**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      DC 20549**





**FORM
      10-Q**




(Mark
      One)


x
            QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934




For
      the
      quarterly period ended September 30, 2008




OR




o
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934




For
      the
      transition period from ______________________________ to
      ______________________________




Commission
      file number 0-19724





**PROTEIN
      POLYMER**


**TECHNOLOGIES,
      INC.**


(Exact
      name of registrant as specified in its charter)





Delaware
            33-0311631(State
                or other jurisdiction of
              incorporation
                or organization)
            (I.R.S.
                Employer Identification No.)





11494
      Sorrento Valley Road, San Diego, CA 92121


(Address
      of principal executive offices) (Zip Code)




(858)
      558-6064


(Registrant’s
      telephone number, including area code)





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





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




Large
                accelerated filero
            Accelerated
                filero
            Non-accelerated
                filero
              (Do
                not check if a smaller reporting company)
            Smaller
                reporting companyþ





Indicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act). YES o NO þ





The
      number of shares of the registrant’s common stock issued and outstanding as of
      November 17, 2008 was 108,450,343.










**PROTEIN
      POLYMER TECHNOLOGIES, INC.**




**FORM
      10-Q — QUARTERLY REPORT**


**FOR
      THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008**




**TABLE
      OF CONTENTS**


**Page****PART
                I. FINANCIAL INFORMATION**Item
                1.
            Financial
                StatementsCondensed
                Balance Sheets as of September 30, 2008 (unaudited) and December
                31,
                2007
            3Condensed
                Statements of Operations for the Three and Nine Months Ended September
                30,
                2008 and 2007 (unaudited)
            4Condensed
                Statements of Cash Flows for the Six Months ended September 30, 2008
                and
                2007 (unaudited)
            5Notes
                to Condensed Financial Statements (unaudited)
            6Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            17Item
                3.
            Quantitative
                and Qualitative Disclosures about Market Risk
            21Item
                4T.
            Controls
                and Procedures
            21**PART
                II****.
                OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            23Item
                1A.
            Risk
                Factors
            23Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            23Item
                3.
            Defaults
                Upon Senior Securities
            23Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            23Item
                5.
            Other
                Information
            23Item
                6.
            Exhibits
            24**SIGNATURES**
            25Exhibit
                10.6.4Exhibit
                10.6.5Exhibit
                31.1Exhibit
                31.2Exhibit
                32.1Exhibit
                32.2


2


**PART
      I — FINANCIAL INFORMATION**





**Item 1.
      Financial Statements**





**Protein
      Polymer Technologies, Inc.**


**Condensed
      Balance Sheets**





September 30
            
            December 312008 (unaudited)
            
            2007AssetsCurrent
                assets:Cash
            
            $
            1,560
            
            $
            21,936Prepaid
                expenses and other current assets
            
            
            59,011
            
            
            33,419Total
                current assets
            
            
            60,571
            
            
            55,355Deposits
            
            
            29,679
            
            
            29,679Equipment
                and leasehold improvements, net
            
            
            28,311
            
            
            128,100Investment
            
            
            520,000
            
            
            520,000Total
                assets
            
            $
            638,561
            
            $
            733,134Liabilities
                and stockholders' deficitCurrent
                liabilities:Accounts
                payable
            
            $
            942,338
            
            $
            827,626Accrued
                liabilities
            
            
            746,314
            
            
            794,312Secured
                note payable - related party, net of unamortized debt
                discount
            
            
            6,414,837
            
            
            5,876,000Current
                maturities of notes payable
            
            
            519,071
            
            
            419,071Total
                current liabilities
            
            
            8,622,560
            
            
            7,917,009Notes
                payable, net of current maturities
            
            
            —
            
            
            100,000Total
                liabilities
            
            
            8,622,560
            
            
            8,017,009Commitments
                and contingencies (Note 9)Stockholders'
                deficit:Convertible
                preferred stock, $0.01 par value; 5,000,000 shares authorized; 65,646
                shares issued and outstanding at September 30, 2008 and December
                31, 2007
                - liquidation preference of $9,677,215 and $9,464,500 at September
                30,
                2008 and December 31, 2007, respectively.
            
            
            6,019,917
            
            
            6,019,917Common
                stock, $0.01 par value; 1,000,000,000 shares authorized; 108,762,528
                and
                73,722,232 shares issued and outstanding at September 30, 2008
                and December 31, 2007, respectively
            
            
            1,087,625
            
            
            737,222Additional
                paid-in capital
            
            
            57,670,632
            
            
            56,227,221Accumulated
                deficit
            
            
            (72,762,173
            )
            
            (70,268,235)
            )Total
                stockholders' deficit
            
            
            (7,983,999
            )
            
            (7,283,875)
            )Total
                liabilities and stockholders’ deficit
            
            $
            638,561
            
            $
            733,134





*The
      accompanying notes are an integral part of these financial statements*


3


**Protein
      Polymer Technologies, Inc.**


**Condensed
      Statements of Operations**


**(unaudited)**




Three months ended
            
            Nine months endedSeptember 30,
            
            September 30,2008
            
            2007
            
            2008
            
            2007Revenues:Contract
                revenue
            
            $
            —
            
            $
            14,500
            
            $
            —
            
            $
            282,118Product
                and other income
            
            
            17,213
            
            
            —
            
            
            23,968
            
            
            —Total
                revenues
            
            
            17,213
            
            
            14,500
            
            
            23,968
            
            
            282,118Operating
                expenses:Research
                and development
            
            
            127,721
            
            
            438,858
            
            
            1,253,211
            
            
            1,712,011Selling,
                general and administrative
            
            
            236,570
            
            
            452,996
            
            
            748,062
            
            
            1,124,294Total
                expenses
            
            
            364,291
            
            
            891,854
            
            
            2,001,273
            
            
            2,836,305Net
                loss from operations
            
            
            (347,078
            )
            
            (877,354
            )
            
            (1,977,305
            )
            
            (2,554,187
            )Other
                income (expense):Interest
                and other income
            
            
            194
            
            
            —
            
            
            194
            
            
            145Interest
                and other expense
            
            
            (183,029
            )
            
            (126,113
            )
            
            (561,271
            )
            
            (331,456
            )Gain
                on sale of equipment
            
            
            —
            
            
            —
            
            
            40,646
            
            
            9,510Gain
                on settlement
            
            
            —
            
            
            —
            
            
            —
            
            
            193,917Total
                other income (expense)
            
            
            (182,835
            )
            
            (126,113
            )
            
            (520,431
            )
            
            (127,884
            )Net
                loss
            
            
            (529,913
            )
            
            (1,003,467
            )
            
            (2,497,736
            )
            
            (2,682,071
            )Undeclared,
                imputed and/or paid dividends on preferred stock
            
            
            69,789
            
            
            69,980
            
            
            207,850
            
            
            215,983Net
                loss applicable to common shareholders
            
            $
            (599,702
            )
            $
            (1,073,447
            )
            $
            (2,705,586
            )
            $
            (2,898,054
            )Basic
                and diluted net loss per common share
            
