued or funded in future periods, the values are to be expensed as in-process research and development and charged to results of operations; any such future charge could be material.  None of the conditions requiring issuance of these contingent shares or funding these payments had been met as of December 31, 2010 and December 31, 2009 except for a $1.0 million milestone payment made by Pharmos due upon the commencement of the Dextofisopam Phase 2b study.

On January 3, 2008, the Company entered into an Amendment to the Merger Agreement relating to its acquisition of Vela. The Amendment defers the payment by the Company of certain cash milestones payable by the Company to the former stockholders of Vela upon (A) the enrollment of the final patient in the Company’s Phase 2b clinical trial for Dextofisopam ($1 million payment obligation) and (B) the successful completion of such Phase 2b trial ($2 million payment obligation). Payment of such cash milestones will be deferred until such time as (X) the Company has successfully entered into a strategic collaboration or licensing agreement with a third party for the development of Dextofisopam resulting in an upfront cash fee of at least $10 million, or a financing with net proceeds of at least such amount, and (Y) payment of one or both of the cash milestones would still leave the Company with at least one year’s operating cash. Additionally, the Company’s obligations to issue to the former Vela stockholders 2 million shares of Common Stock after final patient enrollment in the Dextofisopam Phase 2b clinical trial and was deferred until November 2009, and the 2 million patient enrollment milestone shares were issued in November 2009. Finally the 2.25 million shares of Common Stock after a successful Phase 2b trial milestone was not met as the Phase 2b dextofisopam trial did not meet its primary endpoints, as it did not meet the definition of a successful trial. Therefore the 2.25 million shares related to this milestone are not payable and have been removed from the listing of remaining potential future milestones.


 
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Other

In 2010 and 2009, the Company sold $0 and $49,707,690, respectively, of its State Net Operating Loss carryforwards under the State of New Jersey’s Technology Business Tax Certificate Transfer Program (the Program). The Program allows qualified technology and biotechnology businesses in New Jersey to sell unused amounts of net operating loss carryforwards and defined research and development tax credits for cash. The net proceeds from the sale in 2010 and 2009 were $0 and $3,914,481, respectively and such amounts were recorded as a tax benefit in the consolidated statements of operations. The New Jersey State Governor must approve the Program each year on July 1st within the approval of the annual state budget.  The maximum amount of benefits a participant can apply to sell is capped at $10,000,000 annually per company. The remaining NOL’s which qualify under the program through 2009 amount to $6,890,541. In 2010 the Company did not qualify to participate in sale of net operating losses to the State of New Jersey because it did not meet the minimum number of employees.

Under Internal Revenue Code Section 382 rules, a change in ownership can occur whenever there is a shift in ownership by more than 50 percentage points by one or more five-percent shareholders within a three-year period.  When a change of ownership is triggered, the Company’s net operating losses (NOL) asset may be limited.  The Company believes that substantially all of its Federal NOL’s is subject to restrictions as to future use in accordance with IRS Code Section 382.

Commitments and Long Term Obligations

The table below sets out our current contractual obligations.

   
Payments Due by Period
 
   
 
Total
   
Less than 1 Year
   
1 – 3
Years
   
3 – 5
Years
   
More Than
5 Years
   
 
Undetermined
 
Operating Leases
  $ 25,548     $ 25,548     $ -     $ -     $ -     $ -  
Convertible Debenture Interest
    183,333       100,000       83,333                          
Convertible Debenture
    1,000,000       -       1,000,000       -       -       -  
Total
  $ 1,208,881     $ 125,548     $ 1,083,333     $ -     $ -     $ -  

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 remaining potential future milestones are as follows:

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


 
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(1) The milestone was reached when the final patient was enrolled in the Dextofisopam Phase 2b trial and was recognized in the first quarter of 2009 as all probability criteria were met. The milestone had two components, a cash portion of $1,000,000 and a share portion of 2,000,000 shares valued at $180,000.  The total charge in the first quarter was $1,180,000. The shares were issued in November 2009 under the terms of the Amendment #3 to the agreement and plan of merger. Under that amendment the payment of the cash portion was deferred until such time as 1) the Company successfully entered into a strategic collaboration or licensing agreement with a third party for the development of Dextofisopam resulting in an upfront cash fee of at least $10 million, and 2) payment of the cash milestone would still leave the Company with one year’s operating cash.

The Company recorded the milestone in the first quarter as it met the accounting requirements of under ACS 450. The results of the Phase 2b trial were announced in September 2009 and reported that while there was clearly drug activity, the trial did not achieve its primary endpoint. Under the terms of the Vela acquisition agreement as amended, the 2 million shares were issued on November 2, 2009. The cash portion that was expensed in Q1 2009 was reversed in Q4 2009 since it is not deemed probable that the amended terms would be achieved. Since the trial results were not successful, no other milestones have been achieved.

New accounting pronouncements
 
In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements ("ASU 2009-13"). ASU 2009-13, amends existing revenue recognition accounting pronouncements that are currently within the scope of Codification Subtopic 605-25 (previously included within EITF 00-21, Revenue Arrangements with Multiple Deliverables ("EITF 00-21"). The consensus to ASU 2009-13 provides accounting principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated. This guidance modifies the parameters in establishing the fair value of undelivered products and services enabling separate revenue recognition based upon management's estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. EITF 00-21 previously required that the fair value of the undelivered item be the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately by the vendor. Under EITF 00-21, if the fair value of all of the elements in the arrangement was not determinable, then revenue was deferred until all of the items were delivered or fair value was determined. This new approach is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and allows for retroactive application. The Company is currently evaluating the potential impact of this standard on its financial position and results of operations.
 
In April 2010, the FASB issued ASU No. 2010-17, Milestone Method of Revenue Recognition ("ASU 2010-17"). ASU 2010-17, updates guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate with the scope of Codification Subtopic 605 (previously included within EITF 00-21, Revenue Arrangements with Multiple Deliverables ("EITF 00-21")). The consensus to ASU 2010-17 provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Research or development arrangements frequently include payment provisions whereby a portion or all of the consideration is contingent upon milestone events such as successful completion of phases in a drug study or achieving a specific result from the research or development efforts. An entity often recognizes these milestone payments as revenue in their entirety upon achieving the related milestone, commonly referred to as the milestone period. This new approach is effective prospectively for milestones achieved in fiscal years beginning on or after June 15, 2010 and allows for retroactive application. The Company is currently evaluating the potential impact of this standard on its financial position and results of operations.
 


 
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

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

Item 8.  Financial Statements and Supplementary Data

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

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

On October 19, 2009, Pharmos Corporation dismissed its independent registered public accounting firm, PricewaterhouseCoopers LLP.  The dismissal was approved by the Pharmos Audit Committee.  During the two most recent fiscal years and through October 19, 2009, there have been no disagreements between Pharmos and PricewaterhouseCoopers LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to the satisfaction of PricewaterhouseCoopers LLP would have caused them to make reference thereto in their reports on the financial statements for such years.  During the two most recent fiscal years and through October 19, 2009, there were no reportable events (as defined in Item 304(a)(1)(v)) of Regulation S-K.  Neither of the reports of PricewaterhouseCoopers LLP for the past two years contained an adverse opinion or disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope or accounting principles, except that their report dated February 25, 2009 contained an explanatory paragraph expressing substantial doubt about Pharmos' ability to continue as a going concern.  On October 20, 2009, Pharmos Corporation engaged Friedman LLP as its new independent accounting firm.

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of Pharmos’ internal control over financial reporting based on the criteria in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, management has concluded that Pharmos’ internal control over financial reporting was effective as of December 31, 2010. 


 
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Changes in Internal Control Over Financial Reporting

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

Item 9B. Other Information

None.


 
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PART III

Item 10.  Directors, Executive Officers and Corporate Governance

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

Name
Age
Position
Robert F. Johnston
74
Executive Chairman of the Board of Directors
S. Colin Neill
64
President, Chief Financial Officer, Secretary and Treasurer
Srinivas Akkaraju, MD, Ph.D*
42
Director
Anthony B. Evnin, Ph.D*
69
Director
Charles W. Newhall III
66
Director
Steven Leventer, Ph.D*
55
Director

*
Members of the Audit Committee

Robert F. Johnston became Executive Chairman of the Board of Directors of Pharmos in January 2008. Mr. Johnston, a venture capitalist, is President of Johnston Associates which he founded in 1968 to provide financing for emerging companies in the biotechnology and healthcare fields. Mr. Johnston was a founder and Chairman of Vela Pharmaceuticals, Inc., which merged into Pharmos in late 2006, and has founded numerous public companies including Sepracor, Cytogen, I-STAT (sold to Abbott), Ecogen, Genex and Envirogen (sold to Shaw Environmental). He also played an active and key role in the early formations of private companies such as Sonomed, Immunicon (sold to J&J), PharmaStem (formerly Biocyte), ExSAR and Targent. Mr. Johnston served as CEO of Cytogen from July 1988 to April 1989. He is also a member of the Advisory Council of the Department of Molecular Biology at Princeton University.  Mr. Johnston is a founder and President of Educational Ventures, a foundation focused on funding improvements in the educational system; and  Chairman of Center for Education Reform (CER) an advocate for charter schools. Mr. Johnston received his B.A from Princeton University and his M.B.A. from New York University. Based on Mr. Johnston’s familiarity with the Company as an incumbent member of the Company’s Board of Directors, his prior membership on the board of directors of other public companies and his knowledge of the pharmaceutical industry, the Governance and Nominating Committee of the Board of Directors concluded that Mr. Johnston has the requisite experience, qualifications, attributes and skill necessary to serve as a member of the Board of Directors.


 
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S. Colin Neill became President of Pharmos in January 2008, and has served as Chief Financial Officer, Secretary, and Treasurer of Pharmos since October 2006. Prior to becoming President, he also served as Senior Vice President from October 2006 to January 2008. From September 2003 to October 2006, Mr. Neill served as Chief Financial Officer, Treasurer and Secretary of Axonyx Inc., a biopharmaceutical company that developed products and technologies to treat Alzheimer's disease and other central nervous system disorders, where he played an integral role in the merger between Axonyx and TorreyPines Therapeutics Inc., a privately-held biopharmaceutical company. Mr. Neill served as Senior Vice President, Chief Financial Officer, Secretary and Treasurer of ClinTrials Research Inc., a $100 million publicly traded global contract research organization in the drug development business, from 1998 to its successful sale in 2001. Following that sale from April 2001 to September 2003 Mr. Neill served as an independent consultant assisting small start-up and development stage companies in raising capital. Earlier experience was gained as Vice President Finance and Chief Financial Officer of BTR Inc., a $3.5 billion US subsidiary of BTR plc, a British diversified manufacturing company, and Vice President Financial Services of The BOC Group Inc., a $2.5 billion British owned industrial gas company with substantial operations in the health care field. Mr. Neill served four years with American Express Travel Related Services, first as chief internal auditor for worldwide operations and then as head of business planning and financial analysis. Mr. Neill began his career in public accounting with Arthur Andersen LLP in Ireland and later with Price Waterhouse LLP as a senior manager in New York City. He also served with Price Waterhouse for two years in Paris, France. Mr. Neill graduated from Trinity College, Dublin with a first class honors degree in Business/Economics and he holds a masters degree in Accounting and Finance from the London School of Economics. He is a Certified Public Accountant in New York State and a Chartered Accountant in Ireland. Mr. Neill serves on the board of Pro Pharmaceuticals, Inc. and from April 2004 to June 2008 on the board of OXIS International, Inc.

