U.S.
Securities and Exchange Commission


Washington,
D.C. 20549


Form
10-KSB


(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, 2007[     ]
            
            Transition
      Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
      [No Fee Required]
              
              Commission
      File Number 0-20791AMARILLO
      BIOSCIENCES, INC.
              (Name
      of small business issuer in its charter)Texas
              (State
      of other jurisdiction of incorporation or organization)
            75-1974352
              (I.R.S.
      Employer Identification No.)4134
      Business Park Drive, Amarillo, Texas
              (Address
      of principal executive offices)
            79110-4225
              (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





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 XNo





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


1


Revenues
for its most recent fiscal year were $70,069.





As of
December 31, 2007, there were outstanding 29,465,261 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 24,290,281
shares of common stock held by non-affiliates of the registrant (based on the
average closing price for the common stock on the OTC BB.AMAR for the 60 trading
days ended March 20, 2008) was approximately, $7,501,972.





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 2008 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 “AMAR”), a Texas corporation formed in 1984,
is engaged in developing biologics for the treatment of human and animal
diseases.  We have a proprietary technology for a less toxic method of
administration of interferon, low-dose oral interferon, in FDA Phase 2 clinical
trials.  Injectable interferon is an immune modulator used to treat
viral and autoimmune diseases and cancer with a $5 billion market even though
side effects are often moderate to severe.




Interferon
was discovered in 1957 when scientists isolated a protein inhibiting influenza
virus in chicken embryos, so the first virus known to be inhibited by interferon
was influenza.  Injectable interferons are approved by the FDA for
treatment of various cancers, infectious diseases and multiple
sclerosis.




Interferon
is a powerful immunomodulating protein with action on major organ
systems.  It has been assumed that, for interferon to be effective, it
must reach a high blood level, which is achieved by injecting doses above a
million International Units (IU) to counteract the kidney’s efficient clearance
of interferon from the blood.  These high-dose injections of
interferon frequently cause moderate to severe side effects.




Our
product is a natural human interferon alpha administered into the oral cavity in
low doses (150 to 500 IU) as a small tablet (lozenge) which dissolves in the
mouth. Interferon binds to surface (mucosal) cells in the mouth and throat
resulting in stimulation of immune mechanisms.  Orally delivered
interferon has been shown to activate hundreds of immune system genes in the
peripheral blood.  Human studies have shown that oral interferon is
effective against viral and autoimmune diseases. Oral interferon is given in
concentrations 10,000 times less than that given by injection, so side effects
are eliminated or rare.




2







Our goal
is to achieve FDA approval for an oral formulation of natural human interferon
alpha to 1) treat and prevent influenza, 2) treat other viral diseases, 3) treat
autoimmune diseases, and 4) treat chronic cough.




We are
currently focused on low-dose oral interferon alpha treatment of chronic cough,
influenza and oral warts (human papillomavirus) in HIV+
patients.   Pharma partners are focused on low-dose oral
interferon alpha treatment of Behcet’s disease, hepatitis C and
influenza.  We believe 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 1 pending and 12 issued 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. The Company has filed
with the U.S. Food and Drug Administration (“FDA”), and there now are in effect,
six active Investigational New Drug (“IND”) applications covering indicated uses
for low-dose oral interferon alpha, including treatment of Behçet’s disease,
chronic cough, oral warts in HIV+ patients, hepatitis C, influenza and HIV
infection.




Our
objective is to exploit our proprietary technology to become a leader in the
field of low-dose oral applications of interferon alpha. Our 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 our opinion, have the greatest commercial potential and are most
likely to be approved by the FDA.  We will attempt to gain market
share for approved products by forming alliances with strong marketing
partners.




We have
one part-time and six full-time employees.  We make extensive use of
consultants in business and research and development.  Governmental or
FDA approval is required for our principal products.  Our progress
toward approval is discussed under each specific indication, below.







Low-Dose
Oral Interferon Alpha – FDA Clinical Trials Status





Influenza
– FDA Phase 2 to start





Influenza
(the flu) is a contagious respiratory illness caused by influenza
viruses.  It can cause mild to severe illness, and at times can lead
to death.  Influenza usually starts suddenly and may include the
following symptoms: 1) fever (usually high), 2) headache, 3) tiredness (can be
extreme), 4) cough, 5) sore throat, 6) runny or stuffy nose, 7) body aches, and
8) digestive problems such as diarrhea, nausea and
vomiting.  Complications of flu can include bacterial pneumonia, ear
infections, sinus infections, dehydration, and worsening of chronic medical
conditions, such as congestive heart failure, asthma, or diabetes.




Flu
viruses spread mainly from person to person through coughing or
sneezing.   Sometimes people may become infected by touching
something with flu viruses on it and then touching their mouth or
nose.  Most healthy adults may be able to infect others beginning 1
day before symptoms




3


develop
and up to 5 days after becoming sick.  That means that a person may be
able to pass on the flu to someone else before they know they are sick, as well
as while they are sick.




Influenza
A viruses are divided into subtypes based on 2 proteins on the surface of the
virus: the hemagglutinin (H) and the neuraminidase (N).  There are 16
different H subtypes and 9 different N subtypes, all of which have been found
among influenza A viruses in wild birds.  Wild birds are the primary
natural reservoir for all subtypes of influenza A viruses and are thought to be
the source of influenza A viruses in all other animals.  Most
influenza viruses cause asymptomatic or mild infection in birds; however, the
range of symptoms in birds varies greatly depending on the strain of
virus.  Infection with certain avian influenza A viruses (for example,
some strains of H5 and H7 viruses) can cause widespread disease and death among
some species of wild and especially domestic birds such as chickens and
turkeys.




Pigs can
be infected with both human and avian influenza viruses in addition to swine
influenza viruses.  Infected pigs get symptoms similar to humans, such
as cough, fever and runny nose.  Because pigs are susceptible to
avian, human and swine influenza viruses, they potentially may be infected with
influenza viruses of different species (e.g., ducks and humans) at the same
time.  If this happens, it is possible for the genes of these viruses
to mix and create a new virus.  For example if a pig were infected
with a human influenza virus and an avian influenza virus at the same time, the
viruses could mix (reassort) and produce a new virus with most of the genes from
the human virus, but a hemagglutinin and/or neuraminidase from the avian
virus.  The resulting new virus would likely to be able to infect
humans and spread from person to person, but it would have surface proteins
(hemagglutinin and/or neuraminidase) not previously seen in influenza viruses
that infect humans.  This type of major change in the influenza A
viruses is known as antigenic shift.  Antigenic shift results when a
new influenza A subtype to which most people have little or no immune protection
infects humans.  If this new virus causes illness in people and can be
transmitted easily from person to person, an influenza pandemic can
occur.




Influenza
A viruses are found in many different animals, including ducks, chickens, pigs,
whales, horses and seals.  Influenza B viruses circulate widely only
among humans. While it is unusual for people to get influenza infections
directly from animals, sporadic human infections and outbreaks caused by certain
avian influenza A viruses have been reported.




A number
of natural outbreak or challenge studies indicate that low doses of IFNα given
orally and/or intranasally are safe and effective at treating human
flu.  IFNα administered intranasally coats the oropharynx and comes in
contact with the same receptors as IFNα administered
orally.  Leukocyte interferon was given in low doses intranasally for
3 consecutive days to 374 subjects “at the height” of an
influenza outbreak.  Interferon-treated subjects had less severe
illness than 382 subjects given placebo.  When interferon was given to
320 subjects “before” the influenza outbreak, these subjects had less illness
than the 317 subjects given placebo.  It was reported that the
interferon treatment was free of adverse events.




In 1969,
approximately 14,000 people in Moscow participated in controlled studies of
placebo versus interferon treatment during a natural outbreak of Hong Kong
influenza.  Interferon (about 128 units) or placebo was dripped into
the nose daily for 5 days starting about the time of the first reported
influenza cases.  Interferon treatment significantly (P<0.01)
reduced the number of influenza cases.




4


Intranasal
drops of human interferon alpha (5,000 units daily) given for 4 months reduced
the frequency and severity of diseases due to influenza A(H3N2
and H1N1) and parainfluenza virus.  Data was collected on 83
volunteers in the study.  Fever occurred in 6 of 40 volunteers given
interferon and in 15 of 43 volunteers given placebo
(P<0.01).  Subjective symptoms such as headache, cough, fatigue,
anorexia, myalgia, etc. occurred in 34% of volunteers given interferon and in
67% of volunteers given placebo (P<0.01).




