**U.S.
        Securities and Exchange Commission**
 **Washington,
        D.C. 20549**
 **Form
        10-KSB/A**
 **(AMENDMENT
        NO.1)**
 (Mark
        One)
 **[
        X
        ]**  **Annual
        Report Pursuant to Section 13 or 15(d) of the Securities** **Exchange
        Act of 1934 [Fee Required]** For
        the Fiscal Year
        Ended December 31, 2005
 
 **[    
        ]**  **Transition
        Report Under Section 13 or 15(d) of the Securities Exchange** **Act
        of 1934
        [No Fee Required]**
 
 **Commission
        File Number 0-20791**
 
 **AMARILLO
        BIOSCIENCES, INC.**
 **(Name
        of
        small business issuer in its charter)**
 **Texas**
              **75-1974352**(State
                  of
                  other jurisdiction of
              (I.R.S.
                  Employerincorporation
                  or organization)
              Identification
                  No.)
 
 **4134
                  Business Park Drive, Amarillo, Texas**
              **79110-4225**(Address
                  of
                  principal executive offices)
              (Zip
                  Code)
  **Issuer’s
        telephone number, including area code: (806) 376-1741**
  Securities
        registered under Section 12(b) of the Exchange Act:
 None.
 Securities
        registered under Section 12(g) of the Exchange Act:
 Common
        Stock, Par
        Value $.01
 (Title
        of
        class)
 
 Check
        whether the
        issuer is not required to file reports pursuant to Section 13 or 15(d) of
        the
        Exchange Act. [ ]
 
 Check
        whether the
        issuer (1) filed all reports required to be filed by Section 13 or 15(d)
        of the
        Exchange Act during the past 12 months (or for such shorter period that the
        registrant was required to file such reports), and (2) has been subject to
        such
        filing requirements for the past 90 days. Yes X No
 
 Check
        if there is
        no disclosure of delinquent filers in response to Item 405 of Regulation
        S-B in
        this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB.
        [ X ]
 
 Indicate
        by
        checkmark whether the registrant is a shell company (as defined in Rule 12(b)(2)
        of the Exchange Act). Yes _ No
        X  Revenues
          for its
          most recent fiscal year were $178,286.
 
 As
          of December 31,
          2005, there were outstanding 19,801,990 shares of the registrant’s common stock,
          par value $.01, which is the only class of common or voting stock of the
          registrant. As of that date, the aggregate market value of the shares of
          common
          stock held by non-affiliates of the registrant (based on the closing price
          for
          the common stock on the OTC BB.AMAR) was approximately
          $8,514,856.
  1
  **Explanatory
          Note**
 
 This
        Annual Report
        on Form 10-KSB/A is being filed as Amendment Number 1 to our Annual Report
        on
        Form 10-KSB in response to certain requests from the staff of the Securities
        and
        Exchange Commission. We have not restated our consolidated financial statements
        for the periods presented.
  The
        information in
        this amended Form 10-KSB/A includes the following changes to our Annual Report
        on Form 10-KSB which was originally filed with the Securities and Exchange
        Commission (‘‘SEC’’) on April 3, 2006:
 1.
              Item
                  8A has
                  been changed to state that the Company’s accounting firm has not issued an
                  attestation report on the management’s assessment of internal
                  controls;
 2.
              the
                  Report of
                  Independent Registered Public Accounting Firm has been changed
                  to state
                  that the Company’s recurring losses and need to raise additional funds
                  raise substantial doubt about the Company’s ability to continue as a going
                  concern; and
 3.
              the
                  Notes to
                  the Consolidated Financial Statements include additional and expanded
                  disclosure of our accounting policies regarding research grant
                  revenue,
                  stock options granted to non-employees, and related party
                  transactions.
 
 In
        addition, this
        Form 10-KSB/A has been amended to provide currently-dated certifications
        in the
        form required by Item 601(b)(31) of Regulation S-B. These
        certifications are attached to this Form 10-QSB/A as Exhibits 31.1a and
        31.1b.
 
 For
        the convenience
        of the reader, this Form 10-KSB/A sets forth the entire Form 10-KSB which
        was
        prepared and relates to the
        Company as of December 31,
        2005. However, this Form 10-KSB/A only amends and restates the Items described
        above and no attempt has been made to modify or update other disclosures
        presented in our December 31, 2005 Form 10-KSB. Accordingly, except for the
        foregoing amended information, this Form 10-KSB/A continues to speak as of
        April
        3, 2006 (the original filing date of the December 31, 2005 Form 10-KSB),
        and
        does not reflect events occurring after the filing of our December 31, 2005
        Form
        10-KSB and does not modify or update those disclosures affected by subsequent
        events. Forward looking statements made in the December 31, 2005 Form 10-KSB
        have not been revised to reflect events, results or developments that have
        become known to us after the date of the original filing (other than the
        current
        restatements described above), and such forward looking statements should
        be
        read in their historical context. Unless otherwise stated, the information
        in
        this Form 10-KSB/A not affected by such current restatements is unchanged
        and
        reflects the disclosures made at the time of the original
        filing.


2


PART
      I





*The
      following
      contains forward-looking statements that involve risks and uncertainties. The
      Company’s actual results could differ materially from those discussed in the
      forward-looking statements as a result of certain factors, including those
      set
      forth in “Management’s 2006 Plan of Operations” as well as those discussed
      elsewhere in this Form 10-KSB. The following discussion should be read in
      conjunction with the Financial Statements and the Notes thereto included
      elsewhere in this Form 10-KSB.*





ITEM
      1.  DESCRIPTION
      OF
      BUSINESS.





**General**





Amarillo
      Biosciences, Inc. (the “Company” or “ABI”), a Texas corporation formed in 1984,
      is engaged in developing biologics for the treatment of human and animal
      diseases. The Company is currently focusing its research on human health
      indications for the use of low-dose orally administered natural human interferon
      alpha, particularly for the treatment of Sjögren’s syndrome, Behçet’s disease,
      polycythemia vera, essential thrombocythemia, idiopathic pulmonary fibrosis
      and
      oral warts in HIV+ patients. The Company believes that significant worldwide
      opportunities exist for the development of low-dose orally administered natural
      interferon alpha as a cost-effective, non-toxic, efficacious alternative to
      the
      treatment of diseases by injection of high doses of interferon alpha. In
      addition, the Company believes that low-dose orally administered natural human
      interferon alpha will be an effective treatment for diseases or conditions
      for
      which current therapies are inadequate.




The
      Company owns or
      licenses 15 United States patents relating to the use or composition of low-dose
      oral natural interferon alpha and one patent on the dose formulation of our
      dietary supplement. Since 1992, the Company has filed with the U.S. Food and
      Drug Administration (“FDA”), and there now are in effect, 6 Investigational New
      Drug (“IND”) Applications covering indicated uses for low-dose oral interferon
      alpha, including treatment of Behçet’s disease, Sjögren’s syndrome, and oral
      warts in HIV+ patients.




The
      Company’s
      objective is to exploit its proprietary technology to become a leader in the
      field of low-dose oral applications of interferon alpha. The Company’s business
      strategy is to pursue those indications for low-dose oral interferon alpha
      treatment for which initial clinical research has indicated the treatment is
      efficacious and which, in the opinion of the Company, have the greatest
      commercial potential and are most likely to be approved by the FDA. To the
      extent possible, the Company will attempt to minimize the cost to the Company
      of
      obtaining FDA approval by utilizing forms of interferon
      alpha
      already approved (in other dosage forms and for different indications) by the
      Japanese Ministry of Health and Welfare for human or animal use. The Company
      believes that cost savings will result from this strategy. The Company will
      attempt to gain market share for approved products by forming alliances with
      strong marketing partners.  The
        Company has 4
        full-time employees. The Company makes extensive use of consultants in business
        and research and development. Governmental or FDA approval is required on
        the
        Company’s principal products. The Company’s progress toward approval is
        discussed under each specific indication, below.





3





**Human
      Health Applications**





*Sjögren’s
      Syndrome* .
      Sjögren’s
      syndrome is a chronic autoimmune disorder characterized by dryness of the eyes
      and mouth. It can exist as a primary disorder or in association with other
      autoimmune diseases such as rheumatoid arthritis, systemic lupus erythematosus
      and scleroderma. Patients with primary Sjögren’s syndrome may have clinical
      signs such as rash, arthritis, pneumonitis and nephritis. Typical symptoms
      include the sensation of burning in the eyes, difficulty swallowing, painful
      throat, fatigue and dryness of the mouth, skin, nose and vagina. Oral
      candidiasis (a fungal infection of the mouth) may also arise as a result of
      reduced saliva flow. Although Sjögren’s syndrome is not life threatening, it can
      cause extreme discomfort and seriously impair quality of life.




The
      Sjögren’s
      Syndrome Foundation, Inc. estimates that there are approximately two to four
      million people in the United States who suffer from Sjögren’s syndrome. The
      Company believes that the incidence of Sjögren’s syndrome worldwide is similar
      to its incidence in the United States. Women constitute 90% of Sjögren’s
      syndrome patients.




Topical
      use of
      artificial tears is the prevailing treatment for the dry eye symptom of the
      disease. Artificial tears must be used on a regular basis. Intensive oral
      hygiene is prescribed to prevent progressive oral problems that may develop
      as a
      result of the disease. Topical and systemic means of increasing salivary flow
      may provide transient relief of symptoms.




The
      Company
      believes that oral interferon alpha therapy helps to relieve the dryness
      associated with Sjögren’s syndrome, improves secretory function, and may
      effectively supplement, or be used in lieu of existing treatments. The Company
      has completed two 24-week Phase III clinical trials of the use of interferon
      alpha lozenges in the treatment of primary Sjögren’s syndrome. Results of both
      Phase III clinical trials demonstrate an improvement in saliva production in
      treated patients (see Arthritis Care & Research, 49:585-593, 2003). The
      studies were double-blinded, placebo-controlled tests in which a total of 497
      patients were treated three times daily for 24 weeks with a lozenge containing
      either 150 international units (IU) of interferon alpha or a placebo. Analysis
      of participants who completed the trials, designated as evaluable patients,
      found a significant ( *p* =0.01)
      increase in
      unstimulated whole saliva (UWS) production among the interferon alpha treated
      patients, as compared to those who received placebo. Increases in UWS are
      important to the Sjögren’s patient since UWS represents the basal salivary flow
      that is present over 90% of the day.




Importantly,
      in
      interferon alpha treated subjects a significant ( *p* >0.05)
      correlation was seen between increases in UWS and improvement in a number of
      the
      symptoms of Sjögren’s syndrome that were assessed in the study, including oral
      dryness, throat dryness, nasal dryness and the ability to swallow foods. This
      finding suggests that patients were able to perceive a benefit of having
      increased salivary flow.




Because
      UWS was a
      secondary, and not the primary end point of these studies, these promising
      findings did not result in FDA approval. Instead, the FDA suggested that the
      Company sponsor an additional, large-scale Phase III study that would include
      UWS flow as the primary endpoint. Instead, the Company proposed a study designed
      to demonstrate, by biopsy, improvement at the site of disease activity, the
      salivary glands. The Company believes that, if successful, the salivary gland
      study results, along with the beneficial UWS results generated in the twin
      Phase
      III studies, would form a reasonable basis for the approval of oral interferon
      alpha in the treatment of Sjögren’s syndrome. Even though the FDA stated their
      belief that the data package would still be insufficient, the Company plans
      to
      conduct a biopsy study and, if successful, to file for marketing
      approval.







4




*Oral
      Warts in
      HIV+ Patients.* Oral warts are
      lesions in the mouth caused by the human papillomaviruses. In open-label Phase
      I/II clinical studies with 36 patients, complete or partial clearance of oral
      warts was achieved in 71% (5/7) of HIV+ subjects given interferon- a at 1500
      international units (IU) per day. A double-blind, placebo-controlled Phase
      II
      study to confirm and expand these findings is planned for initiation in 2006.
      The Company filed with the FDA Office of Orphan Drugs and was granted (Summer
      2000) orphan drug status for low dose IFN a treatment in this
      condition.




*Behçet’s
      Disease.* Behçet’s disease
      is a severe chronic relapsing inflammatory disorder marked by oral and genital
      ulcers, eye inflammation (uveitis) and skin lesions, as well as varying
      multisystem involvement including the joints, blood vessels, central nervous
      system, and gastrointestinal tract. The oral lesions are an invariable sign,
      occurring in all patients at some time in the disease. Behçet’s disease is found
      world-wide, and is a significant cause of partial or total disability. The
      US
      patient population has been estimated as 15,000. The Company filed with the
      FDA
      Office of Orphan Drugs and was granted (Spring 2000) orphan drug status for
      low
      dose orally administered IFN a treatment in this
      condition. A double-blind, placebo-controlled Phase II trial is planned for
      2006.




At
      the end of
      February, 2006, Martin Cummins, Director of Regulatory and Clinical Affairs
      for
      ABI, visited Nobel Ilac Sanayii Ve Ticaret A.S. He participated in final
      investigatory meetings prior to the enrollment of 90 patients with Behcet’s
      disease in a study of interferon lozenges versus placebo. The treatment
      duration is 12 weeks, with completion of the study expected within a
      year.




