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 March 31, 2011





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 May 17, 2011 there were 61,209,446 shares of the issuer's common stock and 1,700 shares of the issuer’s preferred stock outstanding.





1


AMARILLO BIOSCIENCES, INC.





INDEX




PAGE NO.PART I:
FINANCIAL INFORMATIONITEM 1.
Financial StatementsBalance Sheets– March 31, 2011  (unaudited) and December 31, 2010
3Statements of Operations – Three Months Ended March 31, 2011 and 2010 (unaudited)
4Condensed Statements of Cash Flows – Three Months Ended March 31, 2011 and 2010 (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
21ITEM 4.
Submission of Matters to a Vote of Security Holders
21ITEM 5.
Other Information
21ITEM 6.
Exhibits.....................................................................
21Signatures

22





2


PART I - FINANCIAL INFORMATION





ITEM 1.
Financial Statements





Amarillo Biosciences, Inc.


Balance Sheets


March 31,

2011


December 31,

2010Assets

(unaudited)Current assets:Cash and cash equivalents

$
1,539


$
4,332Prepaid expense and other current assets


138,608



135,634Total current assets


140,147



139,966Property, equipment and software, net


705



1,349Patents, net


115,413



118,038Total assets

$
256,265


$
259,353Liabilities and Stockholders' DeficitCurrent liabilities:Accounts payable and accrued expenses

$
692,678


$
539,955Accrued interest - related parties


773,912



751,294Accrued expenses – related party


78,360



78,360Derivative liabilities


60,394



59,784Notes payable - related parties


2,220,000



2,200,000Total current liabilities


3,825,344



3,629,393Total liabilities


3,825,344



3,629,393Commitments and contingenciesStockholders' deficitPreferred stock, $0.01 par value:Authorized shares - 10,000,000Issued and outstanding shares –  1,700 at

March 31, 2011 and 1,500 at December 31, 2010


17



15Common stock, $0.01par value:Authorized shares - 100,000,000Issued and outstanding shares – 61,209,446 at March 31, 2011 and 61,147,224 at December 31, 2010


612,094



611,472Additional paid-in capital


30,860,096



30,835,300Accumulated deficit


(35,041,286
)


(34,816,827
)Total stockholders' deficit


(3,569,079
)


(3,370,040
)Total liabilities and stockholders’ deficit

$
256,265


$
259,353





See accompanying notes to financial statements.


3


Amarillo Biosciences, Inc.


Statements of Operations


(Unaudited)





Three months ended

March 31,2011


2010Revenues:Product sales

$
2,720


$
96Total revenues


2,720



96Cost of revenues:Product sales


1,431



57Total cost of revenues


1,431



57Gross margin


1,289



39Operating expenses:Research and development expenses


86,945



101,288Selling, general and administrative expenses


111,224



175,162Total operating expenses


198,169



276,450Operating loss


(196,880
)


(276,411
)Other income (expense):Change in fair value of derivatives


(610
)


63,733Interest expense


(23,063
)


(22,769
)Interest and other income


300



-Net loss


(220,253
)


(235,447
)Preferred stock dividend


(4,206
)


-Net income (loss) applicable to common shareholders

$
(224,459
)

$
(235,447
)Basic and diluted net loss per average share available to common shareholders

$
(0.00
)

$
(0.00
)Weighted average common shares outstanding – basic and diluted


61,172,113



52,795,517





See accompanying notes to financial statements.


4


Amarillo Biosciences, Inc.


Condensed Statements of Cash Flows


(Unaudited)





Three months ended March 31,2011

2010Net cash used in operating activities
$
(39,615
)

$
( 118,579
)Cash from investing activities:Patent expenditures

(1,178
)


( 4,871
)Net cash used in investing activities

(1,178
)


( 4,871
)Cash from financing activities:Proceeds from issuance of note payable related party

20,000



-Proceeds from exercise of options

-



8,200Proceeds from sale of convertible preferred stock

18,000



-Proceeds from sale of common stock

-



103,000Net cash provided by financing activities

38,000



111,200Net change in cash

(2,793
)


(12,250
)Cash and cash equivalents at beginning of period

4,332



24,216Cash and cash equivalents at end of period
$
1,539


$
11,966Supplemental disclosure of cash flow informationCash paid for interest
$
513


$
577Cash 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, 2010 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 three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2011.





