United
States


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q








QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR
15(d)


OF
      THE SECURITIES EXCHANGE ACT OF 1934





For the
Quarterly Period Ended June 30, 2009





Commission
File Number 0-20791





AMARILLO
BIOSCIENCES,
INC.


(Exact name of registrant as
specified in its charter)





TEXAS
            
            75-1974352(State
      or other jurisdiction of incorporation or organization)
            
            (IRS
      Employer Identification No.)4134
      Business Park Drive, Amarillo, Texas 79110(Address
      of principal executive offices) (Zip Code)(806)
      376-1741(Issuer’s
      telephone number, including area
code)







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




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
      accelerated filer [ ]
            
            Accelerated
      filer [ ]Non-accelerated
      filer [ ] (do not check if smaller reporting company)
            
            Smaller
      reporting company [√]







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




As
of  June 30, 2009 there were 44,533,178 shares of the issuer's common
stock and no shares of the issuer’s preferred stock outstanding.





1


AMARILLO
BIOSCIENCES, INC.





INDEX






PAGE NO.PART
      I:
            FINANCIAL
      INFORMATIONITEM
      1.
            Financial
      StatementsBalance
      Sheets– June 30, 2009  (unaudited) and December 31, 2008
            3Statements
      of Operations – Three and Six Months Ended June 30, 2009
              and
      2008 (unaudited)
            4Condensed
      Statements of Cash Flows – Six Months Ended June 30, 2009
              and
      2008 (unaudited)
            5Notes
      to Financial Statements
      (unaudited)
            6ITEM
      2.
            Management's
      Discussion and Analysis of Financial Condition and
              Results
      of Operations
            9ITEM
      3.
            Quantitative
      and Qualitative Disclosures About Market Risk.
            18ITEM
      4.
            Controls
      and
      Procedures
            21PART
      II:
            OTHER
      INFORMATIONITEM
      1.
            Legal
      Proceedings
            22ITEM
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            22ITEM
      3.
            Defaults
      Upon Senior
      Securities
            24ITEM
      4.
            Submission
      of Matters to a Vote of Security Holders
            24ITEM
      5.
            Other
      Information
            24ITEM
      6.
            Exhibits.....................................................................
            24Signatures
            
            25





2


PART I - FINANCIAL
INFORMATION





ITEM
      1.
            Financial
      Statements





Amarillo
Biosciences, Inc.


Balance
Sheets


June
      30, 2009
            
            
            December
      31, 2008Assets
            
            (unaudited)Current
      assets:Cash
      and cash equivalents
            
            $
            3,844
            
            
            $
            10,853Other
      current assets
            
            
            12,935
            
            
            
            12,813Total
      current assets
            
            
            16,779
            
            
            
            23,666Property,
      equipment, and software, net
            
            
            6,285
            
            
            
            9,575Patents,
      net
            
            
            119,205
            
            
            
            126,828Total
      assets
            
            $
            142,269
            
            
            $
            160,069Liabilities
      and Stockholders' DeficitCurrent
      liabilities:Accounts
      payable and accrued expenses
            
            $
            389,812
            
            
            $
            511,236Accrued
      interest - related party
            
            
            617,281
            
            
            
            572,773Accrued
      expenses – related party
            
            
            54,369
            
            
            
            53,971Derivative
      liabilities
            
            
            2,679,459
            
            
            
            -Notes
      payable - related party
            
            
            2,000,000
            
            
            
            2,000,000Total
      current liabilities
            
            
            5,740,921
            
            
            
            3,137,980Total
      liabilities
            
            
            5,740,921
            
            
            
            3,137,980Commitments
      and contingenciesStockholders'
      deficitPreferred
      stock, $0.01 par value:Authorized
      shares - 10,000,000Issued
      and outstanding shares – 0 at June 30, 2009 and 0 at December 31,
      2008,
            
            
            -
            
            
            
            -Common
      stock, $0.01par value:Authorized
      shares - 100,000,000Issued
      and outstanding shares – 44,533,178 at June 30, 2009 and 35,953,377 at
      December 31, 2008
            
            
            445,332
            
            
            
            359,534Additional
      paid-in capital
            
            
            29,299,256
            
            
            
            28,322,564Accumulated
      deficit
            
            
            (35,343,240
            )
            
            
            (31,660,009
            )Total
      stockholders' deficit
            
            
            (5,598,652
            )
            
            
            (2,977,911
            )Total
      liabilities and stockholders’ deficit
            
            $
            142,269
            
            
            $
            160,069





See
accompanying notes to financial statements.


3


Amarillo
Biosciences,
Inc.


Statements
of Operations - Unaudited





Three
      months ended June 30,
            
            
            Six
      months ended June 30,2009
            
            
            2008
            
            
            2009
            
            
            2008Revenues:Dietary
      supplement sales
            
            $
            96
            
            
            $
            396
            
            
            $
            228
            
            
            $
            1,284Sublicense
      fee revenue
            
            
            13
            
            
            
            30,000
            
            
            
            795
            
            
            
            30,000Total
      revenues
            
            
            109
            
            
            
            30,396
            
            
            
            1,023
            
            
            
            31,284Cost
      of revenues:Product
      sales
            
            
            28
            
            
            
            136
            
            
            
            54
            
            
            
            437Sublicense
      fee revenues
            
            
            7
            
            
            
            14,990
            
            
            
            397
            
            
            
            14,990Total
      cost of revenue
            
            
            35
            
            
            
            15,126
            
            
            
            451
            
            
            
            15,427Gross
      Margin
            
            
            74
            
            
            
            15,270
            
            
            
            572
            
            
            
            15,857Operating
      expenses:Research
      and development expenses
            
            
            108,986
            
            
            
            129,724
            
            
            
            279,937
            
            
            
            345,616Selling,
      general and administrative expenses
            
            
            434,564
            
            
            
            400,301
            
            
            
            682,088
            
            
            
            803,985Total
      operating expenses
            
            
            543,550
            
            
            
            530,025
            
            
            
            962,025
            
            
            
            1,149,601Operating
      loss
            
            
            (543,476
            )
            
            
            (514,755
            )
            
            
            (961,453
            )
            
            
            (1,133,744
            )Other
      income (expense)Change
      in fair value of derivative instruments
            
            
            (1,867,012
            )
            
            
            -
            
            
            
            (1,991,736
            )
            
            
            -Interest
      expense
            
            
            (22,855
            )
            
            
            (22,482
            )
            
            
            (45,710
            )
            
            
            (44,956
            )Interest
      and other income
            
            
            1,431
            
            
            
            1,325
            
            
            
            3,391
            
            
            
            2,696Net
      loss
            
            
            (2,431,912
            )
            
            
            (535,912
            )
            
            
            (2,995,508
            )
            
            
            (1,176,004
            )Deemed
      dividend for beneficial conversion feature
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (562,841
            )Dividend
      on preferred stock
            
            
            -
            
            
            
            (25,000
            )
            
            
            -
            
            
            
            (48,056
            )Net
      loss applicable to common shareholders
            
            $
            (2,431,912
            )
            
            $
            (560,912
            )
            
            $
            (2,995,508
            )
            
            $
            (1,786,901
            )Basic
      and diluted net loss per share
            
            $
            (0.05
            )
            
            $
            (0.02
            )
            
            $
            (0.07
            )
            
            $
            (0.06
            )Weighted
      average shares outstanding
            
            
            43,411,139
            
            
            
            29,817,431
            
            
            
            40,891,257
            
            
            
            29,662,750





See
accompanying notes to financial statements.


