**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, 2006**[
                ]**
            
            **Transition
                Report Under Section 13 or 15(d) of the Securities Exchange Act of
                1934
                [No Fee Required]**
              
              **Commission
                File Number 0-20791****AMARILLO
                BIOSCIENCES, INC.**
              **(Name
                of small business issuer in its charter)****Texas**
              (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 X No





Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B in this form, and no disclosure will be contained, to the best
      of
      registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-KSB or any amendment
      to
      this Form 10-KSB. [ X ]





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


1


Revenues
      for its most recent fiscal year were $133,942.





As
      of
      December 31, 2006, there were outstanding 24,476,767 shares of the registrant’s
      common stock, par value $.01, which is the only class of common or voting stock
      of the registrant. As of that date, the aggregate market value of the shares
      of
      common stock held by non-affiliates of the registrant (based on the closing
      price for the common stock on the OTC BB.AMAR) was approximately
      $12,799,970.





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 2007 Plan of Operations” as well as
      those discussed elsewhere in this Form 10-KSB. The following discussion should
      be read in conjunction with the Financial Statements and the Notes thereto
      included elsewhere in this Form 10-KSB.*





ITEM
      1.  DESCRIPTION
      OF BUSINESS.





**General**





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




The
      Company owns or licenses 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. Since 1992, the Company has filed with
      the U.S. Food and Drug Administration (“FDA”), and there now are in effect,
      seven Investigational New Drug (“IND”) Applications covering indicated uses for
      low-dose oral interferon alpha, including treatment of Behcet’s disease,
      Sjogren’s syndrome, idiopathic pulmonary fibrosis and oral warts in HIV+
      patients.




The
      Company’s objective is to exploit its proprietary technology to become a leader
      in the field of low-dose oral applications of interferon alpha. The Company’s
      business strategy is to pursue those indications for low-dose oral interferon
      alpha treatment for which initial clinical research has indicated the treatment
      is efficacious and which, in the opinion of the Company, have the greatest
      commercial potential and are most likely to be approved by the FDA. To the
      extent possible, the Company will attempt to minimize the cost to the Company
      of
      obtaining FDA approval by utilizing forms of interferon alpha already approved
      (in other dosage forms and for different indications) by the Japanese Ministry
      of Health and




2


Welfare
      for human or animal use. The Company believes that cost savings will result
      from
      this strategy. The Company will attempt to gain market share for approved
      products by forming alliances with strong marketing partners.




The
      Company has six full-time employees. The Company makes extensive use of
      consultants in business and research and development. Governmental or FDA
      approval is required on the Company’s principal products. The Company’s progress
      toward approval is discussed under each specific indication, below.




**Human
      Health Applications**





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




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




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




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




3


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




Because
      UWS was a secondary, and not the primary end point of these studies, these
      promising findings did not result in FDA approval. Instead, the FDA suggested
      that the Company sponsor an additional, large-scale Phase III study that would
      include UWS flow as the primary endpoint.




The
      Company proposes to start a study designed to demonstrate, by biopsy,
      improvement at the site of disease activity, the salivary glands. The biopsy
      study will be useful in establishing UWS as a surrogate marker for disease
      activity and in providing insight into the mechanism of action of orally
      administered interferon-alpha. The start date for the study has not been
      established yet.




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




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




At
      the
      end of February, 2006, Martin Cummins, Vice President of Regulatory and Clinical
      Affairs for ABI, visited Nobel Ilac Sanayii Ve Ticaret A.S, ABI’s licensee
      in Turkey. He conducted in study initiation meetings with the clinical
      investigators prior to the commencement of enrollment of 90 patients with
      Behcet’s disease in a study of interferon lozenges versus placebo. The
      treatment duration is 12 weeks, with completion of the study expected within
      calendar year 2007. At the time of this document’s preparation, 58 of 90
      patients have been enrolled.




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




4


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




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




Oral
      interferon has been tested by Dr. Lorenz Lutherer at Texas Tech University
      Health Science Center in Lubbock for the treatment of patients with IPF. This
      IPF study
      was
      funded by a grant from the State of Texas, and the first patient was enrolled
      over five years ago. Eighteen subjects were enrolled and given 150 IU of
      interferon three times daily .
      The
      subjects were evaluated with pulmonary function tests quarterly and chest x-rays
      and high resolution computed tomography (HRCT) annually.




On
      March
      3, 2006 in Atlanta at the Regional Annual Meeting of the Southern Society for
      Clinical Investigations, Dr. Lutherer concluded the following:


1)  Treatment
      with low-dose, oral interferon was tolerated by patients without side
      effects.


2)  Retrospective
      data suggest that this treatment leads to a rapid and significant reduction
      in
      the cough associated with IPF, resulting in improved quality of
      life.


3)  All
      subjects had severely compromised lung function on study entry. Most of the
      ten
      subjects treated for a 12-month period had stable or minimally progressive
      disease.


4)  Each
      of
      the subjects served as their own control and there was no placebo control group
      for comparison. Given the well-documented rapid rate of progression and the
      short life expectancy after diagnosis, stability
      over this long period of time in this high percentage of subjects strongly
      suggests efficacy of oral interferon .


5)  Treatment
      with low-dose, orally administered interferon may be a safe, inexpensive and
      non-invasive way to  prevent
      or decrease the rate of further deterioration of lung function.




In
      collaboration with Dr. Lutherer, the Company applied for an NIH grant in
      December 2006 to fund a phase II study for oral interferon treatment of
      IPF-related chronic coughing. A funding decision is expected in the second
      quarter of 2007.




5


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




Dr.
      Manfred Beilharz, the Head of the 2005 Nobel Prize-winning Department of
      Microbiology and Immunology at the University of Western Australia, recently
      completed animal studies of influenza prophylaxis using oral
      interferon. Mice
      treated with 100 IU of oral interferon per day before and after a lethal
      influenza challenge survived compared to placebo-treated mice. Animal studies
      by
      Dr. Troy Randall of the Trudeau Institute found similar results. ABI’s partner
      in Taiwan, CytoPharm, will fund and start a human Phase II study of oral
      interferon treatment of influenza in 2007.




*Bone
      Marrow Disorders.* ABI
      sponsored a test of low dose oral interferon alpha in patients with rare bone
      marrow proliferative disorders at the University of Texas MD Anderson Cancer
      Center in Houston, TX. Patients with either polycythemia vera (PV) or essential
      thrombocythemia (ET) were eligible to participate. The goal was to explore
      low
      dose oral interferon alpha daily as a means of reducing the elevated blood
      counts observed in such patients, with the hope of reversing the bothersome
      symptoms associated with these disorders. This study was predicated on positive
      data obtained from an earlier study.




PV
      and ET
      are stem cell disorders considered to be incurable. Treatment efforts strive
      to
      reduce clotting events in ET patients, who are at high-risk for thrombosis
      due
      to their elevated platelet count. All patients with PV require phlebotomy
      (drawing blood), because of elevated hematocrit levels (the concentration of
      red
      blood cells). This maneuver prolongs survival by decreasing, but not abolishing,
      the risk of thrombosis.




In
      a
      previous study sponsored by the Company at the Mayo Clinic in Rochester, MN,
      4
      of 7 PV subjects given oral interferon alpha had a 3 50%
      reduction in phlebotomy requirement, compared to the 6 months prior to the
      study, and consequently were considered partial responders. One of 6 ET subjects
      given oral interferon alpha experienced normalization of platelet count, a
      complete response. No serious adverse events occurred in this previous
      study.




A
      total
      of 14 patients (8 PV, 6 ET) were given oral interferon-alpha in the current
      study for a median time of 3 months (range 2.5 to 6). No deaths, serious adverse
      events or significant increases in abnormal blood counts were observed, further
      demonstrating the safety of this therapy. However, the positive results noted
      in
      the previous trial were not confirmed as none of the current patients
      experienced a significant decrease in their abnormal blood counts. The study
      was
      closed in the 4 th quarter
      of 2006.