            $
            (0.01
            )
            $
            (0.02
            )
            $
            (0.03
            )
            $
            (0.04
            )Weighted
                average number of common shares outstanding – basic and
                diluted
            
            
            105,944,857
            
            
            67,809,204
            
            
            93,614,046
            
            
            68,113,966




*The
      accompanying notes are an integral part of these financial statements*


4


**Protein
      Polymer Technologies, Inc.**


**Condensed
      Statements of Cash Flows**


**(unaudited)**




Nine monthsEndedSeptember 30
              
              September 302008
              
              2007**Operating
                  activities**Net
                  loss
              
              $
              (2,497,736
              )
              $
              (2,682,071
              )**Adjustments
                  to reconcile net loss to net cash used for operating
                  activities:**Depreciation
              
              
              39,435
              
              
              75,914Share-based
                  compensation expense
              
              
              7,164
              
              
              142,715Debt
                  discount amortization
              
              
              135,449
              
              
              —Gain
                  on sale of equipment
              
              
              (40,646
              )
              
              —**Changes
                  in operating assets and liabilities:**Prepaid
                  expenses and other current assets
              
              
              (25,592
              )
              
              43,933Rent
                  receivable
              
              
              —
              
              
              39,527Accounts
                  payable
              
              
              114,711
              
              
              (395,169
              )Accrued
                  liabilities
              
              
              490,839
              
              
              345,738**Net
                  cash used for operating activities**
              
              
              (1,776,376
              )
              
              (2,429,413
              )**Investing
                  activities:**Proceeds
                  from sale of equipment
              
              
              101,000
              
              
              —**Net
                  cash provided by investing activities**
              
              
              101,000
              
              
              —**Financing
                  activities:**Net
                  proceeds from sale of common stock
              
              
              1,655,000
              
              
              —Proceeds
                  from issuance of debt - related party
              
              
              —
              
              
              2,414,484**Net
                  cash provided by financing activities**
              
              
              1,655,000
              
              
              2,414,484**Net
                  decrease in cash**
              
              
              (20,376
              )
              
              (14,929
              )Cash
                  at beginning of the period
              
              
              21,936
              
              
              73,495**Cash
                  at end of the period**
              
              $
              1,560
              
              $
              58,566**Supplemental
                  disclosures of cash flow information**Interest
                  paid
              
              $
              2,129
              
              $
              4,738**Non
                  cash investing and financing activity**Issuance
                  of common stock in settlement of indemnification
                  obligation
              
              $
              —
              
              $
              61,067Debt
                  discount recorded in connection with issuance/amendment of
                  warrants
              
              $
              135,449
              
              $
              —Secured
                  note payable-related party issued for payment of accrued
                  interest
              
              $
              538,837
              
              $
              —





*The
      accompanying notes are an integral part of these financial statements*


5


**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





**Note
                1.**
            **Basis
                of Presentation and Summary of Significant Accounting
                Policies**





The
      accompanying unaudited condensed financial statements have been prepared in
      accordance with U.S. generally accepted accounting principles and the rules
      and
      regulations of the Securities and Exchange Commission (“SEC”) related to a
      quarterly report on Form 10-Q under the modified rules and regulations for
      “Smaller Reporting Companies”. Accordingly, they do not include all of the
      information and disclosures required by U.S. generally accepted accounting
      principles for complete financial statements. However, the Company believes
      that
      the condensed financial statements, including the disclosures herein, include
      all adjustments necessary in order to make the financial statements presented
      not misleading. The balance sheet as of December 31, 2007 was derived from
      the
      Company’s audited financial statements. The financial statements herein should
      be read in conjunction with our financial statements and notes thereto included
      in our Annual Report on Form 10-KSB for the year ended December 31, 2007, as
      filed with the U.S. Securities and Exchange Commission. The results of
      operations for the three and nine months ended September 30, 2008 are not
      necessarily indicative of the results expected for the fiscal year ending
      December 31, 2008.





***Going
      Concern and Liquidity***





The
      accompanying financial statements have been prepared on a going concern basis,
      which contemplates the realization of assets and the satisfaction of liabilities
      in the normal course of business. For the nine months ended September 30, 2008,
      the Company incurred a net loss of approximately $2.5 million and at September
      30, 2008, the Company had a working capital deficit of approximately $8.6
      million. Our cash balance as of September 30, 2008 was $1,560 and, in
      combination with anticipated additional contract and license payments, are
      insufficient to meet our ongoing capital requirements.





From
      January 1, 2008 through September 30, 2008, required operating capital has
      been
      obtained through proceeds totaling $1,655,000 from equity purchases of common
      stock and warrants pursuant to a Stock Purchase Agreement entered into as of
      September 27, 2007. Between September 27, 2007 and December 31, 2007, the
      Company received proceeds of $570,000 for the purchase of 5,913,028 shares
      of common stock and 5,913,028 warrants pursuant to this Stock Purchase
      Agreement. Between October 1, 2008 and November 17, 2008, the Company received
      proceeds of $20,000 for the purchase of 608,295 shares of common stock and
      608,295 warrants pursuant to this Stock Purchase Agreement.





Effective
      January 9, 2008, the Company converted a related party note payable with an
      outstanding principal balance of $5,876,000 plus accrued interest totaling
      $539,000, to a new note payable agreement, with a scheduled maturity date of
      September 1, 2008, in the principal amount of $6,415,000. On September 1, 2008,
      the scheduled maturity date of this note payable agreement was extended to
      March
      31, 2009.





On
      October 2, 2008 and November 3, 2008, the Company received proceeds of $100,000
      and $105,000, respectively, as loans. These loans are represented by unsecured
      notes issued by the Company. These notes are due on October 2, 2009 and November
      3, 2009, respectively, and bear an annual interest rate of 8%. The interest
      and
      principal are payable on the maturity dates, either in cash or common stock
      at a
      rate of $0.05 and $0.04 per share respectively, at the discretion of the
      Company. As consideration for the loans, the Company granted warrants to the
      noteholders to purchase an aggregate of 2,000,000 and 2,625,000 shares,
      respectively, of the Company’s common stock at an exercise price of $0.05 and
      $0.04 per share, respectively.





Management
      is currently in discussion with other potential financing sources and
      collaborative partners and is investigating other funding in the form of equity
      investments and license fees. If adequate funds are not available, the Company
      will be required to significantly curtail operations, sell or license out
      significant portions of its technology, or possibly cease operations. The
      financial statements do not include any adjustments that might result should
      the
      Company be unable to continue as a going concern.


6


**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





***Use
      of Estimates***





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States 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 these estimates.





***Investments***





The
      Company determines the appropriate classification of its investments in equity
      securities at the time of acquisition and reevaluates such determinations at
      each balance-sheet date. Marketable equity securities not classified as trading,
      are classified as available-for-sale, and are carried at fair market value,
      with
      the unrealized gains and losses, net of tax, included in the determination
      of
      comprehensive income and reported in shareholders’ equity. Investments, for
      which market prices are not available, are valued and reported at cost in
      periods subsequent to acquisition. No gains or losses are recognized until
      the
      securities are sold.