4


Amarillo
Biosciences, Inc.


Condensed
Statements of Cash Flows - Unaudited





Six
      months ended June 30,2009
            
            
            2008Net
      cash used in operating activities
            
            $
            (558,180
            )
            
            $
            (846,389
            )Cash
      from investing activities:Purchases
      of equipment and software
            
            
            -
            
            
            
            (980
            )Patent
      expenditures
            
            
            (858
            )
            
            
            (12,325
            )Net
      cash used in investing activities
            
            
            (858
            )
            
            
            (13,305
            )Cash
      from financing activities:Proceeds
      from sale of convertible preferred stock
            
            
            -
            
            
            
            793,793Proceeds
      from sale of common stock
            
            
            552,029
            
            
            
            25,000Net
      cash provided by financing activities
            
            
            552,029
            
            
            
            818,793Net
      decrease in cash
            
            
            (7,009
            )
            
            
            (40,901
            )Cash
      and cash equivalents at beginning of period
            
            
            10,853
            
            
            
            47,184Cash
      and cash equivalents at end of period
            
            $
            3,844
            
            
            $
            6,283Supplemental
      disclosure of cash flow informationCash
      paid for interest
            
            $
            1,201
            
            
            $
            200,202Cash
      paid for income taxes
            
            $
            -
            
            
            $
            -Non
      cash transactionsDeemed
      dividend for beneficial conversion feature of preferred
      stock
            
            $
            -
            
            
            $
            562,841Stock
      dividend to preferred shareholders
            
            $
            -
            
            
            $
            48,056





See
accompanying notes to financial statements.


5


Amarillo
Biosciences, Inc.





Notes
To Financial Statements - Unaudited





1.
            Basis
      of presentation. The accompanying financial statements, which should be
      read in conjunction with the financial statements and footnotes included
      in the Company's Form 10-K for the year ended December 31, 2008 filed with
      the Securities and Exchange Commission, are unaudited, but have been
      prepared in accordance with accounting principles generally accepted in
      the United States for interim financial information. Accordingly, they do
      not include all of the information and footnotes required by accounting
      principles generally accepted in the United States for complete financial
      statements. In the opinion of management, all adjustments (consisting only
      of normal recurring adjustments) considered necessary for a fair
      presentation have been included.  Operating results for the six
      months ended June 30, 2009 are not necessarily indicative of the results
      that may be expected for the full year ending December 31,
      2009.





2.
            Financial
      Condition. Our viability as a company is dependent upon successful
      commercialization of products resulting from its research and product
      development activities. We plan 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.  Our products will require significant
      additional development, laboratory and clinical testing and investment
      prior to obtaining regulatory approval to commercially market our
      product(s). Accordingly, for at least the next few years, we will continue
      to incur research and development and general and administrative expenses
      and may not generate sufficient revenues from product sales or license
      fees to support its operations.





The
      Company continues to pursue a broad range of financing alternatives to
      improve its financial condition. These alternatives may include the sale
      or issuance of a substantial amount of common stock, common stock warrants
      or stock options. These financing alternatives could require an increase
      in the number of authorized shares of the Company’s common stock and
      result in significant dilution to existing shareholders and, possibly, a
      change of control of the Company.





3.
            Common
      Stock.  The shareholders have authorized 100,000,000 shares of
      voting common shares for issuance.  On June 30, 2009, a total of
      74,735,724 shares of common stock were either outstanding (44,533,178) or
      (30,202,546) for issuance upon exercise of options and
      warrants.  Common stock issuances in the first and second
      quarters of 2009 are as follows:





Common
      Stock Issued in Q1 2009
            
            Shares
            
            
            Issue
      Price
            
            
            Net
      PricePrivate
      placements – cash
            
            
            3,550,000
            
            
            $
            0.10
            
            
            $
            320,000Directors,
      officers, consultants plan – cash
            
            
            62,500
            
            
            
            0.08
            
            
            
            5,000Directors,
      officers, consultants plan – salaries
            
            
            1,407,905
            
            
            
            0.05-0.08
            
            
            
            105,846Directors,
      officers, consultants plan – services
            
            
            636,364
            
            
            
            0.06
            
            
            
            35,000Total
      Common Stock Issued in Q1 2009
            
            
            5,656,769
            
            
            $
            0.05-0.10
            
            
            $
            465,846





Finders’
fees totaled $35,000 during the first quarter of 2009.  Net price
above reflects net proceeds after finders’ fees are deducted.  Private
placement stock issued during the first quarter of 2009 included 100% warrant
coverage (3,550,000 warrants) with $0.10 – $0.20 exercise price and 3-year
term.


6





Common
      Stock Issued in Q2 2009
            
            Shares
            
            
            Issue
      Price
            
            
            Net
      PricePrivate
      placements – cash
            
            
            2,320,290
            
            
            $
            0.10
            
            
            $
            227,029Exercise
      of cashless warrants
            
            
            183,375
            
            
            
            0.10
            
            
            
            -Directors,
      officers, consultants plan – salaries
            
            
            419,367
            
            
            
            0.10
            
            
            
            41,937Total
      Common Stock Issued in Q2 2009
            
            
            2,923,032
            
            
            $
            0.10
            
            
            $
            268,966





Finders’
fees totaled $5,000 during the second quarter of 2009.  Net price
above reflects net proceeds after finders’ fees are
deducted.  2,280,000 shares of the private placement stock issued
during the second quarter of 2009 included 100% warrant coverage (2,280,000
warrants) with $0.10 exercise price and 3-year term.





4.
            Common
      Stock Options.  We recognized $137,852 of employee options
      expense, related to previously issued options during the first six months
      ended June 30, 2009.  The remaining cost expected to be
      recognized if these options vest is
$259,893.





The 2009A
Officers, Directors, Employees and Consultants Non-Qualified Stock Option Plan
was adopted on April 28, 2009 by the Board of Directors.   We
recognized $166,558 for  1,600,000 stock options approved by the Plan
Committee and granted to officers, directors and employees on April 30,
2009.  The options vest immediately with three-year term and $0.125
exercise price.





The Plan
Committee approved the grant of 400,000 options to Dr. Steve Chen, a Director,
on June 4, 2009 for his work with Cyto Biotech and CyotPharm on behalf of the
Company.  We recognized $23,268 for 200,000 options that vested
immediately with 3 year term.  The remaining 200,000 options vest if
the Company receives $50,000 of royalty payments from South American sales by
Cyto Biotech within four years.





5.
            Common
      Stock Warrants.     During the first quarter of
      2009, 3,550,000 warrants were issued in connection with private placement
      sales of 3,550,000 shares of stock.  The 3-year warrants are
      exercisable from $0.10 to $0.20 per share.  During the second
      quarter of 2009, 2,280,000 warrants were issued in connection with private
      placement sales of 2,280,000 shares of stock.  The 3-year
      warrants are exercisable at $0.10 per
share.