*Idiopathic
      Pulmonary Fibrosis* .
      Idiopathic
      Pulmonary Fibrosis (IPF) is a chronic inflammatory fibrotic disorder localized
      to the lower respiratory tract and characterized by an alveolitis dominated
      by
      alveolar macrophages, polymorphonuclear leukocytes (PMNs) and, to a lesser
      extent, lymphocytes and eosinophils. The disease usually presents as dyspnea
      on
      exertion, the chest x-ray shows diffuse reticulonodular infiltrates, and
      analysis of lung function reveals restrictive abnormalities. The disease process
      does not affect the upper or conducting airways, but bronchiolitis of
      respiratory bronchioles may be present and alveolar units are always
      involved.




Normally,
      overlying
      or interspersed in the alveoli are a variety of immune cells, including alveolar
      macrophages, dendritic macrophages, interstitial monocytes, lymphocytes, and
      inflammatory cells, such as PMNs and eosinophils. The cellular content of normal
      bronchial-alveolar lavage (BAL) fluid consists of approximately 80 percent
      alveolar macrophages, 10 percent lymphocytes (of which 70 percent are T
      lymphocytes), 1 to 5 percent B lymphocytes or plasma cells, 1 to 3 percent
      PMNs,
      and 1 percent eosinophils. In the lymphocyte population, the ratio of CD4 T
      helper and CD8 T suppressor/cytotoxic cells is about 1.5.







5


In
      the earliest,
      reversible forms of alveolar injury, “leakiness” of the alveolar type I cells
      and the adjacent capillary endothelial cells occurs, causing alveolar and
      interstitial edema and the formation of intra alveolar hyaline membranes. With
      persistence of the disease, increased alveolar-capillary permeability and
      desquamation of intra-alveolar cells (alveolitis), mural inflammation, and
      interstitial fibrosis are present on biopsy. This process is also reflected
      in
      the composition of cells and enzymes recovered in BAL fluid and in cellular
      components present in lung biopsy tissue. The presence and severity of the
      disease process are spotty in distribution; a continuum of inflammatory and
      fibrotic changes can be found throughout the affected lung. Fibrosis follows
      from an organization of inflammatory exudate within the airspaces in which
      fibroblasts beneath the type I epithelium proliferate and increase their
      production of fibronectin and collagen. Death of the patient usually occurs
      within 4-5 years of diagnosis.




ABI’s
      low-dose
      orally administered interferon alpha is being tested as a treatment for IPF
      under an Advanced Technology Program Grant awarded by the State of Texas to
      the
      Texas Tech University Health Sciences Center in Lubbock. The $100,000 grant
      is
      being used by the Health Science Center to support a pilot study of 20 patients
      with IPF. ABI is collaborating on this research with Lorenz O. Lutherer, MD,
      PhD, professor, physiology, and Cynthia A. Jumper, MD, associate professor
      patient care, internal medicine, and is providing support in the form of study
      drug, data management and biostatistical analysis. A trial of low-dose,
      oral ly
      administered IFNα (150 IU three times daily) has shown minimal to
      no side effects. Subjects are evaluated with pulmonary function tests every
      three months and high resolution computed tomography (HRCT) at yearly intervals.
      Of the 9 subjects who have completed at least one year, the forced vital
      capacity has remained stable in 8 and the oxygen saturation after a 6-minute
      walk has been stable in 7 and improved in 1. One subject showing lack of
      progression has been followed for over 4 years and another for 2 years. The
      8
      subjects whose pulmonary function tests were stable showed no evidence of
      disease progression on HRCT scans. Most subjects who entered the study with
      a
      cough noted marked improvement within the first few weeks of treatment with
      corresponding increases in quality of life scores. These results strongly
      suggest that this regimen can prevent progression according to the criteria
      defined in the International Consensus Statement published by the American
      Thoracic Society.




*Bone
      Marrow
      Disorders.* ABI will commence
      to test low dose oral interferon alpha in forty patients with rare bone marrow
      proliferative disorders. The study will be conducted at a major Texas cancer
      center with a leading medical authority who specializes in the treatment of
      these myeloproliferative disorders. Twenty patients, each with either
      polycythemia vera (PV) or essential thrombocythemia (ET), will be given low
      dose
      oral interferon alpha daily as a treatment to relieve the signs and symptoms
      associated with these disorders.




In
      1997-1998,
      Amarillo Biosciences, in conjunction with the Mayo Clinic, conducted a 48-week
      pilot study in the treatment of PV and ET. Human interferon alpha lozenges
      were
      administered to 7 PV and 6 ET patients. Because of the benefits noted in the
      pilot study, and because so few good treatment alternatives exist, this
      follow-up study is planned to commence in the second quarter of this year.
      The
      first study treated patients once per day, but with more clinical experience
      and
      a better understanding of the mechanism of action of oral interferon, the new
      study will dose patients three times per day.




PV
      and ET are stem
      cell disorders considered to be incurable. Treatment is directed at reducing
      morbidity and preventing life-threatening complications. The clinical course
      of
      both ET and PV are characterized by vasomotor disturbances (headaches,
      dizziness), acral dysesthesia (impaired sensations in limbs, fingers, ears),
      erythromelalgia (diffused redness and atrophy of skin on legs), visual symptoms,
      thrombohemorrahagic (inappropriate clotting) events, and the risk of
      transformation into acute myeloid leukemia or fibrosis of bone marrow.


6




Treatment
      efforts
      in ET strive to reduce clotting events in patients at high-risk for thrombosis
      without increasing the intrinsically low risk of leukemic transformation. All
      patients with PV require phlebotomy (drawing blood), with the goal of reducing
      hematocrit levels (the concentration of red blood cells). This maneuver prolongs
      survival by decreasing, but not abolishing, the risk of thrombosis. The goal
      of
      therapy in PV is not only to prevent thrombosis, but also to reduce the risk
      of
      transformation into acute myeloid leukemia or myelofibrosis.




In
      the previous
      1997-1998 study, treatment response in PV patients was based on changes in
      hematocrit levels and phlebotomy requirement. Four of 7 subjects had a 3 50%
      reduction in
      phlebotomy requirement, compared to the 6 months prior to the study, and
      consequently were considered partial responders. Response in the ET subjects
      was
      based on changes in platelet count. One of 6 subjects experienced normalization
      of platelet count (complete response), 3 were unchanged and 2 experienced a
      progression of disease during interferon alpha lozenge therapy. No deaths or
      serious adverse events occurred in this study.




Patients
      are
      currently being enrolled in a study at M.D. Anderson Cancer Center in Houston,
      Texas,  to
      evaluate
      interferon lozenges  in
      patients with
      the pre-leukemic conditions known as essential thrombocythemia and
      polycythemia vera. The first stage of enrollment should be completed
      by August. Goal of the study is to support and expand on positive
      data ABI generated in treating these conditions at the Mayo
      Clinic.




*Influenza* .
      Warnings have
      been issued that the avian influenza virus presently killing animals and people
      in Asia may become the new strain of pandemic flu which could potentially kill
      millions of people. These warnings have sparked renewed interest in ways to
      treat or prevent influenza. Clinical observations from thousands of influenza
      patients in Russia, Ukraine, Bulgaria, China, and Japan claim significant
      clinical benefits to patients intranasally given low-dose (a few hundred to
      10,000 units) interferon during natural outbreaks of influenza. In contrast,
      in
      experimental influenza virus challenge studies with human volunteers, those
      volunteers given 800,000 to 70 million units of interferon by intranasal
      delivery did not experience a
      clinical benefit. Data generated using low dose interferon was rejected by
      Western scientists because of the impure nature of the interferon used in early
      studies and because the low dose interferon did not seem to make any sense.
      This
      review proposes that the subject of low dose interferon for influenza be
      revisited. Intranasal and oral administration of low-dose interferon deliver
      interferon to the same receptors in the oral-pharyngeal cavity. Low-dose oral
      interferon may represent an inexpensive, safe way to modulate the immune system
      during, or before, influenza infection.




ABI
      has arranged to
      support two animal studies in influenza. In a study planned in Australia and
      another study planned in the USA, mice will be given oral interferon
      or placebo and challenged with mouse-adapted influenza virus. It is the
      Company’s goal to generate animal data to support the human clinical data from
      studies in the former Soviet Union, Bulgaria, Japan and China. In those cases,
      it was reported that orally or intranasally administered interferon
      significantly (P< 0.05) reduced the severity and duration of naturally
      occurring influenza, compared to placebo. With these new animal data to
      supplement the human data, the Company hopes to insert oral interferon into
      the
      debate as to how best to respond to an influenza pandemic.







7


**Strategic
      Alliance with HBL**





Hayashibara
      Biochemical Laboratories, Inc. (“HBL”) was established in 1970 to engage in
      research and development. It is a subsidiary of Hayashibara Company, Ltd.,
      a
      privately-owned Japanese holding corporation with diversified subsidiaries.
      For
      more than 100 years the Hayashibara Company, Ltd. and its predecessors have
      been
      applying microbiological technology in the starch industry for the production
      of
      maltose and other sugars.




In
      1981, HBL
      established the Fujisaki Institute to accelerate development of industrial
      methods for the production of biologics and to sponsor clinical trials for
      such
      products. In 1985, HBL built the Fujisaki Cell Center to support basic research.
      In 1987, HBL successfully accomplished the mass production of human cells in
      an
      animal host by producing human cells in hamsters. This made it possible to
      economically produce a natural form of human interferon alpha and other
      biologics. HBL also has developed and obtained patents for technology relating
      to the production of interferon alpha-containing lozenges by which the stability
      of the interferon alpha activity can be maintained for up to 24 months at room
      temperature and up to five years if the product is refrigerated. The Company
      believes that the use of such lozenges gives it advantages over competitive
      technologies in terms of cost, taste and ease of handling. On March 13, 1992,
      the Company entered into a Joint Development and Manufacturing/Supply Agreement
      with HBL (the “Development Agreement”). Such Development Agreement was
      subsequently amended on January 17, 1996; May 10, 1996; and September 7, 2001.
      The current expiration date of the Development Agreement is March 12, 2008,
      at
      which time it will automatically renew for an additional three (3) years, unless
      the parties agree otherwise. Among other things, the Development Agreement
      provides the Company with a source of natural human interferon alpha for use
      in
      the Company’s interferon alpha-containing products. Additional information on
      the Development Agreement is set forth in footnote 4 to the Consolidated
      Financial Statements attached to this 10-KSB.







**Strategic
      Alliance with Nobel**





The
      Company signed
      a licensing and supply agreement in September 2004 with a leading Turkish
      pharmaceutical company, NOBEL ILAC SANAYII VE TICARET A.S. , providing
      the
      rights to oral low-dose interferon-alpha for the treatment of Behçet’s disease
      in Turkey and in Azerbaijan, Bosnia & Herzegovina, Bulgaria, Croatia,
      Georgia, Kazakhstan, Kyrghyzstan, Macedonia, Romania, Russia, Saudi Arabia,
      Slovenia, Tajikistan, Turkmenistan, Uzbekistan, and Federal Republic of
      Yugoslavia.




The
      license
      agreement covers a territory whose population is approximately 365 million.
      In
      Turkey, where the disease is more than 600 times more prevalent than in the
      United States, there are from 56,000 to 259,000 people who are afflicted with
      the disease, according to a review published in the New England Journal of
      Medicine. The U.S. Food and Drug Administration (FDA) has granted Orphan Drug
      Designation for this product for the clinical indication of Behçet’s Disease to
      Amarillo Biosciences. The Orphan Drug Designation is designed to promote the
      development of treatments for diseases rare in the United States and provides
      certain marketing exclusivity incentives outlined under the Orphan Drug
      Act.




Under
      the terms of
      the agreement, ABI and NOBEL will conduct Behçet’s disease studies in Turkey
      under an Investigating New Drug (IND) Application submitted by ABI to the U.S.
      FDA. U.S. FDA approval will be sought and this FDA approval will be owned by
      ABI, but will be used by NOBEL to seek regulatory approval in each country
      of
      the Territory.





8
  In
      2005, the
      clinical protocol was developed, clinical supplies were made and packaged,
      and
      clinical investigators identified. The first patients will be enrolled in April
      2006.




At
      the end of
      February 2006, Martin Cummins, Director of Regulatory and Clinical Affairs
      for
      ABI, visited Nobel. He participated in final investigatory meetings prior
      to the enrollment of 90 patients with Behcet’s disease in a study of
      interferon lozenges versus placebo. The treatment duration is 12 weeks,
      with completion of the study expected within a year.







**Other
      Agreements**





On
      October 19,
      2005, ABI reached agreement with Global Kinetics of Kent, Washington to become
      the distributor of oral interferon in Cambodia. Global Kinetics’ sales of
      interferon are expected to begin in the first half of 2006. The supply agreement
      between ABI and Global Kinetics on dry mouth relief was terminated.




On
      December 29,
      2005 ABI announced that it had entered into a distribution agreement with
      Bumimedic (M) Sdn. Bhd, a Malaysian pharmaceutical company to market ABI’s
      low-dose interferon (natural human IFN) in Malaysia, Singapore and Brunei.
      Bumimedic will apply for registration to have ABI’s natural human IFN approved
      for sale, following which it will commence marketing the product. The terms
      of
      the agreement call for Bumimedic to manufacture the tablets from ABI’s natural
      human IFN (which is supplied by Hayashibara Biochemical Laboratories), package
      the tablets and distribute them to local hospitals, pharmacies and clinics
      in
      Malaysia, Singapore and Brunei. Pursuant to the agreement, ABI will receive
      a
      series of payments, which will be received in three stages: upon formal
      execution of the distribution agreement, upon regulatory approval, and upon
      registration. ABI will also receive a royalty on the sale of the natural human
      IFN sold. This agreement was made possible through the company’s previously
      announced relationship with Dr. Claus Martin, President and CEO, Gessellschaft Fűr Medizinisch
      and
      Technische Investionen mbH & CoKG. (GMTI), a privately held German venture
      capital group.