***Revenue
      and Expense Recognition***





Research
      and development contract revenues are recorded as earned in accordance with
      the
      terms and performance requirements of the contracts. If the research and
      development activities are not successful, the Company is not obligated to
      refund payments previously received. Fees from the sale or license of technology
      are recognized on a straight-line basis over the term required to complete
      the
      transfer of technology or the substantial satisfaction of any performance
      related responsibilities. License fee payments received in advance of amounts
      earned are recorded as deferred revenue. Milestone payments are recorded as
      revenue based upon the completion of certain contract specified events that
      measure progress toward completion under certain long-term contracts. Royalty
      revenue related to licensed technology is recorded when earned and in accordance
      with the terms of the license agreement. Research and development costs are
      expensed as incurred.





***Stock-Based
      Compensation***





On
      January 1, 2006 the Company adopted Statements of Financial Accounting Standards
      (“SFAS”) No. 123 (Revised 2004), *Share-Based
      Payment,* (“SFAS
      No. 123R”), using the modified prospective method. In accordance with SFAS No.
      123R, the Company measures the cost of employee services received in exchange
      for an award of equity instruments based on the grant-date fair value of the
      award. That cost is recognized over the period during which an employee is
      required to provide service in exchange for the award - the requisite service
      period. The Company determines the grant-date fair value of employee share
      options using the Black-Scholes option-pricing model.





Under
      the
      modified prospective approach, SFAS No. 123R applies to new awards and to awards
      that were outstanding on January 1, 2006 that are subsequently modified,
      repurchased or cancelled. Under the modified prospective approach, compensation
      cost recognized in each period subsequent to December 31, 2005, includes
      compensation cost for all share-based payments granted prior to, but not yet
      vested on, January 1, 2006, based on the grant-date fair value estimated in
      accordance with the pro forma provisions of SFAS No. 123, *Share-Based
      Payment* (“SFAS
      No. 123”), and compensation cost for all share-based payments granted subsequent
      to January 1, 2006, based on the grant-date fair value estimated in accordance
      with the provisions of SFAS No. 123R. Periods prior to January 1, 2006 were
      not
      restated to reflect the impact of adopting the new standard.


7


**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





***Fair
      Value Measurement***





The
      carrying value of the Company’s cash, accounts payable and short-term debt are
      measured at cost and approximate their respective fair values because of the
      short maturities of these instruments. Notes payable are recorded at cost which
      approximates their fair value.





***Net
      Loss per Common Share***





Basic
      earnings per share are calculated using the weighted-average number of
      outstanding common shares during the period. Diluted earnings per share is
      calculated using the weighted-average number of outstanding common shares and
      dilutive common equivalent shares outstanding during the period, using either
      the as-converted method for convertible notes and convertible preferred stock
      or
      the treasury stock method for options and warrants.





Excluded
      from diluted loss per common share as of September 30, 2008 and 2007 were
      75,919,613 and 26,341,157 shares, respectively, issuable upon conversion of
      convertible preferred stock, and options and warrants to purchase 67,791,167
      and
      28,713,074 shares of common stock, respectively, because the effect would be
      anti-dilutive.  For purposes of this calculation, net loss in 2008 and 2007
      has been adjusted for imputed, accumulated and/or paid dividends on the
      preferred stock.





***Income
      Taxes***





The
      Company records income taxes using the asset and liability method. Deferred
      tax
      assets and liabilities are recognized for the estimated future tax consequences
      attributable to differences between the financial statement carrying amounts
      of
      existing assets and liabilities and their future respective tax bases. Deferred
      tax assets and liabilities are measured using enacted tax rates in effect for
      the year in which those temporary differences are expected to be recorded or
      settled. The effect on deferred tax assets and liabilities of a change in tax
      rates is recognized in income in the period that includes the enactment
      date.





A
      valuation allowance is established to reduce the deferred tax asset if it is
      more likely that the related tax benefits will not be realized in the
      future.





***Reclassifications***





Certain
      prior year amounts have been reclassified to conform to the 2008
      presentation.





***Recent
      Accounting Pronouncements***




In
      September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
      No. 157, *Fair
      Value Measurements* (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a
      framework for measuring fair value, and expands disclosures about fair value
      measurements. This Statement focuses on creating consistency and comparability
      in fair value measurements. SFAS No. 157 is effective with respect to
      financial assets and liabilities for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years.  For
      non-financial assets and liabilities, the effective date of SFAS No. 157 has
      been deferred until fiscal years beginning after November 15, 2008. Our adoption
      of SFAS No. 157 with respect to financial assets and liabilities on January
      1,
      2008 did not have a material affect on our financial statements. The Company
      is
      currently evaluating the impact of adopting SFAS No. 157 on our financial
      statements with respect to non-financial assets and
      liabilities.


8


**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities—including an
      amendment of FASB Statement No. 115* (“SFAS
      No. 159”), which permits entities to choose to measure many financial
      instruments and certain other items at fair value. The fair value option
      established by this Statement permits all entities to choose to measure eligible
      items at fair value at specified election dates. A business entity shall report
      unrealized gains and losses on items for which the fair value option has been
      elected in earnings at each subsequent reporting date. Adoption is required
      for
      fiscal years beginning after November 15, 2007. Our adoption of SFAS No.
      159 on January 1, 2008 did not have a material effect on our financial
      statements.





In
      October 2008, the FASB issued FSP SFAS No. 157-3, *Determining
      the Fair Value of a Financial Asset When The Market for That Asset Is Not
      Active* (“FSP
      157-3”), to clarify the application of the provisions of SFAS 157 and how an
      entity would determine fair value in an inactive market. FSP 157-3 is effective
      immediately and applies to the Company’s September 30, 2008 financial
      statements. The application of the provisions of FSP 157-3 did not materially
      impact the Company’s consolidated financial position, results of operations and
      cash flows as of and for the period ended September 30, 2008.





In
      December 2007, the FASB issued FSP No. EITF 07-1, Accounting for Collaborative
      Arrangements, (“EITF 07-1”), which is effective for fiscal years beginning after
      December 15, 2008. EITF 07-1 defines collaborative arrangements and establishes
      reporting requirements for transactions between participants in a collaborative
      arrangement and between participants in the arrangement and third parties.
      EITF
      07-1 also establishes the appropriate income statement presentation and
      classification for joint operating activities and payments between participants,
      as well as the sufficiency of the disclosures related to these arrangements.
      We
      do not believe the adoption of EITF 07-1 will have a material impact on our
      financial position, results of operations, or cash flows.





In
      June
      2007, the FASB issued FSP No. EITF 07-3, *Accounting
      for Nonrefundable Advance Payments for Goods or Services Received for Use in
      Future Research and Development Activities* (“EITF
      07-3”), which is effective for fiscal years beginning after December 15, 2007,
      and interim periods within those fiscal years. The EITF reached a conclusion
      that nonrefundable advance payments for goods or services that will be used
      or
      rendered for future research and development activities pursuant to an executory
      contractual arrangement should be deferred and capitalized. Such amounts should
      be recognized as expense as the goods are delivered or the related services
      are
      performed. Entities should continue to evaluate whether they expect the goods
      to
      be delivered or services to be rendered. If an entity does not expect the goods
      to be delivered or services to be rendered, the capitalized advance payment
      should be charged to expense. Our adoption of EITF 07-3 on January 1, 2008
      did
      not have a material impact on our financial position, results of operations,
      or
      cash flows.