Warrant
holders exercised 45,157, 226,440 and 123,559 cashless warrant shares with $0.10
exercise price on May 28, 2009, June 11 and June 15, 2009
respectively.  20,000, 103,375 and 60,000 net shares of common stock
were issued, respectively.





Warrants
issued in connection with a preferred stock financing in the first quarter of
2008 (“Firebird warrants”) have an embedded derivative feature (full-ratchet
anti-dilution provision).


We are at
risk of triggering the warrant anti-dilution provisions of previously issued
warrants if we sell stock below $0.10 per share to any non-exempt
parties.  Options and warrants issued prior to January 8, 2008 plus
officers, directors and consultants under stock plans approved by outside board
of director members are exempt from the anti-dilution
provisions.  GAAP accounting regulation EITF 07-5 requires
reclassification of the warrants to liabilities at fair value on January 1, 2009
and subsequent reporting of the change in fair value.





7


The
binomial Black-Scholes
pricing model was used to calculate the value of the warrants.  In the
binomial model, the most likely price which will trigger the anti-dilution
ratchet and the mostlikely price that will not trigger the anti-dilution
ratchet are given estimated probabilities for occurrence.  The
probability of private placement issuances triggering a reset at the closing
stock price on January 1 was estimated as 50%.  The probability of not
triggering the reset at $0.10 per share was also estimated as
50%.  Valuation consists of 50% of the Black-Scholes value for each
probable occurrence. The Black-Scholes option-pricing model was utilized with
the following  assumptions: dividend yield 0.0%, expected volatility
of 138% ,  risk-free interest rate of 0.76% and expected life of
approximately 2 years.   The valuation for the 13.92 million
warrants with embedded features was $687,723 on January 1, 2009.  The
$687,723 was reclassified from the retained earnings account to the derivative
liabilities account on January 1, 2009 as the cumulative effect of the change in
accounting principle.





The
binomial Black-Scholes pricing model was used similar to the valuations above to
calculate the fair value of the warrants with embedded features on June 30,
2009.  The probability of not triggering the reset at $0.10 per share
was estimated as 50%.  The probability of private placement issuances
triggering a reset at the closing stock price on March 31, 2009 ($0.06) was also
estimated as 50%. The Black-Scholes option-pricing model was utilized with the
following assumptions: dividend yield 0.0%, expected volatility 181.26%, risk
free interest rate 1.11%, and expected life of  approximately 2
years.  The valuation for the 13.92 million warrants less 395,157
warrants exercised was $2,679,459 on June 30, 2009.  The derivative
loss for the first six months of 2009 was $1,991,736.




6. 
Notes Payable -
Related Party.  Two $1,000,000 notes are payable under an unsecured
loan agreement with Hayashibara Biochemical Laboratories, Inc. (“HBL”), a major
stockholder, dated July 22, 1999.  Although we are currently in
default of the notes, HBL has not demanded payment.




7.  Line of Credit.   We have a line of credit with
Wells Fargo for $20,000, with an interest rate of prime rate plus 6.75
percent.  There was an outstanding balance on June 30, 2009 of $1,585
which is included in accounts payable.




8.  License
and Sublicense Agreements.  During the first quarter of 2009, a $782
license fees was received.  A $390 sublicense fee payable to HBL was
recorded in the first quarter of 2009.  A $7,500 minimum cash royalty
fee payable to Texas A&M University System was recorded in the first quarter
of 2009.  During the second quarter of 2009, a $13 license fee was
received.  A $7 sublicense fee payable to HBL was recorded in the
second quarter of 2009.





On
February 6, 2009, we entered into a 15-year License and Supply agreement with
Cyto Biotech, Inc. a Taipei, Taiwan animal health company.   Cyto
Biotech purchased common stock, included in the above first quarter 2009
issuances in Amarillo Biosciences; paid an initial license fee; and will pay a
royalty on low dose oral interferon sales.




9. 
Employment Contract.  On May 31, 2009, Dr. Peter R. Mueller resigned
as Chief Operating Officer and Director of Research.  The Company
currently has no plan to replace Dr. Mueller.




10. 
Related Party Transactions.  The Company engaged the law firm of
Underwood, Wilson, Berry, Stein and Johnson  P.C. of which Mr. Morris
is a shareholder.  Mr. Morris is also the Secretary of the
Company.  During the six months ended June 30, 2009 the Company
incurred approximately $22,158 of legal fees from this law
firm.  During the first quarter of 2009, Dr. Steve Chen, Director,
referred the Company to Cyto Biotech and collected a $30,000 finder’s fee for
the $300,000 stock purchase by Cyto Biotech.  During the second
quarter of 2009,  the
Plan Committee approved the grant of 400,000 options to Dr. Chen on June 4, 2009
for his work with Cyto Biotech and CyotPharm on behalf of the
Company.  We recognized $23,268 for 200,000 options that vested
immediately with 3 year term.  The remaining 200,000 options vest if
the Company receives $50,000 of royalty payments from South American sales by
Cyto Biotech within four years.


8





11. 
Subsequent Events.  Since June 30, 2009, the Company sold 350,000
unregistered shares of common stock for $0.10 per share together with 350,000
warrants with 3-year term and exercisable at $0.10 per share.  Net
proceeds totaled $32,000.  A broker was paid
$3,000.





The
company granted 100,000 shares of common stock to a consultant on July 1,
2009.  The shares will be issued in 25,000 share proportions over four
quarters.





Three
warrant holders exercised 775,440 cashless warrant shares with $0.10 exercise
price and received 430,602 net shares of common stock on August 3,
2009.





Effective
July 1, 2009 Joe Cummins’ employment contract was amended to reflect employment
with USDA, continued full-time employment at the Company with all benefits
remaining in force and payment of salary in stock.








ITEM
2.                      Management's
Discussion and Analysis of Financial Condition and Results of
Operations





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.




Company
Goal – FDA Approval and Commercialization of Oral Interferon.


Amarillo
Biosciences, Inc. (OTCBB: AMAR), is the world leader in the development of
low-dose interferon for oral delivery and is conducting Phase 2 clinical studies
testing oral interferon in animal and human diseases. We have changed our focus
from Orphan Diseases (small markets) to treatment of diseases with large markets
to attract large pharma partners.  Our funding strategy is to seek
private placement and partner funding  to complete Phase 2 clinical
studies for influenza,  chronic cough in COPD patients, and hepatitis
C; then seek large pharma partners to fund and help with the regulatory approval
process in the US and Europe.  We believe that our technology and the
large billion dollar markets for these disease indications will attract global
pharma partners sometime next year.





Intellectual
Property


Our
portfolio consists of patents with claims that encompass method of use or
treatment with interferon and composition of matter and
manufacturing.  We currently own or license nine patents and four
pending patents related to low-dose orally delivered interferon, and one issued
patent on our dietary supplement.  We have completed more than 100
pre-clinical (animal) and human studies of the safety and efficacy of low-dose
orally delivered interferon.