Srinivas Akkaraju, M.D., Ph.D., a director since October 2006, is a Managing Director of New Leaf Venture Partners. Dr. Akkaraju joined New Leaf in January 2009. Previously he was a Managing Director of Panorama Capital, LLC, a private equity firm founded by the former venture capital investment team of J.P. Morgan Partners, LLC, and a private equity division of JPMorgan Chase & Co. Prior to August 1, 2006, Dr. Akkaraju was a Partner with J.P. Morgan Partners, LLC which he joined in April 2001. Prior to JPMorgan Partners, LLC, from October 1998 to April 2001, Dr. Akkaraju was in the Business and Corporate Development group at Genentech, Inc. where he served in various capacities, most recently as Senior Manager and project team leader for one of Genentech’s clinical development products. Dr. Akkaraju is currently a member of the Board of Directors of Seattle Genetics, Inc., and several private biotechnology companies. Dr. Akkaraju received his undergraduate degrees in Biochemistry and Computer Science from Rice University and his M.D. and Ph.D. in Immunology from Stanford University. Based on Dr. Akkaraju’s familiarity with the Company as an incumbent member of the Company’s Board of Directors and as a member of our Audit Committee, his membership on the board of directors of other companies and his expertise and experience in the biotechnology industry, the Governance and Nominating Committee of the Board of Directors concluded that Dr. Akkaraju has the requisite experience, qualifications, attributes and skill necessary to serve as a member of the Board of Directors.
 
Anthony B. Evnin, Ph.D., a director since October 2006, is a Partner of Venrock, a venture capital firm, where he has been a Partner since 1975. He is currently a member of the Board of Directors of AVEO Pharmaceuticals, Inc., Icagen, Inc., and Infinity Pharmaceuticals, Inc. as well as being on the Board of Directors of a number of private companies. During the last five years, Dr. Evnin served as a director of Memory Pharmaceuticals Corp., Sunesis, Inc., Renovis, Inc., and Coley Pharmaceuticals Group, Inc. Dr. Evnin is a Trustee of The Rockefeller University, a Trustee of The Jackson Laboratory, a Trustee Emeritus of Princeton University, and a Member of the Board of Overseers of Memorial Sloan-Kettering Cancer Center. He received an A.B. in Chemistry from Princeton University and a Ph.D. in Chemistry from the Massachusetts Institute of Technology. Based on Dr. Evnin’s familiarity with the Company as an incumbent member of the Company’s Board of Directors and as a member of our Audit Committee, his membership on the board of directors of other public companies and his knowledge of the pharmaceutical industry, the Governance and Nominating Committee of the Board of Directors concluded that Dr. Evnin has the requisite experience, qualifications, attributes and skill necessary to serve as a member of the Board of Directors.


 
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Charles W. Newhall, III, a director since October 2006, co-founded New Enterprise Associates (NEA). Founded in 1977, NEA is one of the largest Venture Capital firms in the United States. To date Mr. Newhall has served as a director of over 40 venture backed companies. Many have gone public and have been acquired. Several of these companies achieved market capitalizations in excess of $1 billion. He also started several healthcare information technology companies like PatientKeeper, TargetRx, and LifeMetrix. Some of his current board memberships include Vitae Pharmaceuticals, Supernus Pharmaceuticals, TargetRx, Sensors for Medicine and Science, and BrainCells Inc. In 1986 he founded the Mid-Atlantic Venture Capital Association (MAVA), which now has over 80 venture capital firms that are members, and is one of the most active regional venture associations in the country. He is Chairman Emeritus of MAVA. Before NEA, Mr. Newhall was a Vice President of T. Rowe Price. He served in Vietnam commanding an independent platoon including an initial reconnaissance of Hamburger Hill. His decorations include the Silver Star and Bronze Star V (1st OLC). He received an MBA from Harvard Business School, and an Honors Degree in English from the University of Pennsylvania. Based on Mr. Newhall’s familiarity with the Company as an incumbent member of the Company’s Board of Directors, his membership on the board of directors of other public companies and his knowledge of the pharmaceutical industry, the Governance and Nominating Committee of the Board of Directors concluded that Mr. Newhall has the requisite experience, qualifications, attributes and skill necessary to serve as a member of the Board of Directors.

Steven Leventer, Ph.D., a director since September 2010, currently serves as Vice President, Clinical Research and Head of the Neuroscience Division   at PharmaNet, a full-service contract research organization (CRO) based in Princeton, NJ.  Dr. Leventer was trained as a neurochemist, with post-doctoral fellowships and faculty appointments at the University of Texas, Western Psychiatric Institute and Clinic, and Loyola University Stritch School of Medicine.  Dr. Leventer has over 20 years of experience in all phases of drug development, having held senior positions in large Pharma (Wyeth), small Pharma (Vela Pharmaceuticals and Pharmos Corporation) and CROs (Quintiles and PharmaNet).  His overall experience includes direction of over 100 clinical trials, from single studies to entire development programs across multiple indications and phases of drug development. Based on Dr. Leventer’s familiarity with the Company as an incumbent member of the Company’s Board of Directors and as a member of our Audit Committee and his extensive expertise and experience in the pharmaceutical industry, the Governance and Nominating Committee of the Board of Directors concluded that Dr. Leventer has the requisite experience, qualifications, attributes and skill necessary to serve as a member of the Board of Directors.

Role of the Board; Corporate Governance Matters

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

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

Board Committees

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


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

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

The Audit Committee is primarily responsible for overseeing the services performed by the Company’s independent registered public accounting firm and evaluating the Company’s accounting policies and its system of internal controls.  The Audit Committee is comprised of three members: Messrs. Evnin, Akkaraju and Leventer, all of whom are independent directors.  Mr. Evnin is the designated “audit committee financial expert” under Item 407(d)(5) of Regulation S-K.  Mr. Evnin is considered “independent”.

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

Code of Ethics

As part of our system of corporate governance, our Board of Directors has adopted a Code of Ethics and Business Conduct that is applicable to all employees and specifically applicable to our chief executive officer, president, chief financial officer and controllers.  The Code of Ethics and Business Conduct is available on the Company’s website at www.pharmoscorp.com.  Click “Investors,” and then “Corporate Governance.” We intend to disclose any changes in or waivers from our Code of Ethics and Business Conduct by filing a Form 8-K or by posting such information on our website.

Section 16(a) Beneficial Ownership Reporting Compliance

No person who, during the fiscal year ended December 31, 2010, was a “Reporting Person” defined as a director, officer or beneficial owner of more than ten percent of the Company’s Common Stock which is the only class of securities of the Company registered under Section 12 of the Securities Exchange Act of 1934 (the “Act”), failed to file on a timely basis, reports required by Section 16 of the Act during the most recent fiscal year.  The foregoing is based solely upon a review by the Company of Forms 3 and 4 during the most recent fiscal year as furnished to the Company under Rule 16a-3(d) under the Act, and Forms 5 and amendments thereto furnished to the Company with respect to its most recent fiscal year, and any representation received by the Company from any reporting person that no Form 5 is required.

 
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Item 11.  Executive Compensation

COMPENSATION DISCUSSION AND ANALYSIS

General Executive Compensation Policy

The Compensation and Stock Option Committee of the Board of Directors establishes the general compensation policies of the Company, the compensation plans and specific compensation levels for executive officers, and administers the Company’s 2001 Employee Stock Purchase Plan, as well as the 2000, 1997 and 1992 Incentive and Non-Qualified Stock Option Plans and the 2009 Incentive Compensation Plan. The Compensation and Stock Option Committee is composed of two independent, non-employee Directors who have no interlocking relationships as defined by the Securities and Exchange Commission.

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

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

The Compensation and Stock Option Committee believes that officers’ compensation should be heavily influenced by Company performance.  The Committee establishes base salaries that are within the range of salaries for persons holding positions of similar responsibility at other companies.  In addition, the Committee considers factors such as relative Company performance, the executive’s past performance and future potential in establishing the base salaries of executive officers.

The number of options granted to officers is determined by the subjective evaluation of the executive’s ability to influence the Company’s long-term growth. All options are granted at no less than the current market price. Since the value of an option bears a direct relationship to the Company’s stock price, it is an effective incentive for managers to create value for shareholders.  The Committee therefore views stock options as an important component of its long-term, performance-based compensation philosophy.
 
Bonuses for 2008 and Compensation Determinations for 2009
 
Cash Compensation. The Compensation and Stock Option Committee awarded no 2008 cash bonuses nor did the Committee award any 2009 salary increases due to the Company’s limited capital resources.
 
Equity Compensation.  In May 2009, the Compensation and Stock Option Committee awarded 1.2 million shares of restricted stock to Robert Johnston under the 2000 Stock Option Plan.  The restricted shares shall vest (subject to accelerated vesting or risk of forfeiture in certain circumstances) as follows: one-third of the restricted shares shall vest on the first anniversary of the grant date, and the remaining restricted shares shall vest in quarterly increments over a three-year period commencing on the first anniversary of the grant date.  In May 2009, the Committee also awarded 600,000 ten-year stock options to Colin Neill under the 2000 Stock Option Plan.
 

 
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Bonuses for 2009 and Compensation Determinations for 2010
 
In January 2010, the Compensation and Stock Option Committee, taking into account that no bonuses were awarded for 2008, awarded cash bonuses for 2009 performance in the amount of $80,000 to each of Robert F. Johnston and S. Colin Neill.  The Committee determined to leave base salaries unchanged for 2010.

Bonuses for 2010 and Compensation Determinations for 2011

The Compensation and Stock Option Committee has determined not to award any bonuses for 2010 and to leave base salaries unchanged for 2011.
 
COMPENSATION AND STOCK OPTION COMMITTEE REPORT
 
The Compensation and Stock Option Committee of Pharmos Corporation has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation and Stock Option Committee has recommended to the Board that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.
 

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

 

 
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SUMMARY COMPENSATION TABLE

The following table summarizes the total compensation of the President, Chief Executive Officer and Executive Chairman of the Company in 2010 and the previous year, as well as all other executive officers of the Company who received compensation in excess of $100,000 for 2010.
 
Name/Principal Position
 
Year
 
Salary
   
Bonus
   
Stock
Awards
 
Option
Awards
   
All Other
Compensation
   
Total
Compensation
 
                                       
S. Colin Neill
 
2010
  $ 300,000       -           -     $ 21,967 (1)   $ 321,967  
President,
 
2009
  $ 300,000     $ 80,000         $ 105,820     $ 21,967 (1)   $ 507,787  
Chief Financial Officer,
                                                 
Secretary & Treasurer
                                                 
                                                   
Robert F. Johnston
 
2010
    -       -           -       -       -  
Executive Chairman
 
2009
    -     $ 80,000     $ 264,000     -       -     $ 344,000  
                                                   

(1)
In 2010, consists of $7,350 in 401k employer contribution, $5,617 in life insurance and $9,000 in automobile allowance. In 2009, consists of $7,350 in 401k employer contribution, $5,617 in life insurance and $9,000 in automobile allowance.