In
      December 2007, the FASB issued SFAS No. 141 (revised), *Business
      Combinations* (“SFAS No. 141(R)”). SFAS No. 141(R) changes the accounting for business
      combinations including the measurement of acquirer shares issued in
      consideration for a business combination, the recognition of contingent
      consideration, the accounting for pre-acquisition gain and loss contingencies,
      the recognition of capitalized in-process research and development, the
      accounting for acquisition-related restructuring cost accruals, the treatment
      of
      acquisition related transaction costs and the recognition of changes in the
      acquirer’s income tax valuation allowance. The Company is required to adopt SFAS
      No. 141(R) no later than January 1, 2009. The Company has not yet determined
      the
      impact SFAS No. 141(R) may have on its financial position, results of operations
      or cash flows.


9


**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





In
      December 2007, the FASB issued SFAS No. 160, *Non-controlling
      Interests in Consolidated Financial Statements, an amendment of ARB
      No. 51* (“SFAS No. 160”). SFAS No. 160 changes the accounting for non-controlling
      (minority) interests in consolidated financial statements including the
      requirements to classify non-controlling interests as a component of
      consolidated stockholders’ equity, and the elimination of “minority interest”
accounting in results of operations with earnings attributable to
      non-controlling interests reported as part of consolidated earnings.
      Additionally, SFAS No. 160 revises the accounting for both increases and
      decreases in a parent’s controlling ownership interest. The Company must adopt
      SFAS No. 160 no later than January 1, 2009. The Company has not yet determined
      the impact SFAS No. 160 may have on its financial position, results of
      operations or cash flows.





In
      March
      2008, the FASB issued SFAS No. 161, *Disclosures
      about Derivative Instruments and Hedging Activities – an amendment of FASB
      Statement No. 133* (“SFAS No. 161”), as amended and interpreted, which requires enhanced
      disclosures about an entity’s derivative and hedging activities and thereby
      improves the transparency of financial reporting. Disclosing the fair values
      of
      derivative instruments and their gains and losses in a tabular format provides
      a
      more complete picture of the location in an entity’s financial statements of
      both the derivative positions existing at period end and the effect of using
      derivatives during the reporting period. Entities are required to provide
      enhanced disclosures about (a) how and why an entity uses derivative
      instruments, (b) how derivative instruments and related hedged items are
      accounted for under Statement 133 and its related interpretations, and (c)
      how
      derivative instruments and related hedged items affect an entity’s financial
      position, financial performance, and cash flows. SFAS No. 161 is effective
      for
      financial statements issued for fiscal years and interim periods beginning
      after
      November 15, 2008. Early adoption is permitted. The Company does not expect
      SFAS
      No. 161 to have a material impact on its financial statements.





In
      April
      2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, *Determination
      of Useful Life of Intangible Assets* (“FSP
      FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in
      developing the renewal or extension assumptions used to determine the useful
      life of a recognized intangible asset under FAS 142, “Goodwill and Other
      Intangible Assets.” FSP FAS 142-3 also requires expanded disclosure related to
      the determination of intangible asset useful lives. FSP FAS 142-3 is effective
      for fiscal years beginning after December 15, 2008. Earlier adoption is not
      permitted. The Company does not expect FSP FAS 142-3 to have a material impact
      on its financial statements.





In
      May
      2008, the FASB issued SFAS No. 162, *The
      Hierarchy of Generally Accepted Accounting Policies* (“SFAS
      162”), which reorganizes the GAAP hierarchy. The purpose of the new standard is
      to improve financial reporting by providing a consistent framework for
      determining what accounting principles should be used when preparing the U.S.
      GAAP financial statements. The standard is effective 60 days after the SEC’s
      approval of the PCAOB’s amendments to AU Section 411. The adoption of SFAS 162
      will not have an impact on the Company’s financial position or results of
      operations.





In
      May
      2008, the FASB issued FSP Accounting Principles Board Opinion (“APB”) No. 14-1, *Accounting
      for Convertible Debt Instruments That May Be Settled in Cash upon Conversion
      (Including Partial Cash Settlement)* (“FSP
      APB 14-1”), which requires the issuer of certain convertible debt instruments
      that may be settled in cash (or other assets) on conversion to separately
      account for the liability (debt) and equity (conversion option) components
      of
      the instrument in a manner that reflects the issuer’s nonconvertible debt
      borrowing rate. FSP APB 14-1 will be effective for the Company on January 1,
      2009 and will require retroactive disclosure. The Company is currently
      evaluating the impact of adopting FSP APB 14-1 on its financial position, cash
      flows, and results of operations.


10


**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





In
      June
      2008, the FASB issued FSP No. EITF 03-6-1, *Determining
      Whether Instruments Granted in Share-Based Payment Transactions Are
      Participating Securities* (“EITF
      03-6-1”), which requires entities to apply the two-class method of computing
      basic and diluted earnings per share for participating securities that include
      awards that accrue cash dividends (whether paid or unpaid) any time common
      shareholders receive dividends and those dividends do not need to be returned
      to
      the entity if the employee forfeits the award. EITF 03-6-1 will be effective
      for
      the Company on January 1, 2009 and will require retroactive disclosure. The
      Company is currently evaluating the impact of adopting EITF 03-6-1 on its
      financial position, cash flows, and results of operations.





**Note
                2.**
            **Equipment
                and Leasehold Improvements**




Equipment
      and leasehold improvements consist approximately of the following:




**September**
                **30,**
              
              **December**
                **31,****2008**
              
              **2007**Laboratory
                  equipment
              
              $
              298,000
              
              $
              1,378,000Office
                  equipment
              
              
              60,000
              
              
              220,000Leasehold
                  improvements
              
              
              —
              
              
              360,000358,000
              
              
              1,958,000Less:
                  accumulated depreciation and amortization
              
              
              (330,000
              )
              
              (1,830,000
              )$
              28,000
              
              $
              128,000





Proceeds
      from the sale of equipment were approximately $0 and $101,000 for the three
      and
      nine months ended September 30, 2008, respectively. Gains from the sale of
      equipment were approximately $0 and $41,000 for the three and nine months ended
      September 30, 2008, respectively. The Company did not sell any equipment in
      2007.





Depreciation
      and amortization expense was approximately $4,000 and $39,000 for the three
      and
      nine months ended September 30, 2008 respectively, and approximately $25,000
      and
      $76,000 for the three and nine months ended September 30, 2007
      respectively.





**Note
                3.**
            **Accounts
                Payable and Accrued
                Liabilities**





*Accounts
      Payable*





During
      the quarter ended June 30, 2008, Management identified expenses totaling $98,000
      related to services performed for the Company in the first quarter of 2007
      that
      had not been previously recorded. These expenses were recorded during the
      quarter ended June 30, 2008, and as such are included in R&D expense for the
      nine months ended September 30, 2008, and in accounts payable as of September
      30, 2008. Management has concluded that, based on certain quantitative and
      qualitative factors, this understatement of expense did not result in a material
      misstatement of the Company’s 2007 interim or annual financial
      statements.





