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 September 30, 2010





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 November 17, 2010 there were 57,849,248 shares of the issuer's common stock and 1,200 shares of the issuer’s preferred stock outstanding.





1


AMARILLO BIOSCIENCES, INC.





INDEX


PAGE NO.PART I:
FINANCIAL INFORMATIONITEM 1.
Financial StatementsBalance Sheets– September 30, 2010  (unaudited) and December 31, 2009
3Statements of Operations – Three and Nine Months Ended September 30, 2010 and 2009 (unaudited)
4Condensed Statements of Cash Flows – Nine Months Ended September 30, 2010 and 2009 (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.
16ITEM 4.
Controls and Procedures
19PART II:
OTHER INFORMATIONITEM 1.
Legal Proceedings
20ITEM 2.
Unregistered Sales of Equity Securities and Use of Proceeds
20ITEM 3.
Defaults Upon Senior Securities
22ITEM 4.
Submission of Matters to a Vote of Security Holders
22ITEM 5.
Other Information
22ITEM 6.
Exhibits.....................................................................
22Signatures

23





2


PART I - FINANCIAL INFORMATION




ITEM 1.
Financial Statements Amarillo Biosciences, Inc.


Balance Sheets


September 30, 2010

December 31, 2009Assets

(unaudited)Current assets:Cash and cash equivalents

$
1,399


$
24,216Other current assets


78,635



87,208Total current assets


80,034



111,424Property, equipment, and software, net


2,064



4,321Patents, net


117,373



123,184Total assets

$
199,471


$
238,929Liabilities and Stockholders' DeficitCurrent liabilities:Accounts payable and accrued expenses

$
568,790


$
318,550Accrued interest - related party


728,609



661,294Accrued expenses – related party


78,360



78,360Derivative liabilities


931,775



1,928,120Notes payable - related party


2,000,000



2,000,000Total current liabilities


4,307,534



4,986,324Total liabilities


4,307,534



4,986,324Commitments and contingenciesStockholders' deficitPreferred stock, $0.01 par value:Authorized shares - 10,000,000Series 2010-A, 10,000 shares authorizedIssued and outstanding shares – 950 at September 30, 2010 and December 31, 2009


10



-Common stock, $0.01par value:Authorized shares - 100,000,000Issued and outstanding shares – 54,646,272 at September 30, 2010 and 52,041,001 at  December 31, 2009


546,463



520,410Additional paid-in capital


30,545,354



30,051,134Accumulated deficit


( 35,199,890
)


( 35,318,939
)Total stockholders' deficit


(4,108,063
)


( 4,747,395
)Total liabilities and stockholders’ deficit

$
199,471


$
238,929





See accompanying notes to financial statements.


3





Amarillo Biosciences, Inc.


Statements of Operations - Unaudited





Three months ended September 30,


Nine months ended September 30,2010


2009


2010


2009Revenues:Dietary supplement sales

$
1,375


$
36


$
4,495


$
264Sublicense fee revenue


-



48,000



-



48,795Total revenues


1,375



48,036



4,495



49,059Cost of revenues:Product


600



21



2,695



75Sublicense fees


-



24,009



-



24,407Total cost of revenues


600



24,030



2,695



24,482Gross Margin


775



24,006



1,800



24,577Operating expenses:Research and development


102,268



110,032



301,386



389,969Selling, general and administrative


193,538



235,484



506,105



917,572Total operating expenses


295,806



345,516



807,491



1,307,541Operating loss


( 295,031
)


( 321,510
)


( 805,691
)


( 1,282,964
)Other income (expense)Change in fair value of derivative

Instruments


148,555



( 744,913
)


996,345



( 2,736,649
)Interest expense


( 24,173
)


( 23,697
)


( 70,517
)


( 69,406
)Interest and other income


-



-



140



3,391Net income (loss)


( 170,649
)


( 1,090,120
)


120,277



(4,085,628
)Dividend on preferred stock


( 1,228
)


-



( 1,228
)


-Net income (loss) applicable to common shareholders

$
( 171,877
)

$
( 1,090,120
)

$
119,049


$
(4,085,628
)Basic net income (loss) per share

$
( 0.00
)

$
( 0.02
)

$
0.00


$
( 0.10
)Diluted net income (loss) per share

$
( 0.00
)

$
( 0.02
)

$
0.00


$
( 0.10
)Basic weighted average shares outstanding


54,600,497



45,689,709



53,775,893



42,508,318Diluted weighted average shares outstanding


54,600,497



45,689,709



55,082,699



42,508,318





See accompanying notes to financial statements.