9


Technology
- Non-toxic Interferon


Injectable
interferon is FDA-approved to treat some neoplastic, viral and autoimmune
diseases.  Many patients experience moderate to severe side effects
that result in discontinuance of injectable


interferon
therapy. Our product is a natural human interferon alpha delivered into the oral
cavity as a lozenge in low (nanogram) doses. The lozenge dissolves in the mouth
where interferon binds to surface (mucosal) cells in the mouth and throat
resulting in stimulation of immune mechanisms.  Orally delivered
interferon has been shown to activate hundreds of immune system genes in the
peripheral blood.  Human studies have shown that oral interferon is
effective against viral and autoimmune diseases. Oral interferon is given in
concentrations 10,000 times less than that given by injection resulting in
almost no side effects.





Influenza


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





Flu
viruses spread mainly from person to person through coughing or
sneezing.   Sometimes people may become infected by touching
something with flu viruses on it and then touching their mouth or
nose.  Most healthy adults may be able to infect others beginning 1
day before symptoms develop and up to 5 days after becoming
sick.  That means that a person may be able to pass on the flu to
someone else before they know they are sick, as well as while they are
sick.





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





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


10


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





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





In 1969,
approximately 14,000 people in Moscow participated in controlled studies of
placebo versus interferon treatment during a natural outbreak of Hong Kong
influenza.  Interferon (about 128 units) or placebo was dripped into
the nose daily for 5 days starting about the time of the first reported
influenza cases.  Interferon treatment significantly (P<0.01)
reduced the number of influenza cases. Intranasal drops of human interferon
alpha (5,000 units daily) given for 4 months reduced the frequency and severity
of diseases due to influenza A(H3N2
and H1N1) and parainfluenza virus.  Data was collected on 83
volunteers in the study.  Fever occurred in 6 of 40 volunteers given
interferon and in 15 of 43 volunteers given placebo
(P<0.01).  Subjective symptoms such as headache, cough, fatigue,
anorexia, myalgia, etc. occurred in 34% of volunteers given interferon and in
67% of volunteers given placebo (P<0.01).





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





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





Low doses
of interferon probably do not have a direct antiviral effect but instead exert
an immune modulatory effect through interferon stimulated
genes.  Influenza studies conducted in the USA, Australia and Germany
have shown that oral interferon protects mice against an otherwise fatal
influenza infection.





11


Influenza/Cold
FDA Phase 2 Study (mostly funded by Australian government)


The
University of Western Australia has reached full enrollment in a Phase 2
clinical study of oral interferon as prevention/treatment of respiratory
illnesses, including influenza.   We provided the study drug,
electronic data collection service, and US regulatory support for the
study.  A total of 200 healthy volunteers have been enrolled to take
oral interferon or placebo lozenges once daily for 16 weeks, with an additional
4 weeks of untreated observation. Once per week, the study volunteers will
submit a report detailing the severity of any cold/flu symptoms experienced, any
medications taken, number of days of work missed, etc.  The aim of the
study is to determine whether the volunteers who take oral interferon experience
fewer respiratory illnesses and/or less severe symptoms during the winter
cold/flu season in Australia (June-September).  Final results of the
study are expected to be available before the end of the year.





Two
publications in the April issue of the Journal of Virology report that
interferon placed in the nose of guinea pigs or ferrets suppresses replication
of influenza virus.  These publications reinforce our view that
low-dose interferon, in the nose or in the mouth, is protective against
influenza in humans.


In the
March 20, 2009 issue of Science (page 1560-1561), flu experts stated “Our
ability to anticipate pandemic events is poor, and our anti-pandemic
armamentarium is weak.  In an ever-shifting landscape of influenza
evolution, we need to be farsighted and forceful in optimizing pandemic response
capacity.”





We
believe low-dose oral interferon alpha will help people overcome pandemic
influenza.  The present swine flu epidemic threatens to endanger
millions of people.  The WHO predicted (May 7, 2009) that 2 billion
people could be infected by this new swine flu.





Chronic
Cough – COPD – FDA Phase 2 ongoing, funding sought for a second
study


COPD
affects approximately 10% of the world population over 40, is a growing problem,
and is the 4th leading
cause of death in the world.  Chronic obstructive pulmonary disease
(COPD) is a clinical condition with a progressive airflow limitation that is
poorly reversible and characteristic of chronic bronchitis and
emphysema.  The causes of COPD include tobacco smoke, occupational
dusts, chemicals, vapors and environmental pollutants.  COPD is
estimated to affect more that 600 million people worldwide. There are no
effective therapies for emphysema, nor are there efficient clinical management
strategies.





Data from
a Phase 2 clinical study at Texas Tech University shows that treatment with oral
interferon leads to a rapid and significant reduction in the cough associated
with idiopathic pulmonary fibrosis (IPF), resulting in improved quality of
life.  Blinded, controlled studies in the US and Canada showed that
oral interferon relieves chronic coughing in horses with COPD-like disease. We
have 9 patents and 4 patents pending, including a patent pending for oral
interferon treatment of chronic cough. Oral interferon treatment of cough is
expected to improve quality of life of COPD patients.





A
proof-of-concept study of low-dose oral interferon as treatment of chronic cough
is ongoing at Texas Tech University. This experimental clinical study is a Phase
2, randomized, double-blind, placebo-controlled, parallel trial in which 40
eligible volunteers with IPF or COPD-associated chronic cough will be randomly
assigned to one of two groups in equal numbers to receive either oral interferon
or placebo lozenges. Treatment will be given three times daily for 4 weeks, and
patients will be followed for 4 weeks post-treatment to assess durability of
response. The study will evaluate the ability of oral interferon to reduce the
frequency and severity of chronic cough, compared to placebo.


12




We are
seeking funding to complete an expanded proof-of-concept study of low-dose oral
interferon for treatment of chronic cough. A successful Phase 2 proof-of-concept
study in COPD patients is anticipated to generate interest from potential big
pharma partners, which should result in milestone payments and royalties for the
Company.





Hepatitis
C FDA Phase 2 (funded by Cytopharm)


CytoPharm,
Inc., our licensee for Taiwan and China, has started a Phase 2,
placebo-controlled, dose-ranging study of 165 hepatitis C virus-infected
patients in Taiwan.  The study is designed to test the ability of oral
interferon to reduce the virologic relapse rate of patients who have completed
standard therapy with pegylated interferon plus ribavirin.  Results
are expected by the end of 2010.





Oral
Warts in HIV+ Patients – FDA Phase 2 ongoing, funded by AMAR


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





We have
concluded enrollment of a Phase 2 placebo-controlled, 24-weekstudy. A total of
59 oral warts patients were enrolled at 10 clinical sites.  Treatment
of ongoing patients and collection of data will be completed  by the
end of 2009. If the results of the current study are positive, a partner will be
sought to fund further clinical development, which would include a Phase 3 trial
to confirm safety and efficacy.





Strategic Alliancewith 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.
We believe 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, we
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, 2011, at which
time it will automatically renew for an additional three (3) years, unless the
parties agree otherwise. Among other things, the Development Agreement provides
us with a source of natural human interferon alpha for use in the Company’s
interferon alpha-containing products.