In
      2005 the Company
      also entered into various other licensing and supply arrangements which could
      serve as a source of future revenue for the Company; however, none of these
      arrangements are currently contributing in a significant manner to the Company’s
      revenue, and these arrangements are not considered by the Company’s management
      to be material, either individually or in the aggregate.




**Publishing**
 
 A
        manuscript
        entitled “Orally Administered Interferon Alpha has Systemic Effects” was
        published by the American Journal of Veterinary Research, Vol. 166, 164-176,
        2005.


9


**Animal
      Health Application**




There
      is animal
      health approval for low dose oral administration of human interferon alpha
      supplied by Hayashibara Biochemical Laboratories (HBL) in Japan. The product
      was
      launched in Japan in September 2004. Amarillo Biosciences owns the distribution
      rights to HBL interferon for animal health outside Japan and receives a royalty
      on all Japanese HBL interferon sales.





**Patents
      and
      Proprietary Rights**





No
      new patents were
      issued in 2005.





**Cost
      of
      Compliance with Environmental Regulations**





The
      Company
      incurred no costs to comply with environment regulations in 2005.





**Competition**





The
      pharmaceutical
      industry is an expanding and rapidly changing industry characterized by intense
      competition. The Company believes that its ability to compete will be dependent
      in large part upon its ability to continually enhance and improve its products
      and technologies. In order to do so, the Company must effectively utilize and
      expand its research and development capabilities and, once developed,
      expeditiously convert new technology into products and processes, which can
      be
      commercialized. Competition is based primarily on scientific and technological
      superiority, technical support, availability of patent protection, access to
      adequate capital, the ability to develop, acquire and market products and
      processes successfully, the ability to obtain governmental approvals and the
      ability to serve the particular needs of commercial customers. Corporations
      and
      institutions with greater resources than the Company may, therefore, have a
      significant competitive advantage. The Company’s potential competitors include
      entities that develop and produce therapeutic agents for treatment of human
      and
      animal disease. These include numerous public and private academic and research
      organizations and pharmaceutical and biotechnology companies pursuing production
      of, among other things, biologics from cell cultures, genetically engineered
      drugs and natural and chemically synthesized drugs. Almost all of these
      potential competitors have substantially greater capital resources, research
      and
      development capabilities, manufacturing and marketing resources and experience
      than the Company. The Company’s competitors may succeed in developing products
      or processes that are more effective or less costly than any that may be
      developed by the Company, or that gain regulatory approval prior to the
      Company’s products. The Company also expects that the number of its competitors
      and potential competitors will increase as more interferon alpha products
      receive commercial marketing approvals from the FDA or analogous foreign
      regulatory agencies. Any of these competitors may be more successful than the
      Company in manufacturing, marketing and distributing its products. There can
      be
      no assurance that the Company will be able to compete successfully.





10


**Government
      Regulation**





Once
      a new compound
      has been identified in the laboratory, medicines are developed as
      follows:




*Preclinical
      Testing.* A pharmaceutical
      company conducts laboratory and animal studies to show biological activity
      of
      the compound against the targeted disease, and the compound is evaluated for
      safety.




*Investigational
      New Drug Application (“IND”).* After completing
      preclinical testing, a company files an IND with the FDA to begin to test the
      drug in people. The IND becomes effective if the FDA does not disapprove it
      within 30 days. The IND shows results of previous experiments; how, where and
      by
      whom the new studies will be conducted; the chemical structure of the compound;
      how it is thought to work in the body; any toxic effects found in the animal
      studies; and how the compound is manufactured. All clinical trials must be
      reviewed and approved by the Institutional Review Board (“IRB”) where the trials
      will be conducted. Progress reports on clinical trials must be submitted at
      least annually to FDA and the IRB.




*Clinical
      Trials, Phase I.* These tests
      involve about 20 to 80 normal, healthy volunteers. The tests study a drug’s
      safety profile, including the safe dosage range. The studies also determine
      how
      a drug is absorbed, distributed, metabolized and excreted as well as the
      duration of its action.




*Clinical
      Trials, Phase II.* In this phase,
      controlled trials of approximately 100 to 300 volunteer patients (people with
      the disease) assess a drug’s effectiveness.




*Clinical
      Trials, Phase III.* This phase usually
      involves 1,000 to 3,000 patients in clinics and hospitals. Physicians monitor
      patients closely to confirm efficacy and identify adverse events. These numbers
      may be modified based on the disease prevalence.




*New
      Drug
      Application (“NDA”)/Biologics License Application (“BLA”).* Following the
      completion of all three phases of clinical trials, a company analyzes all of
      the
      data and files with FDA an NDA, in the case of a drug product, or a BLA in
      the
      case of a biologic product, if the data successfully demonstrate both safety
      and
      effectiveness. The NDA/BLA contains all of the scientific information that
      the
      Company has gathered. NDA’s typically run 100,000 pages or more. By law, FDA is
      allowed twelve months to review a standard NDA/BLA.




*Approval.* Once FDA approves
      an NDA, the new medicine becomes available for physicians to prescribe. A
      company must continue to submit periodic reports to FDA, including any cases
      of
      adverse reactions and appropriate quality-control records. For some medicines,
      FDA requires additional trials (Phase IV) to evaluate long-term
      effects.







**Research
      and Development**





During
      the years
      ended December 31, 2005 and 2004, the Company incurred expenses of $187,810
      and
      $171,043, respectively, resulting from Company-sponsored research and
      development activities. Research and development is expected to remain a
      significant component of the Company’s business. The Company has arranged for
      others, at their cost, to perform substantially all of its clinical research
      and
      intends to continue to do so while utilizing its staff for monitoring such
      research. See also ITEM 6, “MANAGEMENT’S 2006 PLAN OF OPERATIONS - Research and
      Development”.


11


ITEM
      2.  DESCRIPTION
      OF
      PROPERTY.





The
      Company’s
      executive and administrative offices are located at 4134 Business Park Drive,
      Amarillo, Texas in a 1,800 square-foot facility rented by the Company. The
      building contains offices, and a small warehouse. The Company believes that
      the
      facility is inadequate and larger office space will be sought in the future.





ITEM
      3.  LEGAL
      PROCEEDINGS.





None.





PART
      II





ITEM
      5.  MARKET
      FOR COMMON
      EQUITY AND RELATED SHAREHOLDER MATTERS.





The
      Company is
      presently traded on the OTC Bulletin Board under the symbol AMAR. The range
      of
      high and low bids as quoted on the OTC Bulletin Board for each quarter of 2005
      and 2004 was as follows:





2005
            2004Quarter
            High
            Low
            High
            LowFirst
            $0.58
            $0.29
            $0.44
            $0.27Second
            0.45
            0.31
            0.35
            0.18Third
            0.38
            0.27
            0.32
            0.20Fourth
            0.61
            0.27
            0.38
            0.21





The
      quotations
      reflect inter-dealer bids without retail markup, markdown, or commission, and
      may not represent actual transactions. As of December 31, 2005, the Company
      had
      approximately 1,620 shareholders of record.





During
      2005 there
      were 32 sales of the unregistered common stock of the Company by private
      placement, raising $850,014 in cash. Of those purchases, 8 were by individuals
      who were not accredited investors within the meaning of Rule 501 of Regulation
      D, promulgated under the U.S. Securities Act of 1933, and 24 purchases were
      made
      by accredited investors. Of these sales, 1,380,000 shares were sold for $0.10
      per share; 3,435,000 shares were sold for $0.20 per share; and 113,700 shares
      were sold for $0.22 per share. The foregoing private placements were conducted
      in reliance on Rule 506, promulgated under Section 4(2) of the Securities Act
      of
      1933.





12





The
      following
      shares of the Company were repurchased in 2005:





Shares
                repurchased from the Crowe Estate:
            120
                shares








ITEM
      6.  MANAGEMENT
      DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.





*The
      following
      discussion should be read in conjunction with our financial statements and
      the
      notes thereto which appear elsewhere in this report. The results shown herein
      are not necessarily indicative of the results to be expected in any future
      periods. This discussion contains forward-looking statements based on current
      expectations, which involve uncertainties. Actual results and the timing of
      events could differ materially from the forward-looking statements as a result
      of a number of factors. Readers should also carefully review factors set forth
      in other reports or documents that we file from time to time with the Securities
      and Exchange Commission.*





**Overview**





The
      Company
      continues to engage in research and development activities focused on developing
      biologics for the treatment of human and animal diseases. The Company has not
      commenced any significant product commer-cialization and, until such time as
      it
      does, will not generate significant product revenues. The Company’s accumulated
      deficit has increased, from approximately $22,507,207 at December 31, 2004
      to
      $23,132,394 at December 31, 2005. Operating losses are expected to continue
      for
      the foresee-able future and until such time as the Company is able to attain
      sales levels sufficient to support its operations.




In
      2006 the Company
      will continue its research and development activities, as well as the activities
      necessary to develop commercial partnerships and licenses. The Company’s
      expenditure of financial resources in 2006 will fall princi-pally into five
      broad categories, as follows: Research and Development; Personnel; Consulting
      and Professional (except legal and accounting); Legal and Accounting; and Public
      Relations, Investor Relations and Shareholder Relations. The Company’s
      expectations and goals with respect to these categories are addressed separately
      below, by category.




ABI
      issued 37,994
      unregistered shares of its voting common stock as payment for consulting
      services performed in 2005. Valuation of the stock granted ranged from $0.29
      to
      $0.4467 per share which generated a value of $13,211.







**Liquidity
      and Capital Resources**





At
      December 31,
      2005, the Company had available cash of approximately $193,515, and had a
      working capital deficit of approximately ($2,402,174). Assuming there is no
      decrease in current accounts payable, and accounting for various one-time
      expenses, the Company’s negative cash flow is approximately $39,000 per month.
      The Company’s continued losses and lack of liquidity indicate that the Company
      may not be able to continue as a going concern for a reasonable period of time.
      The Company’s ability to continue as a going concern is dependent upon several
      factors including, but not limited to, the Company’s ability to generate
      sufficient cash flow to meet its obligations on a timely basis, obtain
      additional financing and continue to obtain supplies and services from its
      vendors.


13


The
      Company will
      need to raise additional funds in order to fully execute its 2006 Plan. The
      Company is presently negotiating with human health commercial development
      partners in various regions of the world including the United States, South
      America, China and Southeast Asia. The Company believes that one or more of
      these agreements will be executed during 2006. These agreements could generally
      include provisions for the commercial partner to pay ABI a technology access
      fee, could include payments for a portion of the clinical trial expenses, could
      include payment obligations to ABI upon the accomplishment of certain defined
      tasks and/or could provide for payments relating to the future sales of
      commercial product. These agreements could be an important source of funds
      for
      ABI. However, there can be no assurance that the Company will be successful
      in
      obtaining additional funding from human health commercial development partners
      or private investors. If the Company is not successful in raising additional
      funds, it will need to significantly curtail clinical trial expenditures and
      to
      further reduce staff and administrative expenses and may be forced to cease
      operations.Total outstanding current liabilities decreased to approximately
      $2.6
      million at December 31, 2005, as compared to approximately $2.8 million at
      December 31, 2004.







ITEM
      7.  FINANCIAL
      STATEMENTS.





The
      financial
      statements of the Company are set forth beginning on page F-1 immediately
      following the signature page of this report.





**Critical
      Accounting Policies**




We
      believe the
      following critical accounting policies, among others, affect our more
      significant judgments and estimates used in the preparation of our financial
      statements:





**Accounting
      for Stock-Based Compensation**





The
      Company
      accounts for stock-based compensation based on the provisions of Accounting
      Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” as
      amended by the Financial Accounting Standards Board Interpretation No. 44,
      “Accounting for Certain Transactions Involving Stock Compensation.” Accounting
      Principles Board Opinion No. 25 and Financial Accounting Standards Board
      Interpretation No. 44 state that no compensation expense is recorded for stock
      options or other stock-based awards to employees that are granted with an
      exercise price equal to or above the estimated fair value per share of the
      company’s common stock on the grant date. We adopted the disclosure requirements
      of Statement of Financial Accounting Standards No. 123, “Accounting for
      Stock-Based Compensation,” which requires compensation expense to be disclosed
      based on the fair value of the options granted at the date of the grant.




In
      December 2002,
      the Financial Accounting Standards Board issued its Statement No. 148,
“Accounting for Stock-Based Compensation — Transition and Disclosure—an
      amendment of Financial Accounting Standards Board Statement No. 123.” This
      Statement amends Statement of Financial Accounting Standards No. 123, to provide
      alternative methods of transition for an entity


14





that
      voluntarily
      changes to the fair value based method of accounting for stock-based employee
      compensation. It also amends the disclosure provisions of Statement of Financial
      Accounting Standards No. 123 to require prominent disclosure about the effects
      on reported net income of an entity’s accounting policy decisions with respect
      to stock-based employee compensation. The transition and annual disclosure
      provisions of Statement of Financial Accounting Standards No. 148 are effective
      for fiscal years ending after December 15, 2002, and the interim disclosure
      provisions were effective for the first interim period beginning after December
      15, 2002. We did not voluntarily change to the fair value based method of
      accounting for stock-based employee compensation, therefore, the adoption of
      Statement of Financial Accounting Standards No. 148 did not have a material
      impact on our operations and/or financial position.