In 1982,
it was reported that human leukocyte interferon (10,000 units/day) or placebo
was dripped into the nostrils of 27 children daily for 60 days.  The
children lived in an orphanage where natural outbreaks of influenza A and
influenza B occurred during the treatment period.  Interferon did not
prevent illness but significantly reduced the duration of fever and reduced the
main peak fever.  Clinical manifestations of influenza were milder in
children given interferon compared to placebo.  Adverse events due to
interferon therapy were not observed.26




During
influenza epidemics in 1983, 1984 and 1985, 140 children were treated with a
spray of natural human interferon alpha into the nose and mouth twice daily for
3-4 days.  The total daily dose was reported to be 700-1600
units.  The 53 control children were given traditional Chinese
herbs.  Children given interferon had a significantly (P<0.01)
faster normalization of temperature at 24, 36 and 48 hours after the first
treatment.  The clinicians reported that pharyngitis and lymphadenosis
of the posterior pharynx improved when fever subsided.




Low doses
of interferon probably do not have a direct antiviral effect but instead exert
an immune modulatory effect through interferon stimulated
genes.  Influenza studies conducted in the USA, Australia and Germany
have shown that oral interferon protects mice against an otherwise fatal
influenza infection.  In February 2008, the Company filed an IND
application with the FDA and plans to launch a Phase 2 clinical study for the
2008 - 2009 influenza season.







Oral
Warts in HIV+ Patients – FDA Phase 2 ongoing





Oral
warts are lesions in the mouth caused by the human papillomavirus. The FDA has
granted Orphan Drug Designation to AMAR for interferon in the treatment of oral
warts in HIV+ patients. In Phase 1/2 clinical studies of 36 HIV+ patients with
multiple oral warts who were receiving highly active antiretroviral therapy
(HAART), efficacy of oral interferon was observed when some subjects achieved a
complete or nearly complete regression of their warts.




The
Company launched a placebo-controlled, Phase 2 study in the 1st quarter
of 2007. The protocol covers a 24-week, 80-patient study in which 20 patients
are receiving placebo and 60 are receiving active treatment at 1500 IU per
day.  If the current study is successful, a Phase 3 trial to confirm
safety and efficacy will be launched in 2009. As of today, 40 oral warts
patients have been enrolled at 12 active clinical sites.  Enrollment
of a further 40 patients at a cost of approximately $120,000 is anticipated by
the end of the second quarter of 2008.







Chronic
Cough – COPD – FDA Phase 2 to start





Chronic
obstructive pulmonary disease (COPD) is a clinical condition with a progressive
airflow limitation that is poorly reversible and characteristic of chronic
bronchitis and emphysema.




5


The
causes of COPD include tobacco smoke, occupational dusts, chemicals, vapors and
environmental pollutants.  COPD occurs in approximately 10% of the
population over the age of 40.  There are no effective therapies for
emphysema, nor are there efficient clinical management
strategies.  Oral interferon treatment of cough is expected to improve
quality of life of COPD patients.




Dr.
Lorenz Lutherer of Texas Tech University has obtained university funding for a
proof-of-concept study to evaluate orally administered IFNα in the
treatment chronic cough in COPD patients. This experimental clinical study will
be a Phase 2 randomized, double-blind, placebo-controlled, parallel trial in
which 40 eligible volunteers with COPD-associated
chronic cough will be randomly assigned to one of two groups in equal numbers to
receive either IFNα or placebo. Treatment will be given three times daily for 4
weeks, and patients will be followed for 4 weeks post-treatment to assess
durability of response. The study will evaluate the ability of IFNα to reduce
the frequency and severity of chronic cough in COPD patients. The study will
launch in the next 30 days with conclusion targeted for thethird quarter
of 2008.  With additional funding, some subjects with Idiopathic
Pulmonary Fibrosis (IPF) can be added to this study to confirm the beneficial
effects reported by Dr. Lutherer from a pilot study of low-dose oral interferon
treatment of patients with IPF.




In study
of subjects with Sjogren’s syndrome, it was noted that chronic dry cough was
relieved by oral interferon therapy.  Chronic cough in horses with
COPD (called inflammatory airway disease) was relieved by oral interferon, but
not placebo.  These 2 observations provide additional support for
conducting a study of oral interferon on chronic coughing in COPD.





Behcet’s
Disease -  FDA Phase 2 ongoing (See Strategic Alliance with Nobel
below)





Hepatitis
C – FDA Phase 2 to start (See Strategic Alliance with Cytopharm
below)





Strategic
Alliance with HBL




Hayashibara
Biochemical Laboratories, Inc. (“HBL”) was established in 1970 to engage in
research and development regarding the manufacture and clinical application of
interferon and other cytokines. It is a subsidiary of Hayashibara Company, Ltd.,
a privately-owned Japanese holding corporation with diversified subsidiaries.
For more than 130 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




6


“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, 2011, 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 Note 4 to the Financial Statements attached to this
10-KSB.






Strategic Alliance with Nobel –Behcet’s
Disease




The
Company signed a licensing and supply agreement in September 2004 with a leading
Turkish pharmaceutical company, NOBEL ILAC SANAYII VE TICARET A.S. (“NOBEL”),
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, AMAR and NOBEL will conduct Behçet’s disease studies in
Turkey under an IND submitted by AMAR to the U.S. FDA.  U.S. FDA
approval will be sought and this FDA approval will be owned by AMAR, but will be
used by NOBEL to seek regulatory approval in each country of the
Territory.




NOBEL has
concluded enrollment in a Phase 2 study in Turkey with 84 Behcet’s disease
patients randomized out of an initial target
of  90.  Clinical results are expected in the second quarter
of 2008.  If the Phase 2 data are encouraging, then NOBEL will conduct
a Phase 3 study before a New Drug Application (NDA) can be submitted to the US
FDA.






Strategic Alliance with Bumimedic -Influenza




On
January 19, 2006, AMAR announced that it had entered into a distribution
agreement with Bumimedic (Malaysia) Sdn. Bhd, a Malaysian pharmaceutical company
that is a part of the Antah HealthCare Group, to market AMAR’s low-dose
interferon (natural human IFN) in Malaysia.  Bumimedic will seek
registration for AMAR’s natural human IFN and commence marketing the product
after approval. The terms of the agreement call for Bumimedic to manufacture
lozenges from AMAR’s bulk natural human IFN (which is supplied by Hayashibara
Biochemical Laboratories); package the lozenges and distribute them to local
hospitals, pharmacies and clinics in Malaysia.  Pursuant to the
agreement, AMAR will receive an initial license fee upon execution of the
agreement and will receive milestone payments, upon regulatory approval, and
upon production.




7


AMAR will
also receive a royalty on the sale of the natural human IFN. This agreement was
made possible through the Company’s previously announced relationship with Dr.
Claus Martin, President and CEO, Gessellschaft Fur Medizinisch and Technische
Investionen mbH & CoKG. (GMTI), a privately held German venture capital
group.   Bumimedic representatives are expected to meet with the
Company in June 2008 to discuss  a protocol for a study in influenza
to be carried out in Malaysia.






Strategic Alliance with CytoPharm –Hepatitis
C




In
November 27, 2006, AMAR announced that it had entered into a License and Supply
Agreement with CytoPharm, Inc., a Taipei, Taiwan-based biopharmaceutical company
whose parent company is Vita Genomics, Inc., the largest biotech company in
Taiwan specializing in pharmaco-genomics and specialty Clinical Research
Organization. Under the terms of the Agreement, CytoPharm and its subsidiary
will conduct all clinical trials, and seek to obtain regulatory approvals in
both China and Taiwan (the Territory) to launch AMAR’s low dose oral interferon
in the Territory for influenza, hepatitis B and hepatitis C indications.
According to the Agreement, CytoPharm will make payments to AMAR upon reaching
certain milestones and will also pay royalties on low dose oral interferon sales
in the Territory.  Enrollment of 144 subjects with hepatitis C in a
Phase 2 clinical trial in Taiwan is expected by CytoPharm to begin in the 3rd quarter
of 2008.






Publishing




A
manuscript entitled “Protection From Lethal Influenza Virus Challenge by Oral
Type 1 Interferon” was published online by the Biochemical & Biophysical
Research Communication in February 12, 2007.






Patents
and Proprietary Rights




Since its
inception, AMAR has worked to build an extensive patent portfolio for low-dose
orally administered interferon. This portfolio consists of patents with claims
that encompass method of use or treatment, composition of matter and
manufacturing.  AMAR presently owns or licenses 12 patents and two
pending patents related to low-dose orally delivered interferon, and one issued
patent on AMAR’s dietary supplement. AMAR has vigorously enforced its patent
position in the past, resulting in successful settlement. There are no current
patent litigation proceedings involving AMAR.






Cost
of Compliance with Environmental Regulations




The
Company incurred no costs to comply with environment regulations in
2007.






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




8


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.






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.




9


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, 2007 and 2006, the Company incurred research and
development expenses of $530,867 and $535,075, respectively. 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
clinical research and intends to continue to do so while utilizing its staff for
monitoring such research. See also ITEM 6, “MANAGEMENT’S 2008 PLAN OF OPERATIONS
- Research and Development”.