During
      the quarter ended September 30, 2008, Management identified expenses totaling
      $37,000 related to legal services performed for the Company in the first and
      second quarters of 2008 that had not been previously recorded. These expenses
      were recorded during the quarter ended September 30, 2008, and as such are
      included in selling, general and administrative expense for the three and nine
      months ended September 30, 2008, and in accrued liabilities as of September
      30,
      2008. Management has concluded that, based on certain quantitative and
      qualitative factors, this understatement of expense did not result in a material
      misstatement of the Company’s financial statements for the first and second
      quarters of 2008.


11


**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





*Accrued
      Liabilities*





Accrued
      liabilities consist approximately of the following:


**September 30,**
              
              **December 31,****2008**
              
              **2007**Payroll
                  and employee benefits
              
              $
              65,000
              
              $
              82,000Accounting
                  & Professional Fees
              
              
              47,000
              
              
              23,000Accrued
                  interest
              
              
              469,000
              
              
              585,000Insurance
                  premium financing
              
              
              43,000
              
              
              22,000Directors
                  fees
              
              
              90,000
              
              
              60,000Other
              
              
              32,000
              
              
              22,000$
              746,000
              
              $
              794,000






**Note
                4.**
            **Secured
                Notes Payable – Related
                Party**





On
      April
      13, 2006, a shareholder loaned $1,000,000 (the “Loan”) to the Company ($500,000
      in cash and an additional $500,000 deposited with an escrow agent as a line
      of
      credit) represented by a note (the “4/13/06 Note”) issued by the Company to the
      shareholder in the principal amount of $1,000,000 (the “Principal”). The Note
      was originally due on July 7, 2006 (the “Maturity Date”) and bore annual
      interest at the rate of 8% payable on the Maturity Date. It was secured, in
      accordance with the terms of a security agreement (the “Security Agreement”), by
      a continuing security interest in and a general lien upon (i) 2,000,000 shares
      of Spine Wave, Inc. common stock owned by the Company; and (ii) all U.S. patents
      owned by the Company. The Note and the Security Agreement were both dated April
      13, 2006.





As
      consideration for the Loan, the Company granted a warrant (the “4/13/06
      Warrant”) to the shareholder to purchase an aggregate of 500,000 shares of the
      Company’s common stock at an exercise price of $0.30 per share. The fair value
      of the 4/13/06 Warrant, estimated to be $70,000, was recognized as interest
      over
      the original term of the note. The shareholder’s counsel acts as the escrow
      agent and now serves as our outside general counsel. Through December 31, 2007,
      the 4/13/06 Note had been amended seven times so that as of December 31, 2007,
      the outstanding principal balance was $5,876,000, and had a scheduled maturity
      date of January 10, 2008.





Effective
      January 9, 2008, the Company replaced the 4/13/06 Note by issuing a new note
      (the “1/09/08 Note”) in the principal amount of $6,415,000. This amount included
      the then $5,876,000 outstanding balance plus the then outstanding $539,000
      of
      accrued interest on the 4/13/06 Note. The 1/09/08 Note bears annual interest
      at
      the rate 8%, the same as did the 4/13/06 Note, and matures on September 1,
      2008.
      The 1/09/08 Note is secured in the same manner as was the 4/13/06 Note. On
      September 1, 2008, the scheduled maturity date of the 1/09/08 Note was extended
      to March 31, 2009.





As
      consideration for the lender agreeing to accept the 1/09/08 Note as payment
      for
      the 4/13/06 Note, the Company i) issued the lender three-year warrants to
      purchase an aggregate of 2,438,000 shares of the Company’s common stock at
      $0.061 per share, ii) lowered the exercise price of the 4/13/06 Warrant from
      $0.30 per share to $0.061 per share, and iii) extended the term of the 4/13/06
      Warrant from April 30, 2009 to January 31, 2011.


12





**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





In
      accordance with Accounting Principals Board Opinion No. 14, *Accounting
      for Convertible Debt and Debt Issued with Stock Purchase Warrants,* the
      relative fair value of the warrants issued in connection with the 1/09/08 Note,
      estimated to be approximately $117,000, was recorded as debt discount. In
      addition, the change in fair value of the 4/13/06 Warrant resulting from the
      modification of the terms, estimated at $18,000, was also recorded as debt
      discount. The fair value of these warrants was estimated on the date of grant
      using the Black Scholes option valuation model with the following
      assumptions:


**April 2006**
                **Issuance**
              
              **January 2008**
                **Modification**
              
              **January 2008**
                **Issuance****4/13/06**
                **Warrant**
              
              **4/13/06**
                **Warrant**
              
              **1/09/08**
                **Warrant**Expected
                  annual dividends
              
              
              0
              %
              
              0
              %
              
              0
              %Risk-free
                  interest rate
              
              
              4.9
              %
              
              3.0
              %
              
              2.7
              %Expected
                  term (in years)
              
              
              3.0
              
              
              1.3
              
              
              3.1Expected
                  Volatility
              
              
              90.0
              %
              
              157.0
              %
              
              157.0
              %





The
      total
      debt discount recorded will be amortized as interest expense over the term
      of
      the 1/09/08 Note using the effective interest method. During the nine months
      ended September 30, 2008, the Company recorded non-cash interest expense of
      approximately $135,000, based on the debt discount amortization during the
      period, and as of September 30, 2008, the debt discount balance was fully
      amortized.





**Note
                5.**
            **Notes
                Payable**





I n
      December 2005, in connection with a license agreement with Surgica Corporation
      for the rights to certain intellectual property, the Company allegedly assumed
      several notes payable agreements .
      The
      notes bear interest at rates ranging from 6% to 10%, and mature at various
      dates
      through January 2009. As of September 30, 2008 the entire balance of the
      outstanding notes payable is reflected as a current liability, as all of the
      notes have maturity dates prior to June 30, 2009.





**Year Ending**
              **December 31,**
            
            **Notes**
              **Payable**
              **Maturities**2008
            
            $
            419,0002009
            
            
            100,000Total
                maturities
            
            $
            519,000





Based
      on
      what the Company believes, among other things, to be a failure of consideration
      relating to the license agreement, the Company believes that it has no liability
      for these notes. On October 15, 2008, the noteholders instituted suit against
      the Company in Superior Court of California, County of Sacramento seeking
      payment of these notes. The name of the case is Lou Matson, Mary Matson, and
      Don
      Brandon v Protein Polymer Technologies, Inc, Case Number 34-2008-00022190.
      The
      Company is defending this action. Until a final determination is made with
      respect to the disposition of the notes, the Company will continue to carry
      them
      on its balance sheet.


