Note 9 - Stock Options and Warrants

12 Months Ended

Dec. 31, 2012

9. Stock Options and Warrants

Stock Options:

During 2012, no options were issued to consultants. During 2011, 100,000 options were issued to consultants, and we recognized $7,280 of expense related to these options and 2,231,792 existing options for employees were cancelled and reissued changing the exercise price and expiration date, we recognized $29,766 of expense related to these options.

Directors, officers and consultants exercised no options in 2011 or 2012.

Stock option activity for the years ended December 31, 2011 and December 31, 2012 are summarized as follows:

	Shares			Weighted Average Exercise Price			Weighted Average Remaining Contractual Life (in Years)		Grant Date Fair Value
Outstanding at December 31, 2010		4,686,737		$	0.26			2.67	$	920,188
Options granted		2,331,792			0.05			4.87		114,800
Options exercised		-			-			-		-
Options cancelled/expired		(3,376,737	)		(0.32	)		-		(796,138	)
Outstanding at December 31, 2011		3,641,792		$	0.07			3.84	$	238,850

Vested at December 31, 2011		3,641,792		$	0.07			3.84	$	238,850

Exercisable at December 31, 2011		3,641,792		$	0.07			3.84	$	238,850

Outstanding at December 31, 2011		3,641,792		$	0.07			3.84	$	238,850
Options granted		-			-			-		-
Options exercised		-			-			-		-
Options cancelled/expired		(1,789,000	)		(0.08	)		-		(134,167	)
Outstanding at December 31, 2012		1,852,792		$	0.06			3.24	$	104,683

Vested at December 31, 2012		1,852,792		$	0.06			3.24	$	104,683

Exercisable at December 31, 2012		1,852,792		$	0.06			3.24	$	104,683

Options reserved for the director, employee and consultant stock option plan but not issued (16,950,000) are not included in the table above. This stock may be utilized for other purposes if not used for the plans.

Stock warrants:

During 2011, 3,332,831 warrants were issued together with private placement sales of 2,666,667 shares of stock. On November 5, 2011, Amarillo Biosciences, Inc. sold 2,666,667 private placement shares at $0.03 per share along with 1,000,000 warrants exercisable at $0.03 per share. The relative fair value of the 1,000,000 warrants was estimated to be $22,826 using the Black-Scholes option pricing model based on the following assumptions: estimated dividend yield 0%, expected volatility 197%, risk free interest rate 0.25%, and expected life of 3 years. The Base Share Price for this dilutive issuance was $0.03 per share.

On February 6, 2012, 724,487 warrants were issued as a result of having issued 693,069 shares for debt to Hope Capital at $0.0202 per share The Base Share Price for this dilutive issuance was $0.0202 per share. ABI sent a Dilutive Issuance Notice to Warrant Strategies, Inc. on February 6, 2012. The notice was sent pursuant to the Series A Common Stock Purchase Warrant dated June 16, 2009, Section 3(b), “…the Exercise Price shall be reduced to equal the Base Share Price and the number of Warrant Shares issuable hereunder shall be increased such that the aggregate Exercise price issuable hereunder, after taking into account the decrease in the Exercise Price, shall be equal to the aggregate Exercise Price prior to such adjustment.”

ABI issued a new Purchase Warrant dated February 6, 2012 reflecting the new Warrant Share amount of 2,217,817 shares (724,487 additional warrants plus the 1,493,330 existing warrants) and an adjusted Exercise Price of $0.0202 per share. The new warrant was sent to Warrant Strategies, Inc. and return of the old warrant was requested.

No warrants were exercised in 2012 or 2011.

A summary of the Company's stock warrant activity and related information for the years ended December 31, 2011 and December 31, 2012 is as follows:

	2012								2011
	Warrants			Price Range					Warrants			Price Range
Outstanding Beg. of Year		8,730,190		$	0.03	-	0.10			8,457,359		$	0.10	-	0.20
Granted		724,487					0.0202			3,332,831			0.03	-	0.04
Cancelled/Expired		(2,812,360	)				(0.10	)		(3,060,000	)				(0.20	)
Exercised		-					-			-					-
Outstanding End of Year		6,642,317		$	0.0202	-	0.10			8,730,190		$	0.03	-	0.10
Exercisable End of Year		6,642,317		$	0.0202	-	0.10			8,730,190		$	0.03	-	0.10

The weighted-average remaining contractual life of the warrants outstanding at December 31, 2012 is 0.77 years.