ITEM
2.                      DESCRIPTION
OF PROPERTY.




The
Company’s executive and administrative offices are located at 4134 Business Park
Drive, Amarillo, Texas in a 3,600 square-foot facility rented by the Company.
The building contains offices and a small warehouse.






ITEM
3.                      LEGAL
PROCEEDINGS.




None.




ITEM
4.                      SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS




The
annual meeting of shareholders was noticed and convened on June 1, 2007, to
consider the election of directors, the authorization to vote proxies on other
business to properly come before the meeting, and to adjourn the meeting to
solicit additional votes.  There were 76.92% of the outstanding shares
of the Company represented at the meeting and constituting a
quorum.






Proposition
1 – Election of Directors.




The
following directors were elected at the meeting to serve until the next annual
meeting of shareholders or until their successor shall have been duly elected
and qualified:




Director
No. 1 – Joseph M. Cummins – 19,531,455 shares voted in favor and 66,022 shares
withheld;




Director
No. 2 – Stephen Chen – 19,582,836 shares voted in favor and 14,641
withheld;




Director
No. 3 – James Page – 19,574,836 shares voted in favor and 22,641
withheld;




Director
No. 4 – Dennis Moore – 19,582,836 shares voted in favor and 14,641
withheld;




10


Director
No. 5 – Thomas D’Alonzo – 19,582,836 shares voted in favor and 14,641 withheld;
and




Director
No. 6 – Thomas Ulie – 19,582,579 shares voted in favor and 14,898
withheld.






Proposition
2 – Approve an amendment to the Company’s articles of Incorporation to Increase
the Number of Authorized Shares of Common Stock from 50,000,000 to
100,000,000.




Proposition
2 passed by a vote of 19,346,958 shares voted in favor, 248,595 voted against,
and 1,922 shares not voted due to broker abstentions.






Proposition
3 – Authorization to vote Proxies on Other Business to Properly Come Before the
Meeting.




Proposition
3 passed by a vote of 19,334,376 shares voted in favor, 207,001 voted against,
and 56,097 shares not voted due to broker abstentions.






Proposition
4 – Adjournment of Meeting to Solicit Additional Votes.




Proposition
4 passed by a vote of 19,420,018 shares voted in favor, 172,884 shares voted
against, and 4,575 shares not voted due to broker abstentions.




No other
business was transacted at the meeting.





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 2007 and 2006 was as follows:


2007
            2006Quarter
            High
            Low
            High
            LowFirst
            $1.08
            $0.59
            $1.73
            $0.39Second
            0.92
            0.55
            1.64
            0.72Third
            0.62
            0.36
            0.89
            0.66Fourth
            0.50
            0.22
            0.90
            0.46





The
quotations reflect inter-dealer bids without retail markup, markdown, or
commission, and may not represent actual transactions.  As of December
31, 2007, the Company had approximately 1,600 shareholders of
record.




During
2007 there were 45 sales of the unregistered common stock of the Company by
private placement, raising $1,154,506 in cash.  Of those purchases, 11
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
34  purchases were made by accredited investors.  Of these
sales, 1,290,012 shares were sold for $0.45 per share; 97,143 shares were sold
for $0.35 per share; and 2,700,000 shares were sold for $0.20 per
share.  The foregoing private placements were conducted in reliance on
Rule 506, promulgated under Section 4(2) of the Securities Act of
1933.




11




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 commer­cialization and, until such time as it does, will
not generate significant product revenues. The Company’s accumulated deficit has
increased, from $25,953,878 at December 31, 2006 to $28,459,951 at December 31,
2007.  Operating losses are expected to continue for the foreseeable
future and until such time as the Company is able to attain sales levels
sufficient to support its operations.




In 2008
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 2008 will fall princi­pally
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.






Liquidity
and Capital Resources




At
December 31, 2007, the Company had available cash of $47,184, and had a working
capital deficit of ($2,702,104).  The Company’s negative cash flow
from operating activities plus equipment purchases, software purchases and
patent filings (burn rate) is approximately $119,000 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. The Company will need to raise additional funds in order to fully
execute its 2008 Plan. The Company is presently negotiating with human health
commercial development partners in various regions of the world. The Company
believes that one or more of these agreements will be executed during 2008.
These agreements could generally include provisions for the commercial partner
to pay us a technology access fee, could include payments for a portion of the
clinical trial expenses, could include payment obligations to us 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. However, there can be no assurance that the Company
will be successful in obtaining additional funding from human health commercial
development partners, institutional 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.




12







Total outstanding current liabilities
stayed approximately the same with approximately $2.78 million at December 31,
2007, as compared to approximately $2.75 million at December 31,
2006.






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




Effective January 1,
2006, the Company adopted SFAS No. 123 (revised),
"Share-Based Payment" (SFAS 123(R)) utilizing the modified prospective approach.
Prior to the adoption of  SFAS 123(R) we accounted for
stock option grant in accordance with APB Opinion No. 25,”
Accounting for Stock Issued to Employees," and
accordingly, recognized compensation expense for stock option grants
using the intrinsic value method.




Under the
modified prospective approach, SFAS 123(R) applies to new awards and
to awards that were outstanding on January 1, 2006 that
are subsequently modified, repurchased or cancelled.  Under the
modified prospective approach, compensation cost recognized in
the first quarter of fiscal 2006 includes compensation cost for all
share-based payments granted prior to, but not yet vested as of January 1, 2006,
based on the grant-date fair value estimated in accordance with the
original  provisions of SFAS 123, and compensation cost for all
share-based payments granted subsequent  to January 1, 2006 based
on the grant-date fair value estimated in accordance with the
provisions of SFAS 123(R).  For all quarters after the first quarter of
fiscal 2006, compensation costs recognized will include compensation costs for
all share-based payments granted based on the grant date fair value estimated in
accordance with the provisions of SFAS 123(R).






Comparison
of results for the fiscal year ended December 31, 2007, to the fiscal year ended
December 31, 2006.




Revenues.  During
the fiscal year ended December 31, 2007, $70,069 from product sales, sublicense
fees and royalties was generated compared to $73,919 for the fiscal year ended
December 31, 2006,  a decrease of $3,850 or approximately
5.2%.  Revenue from federal research grants during the fiscal year
ended December 31, 2006 was $60,023.  No federal research grant funds
were received in 2007.




Selling, General and Administrative
Expenses. Selling, General and Administrative expenses of $1,956,838 were
incurred for the fiscal year ended December 31, 2007, compared to $2,288,045 for
the fiscal year ended December 31, 2006, a decrease of $331,177 or approximately
14%.   Salaries and wages were $84,604 lower in
2007.   Most of the reduction in salaries and wages can be
accounted for by employee stock grant, options and accrued vacation expenses
that were $70,606 lower in 2007. Fund raising fees were $91,043 lower in 2007
than 2006 since private placement stock sales were lower in
2007.  Professional fees were $115,378 lower in 2007.




Non-Cash Consulting
Activities. During the year ended December 31, 2007, 200,000 shares of
restricted stock were issued 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 $166,000 was recorded.   During
2006, 87,309 shares of restricted common stock were issued to consultants
in




13


lieu of
cash payments and a non-cash consulting expense of $49,835 recorded for the
issuance of these shares.  During 2007, the Company issued 1,610,000
options and warrants to consultants and recognized expense of
$644,723.  During 2006, the Company issued 945,500 options to
consultants and recognized expense of $737,863.




In the
third and fourth quarter of 2007, consultants exercised 350,000 options for $.20
per share, generating $70,000.  In the second quarter of 2006,
consultants exercised 250,000 options for $0.10 per share, generating $25,000 in
cash. The rest of the options and warrants issued to consultants have not been
exercised.




Research
and Development Expenses.Research and Development expenses of
$530,867 were incurred for the fiscal year ended December 31, 2007, compared to
$535,075 for the fiscal year ended December 31, 2006, a decrease of $4,208 or
approximately 0.8%.




Net Income
(Loss).  Net Loss applicable to common shareholders for the
fiscal year ended December 31, 2007 was $2,506,073 compared to a Net Loss of
$2,777,661 for the fiscal year ended December 31, 2006, a decrease of $271,588
or approximately 10%.






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.  We currently own four patents and license nine
patents.  No assurance can be given that such licenses or rights used
by us 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 us.




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




14


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.




We
are dependant on funding from private placements of stock.