**Deferred
      Taxes**





Deferred
      income
      taxes reflect the net tax effects of temporary differences between the carrying
      amounts of assets and liabilities for financial reporting purposes and the
      amounts used for income tax reporting purposes. A valuation allowance of
      $6,989,000 has been recorded to reduce the Company’s deferred tax assets to the
      amount that is more likely than not to be realized. Consideration of estimated
      future taxable income and ongoing tax planning strategies is utilized in
      assessing the amount needed for the valuation allowance. Based on these
      estimates, all deferred tax assets have been reserved. If actual results differ
      favorably from those estimates used, the Company might be able to realize all
      or
      part of our net deferred tax assets. Such realization could positively impact
      operating results and cash flows from operating activities.





***Comparison
      of results for the fiscal year ended December 31, 2005, to the fiscal year
      ended
      December 31, 2004.***





**Revenues** .
      During the fiscal
      year ended December 31, 2005, $42,730 from product sales was generated compared
      to revenues from product sales for the fiscal year ended December 31, 2004,
      of
      $45,389, a decrease of $2,659 or approximately 6%. The decrease is primarily
      due
      to lack of sales of interferon products in 2005.





**Selling** **,
      General
      and Administrative Expenses** .
      Selling, General
      and Administrative expenses of $492,659 were incurred for fiscal year ended
      December 31, 2005, compared to $362,388 for the fiscal year ended December
      31,
      2004, an increase of $130,271. There was $13,212 in non-cash expenses in
      recognition of stock issued to cover services provided by consultants in lieu
      of
      cash.





**Non-Cash
      Consulting Activities** .
      During the year
      ended December 31, 2005, the Board of Directors authorized the issuance of
      shares of restricted common stock to various consultants in lieu of cash
      payments. Based upon the common stock trading price at the times of issuance,
      and FASB rules, a non-cash consulting expense of $13,212 was recorded for the
      issuance of these shares during the year ended December 31, 2005. In addition,
      the Company issued 450,000 options to consultants, to purchase restricted common
      stock in exchange for consulting services. The options are as follows, 250,000
      at $0.01 per share, and 200,000 options at $0.05 per share. These options were
      exercised and the fair market value of the stock sales were stated; 250,000
      shares for $0.01 per share, generating $2,500 in cash and $77,500 in non-cash
      consulting services; and 200,000 shares for $0.05 per share, generating $10,000
      in cash and $60,000 in non-cash consulting services.





15





**Net
      Income
      (Loss)** .
      Net Loss
      applicable to common shareholders for the fiscal year ended December 31, 2005
      was $625,186 compared to a Net Loss of $595,205 for the fiscal year ended
      December 31, 2004.





**RISK
      FACTORS**





*You
      should
      carefully consider the risks described below before making an investment in
      Amarillo Biosciences, Inc.  All of these risks may impair our business
      operations.  If any of the following risks actually occurs our business,
      financial condition or results of operations could be materially adversely
      affected.  In such case, the trading price of our common stock could
      decline, and you may lose all or part of your investment.*





**Risks
      Relating to our Business**





*We
      may not be
      able to adequately protect and maintain our intellectual property.*





Our
      success will
      depend in part on our ability to protect and maintain our patents, intellectual
      property rights and licensing arrangements for our products and technology.
      No
      assurance can be given that licenses or rights used by Amarillo Biosciences,
      Inc. will not be challenged, infringed or circumvented, or that the rights
      granted thereunder will provide competitive advantages to us. Furthermore,
      there
      can be no assurance that we will be able to remain in compliance with our
      existing or future licensing arrangements. Consequently, there may be a risk
      that licensing arrangements are withdrawn with no penalties to the licensee
      or
      compensation to Amarillo Biosciences, Inc.





*We
      rely on
      third parties for the supply, manufacture and distribution of our products.*





Third
      parties
      manufacture and distribute all of our products. We do not currently have
      manufacturing facilities or personnel to independently manufacture our products.
      Currently, Marlyn Nutraceutical manufactures our nutraceutical products. Our
      licensed distributors, in the United States and Internationally distribute
      the
      nutraceutical products. Except for any contractual rights and remedies that
      we
      may have with our manufacturer and our distributor, we have no control over
      the
      availability of our products, their quality or cost or the actual distribution
      of our products. If for any reason we are unable to obtain or retain third-party
      manufacturers and distributors on commercially acceptable terms, we may not
      be
      able to produce and distribute our products as planned. If we encounter delays
      or difficulties with our contract manufacturer in producing or packaging our
      products or with our distributor in distributing our products, the production,
      distribution, marketing and subsequent sales of these products would be
      adversely affected, and we may have to seek alternative sources of supply or
      distribution or abandon or sell product lines on unsatisfactory terms. We may
      not be able to enter into alternative supply, production or distribution
      arrangements on commercially acceptable terms, if at all. There can be no
      assurance that the manufacturer that we have engaged will be able to provide
      sufficient quantities of these products or that the products supplied will
      meet
      with our specifications or that our distributor will be able to distribute
      our
      products in accordance with our requirements.





16





*We
      are
      dependant on certain key existing and future personnel.*





Our
      success will
      depend, to a large degree, upon the efforts and abilities of our officers and
      key management employees such as Joseph M. Cummins, our President, Chief
      Executive Officer and Chief Financial Officer; and Martin J. Cummins, our
      Director of Clinical and Regulatory Affairs. The loss of the services of one
      or
      more of our key employees could have a material adverse effect on our
      operations. We do not currently have employment agreements with any of our
      employees. We do not currently maintain key man life insurance on any of our
      key
      employees. In addition, as our business plan is implemented, we will need to
      recruit and retain additional management and key employees in virtually all
      phases of our operations. We cannot assure that we will be able to successfully
      attract and retain key personnel.





*Our
      growth is
      dependent on our ability to successfully develop, acquire or license new drugs.*





We
      must invest
      substantial time, resources and capital in identifying and developing new drugs,
      dosage and delivery systems, either on our own or by acquiring and licensing
      such products from third parties. Our growth depends, in part, on our success
      in
      such process. Our planned expansion over time is founded on a simple principal
      of introducing two new products or line extensions each year and to expand
      distribution into two new territories each year. This strategy has the advantage
      of building brands through geographic expansion and line extensions, and
      establishing incremental capabilities for new product introductions. We believe
      that our planned expansion will require $5.0 million in total over three years,
      which we intend to fund out of our future revenues and, if necessary, additional
      financing. If we are unable to either develop new products on our own or acquire
      licenses for new products from third parties, our ability to grow revenues
      and
      market share will be adversely affected. In addition, we may not be able to
      recover our investment in the development of new drugs, given that projects
      may
      be interrupted, unsuccessful, not as profitable as initially contemplated or
      we
      may not be able to obtain necessary financing for such development if we are
      unable to fund such development from our future revenues. Similarly, there
      is no
      assurance that we can successfully secure such rights from third parties on
      an
      economically feasible basis.





*We
      may be
      subject to product liability claims in the future.*





We
      face an inherent
      business risk of exposure to product liability claims in the event that the
      use
      of our technologies or products are alleged to have resulted in adverse side
      effects. Side effects or marketing or manufacturing problems pertaining to
      any
      of our products could result in product liability claims or adverse publicity.
      These risks will exist for those products in clinical development and with
      respect to those products that receive regulatory approval for commercial sale.
      Furthermore, although we have not historically experienced any problems
      associated with claims by users of our products, we do not currently maintain
      product liability insurance. We plan to have a product liability insurance
      plan
      in place in 2006; however, there can be no assurance that we will be able to
      acquire product liability insurance with terms that are commercially feasible.








17





**Risks
      Relating to Ownership of Common Stock.**





*There
      may not
      be sufficient liquidity in the market for our securities in order for investors
      to sell their securities.*





There
      is currently
      only a limited public market for our common stock, which is listed on the
      Bulletin Board, and there can be no assurance that a trading market will develop
      further or be maintained in the future.








ITEM
      8.  CHANGES
      IN AND
      DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.





None.








ITEM
      8A.  CONTROLS
      AND
      PROCEDURES.





As
      of December 31,
      2005, the disclosure controls and procedures in place have been evaluated and
      are sufficient to ensure the accurate and full disclosure of financial
      matters.





The
      management of
      the Company is responsible for establishing and maintaining adequate internal
      controls over the financial reporting of the Company. The Company uses the
      following framework to evaluate the effectiveness of the internal controls
      over
      financial reporting:




We
      maintain a
      system of disclosure controls and procedures that are designed to provide
      reasonable assurance that information, which is required to be timely disclosed,
      is accumulated and communicated to management in a timely fashion.




In
      the ordinary
      course of business, we review our system of internal control over financial
      reporting and make changes to our systems and processes to improve controls
      and
      increase efficiency, while ensuring that we maintain an effective internal
      control environment. Changes may include such activities as implementing new,
      more efficient systems and automating manual processes.




An
      evaluation of
      the effectiveness of the design and operation of our disclosure controls and
      procedures was performed as of the end of the period covered by this report.
      This evaluation was performed under the supervision and with the participation
      of management, including our Chief Executive Officer, who is also currently
      the
      Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer
      concluded that our disclosure controls and procedures are effective to provide
      reasonable assurance that information required to be disclosed by the Company
      in
      the reports that it files or submits under the Securities Exchange Act of 1934
      is accumulated and communicated to management, including our Chief Executive
      Officer, to allow timely decisions regarding required disclosure and are
      effective to provide reasonable assurance that such information is recorded,
      processed, summarized and reported within the time periods specified by the
      SEC’s rules and forms.







18





Management
      has
      concluded that internal control over financial reporting was effective as of
      December 31, 2005. The Company’s accounting firm has not issued an attestation
      report on the management’s assessment of the Company’s internal controls. No
      material changes to the Company’s internal controls were made in 2005 and no
      material weaknesses in such controls were found.




ITEM
      8B.  OTHER
      INFORMATION.





The
      matters
      disclosed under PART II, ITEM 5, regarding private placements by the Company
      of
      its securities during 2005, were required to be reported in one or more Form
      8-Ks during 2005, but were not so reported. All such matters required to be
      reported on Forms 8-K during 2005 have been included in ITEM 5 of this Form
      10KSB.





PART
      III





ITEM
      9.  DIRECTORS,
      EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION
      16(a)
      OF THE EXCHANGE ACT.





As
      of December 31,
      2005, the directors and executive officers of the Company were as
      follows:


**Name**
            **Age**
            **Position**Joseph
                Cummins, DVM, PhD (1)(3)
            63
            Chairman
                of
                the Board, President,Chief
                Executive Officer, ChiefFinancial
                Officer and DirectorStephen
                Chen,
                PhD (2)(4)
            56
            DirectorKatsuaki
                Hayashibara (3)(4)(5)
            61
            DirectorDennis
                Moore,
                DVM (1)(4)(5)
            59
            DirectorJames
                Page,
                MD (1)(2)(5)
            78
            Director





The
      following is
      not an executive officer, but is expected by the Company to make a significant
      contribution to the business:


Martin
                J
                Cummins
            38
            Director
                of
                Clinical & Regulatory Affairs





(1)
            Member
                of the Executive Committee.


(2)
            Member
                of the Compensation Committee.


(3)
            Member
                of the Finance Committee.


(4)
            Member
                of the Audit Committee. (5)
            Member
              of the Stock Option Plans Administration
              Committee







*Joseph
      Cummins* has been the
      Chairman of the Board of the Company since he founded it in June 1984. Dr.
      Cummins has also served as President of the Company since December 1994 and
      as
      Chief Financial Officer since October 1998. Dr. Cummins has been conducting
      research on oral cytokines, most particularly interferon alpha, in animals
      and
      humans for 29 years. Dr. Cummins has more than 40 publications and a dozen
      patents that reflect his work in the field of oral interferon. He


received
      a PhD
      degree in microbiology from the University of Missouri in 1978 and a doctor
      of
      veterinary medicine degree from the Ohio State University in 1966.





19





*Stephen
      Chen* has been a
      director of the Company since February 1996. He has been President and Chief
      Executive Officer of STC International, Inc., a health care investment firm,
      since May 1992. From August 1989 to May 1992 he was Director of Pharmaceutical
      Research and Development for the Ciba Consumer Pharmaceuticals Division of
      Ciba-Geigy.





*Katsuaki
      Hayashibara* has been a
      director of the Company since 1994. Mr. Hayashibara was named Director of the
      Overseas Business Development Division of Hayashibara Company, Ltd. in January
      1997. Prior to 1997, Mr. Hayashibara served as Director of Research and
      Development for HBL.





*Dennis
      Moore* has been a
      director of the Company since 1986. Dr. Moore has been a doctor of veterinary
      medicine since 1972 and was in private practice from 1972 to 1995. Since 1995,
      Dr. Moore has been involved in managing his personal investments.