OUTSTANDING EQUITY AWARDS AT 2010 FISCAL YEAR-END
 
                                       
   
Option Awards
 
Stock Awards
 
Name
 
Number of securities underlying unexercised options (#) Exercisable
   
Number of securities underlying unexercised options (#) Unexercisable
   
Equity Incentive Plan awards: Number of securities underlying unexercised Unearned Options (#)
   
Option Exercise Price ($)
 
Option Expiration Date
 
Number of Shares or Units of Stock That Have Not Vested
   
Market Value of Shares or Units of Stock That have not vested ($)
 
                                       
S. Colin Neill
    225,000       375,000 (1)     600,000     $ 0.22  
5/11/2019
           
      89,375       40,625 (2)     130,000     $ 0.35  
1/23/2018
           
      37,500       2,500 (3)     40,000     $ 1.84  
1/17/2017
           
      90,000       0 (4)     90,000     $ 1.75  
10/5/2016
           
      441,875       418,125       860,000                        
                                               
Robert F. Johnston
    272,222       77,778 (5)     350,000     $ 0.35  
1/23/2018
 
750,000
 (6)  $
 $67,500
 


 
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(1)       25% of the options were scheduled to vest upon the first anniversary of the grant date May 11, 2009 with the remaining 75% of the grant vesting ratably on a quarterly basis over the three years following the first anniversary of the grant.
(2)       25% of the options were scheduled to vest upon the first anniversary of the grant date January 23, 2008 with the remaining 75% of the grant vesting ratably on a quarterly basis over the three years following the first anniversary of the grant.
(3)       25% of the options granted vested upon the first anniversary of the grant date of January 17, 2007 with the remaining 75% of the grant vesting ratably on a quarterly basis over the three years following the first anniversary of the grant.
(4)       The remaining options are scheduled to vest in seven equal increments on a quarterly basis beginning on January 5, 2009.
(5)       One third of the options granted to Mr. Johnston vested immediately with the remaining two thirds of the grant vesting ratably on a quarterly basis over the three years commencing on the first anniversary of the grant.
(6)       On May 11, 2009, Robert F. Johnston was granted a restricted stock award of 1,200,000 shares. 25% of the options were scheduled to vest upon the first anniversary of the grant date with the remaining 75% of the grant vesting ratably on a quarterly basis over the three years following the first anniversary of the grant.

Stock Option Plans

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

As of December 31, 2010, 3,460,499 options to purchase shares of the Company’s Common Stock were outstanding under various option plans. During 2010, the Company granted 490,000 options to purchase shares of its Common Stock to directors.

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

2000 Plan.  The 2000 Plan is administered by a committee appointed by the Board of Directors (the “Compensation Committee”).  The Compensation Committee will designate the persons to receive options, the number of shares subject to the options and the terms of the options, including the option price and the duration of each option, subject to certain limitations.

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

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


 
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The aggregate fair market value (determined at the time the option is granted) of Common Stock with respect to which incentive stock options are exercisable for the first time in any calendar year by an optionee under the 2000 Plan or any other plan of the Company or a subsidiary, shall not exceed $100,000.  The Compensation Committee will fix the time or times when, and the extent to which, an option is exercisable, provided that no option for annual option grants will be exercisable earlier than one year or later than ten years after the date of grant (or five years in the case of a 10% Stockholder).  The option price is payable in cash or by check to the Company.  However, the Board of Directors may grant a loan to an employee, other than an executive officer, pursuant to the loan provision of the 2000 Plan, for the purpose of exercising an option or may permit the option price to be paid in shares of Common Stock at the then current fair market value, as defined in the 2000 Plan.

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

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

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

Under current federal income tax law, the grant of incentive stock options under the 2000 Plan will not result in any taxable income to the optionee or any deduction for the Company at the time the options are granted.  The optionee recognizes no gain upon the exercise of an option.  However the amount by which the fair market value of Common Stock at the time the option is exercised exceeds the option price is an “item of tax preference” of the optionee, which may cause the optionee to be subject to the alternative minimum tax.  If the optionee holds the shares of Common Stock received on exercise of the option at least one year from the date of exercise and two years from the date of grant, he will be taxed at the time of sale at long-term capital gains rates, if any, on the amount by which the proceeds of the sale exceed the option price.  If the optionee disposes of the Common Stock before the required holding period is satisfied, ordinary income will generally be recognized in an amount equal to the excess of the fair market value of the shares of Common Stock at the date of exercise over the option price, or, if the disposition is a taxable sale or exchange, the amount of gain realized on such sale or exchange if that is less.  If, as permitted by the 2000 Plan, the Board of Directors permits an optionee to exercise an option by delivering already owned shares of Common Stock valued at fair market value) the optionee will not recognize gain as a result of the payment of the option price with such already owned shares.  However, if such shares were acquired pursuant to the previous exercise of an option, and were held less than one year after acquisition or less than two years from the date of grant, the exchange will constitute a disqualifying disposition resulting in immediate taxation of the gain on the already owned shares as ordinary income.  It is not clear how the gain will be computed on the disposition of shares acquired by payment with already owned shares.


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

The total number of shares reserved for issuance under the 2001 Plan is 100,000 shares.  Under the 2001 Plan, for any given calendar year, a participating employee can only be granted Rights to purchase that number of shares which, when multiplied by the exercise price of the Rights, does not exceed more than 10% of the employee’s base pay. To date, the Company has issued 12,560 shares of its common stock under the 2001 Plan. The Company did not issue any shares under the 2001 Plan in 2010 and 2009.

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

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

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

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

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


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

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

2009 Incentive Compensation Plan.

Under the 2009 Plan, the total number of shares of common stock of our company reserved and available for delivery is 8,000,000 shares. The foregoing limit shall be increased by the number of shares of common stock with respect to which awards previously granted under the 2009 Plan are forfeited, expire or otherwise terminate without issuance of shares, or that are settled for cash or otherwise do not result in the issuance of shares, and the number of shares that are tendered (either actually or by attestation) or withheld upon exercise of an award to pay the exercise price or any tax withholding requirements. Awards issued in substitution for awards previously granted by a company acquired by our company or a related entity, or with which our company or any related entity combines, do not reduce the limit on grants of awards under the 2009 Plan. The 2009 Plan imposes individual limitations on the amount of certain awards in part to comply with Code Section 162(m).

The persons eligible to receive awards under the 2009 Plan are the officers, directors, employees, consultants and other persons who provide services to our company or any related entity. An employee on leave of absence may be considered as still in the employ of our company or a related entity for purposes of eligibility for participation in the 2009 Plan.

The 2009 Plan is to be administered by the Compensation Committee, provided, however, that except as otherwise expressly provided in the 2009 Plan, our Board of Directors may exercise any power or authority granted to the Compensation Committee under the 2009 Plan. Subject to the terms of the 2009 Plan, the Compensation Committee is authorized to select eligible persons to receive awards, determine the type, number and other terms and conditions of, and all other matters relating to, awards, prescribe award agreements (which need not be identical for each participant), and the rules and regulations for the administration of the 2009 Plan, construe and interpret the 2009 Plan and award agreements, correct defects, supply omissions or reconcile inconsistencies therein, and make all other decisions and determinations as the Compensation Committee may deem necessary or advisable for the administration of the 2009 Plan.


 
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The Compensation Committee is authorized to grant stock options, including both incentive stock options (“ISOs”), which can result in potentially favorable tax treatment to the participant, and non-qualified stock options, and stock appreciation rights entitling the participant to receive the amount by which the fair market value of a share of common stock on the date of exercise exceeds the grant price of the stock appreciation right. The exercise price per share subject to an option and the grant price of a stock appreciation right are determined by the Compensation Committee, but must not be less than the fair market value of a share of common stock on the date of grant. For purposes of the 2009 Plan, the term “fair market value” means the fair market value of common stock, awards or other property as determined by the Compensation Committee or under procedures established by the Compensation Committee. Unless otherwise determined by the Compensation Committee, the fair market value of common stock as of any given date shall be the closing sales price per share of common stock as reported on the principal stock exchange or market on which common stock is traded on the date as of which such value is being determined or, if there is no sale on that date, then on the last previous day on which a sale was reported or the average of the closing bid and asked prices for the common stock quoted by an established quotation service for over-the-counter securities, if the common stock is not then traded on a national securities exchange, or, in the discretion of the Committee, the last sale price or the closing price. The maximum term of each option or stock appreciation right, the times at which each option or stock appreciation right will be exercisable, and provisions requiring forfeiture of unexercised options or stock appreciation rights at or following termination of employment generally are fixed by the Compensation Committee, except that no option or stock appreciation right may have a term exceeding ten years. Methods of exercise and settlement and other terms of the stock appreciation right are determined by the Compensation Committee. The Compensation Committee, thus, may permit the exercise price of options awarded under the 2009 Plan to be paid in cash, shares, other awards or other property (including loans to participants). Options may be exercised by payment of the exercise price in cash, shares of common stock, outstanding awards or other property having a fair market value equal to the exercise price, as the Compensation Committee may determine from time to time.

The Compensation Committee is authorized to grant restricted stock and deferred stock. Restricted stock is a grant of shares of common stock which may not be sold or disposed of, and which shall be subject to such risks of forfeiture and other restrictions as the Compensation Committee may impose. A participant granted restricted stock generally has all of the rights of a stockholder of our company, unless otherwise determined by the Compensation Committee. An award of deferred stock confers upon a participant the right to receive shares of common stock at the end of a specified deferral period, subject to such risks of forfeiture and other restrictions as the Compensation Committee may impose. Prior to settlement, an award of deferred stock carries no voting or dividend rights or other rights associated with share ownership, although dividend equivalents may be granted, as discussed below.

The Compensation Committee is authorized to grant dividend equivalents conferring on participants the right to receive, currently or on a deferred basis, cash, shares of common stock, other awards or other property equal in value to dividends paid on a specific number of shares of common stock or other periodic payments. Dividend equivalents may be granted alone or in connection with another award, may be paid currently or on a deferred basis and, if deferred, may be deemed to have been reinvested in additional shares of common stock, awards or otherwise as specified by the Compensation Committee.

The Compensation Committee is authorized to grant shares of common stock as a bonus free of restrictions, or to grant shares of common stock or other awards in lieu of company obligations to pay cash under the 2009 Plan or other plans or compensatory arrangements, subject to such terms as the Compensation Committee may specify.

The Compensation Committee or our Board of Directors is authorized to grant awards that are denominated or payable in, valued by reference to, or otherwise based on or related to shares of common stock. The Compensation Committee determines the terms and conditions of such awards.


 
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The Compensation Committee is authorized to grant performance awards to participants on terms and conditions established by the Compensation Committee. The performance criteria to be achieved during any performance period and the length of the performance period is determined by the Compensation Committee upon the grant of the performance award; provided however, that a performance period cannot be shorter than 12 months or longer than 5 years. Performance awards may be valued by reference to a designated number of shares (in which case they are referred to as performance shares) or by reference to a designated amount of property including cash (in which case they are referred to as performance units). Performance awards may be settled by delivery of cash, shares or other property, or any combination thereof, as determined by the Compensation Committee.

Awards may be settled in the form of cash, shares of common stock, other awards or other property, in the discretion of the Compensation Committee. The Compensation Committee may require or permit participants to defer the settlement of all or part of an award in accordance with such terms and conditions as the Compensation Committee may establish, including payment or crediting of interest or dividend equivalents on deferred amounts, and the crediting of earnings, gains and losses based on deemed investment of deferred amounts in specified investment vehicles. The Compensation Committee is authorized to place cash, shares of common stock or other property in trusts or make other arrangements to provide for payment of our company’s obligations under the 2009 Plan. The Compensation Committee may condition any payment relating to an award on the withholding of taxes and may provide that a portion of any shares of common stock or other property to be distributed will be withheld (or previously acquired shares of common stock or other property be surrendered by the participant) to satisfy withholding and other tax obligations. awards granted under the 2009 Plan generally may not be pledged or otherwise encumbered and are not transferable except by will or by the laws of descent and distribution, or to a designated beneficiary upon the participant’s death, except that the Compensation Committee may, in its discretion, permit transfers for estate planning or other purposes subject to any applicable restrictions under Rule 16b-3.