4





Amarillo Biosciences, Inc.


Condensed Statements of Cash Flows


(Unaudited)





Nine months ended September 30,2010

2009Net cash used in operating activities
$
( 312,162
)

$
( 660,471
)Cash from investing activities:Patent expenditures

( 6,555
)


( 10,142
)Net cash used in investing activities

( 6,555
)


( 10,142
)Cash from financing activities:Proceeds from exercise of options

8,200



-Convertible preferred stock issued for cash

85,500



-Proceeds from sale of common stock

202,200



699,735Net cash provided by financing activities

295,900



699,735Net increase (decrease) in cash

(22,817
)


29,122Cash and cash equivalents at beginning of period

24,216



10,853Cash and cash equivalents at end of period
$
1,399


$
39,975Supplemental disclosure of cash flow informationCash paid for interest
$
3,202


$
1,393Cash paid for income taxes

-



-





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, 2009 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 nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2010.





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 September 30, 2010, a total of 80,640,368 shares of common stock were either outstanding (54,646,272) or reserved for issuance upon exercise of options and warrants or conversion of convertible preferred stock (25,994,096).  Common stock issuances in the first, second and third quarters of 2010 are as follows:





Common Stock Issued in Q1 2010

Shares


Issue Price


Net PricePrivate placements – cash


1,060,000


$
0.10


$
103,000Directors, officers, consultants plan – services


145,814



0.105-0.16



19,130Options exercised – cash


82,000



0.10



8,200Options exercised – cashless


70,258



0.10



-Total Common Stock Issued in Q1 2010


1,358,072


$
0.105-0.16


$
130,330





6





Brokerage commissions totaled $3,000 during the first quarter of 2010.  Net price above reflects net proceeds after commissions are deducted.  Private placement stock issued during the first quarter of 2010 included 100% warrant coverage (1,060,000 warrants) with $0.10 exercise price and 3-year term.





Common Stock Issued in Q2 2010

Shares


Issue Price


Net PricePrivate placements – cash


1,075,000


$
0.10


$
99,000Directors, officers, consultants plan – services


90,343



0.08-0.105



8,630Total Common Stock Issued in Q2 2010


1,165,343


$
0.08-0.105


$
107,630





Brokerage commissions totaled $8,500 during the second quarter of 2010.  Net price above reflects net proceeds after commissions are deducted.  Private placement stock issued during the second quarter of 2010 included 100% warrant coverage (1,075,000 warrants) with $0.10 exercise price and 3-year term.





Common Stock Issued in Q3 2010

Shares


Issue Price


Net PricePrivate placements – cash


2,000


$
0.10


$
200Directors, officers, consultants plan – services


79,856



0.06-0.065



4,916Total Common Stock Issued in Q3 2010


81,856


$
0.06-0.10


$
5,116





No brokerage commissions were paid for the sale of common stock during the third quarter of 2010.  Private placement stock issued during the third quarter of 2010 included 100% warrant coverage (2,000 warrants) with $0.10 exercise price and 3-year term.





The common stock issuances above do not trigger any reset provisions of previously issued securities.  The issuances of common stock with prices below $0.10 per share that are issued to employees, directors or consultants pursuant to stock plans approved by a majority of the non-employee directors are exempt issuances.





4.
Convertible Preferred Stock.  The shareholders have authorized 10,000,000 shares of preferred stock shares for issuance. The Board of directors authorized the issuance of up to 10,000 shares of Series 2010-A 10% Convertible Preferred Stock on July 29, 2010.  Each preferred share is convertible into 1,000 common shares ($100 stated value per share divided by $0.10).  Dividends are payable quarterly at 10% per annum in cash or stock at the option of the preferred stock Holder.  Stock dividend payments are valued at the higher of $0.10 per share of common stock or the average of the two highest volume weighted average closing prices for the 5 consecutive trading days ending on the trading day that is immediately prior to the dividend payment date.  During the third quarter of 2010, a total of 950 shares of Series 2010-A 10% Convertible Preferred Stock were issued.  Net proceeds totaled $85,500 after $9,500 of brokerage commissions.  The preferred stock is convertible into 950,000 shares of restricted common stock.





