10KSB 1 v02965_10ksb.txt U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the Fiscal Year Ended December 31, 2003 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] COMMISSION FILE NUMBER 0-20791 AMARILLO BIOSCIENCES, INC. (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER) TEXAS 75-1974352 (State of other jurisdiction of incorporation or (I.R.S. Employer organization) Identification No.) 4134 BUSINESS PARK DRIVE, AMARILLO, TEXAS 79110-4225 (Address of principal executive offices) (Zip Code) ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE: (806) 376-1741 Securities registered under Section 12(b) of the Exchange Act: None. Securities registered under Section 12(g) of the Exchange Act: Common Stock, Par Value $.01 (Title of class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No|_| Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. |X| Revenues for its most recent fiscal year were $99,595 As of December 31, 2003, there were outstanding 11,060,017 shares of the registrant's common stock, par value $.01, which is the only class of common or voting stock of the registrant. As of that date, the aggregate market value of the shares of common stock held by non-affiliates of the registrant (based on the closing price for the common stock on the OTC BB.AMAR) was approximately $3,107,694. PART I The following contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed in the forward-looking statements as a result of certain factors, including those set forth in "Management's 2004 Plan of Operations" as well as those discussed elsewhere in this Form 10-KSB. The following discussion should be read in conjunction with the Financial Statements and the Notes thereto included elsewhere in this Form 10-KSB. ITEM 1. DESCRIPTION OF BUSINESS. GENERAL Amarillo Biosciences, Inc. (the "Company" or "ABI"), a Texas corporation formed in 1984, is engaged in developing biologics for the treatment of human and animal diseases. The Company is currently focusing its research on human health indications for the use of low-dose orally administered natural human interferon alpha, particularly for the treatment of Sjogren's syndrome, Behcet's disease, fibromyalgia, idiopathic pulmonary fibrosis and oral warts in HIV+ patients. The Company believes that significant worldwide opportunities exist for the development of low-dose orally administered natural interferon alpha as a cost-effective, non-toxic, efficacious alternative to the treatment of disease by injection of high doses of interferon alpha. In addition, the Company believes that low-dose orally administered natural human interferon alpha will be an effective treatment for diseases or conditions for which current therapies are inadequate. The Company owns or licenses 16 United States patents relating to the use or composition of low-dose oral natural interferon alpha. Since 1992, the Company has filed with the U.S. Food and Drug Administration ("FDA"), and there now are in effect, 5 Investigational New Drug ("IND") Applications covering indicated uses for low-dose oral interferon alpha, including treatment of Sjogren's syndrome, oral warts and fibromyalgia. The Company's objective is to exploit its proprietary technology to become a leader in the field of low-dose oral applications of interferon alpha. The Company's business strategy is to pursue those indications for low-dose oral interferon alpha treatment for which initial clinical research has indicated the treatment is efficacious and which, in the opinion of the Company, have the greatest commercial potential and are most likely to be approved by the FDA. To the extent possible, the Company will attempt to minimize the cost to the Company of obtaining FDA approval by utilizing forms of interferon alpha already approved (in other dosage forms and for different indications) by the Japanese Ministry of Health and Welfare for human use. The Company believes that cost savings will result from this strategy. The Company will attempt to gain market share for approved products by forming alliances with strong marketing partners. The Company has 4 full-time employees. The Company makes extensive use of consultants in business and research and development. HUMAN HEALTH APPLICATIONS Sjogren's Syndrome. Sjogren's syndrome is a chronic autoimmune disorder characterized by dryness of the eyes and mouth. It can exist as a primary disorder or in association with other autoimmune diseases such as rheumatoid arthritis, systemic lupus erythematosus and scleroderma. Patients with primary Sjogren's syndrome may have clinical signs such as rash, arthritis, pneumonitis and nephritis. Typical symptoms include the sensation of burning in the eyes, difficulty swallowing, painful throat, fatigue and dryness of the mouth, skin, nose and vagina. Oral candidiasis (a fungal infection of the mouth) may also arise as a result of reduced saliva flow. Although Sjogren's syndrome is not life threatening, it can cause extreme discomfort and seriously impair quality of life. The Sjogren's Syndrome Foundation, Inc. estimates that there are approximately two to four million people in the United States who suffer from Sjogren's syndrome. The Company believes that the incidence of Sjogren's syndrome worldwide is similar to its incidence in the United States. Women constitute 90% of Sjogren's syndrome patients. Topical use of artificial tears is the prevailing treatment for the dry eye symptom of the disease. Artificial tears must be used on a regular basis. Intensive oral hygiene is prescribed to prevent progressive oral problems that may develop as a result of the disease. Topical and systemic means of increasing salivary flow may provide transient relief of symptoms. The Company believes that oral interferon alpha therapy helps to relieve the dryness associated with Sjogren's syndrome, improves secretory function, and may effectively supplement, or be used in lieu of, existing treatments. The Company has completed two 24-week Phase III clinical trials of the use of interferon alpha lozenges in the treatment of primary Sjogren's syndrome. Results of both Phase III clinical trials demonstrate an improvement in saliva production in treated patients (see Arthritis Care & Research, 49:585-593, 2003). The studies were double-blinded, placebo-controlled tests in which a total of 497 patients were treated three times daily for 24 weeks with a lozenge containing either 150 international units (IU) of interferon alpha or a placebo. Analysis of participants who completed the trials, designated as evaluable patients, found a significant (p=0.01) increase in unstimulated whole saliva (UWS) production among the interferon alpha treated patients, as compared to those who received placebo. Increases in UWS are important to the Sjogren's patient since UWS represents the basal salivary flow that is present over 90% of the day. Importantly, in interferon alpha treated subjects a significant (p#0.05) correlation was seen between increases in UWS and improvement in a number of the symptoms of Sjogren's syndrome that were assessed in the study, including oral dryness, throat dryness, nasal dryness and the ability to swallow foods. This finding suggests that patients were able to perceive a benefit of having increased salivary flow. Measurements of stimulated whole saliva and subjective oral dryness were the designated primary endpoints of these studies. Neither the evaluable analysis nor the intent-to-treat analysis of these data resulted in significant findings. The FDA typically requires that statistical significance be achieved using an intent-to-treat analysis of primary endpoints in order to achieve regulatory approval. 3 The Company discussed the results of these studies with the FDA in February 2001. The FDA felt the demonstrated improvement in UWS flow was encouraging, but not sufficient for marketing approval as UWS was a secondary, rather than a primary study endpoint. The FDA suggested that the Company sponsor an additional, large-scale Phase III study that would include UWS flow as the primary endpoint. Instead, the Company proposed a study designed to demonstrate, by biopsy, improvement at the site of disease activity, the salivary glands. The Company believes that, if successful, the salivary gland study results, along with the beneficial UWS results generated in the twin Phase III studies, would form a reasonable basis for the approval of oral interferon alpha in the treatment of Sjogren's syndrome. Even though the FDA stated their belief that the data package would still be insufficient, the Company plans to conduct a biopsy study and, if successful, to file for marketing approval. Fibromyalgia Syndrome. The Company completed a second Phase II clinical trial in fibromyalgia in March 2000. Fibromyalgia syndrome has only recently been recognized as a separate clinical entity, much to the relief of patients suffering from chronic pain and stiffness. The market in the U.S. has been estimated at 5-10 million patients, which may well be underestimated. Current treatment consists of antidepressants and painkillers. There is an immense loss of working hours in the U.S. due to fibromyalgia, and a subsequently heavy financial burden to patients, employers and the government (estimated at $15 billion annually). In ABI's initial Phase II fibromyalgia study, 6 weeks of low-dose oral interferon alpha treatment resulted in a significant (p<0.05) reduction in stiffness upon waking ("morning stiffness") compared to placebo. Patients reported feeling better than they had in years. Based on these results, a second, longer study was conducted. The most recently completed Phase II clinical study showed promising results. Patients participating in the study were divided into three groups, and each individual was given three lozenges per day for three months. The three lozenges given to members of the first group contained 50 IU of interferon alpha each, the second group was given one 50 IU interferon alpha lozenge and two placebos, while members of the final group received three placebos. All three groups reported a reduction in morning stiffness, but across the entire study the improvement was most pronounced in those taking one 50 IU lozenge of interferon alpha per day. However, the results did not reach statistical significance relative to the controls, nor did increasing the dose to three interferon alpha lozenges per day improve the results. Participants were also given a low dose of the anti-depressant drug amitriptyline, which they began taking one month prior to the start of the interferon alpha trial and continued throughout the three-month study. The addition of the amitriptyline was deemed necessary so the placebo patients would not have to tolerate a three-month study without any beneficial therapy. However, use of amitriptyline complicated the analysis and interpretation of the study results. Patients who did not worsen during the lead-in month of treatment with amitriptyline went on to demonstrate a significant reduction in morning stiffness (p<0.005) when they took the 50 IU interferon alpha lozenges once a day for three months, as compared to those who received placebo. However, those patients who reported worsening of their morning stiffness during the lead-in month of amitriptyline showed no benefit during the subsequent three months of interferon alpha treatment. 