13





Strategic Alliance with
Nobel.  We signed a licensing and supply agreement in September
2004 with a 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.





Strategic Alliance with
Bumimedic.In January 2006 we entered into a license and
distribution agreement with Bumimedic (Malaysia) Sdn. Bhd, a Malaysian
pharmaceutical company that is a part of the Antah HealthCare Group, to market
our low-dose interferon (natural human IFN) in Malaysia. Bumimedic will seek
registration for our natural human IFN and commence marketing the product after
approval. The terms of the agreement call for Bumimedic to manufacture lozenges
from our 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, we will receive a
series of payments, in three stages: upon formal execution of the distribution
agreement, upon regulatory approval, and upon production. We will also receive a
royalty on the sale of the natural human IFN.





Strategic Alliance with
CytoPharm.In November 2006, we entered into a License and
Supply Agreement with CytoPharm, Inc., a Taipei, Taiwan-based biopharmaceutical
company whose parent company is Vita Genomics, Inc., the largest biotech company
in Taiwan specializing in 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 our low dose oral interferon
in the Territory for influenza and hepatitis B (“HBV”) and hepatitis C (“HCV”)
indications.  According to the Agreement, CytoPharm will make payments
to us upon reaching certain milestones and will also pay royalties on low dose
oral interferon sales in the Territory.





In March
2008, we entered into a Supply Agreement for Animal Health with CytoPharm,
Inc.  Under the terms of the Agreement, CytoPharm will conduct all
clinical trials, and seek to obtain regulatory approvals in China and Taiwan
(the “Territory”) to launch our low dose oral interferon in the Territory for
treatment of diseases and other healthcare applications of swine, cattle and
poultry.  CytoPharm will make payments to us upon reaching certain
milestones and will also pay royalties on low dose oral interferon sales
in the Territory.Strategic
Alliance with Cyto Biotech.On February 6, 2009, we entered
into a 15-year License and Supply agreement with Cyto Biotech, Inc. a Taipei,
Taiwan animal health company.  Under the terms of the agreement, Cyto
Biotech, will, at its sole expense and cost, conduct all clinical trials and
studies and seek to obtain regulatory approvals in China, Taiwan, Thailand, the
Philippines, Cambodia, Vietnam and Malaysia (“the Territory”), subject to the
existing license and supply agreements with CytoPharm, Inc. and Bumimedic SDN.
BHD., required for the commercial launch of our low dose oral interferon in the
Territory for any animal and human health indications.





Cyto
Biotech purchased common stock, included in the above issuances in Amarillo
Biosciences stock; paid an initial license fee to us; and will pay a net royalty
on low dose oral interferon sales.  In addition, the agreement calls for
certain minimum royalty payments to be made.





Nutraceutical
Product.   We sell anhydrous crystalline maltose (ACM) as
Maxisal® to individuals and to pharmacies in the USA and to licensed
distributors overseas. We seek to out-license Maxisal®.


14





Equity Funding.In
the first quarter of 2009, the Company sold 3,050,000 unregistered shares of
common stock for $0.10 per share plus 3,050,000 3-year warrants with $0.20
exercise price and 500,000 unregistered shares of common stock for $0.10 per
share plus 500,000 3-year warrants with $0.10 exercise price.  Net
proceeds from private placement stock sales totaled $320,000 after payment of
$35,000 in commissions and finder’s fees.   A consultant
purchased 62,500 shares at $0.08 per share for $5,000 cash.  Equity
funding net of commissions and finder’s fees totaled $325,000.





In the
second quarter of 2009, the Company sold 2,320,290 unregistered shares of common
stock for $0.10 per share plus 2,280,000 3-year warrants with $0.10 exercise
price.  Net proceeds from private placement stock sales totaled
$227,029 after payment of $5,000 in finder’s fees.  An officer was
paid 419,367 shares of common stock in lieu of $41,937 of salary.  Two
investment bankers exercised 395,156 cashless warrants at $0.10 per share and
received 183,375 shares of common stock.





Results
of Operations for Quarter Ended June 30, 2009 and 2008:





Revenues.  During
the quarter ended June 30, 2009, $96 from dietary supplement sales was generated
compared to $396 for the quarter ended June 30, 2008, a decrease of $300 or
76%.  During the quarter ended June 30, 2009, $13 sublicense fee was
generated compared to a $30,000  sublicense fee the quarter ended June
30, 2008, a decrease of $29,987.





Research
and Development Expenses. Research and development expenses of $108,986 were
incurred for the quarter ended June 30, 2009, compared to $129,724 for the
quarter ended June 30, 2008, a decrease of $20,828 (16%).





Selling,
General and Administrative Expenses. Selling, general and administrative
expenses of $434,564 were incurred for the second quarter in 2009, compared to
$400,301 for the second quarter of 2008, an increase of $34,263
(9%).





Change in
Fair Value of Derivative Instruments.  Change in fair value of
derivative instruments was realized as a $1,867,012 operating expense in the
second quarter of 2009 compared to zero in the second quarter of
2008.  Reclassification of the fair value for warrants with embedded
features was not required by EITF 07-5 in 2008.





Non-cash
Consulting Activities. During the second quarter of 2009 no shares were issued
to a consultant.  During the second quarter of 2008, the Board of
Directors authorized 25,000 shares to be issued to a consultant ($5,500 fair
value) and 40,000 shares plus 80,000 warrants to be issued to a consultant
($20,722) fair value. The Board of Directors also authorized the issuance of
12,500 options each to two consultants ($5,061 fair value) in the second quarter
of 2008.





Interest
and Other Income.  During the second quarter of 2009, $1,431 of
interest and other income was generated compared to $1,325 other income in the
second quarter of 2008, an increase of $106.





Net
Loss.  The Company's net loss for the second quarter of 2009 was
$2,431,912 compared to a net loss of $535,912 for the second quarter of 2008, an
increase of $1,896,000 (354%).  This was mostly a result of the
$1,867,012 change in fair value of derivatives recorded for the second quarter
of 2009.


15


Recognition
of the change in fair value for derivatives was not required by EITF 07-5 in
2008. A $25,000 preferred stock dividend was recognized during the second
quarter of 2008 which increased the net loss applicable to common shareholders
to $560,912.





Results
of Operations for the Six Months Ended June 30, 2009





Revenues.  During
the six month period ended June 30, 2009, $228 from dietary supplement sales was
generated compared to dietary supplement sales for the six-month period ended
June 30, 2008, of $1,284, a decrease of $1,056 or approximately
82%.  During the six-month period ended June 30, 2009 a $795 of
sublicense fees were generated compared to a $30,000 sublicense fee for the six
month period ended June 30, 2008, a $29,205 decrease or approximately
97%.





Research
and Development Expenses. Research and development expenses of $279,937 were
incurred for the six month period ended June 30, 2009, compared to $345,616 for
the six month period ended June 30, 2008, a decrease of $65,679
(9%).   Clinical costs for oral warts in HIV+ patients decreased
$117,764 in the first six months of 2009 compared to the first six months of
2008 since enrollment was completed.  Clinical costs for influenza
increased $39,403 higher the first six months of 2009 compared to the first six
months of 2008 because enrollment started in 2009 for the cold and influenza
study in Australia.  Clinical costs for hepatitis C increased $13,318
during the first six months of 2009 compared to the first six months of
2008.