*James
      Page* has been a
      director of the Company since February 1996. Prior to retiring in 1991 as a
      Vice
      President with Adria Laboratories, Inc., a pharmaceutical company specializing
      in therapy given to cancer and AIDS patients, Dr. Page held various upper
      management level positions with Carter Wallace, Inc., Merck Sharpe & Dohme
      Research Laboratories and Wyeth Laboratories.





*Martin
      Cummins* has held several
      positions within the Company since joining the Company full-time in June 1992.
      Mr. Cummins currently oversees all research studies involving human participants
      as Director of Clinical and Regulatory Affairs. Martin Cummins is the son of
      Joseph Cummins.





The
      Company’s
      directors are elected at the annual meeting of shareholders to hold office
      until
      the annual meeting of shareholders for the ensuing year or until their
      successors have been duly elected and qualified. Directors are reimbursed for
      any out-of-pocket expenses in connection with their attendance at meetings.
      In
      the event of the voluntary termination of a recipient’s association with the
      Company as a director, the options must be exercised within 90 days after such
      termination, and in the event they are not so exercised, will
      lapse.





Officers
      are
      elected annually by the Board of Directors and serve at the discretion of the
      Board.





**Audit
      Committee Financial Expert**





The
      Company does
      not have an audit committee financial expert because no one on the board has
      the
      education or experience to qualify as an audit committee financial expert.
      An
      audit committee financial expert is a person who has an understanding of GAAP
      and financial statements; the ability to assess accounting and financial
      principles in connection with the accounting of the Company; experience
      preparing, auditing, analyzing, or evaluating financial statements; an
      understanding of internal controls over financial reporting; and an
      understanding of audit committee functions.





20





**Code
      of
      Ethics**





The
      Company’s Code
      of Ethics may be found on the Company’s website, www.amarbio.com.





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





Section
      16(a) of
      the Securities Exchange Act of 1934, as amended (the “Exchange Act”) requires
      directors and officers of the Company and persons who own more than 10 percent
      of the Company’s common stock to file with the Securities and Exchange
      Commission (the “Commission”) initial reports of ownership and reports of
      changes in ownership of the common stock. Directors, officers and more than
      10
      percent shareholders are required by the Exchange Act to furnish the Company
      with copies of all Section 16(a) forms they file.





To
      the Company’s
      knowledge based solely on a review of the copies of such reports furnished
      to
      the Company, all filings applicable to its directors, officers and more than
      10%
      beneficial owners were timely filed.





ITEM
      10.  EXECUTIVE
      COMPENSATION.





The
      following table
      sets forth for the three years ended December 31, 2005 compensation paid by
      the
      Company to its Chairman of the Board, President and Chief Executive Officer.
      None of the Company’s other executive officers had annual salary and bonus in
      excess of $100,000 for services rendered during any of the three years ended
      December 31, 2005.





**Summary
      Compensation Table**


**Annual
                Compensation**
            **Long
                Term Compensation****Name
                and Principal Position**
            **Year**
            **Salary**
            **Bonus**
            **Other
                Compensation**
            **Securities
                Underlying Options**Dr.
                Joseph M.
                Cummins, Chairman of the Board, President and Chief Executive
                Officer
            2005
            $
                177,000
            $
                -
            $
                -
            600,0002004
            $
                74,716
            $
                -
            $
                -
            650,0002003
            $
                103,779
            $
                -
            $
                -
            490,000








21


**Option
        Grants in 2005**
 
 The
        following table
        sets forth certain information relating to options granted in 2005 to the
        executive officers named above, to purchase shares of common stock of the
        Company.





**Name**
            **Number
                of Shares of Common Stock Underlying Options Granted
                (#)**
            **%
                of
                Total Options Granted to Employees in 2005**
            **Exercise
                or Base Price ($/Sh)**
            **Expiration
                Date**Joseph
                M.
                Cummins
            100,000
            7.7%
            $0.40
                (1)
            02/25/2010500,000
            38.5%
            $0.30
                (1)
            08/22/2010


(1)
            The
                fair market value of the common stock on the date of the
                grant.








**Aggregated
      Option Exercises at December 31, 2005**


**And
      Year-End Option Values**





The
      following table
      sets forth information for the executive officers named above, regarding the
      exercise of options during 2005 and unexercised options held at the end of
      2005.





**Name**
            **Shares
                Acquired on Exercise (#)**
            **Value
                Realized ($)**
            **Number
                of Shares of Common Stock Underlying Unexercised Options
                at**
              **December
                31, 2005 (#) Exercisable/Unexercisable**
            **Value
                of Unexercised In-The-Money Options at December 31, 2005 ($) (1)
                Exercisable/Unexercisable**Joseph
                Cummins
            --
            --
            1,788,486
            None
            $769,049
            None


(1)
            Calculated
                based on the closing price of the common stock ($0.43) as reported
                by OTC
                BB on December 30, 2005.








**Director
      Compensation for Last Fiscal Year**





Cash
                Compensation
            Stock
                Options**Name**
            **Meeting
                Fees (1)**
            **Consulting
                Fees (2)**
            **Number
                of Securities Underlying Options**Stephen
                Chen,
                PhD
            $
                --
            $
                --
            600,000Katsuaki
                Hayashibara
            --
            --
            600,000Dennis
                Moore,
                DVM
            --
            --
            600,000James
                Page,
                MD
            --
            --
            600,000


(1)  Directors
      do not receive compensation for attendance at directors’ meetings.


(2)
            Directors
                may receive up to $1,200 per day, prorated for partial days, for
                employment on special projects or
                assignments.





There
      are no
      employment agreements with any of the executives of the Company.





22





ITEM
      11.  SECURITY
      OWNERSHIP
      OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
      MATTERS





As
      of December 31,
      2005, there were 19,801,990 shares of the Company’s common stock outstanding.
      The following table sets forth as of December 31, 2005, the beneficial ownership
      of each person who owns more than 5% of such outstanding common
      stock:





**Name
                and Address**
            **Amount
                and Nature of Beneficial Ownership**
            **Percent
                of Class Owned**Hayashibara
                Biochemical Laboratories, Inc.2-3
                Shimoishii 1-chomeOkayama
                700,
                Japan
            3,290,781
            17%





The
      following table
      sets forth the beneficial ownership of the Company’s stock as of December 31,
      2005 by each executive officer and director and by all executive officers and
      directors as a group:


**Name
                and Address of Owner**
            **Amount
                and Nature of Beneficial Ownership**
            **Percent
                of Class Owned**Joseph
                Cummins
              2122
                Harrison
              Amarillo,
                TX
                79109
            2,025,0321
            9.4%Dennis
                Moore
              402
                Fish
                Hatchery
              Hamilton,
                MT
                59840
            864,2992
            4.2%Katsuaki
                Hayashibara
              2-3,
                Shimoishii, 1-chome
              Okayama,
                700
                Japan
            912,3653
            4.4%Stephen
                Chen
              Floor
                7-1,
                No. 18
              Xin
                Yi Road,
                Sec. 5
              Taipei,
                Taiwan
            864,1254
            4.2%James
                Page
              103
                Clubhouse
                Lane, #182
              Naples,
                FL
                34105
            864,1255
            4.2%Total
                Group
                (all directors and executive officers - 5 persons)
            5,529,946
            22.2%








23








1 1,788,486 of these shares are exercisable options


2 814,125 of these shares are exercisable options


3 864,125 of these shares are exercisable options


4 814,125 of these shares are exercisable options


5 864,125 of these shares are exercisable options





**Employee
      Stock Option Plan**





The
      Company has an
      employee stock option plan entitled the 1996 Employee Stock Option Plan, which
      has been approved by the shareholders of the Company, and which was amended
      and
      restated effective September 12, 1998, and May 11, 1999, both of said amendments
      and restatements also having been approved by the shareholders of the Company.
      590,000 shares of the Company’s common stock are reserved for issuance under
      said Employee Stock Option Plan; however, none of such options are currently
      outstanding to employees of the Company. Options granted in prior years under
      the Employee Stock Option Plan have either lapsed, or have been exercised in
      full, or have been returned to the Company in exchange for non-qualified stock
      options. However, the Company may grant qualified stock options to employees
      under the Employee Stock Option Plan from time to time in the
      future.





ITEM
      12.  CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS.





The
      Company has
      relied significantly on HBL, the largest shareholder of the Company, for a
      substantial portion of its capital requirements. Pursuant to the Development
      Agreement described at Item 1 of Part 1 above, HBL advanced $9,000,000 for
      funding of research. In addition, HBL has purchased substantial amounts of
      the
      Company’s common stock from time to time, to the point where it now owns 17% of
      the issued and outstanding shares of common stock of the Company. HBL loaned
      $1
      million to the Company on November 30, 1999 and an additional $1 million on
      February 29, 2000, both loans bearing interest at 4.5% per annum. The November
      30, 1999 loan has been extended until December 2006 and the February 29, 2000
      loan has been extended to February 29, 2007. The aggregate balance on both
      notes
      at December 31, 2005, including principal and accrued interest, was $2,510,701.
      In addition to the above, HBL and the Company are parties to various license
      and
      manufacturing and supply agreements pursuant to which the Company licenses
      certain technology to or from HBL. HBL supplies formulations of its interferon
      alpha and other products to the Company.





During
      2005, the
      Company used the law firm of SandersBaker, P.C. Mr. Edward Morris, Secretary
      of
      the Company is a partner in that firm. The Company was invoiced $20,354 by
      said
      firm in 2005.





All
      future
      transactions and loans between the Company and its officers, directors and
      5%
      shareholders will be on terms no less favorable to the Company than could be
      obtained from independent third parties. There can be no assurance, however,
      that future transactions or arrangements between the Company and its affiliates
      will be advantageous, that conflicts of interest will not arise with respect
      thereto or that if conflicts do arise, that they will be resolved in favor
      of
      the Company.





24





ITEM
      13.  EXHIBITS





**EXHIBIT
      INDEX**





3.1†
            Restated
                Articles of Incorporation of the Company, dated June 22,
                1999.3.3*
            Bylaws
                of the
                Company.4.1*
            Specimen
                Common Stock Certificate.4.2*
            Form
                of
                Underwriter's Warrant.10.2*
            License
                Agreement dated as of March 22, 1988 between the Company and The
                Texas
                A&M University System.10.5*
            Joint
                Development and Manufacturing/Supply Agreement dated March 13, 1992
                between the Company and HBL, as amended.10.7*
            Japan
                Animal
                Health License Agreement dated January 20, 1993 between the Company
                and
                HBL.10.11*
            Manufacturing/Supply
                Agreement dated June 1, 1994 between the Company and
                HBL.10.12*
            Settlement
                Agreement dated April 27, 1995 among the Company, ISI, Pharma Pacific
                Management Pty. Ltd. ("PPM"), Pharma Pacific Pty. Ltd., Pharma Pacific
                Ltd. and Fernz Corporation Limited.10.14*
            PPM/ACC
                Sublicense Agreement dated April 27, 1995 between PPM and the
                Company.10.18*
            Form
                of
                Consulting Agreement between the Company and the
                Underwriter.10.20†
            1996
                Employee
                Stock Option Plan, Amended and Restated as of May 11,
                1999.10.21†
            Outside
                Director and Advisor Stock Option Plan, Amended and Restated as of
                May 11,
                1999.10.22*
            Form
                of
                Indemnification Agreement between the Company and officers and directors
                of the Company.10.23*
            Indemnification
                Agreement between HBL and the Company.10.26**
            License
                Agreement dated July 22, 1997 between Hoffmann-La Roche, Inc. and
                the
                Company.10.27**
            Distribution
                Agreement dated January 12, 1998 between Global Damon Pharmaceutical
                and
                the Company.10.28**
            Distribution
                Agreement dated September 17, 1997 between HBL and the Company (tumor
                necrosis factor-alpha).10.29**
            Distribution
                Agreement dated September 17, 1997 between HBL and the Company (interferon
                gamma).10.30***
            Amendment
                No.
                1 dated September 28, 1998 to License Agreement of March 22, 1988
                between
                The Texas A&M University System and the Company.10.36††
            License
                Agreement dated February 1, 2000 between Molecular Medicine Research
                Institute and the Company (interferon gamma administered
                orally).