4 The Company believes that a modified Phase II study design would confirm the therapeutic benefit of low-dose oral interferon alpha in the treatment of morning stiffness in patients suffering from fibromyalgia. Upon successful completion of an additional Phase II study, ABI would then plan on working with a corporate partner to conduct the Phase III clinical trials necessary to secure marketing approval. Oral Warts in HIV+ Patients. Oral warts are lesions in the mouth caused by the human papillomaviruses. In Phase I/II clinical studies with 36 patients, complete and partial clearance of oral warts was achieved in 70% (5/7) of HIV+ subjects given interferon-(alpha) at 500 international units (IU) three times a day (tid). Completion of a Phase III clinical study offers ABI the fastest, least expensive way to achieve FDA approval. The clinical endpoint is an objective endpoint, i.e. - a decrease in the number and area of warts. A Phase III protocol and IND was submitted to FDA in October, 2003. Ten clinical sites have been identified and the Company will launch its Phase III study when funds are obtained. The Company filed with the FDA Office of Orphan Drugs and was granted (Summer 2000) orphan drug status for low dose IFN(alpha) treatment in this condition. Behcet's Disease. Behcet's disease is a severe chronic relapsing inflammatory disorder marked by oral and genital ulcers, eye inflammation (uveitis) and skin lesions, as well as varying multisystem involvement including the joints, blood vessels, central nervous system, and gastrointestinal tract. The oral lesions are an invariable sign, occurring in all patients at some time in the disease. Behcet's disease is found world-wide, and is a significant cause of partial or total disability. The US patient population has been estimated as 15,000. The Company filed with the FDA Office of Orphan Drugs and was granted (Spring 2000) orphan drug status for low dose orally administered IFN(alpha) treatment in this condition. The Company expects to work with a company in Istanbul, Turkey to conduct Phase II/III studies in Turkey in Behcet's disease patients. These studies will be conducted under FDA Phase II/III protocols so the data can be submitted to the US FDA and to regulatory authorities in Turkey. Idiopathic Pulmonary Fibrosis. Idiopathic Pulmonary Fibrosis (IPF) is a chronic inflammatory fibrotic disorder localized to the lower respiratory tract and characterized by an alveolitis dominated by alveolar macrophages, polymorphonuclear leukocytes (PMNs) and, to a lesser extent, lymphocytes and eosinophils. The disease usually presents as dyspnea on exertion, the chest x-ray shows diffuse reticulonodular infiltrates, and analysis of lung function reveals restrictive abnormalities. The disease process does not affect the upper or conducting airways, but bronchiolitis of respiratory bronchioles may be present and alveolar units are always involved. Normally, overlying or interspersed in the alveoli are a variety of immune cells, including alveolar macrophages, dendritic macrophages, interstitial monocytes, lymphocytes, and inflammatory cells, such as PMNs and eosinophils. The cellular content of normal bronchial-alveolar lavage (BAL) fluid consists of approximately 80 percent alveolar macrophages, 10 percent lymphocytes (of which 70 percent are T lymphocytes), 1 to 5 percent B lymphocytes or plasma cells, 1 to 3 percent PMNs, and 1 percent eosinophils. In the lymphocyte population, the ratio of CD4 T helper and CD8 T suppressor/cytotoxic cells is about 1.5. In the earliest, reversible forms of alveolar injury, "leakiness" of the alveolar type I cells and the adjacent capillary endothelial cells occurs, causing alveolar and interstitial edema and the formation of intra alveolar hyaline membranes. With persistence of the disease, increased alveolar-capillary permeability and desquamation of intra-alveolar cells (alveolitis), mural 5 inflammation, and interstitial fibrosis are present on biopsy. This process is also reflected in the composition of cells and enzymes recovered in BAL fluid and in cellular components present in lung biopsy tissue. The presence and severity of the disease process are spotty in distribution; a continuum of inflammatory and fibrotic changes can be found throughout the affected lung. Fibrosis follows from an organization of inflammatory exudate within the airspaces in which fibroblasts beneath the type I epithelium proliferate and increase their production of fibronectin and collagen. Death of the patient usually occurs within 4-5 years of diagnosis. ABI's low-dose orally administered interferon alpha is being tested as a treatment for IPF under an Advanced Technology Program Grant awarded by the State of Texas to the Texas Tech University Health Sciences Center in Lubbock. The $100,000 grant is being used by the Health Science Center to support a pilot study of 20 patients with IPF. ABI is collaborating on this research with Lorenz O. Lutherer, MD, PhD, professor, physiology, and Cynthia A. Jumper, MD, associate professor patient care, internal medicine, and is providing support in the form of study drug, data management and biostatistical analysis. Ten IPF patients have been enrolled into treatment with interferon alpha lozenges. Four of the IPF patients have already been treated for 12 months and all 4 patients are stable or improved, according to Dr. Lutherer. 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 100 years the Hayashibara Company, Ltd. and its predecessors have been applying microbiological technology in the starch industry for the production of maltose and other sugars. In 1981, HBL established the Fujisaki Institute to accelerate development of industrial methods for the production of biologics and to sponsor clinical trials for such products. In 1985, HBL built the Fujisaki Cell Center to support basic research. In 1987, HBL successfully accomplished the mass production of human cells in an animal host by producing human cells in hamsters. This made it possible to economically produce a natural form of human interferon alpha and other biologics. HBL also has developed and obtained patents for technology relating to the production of interferon alpha-containing lozenges by which the stability of the interferon alpha activity can be maintained for up to 24 months at room temperature and up to five years if the product is refrigerated. The Company believes that the use of such lozenges gives it advantages over competitive technologies in terms of cost, taste and ease of handling. On March 13, 1992, the Company entered into a Joint Development and Manufacturing/Supply Agreement with HBL (the "Development Agreement"). Such Development Agreement was subsequently amended on January 17, 1996 and May 10, 1996. Among other things, the Development Agreement provides the Company with a source of natural human interferon alpha for use in the Company's interferon alpha-containing products. Additional information on the Development Agreement is set forth in footnote 4 to the Consolidated Financial Statements attached to this 10-KSB. 6 OTHER AGREEMENTS In 2003 the Company entered into various licensing and supply arrangements which could serve as a source of future revenue for the Company; however, none of these arrangements are currently contributing in a significant manner to the Company's revenue, and these arrangements are not considered by the Company's management to be material, either individually or in the aggregate. PATENTS AND PROPRIETARY RIGHTS Two patents were issued in 2003. "Interferon-Alpha Mediated Upregulation Of Aquaporin Expression" (U.S. Patent No. 6,506,377) issued January 14, 2003, valid until September 27, 2021 and "Composition And Method For Promoting Oral Health" (U.S. Patent No. 6,656,920) issued December 2, 2003, valid until April 18, 2023 COMPETITION The pharmaceutical industry is an expanding and rapidly changing industry characterized by intense competition. The Company believes that its ability to compete will be dependent in large part upon its ability to continually enhance and improve its products and technologies. In order to do so, the Company must effectively utilize and expand its research and development capabilities and, once developed, expeditiously convert new technology into products and processes which can be commercialized. Competition is based primarily on scientific and technological superiority, technical support, availability of patent protection, access to adequate capital, the ability to develop, acquire and market products and processes successfully, the ability to obtain governmental approvals and the ability to serve the particular needs of commercial customers. Corporations and institutions with greater resources than the Company may, therefore, have a significant competitive advantage. The Company's potential competitors include entities that develop and produce therapeutic agents for treatment of human and animal disease. These include numerous public and private academic and research organizations and pharmaceutical and biotechnology companies pursuing production of, among other things, biologics from cell cultures, genetically engineered drugs and natural and chemically synthesized drugs. Almost all of these potential competitors have substantially greater capital resources, research and development capabilities, manufacturing and marketing resources and experience than the Company. The Company's competitors may succeed in developing products or processes that are more effective or less costly than any that may be developed by the Company, or that gain regulatory approval prior to the Company's products. The Company also expects that the number of its competitors and potential competitors will increase as more interferon alpha products receive commercial marketing approvals from the FDA or analogous foreign regulatory agencies. Any of these competitors may be more successful than the Company in manufacturing, marketing and distributing its products. There can be no assurance that the Company will be able to compete successfully. GOVERNMENT REGULATION Once a new compound has been identified in the laboratory, medicines are developed as follows: Preclinical Testing. A pharmaceutical company conducts laboratory and animal studies to show biological activity of the compound against the targeted disease, and the compound is evaluated for safety. 7 Investigational New Drug Application ("IND"). After completing preclinical testing, a company files an IND with the FDA to begin to test the drug in people. The IND becomes effective if the FDA does not disapprove it within 30 days. The IND shows results of previous experiments; how, where and by whom the new studies will be conducted; the chemical structure of the compound; how it is thought to work in the body; any toxic effects found in the animal studies; and how the compound is manufactured. All clinical trials must be reviewed and approved by the Institutional Review Board ("IRB") where the trials will be conducted. Progress reports on clinical trials must be submitted at least annually to FDA and the IRB. Clinical Trials, Phase I. These tests involve about 20 to 80 normal, healthy volunteers. The tests study a drug's safety profile, including the safe dosage range. The studies also determine how a drug is absorbed, distributed, metabolized and excreted as well as the duration of its action. Clinical Trials, Phase II. In this phase, controlled trials of approximately 100 to 300 volunteer patients (people with the disease) assess a drug's effectiveness. Clinical Trials, Phase III. This phase usually involves 1,000 to 3,000 patients in clinics and hospitals. Physicians monitor patients closely to confirm efficacy and identify adverse events. These numbers may be modified based on the disease prevalence. New Drug Application ("NDA")/Biologics License Application ("BLA"). Following the completion of all three phases of clinical trials, a company analyzes all of the data and files with FDA an NDA, in the case of a drug product, or a BLA in the case of a biologic product, if the data successfully demonstrate both safety and effectiveness. The NDA/BLA contains all of the scientific information that the Company has gathered. NDA's typically run 100,000 pages or more. By law, FDA is allowed twelve months to review a standard NDA/BLA. Approval. Once FDA approves an NDA, the new medicine becomes available for physicians to prescribe. A company must continue to submit periodic reports to FDA, including any cases of adverse reactions and appropriate quality-control records. For some medicines, FDA requires additional trials (Phase IV) to evaluate long-term effects. ABI obtained an IND for oral interferon alpha in the treatment of Sjogren's syndrome in 1994. ABI successfully completed Phase I development in 1996, Phase II development in 1997 and launched the first of its Phase III trials in November 1998. All Phase III trials in the treatment of Sjogren's syndrome were completed in 2000. Our goal is to initiate a biopsy study of patients in 2004. Additionally, ABI expects to launch a Phase III trial in HIV+ patients with oral warts and a Phase II/III trial in patients with Behcet's disease. All progress on approval is dependent on funding. 8 RESEARCH AND DEVELOPMENT During the years ended December 31, 2003 and 2002, the Company incurred expenses of $173,345 and $382,880, respectively, resulting from Company-sponsored research and development activities. Research and development is expected to remain a significant component of the Company's business. The Company has arranged for others to perform substantially all of its clinical research and intends to continue to do so while utilizing its staff for monitoring such research. See also ITEM 6, "MANAGEMENT'S 2004 PLAN OF OPERATIONS - Research and Development". ITEM 2. DESCRIPTION OF PROPERTY. The Company's executive and administrative offices are located at 4134 Business Park Drive, Amarillo, Texas in a 1,800 square-foot facility rented by the Company. The building contains offices, and a small warehouse. The Company believes that the facility is adequate for its present use. ITEM 3. LEGAL PROCEEDINGS. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS. The Company is presently traded on the OTC Bulletin Board under the symbol AMAR. The range of high and low sales prices as quoted on the OTC Bulletin Board for each quarter of 2003 and 2002 was as follows:
2003 2002 ----------------------- ---------------------- Quarter High Low High Low --------------- ----------- ---------- ---------- ---------- First $ 0.19 $ 0.05 $ 1.18 $ 0.3300 Second 0.39 0.09 0.55 0.3100 Third 0.51 0.22 0.47 0.1500 Fourth 0.51 0.29 0.25 0.0500
As of December 31, 2003, the Company had 834 shareholders of record. 9 ITEM 6. MANAGEMENT DISCUSSIONS AND ANALYSIS OR PLAN OF OPERATION. The following discussion should be read in conjunction with our financial statements and the notes thereto which appear elsewhere in this report. The results shown herein are not necessarily indicative of the results to be expected in any future periods. This discussion contains forward-looking statements based on current expectations, which involve uncertainties. Actual results and the timing of events could differ materially from the forward-looking statements as a result of a number of factors. Readers should also carefully review factors set forth in other reports or documents that we file from time to time with the Securities and Exchange Commission. OVERVIEW The Company continues to engage in research and development activities focused on developing biologics for the treatment of human and animal diseases. The Company has not commenced any significant product commercialization and, until such time as it does, will not generate significant product revenues. The Company's accumulated deficit has decreased, from approximately $22,130,000 at December 31, 2002 to $21,912,001 at December 31, 2003. This decrease was primarily a result of income recognized from the reversal of a previous accrued contingent liability of $750,965. Without this reversal, the Company would have recognized a consolidated net loss of $584,334 for the year ended December 31, 2003. Operating losses are expected to continue for the foreseeable future and until such time as the Company is able to attain sales levels sufficient to support its operations. In 2004 the Company will continue its research and development activities, as well as the activities necessary to develop commercial partnerships and licenses. The Company's expenditure of financial resources in 2004 will fall principally into five broad categories, as follows: Research and Development; Personnel; Consulting and Professional (except legal and accounting); Legal and Accounting; and Public Relations, Investor Relations and Shareholder Relations. The Company's expectations and goals with respect to these categories are addressed separately below, by category. Two patents were issued in 2003. "Interferon-Alpha Mediated Upregulation Of Aquaporin Expression" (U.S. Patent No. 6,506,377) issued January 14, 2003, valid until September 27, 2021 and "Composition And Method For Promoting Oral Health" (U.S. Patent No. 6,656,920) issued December 2, 2003, valid until April 18, 2023. On February 14, 2003 the Company's building was sold for a sales price of $137,500. On June 6, 2001 the Company borrowed $90,000 under a real estate lien note agreement collateralizing the Company's building with Apple Cattle Company, a Texas general partnership. The real estate lien note was paid off at closing. The Company now leases about 1,800 square feet of office and warehouse space. In 2003, the Company sold 1,500,945 unregistered shares of its voting common stock in private placement offerings. Of these sales, 300,000 shares were sold for $0.08333 per share; 100,000 shares for $0.10 per share; 250,000 shares for $0.105 per share; 500,000 shares for $0.12 per share; 54,400 shares for 10 $0.25 per share; 30,000 shares for $0.25480 per share; 30,000 shares for $0.27 per share and 36,545 for $0.301 per share, generating $201,594 in cash. On June 4, 2003, ABI issued 300,000 unregistered shares of its voting common stock as payment for consulting services performed in the second quarter of 2003. Valuation of the stock granted was $0.38 per share which generated a value of $114,000. November 5, 2003, ABI issued 100,000 registered shares of its voting common stock as payment for consulting services performed for the Company. Valuation of the stock granted was $0.35 per share which generated a value of $35,000. In 2003 the Company entered into various licensing and supply arrangements which could serve as a source of future revenue for the Company; however, none of these arrangements are currently contributing in a significant manner to the Company's revenue, and these arrangements are not considered by the Company's management to be material, either individually or in the aggregate. The Company had a License Agreement with Atrix Laboratories, Inc. executed September 7, 2001. This Agreement was terminated May 22, 2003 and all rights to the use of the product and technology were returned to the Company. Veldona USA, Inc. ("Veldona"), an inactive subsidiary of the Company, was formally dissolved on September 26, 2003. Prior to formal dissolution, an assignment was entered into between the Company and Veldona that allowed the Company to buy from Veldona all of its previous and existing Investigative New Drug applications, ("INDs") for $50,298. This transaction resulted in the Company recognizing the INDs as an intangible asset on its balance sheet and Veldona recognizing a gain on the sale. The Company purchased the INDs from Veldona based on their probable use in the future, with no current plans of their utilization, therefore, the Company subsequently expensed the cost of the INDs as an impairment loss. Also prior to the dissolution of Veldona and with legal advice, a long-term accrued contingent liability of $750,965 recorded in accounts payable was reversed into income in September 2003. This reversal resulted in the recognition of net income for the nine months ended September 30, 2003. Without this reversal, the Company would have reported a consolidated net loss of $392,802 for the nine months ended September 30, 2003. LIQUIDITY AND CAPITAL RESOURCES At December 31, 2003, the Company had available cash of approximately $11,300, and had a working capital deficit of approximately ($575,611). Assuming there is no decrease in current accounts payable, and accounting for various one-time expenses, the Company's negative cash flow is approximately $39,000 per month. The Company's continued losses and lack of liquidity indicate that the Company may not be able to continue as a going concern for a reasonable period of time. The Company's ability to continue as a going concern is dependent upon several factors including, but not limited to, the Company's ability to generate sufficient cash flows to meet its obligations on a timely basis, obtain additional financing and continue to obtain supplies and services from its vendors. The Company will need to raise additional funds in order to fully execute its 2004 Plan. The Company is presently negotiating with human health and animal health commercial development partners in various regions of the world including the United States, Canada, Europe and the Middle East. The Company believes that one or more of these agreements will be executed during 11 2004. These agreements could generally include provisions for the commercial partner to pay ABI a technology access fee, could include payments for a portion of the clinical trial expenses, could include payment obligations to ABI upon the accomplishment of certain defined tasks and/or could provide for payments relating to the future sales of commercial product. These agreements could be an important source of funds for ABI. However, there can be no assurance that the Company will be successful in obtaining additional funding from either human health and animal health commercial development partners or private investors. If the Company is not successful in raising additional funds, it will need to significantly curtail clinical trial expenditures and to further reduce staff and administrative expenses and may be forced to cease operations. Total outstanding current liabilities decreased to approximately $2.7 million at December 31, 2003, as compared to approximately $3.3 million at December 31, 2002. The current liabilities decrease was the result of the building sale, which decreased notes payable and the write-off of our subsidiaries long-term accrued contingent liability of $750,965 recorded in accounts payable reversed into income in September 2003. From December 31, 2002, to December 31, 2003, total assets decreased by approximately $73,000 as a result of liquidating some property and equipment with the sale of the building. CRITICAL ACCOUNTING POLICIES We believe the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our financial statements: ACCOUNTING FOR STOCK-BASED COMPENSATION The Company accounts for stock-based compensation under the intrinsic value method. Under this method, the Company recognizes no compensation expense for stock options granted when the number of underlying shares is known and exercise price of the option is greater than or equal to the fair market value of the stock on the date of grant. BASIC AND DILUTED NET INCOME (LOSS) PER SHARE We account for stock-based compensation based on the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," as amended by the Financial Accounting Standards Board Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation." Accounting Principles Board Opinion No. 25 and Financial Accounting Standards Board Interpretation No. 44 state that no compensation expense is recorded for stock options or other stock-based awards to employees that are granted with an exercise price equal to or above the estimated fair value per share of the company's common stock on the grant date. We adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," which requires compensation expense to be disclosed based on the fair value of the options granted at the date of the grant. In December 2002, the Financial Accounting Standards Board issued its Statement No. 148, "Accounting for Stock-Based Compensation -- Transition and 12 Disclosure--an amendment of Financial Accounting Standards Board Statement No. 123." This Statement amends Statement of Financial Accounting Standards No. 123, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of Statement of Financial Accounting Standards No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. The transition and annual disclosure provisions of Statement of Financial Accounting Standards No. 148 are effective for fiscal years ending after December 15, 2002, and the interim disclosure provisions were effective for the first interim period beginning after December 15, 2002. We did not voluntarily change to the fair value based method of accounting for stock-based employee compensation, therefore, the adoption of Statement of Financial Accounting Standards No. 148 did not have a material impact on our operations and/or financial position. DEFERRED TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting purposes. A valuation allowance of $6,500,000 has been recorded to reduce the Company's deferred tax assets to the amount that is more likely than not to be realized. Consideration of estimated future taxable income and ongoing tax planning strategies is utilized in assessing the amount needed for the valuation allowance. Based on these estimates, all deferred tax assets have been reserved. If actual results differ favorably from those estimates used, the Company might be able to realize all or part of our net deferred tax assets. Such realization could positively impact operating results and cash flows from operating activities. COMPARISON OF RESULTS FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003, TO THE FISCAL YEAR ENDED DECEMBER 31, 2002. REVENUES. During the fiscal year ended December 31, 2003 $36,927 from product sales was generated compared to revenues from product sales for the fiscal year ended December 31, 2002, of $10,942, an increase of $25,985 or approximately 237%. The increase is primarily due to international orders for Maxisal(R), our dietary supplement. The fiscal year 2003 also includes income from the reversal of a previously accrued contingent liability of $750,965. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, General and Administrative expenses of $394,772 were incurred for fiscal year ended December 31, 2003, compared to $302,977 for the fiscal year ended December 31, 2002, an increase of $91,795. There was $166,500 in non-cash expenses in recognition of stock issued to cover services provided by consultants in lieu of cash. 13 NON-CASH CONSULTING ACTIVITIES. During the year ended December 31, 2003, the Board of Directors authorized the issuance of shares of restricted common stock to various consultants in lieu of cash payments. Based upon the common stock trading price at the times of issuance, and FASB rules, a non-cash consulting expense of $166,500 was recorded for the issuance of these shares during the year ended December 31, 2003. NET INCOME (LOSS). Net Income applicable to common shareholders for the fiscal year ended December 31, 2003 was $166,631 compared to a Net Loss of ($705,822) for the fiscal year ended December 31, 2002. The increase in income was a result of the dissolution of Veldona and with legal advice, a long-term accrued contingent liability of $750,965 recorded in accounts payable that was reversed into income in September 2003. Without this reversal, the Company would have reported a consolidated Net Loss of $584,334 for the fiscal year ended December 31, 2003. RISK FACTORS You should carefully consider the risks described below before making an investment in Amarillo Biosciences, Inc. All of these risks may impair our business operations. If any of the following risks actually occurs our business, financial condition or results of operations could be materially adversely affected. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment. RISKS RELATING TO OUR BUSINESS We may not be able to adequately protect and maintain our intellectual property. Our success will depend in part on our ability to protect and maintain our patents, intellectual property rights and licensing arrangements for our products and technology. No assurance can be given that licenses or rights used by Amarillo Biosciences, Inc. will not be challenged, infringed or circumvented, or that the rights granted thereunder will provide competitive advantages to us. Furthermore, there can be no assurance that we will be able to remain in compliance with our existing or future licensing arrangements. Consequently, there may be a risk that licensing arrangements are withdrawn with no penalties to the licensee or compensation to Amarillo Biosciences, Inc. We rely on third parties for the supply, manufacture and distribution of our products. Third parties manufacture and distribute all of our products. We do not currently have manufacturing facilities or personnel to independently manufacture our products. Currently, Marlyn Nutraceutical manufactures our nutraceutical products. Our licensed distributors, in the United States and Internationally distribute the nutraceutical products. Except for any contractual rights and remedies that we may have with our manufacturer and our distributor, we have no control over the availability of our products, their quality or cost or the actual distribution of our products. If for any reason we are unable to obtain or retain third-party manufacturers and distributors on commercially acceptable terms, we may not be able to produce and distribute our products as planned. If we encounter delays or difficulties with our contract manufacturer in producing or packaging our products or with our distributor in distributing our products, the production, distribution, marketing and subsequent sales of these products would be adversely affected, and we may have 14 to seek alternative sources of supply or distribution or abandon or sell product lines on unsatisfactory terms. We may not be able to enter into alternative supply, production or distribution arrangements on commercially acceptable terms, if at all. There can be no assurance that the manufacturer that we have engaged will be able to provide sufficient quantities of these products or that the products supplied will meet with our specifications or that our distributor will be able to distribute our products in accordance with our requirements. We are dependant on certain key existing and future personnel. Our success will depend, to a large degree, upon the efforts and abilities of our officers and key management employees such as Joseph M. Cummins, our President, Chief Executive Officer and Chief Financial Officer; and Martin J. Cummins, our Director 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 not currently have employment agreements with any of our employees. We do not currently maintain key man life insurance on any of our key employees. In addition, as our business plan is implemented, we will need to recruit and retain additional management and key employees in virtually all phases of our operations. We cannot assure that we will be able to successfully attract and retain key personnel. Our growth is dependent on our ability to successfully develop, acquire or license new drugs. We must invest substantial time, resources and capital in identifying and developing new drugs, dosage and delivery systems, either on our own or by acquiring and licensing such products from third parties. Our growth depends, in part, on our success in such process. Our planned expansion over time is founded on a simple principal of introducing two new products or line extensions each year and to expand distribution into two new territories each year. This strategy has the advantage of building brands through geographic expansion and line extensions, and establishing incremental capabilities for new product introductions. We believe that our planned expansion will require $5.0 million in total over three years, which we intend to fund out of our future revenues and, if necessary, additional financing. If we are unable to either develop new products on our own or acquire licenses for new products from third parties, our ability to grow revenues and market share will be adversely affected. In addition, we may not be able to recover our investment in the development of new drugs, given that projects may be interrupted, unsuccessful, not as profitable as initially contemplated or we may not be able to obtain necessary financing for such development if we are unable to fund such development from our future revenues. Similarly, there is no assurance that we can successfully secure such rights from third parties on an economically feasible basis. We may be subject to product liability claims in the future. We face an inherent business risk of exposure to product liability claims in the event that the use of our technologies or products are alleged to have resulted in adverse side effects. Side effects or marketing or manufacturing problems pertaining to any of our products could result in product liability claims or adverse publicity. These risks will exist for those products in clinical development and with respect to those products that receive regulatory approval for commercial sale. Furthermore, although we have not historically experienced any problems associated with claims by users of our products, we do not currently maintain product liability insurance. We plan to have a product liability insurance plan in place in 2004; however, there can be no assurance 15 that we will be able to acquire product liability insurance with terms that are commercially feasible. RISKS RELATING TO OWNERSHIP OF COMMON STOCK. There may not be sufficient liquidity in the market for our securities in order for investors to sell their securities. There is currently only a limited public market for our common stock, which is listed on the Nasdaq, and there can be no assurance that a trading market will develop further or be maintained in the future. ITEM 7. FINANCIAL STATEMENTS. The financial statements of the Company are set forth beginning on page F-1 immediately following the signature page of this report. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. As of December 31, 2003, the directors and executive officers of the Company were as follows:
NAME AGE POSITION ------------------------------------------------ ------- ------------------------------------------- Joseph Cummins, DVM, PhD (1)(3)................. 61 Chairman of the Board, President, Chief Executive Officer, Chief Financial Officer and Director Stephen Chen, PhD (2)(4)........................ 54 Director James Cook (1)(3)(5)............................ 69 Director Katsuaki Hayashibara (3)(4)(5).................. 59 Director Dennis Moore, DVM (1)(4)(5)..................... 57 Director James Page, MD (1)(2)(5)........................ 76 Director The following is not an executive officer, but is expected by the Company to make a significant contribution to the business: Martin J. Cummins............................... 36 Director of Clinical & Regulatory Affairs
(1) Member of the Executive Committee. (2) Member of the Compensation Committee. (3) Member of the Finance Committee. 16 (4) Member of the Audit Committee. (5) Member of the Stock Option Plans Administration Committee. Joseph Cummins has been the Chairman of the Board of the Company since he founded it in June 1984. Dr. Cummins has also served as President of the Company since December 1994 and as Chief Financial Officer since October 1998. Dr. Cummins has been conducting research on oral cytokines, most particularly interferon alpha, in animals and humans for 29 years. Dr. Cummins has more than 40 publications and a dozen patents which reflect his work in the field of oral interferon. He received a PhD degree in microbiology from the University of Missouri in 1978 and a doctor of veterinary medicine degree from the Ohio State University in 1966. Stephen Chen has been a director of the Company since February 1996. He has been President and Chief Executive Officer of STC International, Inc., a health care investment firm, since May 1992. From August 1989 to May 1992 he was Director of Pharmaceutical Research and Development for the Ciba Consumer Pharmaceuticals Division of Ciba-Geigy. James Cook has been a director of the Company since 1988. He was President and Chief Executive Officer of the First National Bank of Arvada from January 1992 until his retirement in 2001. From April 1987 to December 1991 he was Executive Vice President of First National Bank of Amarillo. Katsuaki Hayashibara has been a director of the Company since 1994. Mr. Hayashibara was named Director of the Overseas Business Development Division of Hayashibara Company, Ltd. in January 1997. Prior to 1997, Mr. Hayashibara served as Director of Research and Development for HBL. Dennis Moore has been a director of the Company since 1986. Dr. Moore has been a doctor of veterinary medicine since 1972 and was in private practice from 1972 to 1995. Since 1995, Dr. Moore has been involved in managing his personal investments. James Page has been a director of the Company since February 1996. Prior to retiring in 1991 as a Vice President with Adria Laboratories, Inc., a pharmaceutical company specializing in therapy given to cancer and AIDS patients, Dr. Page held various upper management level positions with Carter Wallace, Inc., Merck Sharpe & Dohme Research Laboratories and Wyeth Laboratories. Martin Cummins has held several positions within the Company since joining the Company full-time in June 1992. Mr. Cummins currently oversees all research studies involving human participants as Director of Clinical and Regulatory Affairs. Martin Cummins is the son of Joseph Cummins. The Company's directors are elected at the annual meeting of shareholders to hold office until the annual meeting of shareholders for the ensuing year or until their successors have been duly elected and qualified. Directors are reimbursed for any out-of-pocket expenses in connection with their attendance at meetings. In the event of the voluntary termination of a recipient's association with the Company as a director, the options must be exercised within 90 days after such termination, and in the event they are not so exercised, will lapse. Officers are elected annually by the Board of Directors and serve at the discretion of the Board. 17 COMPLIANCE WITH SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") requires directors and officers of the Company and persons who own more than 10 percent of the Company's common stock to file with the Securities and Exchange Commission (the "Commission") initial reports of ownership and reports of changes in ownership of the common stock. Directors, officers and more than 10 percent shareholders are required by the Exchange Act to furnish the Company with copies of all Section 16(a) forms they file. To the Company's knowledge based solely on a review of the copies of such reports furnished to the Company, all filings applicable to its directors, officers and more than 10% beneficial owners were timely filed. ITEM 10. EXECUTIVE COMPENSATION. The following table sets forth for the three years ended December 31, 2003 compensation paid by the Company to its Chairman of the Board, President and Chief Executive Officer and to its Chief Operating Officer. None of the Company's other executive officers had annual salary and bonus in excess of $100,000 for services rendered during any of the three years ended December 31, 2003.