Selling,
General and Administrative Expenses. Selling, general and administrative
expenses of $682,088 were incurred for the six-month period ended June 30, 2009,
compared to $803,985 for the six-month period ended June 30, 2008, a decrease of
$121,897 (15%).  Black-Scholes option expenses for employees and
directors were $205,886 higher (26%) in the first six months of 2009 than the
first six months of 2008.   Public relations and investor
relations expenses were $236,456 lower (29%) in the first six month of 2009 than
the first six months of 2008.  Public relations/investor relations,
travel, accounting, license fees and fund raising were $58,909 (7%) lower in the
first six months of 2009 than in the first six months of 2008.





Non-cash
Consulting Activities.  During the first six months of 2009, no stock
or stock options were issued to consultants. The Company recognized $137,852 of
employee option expense in the first six months of
2009.  During the first six months of 2008, the Board of Directors
authorized the issuance of 230,000 shares of common stock to consultants
($61,372 fair value).  The Board of Directors also authorized the
issuance of 50,000 options each to two consultants, Dr. Kimball Austin Miller
and Dr. Elaine King Miller. Portions of 12,500 Options each vested on March 31,
2008, June 30, 2008, September 30 and December 31 during fiscal
2008.  As of June 30, 2008, $10,121 of expense was recognized from the
Miller options.





Interest
and Other Income.   During the six-month period ended June 30,
2009, $3,391 of interest and other income was generated compare to $2,696 in the
six-month period ended June 30, 2008, an increase of $695.





Net
Loss.  As a result of the above, in the six-month period ended June
30, 2009, the Company's net loss was $2,995,508 compared to a net loss for the
six-month period ended June 30, 2008 of $1,176,004, an increase of $1,819,504
(155%).  The increase in net loss was mostly attributable to a
$1,991,736 change in fair value of derivatives recorded for the six-month period
ended June 30, 2009.  Recognition of the change in fair value for
derivatives was not required by EITF 07-5 in 2008.  A $562,841 deemed
dividend for the conversion feature of preferred stock and $48,056 of preferred
dividends were recognized during the first six months of 2008 which increased
the net loss applicable to common shareholders to $1,786,901.


16


Liquidity
Needs:  On June 30, 2009, the Company had available $3,844 cash and
had a working capital deficit (current assets less current liabilities) of
$5,724,142.  This includes $2,679,459 of non-cash derivative
liabilities for warrants with embedded derivatives.  Current
liabilities include two $1 million notes, $617,281 of accrued interest and
$54,369 of accrued expense owed to Hayashibara Biochemical Laboratories, Inc.
(HBL), the Company’s largest shareholder.   Accrued payroll and
vacation expenses owed mostly to officers are $249,286.





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 and patent filings, the Company’s cash burn rate is
approximately $93,000 per month.  The Company's continued losses and
lack of liquidity raise substantial doubt about whether the Company is 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 license and milestone
fees, 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 2009 Plan.  The Company is currently pursuing
potential investors for funding.  In addition, the Company is also
pursuing potential pharmaceutical partners to provide upfront license fee
payments and funding for clinical studies.  There can be no assurance
that private placement funding or pharmaceutical partner funding will become
available.





Forward-Looking
Statements: Certain statements made in this Plan of Operations and elsewhere in
this report are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995 (the "Act"). Forward-looking statements
include, without limitation, any statement that may predict, forecast, indicate
or imply future results, performance, achievements, costs or expenses and may
contain words such as "believe," "anticipate," "expect," "estimate," "project,"
"budget," or words or phrases of similar meaning. Forward-looking statements
involve risks and uncertainties which may cause actual results to differ
materially from those projected in the forward-looking statements. Such risks
and uncertainties are detailed from time to time in reports filed by the Company
with the Securities and Exchange Commission, including Forms 8-K, 10-Q and 10-K
and include among others the following: promulgation and implementation of
regulations by the U.S. Food and Drug Administration ("FDA"); promulgation and
implementation of regulations by foreign governmental instru­mentalities
with functions similar to those of the FDA; costs of research and development
and clinical trials, including without limitation, costs of clinical supplies,
packaging and inserts, patient recruitment, trial monitoring, trial evaluation
and publication; and possible difficulties in enrolling a sufficient number of
qualified patients for certain clinical trials. The Company is also dependent
upon a broad range of general economic and financial risks, such as possible
increases in the costs of employing and/or retaining qualified personnel and
consultants and possible inflation which might affect the Company's ability to
remain within its budget forecasts. The principal uncertainties to which the
Company is presently subject are its inability to ensure that the results of
trials performed by the Company will be sufficiently favorable to ensure
eventual regulatory approval for commercial sales, its inability to accurately
budget at this time the possible costs associated with hiring and retaining of
additional personnel, uncertainties regarding the terms and timing of one or
more commercial partner agreements and its ability to continue as a going
concern.


17





The risks
cited here are not exhaustive. Other sections of this report may include
additional factors which could adversely impact the Company's business and
future prospects. Moreover, the Company is engaged in a very competitive and
rapidly changing industry.





New risk
factors emerge from time to time and it is not possible for management to
predict all such risk factors, nor can it assess the impact of all such risk
factors on the Company's business, or the extent to which any factor or
combination of factors may cause actual results to differ materially from those
projected in any forward-looking statements. Given these risks and
uncertainties, investors should not place undue reliance on forward-looking
statements as a prediction of actual future events.





ITEM
3.                      Quantitative
and Qualitative Disclosures About Market Risk.





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





We rely on third parties for the
supply, manufacture and distribution of our products.  Third
parties manufacture and distribute all of our products. We do not currently have
manufacturing facilities or personnel to independently manufacture our products.
Currently, Marlyn Nutraceutical manufactures our nutraceutical products. Our
licensed distributors, located in the United States and internationally,
distribute the products.  Except for any contractual rights and
remedies that we may have with our manufacturer and our distributors, 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 funding from
private placements of stock.Our sales revenue, sublicense
fees and royalty income are negligible compared to expenses.  Our
primary focus is to achieve FDA approval of oral interferon for one or more
disease indications.  We do not expect significant sales or royalty
revenue in the near term as Phase 2 and Phase 3 clinical studies must be
completed before a NDA (New Drug Application) may be submitted to the
FDA.  We operate at a net loss and current liabilities exceed current
assets by $5,724,142.  The working capital deficit includes two $1
million notes, $617,281 of accrued interest and $54,369 of accrued expenses owed
to our largest shareholder (HBL); $249,286 of accrued payroll and vacation
expenses owed mostly to officers; and $2,679,459 of
non-cash derivative liabilities for warrants with embedded
derivatives.   The remaining working capital deficit of
approximately $170,000 consists of accounts payable and accrued
expenses.  See a detailed discussion of the HBL notes in Note 6
(“Notes Payable”) to Financial Statements under Part I, Item 1,
above.