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 March 31, 2011, a total of 76,153,542 shares of common stock were either outstanding (61,209,446) or reserved for issuance upon exercise of options and warrants or conversion of convertible preferred stock (14,944,096).  Common stock issuances in the first quarter of 2011 are as follows:





Common Stock Issued in Q1 2011

Shares


Issue Price


Net PriceDirectors, officers, consultants plan – services


62,222


$
0.09


$
5,600Total Common Stock Issued in Q1 2011


62,222


$
0.09


$
5,600





No brokerage commissions were paid for the sale of common stock during the first quarter of 2011.


6





4.
Common Stock Options and Warrants.  The Board granted 100,000 options with a 2-year term and $0.075 exercise price to a consultant on March 8, 2011 with a fair value of $7,280.  One quarter of the options (fair value $1,820) vest each quarter during 2011.





The binomial Black-Scholes pricing model was used to calculate the fair value of the derivative liability arising from warrants with embedded features on March 31, 2011.  The probability of private placement issuances triggering a reset at the estimated stock price of $0.045 per share was estimated as 75% as of March 31, 2011. Triggering the reset provision is in the Company’s control.





The Black-Scholes option-pricing model was utilized with the following assumptions: dividend yield 0.0%, expected volatility 180.79%, risk free interest rate 0.80%, and expected life of approximately 1.775 years.  The valuation for the remaining 447,999 warrants outstanding was $60,394 on March 31, 2011.  The derivative loss for the first three months of 2011 was $610.





5.
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 first quarter of 2011, a total of 200 shares of Series 2010-A 10% Convertible Preferred Stock were issued.  Net proceeds totaled $18,000 after $2,000 of brokerage commissions.  The preferred stock is convertible into 200,000 shares of restricted common stock.





The Company accrued $4,206 of dividends on preferred stock during the quarter.





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





In 2010, the Company entered into a verbal agreement with Paul Tibbits, a Director, to purchase 12,000,000 warrants held by him for $200,000. On January 10, 2011 a promissory note for the $200,000 was executed, includes interest at 0.43% per annum, with no stated maturity date, and no collateral.





On March 9, 2011, the Company entered into a promissory agreement with Paul Tibbits, a Director, for $20,000. A note was executed and includes interest at 0.54% per annum, the note is due upon demand, or if no demand is made, on September 11, 2011.





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 March 31, 2011 of $18,498 which is included in accounts payable.


7





8.
License and Sublicense Agreements.  During the first quarter of 2011 no license fees were received.





9.
Related Party Transactions.  The Company engaged the law firm of Underwood, Wilson, Berry, Stein and Johnson P.C. of which Mr. Morris was a shareholder through March 15, 2011.  Mr. Morris also was, and continues to be, the Secretary of the Company.  During the three months ended March 31, 2011 the Company incurred approximately $17,625 of legal fees to said law firm.





10.
Subsequent Events.





On April 6, 2011, a note was executed for $40,000 owed to a Director, with 0.54% interest rate and no collateral. The note is payable on demand or in six months, whichever comes first.





On April 15, 2011, the Company entered into a convertible debt agreement with Asher Enterprises, Inc. and Hope Capital, Inc.  The note was in the amount of $63,000 at an annual interest rate of 14% on a 365-day basis with a maturity date of April 14, 2012.  All or any part of the outstanding and unpaid principal of the note, along with any accrued and unpaid interest (at the option of the Borrower); can be converted into the Company’s common stock at any time during the term of the note.  The conversion price is either variable or fixed depending on the time of the conversion.  If the conversion takes place on or before the 240th day after effective date of the note, the conversion price will be the greater of the Variable Conversion Price and the Fixed Conversion Price.  If the conversion takes place after the 240th day after the effective date of the note, the conversion price will be the lesser of the Variable Conversion Price and the Fixed Conversion Price.  The Variable Conversion Price is 55% multiplied by the market price (a 45% discount from market price).  The market price is the average of the three lowest trading prices during the ten-day trading period ending on the latest complete trading day prior to the conversion date.  The Fixed Conversion Price is $0.04 per share of common 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 later this year or early next year.


8








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 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 main 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 safe and effective against viral and autoimmune diseases. Oral interferon is given in concentrations 10,000 times less than that usually given by injection. The Company’s low dose formulation results in almost no side effects; high dose injectable interferon causes adverse effects in at least 50% of recipients.