5.
Common Stock Options.  We recognized $112,874 of employee options expense, related to previously issued options during the nine months ended September 30, 2010.  No more costs remain to be recognized for these options.  The Board granted 100,000 options with 2-year term and $0.11 exercise price to a consultant on March 8, 2010 with a fair value of $8,852.  One quarter of the options (fair value $2,213) vest each quarter during 2010.  An officer and a consultant exercised 245,000 options in 2010.  See “7.  Stock Option and Warrant Exercise Incentive” below for more details about 2010 stock option exercises. On July 29, 2010, the Board of Directors authorized the issuance of 1,050,000 options with 5-


7


year term and $0.065 strike price to employees and directors (fair value $67,739) under the 2009A Officers, Directors, Employees, and Consultants Non-Qualified Stock Option Plan.  Options for the purchase of 201,667 shares expired during the period ending March 31, 2010.  No options expired during the second quarter of 2010.  Options for the purchase of 2,720,000 shares expired during the quarter ending September 30, 2010.





6.
Common Stock Warrants.  Private placement stock (1,060,000 shares) issued at $0.10 per share during the first quarter of 2010 included 1,060,000 warrants with $0.10 exercise price and 3-year term.  We received $103,000 of net proceeds.  Private placement stock (1,075,000 shares) issued at $0.10 per share during the second quarter of 2010 included 1,075,000 warrants with $0.10 exercise price and 3-year term.  We received $99,000 of net proceeds.  Private placement stock (2,000 shares) issued at $0.10 per share during the third quarter of 2010 included 2,000 warrants with $0.10 exercise price and 3-year term.





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.  In accordance with Financial Account Standards Board Accounting Standards Codification (“FASB ASC”) Topic 815, the Company reclassified the warrants to liabilities at fair value on January 1, 2009 and reported the change in fair value of the warrants at the end of each quarter to September 30, 2010.





The binomial Black-Scholes pricing model was used to calculate the fair value of the warrants with embedded features on September 30, 2010.  The probability of not triggering the reset at $0.10 per share was estimated as 25% since the stock closing price was $0.045 on September 30, 2010.  The probability of private placement issuances triggering a reset was estimated as 75%.




The Black-Scholes option-pricing model was utilized with the following assumptions: dividend yield 0.0%, expected volatility 203.3%, risks free interest rate 0.42%, and expected life of approximately 2.27 years.  The valuation for the remaining 12,447,999 warrants outstanding was $931,775 on September 30, 2010.  The derivative gain for the first nine months of 2010 was $996,345.




7.     Stock Option and Warrant Exercise Incentive




On November 9, 2009 the Board approved incentives to encourage option and warrant holders to exercise options and warrants. Option and Warrant holders exercised up to one third of the options or warrants they held, at a price of $0.10 per share cash to the Company, and for each option or warrant so exercised, two were converted to cashless options/warrants with an exercise price of $0.10 per share, and deemed exercised immediately, on a cashless basis.  The Board extended the exercise incentive until January 22, 2010.




The Company determined that this was a modification of equity instruments, and accounted for the inducement under ASC Topic 718. For option and warrant holders who accepted the inducement and exercised their instruments under the terms noted above, an incremental fair value of the inducement was determined using the Black-Scholes option pricing model, with the following assumptions: dividend yield 0.0%, expected volatility of 149-193%, risk free interest rate 0.16 -2.37%, and  expected life of  0.61-4.27 years. The Company recognized $4,456 of expense related to the inducement in the first quarter of 2010.  See summary of the exercise incentive transactions below:




8




Options/Warrants Exercised Q1 2010


Common Stock Issued


Release of Reserved into Available Shares


Net Cash to CompanyOptions


245,000



152,258



92,742


$
8,200Warrants


-



-



-



-Total


245,000



152,258



92,742


$
8,200





No options or warrants were exercised during the second or third quarter of 2010.





8.
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 repayment default on the notes, HBL has not demanded payment.





9.
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 September 30, 2010 of $20,047 which is included in accounts payable.





10.
License and Sublicense Agreements.  During the first nine months of 2010 no license fees were received.





On January 7, 2010, we entered into a License and Supply agreement with Intas Pharmaceuticals Ltd., an India-based pharmaceutical company with three decades of experience in the healthcare industry and a global presence in 42 countries worldwide. Under the terms of the agreement, Intas will pay the Company a royalty on net sales in India and Nepal after marketing approval is obtained.





11.
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 nine months ended September 30, 2010 the Company incurred $24,829 of legal fees from this law firm.