18





The
Company is currently pursuing potential investors for funding.  In
addition the Company is also pursuing potential pharmaceutical partners to
provide upfront license fee payments and funding for clinical
studies.  There can be no assurance that private placement funding or
pharmaceutical partner funding will become available.





We are dependent 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 Dr. Joseph M. Cummins, our President and Chief Executive
Officer, Dr. Gary W. Coy, our Chief Financial Officer, and Martin J. Cummins,
our Vice President of Clinical and Regulatory Affairs. The loss of the services
of one or more of our key employees could have a material adverse effect on our
operations. We do currently have employment agreements with our executive
officers. We do not currently maintain key man life insurance on any of our key
employees.  In addition, as our business plan is implemented, we will
need to recruit and retain additional management and key employees in virtually
all phases of our operations. We cannot assure that we will be able to
successfully attract and retain key personnel.





If we do not successfully develop,
acquire or license new drugs our business may not grow.We
must invest substantial time, resources and capital in identifying and
developing new drugs, dosage and delivery systems, either on our own or by
acquiring and licensing such products from third parties. Our growth depends, in
part, on our success in such process.  If we are unable to either
develop new products on our own or acquire licenses for new products from third
parties, our ability to grow revenues and market share may be adversely
affected. In addition, we may not be able to recover our investment in the
development of new drugs, given that projects may be interrupted, unsuccessful,
not as profitable as initially contemplated or we may not be able to obtain
necessary financing for such development if we are unable to fund such
development from our future revenues. Similarly, there is no assurance that we
can successfully secure such rights from third parties on an economically
feasible basis.





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





19


We have been the subject of a going
concern opinion by our independent auditors who have raised substantial doubt as
to our ability to continue as a going concern.Our Independent Registered Public Accountants have added an
explanatory paragraph to their audit  reports issued in connection
with our consolidated financial statements which states that our recurring
losses from operations and the need to raise additional financing in order to
execute our business plan raise substantial doubt about our ability to continue as a going concern. We
have experienced net losses of $1,176,004 for the six months ended June 30, 2008
and $2,995,508 for the six months ended June 30, 2009.  In addition,
as of June 30, 2009 we had an accumulated deficit of $35,343,240. These factors,
among others, raise substantial doubt about our ability to continue as a going
concern. Our financial statements do not include any adjustment that might
result from the outcome of this uncertainty. Assurances cannot be given that
adequate financing can be obtained to meet our capital needs. We have already
significantly curtailed operations, and if we are unable to generate profits and
if we to continue to be unable to obtain financing to meet our working capital
requirements, we will have to cease operations altogether. Our continuation as a
going concern is dependent upon our ability to generate sufficient cash flow to
meet our obligations on a timely basis, to retain our current financing, to
obtain additional financing, and, ultimately, to attain
profitability.





Risk Relating to Our January 2008
Financing Arrangement.There
are 13,524,844 shares underlying our warrants related to our January 2008
financing arrangement that may be available for future sale and the sale of
these shares may depress the market price of our common stock.  In
addition the warrants have an anti-dilution ratchet feature that could cause the
number of warrants to increase and the exercise price to decrease if we should
have any non exempt stock, option or warrant issuances less the $0.10 per
share.As of
June 30, 2009, we had 44,533,178 shares of common stock issued and outstanding
plus 30,202,546 shares reserved for options and warrants which includes the
above January 2008 warrants.





Risks Related to our Common
Stock.There is only a limited market for our common stock and
the price of our common stock may be affected by factors that are unrelated to
the performance of our business.  If any of the risks described in
these Risk Factors or other unseen risks are realized, the market price of our
common stock could be materially adversely affected.  Additionally, market
prices for securities of biotechnology and diagnostic companies have
historically been very volatile.  The market for these securities has from
time to time experienced significant price and volume fluctuations for reasons
that are unrelated to the operating performance of any one company.  In
particular, and in addition to the other risks described elsewhere in these Risk
Factors, the following factors can adversely affect the market price of our
common stock:




·
            announcements
      of technological innovation or improved or new diagnostic products by
      others;


·
            general
      market conditions;


·
            changes
      in government regulation or patent
decisions;


·
            changes
      in insurance reimbursement practices or policies for diagnostic
      products.





Our
common shares have traded on the Over the Counter Bulletin Board at prices below
$5.00 for several years. As a result, our shares are characterized as “penny
stocks” which could adversely affect the market liquidity of our common
stock.  The Securities Enforcement and Penny Stock Reform Act of 1990
requires additional disclosure relating to the market for penny stocks in
connection with trades in any stock defined as a penny stock. Securities and
Exchange Commission regulations generally define a penny stock to be an equity
security that has a market price of less than $5.00 per share, subject to
certain exceptions. Such exceptions include any equity security listed on NASDAQ
or a national securities exchange and any equity security issued by an issuer
that has:





·
            net
      tangible assets in excess of $2,000,000, if such issuer has been in
      continuous operation for three
years;


·
            net
      tangible assets in excess of $5,000,000, if such issuer has been in
      continuous operation for less than three years;
  or


·
            average
      revenue of at least $6,000,000, for the last three
  years.


20




Unless an
exception is available, the regulations require, prior to any transaction
involving a penny stock, that a disclosure schedule explaining the penny stock
market and the risks associated therewith is delivered to a prospective
purchaser of the penny stock.  We currently do not qualify for an
exception, and, therefore, our common stock is considered to be penny stock and
is subject to these requirements.  The penny stock regulations adversely
affect the market liquidity of our common shares by limiting the ability of
broker/dealers to trade the shares and the ability of purchasers of our common
shares to sell in the secondary market.  In addition, certain institutions
and investors will not invest in penny stocks.




Future
sales of a significant number of shares of our common stock by existing
stockholders may lower the price of our common stock, which could result in
losses to our stockholders.  We estimate there that are approximately
25,000,000 restricted shares outstanding which, upon becoming freely tradable
under Rule 144 or 144(k) of the Securities Exchange Act of 1934, may lower the
price of our common stock.





The
Company continues to pursue a broad range of financing alternatives to improve
its financial condition. These alternatives may include the sale or issuance of
a substantial amount of common stock, common stock warrants or stock options.
These financing alternatives could require an increase in the number of
authorized shares of the Company’s common stock and result in significant
dilution to existing shareholders and, possibly, a change of control of the
Company.





ITEM
4.                      Controls
and Procedures




As
required by Rule 13a-15 under the Exchange Act, we have carried out an
evaluation of the effectiveness of the design and operation of our company’s
disclosure controls and procedures as of the end of the period covered by this
quarterly report, being June 30, 2009. This evaluation was carried out under the
supervision and with the participation of our company’s management, including
our company’s president and chief executive officer. Based upon that evaluation,
our company’s president and chief executive officer concluded that our company’s
disclosure controls and procedures are effective as at the end of the period
covered by this report. There have been no significant changes in our company’s
internal controls or in other factors, which could significantly affect internal
controls subsequent to the date we carried out our evaluation.




Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed in our company’s reports filed
or submitted under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed in our company’s reports filed under the Exchange Act
is accumulated and communicated to management, including our company’s president
and chief executive officer as appropriate, to allow timely decisions regarding
required disclosure.