Sales
revenue, sublicense fees and royalty income are low compared to
expenses.  Our primary focus is to achieve FDA approval of oral
interferon for one or more disease indications.  We do not expect
significant sales or royalty revenue in the near term as Phase 2 and Phase 3
clinical studies must be completed before a NDA (New Drug Application) may be
submitted to the FDA.  We operate at a net loss and current
liabilities exceed current assets mostly by the amount owed to HBL for two $1
million notes plus $682,773 of accrued interest on December 31,
2007.  HBL was paid $200,000 of accrued interest in January of 2008
and extended the notes and remaining accrued interest until June 3, 2008 and
August 28, 2008.  HBL will extend the notes and accrued interest until
December 3, 2009 and February 28, 2010 if payment of $145,000 of accrued
interest is received by August 31, 2008.  We do not have sufficient
liquidity to pay off the notes or to fund operating losses unless funding is
obtained from private placements of stock.  There can be no assurance
that private placement funding will always be available as market conditions may
change.




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
and Chief Executive Officer, Gary W. Coy, our Chief Financial Officer, and
Martin J. Cummins, our Vice President 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 currently have employment agreements
with our executive officers. 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.




If
we do not successfully develop, acquire or license new drugs our business may
not grow.




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.  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 may 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.




Our
competitors are much larger and more experienced than we are and, even if we
complete the development of our drugs, we may not be able to successfully
compete with them.




15







The
pharmaceutical industry is highly competitive.  Our biologics and low-dose
oral interferon alpha applications compete with high dose injectable interferon
manufactured by Roche, InterMune, Serano, Biogen, Berlex and
Hemispherx.  High dose injectable interferon has been widely accepted
by the medical community for many years.  Companies who manufacture
injectable interferon alpha applications are more established than we are and
have far greater financial, technical, research and development, sales and
marketing, administrative and other resources than we do.  Even if we
successfully complete the development of our tests, we may not be able to
compete effectively with these much larger companies and their more established
products.




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 is 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.  Even though we have not
historically experienced any problems associated with claims by users of our
products, we do currently maintain product liability insurance.




We
have been the subject of a going concern opinion by our independent auditors who
have expressed substantial doubt as to our ability to continue as a going
concern.




Our
Independent Registered Public Accountants have added an explanatory paragraph to
their audit opinions issued in connection with our consolidated financial
statements which states that our recurring losses from operations and the need
to raise additional financing in order to execute our business plan raise
substantial doubt about our ability to continue as a going
concern.  We have experienced net losses from operations of $2,689,463
for the year ended December 31, 2006 and $2,418,316 for the year ended December
31, 2007.  In addition, as of December 31, 2006 we had an accumulated
deficit of $25,953,878 and $28,459,951 for the year ended December 31, 2007.
These factors, among others, raise substantial doubt about our ability to
continue as a going concern. Our consolidated financial statements do not
include any adjustment that might result from the outcome of this uncertainty.
Assurances cannot be given that adequate financing can be obtained to meet our
capital needs. If we are unable to generate profits and unable to continue to
obtain financing to meet our working capital requirements, we may have to
curtail our business sharply or cease operations altogether. Our continuation as
a going concern is dependent upon our ability to generate sufficient cash flow
to meet our obligations on a timely basis to retain our current financing, to
obtain additional financing, and, ultimately, to attain profitability. Should
any of these events not occur, we will be adversely affected and we may have to
cease operations.




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.




16





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.




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




None.




ITEM
      8A.
            CONTROLS
      AND PROCEDURES.




As of
December 31, 2007, 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 and Chief
Financial Officer. Based upon that evaluation, our Chief Executive Officer and
Chief Financial 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.




Management
assessed the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2007.  In making this assessment, management
used the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission in Internal Control-Integrated Framework.  Based on
such assessment and those criteria, management believes that the Company
maintained effective internal control over financial reporting as of December
31, 2007.  The Company’s accounting firm has not issued an attestation
report on the management’s assessment of the Company’s internal controls. The
Company added cash disbursement, governance, and IT internal controls in 2007
and no material weaknesses in such controls were found. See Exhibit 33.1
for managements report on internal control over financial
reporting.




17


PART
III




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


Name
              Age
              PositionJoseph
      M. Cummins, DVM, PhD (1)
              65
              Chairman
      of the Board, President, Chief Executive Officer and
    DirectorGary
      W. Coy, PhD
              63
              Vice
      President and Chief Financial OfficerMartin
      J. Cummins
              40
              Vice
      President of Clinical & Regulatory AffairsStephen
      Chen, PhD (2)(3)(4)
              58
              DirectorThomas
      D’Alonzo (1)(2)(4)
              64
              DirectorDennis
      Moore, DVM (1)(4)
              61
              DirectorJames
      Page, MD (2)(3)
              80
              DirectorThomas
      Ulie (1)(3)
              59
              Director
 (1)
              Member
      of the Executive Committee.
 (2)
              Member
      of the Compensation & Stock
Committee.
 (3)       Member
of the Audit Committee.
 (4)     Member
of the Search Committee.





Joseph M. 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. Dr.
Cummins has been conducting research on oral cytokines, most particularly
interferon alpha, in animals and humans for 30 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.




Gary W.
Coyprovided financial
consulting services to the Company since 2004 and has been the Chief Financial
Officer since April 2006. Previously, Dr. Coy was Chairman and President of
multiple companies including Lighthouse Properties, Inc., a real estate
partnership syndicator and property management company, and Poly-Drug, Inc., a
toxicology and therapeutic drug monitoring medical laboratory that he founded,
financed, developed and sold to a publicly traded company.  Dr. Coy
has a PhD (Chemistry), an M.B.A. (Finance) and an A.M. (Chemistry) from Boston
University as well as a B.S. from the University of Iowa.




Martin J.
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 Vice President of Clinical and
Regulatory Affairs. Mr. Cummins has received extensive training in the fields of
clinical trial design, monitoring and analysis, as well as regulatory affairs
and compliance and has 11 publications to reflect his work. He received a
Bachelor of Sciences degree in microbiology from Texas Tech University. He is
the son of Joseph Cummins.


18




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.




Thomas
D’Alonzohas been a
director of the Company since June 2006.Mr. D’Alonzo is a seasoned executive
with experience in all major facets of pharmaceutical operations: sales and
marketing, manufacturing, quality assurance, finance and licensing and strategic
planning. Mr. D’Alonzo served as President of Pharmaceutical Product
Development, Inc., a multi-national clinical research organization with 3,000
employees operating in 14 countries and generating $300 million in revenues from
analytical labs and Phase 1, 2, 3 and 4 clinical trials.  Previously, Mr.
D’Alonzo was President of Genevec, Inc., a gene therapy biotech company. Before
that, Mr. D’Alonzo was President of Glaxo, Inc., the US unit of what is now
Glaxo SmithKline.




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.




Thomas Ulie has been a
director of the Company since June 2006. Mr. Ulie, a Chartered Financial
Analyst, has been in the investment field for more than 30 years, and is
currently CEO of First Island Capital, Inc., a West Coast-based NASD
broker-dealer firm. Mr. Ulie also serves as a director of a number of medical
companies and has wide-ranging experience in the investment community, having
worked in investment banking, money management and research. Prior to First
Island Capital, Mr. Ulie was a Senior Managing Director for the Stanford
Company, a NYSE member firm.  Prior to that, Mr. Ulie was an Associate
Director of Bear Stearns.




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 receive
compensation of $1,000 per day for attendance at meetings, $250 per day for
regularly scheduled teleconference meetings, and are reimbursed for any
out-of-pocket expenses in connection with their attendance at
meetings.




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




Audit
Committee Financial Expert




Mr.
Thomas Ulie qualifies as an audit committee financial expert for the
Company.  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.


19




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%
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, the following persons have failed to file, on a timely
basis, the identified reports required by the Exchange Act during the most
recent fiscal year:





Name
      and Principal Position
            Number
      of Late Reports
            Known
      Failures to File a Required FormDr.
      Joseph M. Cummins, Chairman of the Board, President and Chief Executive
      Officer
            1
            0Dr.
      Gary W. Coy, Vice President and Chief Financial Officer
            0
            0Mr.
      Martin J. Cummins, Vice President of Clinical and Regulatory
      Affairs
            1
            0Stephen
      Chen, Director
            1
            0Thomas
      D’Alonzo, Director
            1
            0Dennis
      Moore, Director
            0
            0James
      Page, Director
            1
            0Thomas
      Ulie, Director
            1
            0





ITEM
10.                      EXECUTIVE
COMPENSATION.




The
following table sets forth for the three years ended December 31, 2007
compensation paid by the Company to its Chairman of the Board, President and
Chief Executive Officer and to its Vice President of Clinical and Regulatory
Affairs as well as the compensation paid by the Company to its Vice President
and Chief Financial Officer for the year ended December 31, 2007. Other
compensation in 2006 consists of the fair value of a stock grant approved in the
first quarter and issued in the second quarter of 2006.