12.
Subsequent Events. On October 15 and 20, 2010 two consultants purchased 50,000 shares and 2,857,143 shares of common stock respectively at $0.035 per share under a stock plan for officers, directors and consultants.  Net proceeds totaled $101,750.





On October 4, 2010 an investor purchased 250 shares of Series 2010-A 10% convertible preferred stock at $100 per share.  Conversion price is $0.10 per share of common stock.  Net proceeds after a $2,500 brokerage commission was $22,500.





On October 14, 2010, the Board of Directors appointed Paul Tibbits to a vacant seat on the Board of Directors.





On October 14, 2010, the Company extended the contract with Gary Coy of Biotech Financial, Inc. from September 4, 2010 to March 4, 2011. The cost for services was increased from $75 to $100 per hour payable in stock; and payable in cash in advance if the Company should fail to meet the requirements to trade on the OTCBB exchange.


9





On October 20, 2010, the Company hired a consultant for business development, management, investor and public relations services for 12 months and issued 100,000 stock options with $0.04 exercise price and 5 year term (fair value $3,224).





On October 31, 2010, the Company issued 117,949 shares of common stock to a consultant with 8,026 shares of common stock to be issued for services valued at $5,039.





On November 4, 2010 the Board of Directors and Plan Committee approved the issuance of 12,500,000 options ($47,879 fair value) with 30-day term and $0.04 exercise price to Dr. Stephen Chen, a director.  The exercise price was in excess of the closing stock price ($0.031) on the prior trading day, November 3, 2010.  On November 15, 2010, 3,250,000 options were exercised.  Net proceeds totaled $130,000.





On November 4, 2010 a consultant purchased 15,000 shares of common stock at $0.031 per share under a stock plan for officers, directors and consultants.  Net proceeds totaled $465.





On November 17, 2010, the Company issued 162,884 shares of stock, under a stock plan for officers, directors and consultants, to Dr. Joseph Cummins in payment of $11,402 of salary based on the closing stock price ($0.07) on the prior trading day, November 16, 2010.





The above preferred stock, common stock, option and warrant issuances do not trigger any reset provisions of previously issued securities.  The issuances with common stock and option strike prices below $0.10 per share of common stock that are issued to employees, directors or consultants pursuant to stock or option plans approved by a majority of the non-employee directors are exempt issuances.





On October 18, 2010 the Company entered into a License Supply Agreement with Zydus Cadila of Amedabad, India.  The Company will supply anhydrous crystalline maltose to Zydus Cadila for sale as an active ingredient in nutraceutical and healthcare products for human consumption to relieve dry mouth in India and Nepal.








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  human diseases. We have changed our focus from Orphan Diseases (small markets) to treatment of diseases with large markets to attract pharma partners.  Our


10


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 pharma partners to fund and help with the regulatory approval process in the US and Europe.  We believe that our technology and the large for these disease indications will attract global pharma partners.





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 five patents and two 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.





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 negligible side effects.





Governmental or FDA approval is required for our principal products.  Our progress toward approval is discussed under each specific indication, below.





Influenza/Cold - FDA Phase 2 Study


Dr. Manfred Beilharz, Chair of Microbiology and Immunology, Biomolecular and Chemical Sciences at the University of Western Australia recently reported results of a Phase 2 clinical trial in Perth, Australia that showed low-dose interferon lozenges provide an effective, safe and economical form of prophylaxis against colds and influenza.  Interferon lozenges were also shown in this study to enhance the effectiveness of seasonal influenza vaccine.  We think the implications of this study should help us in attracting a global pharma partner.





AMAR’s licensee in Taiwan, CytoPharm, Inc., will be funding a study of the Company’s interferon-alpha lozenges in the treatment of influenza. The study, which has been approved by the Taiwanese Department of Health, will start in January. Patients with confirmed influenza A infection will be assigned to 5 days of standard treatment with Tamiflu. In addition, half of the patients will take interferon lozenges and half will receive placebo. The aim of the study is to see if the combination of Tamiflu plus oral interferon is superior to Tamiflu alone in the treatment of influenza.





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


COPD affects approximately 10% of the 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.


11








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.  IPF is similar to COPD in that both diseases lead to a chronic cough in the majority of sufferers through inflammation of the airways. A proof-of-concept study of low-dose oral interferon as treatment of chronic cough is ongoing at Texas Tech University. The study will evaluate the ability of oral interferon to reduce the frequency and severity of chronic cough, compared to placebo.