25








10.37††a
            License
                and
                Supply Agreement dated April 3, 2000 with Key Oncologics (Pty) Ltd.
                and
                the Company.10.38††
            Amendment
                No.
                1 dated April 4, 2000, to Interferon Gamma Distribution Agreement
                dated
                September 17, 1997 between HBL and the Company (interferon
                gamma).10.39††a
            License
                and
                Supply Agreement dated April 25, 2000 between Biopharm for Scientific
                Research and Drug Industry Development and the Company.10.40††a
            Sales
                Agreement dated May 5, 2000 between Wilke Resources, Inc. and the
                Company.10.41††
            Engagement
                Agreement dated September 26, 2000 between Hunter Wise Financial
                Group,
                LLC and the Company.10.42††a
            Supply
                Agreement (Anhydrous Crystalline Maltose) dated October 13, 2000
                between
                Hayashibara Biochemical Laboratories, Inc. and the
                Company.10.43††a
            Supply
                Agreement dated December 11, 2000 between Natrol, Inc. and the
                Company.10.44†††a
            License
                Agreement dated September 7, 2001 between Atrix Laboratories, Inc.
                and the
                Company.10.45††††a
            Supply
                Agreement dated June 20, 2004 between Global Kinetics, Inc. and the
                Company.10.46††††a
            License
                and
                Supply Agreement dated September 13, 2004 between Nobel ILAC SANAYII
                VE
                TICARET A.S. and the Company.10.47a
            License
                and
                Supply Agreement dated October 19, 2005 between Global Kinetics,
                Inc. and
                the Company.10.48a
            License
                and
                Supply Agreement dated January 18, 2006, between Bumimedic (Malaysia)
                SDN.
                BHD., and the Company.21.
            Subsidiaries
                of the Company. The following sets forth the name and jurisdiction
                of
                incorporation of each subsidiary of the Company. All of such subsidiaries
                are wholly-owned by the Company.**Name**
            **Jurisdiction
                of Incorporation****Vanguard
                Biosciences, Inc.**
            **Texas****Veldona
                Africa, Inc.**
            **Texas****Veldona
                Poland, Inc.**
            **Texas****ABI
                Taiwan, Inc.**
            **Texas****Amarillo
                Cell of Canada, Inc.**
            **Texas**




26





99.1  906
        Certification
 *The
        Exhibit is incorporated by reference to the exhibit of the same number to
        the
        Company's Registration Statement on Form SB-2 filed with and declared effective
        by the Commission (File No. 333-4413) on August 8, 1996.
 **The
        Exhibit is incorporated by reference to the Company's 1997 Annual Report
        on Form
        10-KSB filed with the Commission on or before March 31, 1998.
 ***The
        Exhibit is incorporated by reference to the Company's 1998 Annual Report
        on Form
        10-KSB filed with the Commission on or before March 31,
        1999.


†
      The Exhibit is incorporated by reference to the Company's Report on Form 10-QSB
      for the quarterly period ended June 30, 1999, filed with the Commission on
      August 12, 1999 and subsequently amended on September 13, 1999.


††
      The Exhibit is incorporated by reference to the Company's 2000 Annual Report
      on
      Form 10-KSB filed with the Commission on or before April 16, 2001.


†††
      The Exhibit is incorporated by reference to the Company's Report on Form 8-K
      filed with the Commission on September 24, 2001.


††††
      The Exhibit is incorporated by reference to the Company's 2004 Annual Report
      on
      Form 10-KSB filed with the Commission on or before April 15, 2005.


a Portions
      of this exhibit have been omitted and filed separately with the
      commission.





ITEM
      14.  PRINCIPAL
      ACCOUNTANT FEES AND SERVICES





The
      following
      summarizes the fees incurred by the Company during 2004 and 2005 for accountant
      and related services.





**Audit
                Fees****2005**
            **2004****Malone
                & Bailey, PLLC**
            
            **$15,000****Lopez,
                Blevins, Bork & Assoc. LLP**
            **$17,875**
            **$
                3,500**








**Audit-Related
                Fees****2005**
            **2004****Johnson
                & Sheldon**
            **$465**
            **$575**





**Tax
                Fees****2005**
            **2004****Johnson
                & Sheldon**
            **$2,750**
            **$2,100**











27





**All
        Other
        Fees**
 
 None.
 
 **Accountant
        Approval Policy**
 
 Before
        an
        accountant is engaged by the Company to perform audit or non-audit services,
        the
        accountant must be approved by the Company’s Audit Committee.
   28
 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.





AMARILLO
                BIOSCIENCES, INC.Date:January 3,
                2007
            By:/s/
                Joseph M.
                Cummins
              Joseph
                M.
                Cummins, Chairman of the Board, President, and Chief Executive OfficerDate: 
              January 3, 2007
            By:
                /s/ Gary
                Coy
              Gary
                Coy, Vice
                President and Chief Financial
                Officer





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/
                Joseph M.
                Cummins
            Chairman
              of
              the Board,President,
              Director andChief
              Executive Officer
            January
                3,
                2007Joseph
              M.
              Cummins/s/
                Stephen
                T. Chen
            Director
            January
                3,
                2007Stephen
                T.
                Chen/s/
                James A.
                Page
            Director
            January
                3,
                2007James
                A.
                Page/s/
                Dennis
                Moore
            Director
            January
                3,
                2007Dennis
                MooreThomas
                D'Alonzo
            DirectorThomas
                Ulie
            Director








29





Amarillo
        Biosciences, Inc. and Subsidiaries
 
 Consolidated
        Financial Statements
 
 Year
        ended December
        31, 2005
 
 
 
 **Contents**
 
 
 Report
                  of
                  Independent Registered Public Accounting Firm
              F-1Audited
                  Consolidated Financial StatementsConsolidated
                  Balance Sheet
              F-2Consolidated
                  Statements of Operations
              F-3Consolidated
                  Statements of Stockholders’ Deficit
              F-4Consolidated
                  Statements of Cash Flows
              F-5Notes
                  to
                  Consolidated Financial Statements
              F-6
  
  
 Report
        of
        Independent Registered Public Accounting Firm
 
 The
        Board of
        Directors
 Amarillo
        Biosciences, Inc.
 
 We
        have audited the
        accompanying consolidated balance sheet of Amarillo Biosciences, Inc. and
        subsidiaries as of December 31, 2005, and the related consolidated statements
        of
        operations, stockholders' deficit and cash flows for each of the two years
        then
        ended. These financial statements are the responsibility of the Company's
        management. Our responsibility is to express an opinion on these financial
        statements based on our audits.
 
 We
        conducted our
        audits in accordance with the standards of the Public Company Accounting
        Oversight Board (United States). Those standards require that we plan and
        perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. An audit includes examining,
        on a
        test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used
        and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audits provide a
        reasonable basis for our opinion.
 
 In
        our opinion,
        based on our audits, the financial statements referred to above present fairly,
        in all material respects, the consolidated financial position of Amarillo
        Biosciences, Inc. and subsidiaries as of December 31, 2005, and the consolidated
        results of their operations and their cash flows for each of the two years
        then
        ended, in conformity with accounting principles generally accepted in the
        United
        States of America.
 
 As
        discussed in
        Note 1 to the financial statements, the Company's recurring losses from
        operations and the need to raise additional financing in order to execute
        its
        2006 Plan raise substantial doubt about its ability to continue as a going
        concern. (Management's plans as to these matters are also described in Note
        1.)
        The 2005 financial statements do not include any adjustments that might result
        from the outcome of this uncertainty.
 
 LOPEZ,
        BLEVINS,
        BORK & ASSOCIATES, LLP
 Houston,
        Texas
 March
        27,
        2006
  F-1
  Amarillo
        Biosciences, Inc. and Subsidiaries
 Consolidated
        Balance Sheet
 December
        31,
        2005
 
 **Assets**Current
                    assets:Cash
                
                $
                193,315Other current assets
                
                
                2,788Total
                    current assets
                
                
                196,103Equipment,
                    net
                
                
                725Patents,
                    net of accumulated amortization of $191,789
                
                
                118,907Total
                    assets
                
                $
                315,735**Liabilities
                    and Stockholders' Deficit**Current
                    liabilities:Accounts payable
                
                $
                41,513Accrued interest expense
                
                
                510,701Notes payable, including notes payable to stockholder
                
                
                2,093,500Total
                    current liabilities
                
                
                2,645,714Total
                    Liabilities
                
                
                2,645,714Commitments
                    and contingenciesStockholders'
                    deficitPreferred stock, $.01 par value:Authorized shares - 10,000,000Issued shares - none
                
                
                -Common stock, $.01par value:Authorized shares - 50,000,000Issued shares - 19,801,870
                
                
                198,019Additional paid-in capital
                
                
                20,648,219Accumulated deficit
                
                
                (23,176,217
                )Total
                    stockholders' deficit
                
                
                (2,329,979
                )Total
                    liabilities and stockholder's deficit
                
                $
                315,735
 *See
        accompanying summary of significant accounting policies and notes to
        consolidated financial statements.*
  F-2
  Amarillo
        Biosciences, Inc. and Subsidiaries
 Consolidated
        Statements of Operations
 Years
                      ended December 31,2005
                  
                  
                  2004Revenues:Dietary supplement sales
                  
                  $
                  42,730
                  
                  $
                  35,899Interferon sales
                  
                  
                  -
                  
                  
                  9,490Federal research grant
                  
                  
                  44,349
                  
                  
                  -Royalty revenue
                  
                  
                  67,486
                  
                  
                  -Other
                  
                  
                  -
                  
                  
                  6,117Total
                      Revenues
                  
                  
                  154,565
                  
                  
                  51,506Expenses:Cost of sales
                  
                  
                  22,456
                  
                  
                  14,949Research and development expenses
                  
                  
                  187,810
                  
                  
                  171,043Selling, general and administrative expenses
                  
                  
                  492,659
                  
                  
                  362,388Interest expense
                  
                  
                  120,651
                  
                  
                  98,331Total
                      Expenses
                  
                  
                  823,576
                  
                  
                  646,711Net
                      income (loss)
                  
                  $
                  (669,011
                  )
                  $
                  (595,205
                  )Basic
                      and diluted net income (loss) per share
                  
                  $
                  (0.04
                  )
                  $
                  (0.05
                  )Weighted
                      average shares outstanding
                  
                  
                  16,495,678
                  
                  
                  12,446,690
  *See
        accompanying summary of significant accounting policies and notes to
        consolidated financial statements.*
  F-3
 
  Amarillo
          Biosciences, Inc. and Subsidiaries
 Consolidated
          Statements of Stockholders’ Deficit
 Years
          Ended December 31, 2005 and 2004
  Common
                    Stock
                
                
                Additional
                    Paid in Capital
                
                
                Accumulated
                    Deficit
                
                
                Total
                    Stockholders' DeficitIssuance
                    Price
                
                
                Shares
                
                
                AmountBalance
                    at December 31, 2003
                
                
                
                
                
                11,060,017
                
                $
                110,600
                
                $
                19,279,417
                
                $
                (21,912,001
                )
                $
                (2,521,984
                )Net
                    loss for year ended December 31, 2004
                
                
                
                
                
                -
                
                
                -
                
                
                -
                
                
                (595,205
                )
                
                (595,205
                )Issuance
                    of common stock for services
                
                
                0.2033-0.350
                
                
                47,380
                
                
                474
                
                
                13,486
                
                
                -
                
                
                13,960Issuance
                      of common stock for cash in privateplacements
                
                
                0.10-0.13
                
                
                2,576,385
                
                
                25,764
                
                
                245,166
                
                
                -
                
                
                270,930Issuance
                    of common stock for debt
                
                
                0.37
                
                
                100,000
                
                
                1,000
                
                
                36,000
                
                
                -
                
                
                37,000Exercise
                    of options for service
                
                
                0.20-0.21
                
                
                450,000
                
                
                4,500
                
                
                87,500
                
                
                -
                
                
                92,000Exercise
                    of options for cash
                
                
                0.06
                
                
                151,514
                
                
                1,515
                
                
                7,576
                
                
                -
                
                
                9,091Balance
                    at December 31, 2004
                
                
                
                
                
                14,385,296
                
                
                143,853
                
                
                19,669,145
                
                
                (22,507,206
                )
                
                (2,694,208
                )Net
                    loss for year ended December 31, 2005
                
                
                
                
                
                -
                
                
                -
                
                
                -
                
                
                (669,011
                )
                
                (669,011
                )Issuance
                    of common stock for services
                
                
                0.29-0.4467
                
                
                37,994
                
                
                380
                
                
                12,832
                
                
                -
                
                
                13,212Issuance
                      of common stock for cash in privateplacements
                
                
                0.20-0.22
                
                
                4,928,700
                
                
                49,287
                
                
                800,702
                
                
                -
                
                
                849,989Exercise
                    of options for service
                
                
                0.32-0.35
                
                
                450,000
                
                
                4,500
                
                
                145,500
                
                
                -
                
                
                150,000Issuance
                    of warrants in connection with debt
                
                
                
                
                
                -
                
                
                -
                
                
                20,105
                
                
                -
                
                
                20,105Purchase
                    and retirement of common stock
                
                
                0.55
                
                
                (120
                )
                
                (1
                )
                
                (65
                )
                
                
                
                
                (66
                )Balance
                    at December 31, 2005
                
                
                
                
                
                19,801,870
                
                $
                198,019
                
                $
                20,648,219
                
                $
                (23,176,217
                )
                $
                (2,329,979
                )
  *See
        accompanying summary of significant accounting policies and notes to
        consolidated financial statements.*
 
 F-4
  Amarillo
        Biosciences, Inc. and Subsidiaries
 Consolidated
        Statements of Cash Flows
 
 **Years
                    ended December 31,****Operating
                    Activities**
                
                
                **2005**
                
                
                **2004**Net
                    income (loss)
                
                $
                (669,011
                )
                $
                (595,205
                )Adjustments
                    to reconcile net income (loss) to net cash provided by (used
                    for)
                    operating activities:Depreciation and amortization
                
                
                12,439
                
                
                29,041Common stock issued for services
                
                
                150,712
                
                
                105,960Issuance
                    of warrants in connection with debt
                
                
                20,105Changes in operating assets and liabilities:Other current assets
                
                
                (1,953
                )
                
                4,737Accounts payable
                
                
                (120,381
                )
                
                18,490Accrued expenses
                
                
                (47,302
                )
                
                108,925Net
                    cash used in operating activities
                
                
                (655,391
                )
                
                (328,052
                )**Investing
                    Activities**Patents
                
                
                -
                
                
                (3,486
                )Net
                    cash provided by (used in) investing activities
                
                
                -
                
                
                (3,486
                )**Financing
                    Activities**Proceeds
                    from notes payable
                
                
                -
                
                
                20,000Proceeds
                    from excersise of options
                
                
                12,500
                
                
                -Repayments
                    of notes payable
                
                
                (20,000
                )
                
                (10,500
                )Purchase
                    and retirement of common stock
                
                
                (66
                )
                
                -Issuance
                    of common stock
                
                
                849,989
                
                
                317,021Net
                    cash provided by financing activities
                
                
                842,423
                
                
                326,521Net
                    increase (decrease) in cash
                
                
                187,032
                
                
                (5,017
                )Cash
                    at beginning of period
                
                
                6,283
                
                
                11,300Cash
                    at end of period
                
                $
                193,315
                
                $
                6,283**Supplemental
                    Cash Flow Information**Cash
                    paid for interest
                
                $
                36,967
                
                $
                5,542
 
 *See
        accompanying summary of significant accounting policies and notes to
        consolidated financial statements.*  F-5
 Amarillo
        Biosciences, Inc. and Subsidiaries
 Notes
        to Consolidated Financial Statements
 December
        31,
        2005
  **1.
        Organization and Summary of Significant Accounting
        Policies**
 
 **Organization
        and Business**
 
 Amarillo
        Biosciences, Inc. (the "Company" or "ABI"), a Texas corporation formed in
        1984,
        is engaged in developing biologics for the treatment of human and animal
        diseases. The Company is continuing its clinical studies as part of the process
        of obtaining regulatory approval from the United States Food and Drug
        Administration ("FDA"), so that commercial marketing can begin in the United
        States. The Company has developed a dietary supplement and an interferon
        alpha
        lozenge, but have not commenced any significant product commercialization
        activities.
 