20





Summary
      Compensation TableAnnual
      Compensation
            Long
      Term CompensationName
      and Principal Position
            
            Year
            
            Salary
            
            Bonus
            
            Other
      Compensation
            
            Securities
      Underlying OptionsDr.
      Joseph M. Cummins,
              Chairman
      of the Board,
              President
      and Chief
              Executive
      Officer
            
            2007
            
            $  175,000
            
            $     –
            
            $          -2006
            
            $  141,416
            
            $60,000
            
            $
      216,000
            
            400,0002005
            
            $  177,000
            
            $     –
            
            $          –
            
            600,000Mr.
      Martin J. Cummins,
              Vice
      President of Clinical
              and
      Regulatory Affairs
            
            2007
            
            $  125,000
            
            $    500
            
            $          –2006
            
            $    97,866
            
            $     –
            
            $          –
            
            400,0002005
            
            $    84,878
            
            $     –
            
            $          –
            
            500,000Dr.
      Gary W. Coy,
              Vice
      President and Chief
              Financial
      Officer
            
            2007
            
            $  125,000
            
            $    500
            
            $          –2006
            
            $    88,542
            
            $     -
            
            $          -
            
            400,000







Option
Grants in 2007





No
options were granted in 2007 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
      2007
            
            Exercise
      or Base Price
              ($/Sh)
            
            Expiration
              DateJoseph
      M.
      Cummins
            
            0
            
            0%Martin
      J.
      Cummins
            
            0
            
            0%Gary
      W.
      Coy
            
            0
            
            0%





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


21


Aggregated
Option Exercises at December 31, 2007


And
Year-End Option Values


The
following table sets forth information for the executive officers named above,
regarding the exercise of options during 2007 and unexercised options held at
the end of 2007.





Name
            
            Number
      of Shares Acquired on
              Exercise
            
            Value
              Realized
            
            Number
      of Shares of Common Stock Underlying Unexercised Options at
              December
      31, 2007 Exercisable/Unexercisable
            
            
            Value
      of Unexercised
              In-The-Money
              Options
      at
              December
      31, 2007 (1) Exercisable/UnexercisableJoseph
      M. Cummins
            
            58,486
            
            $44,159
            
            1,830,000
            /
            300,000
            
            
            $
      32,400
            /
            NoneMartin
      J. Cummins
            
            101,818(2)
            
            $34,800
            
            779,000
            
            300,000
            
            
            $   9,000
            
            NoneGary
      W. Coy
            
            None
            
            None
            
            100,000
            /
            300,000
            
            
            None
            /
            None





(1)
            Calculated
      based on the closing price of the common stock ($0.29) as reported by OTC
      BB on December 31, 2007.


(2)
            Cashless
      exercise of 100,000 options resulted in a net issuance of 81,818 shares
      plus exercise of 20,000 options resulted in issuance of 20,000
      shares.





Director
      Compensation for Last Fiscal Year


Cash
      Compensation
            
            Stock
      OptionsName
            
            Meeting
      Fees (1)
            
            Consulting
      Fees (2)
            
            Number
      of Securities Underlying OptionsStephen
      Chen, PhD
            
            $         1,000
            
            $                --
            
            --Thomas
      D’Alonzo
            
            $         1,000
            
            --
            
            --Dennis
      Moore, DVM
            
            $         1,000
            
            --
            
            --James
      Page, MD
            
            $         1,000
            
            --
            
            --Thomas
      Ulie
            
            $         1,000
            
            --
            
            --


(1)
            Directors
      receive $1,000 compensation for attendance at directors’ meetings and $250
      for regularly scheduled teleconference
meetings.


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





Employment
agreements were executed with Joseph M. Cummins, Martin J. Cummins and Gary W.
Coy during 2006.  No employment or Director agreements were executed
in 2007.


22





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




As of
December 31, 2007, there were 29,465,261 shares of the Company’s common stock
outstanding. The following table sets forth as of December 31, 2007, 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 OwnedHayashibara
      Biochemical Laboratories, Inc.
                2-3
      Shimoishii 1-chome
                Okayama
      700, Japan
              
              3,118,655*
              
              10.58%Claus
      Martin, MD
                Gutenreuth
      1
                D-83700
      Rottach-Egern, Germany
              
              1,633,617*
              
              5.54%4,752,272
              
              16.12%


*
Shareholders above holding more than 5% of the common stock own no options or
warrants







The
following table sets forth the beneficial ownership of the Company’s stock as of
December 31, 2007 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
      Owned8Joseph
      M. Cummins
              7308
      Ashland
              Amarillo,
      TX 79119
            
            2,193,6211
            
            5.47%Gary
      W. Coy
              907
      Cat Hollow Club Drive
              Spicewood,
      TX 78669
            
            460,7412
            
            1.15%Martin
      J. Cummins
              6615
      Sandie
              Amarillo,
      TX 79109
            
            934,9663
            
            2.33%Dennis
      Moore
              402
      Fish Hatchery
              Hamilton,
      MT  59840
            
            1,020,7414
            
            2.54%Thomas
      D’Alonzo
              908
      Vance Street
              Raleigh,
      NC 27608
            
            35,4725
            
            0.09%Stephen
      Chen
              Floor
      7-1, No. 18
              Xin
      Yi Road,  Sec. 5
              Taipei,
      Taiwan
            
            902,6256
            
            2.25%James
      Page
              103
      Clubhouse Lane, #182
              Naples,
      FL  34105
            
            855,0347
            
            2.13%Thomas
      Ulie
              P.O.
      Box 814
              Mercer
      Island, WA 98040
            
            771,300
            
            1.92%Total
      Group (all directors and executive officers - 8 persons)
            
            7,174,500
            
            17.88%





1  1,830,000
      of these shares are exercisable options
            6     774,125
      of these shares are exercisable options2100,000
      of these shares are exercisable options
            7814,125
      of these shares are exercisable options3     799,000
      of these shares are exercisable options
            8
      Calculated based on 40,118,673 total shares outstanding and
      reserved4     814,125
      of these shares are exercisable options5         6,800
      of these shares are exercisable options





Employee
Stock Option Plan




The
Company has two employee stock option plans. The first is 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 1996
Employee Stock Option Plan from time to time in the future.




The
Company also has in place the 2006 Employee Stock Option and Stock Bonus Plan.
This plan has authorized a maximum of 500,000 shares of the Company’s common
stock to be issued or reserved. During 2006, 300,000 shares were issued under
this plan to an employee of the Company. The plan shall remain in effect until
the end of the Company’s fiscal year 2011. Options granted under the plan have a
ten year term and become exercisable over a five year period. The option price
is equal to 100% of the fair value of the common stock on the date of
grant.




23







Director
Stock Option Plan




The 1996
Director 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.  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.  Options under the plan have a ten year term and
become exercisable over a five year period.  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.









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 13% of the issued and outstanding shares of common stock of the
Company. HBL loaned $1 million to the Company on December 3, 1999 and an
additional $1 million on February 29, 2000, both loans bearing interest at 4.5%
per annum. The December 3, 1999 loan has been extended until June 3, 2008 and
the February 29, 2000 loan has been extended to August 28, 2008.  The
aggregate balance on both notes at December 31, 2007, including principal and
accrued interest, was $2,682,773. 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.
Additional information on these agreements is set forth in Notes 4 and 8 to the
Financial Statements attached to this 10-KSB.




During
2007, 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
$59,387  by said firm in 2007.




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 July 5,
    2007.3.3*
            
            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).10.37††
      a
            
            License
      and Supply Agreement dated April 3, 2000 with Key Oncologics (Pty) Ltd.
      and the Company.


25





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 Company10.47a
            
            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.10.49
            
            Employment
      Contract dated March 13, 2006, between Gary W. Coy and the
      Company.10.50
            
            Employment
      Contract dated September 10, 2006, between Joseph M. Cummins and the
      Company.10.51
            
            Employment
      Contract dated September 10, 2006, between Martin J. Cummins and the
      Company.10.52a
            
            Supply
      Agreement (Anhydrous Crystalline Maltose) dated October 16, 2006 between
      Hayashibara Biochemical Laboratories, Inc. and the
  Company10.53a
            
            License
      and Supply Agreement dated November 16, 2006, between CytoPharm, Inc. and
      the Company.





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.


‡ The
Exhibit is incorporated by reference to the Company's 2007 Annual Report on Form
10-KSB filed with the Commission on or before March 31, 2008.


aPortions
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 2007 and 2006 for accountant and related
services.




Audit
Fees


2007
            2006LBB
      & Associates Ltd., LLP
            $37,137
            $
      28,050





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.