6


*Chronic
      Hepatitis B* .
      Approximately 2 billion people are infected with hepatitis B virus worldwide
      with more than 350 million having lifelong chronic hepatitis B infection.
      Chronic hepatitis B causes cirrhosis and liver cancer and kills approximately
      one million people each year. The disease can be quite severe and long lasting
      for those that recover. Vaccination for chronic hepatitis B is 95% effective.
      Hepatitis B is transmitted by contact with blood or body fluids (sexual contact)
      of infected people. Infections may also be transmitted from mother to child.
      Chronic hepatitis B is currently treated with antivirals (lamivudine, entecavir
      and adefovir dipivoxil) and immunomodulators (injectable pegylated interferons).
      Side effects of injectable pegylated interferons are common and often severe.
      Chronic hepatitis B requires long term treatment. Lamivudine resistance develops
      in approximately 24% of patients after one year and 67% after four
      years.




AMAR
      conducted a Phase 2 hepatitis B study in Poland where the incidence of the
      disease is high. Hepatitis Be antigen seroconversion occurred in 52% of the
      patients treated with AMAR’s low-dose oral interferon-alpha. Seroconversion
      indicates that there is no evidence of hepatitis B in the blood. Side effects
      for AMAR’s low-dose oral interferon are low compared with the common and often
      severe side effects of high dose injectable interferon.




AMAR’s
      partner in Taiwan, CytoPharm, will start a study of oral interferon treatment
      of
      chronic hepatitis B in 2007.




**Strategic
      Alliance with HBL**




Hayashibara
      Biochemical Laboratories, Inc. (“HBL”) was established in 1970 to engage in
      research and development. It is a subsidiary of Hayashibara Company, Ltd.,
      a
      privately-owned Japanese holding corporation with diversified subsidiaries.
      For
      more than 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 “Development Agreement”). Such Development Agreement was
      subsequently amended on January 17, 1996; May 10, 1996; and September 7, 2001.
      The current expiration date of the Development Agreement is March 12, 2008,
      at
      which time it will automatically renew for an additional three (3) years, unless
      the parties agree otherwise. Among other things, the Development Agreement
      provides the Company with a source of natural human interferon alpha for use
      in
      the Company’s interferon alpha-containing products. Additional information on
      the Development Agreement is set forth in Note 4 to the Financial Statements
      attached to this 10-KSB.




7


**Strategic
      Alliance with Nobel**




The
      Company signed a licensing and supply agreement in September 2004 with a leading
      Turkish pharmaceutical company, NOBEL ILAC SANAYII VE TICARET A.S. , providing
      the rights to oral low-dose interferon-alpha for the treatment of Behcet’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 Behcet’s Disease to
      Amarillo Biosciences. The Orphan Drug Designation is designed to promote the
      development of treatments for diseases rare in the United States and provides
      certain marketing exclusivity incentives outlined under the Orphan Drug
      Act.




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




In
      2005,
      the clinical protocol was developed, clinical supplies were made and packaged,
      and clinical investigators identified. The study is ongoing and at the time
      of
      preparation of this document, 58 of 90 patients have been enrolled in a study
      of
      interferon lozenges versus placebo. The treatment duration is 12 weeks,
      with completion of the study expected within 2007.




**Strategic
      Alliance with Bumimedic**




On
      January 19, 2006, Amarillo Biosciences, Inc 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
      ABI’s low-dose interferon (natural human IFN) in Malaysia. Bumimedic will seek
      registration for ABI’s natural human IFN and commence marketing the product
      after approval. The terms of the agreement call for Bumimedic to manufacture
      lozenges from ABI’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, ABI
      will receive a series of payments, in three stages: upon formal execution of
      the
      distribution agreement, upon regulatory approval, and upon production. ABI
      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 has entered into discussions with Malaysian regulatory agencies
      to conduct clinical trials for oral interferon treatment of
      influenza.




**Strategic
      Alliance with CytoPharm**




In
      November 27, 2006, ABI 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




8


Genomics,
      Inc., the largest biotech company in Taiwan specializing in pharmacogenomics
      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
      ABI’s low dose oral interferon in the Territory for influenza and hepatitis B
      (HBV) indications. CytoPharm has entered into discussions with regulatory
      agencies in the Territory to conduct clinical trials for oral interferon
      treatment of hepatitis B and influenza, which are expected to commence in 2007.
      According to the Agreement, CytoPharm will make payments to ABI upon reaching
      certain milestones and will also pay royalties on low dose oral interferon
      sales
      in the Territory.




**License
      Agreement with Global Kinetics**




On
      October 19, 2005, ABI entered into a License and Supply Agreement with Global
      Kinetics, Inc. Under the terms of the Agreement Global will conduct all clinical
      trials and seek to obtain regulatory approvals in Cambodia, Vietnam and Laos
      for
      oral interferon treatment of human diseases. ABI terminated the Agreement under
      provisions therein by giving notice to Global on January 10, 2007. ABI is
      currently seeking license agreement candidates for this territory.




**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, ABI 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. During
      2006 one patent expired and two new patent applications were filed. ABI
      presently owns or licenses 12 patents and two pending patents related to
      low-dose orally delivered interferon, and one issued patent on ABI’s dietary
      supplement. ABI has vigorously enforced its patent position in the past,
      resulting in successful settlement. There are no current patent litigation
      proceedings involving ABI.




**Cost
      of Compliance with Environmental Regulations**




The
      Company incurred no costs to comply with environment regulations in
      2006.




**Competition**




The
      pharmaceutical industry is an expanding and rapidly changing industry
      characterized by intense competition. The Company believes that its ability
      to
      compete will be dependent in large part upon its ability to continually enhance
      and improve its products and technologies. In order to do so, the Company must
      effectively utilize and expand its research and development capabilities and,
      once developed, expeditiously convert new technology into products and
      processes, which can be commercialized. Competition is based primarily on
      scientific and technological superiority, technical support, availability of
      patent protection, access to adequate capital, the ability to develop, acquire
      and market products and processes successfully, the ability to obtain
      governmental approvals and the ability to serve the particular needs of
      commercial customers. Corporations and institutions with greater resources
      than
      the Company may, therefore, have a




9


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.




*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.




10


*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, 2006 and 2005, the Company incurred expenses of
      $535,075 and $187,810, respectively, resulting from Company-sponsored research
      and development activities. Research and development is expected to remain
      a
      significant component of the Company’s business. The Company has arranged for
      others, at their cost, to perform substantially all of its clinical research
      and
      intends to continue to do so while utilizing its staff for monitoring such
      research. See also ITEM 6, “MANAGEMENT’S 2007 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 22, 2006, 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 fewer than 50% of the outstanding shares
      of
      the Company represented at the meeting so the meeting was adjourned until July
      7, 2006, in order to solicit additional votes and obtain a quorum.




The
      following persons were directors of the Company before the meeting and continued
      to serve as directors of the Company until the meeting was reconvened on July
      7,
      2006: Joseph M. Cummins, Stephen Chen, James Page, Dennis Moore, and Katsuaki
      Hayashibara.




The
      meeting reconvened on July 7, 2006, with 11,181,724 shares of the voting common
      stock of the Company represented, being 51.8% of the issued and outstanding
      voting common shares of the Company, 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 - 11,126,872 shares voted in favor and 54,852 share
      withheld;




Director
      No. 2 - Stephen Chen - 11,163,449 shares voted in favor and 18,275 withheld;




11


Director
      No. 3 - James Page - 11,159,449 shares voted in favor and 22,275 withheld;




Director
      No. 4 - Dennis Moore - 11,109,001 shares voted in favor and 72,723 withheld;




Director
      No. 5 - Thomas D’Alonzo - 11,159,449 shares voted in favor and 22,275 withheld;
      and




Director
      No. 6 - Thomas Ulie - 11,109,301 shares voted in favor and 72,423 withheld.