Awards under the 2009 Plan are generally granted without a requirement that the participant pay consideration in the form of cash or property for the grant (as distinguished from the exercise), except to the extent required by law. The Compensation Committee may, however, grant awards in exchange for other awards under the 2009 Plan, awards under other company plans, or other rights to payment from our company, and may grant awards in addition to and in tandem with such other awards, rights or other awards.

Employment Contracts

S. Colin Neill. In October 2006, the Compensation and Stock Option Committees of the Board of Directors recommended, and the Board approved, a one year employment agreement for Mr. Neill as full time Senior Vice President, Chief Financial Officer, Secretary and Treasurer of the Company.  Mr. Neill’s initial base compensation was $265,000. The other provisions of Mr. Neill’s employment agreement relate to benefits, severance arrangements, automatic renewal and confidentiality and non-competition obligations. Mr. Neill received a sign-on bonus of $20,000 in October 2006.  Mr. Neill was named President on January 3, 2008 and retained all previous titles and positions.

Compensation of Directors

Our Director Compensation policy is as follows:

 
1.
At the election of each Director, either (i) 20,000 fully vested ten-year stock options are granted in January and 20,000 fully vested ten-year stock options are granted on July 1, or (ii) a cash payment of $6,000 is made in January and $6,000 on July 1.

 
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2.
The Chairman of the Audit Committee will be granted an additional 5,000 fully vested ten-year stock options in January and 5,000 fully vested ten-year stock options on July 1; and the Chairmen of the Compensation and the Governance and Nominating Committees will each be granted an additional 2,500 fully vested ten-year stock options in January and 2,500 fully vested ten-year stock options on July 1.
 
3.
Effective September 2, 2010, newly elected members of the Board of Directors shall receive a one-time grant of 350,000 ten-year stock options, one-third of which shall be immediately vested and exercisable, one-third of which shall vest on the first anniversary of grant and one-third of which shall vest on the second anniversary of grant, at an exercise price equal to the closing price of the company’s Common Stock on the trading date immediately prior to the date a new Director joins the Board; and that any Director receiving such one-time grant will not be eligible for compensation customarily awarded to Directors until the first semi-annual option grant or cash payment to Directors following the first anniversary of his or her one-time option grant.

DIRECTOR COMPENSATION FOR 2010

The table below summarizes the compensation paid by the Company to non-employee Directors for the fiscal year ended December 31, 2010:

 Name
 
Fees Earned or Paid in Cash($)
 
Option Awards ($) (1)
   
All Other Compensation ($)
     
Total ($)
 Srinivas Akkaraju, M.D., Ph.D. 
   
0
 
$
2,336
   
$
-
     $
2,336
 Anthony B. Evnin, Ph.D.  
   
0
 
$
2.920
   
$
-
     $
2,920
 Charles W. Newhall, III  
   
0
 
$
2,920
   
$
-
     $
2,920
 Steven Leventer, Ph.D.
   
0
 
$
35,069
 (2)
 
$
20,000
 (3)    $
55,069

 
(1)
Reflects the aggregate grant date fair value in accordance with FAS ASC Topic 718.  All options awarded to Directors in 2010 remained outstanding at fiscal year-end.
 
(2)
Dr Leventer was granted 350,000 ten-year options in September 2010 upon his appointment as a new board member of the Company.
 
(3)
Represents fees paid by the Company to PharmaNet, with whom Dr. Leventer is employed, pursuant to a consulting arrangement.  The fees consisted of $19,250 for consulting, and $750 in travel expense reimbursement.

New Director Appointment in 2010

In September of 2010 Steven Leventer, Ph.D was appointed as a new board member.

Compensation Committee Interlocks and Insider Participation

The members of the Compensation and Stock Option Committee in 2010 were Anthony B. Evnin and Charles W. Newhall, III.  There were no interlocks on the Compensation and Stock Option Committee in 2010.


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

EQUITY COMPENSATION PLAN INFORMATION

The table below provides certain information concerning our equity compensation plans as of December 31, 2010.

Plan Category
 
Number of securities to be issued upon exercise of outstanding options, warrants and rights
 
(a)
   
Weighted average exercise price of outstanding options, warrants and rights
 
(b)
   
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)
 
(c)
 
Equity compensation plans approved by security holders
    3,498,474     $ 1.97       7,580,000  
Equity compensation plans not approved by security holders
    N/A       N/A       N/A  
Total
    3,498,474     $ 1.97       7,580,000  


 
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
 
The following table sets forth certain information with respect to the beneficial ownership of the Company’s Common Stock as of February 17, 2011, except as set forth in the footnotes, by (i) each person who was known by the Company to own beneficially more than 5% of any class of the Company’s Stock, (ii) each of the Company’s executive officers and Directors, and (iii) all current Directors and executive officers of the Company as a group. Except as otherwise noted, each person listed below has sole voting and dispositive power with respect to the shares listed next to such person’s name.

 Name and Address of Beneficial Owner
Amount of Beneficial Ownership
 
  
Percentage of Total (1)
Robert F. Johnston 
    c/o Pharmos Corporation
    99 Wood Avenue South, Suite 302, Iselin, NJ 08830
17,986,584
 
(2) 
 
27.2%
Srinivas Akkaraju, M.D., Ph.D.
    c/o New Leaf Venture Partners
    2500 Sand Hill Road, Suite 203, Menlo Park, CA 94025
203,750
 
(3) 
*
Anthony B. Evnin
    c/o Venrock Associates
    530 Fifth Avenue, 22nd Floor, New York, NY 10036
13,857,695
 
(4)
21.7%
Steven Leventer
c/o Pharmos Corporation
    99 Wood Avenue South, Suite 302, Iselin, NJ 08830
157,778
 
(5)
*
Charles W. Newhall, III 
c/o New Enterprise Associates
1954 Greenspring Drive, Suite 600, Timonium, MD 21093
22,623,150
 
(6) 
33.3%
S. Colin Neill
    c/o Pharmos Corporation
    99 Wood Avenue South, Suite 302, Iselin, NJ 08830
565,000
 
(7) 
*
 
All Current Directors and Executive Officers as a group (six persons)
55,393,957
 
(8)
69.9%
New Enterprise Associates 10, LP
    1954 Greenspring Drive, Suite 600, Timonium, MD 21093
22,435,650
 
(9)
33.1%
Venrock Associates
    Venrock Associates III LP
    Venrock Entrepreneurs Fund III LP
    530 Fifth Avenue, 22nd Floor, New York, NY 10036 
13,665,195
 
(10)
21.4%

* Less than 1%.

(1)
Based on 59,732,332 shares of common stock outstanding as of February 17, 2011, plus each individual’s warrants or options which are either currently exercisable or will be exercisable within 60 days of the date set forth above.  Assumes that no other individual will exercise any warrants and/or options.


 
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(2)
Consists of 5,694,921 outstanding shares, 291,663 shares issuable upon exercise of currently exercisable options, and 6,000,000 outstanding shares and 6,000,000 currently exercisable warrants held by Demeter Trust.

(3)
Consists of 203,750 shares issuable upon exercise of currently exercisable options.

(4)
Consists of shares beneficially owned by Venrock Associates, Venrock Associates III LP and Venrock Entrepreneurs Fund III LP and 192,500 shares issuable upon exercise of currently exercisable options.

(5)
Consists of 41,111 outstanding shares and 116,667 shares issuable upon exercise of currently exercisable options.

(6)
Consists of shares beneficially owned by New Enterprise Associates 10, LP and 187,500 shares issuable upon exercise of currently exercisable options.

(7)
Consists of 75,000 outstanding shares and 490,000 shares issuable upon exercise of currently exercisable options.

(8)
Consists of 35,911,877 outstanding shares, 1,482,080 shares issuable upon exercise of currently exercisable options and 18,000,000 shares issuable upon exercise of currently exercisable warrants.

(9)
Consists of 14,435,650 outstanding shares and 8,000,000 shares issuable upon exercise of currently exercisable warrants.

(10)
Consists of 9,665,195 outstanding shares and 4,000,000 shares issuable upon exercise of currently exercisable warrants.


 
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Item 13. Certain Relationships, Related Transactions and Director Independence
 
Director Independence.  The Company has determined that four of the five Directors serving at December 31, 2010 (Srinivas Akkaraju, Anthony B. Evnin, Charles W. Newhall, III and Steven Leventer), were independent under the standards of the Nasdaq Stock Market.

Item 14. Principal Accounting Fees and Services

On October 19, 2009, Pharmos Corporation dismissed its independent registered public accounting firm, PricewaterhouseCoopers LLP.  The dismissal was approved by the Pharmos Audit Committee.  During the two most recent fiscal years and through October 19, 2009, there have been no disagreements between Pharmos and PricewaterhouseCoopers LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to the satisfaction of PricewaterhouseCoopers LLP would have caused them to make reference thereto in their reports on the financial statements for such years.  During the two most recent fiscal years and through October 19, 2009, there were no reportable events (as defined in Item 304(a)(1)(v)) of Regulation S-K.  Neither of the reports of PricewaterhouseCoopers LLP for the past two years contained an adverse opinion or disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope or accounting principles, except that their report dated February 25, 2009 contained an explanatory paragraph expressing substantial doubt about Pharmos' ability to continue as a going concern.  On October 20, 2009, Pharmos Corporation engaged Friedman LLP as its new independent accounting firm.

Audit fees

For 2010 the aggregate fees billed by Friedman LLP for professional services rendered for the audit of the Company’s annual financial statements for the year ending December 31, 2010 and for the review of the financial statements included in the Company’s quarterly reports on Form 10-Q was $55,000.

For 2009 the aggregate fees billed by Friedman LLP for professional services rendered for the audit of the Company’s annual financial statements for the year ending December 31, 2009 and for the review of the financial statements included in the Company’s quarterly reports on Form 10-Q for the quarter ended September 30, 2009 was $36,000.

For 2009 the aggregate fees billed by PricewaterhouseCoopers LLP for professional services rendered for the review of the financial statements included in the Company’s quarterly reports on Form 10Q for the quarters ended March 31, 2009 and June 30, 2009 were $40,000. PricewaterhouseCoopers LLP also billed $7,700 for the reissuance of the 2008 audit opinion. The Pricewaterhouse Israel fee for the statutory audit of the Pharmos Limited financial statements was $4,000.

Audit-related fees

There were no audit-related fees in 2010 and 2009.

Tax fees

Aggregate fees for professional services rendered by Friedman LLP in connection with its income tax compliance and related tax services for the years ended December 31, 2010 and 2009 were $0 and $0, respectively.

 
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All other fees

There were no other fees in 2010 and 2009.

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

The charter of the Audit Committee requires that the Committee review and pre-approve all audit, review or attest engagements of, and non-audit services to be provided by, the independent registered public accounting firm (other than with respect to the de minimis exception permitted by the Sarbanes-Oxley Act of 2002 and the SEC rules promulgated there under). The Audit Committee pre-approved all auditing services and permitted non-audit services rendered by Friedman LLP in 2010.