13





**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





**Note
                6.**
            **Common
                Stock**





The
      Company’s Board of Directors agreed to the terms of a Stock Purchase Agreement
      (“SPA”) and a Registration Rights Agreement (“RRA”), each dated as of September
      27, 2007, with TAG Virgin Islands, Inc. (“TAG”), as agent for certain purchasers
      of the Company’s common stock. TAG is a registered investment advisor and
      advises a number of our stockholders, including certain members of our Board
      of
      Directors, in investment decisions, including decisions about whether to invest
      in our stock. Based upon our stock records and data supplied to us by our
      stockholders, we believe that clients of TAG beneficially owned approximately
      55.1% of our common stock as of September 27, 2007, prior to the stock purchases
      subject to the SPA. The SPA essentially provides for the Company selling,
      from time to time, shares of its common stock, par value $0.01, to the
      purchasers at a purchase price determined as the closing price of the stock
      on
      sale date. As a component of the purchase of the common stock, the purchaser
      also will receive a warrant to purchase the same number of shares of common
      stock in the future. Each warrant expires in five years from the date of
      purchase and is exercisable at a per share price, subject to certain
      anti-dilution provisions, equal to 110% of the purchase price paid by the
      purchase.





As
      of
      November 28, 2007, the SPA was amended so that on and after that date the
      warrants are exercisable at 100% of the price of the shares that are purchased.
      The SPA can be terminated at any time by TAG. The purchasers have certain
      registration rights, as provided by the RRA, to require the Company, at its
      cost, to file an effective registration statement with the Securities and
      Exchange Commission. The Company is not subject to liquidated damages or other
      penalties in the event that it fails to meet the registration obligations
      included in the RRA.





For
      the
      nine months ended September 30, 2008, the Company received aggregate proceeds
      of
      $1,655,000 for the purchase of 35,040,296 shares of common stock and 35,040,296
      warrants, subject to the terms of the SPA and RRA.





**Note
                7.**
            **Stock
                Options**





The
      Company did not grant options during the nine months ended September 30, 2008.
      Stock option activity for the nine months ended September 30, 2008 is as
      follows:





Options
              Outstanding
            
            Weighted
              Average
              Exercise
              Price
            
            Weighted Average
              Remaining
              Contractual Term
              (Years)Outstanding
                at December 31, 2007
            
            
            11,497,486
            
            
            0.65
            
            
            5.3Issued
            
            
            -
            
            
            -Cancelled
            
            
            (156,839
            )
            
            (1.14
            )Exercised
            
            
            -
            
            
            -Outstanding
                at September 30, 2008
            
            
            11,340,647
            
            $
            0.65
            
            
            4.6Exercisable
                at September 30, 2008
            
            
            11,269,633
            
            $
            0.65
            
            
            4.6





During
      the three and nine month periods ended September 30, 2008, the Company
      recognized approximately $2,900 and $7,200, respectively, in stock-based
      compensation expense. The charges in the comparable periods ended September
      30,
      2007 were $24,000 and $133,000, respectively. As of September 30, 2008, there
      was approximately $7,700 of unrecognized compensation expense related to
      unvested shared-based compensation arrangements which is expected to be fully
      recognized by the end of 2009.


14





**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





**Note
                8.**
            **Warrants
                to Purchase Common Stock**





During
      the three and nine months ended September 30, 2008, the Company granted warrants
      to purchase an aggregate of 11,378,075 and 35,040,296, respectively, of the
      Company’s common stock pursuant to the terms of a stock purchase agreement dated
      September 27, 2007 (See Note 6). Such warrants are exercisable at prices ranging
      from $0.04 to $0.07 per share and expire at various times through August
      2013.





The
      Company also granted warrants to purchase an aggregate of 2,438,000 shares
      of
      the Company’s common stock pursuant to the terms of a note agreement dated
      January 9, 2008 (see Note 4). Such warrants are exercisable at a price of $0.061
      per share and expire in January 2011.





In
      addition, the Company extended the expiration date of warrants to acquire
      500,000 shares of the Company’s common stock from April 2009 to January 2011,
      and reduced the exercise price from $0.30 per share to $0.061 per share (see
      Note 4).





No
      warrants were exercised during the three and nine months ended September 30,
      2008. A summary of warrant activity for the nine months ended September 30,
      2008
      is as follows:





Number of
              Warrants
              Outstanding
              and
              Exercisable
            
            Weighted-
              Average
              Exercise
              PriceOutstanding, December 31, 2007
            
            
            21,771,220
            
            $
            0.40Granted
            
            
            37,478,295
            
            $
            0.08Exercised
            
            
            —
            
            $
            —Expired
            
            
            (2,798,996
            )
            $
            (0.18
            )Outstanding,
                September 30, 2008
            
            
            56,450,519
            
            $
            0.16





At
      September 30, 2008, the weighted-average remaining contractual life of the
      warrants was approximately 3.5 years.





**Note
                9.**
            **Commitments
                and Contingencies**





***Facilities
      Lease Agreement***





The
      Company leased its office and research facilities totaling 27,000 square feet
      under an operating lease which expired on April 30, 2008. The Company did not
      renew the facilities lease and has vacated the premises. As of September 30,
      2008, the Company had accrued $14,000 in repair and maintenance costs related
      to
      the termination of this facilities lease. We are currently exploring
      arrangements to relocate our administrative offices and outsource our laboratory
      and production facilities.




Through
      April 30, 2008, the Company subleased 6,183 square feet of its office and
      research facilities under a month-to-month arrangement for $13,000 per month
      plus utilities. As of September 30, 2008, our former sub-lessee owed us
      approximately $200,000 for accrued unpaid rent. Due to the uncertainty regarding
      the collectibility of the amount owed, the entire balance is fully reserved
      as
      of September 30, 2008.


15





**Protein
      Polymer Technologies, Inc.**


**Notes
      to Condensed Financial Statements**


**(unaudited)**





**Note
                10.**
            **Subsequent
                Events**




Additional
      developments during the period October 1, 2008 through November 11, 2008 include
      the following:





·
            On
                October 2, 2008, the Company received proceeds of $100,000 as a loan
                from
                clients of TAG Virgin Islands, Inc. (hereafter “TAG”). This loan is
                represented by an unsecured note (the “10/02/08 Note”) issued by the
                Company. The note is due on October 2, 2009 and bears an annual interest
                rate of 8%. The interest and principal are payable on the maturity
                date,
                either in cash or common stock at a rate of $0.05 per share, at the
                discretion of the Company. As consideration for the loan, the Company
                granted a warrant (the “10/02/08 Warrant”) to the noteholders to purchase
                an aggregate of 2,000,000 shares of the Company’s common stock at an
                exercise price of $0.05 per share.





On
      November 3, 2008, the Company received proceeds of $105,000 as a loan from
      clients of TAG Virgin Islands, Inc. (hereafter “TAG”). This loan is represented
      by an unsecured note (the “11/03/08 Note”) issued by the Company. The note is
      due on November 3, 2009 and bears an annual interest rate of 8%. The interest
      and principal are payable on the maturity date, either in cash or common stock
      at a rate of $0.04 per share, at the discretion of the Company. As consideration
      for the loan, the Company granted a warrant (the “11/03/08 Warrant”) to the
      noteholders to purchase an aggregate of 2,625,000 shares of the Company’s common
      stock at an exercise price of $0.04 per share.