Hepatitis C - FDA Phase 2 study ongoing


CytoPharm, Inc., our licensee for Taiwan and China, is funding an ongoing 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. Preliminary results are expected in the second half of 2011.





Oral Warts in HIV+ Patients – FDA Phase 2 study completed


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 about 1/3 of the treated subjects achieved a complete or nearly complete regression of their warts.





In a Phase 2 double-blind follow-up study, 31% of evaluable subjects in the IFN group had a 75% or greater reduction in their mouth warts (complete response), compared to only 17% of the subjects in the placebo group. None of the subjects in the placebo group had a 75% or greater reduction in their lip warts, but 39% of the evaluable subjects in the IFN group met this criterion for complete response. However, given the small number of subjects with lip warts and the failure of the study to achieve full enrollment, neither of these differences in favor of IFN over placebo was statistically significant. Oral IFN treatment was found to be safe in this study as there were no increases in adverse event frequency or severity, compared to placebo.





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 to 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 us advantages over competitive technologies in terms of cost, taste and ease of handling.  12


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.





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.


13





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.





Strategic Alliance with Intas Pharmaceuticals.


On January 7, 2010, we entered into a License and Supply agreement with Intas Pharmaceuticals Ltd., an India-based pharmaceutical company with three decades of experience in the healthcare industry and a global presence in 42 countries worldwide. Under the terms of the agreement, Intas will pay the Company a royalty on net sales in India and Nepal after marketing approval is obtained.





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®.





On October 18, 2010 the Company entered into a License Supply Agreement with Zydus Cadila of Amedabad, India.  The Company will supply anhydrous crystalline maltose to Zydus Cadila for sale as an active ingredient in nutraceutical and healthcare products for human consumption to relieve dry mouth in India and Nepal.





Equity Funding.In the first quarter of 2010, the Company sold 1,060,000 unregistered shares of common stock for $0.10 per share plus 1,060,000 3-year warrants with $0.10 exercise price.  Net proceeds from private placement stock sales totaled $103,000 after payment of $3,000 in commissions.  The Board extended incentives encouraging option and warrant holders to exercise options and warrants until January 22, 2010.   An officer and a consultant exercised 82,000 options at $0.10 per share to purchase 82,000 shares of unregistered common stock. The officer and consultant also exercised a total of 163,000 cashless options at $0.10 per share resulting in the issuance of 70,258 unregistered shares of common stock with 92,742 shares of common stock previously held in reserve for options returned to the Treasury.  The incremental fair value of the option exercise inducement was $4,456, which was recognized as an expense.  Net proceeds from the private placement stock sales and option exercises totaled $111,200 during the first quarter of 2010.  Two consultants were issued 135,814 registered shares and 10,000 unregistered shares of common stock for $18,080 and $1,050 of services, respectively.





In the second quarter of 2010, the Company sold 1,075,000 unregistered shares of common stock for $0.10 per share plus 1,075,000 3-year warrants with $0.10 exercise price.  Net proceeds from private placement stock sales totaled $99,000 after payment of $8,500 in commissions.  One consultant was issued 90,343 shares of common stock in exchange for $8,630 of services.





In the third quarter of 2010, the Company sold 2,000 unregistered shares of common stock for $0.10 per share plus 2,000 3-year warrants with $0.10 exercise price.  Net proceeds were $200.  The Company sold a total of 950 shares of Series 2010-A 10% Convertible Preferred Stock.  Net proceeds totaled $85,500 after $9,500 of brokerage commissions.  The preferred stock is convertible into 950,000 shares of restricted common stock.  One consultant was issued 79,856 shares of common stock in exchanges for $4,916 of services.





14


Results of Operations for Quarters Ended September 30, 2010 and 2009:





Revenues.  During the quarter ended September 30, 2010, $1,375 from dietary supplement sales compared to $36 of dietary supplement sales only for the quarter ended September 30, 2009, an increase of $1,339.  During the quarter ended September 30, 2010, no sublicense fee was generated compared to $48,000 sublicense fee the quarter ended September 30, 2009.





Research and Development Expenses. Research and development expenses of $102,268 were incurred for the quarter ended September 30, 2010, compared to $110,032 for the quarter ended September 30, 2009, a decrease of $7,764 (7%).  The decrease was because oral warts and influenza were mostly completed in 2009. The reduction was mostly $3,128 (4%) lower personnel costs, $2,598 (99%) lower influenza costs $1,416 (43%) lower insurance costs.