SUMMARY COMPENSATION TABLE ANNUAL COMPENSATION ------------------------------------------------------------------ NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OTHER SECURITIES COMPEN- UNDERLYING SATION OPTIONS ------------------------------------- ------- -------------- ---------- -------------- ---------------- Dr. Joseph M. Cummins, $ -- $ -- 290,000 Chairman of the Board, President and Chief Executive Officer 2003 $103,779 2002 $121,338 $ -- $ -- 150,000 2001 $148,042 $ -- $ -- 20,000
18 OPTION GRANTS IN 2003 The following table sets forth certain information relating to options granted in 2003 to the executive officers named above, to purchase shares of common stock of the Company.
NUMBER OF SHARES % OF TOTAL OF COMMON STOCK OPTIONS GRANTED EXERCISE OR NAME UNDERLYING OPTIONS TO EMPLOYEES BASE PRICE EXPIRATION GRANTED (#) IN 2003 ($/SH) DATE -------------------------------------- ----------------- --------------- -------------- ------------- Joseph M. Cummins..................... 290,000 87% $0.40 (1) 09/29/2008
(1) The fair market value of the common stock on the date of the grant. AGGREGATED OPTION EXERCISES AT DECEMBER 31, 2003 AND YEAR-END OPTION VALUES The following table sets forth information for the executive officers named above, regarding the exercise of options during 2003 and unexercised options held at the end of 2003.
VALUE OF UNEXERCISED NUMBER OF SHARES OF COMMON STOCK IN-THE-MONEY SHARES VALUE UNDERLYING UNEXERCISED OPTIONS AT OPTIONS AT ACQUIRED ON REALIZED DECEMBER 31, 2003 (#) DECEMBER 31, 2003 ($) (1) NAME EXERCISE (#) ($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE --------------------------- --------------- ----------- ------------------------------------ -------------------------------- Joseph Cummins -- -- 440,000 / None $176,000 / None
(1) Calculated based on the closing price of the common stock ($0.40) as reported by OTC BB on December 31, 2003. DIRECTOR COMPENSATION FOR LAST FISCAL YEAR
Cash Compensation Security Grants NUMBER OF SECURITIES NAME MEETING FEES (1) CONSULTING FEES (2) UNDERLYING OPTIONS --------------------------------- ------------------- ------------------- -------------------- Stephen Chen, PhD $ -- $ -- James Cook -- -- Katsuaki Hayashibara -- -- Dennis Moore, DVM -- -- James Page, MD -- --
19 (1) Directors do not receive compensation for attendance at directors' meetings. (2) Each director receives $1,200 per day, prorated for partial days, for employment on special projects or assignments. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. As of December 31, 2003, there were 11,060,017 shares of the Company's common stock outstanding. The following table sets forth as of December 31, 2003, the beneficial ownership of each person who owns more than 5% of such outstanding common stock:
NAME AND ADDRESS NUMBER OF SHARES PERCENT OF TOTAL ---------------------------------------------------------- ------------------- ------------------- Hayashibara Biochemical Laboratories, Inc. 2-3 Shimoishii 1-chome Okayama 700, Japan 3,290,781 30% Cheryl A. Ulie 8843 SE 77th Place 1,000,000 9% Mercer Island, Washington 98040 Hy Ochberg 653,000 6% 102 N.E. 2nd St. Boca Raton, FL 33432
The following table sets forth the beneficial ownership of the Company's stock as of December 31, 2003 by each executive officer and director and by all executive officers and directors as a group:
DIRECTORS NUMBER OF SHARES PERCENT OF TOTAL 237,546 2% Joseph Cummins Dennis Moore 141,442 1% James Cook 66,600 (1) * Katsuaki Hayashibara 48,240 * Stephen Chen 63,500 * James Page - - Total Group (all directors and executive officers - 6 persons) 557,328 5%
* Less than 1% (1) All of such shares are owned jointly with Mr. Cook's wife. 20 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The Company has relied significantly on HBL, the largest shareholder of the Company, for a substantial portion of its capital requirements. Pursuant to the Development Agreement described at Item 1 of Part 1 above, HBL advanced $9,000,000 for funding of research. In addition, HBL has purchased substantial amounts of the Company's common stock from time to time, to the point where it now owns 30% of the issued and outstanding shares of common stock of the Company. HBL loaned $1 million to the Company on November 30, 1999 and an additional $1 million on February 29, 2000, both loans bearing interest at 4.5% per annum. The aggregate balance on both notes at December 31, 2003, including principal and accrued interest, was $2,356,351. In addition to the above, HBL and the Company are parties to various license and manufacturing and supply agreements pursuant to which the Company licenses certain technology to or from HBL. HBL supplies formulations of its interferon alpha and other products to the Company. During 2003, the Company used the law firm of SandersBaker, P.C. Mr. Edward Morris, Secretary of the Company is a partner in that firm. The Company was invoiced $22,686 by said firm in 2003. All future transactions and loans between the Company and its officers, directors and 5% shareholders will be on terms no less favorable to the Company than could be obtained from independent third parties. There can be no assurance, however, that future transactions or arrangements between the Company and its affiliates will be advantageous, that conflicts of interest will not arise with respect thereto or that if conflicts do arise, that they will be resolved in favor of the Company. 21 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. EXHIBIT INDEX NUMBER DESCRIPTION --------------- ------------------------------------------------------------ 3.1+ Restated Articles of Incorporation of the Company, dated June 22, 1999. 3.3* Bylaws of the Company. 4.1* Specimen Common Stock Certificate. 4.2* Form of Underwriter's Warrant. 10.2* License Agreement dated as of March 22, 1988 between the Company and The Texas A&M University System. 10.5* Joint Development and Manufacturing/Supply Agreement dated March 13, 1992 between the Company and HBL, as amended. 10.7* Japan Animal Health License Agreement dated January 20, 1993 between the Company and HBL. 10.11* Manufacturing/Supply Agreement dated June 1, 1994 between the Company and HBL. 10.12* Settlement Agreement dated April 27, 1995 among the Company, ISI, Pharma Pacific Management Pty. Ltd. ("PPM"), Pharma Pacific Pty. Ltd., Pharma Pacific Ltd. and Fernz Corporation Limited. 10.14* PPM/ACC Sublicense Agreement dated April 27, 1995 between PPM and the Company. 10.18* Form of Consulting Agreement between the Company and the Underwriter. 10.20+ 1996 Employee Stock Option Plan, Amended and Restated as of May 11, 1999. 10.21+ Outside Director and Advisor Stock Option Plan, Amended and Restated as of May 11, 1999. 10.22* Form of Indemnification Agreement between the Company and officers and directors of the Company. 10.23* Indemnification Agreement between HBL and the Company. 10.26** License Agreement dated July 22, 1997 between Hoffmann-La Roche, Inc. and the Company. 10.27** Distribution Agreement dated January 12, 1998 between Global Damon Pharmaceutical and the Company. 10.28** Distribution Agreement dated September 17, 1997 between HBL and the Company (tumor necrosis factor-alpha). 10.29** Distribution Agreement dated September 17, 1997 between HBL and the Company (interferon gamma). 10.30*** Amendment No. 1 dated September 28, 1998 to License Agreement of March 22, 1988 between The Texas A&M University System and the Company. 10.36++ License Agreement dated February 1, 2000 between Molecular Medicine Research Institute and the Company (interferon gamma administered orally). 22 NUMBER DESCRIPTION --------------- ------------------------------------------------------------ 10.37++a License and Supply Agreement dated April 3, 2000 with Key Oncologics (Pty) Ltd. and the Company. 10.38++ Amendment No. 1 dated April 4, 2000, to Interferon Gamma Distribution Agreement dated September 17, 1997 between HBL and the Company (interferon gamma). 10.39++a License and Supply Agreement dated April 25, 2000 between Biopharm for Scientific Research and Drug Industry Development and the Company. 10.40++a Sales Agreement dated May 5, 2000 between Wilke Resources, Inc. and the Company. 10.41++ Engagement Agreement dated September 26, 2000 between Hunter Wise Financial Group, LLC and the Company. 10.42++a Supply Agreement (Anhydrous Crystalline Maltose) dated October 13, 2000 between Hayashibara Biochemical Laboratories, Inc. and the Company. 10.43++a Supply Agreement dated December 11, 2000 between Natrol, Inc. and the Company. 10.44+++a License Agreement dated September 7, 2001 between Atrix Laboratories, Inc. and the Company. 21. Subsidiaries of the Company. The following sets forth the name and jurisdiction of incorporation of each subsidiary of the Company. All of such subsidiaries are wholly-owned by the Company. NAME JURISDICTION OF INCORPORATION --------------------------- ------------------------------- VANGUARD BIOSCIENCES, INC. TEXAS VELDONA USA, INC. TEXAS VELDONA AFRICA, INC. TEXAS VELDONA POLAND, INC. TEXAS ABI TAIWAN, INC. TEXAS AMARILLO CELL OF CANADA, INC. TEXAS 99.1 906 Certification *The Exhibit is incorporated by reference to the exhibit of the same number to the Company's Registration Statement on Form SB-2 filed with and declared effective by the Commission (File No. 333-4413) on August 8, 1996. **The Exhibit is incorporated by reference to the Company's 1997 Annual Report on Form 10-KSB filed with the Commission on or before March 31, 1998. ***The Exhibit is incorporated by reference to the Company's 1998 Annual Report on Form 10-KSB filed with the Commission on or before March 31, 1999. +The Exhibit is incorporated by reference to the Company's Report on Form 10-QSB for the quarterly period ended June 30, 1999, filed with the Commission on August 12, 1999 and subsequently amended on September 13, 1999. ++The Exhibit is incorporated by reference to the Company's 2000 Annual Report on Form 10-KSB filed with the Commission on or before April 16, 2001. +++ The Exhibit is incorporated by reference to the Company's Report on Form 8-K filed with the Commission on September 24, 2001. aPortions of this exhibit have been omitted and filed separately with the commission. 23 REPORTS ON FORM 8-K None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AMARILLO BIOSCIENCES, INC. By: /s/ Joseph M. Cummins ------------------------------------------ Joseph M. Cummins, Chairman of the Board, President, Chief Financial Officer and Chief Executive Officer Date: April 28, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature ---------