TAG
      Virgin Islands, Inc. is a registered investment advisor and advises a number
      of
      our stockholders, including certain members of our Board of Directors, in
      investment decisions, including decisions about whether to invest in our stock.
      Based upon our stock records and data supplied to us by our stockholders, we
      believe that clients of TAG beneficially own approximately 56.2% of our common
      stock as of November 17, 2008. TAG has discretionary authority to vote or
      dispose of the shares of our common stock held in its client accounts and,
      therefore, may be deemed to be the beneficial owner of such shares in accordance
      with the Commission's Rules. TAG has informed us that James Tagliaferri is
      the
      natural person at TAG with such discretionary authority. TAG expressly disclaims
      beneficial ownership of any shares owned by its clients.





·
            On
                October 15, 2008, certain noteholders instituted suit against the
                Company
                in Superior Court of California, County of Sacramento, seeking payment
                of
                outstanding notes payable allegedly owed by the Company. The Company
                is
                defending this action, and believes that it has no liability for
                these
                notes, based on, among other things, a failure of consideration for
                the
                related December 2005 licensing agreement with Surgica Corporation.
                Until
                a final determination is made with respect to the disposition of
                the
                notes, the Company will continue to carry them on its balance
                sheet.





·
            On
                October 30, 2008, the Company repurchased 920,480 common shares and
                a
                collective total of 45,408 Series D, F, H, and I preferred shares
                held by
                Johnson & Johnson Development Corporation, a beneficial owner of more
                than 5% of the common stock and preferred stock on an as converted
                basis,
                for $5,000. These shares represent all outstanding shares held by
                this
                shareholder.





·
            On
                November 12, 2008, the Company received proceeds of $10,000 from
                an
                affiliate of one of our board directors for the purchase of 285,714
                shares
                of common stock and 285,714 warrants pursuant to the SPA dated September
                27, 2007.





·
            On
                November 17, 2008, the Company received proceeds of $10,000 from
                one of
                our board directors for the purchase of 322,581 shares of common
                stock and
                322,581 warrants pursuant to the SPA dated September 27,
                2007.


16





**Item 2.
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations**





*The
      interim financial statements and this Management’s Discussion and Analysis of
      Financial Condition and Results of Operations should be read in conjunction
      with
      the financial statements and notes thereto for the year ended December 31,
      2007, and the related Management’s Discussion and Analysis of Financial
      Condition and Results of Operations, both of which are contained in our Annual
      Report on Form 10-KSB for the year ended December 31, 2007. In addition to
      historical information, this discussion and analysis contains forward-looking
      statements that involve risks, uncertainties, and assumptions. When used herein,
      the words “believe,” “anticipate,” “expect,” “estimate” and similar expressions
      are intended to identify such forward-looking statements. Our actual results
      may
      differ materially from those anticipated in these forward-looking statements
      as
      a result of certain factors, including but not limited to those set forth under
      the caption “Risk Factors” in the Form 10-KSB for the year ended
      December 31, 2007 and the caption “Risk Factors” in this Form 10-Q for the
      quarter ended September 30, 2008. We undertake no obligation to update any
      of
      the forward-looking statements contained herein to reflect any future events
      or
      developments.*





**Company
      and Technology Background**





Protein
      Polymer Technologies, Inc. (hereafter the “Company” or “we”), a Delaware
      corporation, is a biotechnology company incorporated on July 6, 1988. We are
      engaged in the research, development, and production of bio-active devices
      to
      improve medical and surgical outcomes. Through our patented technology to
      produce proteins of unique design, biological and physical product components
      are integrated to provide for optimized clinical performance.




We
      are
      focused on developing products to improve medical and surgical outcomes, based
      on an extensive portfolio of proprietary biomaterials. Biomaterials are
      materials that are used to direct, supplement, or replace the functions of
      living systems. The interaction between materials and living systems is dynamic.
      It involves the response of the living system to the materials (e.g.,
      biocompatibility) and the response of the materials to the living system (e.g.,
      remodeling). The requirements for performance within this demanding biological
      environment have been a critical factor in limiting the possible metal, polymer,
      and ceramic compositions to a relatively small number that to date have been
      proven useful in medical devices implanted within the body.




The
      goal
      of biomaterials development historically has been to produce inert materials,
      i.e., materials that elicit little or no response from the living system.
      However, we believe that such conventional biomaterials are constrained by
      their
      inability to convey appropriate messages to the cells that surround them, the
      same messages that are conveyed by proteins in normal human
      tissues.




The
      products we have targeted for development are based on a new generation of
      biomaterials which have been designed to be recognized and accepted by human
      cells to aid in the natural process of bodily repair, (including the healing
      of
      tissue and the restoration or augmentation of its form and function) and,
      ultimately, to promote the regeneration of tissues. We believe that the
      successful realization of these properties will substantially expand the role
      that artificial devices can play in the prevention and treatment of human
      disability and disease, and enable the culture of native tissues for successful
      reimplantation.





Through
      our proprietary core technology, we produce high molecular weight polymers
      that
      can be processed into a variety of material forms such as gels, sponges, films,
      and fibers, with their physical strength and rate of resorption tailored to
      each
      potential product application. These polymers are constructed of the same amino
      acids as natural proteins found in the body. We have demonstrated that our
      polymers can mimic the biological and chemical functions of natural proteins
      and
      peptides, such as the attachment of cells through specific membrane receptors
      and the ability to participate in enzymatic reactions, thus overcoming a
      critical limitation of conventional biomaterials. In addition, materials made
      from our polymers have demonstrated excellent biocompatibility in a variety
      of
      preclinical safety studies.


17





Our
      patented core technology enables messages that direct activities of cells to
      be
      precisely formulated and presented in a structured environment similar to what
      nature has demonstrated to be essential in creating, maintaining and restoring
      the body’s functions. Our protein polymers are made by combining the techniques
      of modern biotechnology and traditional polymer science. The techniques of
      biotechnology are used to create synthetic genes that direct the biological
      synthesis of protein polymers in recombinant microorganisms. The methods of
      traditional polymer science are used to design novel materials for specific
      product applications by combining the properties of individual “building block”
components in polymer form.





In
      contrast to natural proteins, either isolated from natural sources or produced
      using traditional genetic engineering techniques, our technology results in
      the
      creation of new proteins with unique properties. We have demonstrated an ability
      to create materials that:





·
            combine
                properties of different proteins found in
                nature;


·
            reproduce
                and amplify selected activities of natural
                proteins;


·
            eliminate
                undesired properties of natural proteins;
                and


·
            incorporate
                synthetic properties via chemical
                modifications




This
      ability is fundamental to our current primary product research and development
      focus — tissue repair and regeneration. Tissues are highly organized structures
      made up of specific cells arranged in relation to an extra-cellular matrix
      (“ECM”), which is principally composed of proteins. The behavior of cells is
      determined largely by their interactions with the ECM. Thus, the ability to
      structure the cells’ ECM environment allows the protein messages they receive —
and their activity — to be controlled.