**Proposition
      2 - Authorization to vote Proxies on Other Business to Properly Come Before
      the
      Meeting.**




Proposition
      2 passed by a vote of 11,091,549 shares voted in favor, 80,900 voted against,
      and 9,275 shares not voted due to broker abstentions.




**Proposition
      3 - Adjournment of Meeting to Solicit Additional Votes.**




Proposition
      3 passed by a vote of 11,110,072 shares voted in favor, 63,677 shares voted
      against, and 7,975 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 2006 and 2005 was as follows:


2006
            2005Quarter
            High
            Low
            High
            LowFirst
            $1.71
            $0.42
            $0.58
            $0.29Second
            1.50
            0.80
            0.45
            0.31Third
            0.89
            0.66
            0.38
            0.27Forth
            0.82
            0.46
            0.61
            0.27





The
      quotations reflect inter-dealer bids without retail markup, markdown, or
      commission, and may not represent actual transactions. As of December 31, 2006,
      the Company had approximately 1,495 shareholders of record.





During
      2006 there were 22 sales of the unregistered common stock of the Company by
      private placement, raising $1,550,085 in cash. Of those purchases, 3 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 19
      purchases were made by accredited investors. Of these sales, 671,300 shares
      were
      sold for $0.20 per share; 200,000 shares were sold for $0.38 per share; 33,617
      shares were sold for $0.47 per


12


share;
      600,000 shares were sold for $0.52 per share; and 1,840,000 shares were sold
      for
      $0.55 per share. The foregoing private placements were conducted in reliance
      on
      Rule 506, promulgated under Section 4(2) of the Securities Act of
      1933.





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





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





**Overview**





The
      Company continues to engage in research and development activities focused
      on
      developing biologics for the treatment of human and animal diseases. The Company
      has not commenced any significant product commer-cialization and, until such
      time as it does, will not generate significant product revenues. The Company’s
      accumulated deficit has increased, from approximately $23,176,217 at December
      31, 2005 to $25,953,878 at December 31, 2006. Operating losses are expected
      to
      continue for the foresee-able future and until such time as the Company is
      able
      to attain sales levels sufficient to support its operations.





In
      2007
      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 2007 will fall princi-pally into
      five broad categories, as follows: Research and Development; Personnel;
      Consulting and Professional (except legal and accounting); Legal and Accounting;
      and Public Relations, Investor Relations and Shareholder Relations.







**Liquidity
      and Capital Resources**





At
      December 31, 2006, the Company had available cash of $213,844, and had a working
      capital deficit of ($2,505,868). Assuming there is no decrease in current
      accounts payable, and accounting for various one-time expenses, the Company’s
      negative cash flow for operating activities plus equipment purchases, patent
      filings, and payoff of a note (burn rate) is approximately $132,700 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 2007 Plan. The Company is presently negotiating with human health
      commercial development partners in




13


various
      regions of the world including South America and Southeast Asia. The Company
      believes that one or more of these agreements will be executed during 2007.
      These agreements could generally include provisions for the commercial partner
      to pay ABI a technology access fee, could include payments for a portion of
      the
      clinical trial expenses, could include payment obligations to ABI upon the
      accomplishment of certain defined tasks and/or could provide for payments
      relating to the future sales of commercial product. These agreements could
      be an
      important source of funds for ABI. However, there can be no assurance that
      the
      Company will be successful in obtaining additional funding from human health
      commercial development partners or private investors. If the Company is not
      successful in raising additional funds, it will need to significantly curtail
      clinical trial expenditures and to further reduce staff and administrative
      expenses and may be forced to cease operations.




Total
      outstanding current liabilities stayed approximately the same with approximately
      $2.8 million at December 31, 2006, as compared to approximately $2.6 million
      at
      December 31, 2005.





ITEM
      7.  FINANCIAL
      STATEMENTS.





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





**Critical
      Accounting Policies**




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





**Accounting
      for Stock-Based Compensation**





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).





14


***Comparison
      of results for the fiscal year ended December 31, 2006, to the fiscal year
      ended
      December 31, 2005.***





**Revenues** .
      During
      the fiscal year ended December 31, 2006, $3,934 from product sales was generated
      compared to revenues from product sales for the fiscal year ended December
      31,
      2005, of $42,730, a decrease of $38,796 or approximately 91%. The decrease
      is
      primarily due to lack of sales of interferon products in 2006.





**Selling** **,
      General and Administrative Expenses** .
      Selling, General and Administrative expenses of $2,288,045 were incurred for
      the
      fiscal year ended December 31, 2006, compared to $492,659 for the fiscal year
      ended December 31, 2005, an increase of $1,795,386. The majority of this
      increase is a result of option and warrant recognition. In 2006, the Company
      recognized the following non-cash expenses utilizing the Black Scholes
      option-pricing model: $737,863 for stock options and warrants issued to
      consultants and $113,655 for stock options issued to employees. In addition,
      the
      Company recognized a $216,000 non-cash expense for stock granted to an
      employee.





**Non-Cash
      Consulting Activities** .
      During
      the year ended December 31, 2006, the Board of Directors authorized the issuance
      of 87,309 shares of restricted common stock to various consultants in lieu
      of
      cash payments. Based upon the common stock trading price at the times of
      issuance, and FASB rules, a non-cash consulting expense of $49,835 was recorded
      for the issuance of these shares during the year ended December 31, 2006. During
      2006, the Company issued 945,500 options to consultants and 1,200,000 options
      to
      employees, and recognized expense of $851,518 relating to the vested portion
      of
      these option grants.




In
      the
      second quarter, 250,000 options were exercised for $0.10 per share, generating
      $25,000 in cash. The rest of the options and warrants have not been
      exercised.




**Net
      Income (Loss)** .
      Net
      Loss applicable to common shareholders for the fiscal year ended December 31,
      2006 was $2,777,661 compared to a Net Loss of $669,011 for the fiscal year
      ended
      December 31, 2005.




**RISK
      FACTORS**




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




**Risks
      Relating to our Business**




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




Our
      success will depend in part on our ability to protect and maintain our patents,
      intellectual property rights and licensing arrangements for our products and
      technology. No assurance can be given that licenses or rights used by Amarillo
      Biosciences, Inc. will not be challenged, infringed or circumvented,


15


or
      that
      the rights granted thereunder will provide competitive advantages to us.
      Furthermore, there can be no assurance that we will be able to remain in
      compliance with our existing or future licensing arrangements. Consequently,
      there may be a risk that licensing arrangements are withdrawn with no penalties
      to the licensee or compensation to Amarillo Biosciences, Inc.




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




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




*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.




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




We
      must
      invest substantial time, resources and capital in identifying and developing
      new
      drugs, dosage and delivery systems, either on our own or by acquiring and
      licensing such products from third parties. Our growth depends, in part, on
      our
      success in such process. Our planned expansion over time is founded on a simple
      principal of introducing two new products or line extensions each year and
      to
      expand distribution into two new territories each year. This strategy has the
      advantage of building brands through geographic expansion and line extensions,
      and establishing incremental capabilities for new product introductions. We
      believe that our planned expansion will require $5.0 million in total over
      two
      years, which




16


we
      intend
      to fund out of our future revenues and additional financing. If we are unable
      to
      either develop new products on our own or acquire licenses for new products
      from
      third parties, our ability to grow revenues and market share will be adversely
      affected. In addition, we may not be able to recover our investment in the
      development of new drugs, given that projects may be interrupted, unsuccessful,
      not as profitable as initially contemplated or we may not be able to obtain
      necessary financing for such development if we are unable to fund such
      development from our future revenues. Similarly, there is no assurance that
      we
      can successfully secure such rights from third parties on an economically
      feasible basis.