Selling, General and Administrative Expenses.  Selling, general and administrative expenses of $193,538 were incurred for the third quarter in 2010, compared to $235,484 for the third quarter of 2009, a decrease of $41,946 (18%).  Most of this decrease was from lower employee and director compensation costs in the third quarter of 2010.





Change in Fair Value of Derivative Instruments.  Change in fair value of derivative instruments was realized as a $148,555 gain in the third quarter of 2010 compared to $744,913 loss in the third quarter of 2009.   Derivative liabilities decreased $2,492,597 from September 30, 2009 to September 30, 2010 mostly because our stock price declined from $0.26 on September 30, 2009 to $0.045 on September 30, 2010.





Other Income.  During the three-month periods ended September 30, 2010 and 2009, no interest and other income was generated.





Net Operating Loss.  In the three-month period ended September 30, 2010, the Company's net operating loss was $295,031compared to a net operating loss for the three-month period ended September 30, 2009 of $321,510, a $26,479 (8%) reduction.  The operating loss was lower mostly because compensation costs for employees and directors were lower in the first three months of 2010.





Net Loss.  In the three-month period ended September 30, 2010, net loss was $170,649 compared to a net loss for the three-month period ended September 30, 2009 of $1,090,120, a decrease in net loss of $919,471 (84%).  This reduction was mostly the $893,468 (120%) difference in derivative gains in the third quarter of 2010 and derivative losses in the third quarter of 2009.





Results of Operations for the Nine Months Ended September 30, 2010 and September 30, 2009





Revenues.  During the nine months ended September 30, 2010, $4,495 from dietary supplement and ACM sales were generated compared to $264 of dietary supplement sales only for the nine months ended September 30, 2009, an increase of $4,231.  During the nine months ended September 30, 2010, no sublicense fee was generated compared to $48,795 sublicense fees the nine months ended September 30, 2009.





Research and Development Expenses. Research and development expenses of $301,386 were incurred for the nine month period ended September 30, 2010, compared to $389,969 for the nine  month period ended September 30, 2009, a decrease of $88,583 (23%).  Research and development costs were lower the first nine months of 2010 because oral warts in HIV+ patients





15





and influenza studies were mostly completed in 2009. Personnel costs were $45,150 (16%) lower, insurance costs $10,958 (111%) lower, influenza costs $41,873 (92%) lower and oral warts costs $14,358 (47%) lower in the first 9 months of 2010.





Selling, General and Administrative Expenses. Selling, general and administrative expenses of $506,105 were incurred for the nine-month period ended September 30, 2010, compared to $917,572 for the nine-month period ended September 30, 2009, a decrease of $411,467 (45%).  General and administrative expenses were lower in the nine months ended September 30, 2010 mostly because compensation costs for employees and directors were $385,954 (57%) lower than in the first nine months of 2009.





Change in Fair Value of Derivative Instruments.  Change in fair value of derivative instruments was realized as a $996,345 gain for the nine-month period ended September 30, 2010 compared to $2,736,649 loss in the nine-month period ended September 30, 2009.   Derivative liabilities decreased $2,492,591 (73%) from September 30, 2009 to September 30, 2010 mostly because our stock price declined from $0.26 on September 30, 2009 to $0.045 on September 30, 2010.





Interest and Other Income.   During the nine-month period ended September 30, 2010, $140 of interest and other income was generated compared to $3,391 in the nine-month period ended September 30, 2009, a decrease of $3,251(96%).  Interest and other income was higher during the first nine months of 2009 mostly because the Company sold some office furniture.





Net Operating Loss.  In the nine-month period ended September 30, 2010, the Company's net operating loss was $805,691 compared to a net operating loss for the nine-month period ended September 30, 2009 of $1,282,964 a $477,273 (37%) reduction.  The operating loss was lower mostly because general and administrative costs were $411,467 (45%) lower and research and development costs were $88,583 (23%) lower in the first nine months of 2010.





Net Income (Loss).  In the nine-month period ended September 30, 2010, net income was $120,277 compared to a net loss for the nine-month period ended September 30, 2009 of $4,085,628, a decrease in net loss of $4,205,905 (127%).  The increase was mostly the $3,732,994 difference in derivative gains in the first nine months of 2010 and derivative losses in the first nine months of 2009.  The $411,467 (45%) reduction in general and administrative costs during the first nine months of 2010 compared to the first nine months of 2009 also contributed to the difference.