 The
        Company's
        viability is dependent upon successful commercialization of products resulting
        from its research and product development activities. The Company plans on
        working with commercial development partners in the United States and in
        other
        parts of the world to provide the necessary sales, marketing and distribution
        infrastructure to successfully commercialize the interferon alpha product
        for
        both human and animal applications. All of the Company's products will require
        significant additional development, laboratory and clinical testing and
        investment prior to the Company obtaining regulatory approval to commercially
        market its product(s). Accordingly, for at least the next few years, the
        Company
        will continue to incur research and development and general and administrative
        expenses and may not generate sufficient revenues from product sales to support
        its operations.
 
 The
        Company has
        been dependent upon financing from its stockholders. The Company’s activities
        have been financed primarily through the issuance of common stock, and under
        an
        agreement with a major stockholder, and its initial public
        offering.
 
 The
        Company’s 2006
        Plan of Operations calls for the Company to expend approximately $5 million
        in
        2006. At December 31, 2005, the Company had available cash of $193,315 and
        negative working capital of approximately ($2,402,174). The Company’s continued
        losses and lack of liquidity indicate that the Company may not be able to
        continue as a going concern for a reasonable period of time. The Company’s
        ability to continue as a going concern is dependent upon several factors
        including, but not limited to, the Company’s ability to generate sufficient cash
        flows to meet its obligations on a timely basis, obtain additional financing
        and
        continue to obtain supplies and services from its vendors. The Company will
        need
        to raise additional funds in order to execute its 2006 Plan. The Company
        is
        presently negotiating with human health commercial development partners in
        various regions of the world including the United States, China, South America
        and Southeast Asia. The Company believes that one or more of these agreements
        will be executed during 2006. These agreements could generally include
        provisions for the commercial partner to pay ABI a technology access fee,
        could
        include payments for a portion of the clinical trial expenses, could include
        payment obligations to ABI upon the accomplishment of certain defined tasks
        and/or could provide for payments relating to the future sales of commercial
        product. These agreements could be an important source of funds for ABI.
        However, there can be no assurance that the Company will be successful in
        obtaining additional funding from either human health and animal health
        commercial development partners or private investors. If the Company is not
        successful in raising additional funds, it will need to significantly curtail
        clinical trial expenditures and to further reduce staff and administrative
        expenses and may be forced to cease operations.
 
 F-6
 Amarillo
          Biosciences, Inc. and Subsidiaries
 Notes
          to Consolidated Financial Statements
 December
          31,
          2005
  Principles
        of Consolidation
 
 The
        accompanying
        consolidated financial statements include the accounts of the Company and
        its
        wholly-owned subsidiaries, Amarillo Cell of Canada, Inc., Veldona Africa,
        Inc.,
        Veldona Poland, Inc., Vanguard Biosciences, Inc. and ABI Taiwan, Inc. (all
        Texas
        corporations). All significant intercompany balances and transactions have
        been
        eliminated in consolidation. The effect of translation of foreign currencies
        is
        not material.
 
 **Fair
        Value
        of Financial Instruments**
 
 The
        Company's
        financial instruments consist of cash and cash equivalents, receivables and
        debt. The carrying amount of these financial instruments approximates fair
        value
        due either to length of maturity or interest rates that approximate prevailing
        market rates unless otherwise disclosed in these consolidated financial
        statements.
 
 **Recent
        Accounting Pronouncements**
 
 In
        December 2004,
        the FASB, issued a revision to SFAS 123, also known as SFAS 123R, that amends
        existing accounting pronouncements for share-based payment transactions in
        which
        an enterprise receives employee and certain non-employee services in exchange
        for (a) equity instruments of the enterprise or (b) liabilities that
        are based on the fair value of the enterprise’s equity instruments or that may
        be settled by the issuance of such equity instruments. SFAS 123R eliminates
        the
        ability to account for share-based compensation transactions using APB 25
        and
        generally requires such transactions be accounted for using a fair-value-based
        method. SFAS 123R’s effective date would be applicable for awards that are
        granted, modified, become vested, or settled in cash in interim or annual
        periods beginning after June 15, 2005. SFAS 123R includes three transition
        methods: one that provides for prospective application and two that provide
        for
        retrospective application. The Company adopted SFAS 123R commencing in the
        third
        quarter of the fiscal year ending December 31, 2005. It is expected that
        the adoption of SFAS 123R will cause the Company to record, as expense each
        quarter, a non-cash accounting charge approximating the fair value of such
        share
        based compensation meeting the criteria outlined in the provisions of SFAS
        123R.
 
 F-7
  Amarillo
        Biosciences, Inc. and Subsidiaries
 Notes
        to Consolidated Financial Statements
 December
        31,
        2005
  **Long-lived
        Assets**
 
 Fixed
        assets are
        stated on the basis of historical cost less accumulated depreciation.
        Depreciation is provided using the straight-line method over the two to five
        year estimated useful lives of the assets.
 
 Impairment
        losses
        are recorded on long-lived assets used in operations when indicators of
        impairment are present and the undiscounted cash flows estimated to be generated
        by those assets are less than the assets' carrying amount. No impairment
        losses
        have been recorded since inception.
 
 **Patents;
        Patent Expenditures**
 
 ABI
        holds patent
        license agreements and also holds patents which are owned by the Company.
        All
        patent license agreements remain in effect over the life of the underlying
        patents. Accordingly, the patent license fee is being amortized over 15-17
        years
        using the straight-line method. Patent fees and legal fees associated with
        the
        issuance of new owned patents are capitalized and amortized over 15-17 years. Amortization
        expense amounted to $12,379 and $19,321 for the years ended December 31,
        2005
        and 2004, respectively.
 
 **Income
        Taxes**
 
 The
        asset and
        liability approach is used to account for income taxes by recognizing deferred
        tax assets and liabilities for the expected future tax consequences of temporary
        differences between the carrying amounts and the tax bases of assets and
        liabilities. The Company records a valuation allowance to reduce the deferred
        tax assets to the amount that is more likely than not to be
        realized.
 
 **Revenue
        Recognition**
 
 *Dietary
        supplement and interferon sales*
 
 Revenues
        for the
        dietary supplement sales are recognized when an arrangement exists, the price
        is
        fixed and it has been determined that collectibilty is reasonably assured.
        This
        generally occurs at the point when the goods are shipped to the
        customer,
 
 *Federal
        research grant*
 
 The
        Company was
        awarded a research grant in May 2005 by the National Institute of
        Health, Small Business Innovation Research Program (“NIH”). The funded research
        has been subcontracted to Ohio State University (“OSU”) by the Company. Revenue
        is recognized by the Company as earned and collectability is reasonably assured.
        Revenue is earned under the grant with NIH as qualified research costs are
        incurred. Costs are recognized by the Company on an ongoing basis as incurred
        by
        OSU and invoiced to the Company.
 
 F-8
 Amarillo
          Biosciences, Inc. and Subsidiaries
 Notes
          to Consolidated Financial Statements
 December
          31,
          2005
 *Royalty
        revenue*
 
 Royalty
        revenue is
        calculated based on a percent of sales relating to a license. Amarillo
        recognized revenue on these royalties in the month the revenue is generated
        by
        the licensee.
 
 **Research
        and Development**
 
 Research
        and
        development costs are expensed as incurred.
  **Use
        of
        Estimates**
 
 The
        preparation of
        financial statements in conformity with accounting principles generally accepted
        in the United States of America requires management to make estimates and
        assumptions that affect the reported amounts of assets and liabilities and
        disclosure of contingent assets and liabilities at the date of the financial
        statements and the reported amounts of revenues and expenses during the
        reporting period. Actual results could differ from those estimates.
 
 **Stock
        Options**
 
 The
        Company
        accounts for its employee stock-based compensation plans under Accounting
        Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to
        Employees. There were 520,000 options granted to purchase common stock in
        the
        three months ended March 31, 2005, with an exercise price of $0.40 per share
        with a 5 year term. No options were granted in the three month period ending
        June 30, 2005. During the three month period ending September 30, 2005 there
        were 3,400,000 options granted to purchase common stock, with an exercise
        price
        of $0.30 per share with a 5 year term. These options vest immediately. No
        options were granted in the three month period ending December 31,
        2005.
 
 F-9
 
 Amarillo
        Biosciences, Inc. and Subsidiaries
 Notes
        to Consolidated Financial Statements
 December
        31,
        2005






The
      following table
      illustrates the effect on net loss and net loss per share if Amarillo had
      applied the fair value provisions of FASB Statement No. 123, Accounting for
      Stock-Based Compensation, to stock-based employee compensation.





For
                  the Year Ended December 31,2005
              
              
              2004Net loss, as reported
              
              $
              (625,186
              )
              $
              (595,205
              )Less: stock based compensation determined
                  under fair value based method
              
              $
              (984,339
              )
              $
              (360,199
              )Pro forma net loss
              
              $
              (1,609,525
              )
              $
              (955,404
              )Basic and diluted net loss per shareAs reported
              
              $
              (0.04
              )
              $
              (0.05
              )Pro forma
              
              $
              (0.10
              )
              $
              (0.08
              )




The
      fair value of
      each option granted is estimated on the date of grant using the Black-Scholes
      option-pricing model with the following weighted average assumptions: dividend
      yield 0.0%, expected volatility of 141.0%, risk-free interest rate of 1.5%
      and
      expected life of 60 months.





The
      Company also
      issues stock options to outside directors, consultants, and scientific advisors
      in exchange for services. The Company accounts for stock options issued to
      third
      parties for services under the provisions of FASB Statement No. 123, accounting
      for stock based compensation, using the same accounting policy, methods and
      assumptions used for accounting for stock options issued to employees.





**Basic
      and
      Diluted Net Loss Per Share**





Net
      loss per share
      is based on the number of weighted average shares outstanding. The effect of
      warrants and options outstanding (see Notes 7 and 8) is
      anti-dilutive.





F-10


Amarillo
        Biosciences, Inc. and Subsidiaries
 Notes
        to Consolidated Financial Statements
 December
        31,
        2005


**2.
      Equipment**





Equipment
      is stated
      at cost and consists of the following:





December
                31,
                2005Furniture
                and
                equipment
            
            $
            54,01154,011Less
                accumulated depreciation
            
            
            53,286$
            725





Depreciation
      expense amounted to $60 and $1,667 for the years ended December 31, 2005 and
      2004, respectively.





**3.
      Notes
      Payable**





The
      Company had a
      loan agreement with HBL (July 22, 1999), which called for HBL to loan the
      Company $3,000,000 to be advanced in three installments. One of these 3 notes
      was converted into stock as shown below. The annual interest rate on unpaid
      principal from the date of each respective advance was 4 1⁄2%, with accrued
      interest being payable at the maturity of the note. $1,000,000 was payable
      on or
      before December 3, 2005, or on or before the expiration of one (1) year after
      approval of the Company’s product by the FDA, whichever occurs first. This note
      has been extended and is payable on or before December 3, 2006, or on or before
      the expiration of one (1) year after approval of the Company's product by the
      FDA, whichever occurs first. The other $1,000,000 is due on or before February
      29, 2007, or on or before the expiration of one year after approval of the
      Company’s product by the FDA, whichever occurs first.





On
      September 30,
      1999, the Company entered into an Agreement to Convert Debt with HBL regarding
      the above described note payable to HBL in the then principal amount of
      $1,000,000, the first loan installment having by then been advanced. On October
      15, 1999, pursuant to the Agreement to Convert Debt, HBL canceled the then
      note
      balance in exchange for 1,111,831 shares of common stock of the Company valued
      at the then market value of $0.9044 per share. This stock conversion leaves
      the
      Company owing HBL a principal amount of $2,000,000 plus accrued
      interest.