27


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:March 24,
      2008
            By:
      /s/ Joseph M.
      Cummins
              Joseph
      M. Cummins, Chairman of the Board,
              President,
      and Chief Executive OfficerDate:
      March 25,
      2008
            By:
      /s/ Gary W.
      Coy
              Gary
      W. Coy, Vice President,
              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 and
              Chief
      Executive Officer
            March
      24, 2008Joseph
      M. Cummins/s/
      Stephen Chen
            Director
            March
      25, 2008Stephen
      Chen/s/
      James Page
            Director
            March
      24, 2008James
      Page/s/
      Dennis Moore
            Director
            March
      24, 2008Dennis
      Moore/s/
      Thomas D’Alonzo
            Director
            March
      24, 2008Thomas
      D’Alonzo/s/
      Thomas Ulie
            Director
            March
      24, 2008Thomas
      Ulie













Amarillo
Biosciences, Inc.





Financial
Statements





Year
ended December 31, 2007





ContentsReport
      of Independent Registered Public Accounting
      Firm
              F-1Audited
      Financial StatementsBalance
      Sheet
              F-2Statements
      of
      Operations
              F-3Statements
      of Stockholders’
      Deficit
              F-4Statements
      of Cash
      Flows
              F-5Notes
      to Financial
      Statements
              F-6


Report of Independent
Registered Public Accounting Firm





To the
Board of Directors of


Amarillo
Biosciences, Inc.


Amarillo,
TX





We have
audited the accompanying balance sheet of Amarillo Biosciences, Inc. (the
“Company”) as of December 31, 2007, and the related statements of operations,
stockholders' deficit, and cash flows for each of the years in the two-year
period ended December 31, 2007. 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 audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting.  Our audits included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting.  Accordingly, we express no
such opinion.  An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Amarillo Biosciences, Inc. as of
December 31, 2007, and the results of its operations and its cash flows for each
of the years in the two-year period ended December 31, 2007 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 absence of
significant revenues, recurring losses from operations, and its need for
additional financing in order to fund its projected loss in 2008 raise
substantial doubt about its ability to continue as a going concern. The 2007
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.





LBB &
Associates Ltd., LLP





Houston,
Texas


March 17,
2008


F-1








Amarillo
Biosciences, Inc.


Balance
Sheet


December
31, 2007


AssetsCurrent
      assets:Cash
      and cash equivalents
            $           47,184Other
      current assets
            31,688Total
      current assets
            78,872Property,
      equipment, and software, net of accumulated depreciation of
      $51,463
            14,098Patents,
      net of accumulated amortization of $218,139
            120,925Total
      assets
            $           213,895Liabilities
      and Stockholders' DeficitCurrent
      liabilities:Accounts
      payable and accrued expenses
            $           98,203Accrued
      interest - related party
            682,773Notes
      payable - related party
            2,000,000Total
      current liabilities
            2,780,976Total
      liabilities
            2,780,976Commitments
      and contingenciesStockholders'
      deficitPreferred
      stock, $.01 par value:Authorized
      shares - 10,000,000Issued
      shares – none
            -Common
      stock, $.01 par value:Authorized
      shares - 100,000,000Issued
      shares - 29,465,261
            294,653Additional
      paid-in capital
            25,598,217Accumulated
      deficit
            (28,459,951)Total
      stockholders' deficit
            (2,567,081)Total
      liabilities and stockholder's deficit
            $           213,895








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


F-2


Amarillo
Biosciences, Inc.


Statements
of Operations





Year
      ended December 31,2007
            2006Revenues:Sales
      – Nutraceutical
            $         2,150
            $       3,934Federal
      research grants
            -
            60,023Sublicense
      fee revenue
            40,000
            69,985Royalty
      revenue – Related Party
            27,919
            -Total
      revenues
            70,069
            133,942Operating
      expenses:Cost
      of sales
            680
            258Research
      and development expenses
            530,867
            535,075Selling,
      general and administrative expenses
            1,956,838
            2,288,045Total
      operating expenses
            2,488,385
            2,823,378Operating
      loss
            (2,418,316)
            (2,689,436)Other
      income (expense)Interest
      expense
            (90,648)
            (93,149)Interest
      income
            2,891
            3,034Investment
      income
            -
            1,890Net
      loss
            $
      (2,506,073)
            $
      (2,777,661)Basic
      and diluted net loss per share
            $          (0.09)
            $          (0.12)Weighted
      average shares outstanding
            26,569,803
            22,479,399











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


F-3
 Amarillo
Biosciences, Inc.
 Statements
of Stockholders’ Deficit
 Years
Ended December 31, 2007 and 2006


Issuance
      Price
            Common
      Stock
            Additional
      Paid in Capital
            Accumulated
      Deficit
            Total
      Stockholders' DeficitShares
            AmountBalance
      at December 31, 2005
            
            19,801,870
            $   198,019
            $  20,648,219
            $  (23,176,217)
            $ (2,329,979)Net
      loss for year ended December 31, 2006
            
            -
            -
            -
            (2,777,661)
            (2,777,661)Fair
      value of options issued
            
            
            
            851,518
            
            851,518Exercise
      of options for cash
            0.06-0.27
            350,000
            3,500
            34,400
            -
            37,900Conversion
      and exercise of cashless options
            0.84
            547,216
            5,472
            (5,472)
            -
            -Issuance
      of common stock for cash in
      private     placements
            0.20-0.55
            3,344,917
            33,449
            1,516,636
            -
            1,550,085Issuance
      of common stock for services
            0.433-1.6233
            387,309
            3,873
            261,962
            -
            265,835Issuance
      of common stock for debt
              repayment
            0.55
            45,455
            455
            38,182
            -
            38,637Balance
      at December 31, 2006
            
            24,476,767
            244,768
            23,345,445
            (25,953,878)
            (2,363,665)Net
      loss for year ended December 31, 2007
            
            -
            -
            -
            (2,506,073)
            (2,506,073)Fair
      value of options issued
            
            
            
            879,662
            
            879,662Exercise
      of options & warrants for cash
            0.06-0.44
            529,486
            5,295
            97,194
            -
            102,489Conversion
      and exercise of cashless options
            0.06-0.44
            171,853
            1,719
            (1,719)
            -
            -Issuance
      of common stock for cash in
              private placements
            0.20-0.45
            4,087,155
            40,871
            1,113,635
            -
            1,154,506Issuance
      of common stock for services
            0.82-0.84
            200,000
            2,000
            164,000
            -
            166,000Balance
      at December 31, 2007
            
            29,465,261
            $   294,653
            $  25,598,217
            $  (28,459,951)
            $            (2,567,081)





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


F-4


Amarillo
Biosciences, Inc.


Statements
of Cash Flows


Year
      ended December 31,Operating
      Activities
            2007
            2006Net
      loss
            $  (2,506,073)
            $  (2,777,661)Adjustments
      to reconcile net loss to net cash
              used
      for operating activities:Depreciation
      and amortization
            18,783
            15,178Common
      stock issued for services and
              retirement
      of debt
            166,000
            279,473Fair
      value of options issued
            879,662
            851,518Changes
      in operating assets and liabilities:Other
      current assets
            2,683
            (31,583)Accounts
      payable and accrued liabilities
            (55,179)
            111,868Accrued
      interest
            82,072
            90,000Net
      cash used in operating activities
            (1,412,052)
            (1,461,207)Investing
      ActivitiesPurchase
      of property and equipment
            (2,578)
            (18,406)Investment
      in Patents
            (9,025)
            (19,343)Net
      cash used in investing activities
            (11,603)
            (37,749)Financing
      ActivitiesProceeds
      from exercise of warrants and options
            102,489
            37,900Repayments
      of notes payable
            -
            (68,500)Issuance
      of common stock
            1,154,506
            1,550,085Net
      cash provided by financing activities
            1,256,995
            1,519,485Net
      increase (decrease) in cash
            (166,660)
            20,529Cash
      and cash equivalents at beginning of period
            213,844
            193,315Cash
      and cash equivalents at end of period
            $         47,184
            $        213,844Supplemental
      Cash Flow InformationCash
      paid for interest
            $           2,891
            $            3,149Stock
      issued for debt repayment
            $   
                     -
            $          25,000








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


F-5


Amarillo
Biosciences, Inc.


Notes
to Financial Statements


December
31, 2007








1.
Organization and Summary of Significant Accounting Policies





Organization
and Business





Amarillo
Biosciences, Inc. (the "Company” or “AMAR"), 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 has not commenced any significant product commercialization
activities.





Going
Concern





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 2008 plan of operations calls for the Company to expend approximately
$2 million cash, excluding funding fees, in 2008. At December 31, 2007, the
Company had available cash of $47,184 and negative working capital (current
assets less current liabilities) of ($2,702,104).  Current liabilities
included two $1 million notes and $682,773 accrued interest owed to Hayashibara
Biochemical Laboratories, Inc. (“HBL”), the Company’s largest shareholder and
supplier of interferon. The Company paid $200,000 of accrued interest to HBL in
January of 2008 and HBL extended the notes and accrued interest until June 3,
2008 and August 28, 2008.   HBL will extend the notes until
December 3, 2009 and February 28, 2010 if payment of $145,000 of accrued
interest is received by August 31, 2008.