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




We
      face
      an inherent business risk of exposure to product liability claims in the event
      that the use of our technologies or products 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.




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




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




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






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




None.






ITEM
      8A.  CONTROLS
      AND PROCEDURES.




As
      of
      December 31, 2006, 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.




17


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
      has concluded that internal control over financial reporting was effective
      as of
      December 31, 2006. The Company’s accounting firm has not issued an attestation
      report on the management’s assessment of the Company’s internal controls. No
      material changes to the Company’s internal controls were made in 2006 and no
      material weaknesses in such controls were found.









PART
      III




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




As
      of
      December 31, 2006, the directors and executive officers of the Company were
      as
      follows:


**Name**
            **Age**
            **Position**Joseph
                M. Cummins, DVM, PhD (1)
            64
            Chairman
                of the Board, President, Chief Executive Officer and
                DirectorGary
                W. Coy, PhD
            62
            Vice
                President and Chief Financial OfficerMartin
                J. Cummins
            39
            Vice
                President of Clinical & Regulatory AffairsStephen
                Chen, PhD (2)(3)(4)
            57
            DirectorThomas
                D’Alonzo (1)(2)(4)
            63
            DirectorDennis
                Moore, DVM (1)(4)
            60
            DirectorJames
                Page, MD (2)(3)
            79
            DirectorThomas
                Ulie (1)(3)
            58
            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.
 .





18


*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. Coy* provided
      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.




*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’Alonzo* has 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.


19


*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 and are reimbursed for any out-of-pocket expenses
      in connection with their attendance at meetings. In the event of the voluntary
      termination of a recipient’s association with the Company as a director, the
      options must be exercised within 90 days after such termination, and in the
      event they are not so exercised, will lapse.




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




**Audit
      Committee Financial Expert**




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.




**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:


20





**Name
                and Principal Position**
            **Number
                of Late Reports**
            **Known
                Failures to File a Required Form**Dr.
                Joseph M. Cummins, Chairman of the Board, President and Chief Executive
                Officer
            1
            0Dr.
                Gary W. Coy, Vice President and Chief Financial Officer
            2
            0Mr.
                Martin J. Cummins, Vice President of Clinical and Regulatory
                Affairs
            1
            0Stephen
                Chen, Director
            1
            0Thomas
                D’Alonzo, Director
            1
            0Dennis
                Moore, Director
            1
            0Thomas
                Ulie, Director
            1
            0





ITEM
      10.  EXECUTIVE
      COMPENSATION.




The
      following table sets forth for the three years ended December 31, 2006
      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, 2006. 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.







**Summary
                Compensation Table****Annual
                Compensation**
            **Long
                Term Compensation****Name
                and Principal Position**
            
            **Year**
            
            **Salary**
            
            **Bonus**
            
            **Other
                Compen-sation**
            
            **Securities
                Underlying Options**Dr.
                Joseph M. Cummins,
              Chairman
                of the Board,
              President
                and Chief
              Executive
                Officer
            
            2006
            
            $
                181,416
            
            $
                -
            
            $
                216,000
            
            400,0002005
            
            $
                177,000
            
            $
                -
            
            $
                -
            
            600,0002004
            
            $
                74,716
            
            $
                -
            
            $
                -
            
            650,000Mr.
                Martin J. Cummins,
              Vice
                President of Clinical
              and
                Regulatory Affairs
            
            2006
            
            $
                97,866
            
            $
                -
            
            $
                -
            
            400,0002005
            
            $
                84,878
            
            $
                -
            
            $
                -
            
            500,0002004
            
            $
                33,299
            
            $
                -
            
            $
                -
            
            150,000Dr.
                Gary W. Coy,
              Vice
                President and Chief
              Financial
                Officer
            
            2006
            
            $
                88,542
            
            $
                -
            
            $
                -
            
            400,000


21


**Option
      Grants in 2006**





The
      following table sets forth certain information relating to options granted
      in
      2006 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
                2006**
            
            **Exercise
                or Base Price**
              **($/Sh)**
            
            **Expiration**
              **Date**Joseph
                M. Cummins
            
            100,000
            
            8.3%
            
            $0.85
                (1)
            
            09/09/2012100,000
            
            8.3%
            
            $0.85
                (1)
            
            09/09/2013100,000
            
            8.3%
            
            $0.85
                (1)
            
            09/09/2014100,000
            
            8.3%
            
            $0.85
                (1)
            
            09/09/2015Martin
                J. Cummins
            
            100,000
            
            8.3%
            
            $0.85
                (1)
            
            09/09/2012100,000
            
            8.3%
            
            $0.85
                (1)
            
            09/09/2013100,000
            
            8.3%
            
            $0.85
                (1)
            
            09/09/2014100,000
            
            8.3%
            
            $0.85
                (1)
            
            09/09/2015Gary
                W. Coy
            
            100,000
            
            8.3%
            
            $0.75
            
            03/31/2012100,000
            
            8.3%
            
            $0.75
            
            03/31/2013100,000
            
            8.3%
            
            $0.75
            
            03/31/2014100,000
            
            8.3%
            
            $0.75
            
            03/31/2015





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





**Aggregated
      Option Exercises at December 31, 2006**


**And
      Year-End Option Values**


The
      following table sets forth information for the executive officers named above,
      regarding the exercise of options during 2006 and unexercised options held
      at
      the end of 2006.





**Name**
            
            **Number
                of Shares Acquired on**
              **Exercise**
            
            **Value**
              **Realized**
            
            **Number
                of Shares of Common Stock Underlying Unexercised Options
                at**
              **December
                31, 2006 Exercisable/Unexercisable**
            
            
            **Value
                of Unexercised**
              **In-The-Money****Options
                at**
              **December
                31, 2006 (1) Exercisable/Unexercisable**Joseph
                M. Cummins
            
            --
            
            --
            
            1,788,486
            /
            400,000
            
            
            $1,162,516
            /
            NoneMartin
                J. Cummins
            
            --
            
            --
            
            799,000
            
            400,000
            
            
            $
                519,350
            
            NoneGary
                W. Coy
            
            --
            
            --
            
            None
            /
            400,000
            
            
            None
            /
            None





(1)
            Calculated
                based on the closing price of the common stock ($0.65) as reported
                by OTC
                BB on December 29, 2006.


22


**Director
      Compensation for Last Fiscal Year**





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


****(1)
            Directors
                receive $1,000 compensation for attendance at directors’
                meetings.


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





Employment
      agreements were executed with Joseph M. Cummins, Martin J. Cummins and Gary
      W.
      Coy during 2006.





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




As
      of
      December 31, 2006, there were 24,476,767 shares of the Company’s common stock
      outstanding. The following table sets forth as of December 31, 2006, the
      beneficial ownership of each person who owns more than 5% of such outstanding
      common stock:




**Name
                and Address**
            
            **Amount
                and Nature of Beneficial Ownership**
            
            **Percent
                of Class Owned**Hayashibara
                Biochemical Laboratories, Inc.
              2-3
                Shimoishii 1-chome
              Okayama
                700, Japan
            
            3,118,655
            
            13%





23


The
      following table sets forth the beneficial ownership of the Company’s stock as of
      December 31, 2006 by each executive officer and director and by all executive
      officers and directors as a group:




**Name
                and Address of Owner**
            
            **Amount
                and Nature of Beneficial Ownership**
            
            **Percent
                of Class Owned**7Joseph
                M. Cummins
              7308
                Ashland
              Amarillo,
                TX 79119
            
            2,256,0321
            
            6.8%Gary
                W. Coy
              907
                Cat Hollow Club Drive
              Spicewood,
                TX 78669
            
            300,741
            
            0.9%Martin
                J. Cummins
              6615
                Sandie
              Amarillo,
                TX 79109
            
            873,1482
            
            2.6%Dennis
                Moore
              402
                Fish Hatchery
              Hamilton,
                MT 59840
            