Title Date /s/ ----- ------ ------------------------------------------------------------ Chairman of the Board, April 28, 2004 Joseph M. Cummins President, Chief Financial Officer, --------------------- Director and Chief Executive Officer /s/ Director April 29, 2004 ------------------------------------------------------------ ---------------------------------------- --------------------- Stephen T. Chen /s/ Director April 29, 2004 ------------------------------------------------------------ ---------------------------------------- --------------------- James Cook /s/ Director April 29, 2004 ------------------------------------------------------------ ---------------------------------------- --------------------- Katsuaki Hayashibara /s/ Director April 29, 2004 ------------------------------------------------------------ ---------------------------------------- --------------------- Dennis Moore /s/ Director April 29, 2004 ------------------------------------------------------------ ---------------------------------------- --------------------- James A. Page
24 Amarillo Biosciences, Inc. and Subsidiaries Consolidated Financial Statements Year ended December 31, 2003 Contents Report of Independent Auditors ..............................................F-1 Audited Consolidated Financial Statements Consolidated Balance Sheet ..................................................F-2 Consolidated Statements of Operations .......................................F-3 Consolidated Statements of Stockholders' Deficit ............................F-4 Consolidated Statements of Cash Flows .......................................F-5 Notes to Consolidated Financial Statements ..................................F-6 Report of Malone & Bailey, PLLC Independent Auditors The Board of Directors Amarillo Biosciences, Inc. We have audited the accompanying consolidated balance sheet of Amarillo Biosciences, Inc. and subsidiaries as of December 31, 2003, and the related consolidated statements of operations, stockholders' deficit and cash flows for each of the two years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audits, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Amarillo Biosciences, Inc. and subsidiaries as of December 31, 2003, and the consolidated results of their operations and their cash flows for each of the two years then ended, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the financial statements, the Company's recurring losses from operations and the need to raise additional financing in order to execute its 2004 Plan raise doubt about its ability to continue as a going concern. (Management's plans as to these matters are also described in Note 1.) The 2003 financial statements do not include any adjustments that might result from the outcome of this uncertainty. MALONE & BAILEY, PLLC Houston, Texas April 16, 2004 F-1 Amarillo Biosciences, Inc. and Subsidiaries Consolidated Balance Sheet December 31, 2003 ASSETS Current assets: Cash $ 11,300 Other current assets 5,572 --------------- Total current assets 16,872 Equipment, net 2,106 Patents, net of accumulated amortization of $151,689 155,521 --------------- Total assets $ 174,499 =============== LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable $ 159,844 Accrued interest expense 356,886 Accrued payroll 69,543 Other accrued expense 6,211 Current maturities of long term debt 1,045,000 --------------- Total current liabilities 1,637,484 Notes payable to stockholders 1,059,000 --------------- Total liabilities 2,696,484 Commitments and contingencies Stockholders' Deficit Preferred stock, $.01 par value: Authorized shares - 10,000,000 Issued shares - none - Common stock, $.01 par value: Authorized shares - 20,000,000 Issued shares - 11,060,017 in 2003 110,600 Additional paid-in capital 19,279,417 Accumulated deficit (21,912,001) --------------- Total stockholders' deficit (2,521,985) --------------- Total liabilities and stockholders' deficit $ 174,499 =============== See accompanying summary of significant accounting policies and notes to consolidated financial statements. F-2 Amarillo Biosciences, Inc. and Subsidiaries Consolidated Statements of Operations
YEARS ENDED DECEMBER 31, -------------------------------- 2003 2002 ------------------------------- Revenues: Dietary supplement sales $ 26,927 $ 10,942 Interferon sales 10,000 - Interest income - 1,740 Federal research grant 6,586 48,342 Sublicense fees - 10,000 Gain on sale of intangible assets 50,298 Other 5,784 8,707 99,595 79,730 ------------------------------- Expenses: Cost of sales 4,012 650 Research and development expenses 173,345 382,880 Selling, general and administrative expenses 394,772 302,977 Interest expense 97,956 99,045 Loss on dissolution of subsidiary 1,000 -- Impairment of intangible assets 50,298 -- Gain on sale of building and equipment (37,454) -- Reversal of accrued contingent liability (750,965) -- ------------------------------- (67,036) 785,552 ------------------------------- Net income (loss) $ 166,631 $ (705,822) =============================== Basic and diluted net income (loss) per share $ 0.02 (0.08) =============================== Weighted average shares outstanding 9,800,073 8,864,277 ===============================
See accompanying summary of significant accounting policies and notes to consolidated financial statements. F-3 Amarillo Biosciences, Inc. and Subsidiaries Consolidated Statements of Stockholders' Deficit Years Ended December 31, 2003 and 2002
COMMON STOCK ADDITIONAL TOTAL ISSUANCE ---------------------- PAID IN ACCUMULATED STOCKHOLDERS' PRICE SHARES AMOUNT CAPITAL DEFICIT DEFICIT ------------------------------------------------------------------------------------ Balance at December 31, 2001 7,912,405 $ 79,124 $ 18,454,599 $ (21,373,811) $ (2,840,088) Net loss for year ended December 31, 2002 -- -- -- (705,822) (705,822) Issuance of common stock for cash in private placement, net of expenses 0.500 1,000,000 10,000 440,000 -- 450,000 Issuance of common stock for cash in private placement 0.360 81,667 817 28,583 -- 29,400 --------------------------------------------------------------------- Balance at December 31, 2002 8,994,072 $ 89,941 $ 18,923,182 $ (22,079,633) $ (3,066,510) Net income for year ended December 31, 2003 -- -- -- $ 166,631 $ 166,631 Issuance of common stock for services 0.35-0.44 455,000 4,550 164,150 -- 168,500 Issuance of common stock for cash in private placements 0.060-0.301 1,500,945 15,009 186,585 -- 201,594 Exercise of options for cash 0.060 110,000 1,100 5,500 -- 6,600 Loss on dissolution of subsidiary -- -- -- -- (1,000) --------------------------------------------------------------------- Balance at December 31, 2003 11,060,017 $ 110,600 $ 19,279,417 $ (21,912,001) $ (2,521,985) =====================================================================
See accompanying summary of significant accounting policies and notes to consolidated financial statements. F-4 Amarillo Biosciences, Inc. and Subsidiaries Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31, 2003 2002 ----------------------- OPERATING ACTIVITIES Net income (loss) $ 166,631 $ (705,822) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 22,145 22,831 Loss on obsolete inventory -- 48,639 Gain on sale of assets (37,453) (2,560) Reversal of accrued liability (750,965) -- Common stock issued for services 168,500 -- Changes in operating assets and liabilities: Other current assets 4,468 41,366 Accounts payable 33,797 (2,548) Accrued expenses 117,515 55,961 ----------------------- Net cash used in operating activities (275,362) (542,133) ----------------------- INVESTING ACTIVITIES Proceeds from sale of assets 117,485 9,225 Purchase of equipment (3,056) (7,359) Patents (12,303) (46,548) ----------------------- Net cash used in investing activities 102,126 (44,682) ----------------------- FINANCING ACTIVITIES Proceeds from notes payable 63,844 45,000 Repayments of notes payable (87,602) (5,803) Issuance of common stock 208,194 479,400 ----------------------- Net cash provided by financing activities 184,436 518,597 ----------------------- Net decrease in cash 11,200 (68,218) Cash at beginning of period 100 68,318 ----------------------- Cash at end of period $ 11,300 $ 100 ======================= SUPPLEMENTAL INFORMATION Cash paid for income taxes -- -- Cash paid for interest $ 11,142 $ 9,045 =======================
See accompanying summary of significant accounting policies and notes to consolidated financial statements. F-5 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BUSINESS Amarillo Biosciences, Inc. (the "Company" or "ABI"), a Texas corporation formed in 1984, is engaged in developing biologics for the treatment of human and animal diseases. The Company is continuing its clinical studies as part of the process of obtaining regulatory approval from the United States Food and Drug Administration ("FDA"), so that commercial marketing can begin in the United States. The Company has developed a dietary supplement and an interferon alpha lozenge, but have not commenced any significant product commercialization activities. The Company's viability is dependent upon successful commercialization of products resulting from its research and product development activities. The Company plans on working with commercial development partners in the United States and in other parts of the world to provide the necessary sales, marketing and distribution infrastructure to successfully commercialize the interferon alpha product for both human and animal applications. All of the Company's products will require significant additional development, laboratory and clinical testing and investment prior to the Company obtaining regulatory approval to commercially market its product(s). Accordingly, for at least the next few years, the Company will continue to incur research and development and general and administrative expenses and may not generate sufficient revenues from product sales to support its operations. The Company has been dependent upon financing from its stockholders. The Company's activities have been financed primarily through the issuance of common stock, and under an agreement with a major stockholder, and its initial public offering. The Company's 2004 Plan of Operations calls for the Company to expend