F-6


1.
Organization and Summary of Significant Accounting Policies
(Continued)





Going
Concern (Continued)





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.  On January 8, 2008, the Company received gross proceeds of
$1,000,000 from the sales of convertible preferred stock. After deducting
expenses of the private placement, the Company received net proceeds of
approximately $841,500.  The Company will need to raise approximately
$1,500,000 additional funds in order to execute its 2008 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 2008. These agreements could generally
include provisions for the commercial partner to pay  a technology
access fee, could include payments for a portion of the clinical trial expenses,
could include payment obligations 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
the Company. 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.





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
financial statements.





Stock
Based Compensation





Effective January 1,
2006, the Company adopted SFAS No. 123 (revised),
"Share-Based Payment" (SFAS 123(R)) utilizing the modified prospective approach.
Prior to the adoption of SFAS 123(R) we accounted for
stock option grant in accordance with APB Opinion No. 25,
“Accounting for Stock Issued to Employees," and
accordingly, recognized compensation expense for stock option grants
using the intrinsic value method.





Under the
modified prospective approach, SFAS 123(R) applies to new awards and
to awards that were outstanding on January 1, 2006 that
are subsequently modified, repurchased


F-7


1.
Organization and Summary of Significant Accounting Policies
(Continued)





or
cancelled.  Under the modified prospective approach, compensation
cost recognized in the first quarter of fiscal 2006 includes
compensation cost for all share-based payments granted prior to, but not yet
vested as of January 1, 2006, based on the grant-date fair value estimated in
accordance with the original  provisions of SFAS 123, and
compensation cost for all share-based payments granted
subsequent  to January 1, 2006 based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123(R).  For all
quarters after the first quarter of fiscal 2006, compensation costs recognized
will include compensation costs for all share-based payments granted based on
the grant date fair value estimated in accordance with the provisions of SFAS
123(R).





The fair
value of each option granted in 2006  is estimated on the date of
grant using the Black-Scholes option-pricing model with the following weighted
average assumptions: dividend yield of 0.0%, expected volatility of 134.0%,
risk-free interest rate of 1.5% and expected life of 60 months.  The
fair value of each option granted in 2007 is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions: dividend yield of 0.0%, expected volatility of 103.2%, risk-free
interest rate of 4.34% and expected life of 1.57 years.





Cash
and Cash Equivalents





The
Company classifies investments as cash equivalents if the original maturity of
an investment is three months or less.





Allowance
for Doubtful Accounts





The
Company establishes an allowance for doubtful accounts to ensure trade and notes
receivable are not overstated due to uncollectibility.  The Company’s
allowance is based on a variety of factors, including age of the receivable,
significant one-time events, historical experience, and other risk
considerations.  The balance of the allowance for doubtful accounts as
of December 31, 2007 is $0.





Accounts
receivable amounted to $887 as of December 31, 2007, and are included with other
current assets in the accompanying financial statements.





Inventory





Inventories
are stated at the lower of cost or market. Cost is determined on a first-in,
first-out basis. The Company continually assesses the appropriateness of
inventory valuations giving consideration to slow-moving, non-saleable,
out-of-date or close-dated inventory. As of December 31, 2007 the Company has
$3,133 of inventory included in other current assets.


F-8


1.
Organization and Summary of Significant Accounting Policies
(Continued)





Property
and Equipment





Property,
equipment and software 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.





Patents
and Patent Expenditures





AMAR
holds patent license agreements and holds patents that 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 $13,970 and $12,380 for the
years ended December 31, 2007 and 2006, respectively.





Long-lived
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.





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 collectibility is reasonably
assured.  This generally occurs at the point when the goods are
shipped to the customer.


F-9


1.
Organization and Summary of Significant Accounting Policies
(Continued)





Sublicense
fee revenue





Sublicense
revenue is calculated based on fees relating to a license.  Amarillo
recognizes revenue on these sublicense fees in the month the revenue is
generated by the licensee.





Royalty
revenue





Royalty
revenue is calculated based on royalty fees as a percent of net sales relating
to a license.  Amarillo recognizes revenue on these royalty payments
in the year the revenue is generated by the licensee.  Royalty revenue
of $27,919 was reported in the year ended December 31, 2007 for HBL sales of
Bimron to BioVet.





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.





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 is anti-dilutive.





Concentration
of Credit Risk





Financial
instruments that potentially subject the Company to significant concentration of
credit risk consist principally of cash and accounts receivable.





The
Company has cash balances in a single financial institution which, from time to
time, exceed the federally insured limit of $100,000.   No loss
has been incurred related to this concentration of cash.


F-10


1.
Organization and Summary of Significant Accounting Policies
(Continued)





Other
Concentrations





The
Company and its sublicensees are reliant on a single, foreign supplier for its
products.  The loss of this supplier could adversely affect the
Company’s future revenues.  During 2007 the majority of revenue came
from royalties from its foreign supplier and a sublicense fee from one of its
sublicensees.  The loss of revenue from one these revenue sources
could adversely affect the Company’s future revenues.





Recent
Accounting Pronouncements





In
September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 157, Fair Value Measurements.  SFAS No. 157 defines fair value,
establishes a framework for measuring fair value in GAAP, and expands
disclosures about fair value measurements.  This statement is effective for
financial statements issued for fiscal years beginning after November 15,
2007.  Management is currently evaluating the impact SFAS No. 157 will have
on the Company’s financial position, results of operations, and cash
flows.





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – including an amendment of FASB
statement No. 115.” This Statement permits all entities to choose, at specified
election dates, to measure eligible items at fair value (the “fair value
option”). A business entity shall report unrealized gains and losses on items
for which the fair value option has been elected in earnings (or another
performance indicator if the business entity does not report earnings) at each
subsequent reporting date. Upfront costs and fees related to items for which the
fair value option is elected shall be recognized in earnings as incurred and not
deferred. If an entity elects the fair value option for a held-to-maturity or
available-for-sale security in conjunction with the adoption of this Statement,
that security shall be reported as a trading security under Statement 115, but
the accounting for a transfer to the trading category under paragraph 15(b) of
Statement 115 does not apply. Electing the fair value option for an existing
held-to-maturity security will not call into question the intent of an entity to
hold other debt securities to maturity in the future. This statement is
effective as of the first fiscal year that begins after November 15,
2007.  The Company is currently analyzing the effects of SFAS 159 but
does not expect its implementation will have a significant impact on the
Company's financial condition or results of operations.


F-11





2.
Property, Equipment and Software





Equipment
is stated at cost and consists of the following at December 31,
2007:
 
 Furniture
      and equipment
              $       58,528Software
              7,03365,561Less:  accumulated
      depreciation
              $       14,098




Depreciation
expense amounted to $4,813 and $2,798 for the years ended December 31, 2007 and
2006, respectively.





3. Notes Payable





The
Company had an unsecured 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 three notes was converted into stock as described below.  The
annual interest rate on unpaid principal from the date of each respective
advance was 4.5 percent, with accrued interest being payable at the maturity of
the note. $1,000,000 was payable on or before December 3, 2007, 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 June 3, 2008, 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 was payable on or before February 29, 2008, or on or before the
expiration of one 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 August 28, 2008, or on or before expiration or on or before the
expiration of one year after approval of the Company’s product by the FDA,
whichever occurs first.   HBL will extend the notes to December
3, 2009 and February 28, 2010 respectively if $145,000 of accrued interest is
paid on or before August 31, 2008.





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.





The
Company has a line of credit with Wells Fargo for $20,000, with
interest at the prime rate plus 6.75 percent. There was an outstanding balance
at December 31, 2007 of $1,915 which is included in accounts payable and accrued
expenses. This line is used from time to time for
purchases.


F-12





4.
Manufacturing and Supply Agreements





The
Company was a party to the following manufacturing and supply agreements at
December 31, 2007:





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, 2011.





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.





A $7,500
minimum cash royalty was paid by the Company to Texas A&M University System
during 2007. A $19,991 sublicense fee was paid to HBL in 2007 based on
sublicense fee income earned by the Company during the year.  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.


F-13





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.  The Company plans to pay third parties
approximately $120,000 to complete enrollment of 40 HIV+ patients in the oral
warts Phase 2 clinical trials in 2008.





7.
Common and Preferred Stock





The
Company has 100,000,000 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 shareholders approved an increase in authorized
shares from 50,000,000 to 100,000,000 in 2007. The Company has 40,118,673 shares
of common stock outstanding and reserved for issuance upon exercise of options
and warrants granted including 1,200,000 of options reserved but not issued for
employee and director plans.





During
2007, the Company sold 4,087,155 unregistered shares of its voting common stock
in private placement offerings.  Of these sales, 1,290,012 shares were
sold for $0.45 per share; 97,143 shares were sold for $0.35 per share; and
2,700,000 shares were sold for $0.20 per share: generating $1,154,506 in
cash.