Liquidity Needs:  On September 30, 2010, the Company had available $1,399 cash and had a working capital deficit (current assets less current liabilities) of $4,227,500.  Current liabilities include two $1 million notes, $728,609 of accrued interest and $78,360 of accrued expenses owed to Hayashibara Biochemical Laboratories, Inc. (HBL), the Company’s second largest shareholder.   Accrued payroll and vacation expenses owed mostly to officers is $301,782.  Non cash derivative liabilities from warrants with embedded variable features valued at $931,775 are also included in the working capital deficit.  Derivative liabilities are based on Black-Scholes fair value calculations each quarter.  That leaves approximately $186,974 of accounts payables and accrued expenses in the working capital deficit.





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 $61,000 per month (excluding approximately $3,600 per month of consultant fees paid in stock).  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 factor including, but not limited to, the Company's ability to generate sufficient cash flows to meet its


16


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 2010 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-Qand 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.





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


17


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 $4,227,500.  The working capital deficit includes two $1 million notes, $728,609 of accrued interest and $78,360 of accrued expenses owed to our second largest shareholder (HBL); $301,782 of accrued payroll and vacation expenses owed mostly to officers; and $931,775 of non-cash derivative liabilities for warrants with embedded derivatives. The remaining working capital deficit of approximately $186,974 consists of accounts payable and accrued expenses.





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, Bernard Cohen, 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.


18





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, and Berlex. High dose injectable interferon has been widely accepted by the medical community for many years.  Companies who manufacture injectable interferon alpha applications are more established than we are and have far greater financial, technical, research and development, sales and marketing, administrative and other resources than we do.  Even if we successfully complete the development of our tests, we may not be able to compete effectively with these much larger companies and their more established products.





We 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 Accounting firm has added an explanatory paragraph to their audit reports issued in connection with our financial statements for December 31, 2009 and 2008 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 a net income of $120,277 for the nine months ended September 30, 2010 and a net loss of $4,085,628 for the nine months ended September 30, 2009.  The operating loss for the nine months ended September 30, 2010 was $805,691 but was offset by a non-cash accounting gain of $996,345 from the change in fair value of derivative instruments.  In addition, as of September 30, 2010 we had an accumulated deficit of $35,199,890.  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 12,477,999 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 September 30,


19


2010, we had 54,646,272 shares of common stock issued and outstanding plus 25,994,096 shares reserved for convertible preferred stock, 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.





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.  Approximately 2,302,000 restricted shares were issued during the nine months ended September 30, 2010 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 number of shares of restricted stock issued prior to September 1, 2009 that has been held for at least six months and hasn’t had the legends removed to become freely tradable under Rule 144 or 144(k) is not known.


20





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 September 30, 2010. 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 period ended September 30, 2010.





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 2010, the Company sold 1,060,000 unregistered shares of common stock for $0.10 per share plus 1,060,000 3-year warrants with $0.10 exercise price.  Net proceeds from private placement stock sales totaled $103,000 after payment of $3,000 in commissions.  The Board extended incentives encouraging option and warrant holders to exercise options and warrants until January 22, 2010.   An officer and a consultant exercised 82,000 options at $0.10 per share to purchase 82,000 shares of unregistered common stock. The officer and consultant also exercised a total of 163,000 cashless options at $0.10 per share resulting in the issuance of 70,258 unregistered shares of common stock with 92,742


21


shares of common stock previously held in reserve for options returned to the Treasury.  The incremental fair value of the option exercise inducement was $4,456, which was recognized as an expense.  Net proceeds from the private placement stock sales and option exercises totaled $111,200 during the first quarter of 2010.  One consultant was issued 10,000 unregistered shares of common stock for services valued at $1,050.





In the second quarter of 2010, the Company sold 1,075,000 unregistered shares of common stock for $0.10 per share plus 1,075,000 3-year warrants with $0.10 exercise price.  Net proceeds from private placement stock sales totaled $99,000 after payment of $8,500 in commissions.





In the third quarter of 2010, the Company sold 2,000 unregistered shares of common stock for $0.10 per share plus 2,000 3-year warrants with $0.10 exercise price.  Net proceeds were $200.  The Company sold a total of 950 shares of Series 2010-A 10% Convertible Preferred Stock.  Net proceeds totaled $85,500 after $9,500 of brokerage commissions.  The preferred stock is convertible into 950,000 shares of restricted common stock.  One consultant was issued 79,856 shares of common stock in exchanges for $4,916 of services.