approximately $500,000 in 2004. At December 31, 2003, the Company had available cash of $11,300 and negative working capital of approximately ($575,611). The Company's continued losses and lack of liquidity indicate that the Company may not be able to continue as a going concern for a reasonable period of time. The Company's ability to continue as a going concern is dependent upon several factors including, but not limited to, the Company's ability to generate sufficient cash flows to meet its obligations on a timely basis, obtain additional financing and continue to obtain supplies and services from its vendors. The Company will need to raise additional funds in order to execute its 2004 Plan. The Company is presently negotiating with human health and animal health commercial development partners in various regions of the world including the United States, Canada, Europe and the Middle East. The Company believes that one or more of these agreements will be executed during 2004. These agreements could generally include provisions for the commercial partner to pay ABI a technology access fee, could include payments for a portion of the clinical trial expenses, could include payment obligations to ABI upon the accomplishment of certain defined tasks and/or could provide for payments relating to F-6 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 the future sales of commercial product. These agreements could be an important source of funds for ABI. However, there can be no assurance that the Company will be successful in obtaining additional funding from either human health and animal health commercial development partners or private investors. If the Company is not successful in raising additional funds, it will need to significantly curtail clinical trial expenditures and to further reduce staff and administrative expenses and may be forced to cease operations. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Amarillo Cell of Canada, Inc., Veldona Africa, Inc., Veldona Poland, Inc., Veldona USA, Inc., Vanguard Biosciences, Inc. and ABI Taiwan, Inc. (all Texas corporations). All significant intercompany balances and transactions have been eliminated in consolidation. The effect of translation of foreign currencies is not material. Veldona USA, Inc. ("Veldona"), an inactive subsidiary of the Company, was formally dissolved on September 26, 2003. Prior to formal dissolution, an assignment was entered into between the Company and Veldona that allowed the Company to buy from Veldona all of its previous and existing Investigative New Drug applications, ("INDs") for $50,298. This transaction resulted in the Company recognizing the INDs as an intangible asset on its balance sheet and Veldona recognizing a gain on the sale. The Company purchased the INDs from Veldona based on their probable use in the future, with no current plans of their utilization, therefore, the Company subsequently expensed the cost of the INDs as an impairment loss. Also prior to the dissolution of Veldona and with legal advice, a long-term accrued contingent liability of $750,965 recorded in accounts payable was reversed into income in September 2003. This reversal resulted in the recognition of net income for the twelve months ended December 31, 2003. Without this reversal, the Company would have reported a consolidated net loss of $584,334 for the twelve months ended December 31, 2003. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. F-7 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is calculated using methods that approximate the declining balance method over the estimated useful lives of the assets. PATENTS; PATENT EXPENDITURES ABI holds patent license agreements and also holds patents which are owned by the Company. All patent license agreements remain in effect over the life of the underlying patents. Accordingly, the patent license fee is being amortized over 15-17 years using the straight-line method. Patent fees and legal fees associated with the issuance of new owned patents are capitalized and amortized over 15-17 years. INCOME TAXES The asset and liability approach is used to account for income taxes by recognizing deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. The Company records a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. REVENUE RECOGNITION Contract revenue for research and development performed under the manufacturing and supply agreement with Hayashibara Biochemical Laboratories, Inc. ("HBL") (see Note 4) was recorded as earned based on research and administrative costs incurred. Sales, reimbursement income, sublicense fees, etc. are recognized upon receipt of payment. RESEARCH AND DEVELOPMENT Research and development costs are expensed as incurred. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-8 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 STOCK-BASED COMPENSATION The Company accounts for stock-based compensation under the intrinsic value method. Under this method, the Company recognizes no compensation expense for stock options granted when the number of underlying shares is known and exercise price of the option is greater than or equal to the fair market value of the stock on the date of grant. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The expense amounts for 2003 and 2002 are not necessarily indicative of the effects on reported net income (loss) for future years. The Company's pro forma information as of December 31, is as follows:
2003 2002 ---------------------------------- Pro forma net loss $ 145,284 $ (745,027) Pro forma basic and diluted net loss per share $ (0.01) $ (0.08)
Based on the Black-Scholes method, the fair value of the options granted during the year ended December 31, is as follows:
2003 2002 ---------------------------------- Number of options issued at fair market value of stock 782,037 640,000 Weighted-average fair value of options $0.42 $0.06 Weighted-average exercise price of options $0.42 $0.08
BASIC AND DILUTED NET LOSS PER SHARE Net loss per share is based on the number of weighted average shares outstanding. The effect of warrants and options outstanding (see Notes 7 and 8) is anti-dilutive. F-9 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 2. EQUIPMENT Equipment is stated at cost and consists of the following: December 31, ------------- 2003 ------------- Land $ -- Building -- Furniture and equipment 67,029 ------------- 67,029 Less accumulated depreciation 64,923 ------------- $ 2,106 ============= 3. NOTES PAYABLE The Company had a loan agreement with HBL, which called for HBL to loan the Company $3,000,000 to be advanced in three installments. The annual interest rate on unpaid principal from the date of each respective advance was 4 1/2%, with accrued interest being payable at the maturity of the note. $1,000,000 is payable on or before July 22, 2004, or on or before the expiration of one (1) year after approval of the Company's product by the FDA, whichever occurs first. The other $1,000,000 is due on or before February 29, 2005, or on or before the expiration of one year after approval of the Company's product by the FDA, whichever occurs first. On September 30, 1999, the Company entered into an Agreement to Convert Debt with HBL regarding the above described note payable to HBL in the then principal amount of $1,000,000, the first loan installment having by then been advanced. On October 15, 1999, pursuant to the Agreement to Convert Debt, HBL canceled the then note balance in exchange for 1,111,831 shares of common stock of the Company valued at the then market value of $0.9044 per share. This stock conversion leaves the Company owing HBL a principal amount of $2,000,000 plus accrued interest. On June 6, 2001 the Company borrowed $90,000 under a real estate lien note agreement collateralizing the Company's building with Apple Cattle Company, a Texas general partnership. The annual interest rate on unpaid principal is 10% , due and payable in monthly installments of $1,660, including escrow for taxes and insurance of $471, continuing until June 6, 2011. The building was sold on February 14, 2003 for a sales price of $137,500. The real estate lien note was paid off at closing. Effective November 1, 2002 the Company executed a Promissary Note for $45,000 payable to an individual stockholder. The Promissary Note accrues interest at the rate per year that will be F-10 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 the lesser of 3% in excess of the prime interest rate published from time to time in the Wall Street Journal, adjusted on the first day of each calendar month based on such rate then in effect, or the maximum nonusurious rate of interest permitted by applicable law. Accrued interest is payable monthly, in arrears and the entire principal amount is payable October 31, 2004. The Note Holder is granted the right to purchase, within the next 3 years, up to 30,000 shares of stock at an exercise price of $0.15 per share. Effective March 21, 2003 the Company executed a second Promissary Note for $45,000 payable to the same individual stockholder. The Promissary Note accrues interest at the rate per year that will be the lesser of 3% in excess of the prime interest rate published from time to time in the Wall Street Journal, adjusted on the first day of each calendar month based on such rate then in effect, or the maximum nonusurious rate of interest permitted by applicable law. Accrued interest is payable monthly, in arrears and the entire principal amount is payable March 20, 2005. The Note Holder is granted the right to purchase, within the next 3 years, up to 50,000 shares of stock at an exercise price of $0.06 per share. Subsequent events. January 27, 2004 the Company borrowed $5,000 from the above mentioned individual stockholder. February 6, 2004 the Company borrowed an additional $5,000 from the above mentioned individual stockholder. This $10,000 has been added to the Promissory Note above and interest is calculated and paid in accordance with the terms stated above. On October 10, 2003 and December 31, 2003, unsecured loans totaling $14,000 were received from an individual stockholder. Subsequently, on February 26, 2004, $10,500 of that money was used to purchase private placement shares of the Company. The Company is still in debt to the stockholder for $3,500. 