            920,7413
            
            2.8%Thomas
                D’Alonzo
              908
                Vance Street
              Raleigh,
                NC 27608
            
            41,1394
            
            0.1%Stephen
                Chen
              Floor
                7-1, No. 18
              Xin
                Yi Road, Sec. 5
              Taipei,
                Taiwan
            
            827,6255
            
            2.5%James
                Page
              103
                Clubhouse Lane, #182
              Naples,
                FL 34105
            
            864,1256
            
            2.6%Thomas
                Ulie
              P.O.
                Box 814
              Mercer
                Island, WA 98040
            
            671,300
            
            2.0%Total
                Group (all directors and executive officers - 8 persons)
            
            6,754,851
            
            20.3%


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


2 799,000
      of these shares are exercisable options


3 814,125
      of these shares are exercisable option


4 31,139
      of these shares are exercisable options








5 794,125
      of these shares are exercisable options


6 864,125
      of these shares are exercisable options


7 Calculated based on 33,356,004 total shares outstanding and
      reserved





24





**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.




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 November 30, 1999 and an
      additional $1 million on February 29, 2000, both loans bearing interest at
      4.5%
      per annum. The November 30, 1999 loan has been extended until December 2007
      and
      the February 29, 2000 loan has been extended to February 29, 2008. The aggregate
      balance on both notes at December 31, 2006, including principal and accrued
      interest, was $2,600,701. In addition to the above, HBL and the Company are
      parties to various license and manufacturing and supply agreements pursuant
      to
      which the Company licenses certain technology to or from HBL. HBL supplies
      formulations of its interferon alpha and other products to the Company.
      Additional information on these agreements is set forth in Notes 4 and 8 to
      the
      Financial Statements attached to this 10-KSB.




During
      2006, 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
      $61,707 by said firm in 2006.




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.




25


ITEM
      13.  EXHIBITS




**EXHIBIT
      INDEX**




3.1†
              
              Restated
                  Articles of Incorporation of the Company, dated June 22,
                  1999.3.3*
              
              Bylaws
                  of the Company.4.1*
              
              Specimen
                  Common Stock Certificate.4.2*
              
              Form
                  of Underwriter's Warrant.10.2*
              
              License
                  Agreement dated as of March 22, 1988 between the Company and The
                  Texas
                  A&M University System.10.5*
              
              Joint
                  Development and Manufacturing/Supply Agreement dated March 13,
                  1992
                  between the Company and HBL, as amended.10.7*
              
              Japan
                  Animal Health License Agreement dated January 20, 1993 between
                  the Company
                  and HBL.10.11*
              
              Manufacturing/Supply
                  Agreement dated June 1, 1994 between the Company and
                  HBL.10.12*
              
              Settlement
                  Agreement dated April 27, 1995 among the Company, ISI, Pharma Pacific
                  Management Pty. Ltd. ("PPM"), Pharma Pacific Pty. Ltd., Pharma
                  Pacific
                  Ltd. and Fernz Corporation Limited.10.14*
              
              PPM/ACC
                  Sublicense Agreement dated April 27, 1995 between PPM and the
                  Company.10.18*
              
              Form
                  of Consulting Agreement between the Company and the
                  Underwriter.10.20†
              
              1996
                  Employee Stock Option Plan, Amended and Restated as of May 11,
                  1999.10.21†
              
              Outside
                  Director and Advisor Stock Option Plan, Amended and Restated as
                  of May 11,
                  1999.10.22*
              
              Form
                  of Indemnification Agreement between the Company and officers and
                  directors of the Company.10.23*
              
              Indemnification
                  Agreement between HBL and the Company.10.26**
              
              License
                  Agreement dated July 22, 1997 between Hoffmann-La Roche, Inc. and
                  the
                  Company.10.27**
              
              Distribution
                  Agreement dated January 12, 1998 between Global Damon Pharmaceutical
                  and
                  the Company.10.28**
              
              Distribution
                  Agreement dated September 17, 1997 between HBL and the Company
                  (tumor
                  necrosis factor-alpha).10.29**
              
              Distribution
                  Agreement dated September 17, 1997 between HBL and the Company
                  (interferon
                  gamma).10.30***
              
              Amendment
                  No. 1 dated September 28, 1998 to License Agreement of March 22,
                  1988
                  between The Texas A&M University System and the
                  Company.10.36††
              
              License
                  Agreement dated February 1, 2000 between Molecular Medicine Research
                  Institute and the Company (interferon gamma administered
                  orally).10.37††a
              
              License
                  and Supply Agreement dated April 3, 2000 with Key Oncologics (Pty)
                  Ltd.
                  and the Company.
  26
  
 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 Company10.47‡a
              
              License
                  and Supply Agreement dated October 19, 2005 between Global Kinetics,
                  Inc.
                  and the Company.10.48‡a
              
              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.10.52‡‡a
              
              Supply
                  Agreement (Anhydrous Crystalline Maltose) dated October 16, 2006
                  between
                  Hayashibara Biochemical Laboratories, Inc. and the
                  Company10.53‡‡a
              
              License
                  and Supply Agreement dated November 16, 2006, between CytoPharm,
                  Inc. and
                  the Company.
 
  27
  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 2005 Annual Report on Form
        10-KSB filed with the Commission on or before April 15, 2006.
 ‡‡
The
        Exhibit is incorporated by reference to the Company’s 2006 Annual Report on Form
        10-KSB filed with the Commission on or before April 15, 2007.
 a Portions
        of this exhibit have been omitted and filed separately with the
        commission.




ITEM
      14.  PRINCIPAL
      ACCOUNTANT FEES AND SERVICES




The
      following summarizes the fees incurred by the Company during 2005 and 2006
      for
      accountant and related services.




**Audit
      Fees**


**2006**
            **2005****LBB
                & Associates Ltd., LLP (formerly Lopez, Blevins, Bork & Assoc.
                LLP)**
            **$28,050**
            **$
                17,875**





**All
      Other Fees**




None.




**Accountant
      Approval Policy**




Before
      an
      accountant is engaged by the Company to perform audit or non-audit services,
      the
      accountant must be approved by the Company’s Audit Committee.







28


**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized.


AMARILLO
                BIOSCIENCES, INC.Date:March
                16, 2007
            By:/s/  Joseph M. Cummins
              Joseph
                M. Cummins, Chairman of the Board,
              President,
                and Chief Executive OfficerDate:March
                16, 2007
            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
                16, 2007Joseph
                M. Cummins/s/  Stephen Chen
            Director
            March
                17, 2007Stephen
                Chen/s/ 
James
              Page
            Director
            March
                16, 2007James
                Page/s/  Dennis Moore
            Director
            March
                  22, 2007Dennis
                Moore/s/ 
Thomas
              D'Alonzo
            Director
            March
                17, 2007Thomas
                D’Alonzo/s/ 
Thomas
              Ulie
            Director
            March
                22, 2007Thomas
                Ulie








Amarillo
      Biosciences, Inc.





Financial
      Statements


Year
      ended December 31, 2006











**Contents**





Report
                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








F-1








**Report
      of Independent Registered Public Accounting Firm**





The
      Board
      of Directors


Amarillo
      Biosciences, Inc.





We
      have
      audited the accompanying balance sheet of Amarillo Biosciences, Inc. as of
      December 31, 2006, and the related statements of operations, stockholders'
      deficit and cash flows for each of the two years then ended. These financial
      statements are the responsibility of the Company's management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. 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, based on our audits, the financial statements referred to above present
      fairly, in all material respects, the financial position of Amarillo
      Biosciences, Inc. as of December 31, 2006, and the results of their operations
      and their cash flows for each of the two years then ended, in conformity
      with accounting principles generally accepted in the United States of
      America.