During
2007, the Board of Directors authorized the issuance of 200,000 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 $166,000 was recorded for the issuance of these shares
during the year ended December 31, 2007.





During
the years ended December 31, 2007 and 2006, finder’s fees paid related to
private placements of stock totaled $34,950 and $120,850, and are included as
general and administrative expenses in the accompany statements of
operations.





8.
Stock Options and Warrants





The
Company has three stock option plans: the 1996 Employee Stock Option Plan (1996
Employee Plan), the 2006 Employee Stock Option and Stock Bonus Plan (2006
Employee Plan) and the Outside Director and Advisor Stock Option Plan (Director
Plan).





The 1996
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.


F-14


8.
Stock Options and Warrants (Continued)





The 2006
Employee Plan has authorized a maximum of 500,000 shares of the Company’s common
stock to be issued or reserved. During 2006, 300,000 shares under this plan were
issued to an employee of the Company. The plan shall remain in effect until the
end of the Company’s fiscal year 2011. Options granted under the plan have a
ten-year term and become exercisable over a five-year period. The option price
is equal to 100% of the fair value of the common stock on the date of
grant.





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
2006, the Company issued 945,500 options to consultants to purchase restricted
common stock in exchange for consulting services and recognized $737,862 expense
related to these options.  During 2007, the Company issued 1,600,000
options to consultants and 10,000 options to an Scientific Advisory Committee
member and recognized $644,723 expense related to these options.





During
2006, the Company issued 1,200,000 options to employees of the Company. These
options vest over the next four years. The Company recognized $113,656 expense
in 2006 and $234,939 expense in 2007 related to these options.  The
remaining cost expected to be recognized if these options vest is
$626,726.  No options were issued to employees during
2007.





During
2006, a former Director received 547,216 shares of common stock from the
cashless exercise of 864,125 options.  The stock is restricted from
selling for one year.  During 2007, two Directors and two employees
received 171,853 shares of common stock from the cashless exercise of 214,000
options.





During
2006, a consultant exercised 250,000 options at $0.10 per share for
cash.  A Board member exercised 20,000 options at $0.27 per
share.  An investor exercised 30,000 warrants at $0.15 per share and
50,000 warrants at $0.06 per share.  During 2007, consultants
exercised 350,000 options at $0.20 per share for cash.  A Board member
exercised 20,000 options at $0.27 per share.   Employees
exercised 90,486 shares at $0.06, 10,000 shares at $0.23 and 25,000 shares at
$0.44.  A former employee exercised 4,000 shares at
$0.44.  An investor exercised 30,000 warrants at $0.22 per
share.


F-15





8.
Stock Options and Warrants (Continued)





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


2007
            2006Options
            Price
            Options
            PriceOutstanding
      Beg of Year
            8,589,237
            $0.06-4.00
            6,920,862
            $0.06-5.00Granted
            1,610,000
            0.20-0.40
            2,825,500
            0.10-0.87Cancelled
            (292,339)
            0.44-4.00
            (23,000)
            0.42-5.00Exercised
            (713,486)
            0.06-0.44
            (1,134,125)
            0.10-0.51Outstanding
      End of Year
            9,193,412
            0.20-0.87
            8,589,237
            0.06-4.00Exercisable
      End of Year
            7,773,412
            0.20-0.87
            7,709,237
            0.06-4.00





Options
reserved for employee and director plans but not issued (1,200,000) are not
included in the table above.





Exercise
prices for options outstanding as of December 31, 2007 ranged from $0.20 to
$0.87.  The weighted-average remaining contractual life of those
options is 2.45 years.





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


2007
            2006Warrants
            Price
      Range
            Warrants
            Price
      RangeOutstanding
      Beg of Year
            290,000
            $0.22-2.00
            282,000
            $0.06-1.75Granted
            -
            -
            200,000
            2.00Cancelled
            -
            -
            (112,000)
            1.75Exercised
            (30,000)
            0.22
            (80,000)
            0.06-0.15Outstanding
      End of Year
            260,000
            0.47-2.00
            290,000
            0.22-2.00Exercisable
      End of Year
            260,000
            0.47-2.00
            290,000
            0.22-2.00





The
weighted-average remaining contractual life of the warrants outstanding at
December 31, 2007 is 1.27 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, 2007 and 2006, were $0, and $0, respectively.


F-16





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 $8,000,000 and $7,400,000 at December 31, 2007 and 2006
respectively, was subject to a valuation allowance of $8,000,000 and $7,400,000
at December 31, 2007 and 2006 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, 2007, the Company has net operating loss carryforwards of
approximately $23,509,000 for federal income tax purposes expiring in 2008
through 2027. 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.





11.
Commitments and Contingencies





Lease
commitment





During
2006, the Company entered into an operating lease agreement for its offices in
Amarillo, TX.  The lease for 3,675 square feet is for a period of 24
months commencing in January 2007.  Minimum lease payments under this
operating lease are $44,400 for 2007 and 2008.  The Company has no
material lease obligations beyond December 2008.





Minimum
Royalties





The
agreement with Texas A&M University requires the Company to make minimum
annual royalty payments of $7,500 through 2019.





Clinical Trial
Costs





Thirteen
clinical investigation sites are participating in an oral interferon treatment
of oral warts in HIV+ patients FDA Phase 2 study in Augusta (GA), Baltimore,
Boston, Chicago, Dallas, Ft. Lauderdale, Lexington (KY), Newark, New Orleans,
New York City, Philadelphia, San Antonio and San Francisco.   The
Company estimates the clinical trial costs for the oral warts Phase 2 study to
be approximately $305,000 in 2008.


F-17





11.
Commitments and Contingencies (Continued)





Litigation





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,
2007.





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 previously described, 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 10.58% of the
issued and outstanding shares of common stock of the Company.





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. The Company pays HBL a 12% royalty on the first
$100 million of interferon alpha net sales and a 10% royalty on additional net
sales.





Additionally,
the Company is obligated to pay HBL a percentage of sublicense fee income the
Company receives.  There were no sales of interferon alpha and no
royalty payments made to HBL in 2007.  A $19,991 sublicense fee to HBL
was recorded in 2007.





During
2007 and 2006, the Company purchased $0 and $8,240 of interferon alpha and other
products from HBL, respectively.  The Company paid HBL 50% of
sublicense fees of $19,991 in 2007 and $19,993 in 2006.  At December
31, 2007 and 2006 the Company did not have any outstanding amounts owed to HBL
for purchases of interferon alpha or other products.





HBL is
obligated to pay the Company a 8% royalty on sales of oral interferon in
Japan.  The Company received $27,919 of royalties in 2007 from HBL
animal health sales of oral interferon.





During
2007, the Company engaged the law firm of SandersBaker, P.C.  Mr.
Edward Morris, Secretary of the Company, is a partner in that firm. The Company
was invoiced $59,387 during 2007 for legal services rendered by
SandersBaker.


F-18





13.  Subsequent
Events





Since
December 31, 2007, the Company has sold 1,000 shares of convertible preferred
stock for $1,000 per share in a private placement offering; generating gross
proceeds of $1,000,000 and net proceeds of $841,500, excluding commissions,
estimated registration costs and closing costs.   The convertible
preferred stock is convertible into 4,000,000 shares of common
stock.  The investor also received 5 year warrants to purchase
4,000,000 shares of common stock at $0.30 per share. The investment banker was
paid a commission of $80,000 plus received 5 year warrants to purchase 640,000
shares of common stock at $0.30 per share. The Company is required to register
with the SEC the common stock reserved for preferred stock and warrants on or
before April 25, 2008.





On
January 8, 2008, an employee received a $2,500 cash bonus and a $2,500 stock
bonus (7,575 shares) as an award for closing the above $1 million
funding.





On
January 4, 2008, 100,000 options with 25,000 options vesting quarterly were
issued to two consultants with exercise prices at market ($0.35) and 2 year
terms.





On
January 10, 2008, the Company paid HBL $200,000 of accrued interest for two
$1,000,000 notes.  HBL extended the notes from December 3, 2007 and
February 29, 2008 to June 3, 2008 and August 28, 2008.  HBL will
extend the notes to December 3, 2009 and February 28, 2010, respectively, if
$145,000 of accrued interest is paid on or before August 31, 2008.





On
February 22, 2008, the Company entered into a 1 year consulting agreement to
provide investor relations, public relations and shareholder relations
services.  The Company may terminate the agreement the remaining 9
months of services by giving notice on or before May 22, 2008.  The
Company agreed to pay the Consultant $30,000 plus a common stock grant of 90,000
shares for the first 3 months and if the agreement is continued the remainder of
the term, an additional $7,500 per month for 8 months plus a common stock grant
for 270,000 shares.








F-19