4. MANUFACTURING AND SUPPLY AGREEMENTS The Company was a party to the following manufacturing and supply agreements at December 31, 2003: The Company has a Joint Development and Manufacturing/Supply Agreement with HBL (the Development Agreement), a major stockholder under which HBL will formulate, manufacture and supply HBL interferon for the Company or any sublicensee. In exchange, HBL is entitled to receive a transfer fee, specified royalties and a portion of any payment received by the Company for sublicense of rights under this agreement. The agreement further provides that the Company sublicense to HBL the right to market HBL interferon for oral use in humans and in non-human, warm-blooded species in Japan, in exchange for the Company receiving a royalty fee based on net sales. The Company is the exclusive agent for the development of HBL interferon for non-oral use in humans and in non-human, warm-blooded species in North America, in exchange, HBL is entitled to receive a transfer fee based on units of interferon supplied and the agreement also F-11 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 provides that a royalty fee be paid to HBL. As part of the License Agreement with Atrix Laboratories, Inc. (executed September 7, 2001, terminated May 22, 2003) a second amendment to the Development Agreement was executed extending the Development Agreement to March 12, 2005 and will be renewed automatically for successive three-year terms. The Company has a supply agreement with HBL under which the Company gained an exclusive right to purchase and distribute anhydrous crystalline maltose for the treatment of dry mouth (xerostomia). This exclusive supply agreement is worldwide, except Japan. 5. LICENSE AND SUBLICENSE AGREEMENTS The Company holds patent rights for which the Company has paid certain license fees under three license agreements. Under these agreements, the Company will pay the licensor a portion of any sublicense fee received by the Company with respect to the manufacturing, use or sale of a licensed product, as well as a royalty fee based on the net selling price of licensed products, subject to a minimum annual royalty. The Company has also entered into various sublicense agreements under which the Company is entitled to receive royalties based on the net sales value of licensed products. 6. RESEARCH AGREEMENTS The Company contracts with third parties throughout the world to conduct research including studies and clinical trials. These agreements are generally less than one year in duration. 7. COMMON STOCK The Company has 20,000,000 shares of voting common shares authorized for issuance and 10,000,000 shares of preferred stock authorized for issuance which is issuable in series. To date, no preferred stock has been issued. The Company has 2,228,884 shares of common stock reserved for issuance upon exercise of options and warrants granted. In 2003, the Company sold 1,500,945 unregistered shares of its voting common stock in private placement offerings. Of these sales, 300,000 shares were sold for $0.08333 per share; 100,000 shares for $0.10 per share; 250,000 shares for $0.105 per share; 500,000 shares for $0.12 per share; 54,400 shares for $0.25 per share; 30,000 shares for $0.25480 per share; 30,000 shares for $0.27 per share and 36,545 for $0.301 per share, generating $201,594 in cash. The Company completed a private placement in January 2002 pursuant to which it sold 1,000,000 shares of its voting common stock at $.50 per share, for a total of $500,000. After deducting F-12 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 selling commission of $45,000 paid to First Island Capital, Inc., and other offering costs of $5,000, the net proceeds to the Company were $450,000. The Company has 63,200 warrants to purchase common stock through April 11, 2005 at $3.125 per share and warrants to purchase common stock at $3.75 per share. Accordingly, the Company has reserved an additional 126,400 shares of its common stock to satisfy the possible future exercise of such warrants. 8. STOCK OPTION PLAN The Company has elected to follow APB 25 and related interpretations in accounting for its stock-based compensation. Under APB 25, because the exercise price of the Company's stock options has been equal to or greater than the market price of the underlying stock on the date of grant, no compensation expense has been recognized. The Company has two stock option plans: the 1996 Employee Stock Option Plan (Employee Plan) and the Outside Director and Advisor Stock Option Plan (Director Plan). The Employee Plan has authorized the grant of options to employees for up to 590,000 shares of the Company's common stock. All options granted have five to ten year terms and become exercisable over a four to five year period. The option price is equal to 100% to 110% of the fair value of the common stock on the date of grant depending on the percentage of common stock owned by the optionee on the grant date. The Director Plan allows options to purchase a maximum of 410,000 shares of the Company's common stock to be granted to outside directors and scientific advisors to the Company at an exercise price equivalent to 100% of the fair market value of the common stock on the date of grant. These are ten-year options and become exercisable over a period of five years. On September 26, 2003, the Board of Directors passed a resolution approving 788,437 options be granted to persons named in the resolution, effective upon relinquishment by each of an equal number of options currently owned, such new options to be exercisable for a period of five years from grant, at an exercise price equal to the closing price of the Company's stock on the OTC BB on the last business date preceding the date of grant. Of the 788,437 options approved, 768,437 options were issued, with exercise prices ranging from $0.35 to $0.51 per share. Additionally, 13,600 non-qualified options were granted to Directors for consulting services rendered. The 13,600 non-qualified options have an exercise price of $0.44 per share and are exercisable over five years. All such options vested immediately. Supplemental information regarding net loss and net loss per share is required by SFAS 123 and has been determined as if the Company had accounted for its stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions F-13 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 for 2003 and 2002, respectively: risk-free interest rate of 3.00% and 4.10%; dividend yield of 0% and 0%; volatility factors of the expected market price of the Company's common stock of 166% and 106%; and a weighted-average expected life of the option of 5 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The expense amounts for 2003 and 2002 are not necessarily indicative of the effects on reported net income (loss) for future years. The Company's pro forma information as of December 31, is as follows: F-14 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003
2003 2002 ------------------------------------ Pro forma net loss $ 145,284 $ (745,027) Pro forma basic and diluted net loss per share $ (0.01) $ (0.08)
Based on the Black-Scholes method, the fair value of the options granted during the year ended December 31, is as follows:
2003 2002 ------------------------------------ Number of options issued at fair market value of stock 782,037 640,000 Weighted-average fair value of options $0.42 $0.06 Weighted-average exercise price of options $0.42 $0.08
A summary of the Company's stock option activity and related information for the year ended December 31, is as follows:
2003 2002 --------------------------------------------------------------- Weighted Weighted Average Average Exercise Exercise Options Price Options Price --------------------------------------------------------------- Outstanding, beginning of year 1,562,776 $0.98 997,187 $1.76 Granted 782,037 0.42 711,589 0.12 Canceled (473,125) 0.54 (146,000) 0.98 Exercised -- -- -- -- Outstanding, end of year 1,871,688 $0.54 1,562,776 $0.98 ============ ============= Exercisable at end of year 1,871,688 $0.54 1,521,653 $0.97 ============ =============
Exercise prices for options outstanding as of December 31, 2003 ranged from $0.06 to $5.00. Of these options, 10,000 have exercise prices ranging from $4.00 to $5.00 and the remainder range from $0.06 to $1.63. The weighted-average remaining contractual life of those options is 5.03 years. 9. EMPLOYEE BENEFIT PLAN The Company has a Simplified Employee Pension Plan (the Plan), which is a F-15 Amarillo Biosciences, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 contributory plan that covers all employees of the Company. Contributions to the Plan are at the discretion of the Company. The plan expense for the years ended December 31, 2003 and 2002, were $0, and $0, respectively. 10. INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting purposes. The Company's deferred tax asset of approximately $6,500,000 and $7,000,000 at December 31, 2003 and 2002 respectively, was subject to a valuation allowance of $6,500,000 and $7,000,000 at December 31, 2003 and 2002 respectively, because of uncertainty regarding the Company's ability to realize future tax benefits associated with the deferred tax assets. Deferred tax assets were comprised primarily of net operating loss carryovers under the cash method of accounting used by the Company for federal income tax reporting. At December 31, 2003, the Company has net operating loss carryforwards of approximately $19,100,000 for federal income tax purposes expiring in 2006 through 2023. The ability of the Company to utilize these carryforwards may be limited should changes in stockholder ownership occur. The difference between the reported income tax provision and the benefit normally expected by applying the statutory rate to the loss before income taxes results primarily from the inability of the Company to recognize its tax losses. 11. CONTINGENCIES The Company is not a party to any litigation and is not aware of any pending litigation or unasserted claims or assessments as of December 31, 2003. 12. RELATED PARTY TRANSACTIONS In the ordinary course of business, the Company has and expects to have transactions with related parties, including stockholders. In addition to the transactions disclosed elsewhere in these financial statements, during 2003 the Company has used the law firm of SandersBaker, P.C. Mr. Edward Morris, Secretary of the Company, is a partner in that firm. The Company was invoiced $22,686 during 2003 for legal services rendered by SandersBaker. F-16