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





Influenza


Influenza, commonly referred to as the flu, is an infectious disease caused by RNA viruses of the family Orthomyxoviridae that affects birds and mammals. The most common symptoms of the disease are chills, fever, sore throat, muscle pains, severe headache, coughing, weakness/fatigue and general discomfort. Influenza spreads around the world in seasonal epidemics, resulting in the deaths of between 250,000 and 500,000 people every year, up to millions in some pandemic years. On average 41,400 people died each year in the United States between 1979 and 2001 from influenza. Two publications in the April 2009 issue of the Journal of Virology report that interferon placed in the nose of guinea pigs or ferrets significantly suppresses replication of influenza virus.  These publications reinforce the Company’s view that low-dose interferon is protective against influenza.





Further support of the efficacy of oral interferon against influenza was generated by The University of Western Australia in a Phase 2 clinical trial with 200 healthy volunteers during the 2009 winter cold/flu season in Australia. The study found that volunteers who took oral interferon had less severe cold/flu symptoms, compared to volunteers who received placebo. Publication of these results is pending.





In January 2011, CytoPharm, Inc., ABI’s licensee for Taiwan and China, launched an influenza treatment study in Taiwan. Up to 60 patients being treated with Tamiflu for influenza A infection of less than 48 hours duration may be randomly assigned to co-treatment with oral IFN or placebo. The aim of the study is to examine whether the combination of oral IFN and Tamiflu is superior to Taimflu alone in the treatment of influenza illness.


9





Chronic Cough in COPD


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.





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.  A proof-of-concept study of low-dose oral interferon as treatment of chronic cough is ongoing at Texas Tech University. This  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.





Hepatitis C


ABI’s licensee CytoPharm, Inc. is funding an ongoing Phase 2 study of oral interferon treatment of hepatitis C virus-infected patients in Taiwan.  The study is exploring the ability of oral interferon to reduce virologic relapse in patients who have completed standard therapy with pegylated interferon plus Ribavirin.  Up to 50% of patients with certain genotypes of HCV relapse after receiving standard therapy, so reducing this relapse rate will represent a major breakthrough in the management of HCV.Completion of the study is expected by the end of 2011 with final results to be available in early 2012. Enrollment was completed in 2010 with 167 subjects.





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. 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


10


January 17, 1996; May 10, 1996; and September 7, 2001.  The current expiration date of the Development Agreement is March 12, 2014, 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.





HBL is part of the Hayashibara Group of companies, which announced on February 2, 2011 on its website in Japan that it had filed a petition for corporate reorganization with the Tokyo District Court. In a letter to customers dated February 2, 2011, Mr. Hideki Matsushima, who has been appointed by the Tokyo District Court to be the provisional administrator of HBL, made the following statement, “We believe that we will be able to ensure a stable supply of our products, since we have been permitted by the Tokyo District Court to pay our debts to our suppliers related to the purchase of raw materials for our products, on the condition that our suppliers will continue to do business with us under the pre-existing payment terms and conditions.” Based on this statement from Mr. Matsushima, ABI does not expect any disruption in the supply of interferon or ACM from HBL.





Strategic Alliance with Nobel.


A licensing and supply agreement was executed 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, a license and distribution agreement was executed 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 bulk natural human IFN (supplied by Hayashibara Biochemical Laboratories); package the lozenges and distribute them to local hospitals, pharmacies and clinics in Malaysia. Pursuant to the agreement, the Company will receive a series of payments, in three stages: upon formal execution of the distribution agreement, upon regulatory approval, and upon production. The Company will also receive a royalty on the sale of the natural human IFN.





Strategic Alliance with CytoPharm.


In November 2006, the Company 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 is a 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 the Company upon reaching certain milestones and will also pay royalties on low dose oral interferon sales in the Territory.





In March 2008, the Company 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 regulatory approvals in China and Taiwan (the “Territory”) to launch  11


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 Intas Pharmaceuticals.


On January 7, 2010, the Company 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.





Strategic Alliance with Cadila Healthcare


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





Strategic Alliance with Oasis Diagnostics


On January 12, 2011, the Company entered into a License and Supply Agreement with Oasis Diagnostics of Vancouver, WA.  The Company will supply ACM to Oasis for sale as an active ingredient in nutraceutical and healthcare products for human consumption to relieve dry mouth in China, Taiwan and the Americas.





Equity Funding.In the first quarter of 2011, the Company sold 200 unregistered shares of preferred stock for $100 per share, convertible to common stock with a $0.10 conversion price.  Net proceeds from the stock sale were $18,000 after payment of $2,000 in commissions.





Results of Operations for Quarters Ended March 31, 2011 and 2010:





Revenues.  During the quarter ended March 31, 2011, $1,320 from dietary supplement sales was generated compared to $96 for the quarter ended March 31, 2010, an increase of $1,224 (1275%).  During the quarter ended March 31, 2011, $1,400 of ACM sales was generated compared to no ACM sales for the quarter ended March 31, 2010, an increase of $1,400 (100%).