There
were no changes in internal controls over financial reporting during the second
quarter of 2009.


21


PART
II - OTHER INFORMATION





ITEM
1.                      Legal
Proceeding.





From time
to time, we may become involved in various lawsuits and legal proceedings which
arise in the ordinary course of business. Litigation is subject to inherent
uncertainties, and an adverse result in these or other matters may arise from
time to time that may harm our business.  As of the date of this
report, we were not aware of any such legal proceedings or claims against
us.





ITEM
      2.
            Unregistered
      Sales of Equity Securities and Use of
Proceeds





During
the first quarter of 2009, we sold 3,550,000 restricted shares of common stock
at $0.10 per share with 3,550,000 three year warrants exercisable at $0.10 -
$0.20 per share (private placements) to four investors, generating net proceeds
of $320,000 in cash after $35,000 of commissions and finder fees were
paid.  Also, a consultant purchased 62,500 shares of common stock at
$0.08 per share (Directors, Officers, Consultants Plan), generating $5,000 in
cash.





During
the first quarter of 2009, officers were paid 1,407,905 shares of common stock
at $0.05 - $0.08 per share in lieu of salaries (Directors, Officers, Consultants
Plan).  Also, consultants were paid 636,364 shares of common stock at
$0.055 per share in lieu of services (Directors, Officers, Consultants
Plan).   Salaries and services paid in stock totaled
$140,846.





During
the second quarter of 2009, we sold 2,280,000 restricted shares of common stock
at $0.10 per share with 2,280,000 three year warrants exercisable at $0.10 per
share (private placements) to five investor, generating $223,000 after $5,000 of
commissions and finder’s fees were paid.  We sold 40,290 shares at
$0.10 per share to Bumimedic, a licensee, generating $4,029.





During
the second quarter of 2009, an officer was paid 419,367 shares of common stock
at $0.10 per share in lieu of salaries (Directors, Officers, Consultants
Plan).  Two warrant holders exercised 395,156 cashless warrants at
$0.10 per share and received183,375 shares of common stock.




Date
      (2009)
            Shares
      of Common Stock
            Purchaser
            Discount1Issue
      Price
            Number
            Per
      Share
            Total1
            January
      92
            $
            .10
            50,000
            Jo
      Lynn Carney
            $
            0
            $
            02
            February
      5
            
            .08
            62,500
            Katsuaki
      Hayashibara
            
            0
            
            03
            February
      133
            
            .10
            3,000,000
            Cyto
      Biotech
            
            0
            
            04
            February
      20
            
            .08
            134,984
            Dr.
      Joseph Cummins
            
            0
            
            05
            February
      20
            
            .08
            100,510
            Dr.
      Gary Coy
            
            0
            
            06
            February
      20
            
            .08
            969,835
            Dr.
      Peter Mueller
            
            0
            
            07
            March
      14
            
            .10
            250,000
            Paul
      Tibbits
            
            0
            
            08
            March
      14
            
            .10
            250,000
            Marian
      Tibbits
            
            0
            
            09
            March
      12
            
            .0465
            116,116
            Dr.
      Joseph Cummins
            
            0
            
            010
            March
      12
            
            .0465
            86,460
            Dr.
      Gary Coy
            
            0
            
            0




22


11
            March
      25
            
            .055
            318,182
            Alicia
      Browner
            
            0
            
            012
            March
      25
            
            .055
            318,182
            Richard
      Tieken
            
            0
            
            013
            April
      275
            
            .10
            150,000
            Griffin
      Family Trust
            
            .045
            
            6,75014
            April
      296
            
            .10
            10,000
            Stacy
      Barnett
            
            .075
            
            75015
            April
      30
            
            .10
            40,290
            Bumimedic
            
            .025
            
            1,00716
            April
      307
            
            .10
            500,000
            Paul
      Tibbits
            
            .025
            
            12,50017
            May
      18
            
            .10
            1,000,000
            Cheryl
      Ulie
            
            .03
            
            30,00018
            May
      59
            
            .10
            500,000
            Robert
      Barnett
            
            0
            
            019
            May
      59
            
            .10
            100,000
            Noelle
      Gehm
            
            0
            
            020
            May
      6
            
            .10
            419,367
            Dr.
      Peter Mueller
            
            0
            
            021
            May
      1110
            
            .10
            20,000
            Adam
      Cabibi
            
            .02
            
            40022
            June
      1110
            
            .10
            103,375
            Biomed
      Cap, LLC
            
            .08
            
            8,27023
            June
      1210
            
            .10
            60,000
            Adam
      Cabibi
            
            .05
            
            3,00024
            June
      3011
            
            .10
            20,000
            Shirley
      Ritschel
            
            .07
            
            1,400




1. Discounts were calculated based on the closing price of the last
transaction on each date.


2. The
      price was $0.10 for each share of common stock and one warrant with three
      year term and exercisable at $0.20 per share.  The stock closing
      price on January 9, 2009 was $0.07 per
share.


3. The
      price was $0.10 for each share of common stock and one warrant with three
      year term and exercisable at $0.20 per share.  The stock closing
      price on February 13, 2009 was $0.065 per
share.


4. The
      price was $0.10 for each share of common stock and one warrant with three
      year term and exercisable at $0.10 per share.  The stock closing
      price on March 1, 2009 was $0.07 per
share.


5. The
      price was $0.10 for each share of common stock and one warrant with three
      year term and exercisable at $0.10 per share.  The stock closing
      price on April 27, 2009 was $0.145 per
share.


6. The
      price was $0.10 for each share of common stock and one warrant with three
      year term and exercisable at $0.10 per share.  The stock closing
      price on April 29, 2009 was $0.175 per
share.


7. The
      price was $0.10 for each share of common stock and one warrant with three
      year term and exercisable at $0.10 per share.  The stock closing
      price on April 30, 2009 was $0.125 per
share.


8. The
      price was $0.10 for each share of common stock and one warrant with three
      year term and exercisable at $0.10 per share.  The stock closing
      price on May 1, 2009 was $0.13 per
share.


9. The
      price was $0.10 for each share of common stock and one warrant with three
      year term and exercisable at $0.10 per share.  The stock closing
      price on May 5, 2009 was $0.095 per
share.


10. Two
warrant holders exercised 395,156 cashless warrants at $0.10 per share and
received 183, 375 shares of common stock.


11. The
price was $0.10 for each share of common stock and one warrant with three year
term and exercisable at $0.10 per share.  The stock closing price on
May 30, 2009 was $0.17 per share.


23








ITEM
      3.
            Defaults
      Upon Senior Securities.


None,
      other than set forth in Note 6 to Financial Statements, “Notes Payable”,
      under Part I, Item 1, above, regarding non-payment of the HBL
      Notes.





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


None.





ITEM.5.
            Other
      Information


None





ITEM
      6.
            Exhibits.


None







24







SIGNATURES




Pursuant
to the requirements of 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:
      August 12, 2009
            By:/s/ Joseph
      M. Cummins


Joseph M. Cummins


President and Chief Executive
Officer







Date:
      August 12, 2009
            By:/s/ Gary
      W. Coy


Gary W.
Coy
 Vice President and Chief Financial
Officer





25