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

 
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PART IV

Item 15.  Exhibits and Financial Statement Schedules

(a)
Financial Statements and Exhibits

(1)
FINANCIAL STATEMENTS
 
Report of Independent Registered Public Accounting Firm
 
Consolidated Balance Sheets as of December 31, 2010 and 2009
 
Consolidated Statements of Operations for the years ended
 
December 31, 2010 and 2009
 
Consolidated Statements of Changes in Shareholders’ Equity
 
for the years ended December 31, 2010 and 2009
 
Consolidated Statements of Cash Flows for the years ended
 
December 31, 2010 and 2009
 
Notes to consolidated financial statements
 

 
(2)
FINANCIAL STATEMENT SCHEDULES
 
All schedules have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto.

(3)
EXHIBITS
 
2
Plan of purchase, sale, reorganization, arrangement, liquidation, or succession

 
2(a)
Agreement and Plan of Merger by and among Pharmos Corporation, Vela Acquisition Corporation and Vela Pharmaceuticals Inc. dated March 14, 2006 (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed March 15, 2006).
 
 
2(b)
Amendment to Agreement and Plan of Merger by and among Pharmos Corporation, Vela Acquisition Corporation and Vela Pharmaceuticals Inc. dated August 31, 2006 (incorporated by reference to Exhibit 2.1 of the registrant’s Current Report on Form 8-K filed September 5, 2006).
 
 
2(c)
Amendment No.2 to Agreement and Plan of Merger by and among Pharmos Corporation, Vela Acquisition Corporation, Vela Acquisition No.2 Corporation and Vela Pharmaceuticals Inc. dated September 29, 2006 (incorporated by reference to Exhibit 2.1 of the registrant’s Current Report on Form 8-K filed October 5, 2006).
 
 
2(d)
Amendment No. 3 to Agreement and Plan of Merger dated as of January 3, 2008 by and among Pharmos Corporation and the Representatives named therein (incorporated by reference to Exhibit 4.5 of the registrant’s Current Report on Form 8-K filed January 4, 2008).

3
Articles of Incorporation and By-Laws
 
 
3(a)
Restated Articles of Incorporation (Incorporated by reference to Appendix E to the Joint Proxy Statement/Prospectus included in the Form S-4 Registration Statement of the Company dated September 28, 1992 (No. 33-52398)
 
 
3(b)
Certificate of Amendment of Restated Articles of Incorporation dated January 30, 1995 (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1994).
 
 
3(c)
Certificate of Amendment of Restated Articles of Incorporation dated January 16, 1998 (Incorporated by reference to the Company’s Current Report on Form 8-K, dated February 6, 1998).
 

 
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3(d)
Certificate of Amendment of Restated Articles of Incorporation dated October 21, 1999 (Incorporated by reference to exhibit 4(e) to the Form S-3 Registration Statement of the Company filed September 28, 2000 (No. 333-46818)).
 
 
3(e)
Certificate of Amendment of Restated Articles of Incorporation dated July 19, 2002 (Incorporated by reference to Exhibit 3 to the Company’s Report on Form 10-Q for the quarter ended June 30, 2002).
 
 
3(f)
Certificate of Amendment of Restated Articles of Incorporation dated July 7, 2004 (Incorporated by reference to Exhibit 3.1 to the Company’s Report on Form 10-Q for the quarter ended June 30, 2004).
 
 
3(g)
Certificate of Amendment to Articles of Incorporation dated September 23, 2005 (Incorporated by reference to exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
 
 
3(h)
Certificate of Amendment to Articles of Incorporation dated August 5, 2009 (Incorporated by reference to exhibit 3.8 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2009).

 
3(i)
Amended and Restated By-Laws (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007.
 
4
Instruments defining the rights of security holders, including indentures
 
 
4(a)
Form of Employee Warrant Agreement, dated April 11, 1995, between the Company and Oculon Corporation (Incorporated by reference to the Company’s Current Report on Form 8-K, dated April 11, 1995, as amended).
 
 
4(b)
Form of Warrant Agreement dated as of April 30, 1995 between the Company and Charles Stolper (Incorporated by reference to Form S-3 Registration Statement of the Company dated November 14, 1995, as amended [No. 33-64289]).
 
 
4 (c)
Form of Stock Purchase Warrant dated as of March 31, 1997 between the Company and the Investor (Incorporated by reference to Form S-3 Registration Statement of the Company dated March 5, 1998 [No. 333-47359]).
 
 
4(d)
Form of Common Stock Purchase Warrant exercisable until September 1, 2005 (Incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on September 11, 2000).
 
 
4(e)
Form of placement agent warrant with Ladenburg Thalmann & Co. Inc. (Incorporated by reference to Form S-3 Registration Statement of the Company dated September 28, 2000 (No. 333-46818).
 
 
4(f)
Form of placement agent warrant with SmallCaps OnLine LLC (Incorporated by reference to Form S-3 Registration Statement of the Company dated September 28, 2000 (No. 333-46818).
 
 
4(g)
Form of consulting warrant with SmallCaps OnLine LLC (Incorporated by reference to Form S-3 Registration Statement of the Company dated September 28, 2000 (No. 333-46818).
 
 
4(h)
Certificate of Designation, Rights Preferences and Privileges of Series D Preferred Stock of the Company (Incorporated by reference to Exhibit 99.3 to the Company’s Current Report on Form 8-K filed on October 24, 2002).
 
 
4(i)
Rights Agreement dated as of October 23, 2002 between the Company and American Stock Transfer & Trust Company, as Rights Agent (Incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on October 24, 2002).
 

 
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4(j)
Form of Investor Warrant dated March 4, 2003 (Incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on March 4, 2003).
 
 
4(k)
Form of Placement Agent’s Warrant dated March 4, 2003 (Incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on March 4, 2003).
 
 
4(l)
Registration Rights Agreement dated as of May 30, 2003 between the Company and the purchasers. (Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on June 3, 2003).
 
 
4(m)
Form of Investor Warrant dated June 2, 2003 (Incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on June 3, 2003).
 
 
4(n)
Securities Purchase Agreement dated as of September 26, 2003 between the Company and the purchasers identified on the signature pages thereto 2003 (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on September 30, 2003).
 
 
4(o)
Form of 4% convertible debenture due March 31, 2005 (Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on September 30, 2003).
 
 
4(p)
Registration Rights Agreement dated as of September 26, 2003 between the Company and the purchasers signatory thereto (Incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on September 30, 2003).
 
 
4(q)
Form of Common Stock Purchase Warrant (Incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on September 30, 2003).
 
 
4(r)
Escrow Agreement dated as of September 26, 2003 between the Company, the purchasers signatory thereto and Feldman Weinstein LLP (Incorporated by reference to Exhibit 4.5 to the Company’s Current Report on Form 8-K filed on September 30, 2003).
 
 
4(s)
Form of Placement Agent Common Stock Purchase Warrant (Incorporated by reference to Exhibit 4.6 to the Company’s Current Report on Form 8-K filed on September 30, 2003).
 
 
4(t)
Rights Agreement Amendment, dated October 23, 2006, between Pharmos Corporation and American Stock Transfer & Trust Co. (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 27, 2006).
 
 
4(u)
Registration Rights Agreement, dated as of October 25, 2006, by and among Pharmos Corporation and the Representatives named therein (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 31, 2006).
 
 
4(v)
10% Convertible Debenture dated as of January 3, 2008 of Pharmos Corporation (Incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on January 4, 2008).
 
 
4(w)
Registration Rights Agreement dated as of January 3, 2008 by and among Pharmos Corporation and the Purchasers named therein (Incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on January 4, 2008).
 
 
4(x)
Amendment No. 2 dated as of January 3, 2008 to the Rights Agreement, dated as of September 5, 2002, as amended on October 23, 2006 (the ÒRights AgreementÓ), between Pharmos Corporation and American Stock Transfer & Trust Co., as Rights Agent (Incorporated by reference to Exhibit 4.6 to the Company’s Current Report on Form 8-K filed on January 4, 2008).
 
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4(y)
Amendment No. 1 to Registration Rights Agreement dated as of April 25, 2008 by and among Pharmos Corporation and the Purchasers named therein (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on May 1, 2008).
 
 
4(z)
Amendment No. 2 to Registration Rights Agreement by and among Pharmos Corporation and the Purchasers named therein (Incorporated by reference to Exhibit 4.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2008).
 
 
4(aa)
Form of waiver under Pharmos Corporation 10% Convertible Debentures Due November 1, 2012 (Incorporated by reference to exhibit 4.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2008).
 
 
4(bb)
Form of waiver, dated January 15, 2009, under Pharmos Corporation 10% Convertible Debentures Due November 1, 2012 (incorporated by reference to exhibit 4.1 to the Company’s Current Report on Form 8-K filed January 22, 2009)
 
4(cc)
Securities Purchase Agreement dated as of April 21, 2009 by and among Pharmos Corporation and the Purchasers named therein (incorporated by reference to exhibit 4.1 to the Company’s Current Report on Form 8-K filed April 23, 2009).

 
4(dd)
Form of Stock Purchase Warrant dated April 21, 2009 (incorporated by reference to exhibit 4.2 to the Company’s Current Report on Form 8-K filed April 23, 2009).

 
4(ee)
Registration Rights Agreement dated as of April 21, 2009 by and among Pharmos Corporation and the Purchasers named therein (incorporated by reference to exhibit 4.3 to the Company’s Current Report on Form 8-K filed April 23, 2009).

 
4(ff)
Debenture Amendment Agreement dated April 21, 2009 among Pharmos Corporation, New Enterprise Associates 10, Limited Partnership, Venrock Associates, Venrock Associates III, L.P., Venrock Entrepreneurs Fund III, L.P. and Robert F. Johnston (incorporated by reference to exhibit 4.4 to the Company’s Current Report on Form 8-K filed April 23, 2009).

 
4(gg)
Amendment No. 3 dated as of April 21, 2009 to the Rights Agreement, dated as of October 23, 2002, as amended on October 23, 2006 and on January 3, 2008 (the “Rights Agreement”), between Pharmos Corporation and American Stock Transfer & Trust Company, LLC, as Rights Agent (incorporated by reference to exhibit 4.5 to the Company’s Current Report on Form 8-K filed April 23, 2009).
 