Derivative Liabilities:

In 2008, the Company sold preferred stock with attached warrants. As of December 31, 2009, there were 12,447,999 of these warrants outstanding. These warrants contain an anti-dilution ratchet provision. The Company is at risk of triggering the warrant anti-dilution provisions in the future if stock is sold below $0.10 per share to any non-exempt parties. Holders of options and warrants 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 2010, a Director of the Company purchased 12,000,000 of these warrants from the holder, along with their outstanding shares of stock in the Company, for $200,000. In December 2010, the Company agreed to buy the 12,000,000 warrants from the Director for $200,000. A verbal agreement was reached for the purchase price, with interest at 0.43% per annum in December 2010, which was formally executed as a promissory note in January 2011.The warrants were retired due to the purchase by the Company. As of December 31, 2010, 447,999 of the warrants with the anti-dilution provision remained outstanding.

On November 5, 2011, Amarillo Biosciences, Inc. sold 2,666,667 private placement shares at $0.03 per share along with 1,000,000 warrants exercisable at $0.03 per share. The Base Share Price for this dilutive issuance was $0.03 per share. ABI sent a Dilutive Issuance Notice to Warrant Strategies, Inc. on November 7, 2011. The notice was sent pursuant to the Series A Common Stock Purchase Warrant dated June 16, 2009, Section 3(b), “…the Exercise Price shall be reduced to equal the Base Share Price and the number of Warrant Shares issuable hereunder shall be increased such that the aggregate Exercise price issuable hereunder, after taking into account the decrease in the Exercise Price, shall be equal to the aggregate Exercise Price prior to such adjustment.” ABI issued a new Purchase Warrant dated November 7, 2011 reflecting the new Warrant Share amount of 1,493,330 shares (447,999 original warrants plus the additional 1,045,331 warrants) and an adjusted Exercise Price of $0.03 per share. The new warrant was sent to Warrant Strategies, Inc. and return of the old warrant was requested.

On February 6, 2012, Amarillo Biosciences, Inc. issued 724,487 warrants as a result of having issued 693,069 shares for debt to Hope Capital at $0.0202 per share The Base Share Price for this dilutive issuance was $0.0202 per share. ABI sent a Dilutive Issuance Notice to Warrant Strategies, Inc. on February 6, 2012. The notice was sent pursuant to the Series A Common Stock Purchase Warrant dated June 16, 2009, Section 3(b), “…the Exercise Price shall be reduced to equal the Base Share Price and the number of Warrant Shares issuable hereunder shall be increased such that the aggregate Exercise price issuable hereunder, after taking into account the decrease in the Exercise Price, shall be equal to the aggregate Exercise Price prior to such adjustment.”

During 2010, 2,137,000 warrants were issued together with private placement sales of 2,137,000 shares of stock. The total purchase price for private placement stock and warrants was recognized as the cost to purchase the stock. During 2011, 3,332,831 warrants were issued together with private placement sales of 2,666,667 shares of stock, with convertible debt agreements, and dilutive issuance issued to Warrant Strategies. During 2012, there were no private placement sales of common stock and no warrants issued.

The anti-dilution provision was determined by management to be an embedded derivative, and was recognized as a liability in accordance with ASC 815 as of January 1, 2009. The Company measures the fair value of the liability at the end of each reporting period, with changes in value recorded as part of other income or expense.

The fair value of warrants with embedded derivative feature was estimated at December 31, 2012 with the binomial Black-Scholes option-pricing model using the following assumptions: probability of anti-dilution ratchet of 75%; a probable reset share price of $0.0155; dividend yield 0.0%; expected volatility of 234.76%, risk-free interest rate of 0.14% and expected life of approximately 0.02 years (the remaining term of the warrants). The fair value of the 2,217,817 outstanding warrants was $4,217.

The fair value of warrants with embedded derivative feature was estimated at December 31, 2011 with the binomial Black-Scholes option-pricing model using the following assumptions: probability of anti-dilution ratchet of 75%; a probable reset share price of $0.0202; dividend yield 0.0%; expected volatility of 197.99%, risk-free interest rate of 0.25% and expected life of approximately 1.03 years (the remaining term of the warrants). The fair value of the 1,493,330 outstanding warrants was $46,461.

During the year ended December 31, 2012, Hope Capital, Inc. exercised its right to convert debt into shares of ABI Common Stock. The embedded conversion features in the debt conversion and redemption features were accounted for as a derivative liability. The debt also included warrants which were valued as a liability and discount to the note, due to the unknown number of shares to be issued upon conversion of the debt, causing a lack of sufficient authorized shares to be available to settle the warrants. The derivative liabilities were marked-to-market each quarter with the change in fair value recorded in the income statement. At each respective conversion date, the derivative liabilities were remeasured with the changes in fair value recorded to the income statement. At full conversion of the debt the warrants were no longer deemed to be a liability and were returned to equity for $17,035.

Net derivative gains for 2012 were $44,096. In 2011, the derivative gain was $36,468.