As
      discussed in Note 1 to the financial statements, the Company's recurring losses
      from operations, and the need to raise additional financing in order to execute
      its 2007 plan, raise substantial doubt about its ability to continue as a going
      concern. (Management's plans as to these matters are also described in Note
      1.)
      The 2006 financial statements do not include any adjustments that might result
      from the outcome of this uncertainty.





LBB
&
      Associates Ltd., LLP


Houston,
      Texas


February
      26, 2007


F-2


Amarillo
      Biosciences, Inc.


Balance
      Sheet


December
      31, 2006


**Assets**Current
                assets:Cash
                and cash equivalents
            
            $
            213,844Other
                current assets
            
            
            34,370Total
                current assets
            
            
            248,214Property,
                equipment, and software, net of accumulated depreciation of
                $46,650
            
            
            16,333Patents,
                net of accumulated amortization of $204,169
            
            
            125,870Total
                assets
            
            $
            390,417**Liabilities
                and Stockholders' Deficit**Current
                liabilities:Accounts
                payable and accrued expenses
            
            $
            153,381Accrued
                interest - related party
            
            
            600,701Notes
                payable - related party
            
            
            2,000,000Total
                current liabilities
            
            
            2,754,082Total
                liabilities
            
            
            2,754,082Commitments
                and contingenciesStockholders'
                deficitPreferred
                stock, $.01 par value:Authorized
                shares - 10,000,000Issued
                shares - none
            
            
            -Common
                stock, $.01 par value:Authorized
                shares - 50,000,000Issued
                shares - 24,476,767
            
            
            244,768Additional
                paid-in capital
            
            
            23,345,445Accumulated
                deficit
            
            
            (25,953,878
            )Total
                stockholders' deficit
            
            
            (2,363,665
            )Total
                liabilities and stockholder's deficit
            
            $
            390,417








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





F-3


Amarillo
      Biosciences, Inc.


Statements
      of Operations





Year
                ended December 31,2006
            
            
            2005Revenues:Sales
                - Nutraceutical
            
            $
            3,934
            
            $
            42,730Federal
                research grants
            
            
            60,023
            
            
            44,349Sublicense
                fee revenue
            
            
            69,985
            
            
            67,486Total
                Revenues
            
            
            133,942
            
            
            154,565Operating
                Expenses:Cost
                of sales
            
            
            258
            
            
            22,456Research
                and development expenses
            
            
            535,075
            
            
            187,810Selling,
                general and administrative expenses
            
            
            2,288,045
            
            
            492,659Total
                Operating Expenses
            
            
            2,823,378
            
            
            702,925Operating
                loss
            
            
            (2,689,436
            )
            
            (548,360
            )Other
                income (expense)Interest
                expense
            
            
            (93,149
            )
            
            (120,651
            )Interest
                income
            
            
            3,034
            
            
            -Investment
                income
            
            
            1,890
            
            
            -Net
                income (loss)
            
            $
            (2,777,661
            )
            $
            (669,011
            )Basic
                and diluted net income (loss) per share
            
            $
            (0.12
            )
            $
            (0.04
            )Weighted
                average shares outstanding
            
            
            22,479,399
            
            
            16,495,678




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





F-4


Amarillo
      Biosciences, Inc.


Statements
        of Stockholders’ Deficit
 Years
        Ended December 31, 2006 and 2005


Issuance
                Price
            
            Common
                Stock
              Shares                   Amount
            
            Additional
                Paid in Capital
            
            
            Accumulated
                Deficit
            
            
            Total
                Stockholders' DeficitBalance
                at December 31, 2004
            
            
            
            
            
            14,385,296
            
            $
            143,853
            
            $
            19,669,145
            
            $
            (22,507,206
            )
            $
            (2,694,208
            )Net
                loss for year ended December 31, 2005
            
            
            
            
            
            -
            
            
            -
            
            
            -
            
            
            (669,011
            )
            
            (669,011
            )Issuance
                of common stock for services
            
            $
            0.29-0.4467
            
            
            37,994
            
            
            380
            
            
            12,832
            
            
            -
            
            
            13,212Issuance
                of common stock for cash in private placements
            
            
            0.20-0.22
            
            
            4,928,700
            
            
            49,287
            
            
            800,702
            
            
            -
            
            
            849,989Exercise
                of options for service
            
            
            0.32-0.35
            
            
            450,000
            
            
            4,500
            
            
            145,500
            
            
            -
            
            
            150,000Issuance
                of warrants in connection with debt
            
            
            
            
            
            -
            
            
            -
            
            
            20,105
            
            
            -
            
            
            20,105Purchase
                and retirement of common stock
            
            
            0.55
            
            
            (120
            )
            
            (1
            )
            
            (65
            )
            
            
            
            
            (66
            )Balance
                at December 31, 2005
            
            
            
            
            
            19,801,870
            
            
            198,019
            
            
            20,648,219
            
            
            (23,176,217
            )
            
            (2,329,979
            )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
            
            
            100,000
            
            
            1,000
            
            
            11,900
            
            
            -
            
            
            12,900Exercise
                of options for services
            
            
            0.10
            
            
            250,000
            
            
            2,500
            
            
            22,500
            
            
            -
            
            
            25,000Conversion
                and exercise of cashless options
            
            
            
            
            
            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
            )





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





F-5


Amarillo
      Biosciences, Inc.


Statements
      of Cash Flows


**December
                            31,****Operating
                            Activities**
                        
                        
                        **2006**
                        
                        
                        **2005**Net
                            loss
                        
                        $
                        (2,777,661
                        )
                        $
                        (669,011
                        )Adjustments
                            to reconcile net loss to net cash
                          used
                            for operating activities:Depreciation
                            and amortization
                        
                        
                        15,178
                        
                        
                        12,439Common
                            stock issued for services and
                          retirement
                            of debt
                        
                        
                        279,473
                        
                        
                        150,712Fair
                            value of options issued
                        
                        
                        851,518
                        
                        
                        -Issuance
                            of warrants in connection with debt
                        
                        
                        -
                        
                        
                        20,105Changes
                            in operating assets and liabilities:Other
                            current assets
                        
                        
                        (31,583
                        )
                        
                        (1,953
                        )Accounts
                            payable and accrued liabilities
                        
                        
                        111,868
                        
                        
                        (120,381
                        )Accrued
                            interest
                        
                        
                        90,000
                        
                        
                        (47,302
                        )Net
                            cash used in operating activities
                        
                        
                        (1,461,207
                        )
                        
                        (655,391
                        )**Investing
                            Activities**Purchase
                            of property and equipment
                        
                        
                        (18,406
                        )
                        
                        -Patents
                        
                        
                        (19,343
                        )
                        
                        -Net
                            cash used in investing activities
                        
                        
                        (37,749
                        )
                        
                        -**Financing
                            Activities**Proceeds
                            from exercise of options
                        
                        
                        37,900
                        
                        
                        12,500Repayments
                            of notes payable
                        
                        
                        (68,500
                        )
                        
                        (20,000
                        )Purchase
                            and retirement of common stock
                        
                        
                        -
                        
                        
                        (66
                        )Issuance
                            of common stock
                        
                        
                        1,550,085
                        
                        
                        849,989Net
                            cash provided by financing activities
                        
                        
                        1,519,485
                        
                        
                        842,423Net
                            increase (decrease) in cash
                        
                        
                        20,529
                        
                        
                        187,032Cash
                            and cash equivalents at beginning of period
                        
                        
                        193,315
                        
                        
                        6,283Cash
                            and cash equivalents at end of period
                        
                        $
                        213,844
                        
                        $
                        193,315**Supplemental
                            Cash Flow Information**Cash
                            paid for interest
                        
                        $
                        3,149
                        
                        $
                        36,967Stock
                            issued for debt repayment
                        
                        $
                        25,000
                        
                        $
                        -


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





F-6


**Amarillo
      Biosciences, Inc.**


**Notes
      to Financial Statements**


**December
      31, 2006**








**1.
      Organization and Summary of Significant Accounting
      Policies**





**Organization
      and Business**





Amarillo
      Biosciences, Inc. (the "Company" or "ABI"), a Texas corporation formed in 1984,
      is engaged in developing biologics for the treatment of human and animal
      diseases. The Company is continuing its clinical studies as part of the process
      of obtaining regulatory approval from the United States Food and Drug
      Administration ("FDA"), so that commercial marketing can begin in the United
      States. The Company has developed a dietary supplement and an interferon alpha
      lozenge, but 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 2007 plan of operations calls for the Company to expend approximately
      $2.2 million cash, excluding funding fees, in 2007. At December 31, 2006, the
      Company had available cash of $213,844 and negative working capital (current
      assets less current liabilities) of ($2,505,868). Current liabilities included
      two $1 million dollar notes and $600,701 accrued interest owed to Hayashibara
      Biochemical Laboratories, Inc. (“HBL”), the Company’s largest shareholder and
      benefactor. In the past, HBL has extended the notes and accrued interest for
      one
      year terms. The notes have been extended until December 3, 2007 and February
      28,
      2008, respectively.