10
Material Contracts
 
 
10(a)
Employment Agreement dated as of April 2, 2001, between Pharmos Corporation and Haim Aviv (Incorporated by reference to Exhibit 10(n) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001).**
 
 
10(b)
Amendment of Employment Agreement with Haim Aviv, dated as of January 25, 2006 (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).**
 
 
10(c)
Employment Agreement dated as of April 2, 2001, between Pharmos Corporation and Gad Riesenfeld (Incorporated by reference to Exhibit 10(o) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001).**
 
 
10(d)
Amendment of Employment Agreement dated as of April 23, 2001, between Pharmos Corporation and Gad Riesenfeld (Incorporated by reference to Exhibit 10(p) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001).**
 
53

 
 
 
 
10(e)
Amendment of Employment Agreement dated as of February 16, 2005 between Pharmos Corporation and Gad Riesenfeld (Incorporated by reference to Exhibit 10(w) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004).**
 
 
10(f)
Employment Agreement dated as of July 19, 2004 between Pharmos Corporation and James A. Meer (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).**
 
 
10(g)
Employment Agreement dated as of November 7, 2005, between Pharmos Corporation and Alan L. Rubino (Incorporated by reference to exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).**
 
 
10(h)
Employment Agreement between Pharmos Corporation and S. Colin Neill, dated as of October 5, 2006 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 6, 2006).**
 
 
10(i)
Retention Award Agreement dated as of September 6, 2004 between Pharmos Corporation and Dr. Haim Aviv (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on September 10, 2004).**
 
 
10(j)
Retention Award Agreement dated as of September 6, 2004 between Pharmos Corporation and Dr. Gad Riesenfeld (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on September 10, 2004).**
 
 
10(k)
Consulting Agreement between Pharmos Corporation and Dr. Georges Anthony Marcel, dated October 17, 2006 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 20, 2006).**
 
 
10(l)
Consulting Agreement between Pharmos Corporation and Dr. Lawrence F. Marshall, dated October 17, 2006 (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on October 20, 2006).**
 
 
10(n)
Amended and Restated 2000 Incentive and Non-Qualified Stock Option Plan.**
 
 
10(o)
Amendment to the 2000 Stock Option Plan (incorporated by reference to Appendix D to the Company’s Definitive Proxy Statement on Schedule 14A filed on September 10, 2007).**
 
 
10(p)
2001 Employee Stock Purchase Plan (Incorporated by reference to Exhibit B to the Company’s Definitive Proxy Statement on Form 14A filed on June 6, 2001).**
 
 
10(q)(1)
Agreement between Avitek Ltd. (“Avitek”) and Yissum Research Development Company of the Hebrew University of Jerusalem (“Yissum”) dated November 20, 1986 (Incorporated by reference to Annual Report on Form 10-K, as amended by Form10-K/A, for year ended December 31, 1992).  (1)
 
 
10(q)(2)
Supplement to Agreement (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K/A, for year ended December 31, 1992).  (1)
 
 
10(q)(3)
Hebrew language original executed version of Agreement (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K/A, for year ended December 31, 1992).  (1)
 
54

 

 
 
10(r)(1)
Agreement between Avitek and Yissum dated January 25, 1987 (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K/A, for year ended December 31, 1992).  (1)
 
 
10(r)(2)
Schedules and Appendixes to Agreement (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K/A, for year ended December 31, 1992).  (1)
 
 
10(r)(3)
Hebrew language original executed version of Agreement (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K/A, for year ended December 31, 1992).  (1)
 
 
10(s)(1)
Research, Development and License Agreement between Pharmos Ltd., Pharmos Corporation (“Old Pharmos”) and Yissum dated February 5, 1991 (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K/A, for year ended December 31, 1992).  (1)
 
 
10(s)(2)
Schedules and Appendixes to Agreement (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K/A, for year ended December 31, 1992).  (1)
 
 
10(s)(3)
Amendment No.1 to Research, Development and License Agreement between Pharmos Corporation, Pharmos Ltd. and Yissum Research Development Company of the Hebrew University of Jerusalem, dated May 31, 2006 (incorporated by reference to exhibit 99.1 to the registrant’s Current Report on Form 8-K filed June 6, 2006).
 
 
10(t)
License Assignment and Amendment Agreement dated as of October 9, 2001 by and among Dr. Nicholas S. Bodor, Pharmos Corporation and Bausch & Lomb Incorporated (Incorporated by reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K filed on October 16, 2001).
 
 
10(u)
Asset Purchase Agreement between Bausch & Lomb Incorporated and Pharmos Corporation dated October 9, 2001 (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on October 16, 2001).
 
 
10(v)
Amendment No. 1 to Asset Purchase Agreement dated as of December 28, 2001 between Bausch & Lomb Incorporated and Pharmos Corporation (Incorporated by reference to Exhibit 10(v) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001).
 
 
10(w)
Amendment No. 2 to Asset Purchase Agreement dated as of December 30, 2004 between Bausch & Lomb Incorporated and Pharmos Corporation (Incorporated by reference to Exhibit 10(v) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004).
 
 
10(x)
License Agreement dated as of December 18, 2001 between Pharmos Ltd. and Herbamed Ltd. (Incorporated by reference to Exhibit 10(p) to the Annual Report on Form 10-K for year ended December 31, 2002).
 
 
10(y)
Amendment No. 1, dated as of June 30, 2005, to the License Agreement by and between Pharmos Ltd. and Herbamed Ltd., dated as of December 18, 2001 (Incorporated by reference to exhibit 99.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005).
 
 
10(z)
Settlement Agreement between the Company and Lloyd I. Miller, III dated August 31, 2006 (incorporated by reference to Exhibit 10.1 of the registrant’s Current Report on Form 8-K filed September 5, 2006).
 
 
10(aa)
Voting Agreement and Waiver by and among the Company, Lloyd I. Miller, III, Trust A-4 - Lloyd I. Miller, Milfam II L.P. and Milfam LLC dated August 31, 2006 (incorporated by reference to Exhibit 10.2 of the registrant’s Current Report on Form 8-K filed September 5, 2006).
 
 
10(bb)
Employment Agreement between Pharmos Corporation and Elkan R. Gamzu, dated as of March 20, 2007 (incorporated by reference to Exhibit 10.1 of the registrant’s Current Report on Form 8-K filed March 26, 2007).
 
 
55

 
 
 
10(cc)
Letter of Agreement between Pharmos Corporation and Haim Aviv, dated March 20, 2007 (incorporated by reference to Exhitit 10.2 of the registrant’s Current Report on Form 8-K filed March 26, 2007.

 
10(dd)
Securities Purchase Agreement dated as of January 3, 2008 by and among Pharmos Corporation and the Purchasers named therein (incorporated by reference to Exhibit 4.1 of the registrant’s Current Report on Form 8-K filed January 4, 2008).
 
 
10(ee)
Letter Agreement dated January 3, 2008 regarding Additional Debenture Investment among Pharmos Corporation, New Enterprise Associates 10, Limited Partnership, Lloyd I. Miller, III and Robert F. Johnston (incorporated by reference to Exhibit 4.2 of the registrant’s Current Report on Form 8-K filed January 4, 2008).

 
10(ff)
Agreement dated January 3, 2008 between Pharmos Corporation and Mony Ben Dor (incorporated by reference to Exhibit 10.1 of the registrant’s Current Report on Form 8-K filed January 4, 2008).

 
10(gg)
Agreement dated January 3, 2008 between Pharmos Corporation and David Schlachet (incorporated by reference to Exhibit 10.2 of the registrant’s Current Report on Form 8-K filed January 4, 2008).

 
10(hh)
Agreement dated January 3, 2008 between Pharmos Corporation and Haim Aviv (incorporated by reference to Exhibit 10.3 of the registrant’s Current Report on Form 8-K filed January 4, 2008).

 
10(ii)
Asset Purchase Agreement, dated as of February 11, 2009, by and between Pharmos Corporation, Pharmos Ltd. and Reperio Pharmaceuticals Ltd. (Incorporated by reference to exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2009)

 
10(jj)
Form of Pharmos Corporation Indemnification Agreement dated as of April 21, 2009 (incorporated by reference to exhibit 10.1 to the Company’s Current Report on Form 8-K filed April 23, 2009).

 
10(kk)
2009 Incentive Compensation Plan (incorporated by reference to Appendix A to the Registrant’s Definitive Proxy Statement on Schedule 14A filed on June 18, 2009).**

21
Subsidiaries of the Registrant

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

23
Consents of Experts and Counsel

 
23(a) ***
Consent of Friedman LLP

31  Rule 13a-14(a)/15d-14(a) Certifications

 
31(a) ***
Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer
 
 
31(b) ***
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
 
32  Section 1350 Certifications
 
 
32(a)***
Section 1350 Certification of Principal Executive Officer and Chief Financial Officer

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

 
56

 

SIGNATURES


Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
  PHARMOS CORPORATION  
       
 
By:
/s/ Robert F. Johnston  
    Robert F. Johnston  
    Executive Chairman  
     (Principal Executive Officer)  
     Date:  February 17, 2011      

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

Signature
 Title
Date
 
 
 
     
/s/ Robert F. Johnston
   
Robert F. Johnston
Executive Chairman
February 17, 2011
 
(Principal Executive Officer)
 
     
/s/ S. Colin Neill
   
S. Colin Neill
President and Chief Financial Officer
February 17, 2011
 
(Principal Financial and Accounting Officer)
 
     
/s/ Srinivas Akkaraju
   
Srinivas Akkaraju, MD, Ph.D.
Director
February 17, 2011
     
     
/s/ Anthony B. Evnin
   
Anthony B. Evnin, Ph.D.
Director
February 17, 2011
     
     
/s/ Charles W. Newhall, III
   
Charles W. Newhall, III
Director
February 17, 2011
     
 
/s/ Steven Leventer
   
Steven Leventer, Ph.D.
Director
February 17, 2011



 
 

 


Pharmos Corporation
Index to Consolidated Financial Statements


 
 
 
 
Report of Independent Registered Public Accounting Firm
 
F-2
Consolidated Balance Sheets as of December 31, 2010 and 2009
 
F-3
Consolidated Statements of Operations for the years ended
   
December 31, 2010 and 2009
 
F-4
Consolidated Statements of Changes in Shareholders’ Equity
   
for the years ended December 31, 2010 and 2009
 
F-5
Consolidated Statements of Cash Flows for the years ended
   
December 31, 2010 and 2009
 
F-6
Notes to consolidated financial statements
 
F-7


 
 
F-1

 

 
Report of Independent Registered Public Accounting Firm
 



The Board of Directors and
Shareholders’ of Pharmos Corporation
Iselin, New Jersey

We have audited the accompanying consolidated balance sheets of Pharmos Corporation and its subsidiaries (the “Company”) as of December 31, 2010 and December 31, 2009, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of their internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion of the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pharmos Corporation and subsidiaries as of December 31, 2010 and December 31, 2009, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations, has an accumulated deficit and expects to continue to incur losses going forward, all of which raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.



Friedman LLP
East Hanover, New Jersey
February 17, 2011

 
 
F-2

 


PHARMOS CORPORATION
           
Consolidated Balance Sheets
           
   
December 31,
 
   
2010
   
2009
 
Assets
           
Current Assets
           
Cash and cash equivalents
  $ 3,139,347     $ 4,629,486  
Prepaid expenses and other current assets
    46,833       25,678  
Total current assets
    3,186,180       4,655,164  
                 
Fixed assets, net
    5,613       1,379  
Other assets
    -       32,479  
                 
Total assets
  $ 3,191,793     $ 4,689,022  
                 
Liabilities and Shareholders’ Equity
               
Current liabilities
               
Accounts payable
  $ 67,199     $ 73,717  
Accrued expenses
    103,913       148,414  
Accrued wages and other compensation
    -       195,000  
Total current liabilities
    171,112       417,131  
                 
Convertible debenture
    1,000,000       1,000,000  
Total liabilities
    1,171,112       1,417,131  
                 
Shareholders’ Equity
               
Preferred stock, $.03 par value, 1,250,000 shares authorized, none issued and outstanding
    -       -  
Common stock, $.03 par value; 120,000,000 shares authorized,  59,585,273 and 59,291,154  issued in 2010 and 2009, respectively
    1,787,558       1,778,735  
Paid-in capital in excess of par
    211,587,386       211,301,675  
Accumulated deficit
    (211,353,837 )     (209,808,093 )
Treasury stock, at cost, 2,838 shares
    (426 )     (426 )
Total shareholders' equity
    2,020,681       3,271,891  
                 
Total liabilities and shareholders' equity
  $ 3,191,793     $ 4,689,022  
The accompanying notes are an integral part of these consolidated financial statements.
 