F-11


Amarillo
        Biosciences, Inc. and Subsidiaries
 Notes
        to Consolidated Financial Statements
 December
        31,
        2005


Effective
      November
      1, 2002 the Company executed a Promissory Note for $45,000 payable to an
      individual stockholder. The Promissory Note accrues interest at the rate per
      year that will be the lesser of 3% in excess of the prime interest rate
      published from time to time in the Wall Street Journal, adjusted on the first
      day of each calendar month based on such rate then in effect, or the maximum
      nonusurious rate of interest permitted by applicable law. Accrued interest
      is
      payable monthly, in arrears and the entire principal amount was payable October
      31, 2004, in November 2005 the Company paid $20,000 toward the principle of
      this
      note and a the Note was amended restating the Note amount as $25,000, this
      Note
      is due October 31, 2006. The Note Holder is granted the right to purchase the
      following; up to 30,000 shares of stock at an exercise price of $0.15 per share
      on or before October 31, 2006; up to 30,000 shares of stock at an exercise
      price
      of $0.22 per share on or before October 31, 2007; and 30,000 shares of stock
      at
      an exercise price of $0.47 per share on or before November 15, 2008.





Effective
      March 21, 2003
      the Company executed a second Promissory Note for $45,000 payable to the same
      individual stockholder. The
      Promissory Note
      accrues interest at the rate per year that will be the lesser of 3% in excess
      of
      the prime interest rate published from time to time in the Wall Street Journal,
      adjusted on the first day of each calendar month based on such rate then in
      effect, or the maximum nonusurious rate of interest permitted by applicable
      law.
      Additions were made to this Promissory Note as follows: January 27, 2004,
      $5,000; February 6, 2004 $5,000 and November 30, 2004 $10,000, bringing the
      total of this Note to $65,000. Accrued interest is payable monthly, in arrears
      and the entire principal amount is payable March 20, 2005. This note payable
      date was extended to March 20, 2006. The Note Holder is granted the right to
      purchase the following; up to 50,000 shares of stock at an exercise price of
      $0.06 per share on or before March 31, 2007; and 30,000 shares of stock at
      an
      exercise price of $0.50 per share on or before March 20, 2008.





On
      October 10, 2003
      and December 31, 2003, unsecured loans totaling $14,000 were received from
      an
      individual stockholder. Subsequently, on February 26, 2004, $10,500 of that
      money was used to purchase private placement shares of the Company. The Company
      is still in debt to the stockholder for $3,500.





The
      Company has
      secured a line of credit for up to $10,000 from it’s bank Wells Fargo. This line
      is used from time to time for purchases.





**4.
      Manufacturing and Supply Agreements**





The
      Company was a
      party to the following manufacturing and supply agreements at December 31,
      2005:


F-12
 
 Amarillo
          Biosciences, Inc. and Subsidiaries
 Notes
          to Consolidated Financial Statements
 December
          31,
          2005
 The
        Company has a Joint Development and Manufacturing/Supply Agreement with HBL
        (the
        Development Agreement), a major stockholder under which HBL will formulate,
        manufacture and supply HBL interferon for the Company or any sublicensee.
        In
        exchange, HBL is entitled to receive a transfer fee, specified royalties
        and a
        portion of any payment received by the Company for sublicense of rights under
        this agreement. The agreement further provides that the Company sublicense
        to
        HBL the right to market HBL interferon for oral use in humans and in non-human,
        warm-blooded species in Japan, in exchange for the Company receiving a royalty
        fee based on net sales. The Company is the exclusive agent for the development
        of HBL interferon for non-oral use in humans and in non-human, warm-blooded
        species in North America, in exchange, HBL is entitled to receive a transfer
        fee
        based on units of interferon supplied and the agreement also provides that
        a
        royalty fee be paid to HBL. As part of the License Agreement with Atrix
        Laboratories, Inc. (executed September 7, 2001, terminated May 22, 2003)
        a
        second amendment to the Development Agreement was executed extending the
        Development Agreement to March 12, 2005 and will be renewed automatically
        for
        successive three-year terms. The current expiration date of the Development
        Agreement is March 12, 2008.





The
      Company has a
      supply agreement with HBL under which the Company gained an exclusive right
      to
      purchase and distribute anhydrous crystalline maltose for the treatment of
      dry
      mouth (xerostomia). This exclusive supply agreement is worldwide, excluding
      Japan.





**5.
      License
      and Sublicense Agreements**





The
      Company holds
      patent rights for which the Company has paid certain license fees under three
      license agreements. Under these agreements, the Company will pay the licensor
      a
      portion of any sublicense fee received by the Company with respect to the
      manufacturing, use or sale of a licensed product, as well as a royalty fee
      based
      on the net selling price of licensed products, subject to a minimum annual
      royalty. The Company has also entered into various sublicense agreements under
      which the Company is entitled to receive royalties based on the net sales value
      of licensed products.





**6.
      Research
      Agreements**





The
      Company
      contracts with third parties throughout the world to conduct research including
      studies and clinical trials. These agreements are generally less than one year
      in duration.





**7.
      Common
      and Preferred Stock**





The
      Company has
      50,000,000 shares of voting common shares authorized for issuance and 10,000,000
      shares of preferred stock authorized for issuance which is issuable in series.
      To date, no preferred stock has been issued.





The
      Company has
      7,512,862 shares of common stock reserved for issuance upon exercise of options
      and warrants granted.


F-13


Amarillo
        Biosciences, Inc. and Subsidiaries
 Notes
        to Consolidated Financial Statements
 December
        31,
        2005




In
      2005, the
      Company sold 4,928,700 unregistered shares of its voting common stock in private
      placement offerings. Of these sales, 1,380,000 shares were sold for $0.10 per
      share; 3,435,000 shares for $0.20 per share; 113,700 shares for $0.22 per share;
      generating $850,014 in cash.





During
      the year
      ended December 31, 2005, the Board of Directors authorized the issuance of
      37,994 shares of restricted common stock to consultants in lieu of cash
      payments. Based upon the common stock trading price at the times of issuance,
      and FASB rules, a non-cash consulting expense of $13,211 was recorded for the
      issuance of these shares during the year ended December 31, 2005.





**8.
      Stock
      Options and Warrants**





During
      2005, the
      Company issued 450,000 options to consultants, to purchase restricted common
      stock in exchange for consulting services. The options are as follows, 250,000
      at $0.01 per share, and 200,000 options at $0.05 per share. These options were
      exercised and the fair market value of the stock sales were stated; 250,000
      shares for $0.01 per share, generating $2,500 in cash and $77,500 in non-cash
      consulting services; and 200,000 shares for $0.05 per share, generating $10,000
      in cash and $60,000 in non-cash consulting services.





The
      Company has two
      stock option plans: the 1996 Employee Stock Option Plan (Employee Plan) and
      the
      Outside Director and Advisor Stock Option Plan (Director Plan). The Employee
      Plan has authorized the grant of options to employees for up to 590,000 shares
      of the Company’s common stock. All options granted have five to ten year terms
      and become exercisable over a four to five year period. The option price is
      equal to 100% to 110% of the fair value of the common stock on the date of
      grant
      depending on the percentage of common stock owned by the optionee on the grant
      date. The Director Plan allows options to purchase a maximum of 410,000 shares
      of the Company's common stock to be granted to outside directors and scientific
      advisors to the Company at an exercise price equivalent to 100% of the fair
      market value of the common stock on the date of grant. These are ten-year
      options and become exercisable over a period of five years. During 2005 and
      2004
      the Company did not recognize any expense for stock options issued to directors,
      consultants, and scientific advisors.





A
      summary of the
      Company's stock option activity and related information for the year ended
      December 31, is as follows:


F-14


Amarillo
        Biosciences, Inc. and Subsidiaries
 Notes
        to Consolidated Financial Statements
 December
        31,
        2005


**2005**
              
              
              **2004****Options**
              
              
              **Price**
              
              
              **Options**
              
              
              **Price**Outstanding
                  Beg of Year
              
              
              2,925,862
              
              
              0.41
              
              
              2,071,688
              
              
              0.54Granted
              
              
              3,920,000
              
              
              0.31
              
              
              1,500,000
              
              
              0.25Cancelled
              
              
              -
              
              
              
              
              
              (494,312
              )
              
              1.12Exercised
              
              
              -
              
              
              
              
              
              (151,514
              )
              
              0.06Outstanding
                  End of Year
              
              
              6,845,862
              
              
              0.31
              
              
              2,925,862
              
              
              0.41Exercisable
                  End of Year
              
              
              6,845,862
              
              
              0.31
              
              
              2,925,862
              
              
              0.41





Exercise
      prices for
      options outstanding as of December 31, 2005 ranged from $0.06 to $5.00. Of
      these
      options, 10,000 have exercise prices ranging from $4.00 to $5.00 and the
      remainder range from $0.06 to $1.63. The weighted-average remaining contractual
      life of those options is 5.01 years.





**9.
      Employee
      Benefit Plan**





The
      Company has a
      Simplified Employee Pension Plan (the Plan), which is a contributory plan that
      covers all employees of the Company. Contributions to the Plan are at the
      discretion of the Company. The plan expense for the years ended December 31,
      2005 and 2004, were $0, and $0, respectively.





**10.
      Income
      Taxes**





Deferred
      income
      taxes reflect the net tax effects of temporary differences between the carrying
      amounts of assets and liabilities for financial reporting purposes and the
      amounts used for income tax reporting purposes. The Company’s deferred tax asset
      of approximately $6,989,000 and $6,660,000 at December 31, 2005 and 2004
      respectively, was subject to a valuation allowance of $6,989,000 and $6,660,000
      at December 31, 2005 and 2004 respectively, because of uncertainty regarding
      the
      Company’s ability to realize future tax benefits associated with the deferred
      tax assets. Deferred tax assets were comprised primarily of net operating loss
      carryovers under the cash method of accounting used by the Company for federal
      income tax reporting.





At
      December 31,
      2005, the Company has net operating loss carryforwards of approximately
      $20,556,000 for federal income tax purposes expiring in 2006 through 2024.
      The
      ability of the Company to utilize these carryforwards may be limited should
      changes in stockholder ownership occur.





The
      difference
      between the reported income tax provision and the benefit normally expected
      by
      applying the statutory rate to the loss before income taxes results primarily
      from the inability of the Company to recognize its tax losses.


F-15


Amarillo
        Biosciences, Inc. and Subsidiaries
 Notes
        to Consolidated Financial Statements
 December
        31,
        2005


**11.
      Contingencies**





The
      Company is not
      a party to any litigation and is not aware of any pending litigation or
      unasserted claims or assessments as of December 31, 2005.





**12.
      Related
      Party Transactions**





The
      Company has
      relied significantly on HBL, the largest shareholder of the Company, for a
      substantial portion of its capital requirements. Pursuant to the Development
      Agreement described at Item 1 of Part 1 above, HBL advanced $9,000,000 for
      funding of research. In addition, HBL has purchased substantial amounts of
      the
      Company’s common stock from time to time, to the point where it now owns 17% of
      the issued and outstanding shares of common stock of the Company. HBL loaned
      $1
      million to the Company on November 30, 1999 and an additional $1 million on
      February 29, 2000, both loans bearing interest at 4.5% per annum. The November
      30, 1999 loan has been extended until December 2006 and extension of the
      February 29, 2000 loan is under discussion. The aggregate balance on both notes
      at December 31, 2005, including principal and accrued interest, was $2,510,701.
      In addition to the above, HBL and the Company are parties to various license
      and
      manufacturing and supply agreements pursuant to which the Company licenses
      certain technology to or from HBL. HBL supplies formulations of its interferon
      alpha and other products to the Company at contractual prices. During 2005
      and
      2004 the Company purchased $2,410 and $4,760 of interferon alpha and other
      products from HBL, respectively. At December 31, 2005 and 2004 the Company
      did
      not have any outstanding amounts owed to HBL for purchases of interferon alpha
      or other products.





All
      future
      transactions and loans between the Company and its officers, directors and
      5%
      shareholders will be on terms no less favorable to the Company than could be
      obtained from independent third parties. There can be no assurance, however,
      that future transactions or arrangements between the Company and its affiliates
      will be advantageous, that conflicts of interest will not arise with respect
      thereto or that if conflicts do arise, that they will be resolved in favor
      of
      the Company.





In
      the ordinary
      course of business, the Company has and expects to have transactions with
      related parties, including stockholders. In addition to the transactions
      disclosed elsewhere in these financial statements, during 2005 the Company
      has
      used the law firm of SandersBaker, P.C. Mr. Edward Morris, Secretary of the
      Company, is a partner in that firm. The Company was invoiced $20,354 during
      2005
      for legal services rendered by SandersBaker.


F-16


Amarillo
      Biosciences, Inc. and Subsidiaries Notes
        to Consolidated Financial Statements
 December
        31,
        2005




**13.
      Subsequent Events (Unaudited)**





On
      March 14, 2006
      the Company paid a Promissory Note for $65,000 payable to an individual
      stockholder.





Since
      December 31,
      2005, the Company has sold 1,471,060 shares of unregistered stock in private
      placement offerings. Of these sales, 671,000 shares were sold for $0.20 per
      share; 200,000 were sold for $0.38 per share; 600,000 were sold for $0.52 per
      share; generating cash of $522,260.


F-17