F-7


**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. The Company will need to raise additional funds in order to execute
      its
      2007 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 2007. These agreements could generally
      include provisions for the commercial partner to pay ABI a technology access
      fee, could include payments for a portion of the clinical trial expenses, could
      include payment obligations to ABI upon the accomplishment of certain defined
      tasks and/or could provide for payments relating to the future sales of
      commercial product. These agreements could be an important source of funds
      for
      ABI. However, there can be no assurance that the Company will be successful
      in
      obtaining additional funding from either human health and animal health
      commercial development partners or private investors. If the Company is not
      successful in raising additional funds, it will need to significantly curtail
      clinical trial expenditures and to further reduce staff and administrative
      expenses and may be forced to cease operations.





**Dissolution
      of Subsidiaries**





Effective
      October 1, 2006, the following subsidiaries of the Company were dissolved with
      the State of Texas: ABI Taiwan Inc, Amarillo Cell of Canada Inc, Vanguard
      Biosciences Inc, Veldona Africa Inc, and Veldona Poland Inc. All the above
      subsidiaries have been inactive for the past several years with no revenues,
      expenses, assets or liabilities represented in the consolidated financial
      statements. The capital accounts of the above subsidiaries and the investment
      in
      subsidiaries by the Company were eliminated during 2006. No gain or loss was
      recognized on the dissolution of the above subsidiaries during
      2006.





**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.


F-8


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





**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).





The
      following illustrates the effect on net loss and net loss per share if Amarillo
      had applied the fair value provisions of FASB Statement No. 123, Accounting
      for
      Stock-Based Compensation, to stock-based employee compensation prior to January
      1, 2006.





For
                the year ended December 31,
            
            
            2005Net
                loss, as reported
            
            $
            (669,011
            )Less:
                stock based compensation determined
              under
                fair value based method
            
            
            (984,339
            )Pro-forma
                net loss
            
            $
            (1,653,350
            )Basic
                and diluted net loss per share:As
                reported
            
            $
            (0.04
            )







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





F-9


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





**Cash
      and Cash Equivalents**





The
      Company classifies investments as cash equivalents if the 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. In 2006,
      the Company wrote off a $6,000 note receivable as bad debt as the note was
      deemed by management to be uncollectible. The balance of the allowance for
      doubtful accounts as of December 31, 2006 is $0.





Accounts
      and notes receivable amounted to $437 as of December 31, 2006, 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, 2006 the Company has
      $4,064 of inventory included in other current assets.





**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;
      Patent Expenditures**





ABI
      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 $12,380 and $12,379 for the years ended December 31, 2006
      and 2005, respectively.


F-10


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





**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,





*Federal
      research grant*





The
      Company was awarded a research grant in May 2005 by the National
      Institute of Health, Small Business Innovation Research Program (“NIH”). The
      funded research was subcontracted to Ohio State University (“OSU”) by the
      Company. Revenue is recognized by the Company as earned and collectibility
      is
      reasonably assured. Revenue is earned under the grant with NIH as qualified
      research costs are incurred. Costs are recognized by the Company on an ongoing
      basis as incurred by OSU and invoiced to the Company.





*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.


F-11


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





**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 (see Notes 7 and 8) 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. As of December 31, 2006,
      the Company’s cash balance exceeded the federally insured limit by $113,844. No
      loss has been incurred related to this concentration of cash.





**Other
      Concentrations**





The
      Company and its sublicensees are reliant on a single, foreign supplier for
      its
      products. The loss of this supplier could adversely effect the Company’s future
      revenues.


F-12


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





**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.





In
      July
      2006, the FASB issued FASB Interpretation (“FIN”) No. 48 Accounting for
      Uncertainly in Income Taxes - An Interpretation of FASB Statement No. 109. 
FIN 48 prescribes detailed guidance for the financial statement recognition,
      measurement, and disclosure of uncertain tax positions recognized in an
      enterprise’s financial statements in accordance with SFAS No. 109, Accounting
      for Income Taxes.  Tax positions must meet a more-likely-than-not
      recognition threshold at the effective date to be recognized upon the adoption
      of FIN 48 and in subsequent periods.  FIN 48 will be effective for fiscal
      years beginning after December 15, 2006, and the provisions of FIN 48 will
      be
      applied to all positions upon the adoption of the Interpretation.  The
      cumulative effect of this applying the provisions of this Interpretation will
      be
      reported as an adjustment to the opening balance of retained earnings for that
      fiscal year.  Management is currently evaluating the impact of FIN 48 on
      the financial statements but does not believe that its adoption will have a
      material effect on the Company’s financial position, results of operations, or
      cash flows.


F-13


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





**Recent
      Accounting Pronouncements (Continued)**





In
      September 2006, the SEC issued Staff Accounting Bulletin No. 108,
      Considering the Effects of Prior Year Misstatements when quantifying
      Misstatements in Current Year Financial Statements (“SAB 108”).
      SAB 108 requires companies to evaluate the materiality of identified
      unadjusted errors on each financial statement and related financial statement
      disclosure using both the rollover approach and the iron curtain approach,
      as
      those terms are defined in SAB 108. The rollover approach quantifies
      misstatements based on the amount of the error in the current year financial
      statement, whereas the iron curtain approach quantifies misstatements based
      on
      the effects of correcting the misstatement existing in the balance sheet at
      the
      end of the current year, irrespective of the misstatement’s year(s) of origin.
      Financial statements would require adjustment when either approach results
      in
      quantifying a misstatement that is material. Correcting prior year financial
      statements for immaterial errors would not require previously filed reports
      to
      be amended. If a Company determines that an adjustment to prior year financial
      statements is required upon adoption of SAB 108 and does not elect to
      restate its previous financial statements, then it must recognize the cumulative
      effect of applying SAB 108 in fiscal 2006 beginning balances of the
      affected assets and liabilities with a corresponding adjustment to the fiscal
      2006 opening balance in retained earnings. SAB 108 is effective for interim
      periods of the first fiscal year ending after November 15, 2006, and will
      be adopted by the Company in the first quarter of 2007. The Company does not
      expect the adoption of this interpretation to have an impact on its financial
      position or results of operations.





**2.
      Property, Equipment and Software**





Equipment
      is stated at cost and consists of the following at December 31,
      2006:





Furniture
                and equipment
            
            $
            57,263Software
            
            
            5,72062,983Less:
                accumulated depreciation
            
            
            46,650$
            16,333





Depreciation
      expense amounted to $2,798 and $60 for the years ended December 31, 2006 and
      2005, respectively.


F-14


**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, 2005, or on or before the
      expiration of one (1) year after approval of the Company’s product by the FDA,
      whichever occurs first. This note has been extended and is payable on or before
      December 3, 2007, or on or before the expiration of one (1) year after approval
      of the Company's product by the FDA, whichever occurs first. The other
      $1,000,000 is due on or before February 28, 2008, or on or before the expiration
      of one year after approval of the Company’s product by the FDA, whichever occurs
      first.