 

 
 
F-3

 

PHARMOS CORPORATION
Consolidated Statements of Operations

 
Year ended December 31,
   
2010
   
2009
 
Expenses
           
Research and development, gross
  $ 497,935     $ 4,422,600  
Grants
    (244,479 )     -  
Research and development, net of grants
    253,456       4,422,600  
In-process acquired research and development
    -       180,000  
General and administrative
    1,187,335       1,536,470  
Depreciation and amortization
    1,551       8,314  
Total operating expenses
    1,442,342       6,147,384  
                 
Loss from operations
    (1,442,342 )     (6,147,384 )
                 
Other income (expense)
               
                 
Debt conversion expense
    -       (596,104 )
Interest income
    1,520       8,412  
Interest expense
    (110,744 )     (225,335 )
Other income (expense)
    5,822       (8,404 )
Other (expense), net
    (103,402 )     (821,431 )
                 
Loss before income taxes
  $ (1,545,744 )   $ (6,968,815 )
Income tax benefit
    -       (3,914,481 )
                 
                 
Net loss
  $ (1,545,744 )   $ (3,054,334 )
                 
Net loss per share
               
- basic and diluted
  $ (0.03 )   $ (0.06 )
                 
Weighted average shares outstanding
               
- basic and diluted
    58,529,204       47,445,014  

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


 
 
F-4

 

Pharmos Corporation
Consolidated Statements of Changes in Shareholders’ Equity
For the Years ended December 31, 2010 and 2009

   
Common Stock
   
Treasury Stock
       
   
 
Shares
   
 
Amount
   
Paid-in Capital in Excess of Par
   
Accumulated
Deficit
   
 
Shares
   
 
Amount
   
Total Stockholders’ Equity
 
December 31, 2008
    26,210,290      $ 786,307      $ 206,309,096      $ (206,753,758 )     2,838      $ (426 )    $ 341,219  
                                                         
Stock and option issuance for employee compensation
                    175,438                               175,438  
April 2009 financing net
    18,000,000       540,000       1,239,777                               1,779,777  
Debentures converted to equity
    10,909,091       327,275       3,268,829                               3,596,104  
Reversal of deferred financing fees
                    (78,382 )                             (78,382 )
Vela Milestone
    2,000,000       60,000       120,000                               180,000  
Restricted stock grant
    1,200,000       36,000       (36,000 )                             -  
Issuance of  Common Stock for Debenture Interest payment
    971,773       29,153       302,917                               332,070  
Net Loss
                            (3,054,335 )                     (3,054,335 )
December 31, 2009
    59,291,154       1,778,735       211,301,675       (209,808,093 )     2,838       (426 )     3,271,891  
 
Stock and option issuance for employee compensation
                    194,534                               194,534  
Issuance of  Common Stock for Debenture Interest payment
    294,119       8,823       91,177                               100,000  
Net Loss
                            (1,545,744 )                     (1,545,744 )
December 31, 2010
    59,585,273     $ 1,787,558     $ 211,587,386     $ (211,353,837 )     2,838     $ (426 )   $ 2,020,681  
                                                         
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
F-5

 

Pharmos Corporation
Consolidated Statements of Cash Flows
   
Year Ended December 31,
   
2010
   
2009
 
Cash flows from operating activities
           
Net loss
  $ (1,545,744 )   $ (3,054,334 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    1,551       8,314  
Amortization of deferred financing fees
    10,745       32,432  
Non cash debt conversion expense
    -       596,104  
Share-based compensation
    194,534       175,438  
Debenture interest paid in common stock
    100,000       130,403  
Milestone paid in common shares
    -       180,000  
Changes in operating assets and liabilities:
               
Prepaid expenses and other current assets
    579       656,228  
Accounts payable
    (6,518 )     (810,249 )
Accrued expenses
    (44,501 )     (265,585 )
Accrued wages and other compensation
    (195,000 )     108,000  
Other liabilities
    -       (44,316 )
Net cash used in operating activities
    (1,484,354 )     (2,287,565 )
                 
Cash flows from investing activities
               
Purchases of fixed assets
    (5,785 )     -  
Proceeds from disposition of fixed assets
    -       367,994  
Decrease in restricted cash
    -       38,998  
Net cash (used in) provided by investing activities
    (5,785 )     406,992  
                 
Cash flows from financing activities
               
Proceeds from issuance of common stock and warrants, net
    -       1,779,777  
Net cash provided by financing activities
    -       1,779,777  
                 
Net decrease in cash and cash equivalents
    (1,490,139 )     (100,796 )
                 
Cash and cash equivalents at beginning of year
    4,629,486       4,730,282  
                 
Cash and cash equivalents at end of year
  $ 3,139,347     $ 4,629,486  
                 
                 
Supplemental disclosure of non-cash investing and financing activities:
               
Common shares issued for accrued interest
  $ 100,000     $ 201,667  
Write off of deferred financing fees with conversion of debentures
    -     $ 78,382  
Conversion of debentures to common stock
    -     $ 3,000,000  

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

 
 
F-6

 
Pharmos Corporation
Notes to Consolidated Financial Statements

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), with a focus on pain/inflammation, and autoimmune disorders. The Company's most advanced product is Dextofisopam for the treatment of irritable bowel syndrome (IBS).

The Phase 2b Dextofisopam trial did not meet its primary endpoints. During 2010 the Company conducted minimal research and development activity. The Company’s focus was on further understanding the Dextofisopam Phase 2b results and discussing these with a wide variety of potential pharmaceutical partners and investment funds to participate in a Phase 2c clinical trial as the next development stage for Dextofisopam.

During 2010 the Company explored initiating proof of concept clinical studies in other therapeutic areas with its compounds and conferred with clinical and scientific experts as to the best opportunity.

The Company has executive offices in Iselin, New Jersey. The Company’s operations in Israel were closed effective October 31, 2008.

2.
Liquidity, Business Risks and Ability to Continue as a Going Concern

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. The Company had an accumulated deficit of $211.4 million as of December 31, 2010 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. Previously the Company had financed its operations with public and private offerings of securities, advances and other funding pursuant to an earlier 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 (NOL’s), and interest income. During 2010 the Company was awarded a cash grant of $244,000 under the Federal Qualifying Discovery Project Program for the further development of Dextofisopam. The Company had approximately $3.1 million of cash and cash equivalents at December 31, 2010. However, the Company’s ability to continue as a going concern is largely dependent upon achieving a collaboration with a pharmaceutical partner or raising additional capital to either advance its lead compound, Dextofisopam, for the treatment of IBS or to advance other earlier stage intellectual property assets.   The Company has in the past pursued various funding and financing options; however management believes that future funding or financing options may be challenging because of the current environment.

The Company does not currently have the finances and resources to complete full clinical trials for its lead compound, Dextofisopam. As a result it may decide to embark on smaller clinical trials for Dextofisopam or commence pre-clinical development on its other intellectual property assets which could further reduce the company’s current resources.

As such these factors raise substantial doubt as to the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from this uncertainty.


 
 
F-7

 
Pharmos Corporation
Notes to Consolidated Financial Statements

3.
Significant Accounting Policies

Basis of consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: Pharmos Ltd. and Vela Pharmaceuticals.  All significant intercompany balances and transactions are eliminated in consolidation. Vela Acquisition Corp. is dormant and was used as the vehicle to acquire Vela Pharmaceuticals Inc. in October 2006.  The Israel operations, including research and development activities, ceased effective October 31, 2008 and the Company completed its voluntary liquidation in May 2010.

Use of estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues, costs and expenses during the reporting period. The most significant estimates and assumptions related to stock based compensation, estimates of commitments and contingencies, and the tax valuation allowance.  Actual results could differ from those estimates.

Net loss per common share

Basic and diluted net loss per common share was computed by dividing the net loss for the period by the weighted average number of shares of common stock issued and outstanding. In accordance with the requirements of FASB ASC Topic 260 covering earnings per share, potential shares of common stock have been excluded from the calculation of diluted net loss per common share, as their inclusion would be antidilutive.

The following table summarized the equivalent number of potential common shares assuming the related securities that were outstanding as of December 31, 2010 and 2009 had been converted.

   
2010
   
2009
 
Stock options
    3,460,499       3,647,155  
Restricted stock
    750,000       1,200,000  
Convertible debenture
    1,428,571       1,428,571  
Warrants
    18,000,000       18,000,000  
Total potential dilutive securities not included in loss per share
    23,639,070       24,275,726  

Cash and cash equivalents

The Company considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents primarily consist of US short term government obligations at December 31, 2010 and 2009.


 
 
F-8

 
Pharmos Corporation
Notes to Consolidated Financial Statements

Concentrations of Credit Risk

Financial instruments that subject the Company to credit risk primarily consist of cash and cash equivalents. The Company maintains its cash and cash equivalent balances with a high quality financial institution who invests the Company’s funds in Government short-term instruments. Consequently the Company believes that such funds are subject to minimal credit risk.

Revenue recognition

The Company’s policy with respect to license fees is to recognize revenue when all performance obligations are completed. The Company had no licensing revenue or product sales revenue during 2010 or 2009 and does not expect product sale revenues for the next few years and may never have such sales if products currently under development fail to be commercialized.

Grants

The costs and expenses of research and development activities are partially funded by grants the Company received. The grants are deducted from research and development expenses at the time such grants are received.

Research and development costs

All research and development costs are expensed when incurred. The Company accounts for reimbursements of research and development costs as a reduction of research and development expenses as the underlying expenses are incurred.

Effective January 1, 2008 the Company adopted the provisions of FASB ASC Topic 730 which requires companies involved in research and development activities to capitalize 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. Advance payments are capitalized until the goods have been delivered or the related services have been performed.   At December 31, 2010 and 2009 there was $0 and $0, respectively, in capitalized prepayments.

Fixed assets

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

Laboratory, pilot plant and other equipment
7 years to 14 years
Office furniture and fixtures
3 years to 17 years
Computer equipment
3 years to 4 years
Vehicles
5 years to 7 years

Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated lives of the related assets.  Maintenance and repairs are expensed as incurred.


 
 
F-9

 
Pharmos Corporation
Notes to Consolidated Financial Statements

Income taxes

The Company accounts for income taxes in accordance with the provisions of FASB ASC Topic 740. “Accounting for Income Taxes” (“ASC – Topic 740”).  Under the asset and liability method of Topic 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.  Deferred tax assets and liabilities, if any, are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  Under Topic 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date.

The Company follows the guidance of Financial Accounting Standards Board interpretation in ASC Topic 740 which covers, Accounting for Uncertainty in Income Taxes. 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 as a result, files US and New Jersey income tax returns. The Company announced that effective October 31, 2008 it would cease operations in Rehovot, Israel. 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, there was no effect on our financial position, results of operations or cash flows related to this Interpretation.

Foreign exchange

The Company’s foreign operations are principally conducted in U.S. dollars. Any transactions or balances in currencies other than U.S. dollars are remeasured and any resultant gains and losses are included in other income (expense).  Such gains and losses have been insignificant in 2010 and 2009.

Fair value of financial instruments

The carrying amounts of the Company’s financial instruments, including cash and cash equivalents, investments, other receivables, other assets, accounts payable and accrued liabilities approximate fair value due to their short term maturities. See note for fair value of convertible debentures, due November 2012.