The chart below details unregistered issuances of common stock.


Date (2010)
Shares of Common Stock
Purchaser
Discount1Issue Price
Number
Per Share
Total1
January 72
$
.10
100,000
Dan Mascarenhas
$
0.08
$
8,0002
January 113

.10
30,000
Dr. Joseph Cummins

0.071

2,1303
January 114

.175
25,714
Dr. Joseph Cummins

0

04
January 185

.10
500,000
Thomas Ulie

.07

35,0005
January 196

.10
10,000
Dr. Kimball Miller

.0763

7,6306
January 227

.10
52,000
Dr. Gary Coy

.07

3,6407
January 228

.1762
44,544
Dr. Gary Coy

0

08
February 99

.10
50,000
David Min

.0329

1,6459
March 1210

.10
150,000
Marian Tibbits

.005

75010
March 1210

.10
150,000
Paul Tibbits

.005

75011
March 12

.105
10,000
George Bergleitner, Jr.

0

012
March 2911

.10
50,000
Robert Costes

.025

1,25013
March 2911

.10
50,000
Joanna Costes

.025

1,25014
April 1512

.10
100,000
Marian Tibbits

.02

2,00015
April 1512

.10
100,000
Paul Tibbits

.02

2,00016
April 2613

.10
25,000
David Minn

.0198

49517
May 714

.10
150,000
Marian Tibbits

.0089

1,33518
May 714

.10
150,000
Paul Tibbits

.0089

1,33519
June 415

.10
350,000
Paul Tibbits

0

020
June 2916

.10
200,000
Virginia Sumner, Trustee

0

021
July 1517

.10
2,000
Stephen H. Gens

0

0





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




22


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 7, 2010 was $0.18 per share.




3.
Options were exercised for cash.  The stock closing price on January 11, 2010 was $0.1701 per share.




4.
A total of 60,000 cashless options were exercised at $0.10 per share.  25,714 shares of common stock were issued and 34,286 shares of common stock held in reserve for options were returned to Treasury.  The stock closing price on January 11, 2010 was $.1701 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 Friday, January 15, 2010 was $0.17 per share.  No shares traded on January 18, 2010.




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 January 19, 2010 was $0.1763 per share.




7.
Options were exercised for cash.  The stock closing price on January 22, 2010 was $0.17 per share.




8.
103,000 cashless options were exercised at $0.10 per share.  44,544 shares of common stock were issued and 58,456 shares of common stock held in reserve for options were returned to Treasury. The stock closing price on January 22, 2010 was $0.17 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 February 9, 2010 was $0.1329 per share.




10.
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 6, 2010 was $0.105 per share.




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 March 29, 2010 was $0.125 per share.




12.
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 15, 2010 was $0.12 per share.




13.
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 26, 2010 was $0.1198 per share.




14.
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 7, 2010 was $0.1089 per share.




15.
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 June 4, 2010 was $0.076 per share.




16.
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 June 29, 2010 was $0.08 per share.


23


17.
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 July 15, 2010 was $0.07 per share.




Date (2010)
Shares of Convertible Preferred Stock*
Purchaser
DiscountIssue Price
Number
Per Share
Total1
July 22
$                            100
300
Paul Tibbits
$                            .00
02
August 11
100
350
Paul Tibbits
.00
03
August 31
100
100
Paul Tibbits
.00
04
September15
100
200
Paul Tibbits
.00
0





*    Each preferred share is convertible into 1,000 common shares ($100 stated value per share divided by $0.10).  Dividends are payable quarterly at 10% per annum in cash or stock at the option of the preferred stock Holder.  Stock dividend payments are valued at the higher of $0.10 per share of common stock or the average of the two highest volume weighted average closing prices for the 5 consecutive trading days ending on the trading day that is immediately prior to the dividend payment date.  The stock closing price was $0.07, $0.053, $0.05 and $0.055 per share on July 22, August 11, August 31 and September 15, 2010, respectively.




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





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: November 19, 2010
By:/s/ Joseph M. Cummins


Joseph M. Cummins


President and Chief Executive Officer














Date: November 19, 2010
By:/s/ Bernard Cohen


Bernard Cohen


Vice President and Chief Financial Officer




24