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





The
      Company has a line
      of
      credit with Wells Fargo for $16,000, with interest at the prime rate plus 6.75
      percent. There was an outstanding balance at December 31, 2006 of $2,050, which
      is included in accounts payable. This line is used from time to time for
      purchases.





**4.
      Manufacturing and Supply Agreements**





The
      Company was a party to the following manufacturing and supply agreements at
      December 31, 2006:





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.








F-15


**4.
      Manufacturing and Supply Agreements (Continued)**





As
      part
      of the license agreement with Atrix Laboratories, Inc. (executed September
      7,
      2001, terminated May 22, 2003) a second amendment to the Development Agreement
      was executed extending the Development Agreement to March 12, 2005 and will
      be
      renewed automatically for successive three-year terms. The current expiration
      date of the Development Agreement is March 12, 2008.





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





**5.
      License and Sublicense Agreements**





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





A
      $7,500
      minimum cash royalty was paid by the Company to Texas A&M University System
      during 2006. A $19,992 sublicense fee payable to HBL was included in accounts
      payable at the end of 2006 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.





**6.
      Research Agreements**





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





**7.
      Common and Preferred Stock**





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





The
      Company has 8,879,237 shares of common stock reserved for issuance upon exercise
      of options and warrants granted.





During
      2006, the Company sold 3,344,917 unregistered shares of its voting common stock
      in private placement offerings. Of these sales, 671,300 shares were sold for
      $0.20 per share; 200,000 shares


F-16


**7.
      Common and Preferred Stock (Continued)**





were
      sold
      for $0.38 per share; 33,617 shares were sold for $0.47 per share; 600,000 shares
      were sold for $0.52 per share; and 1,840,000 shares were sold for $0.55 per
      share: generating $1,550,085 in cash.





During
      2006, the Board of Directors authorized the issuance of 87,309 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 $49,835 was recorded for the issuance of these shares
      during the year ended December 31, 2006.





The
      Company recognized $216,000 (fair value) of expense in connection with the
      February 2006 grant of 300,000 shares of stock to an employee of the
      Company.  The certificate was issued in May 2006.





In
      July
      2006, the Company applied the balance of a $25,000 note payable towards the
      purchase of 45,455 shares of restricted common stock. Because the exchange
      ratio
      assumed a discounted share price, the Company recorded at loss on retirement
      of
      debt in the amount of $13,637 in conjunction with this transaction.





During
      the years ended December 31, 2006 and 2005, finder’s fees paid related to
      private placements of stock totaled $120,850 and $9,901, 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.





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.


F-17





**8.
      Stock Options and Warrants (Continued)**





The
      Director Plan allows options to purchase a maximum of 410,000 shares of the
      Company's common stock to be granted to outside directors and scientific
      advisors to the Company at an exercise price equivalent to 100% of the fair
      market value of the common stock on the date of grant. These are ten-year
      options and become exercisable over a period of five years.





During
      2005, the Company did not recognize any expense for stock options issued to
      directors, consultants, and scientific advisors. 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
      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
      related to these options. The remaining cost expected to be recognized if these
      options vest is $861,665.





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.





A
      consultant exercised 250,000 options at $0.10 per share for services. 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.





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


2006
            2005Options
            
            
            Price
            
            
            Options
            
            
            PriceOutstanding
                Beg of Year
            
            
            6,845,862
            
            $
            0.06-5.00
            
            
            2,925,862
            
            $
            0.06-5.00Granted
            
            
            2,725,500
            
            
            0.10-0.87
            
            
            3,920,000
            
            
            0.40-0.40Cancelled
            
            
            23,000
            
            
            0.42-5.00
            
            
            -
            
            
            -Exercised
            
            
            1,134,125
            
            
            0.10-0.51
            
            
            -
            
            
            -Outstanding
                End of Year
            
            
            8,414,237
            
            
            0.06-4.00
            
            
            6,845,862
            
            
            0.06-5.00Exercisable
                End of Year
            
            
            6,334,237
            
            
            0.06-4.00
            
            
            6,845,862
            
            
            0.06-5.00





Exercise
      prices for options outstanding as of December 31, 2006 ranged from $0.06 to
      $4.00. Of these options, 5,000 have an exercise price of $4.00 and the remainder
      range from $0.06 to $0.87. The weighted-average remaining contractual life
      of
      those options is 5.21 years.





F-18


**8.
      Stock Options and Warrants (Continued)**





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


2006
            2005Warrants
            
            
            Price
                Range
            
            
            Warrants
            
            
            Price
                RangeOutstanding
                Beg of Year
            
            
            357,000
            
            $
            0.06-1.75
            
            
            387,900
            
            $
            0.06-3.75Granted
            
            
            300,000
            
            
            0.20-2.00
            
            
            135,000
            
            
            0.22-0.50Cancelled
            
            
            112,000
            
            
            1.75
            
            
            165,900
            
            
            0.40-3.75Exercised
            
            
            80,000
            
            
            0.06-0.15
            
            
            -
            
            
            -Outstanding
                End of Year
            
            
            465,000
            
            
            0.20-2.00
            
            
            357,000
            
            
            0.06-1.75Exercisable
                End of Year
            
            
            465,000
            
            
            0.20-2.00
            
            
            357,000
            
            
            0.06-1.75





The
      weighted-average remaining contractual life of the warrants outstanding at
      December 31, 2006 is 2.57 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, 2006 and 2005, were $0, and $0, respectively.





**10.
      Income Taxes**





Deferred
      income taxes reflect the net tax effects of temporary differences between the
      carrying amounts of assets and liabilities for financial reporting purposes
      and
      the amounts used for income tax reporting purposes. The Company’s deferred tax
      asset of approximately $7,800,000 and $6,989,000 at December 31, 2006 and 2005
      respectively, was subject to a valuation allowance of $7,800,000 and $6,989,000
      at December 31, 2006 and 2005 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, 2006, the Company has net operating loss carryforwards of
      approximately $23,000,000 for federal income tax purposes expiring in 2007
      through 2026. The ability of the Company to utilize these carryforwards may
      be
      limited should changes in stockholder ownership occur.





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


F-19


**11.
      Commitments and Contingencies**





Lease
      commitment





During
      2006, the Company entered into an operating lease agreement for its offices
      in
      Amarillo, TX. The lease is for a period of 24 months commencing in January
      2007.
      Minimum lease payments under this operating lease are $22,200 for 2007 and
      2008.
      The Company has no material lease obligations beyond December 2008.





Rent
      expense recognized under its previous lease agreement during the years ended
      December 31, 2005 and 2004 amounted to $11,700 and $11,640,
      respectively.





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





Six
      clinical investigation sites are participating in an oral interferon treatment
      of oral warts in HIV+ patients FDA Phase 2 study in San Francisco, Chicago,
      Dallas, Baltimore, Boston and New York. Two or more additional sites may be
      registered. The Company estimates the clinical trial costs for the oral warts
      Phase 2 study to be approximately $335,000 in 2007.





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,
      2006.





**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 13% 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%


F-20


**12.
      Related Party Transactions (Continued)**





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 2006. A $19,992
      sublicense fee to HBL was recorded in 2006.





During
      2006 and 2005 the Company purchased $8,240 and $2,410 of interferon alpha and
      other products from HBL, respectively. At December 31, 2006 and 2005 the Company
      did not have any outstanding amounts owed to HBL for purchases of interferon
      alpha or other products.





During
      2006 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
      $61,707 during 2006 for legal services rendered by SandersBaker.





**13.
      Subsequent Events (Unaudited)**





Since
      December 31, 2006, the Company has sold 998,000 shares of unregistered stock
      for
      $0.45 per share in private placement offerings; generating cash of $449,100.