Share based compensation

The Company has stock-based compensation plans under which employees and outside directors receive stock options and other equity-based awards. The plans provide for the granting of stock options, restricted stock awards, and other stock unit awards.  The 2009 Plan approved at the annual meeting of shareholders is administered by the Compensation Committee, which is authorized to select eligible persons to receive awards, determine the type, number and other terms and conditions of, and all other matters relating to, awards and prescribe award agreements.  The total number of shares of common stock reserved and available for delivery under the 2009 Plan is 8,000,000 shares.   No further shares may be issued from the 2000 Plan, as amended, as it expired after ten years. At December 31, 2010, awards under the 2000 and 2009 plans totalling 3,460,499 shares were outstanding. Pharmos stock options are granted with an exercise price equal to 100% of the market value of a share of common stock on the date of the grant, generally have 10 year terms, and vest no later than four years from the date of grant.


 
 
F-10

 
Pharmos Corporation
Notes to Consolidated Financial Statements

Under the terms of the Pharmos Employee Stock Purchase Plan (ESPP), all full-time and part-time employees of the Company who have completed a minimum of 6 months of employment are eligible to participate. The price of the Common Stock is calculated at 85% of the lower of either the mean between the highest and lowest prices at which Pharmos common stock trades on the first business day of the month, or the mean between the highest and lowest trading prices on the day of exercise (the last day of the month). A participant can purchase shares not to exceed 10% of one’s annualized base pay; $25,000; or 5% or more of shares outstanding. The total number of shares reserved for issuance under the 2001 Plan is 100,000 shares.  During the years ended December 31, 2010 & 2009, no shares were purchased under the ESPP and 87,440 shares remain for issuance under the 2001 Plan.
 
Recently Issued Accounting Standards
 
In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements ("ASU 2009-13"). ASU 2009-13, amends existing revenue recognition accounting pronouncements that are currently within the scope of Codification Subtopic 605-25 (previously included within EITF 00-21, Revenue Arrangements with Multiple Deliverables ("EITF 00-21"). The consensus to ASU 2009-13 provides accounting principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated. This guidance modifies the parameters in establishing the fair value of undelivered products and services enabling separate revenue recognition based upon management's estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. EITF 00-21 previously required that the fair value of the undelivered item be the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately by the vendor. Under EITF 00-21, if the fair value of all of the elements in the arrangement was not determinable, then revenue was deferred until all of the items were delivered or fair value was determined. This new approach is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and allows for retroactive application. The Company is currently evaluating the potential impact of this standard on its financial position and results of operations.
 
In April 2010, the FASB issued ASU No. 2010-17, Milestone Method of Revenue Recognition ("ASU 2010-17"). ASU 2010-17, updates guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate with the scope of Codification Subtopic 605 (previously included within EITF 00-21, Revenue Arrangements with Multiple Deliverables ("EITF 00-21")). The consensus to ASU 2010-17 provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Research or development arrangements frequently include payment provisions whereby a portion or all of the consideration is contingent upon milestone events such as successful completion of phases in a drug study or achieving a specific result from the research or development efforts. An entity often recognizes these milestone payments as revenue in their entirety upon achieving the related milestone, commonly referred to as the milestone period. This new approach is effective prospectively for milestones achieved in fiscal years beginning on or after June 15, 2010 and allows for retroactive application. The Company is currently evaluating the potential impact of this standard on its financial position and results of operations.

4.
Convertible Debentures

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


 
 
F-11

 
Pharmos Corporation
Notes to Consolidated Financial Statements

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

The Debentures mature the earlier of November 1, 2012 or the sale of the Company. The Debentures, together with all accrued and unpaid interest thereon, may be repaid, without premium or penalty, commencing on November 1, 2011. Starting on November 1, 2009 (or earlier sale of the Company), any outstanding Debenture may be converted into common shares at the option of the holder. The conversion price is fixed equal to $0.70 per share. The Debentures bear interest at the rate of 10% per annum, payable semi-annually either in cash or common stock of the Company at the option of the Company, provided that an effective registration statement is in effect.  

The closing price on the date of the first interest payment date was $0.34 which means that, under the payment terms of the Convertible Debentures, up to an additional 970,126 shares of common stock could be issued as interest over the remaining life of the Convertible Debentures that remain outstanding. Should the price be greater than $0.34 at the payment date, fewer shares would be issued.

On April 21, 2009, Venrock Associates (which is affiliated with Anthony B. Evnin, a Director of the Company), New Enterprise Associates (which is affiliated with Charles W. Newhall, III, a Director of the Company) and Robert F. Johnston, the Company’s Executive Chairman of the Board of Directors, agreed to convert as of such date the Company’s 10% Convertible Debentures due November 1, 2012 held by them, comprising an aggregate of $3,000,000 in principal amount, at a conversion price of $0.275 per share.  Accrued but unpaid interest on their debentures, aggregating $80,403, was also converted on such date, at a conversion price of $0.34 per share.  An aggregate of 11,145,570 shares was issued upon conversion of the principal and accrued but unpaid interest on the debentures.

As described above, $3,000,000 of the convertible debentures were converted on April 21, 2009 resulting in an issuance of 10,909,091 shares of common stock. The original conversion price of $0.70 was reduced to $0.275. The remaining $1,000,000 debenture not converted retains the original $0.70 conversion price. Conversion of this debenture at $0.70 would result in the issuance of 1,428,571 shares of common stock. The conversion of the debentures at a reduced conversion price resulted in a non cash debt conversion expense of $596,104 which has been reflected in the consolidated statement of operations

A registration statement covering the resale of the shares underlying the debenture held by Lloyd I. Miller, III, was declared effective in February 2010.

The Company incurred $217,083 in financing costs which were capitalized and are being amortized utilizing an effective interest rate of 7%.  $10,745 in costs has been amortized in the twelve months ended December 31, 2010.  These costs have been included in interest expense. Three quarters of the deferred financing costs of $78,382 were written off to equity on April 21, 2009 when the related debentures were converted. As of December 31, 2010, $2,789 of interest for the fourth debenture remains to be amortized over the life of the debenture.

5.
Acquisition of Vela Pharmaceuticals, Inc.

In March 2006, the Company announced an agreement to acquire Vela Pharmaceuticals, Inc. (“Vela”), which has a Phase II product candidate, Dextofisopam, in development to treat IBS. The Company has dedicated substantial resources to complete clinical development of this product candidate. The Vela acquisition also includes additional compounds in preclinical and/or clinical development for neuropathic pain, inflammation and sexual dysfunction. The final merger agreement, as amended, was approved by the Company’s shareholders on October 25, 2006.
 

 
 
F-12

 
Pharmos Corporation
Notes to Consolidated Financial Statements

Under the amended Merger Agreement, the Company issued 6.5 million shares of common stock and paid $6 million to Vela shareholders at closing. Pharmos also agreed to reimburse Vela for $679,000 of operating expenses from July 1, 2006 through closing. The amended Merger Agreement also includes additional performance-based milestone payments to the Vela stockholders related to the development of Dextofisopam, aggregating up to an additional $5 million in cash and the issuance of up to an additional 9,250,000 shares of Pharmos common stock. None of the milestone conditions were met at December 31, 2009 and December 31, 2010 except for a $1.0 million milestone payment made by Pharmos due upon the study’s commencement which was paid in 2008.

The remaining milestones are as follows:

·             $1 million cash: Final patient enrolled in Phase 2b trial (1)
·             $2 million + 2 million shares: NDA submission
·             $2 million cash +2.25 million shares: FDA approval
·             1 million shares: Approval to market in Europe or Japan
·             4 million shares: $100 million sales of Dextofisopam, when and if approved, in any 12-month period
 
(1) The milestone was reached when the final patient was enrolled in the Dextofisopam Phase 2b trial and was recognized in the first quarter of 2009 as all probability criteria were met. The milestone had two components, a cash portion of $1,000,000 and a share portion of 2,000,000 shares valued at $180,000.  The total charge in the first quarter was $1,180,000. The shares were issued in November 2009 under the terms of the Amendment #3 to the agreement and plan of merger. Under that amendment the payment of the cash portion was deferred until such time as 1) the Company successfully entered into a strategic collaboration or licensing agreement with a third party for the development of Dextofisopam resulting in an upfront cash fee of at least $10 million, and 2) payment of the cash milestone would still leave the Company with one year’s operating cash.

The results of the Phase 2b trial were announced in September 2009 and reported that while there was clearly drug activity, the trial did not achieve its primary endpoints. Under the terms of the Vela acquisition agreement as amended, the 2 million shares were issued on November 2, 2009. The cash portion that was expensed in Q1 2009 was reversed in Q4 2009 since it is not deemed probable that the amended terms would be achieved. To date, the Company has not been able to achieve the requirements stipulated in Amendment #3 noted above. Since the trial results were not successful, no other milestones have been achieved.

6.
Fixed Assets

Fixed assets consist of the following:

   
December 31,
 
   
2010
   
2009
 
 Leasehold improvements 
 
$
158,023
   
$
158,023
 
 Office furniture and fixtures
   
87,229
     
87,229
 
 Computer equipment
   
240,324
     
234,538
 
     
485,576
     
479,790
 
 Less - Accumulated depreciation
   
(479,963
)
   
(478,411
)
 Fixed Assets, net
 
$
5,613
   
$
1,379
 
 
Depreciation of fixed assets was $1,551 and $8,314 in 2010 and 2009, respectively.
 
F-13

 

7.
Grants for Research and Development

During the years the Company operated a facility in Israel, grants were received from the Office of the Chief Scientist in Israel. The Company did not receive any grants since 2007 and with the closure of the Israel location, will not be eligible for further grants.

The agreements with agencies of the State of Israel place certain legal restrictions on the transfer of the technology and manufacture of resulting products outside Israel. The Company will be required to pay royalties, at rates ranging from 3% to 5%, to such agencies from the sale of products, if any, developed as a result of the research activities carried out with the grant funds up to the amount received and interest.

As of December 31, 2010, the total amounts received under such grants amounted to $17,897,830.  Aggregate future royalty payments related to sales of products developed, if any, as a result of these grants are limited to $16,408,890, exclusive of interest, based on grants received through December 31, 2010.

The Company closed its operations in Israel effective October 31, 2008 and has subsequently reconciled and repaid a grant in 2009 that was overpaid. All obligations of the Company have been settled except the requirement to pay royalties should any of the related technologies be licensed out and further developed.

The Company applied for a cash grant under the Federal Qualifying Therapeutic Discovery Project, which was provided under new section 48D of the Internal Revenue Service, as enacted as part of the Patient Protection and Affordable Care Act of 2010. In December the Company received $244,479 under this program.

8.
Shareholders Equity Transactions

2010 Transactions

In the first quarter of 2010, the Company elected to pay the interest on its 10% Convertible Debentures due November 2012 incurred through the fourth interest payment date, January 15, 2010, in common stock to the remaining debenture holder. The dollar amount of interest incurred from July 15, 2009 to January 15, 2010 to be paid in stock amounted to $50,000 which, converted at $0.34 per share, resulted in an aggregate of 147,059 shares issued to the debenture holder.

In the third quarter of 2010, the Company elected to pay the interest on its 10% Convertible Debentures due November 2012 incurred through the fifth interest payment date, July 15, 2010, in common stock to the remaining debenture holder. The dollar amount of interest incurred from January 15, 2010 to July 15, 2010 to be paid in stock amounted to $50,000 which, converted at $0.34 per share, resulted in an aggregate of 147,059 shares issued to the debenture holder.

The Company elected to pay the interest on its 10% Convertible Debenture due November 2012 in common stock. The interest conversion rate is defined as the greater of (i) the average of the five closing prices immediately prior to the applicable interest payment date, (ii) the closing price on the date of a second closing (which did not occur), and (iii) the closing price on the date of the first closing (which was $0.34).