Research and Development Expenses. Research and development expenses of $86,945 were incurred for the quarter ended March 31, 2011, compared to $101,288 for the quarter ended March 31, 2010, a decrease of $14,343 (14%).  The decrease was mostly because oral warts, influenza and hepatitis C costs and personnel costs were lower in the first quarter of 2011.   The oral warts in HIV+ patients and influenza studies were mostly completed in 2009.





Selling, General and Administrative Expenses.  Selling, general and administrative expenses of $111,224 were incurred for the first quarter in 2011, compared to $175,162 for the first quarter of 2010, a decrease of $63,938 (37%).  Most of this decrease was due to lower salaries, Black-Scholes option expense, PR/IR, insurance and stock grants than in the first quarter of 2011.


12





Change in Fair Value of Derivative Instruments.  Change in fair value of derivative instruments was realized as a $610 loss in the first quarter of 2011 compared to $63,733 gain in the first quarter of 2010.   Derivative liabilities increased $610 from December 31, 2010 to March 31, 2011.





Other Income.  During the three-month period ended March 31, 2011, $300 interest and other income was generated compared to no interest and other income for the three-month period ended March 31, 2010.





Net Operating Loss.  In the three-month period ended March 31, 2011, the Company's net operating loss was $196,880 compared to a net operating loss for the three-month period ended March 31, 2010 of $276,411, a $79,531 (29%) reduction.  The operating loss was lower mostly because the $63,938 (37%) reduction in Selling, General and Administrative expenses.





Net Loss. In the three-month period ended March 31, 2011, the Company's net loss was $220,253 compared to a net loss for the three-month period ended March 31, 2010 of $235,447 a $15,194 (6%) reduction.  The operating loss was lower mostly because of the derivative liabilities decrease, due to a return of 12,000,000 warrants to the Company in December 2010.





Liquidity Needs:  On March 31, 2011, the Company had available $1,539 cash and had a working capital deficit (current assets less current liabilities) of $3,685,197.  Current liabilities include two $1 million notes, $773,486 of accrued interest and $78,360 of accrued expenses owed to Hayashibara Biochemical Laboratories, Inc. (HBL), and $220,000 of notes, and $426 of accrued interest owed to Paul Tibbits. Accrued payroll and vacation expenses owed mostly to officers is $385,021.  Derivative liabilities from warrants with embedded variable features valued at $60,394 are also included in the working capital deficit.  That leaves approximately $307,657 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 patent filings, the Company’s cash burn rate is approximately $66,000 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 2011 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.


13


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.





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  14


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 dependent 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 approximately $3,685,197.  The working capital deficit includes two $1 million notes, $773,486 of accrued interest and $78,360 of accrued expenses owed to our shareholder (HBL); $220,000 of notes, and $426 of accrued interest owed to our director and shareholder Paul Tibbits; $385,021 of accrued payroll and vacation expenses owed mostly to officers; and $60,394 of non-cash derivative liabilities for warrants with embedded derivatives. The remaining working capital deficit of approximately $307,657 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.





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.


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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.





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 added an explanatory paragraph to their audit reports issued in connection with our financial statements for December 31, 2010 and 2009 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 incurred a net loss of $220,253 for the three months ended March 31, 2011 and a net loss of $235,447 for the three months ended March 31, 2010.  The operating loss for the three months ended March 31, 2011 was $196,880.  In addition, as of March 31, 2011 we had an accumulated deficit of $35,041,286. 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 447,999 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 at less than the $0.10 per share.As of March 31, 2011, we had 61,209,446 shares of common stock issued and outstanding plus 14,944,096 shares reserved for options and warrants or conversion of convertible preferred stock 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:


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·
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 6,500,000 of our restricted shares were issued during the six months ended March 31, 2011 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, 2010 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.





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 March 31, 2011. This


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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 first quarter of 2011.





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 2011, the Company sold 200 unregistered shares of preferred stock for $100 per share, convertible to common stock with a $0.10 conversion price.  Net proceeds from the stock sale were $18,000 after payment of $2,000 in commissions.





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





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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: May 19, 2011
By:/s/ Joseph M. Cummins


Joseph M. Cummins


President and Chief Executive Officer











Date: May 19, 2011
By:/s/ Bernard Cohen


Bernard Cohen


Vice President and Chief Financial Officer




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