**Results
      of Operations**




***Revenues*** **.** Revenues
      from product sales for the three and nine months ended September 30, 2008 were
      $17,000 and $24,000 respectively, compared to $15,000 and $282,000 respectively
      for contract and licensing revenue for the comparable periods in 2007. Future
      revenues are subject to future collaborative development and licensing
      agreements.





We
      cannot
      forecast with any degree of certainty which potential product lines will be
      subject to future collaborations or other strategic transactions, when such
      arrangements will be secured, if at all, and to what degree such arrangements
      would affect our development plans and capital requirements. As a result, we
      cannot be certain when and to what extent we will receive cash inflows from
      the
      commercialization of product candidates or collaboration agreements, if at
      all.





***Research
      and Development Expenses*** **.** Research
      and development expenses for the three and nine months ended September 30,
      2008
      were $128,000 and $1,253,000 respectively, compared to $439,000 and $1,712,000,
      respectively, for the comparable periods in 2007. We expect further decline
      from
      2007 expense levels as a result of significantly reduced activity levels of
      clinical testing and regulatory consulting costs in 2008. We expect our research
      and development expenses will increase in the future only to the extent that
      additional capital is obtained or future collaborative development and licensing
      agreements are secured.





***Selling,
      General and Administrative Expenses*** **.** Selling,
      general and administrative expenses for the three and nine months ended
      September 30, 2008 were $237,000 and $748,000, respectively, as compared to
      $453,000 and $1,124,000, respectively, for the comparable periods in 2007.
      We
      made significant reductions in administration expenses in the first two quarters
      of 2008. Several highly compensated positions were eliminated and all
      non-mission sensitive expenses were reviewed and either eliminated or reduced,
      including the cost of facilities. To the extent possible, we continue to
      concentrate on controlling costs in this area. We expect our selling, general
      and administrative expenses will increase in the future only to the extent
      that
      additional capital is obtained or future collaborative development and licensing
      agreements are secured.


18





***Operating
      Losses*** .
      For the
      three months ended September 30, 2008, we recorded a net loss applicable to
      common shareholders of $600,000 or $0.01 per share, as compared to a loss of
      $1,073,000 or $0.02 per share for the comparable period in 2007. For the nine
      months ended September 30, 2008, we recorded a net loss applicable to common
      shareholders of $2,706,000 or $0.03 per share, as compared to a loss of
      $2,898,000 or $0.04 per share for the comparable period in 2007.





**Inflation**





To
      date,
      we believe that inflation and changing prices have not had a material impact
      on
      our continuing operations.




**Liquidity
      and Capital Resources**





As
      of
      September 30, 2008, we had cash totaling approximately $2,000, as compared
      to
      $22,000 at December 31, 2007. As of September 30, 2008, we had a working capital
      deficit of $8,562,000 compared to a working capital deficit of $7,862,000 at
      December 31, 2007.





We
      do not
      have any off balance sheet financing activities and do not have any special
      purpose entities. We had no long-term capital lease obligations as of September
      30, 2008. During the nine months ended September 30, 2008, we did not purchase
      any capital equipment or leasehold improvements, and received proceeds from
      the
      sale of equipment of $101,000. We do not anticipate significant expenditures
      for
      capital equipment or leasehold improvements for the remainder of
      2008.





Our
      existing available cash as of September 30, 2008, and continuing contractual
      commitments, are insufficient to meet our anticipated funding requirements.
      Substantial additional capital resources are required to fund continuing
      expenditures related to our operating, research, development, manufacturing
      and
      business development activities. As discussed in Note 6 to the financial
      statements, the Company entered into a common stock purchase agreement
      (hereafter “SPA”) in September 2007 and has raised $2,245,000 as of November 17,
      2008, as a result of that SPA. Pursuant to the SPA, which has been our main
      source of external financing since September 2007, the investors purchase shares
      of our common stock at the closing price of the stock on the day the investment
      is made. In addition, we issued a five-year warrant to each investor to purchase
      the same number of shares as those purchased by such investor at 110% of the
      price at which the shares are purchased. As of November 28, 2007, the SPA was
      amended so that warrants issued on and after that date are exercisable at 100%
      of the price at which the shares are purchased. We have also granted the
      investors demand and piggy-back registration rights covering the shares
      purchased and the sharers issuable upon exercise of the warrants. Prior to
      the
      SPA, required funding was provided to us through a note payable agreement (known
      as the Szulik Loan) by Matthew Szulik, one of our stockholders. This loan was
      outlined in previous filings and is further described in Note 4 to the financial
      statements. As with the Escrow Agreement relating to the Szulik Loan, the Stock
      Purchase Agreement provides that TAG
      Virgin Island s,
      Inc.
      (hereafter “TAG”), as agent for the equity investors, will advise the Board as
      to which of the Company’s expenses will be paid with the funds invested by these
      investors.





As
      of
      January 9, 2008, we replaced the Szulik Loan by issuing to Mr. Szulik a new
      note
      in the principal amount of $6,415,000. This amount included the then $5,876,000
      outstanding principal balance plus the then outstanding $539,000 in accrued
      interest on the old note. The new note bears annual interest at the rate 8%,
      the
      same as did the old note, matures on September 1, 2008 and is secured in the
      same manner as was the old note. On September 1, 2008, the scheduled maturity
      date of the 1/09/08 Note was extended to March 31, 2009. As consideration for
      Mr. Szulik agreeing to accept the new note, we issued him three-year warrants
      to
      purchase an aggregate of 2,438,000 shares of our common stock at $0.061 per
      share and lowered the exercise price of warrants to purchase 500,000 shares
      of
      our common stock that we had previously issued to him from $0.30 per share
      to
      $0.061 per share.


19





On
      October 2, 2008 and November 3, 2008, the Company received proceeds of $100,000
      and $105,000, respectively as loans from clients of TAG. These loans are
      represented by unsecured notes issued by the Company. These notes are due on
      October 2, 2009 and November 3, 2009, respectively, and bear an annual interest
      rate of 8%. The interest and principal are payable on the maturity dates, either
      in cash or common stock at a rate of $0.05 and $0.04 per share respectively,
      at
      the discretion of the Company. As consideration for the loan, the Company
      granted warrants to the noteholders to purchase an aggregate of 2,000,000 and
      2,625,000 shares, respectively, of the Company’s common stock at an exercise
      price of $0.05 and $0.04 per share, respectively.





TAG
      Virgin Islands, Inc. is a registered investment advisor and advises a number
      of
      our stockholders, including certain members of our Board of Directors, in
      investment decisions, including decisions about whether to invest in our stock.
      Based upon our stock records and data supplied to us by our stockholders, we
      believe that clients of TAG beneficially own approximately 56.2% of our common
      stock as of November 17, 2008. TAG has discretionary authority to vote or
      dispose of the shares of our common stock held in its client accounts and,
      therefore, may be deemed to be the beneficial owner of such shares in accordance
      with the Commission's Rules. TAG has informed us that James Tagliaferri is
      the
      natural person at TAG with such discretionary authority. TAG expressly disclaims
      beneficial ownership of any shares owned by its clients.





As
      noted
      above, we believe our existing available cash as of September 30, 2008 will
      not
      be sufficient to meet our anticipated capital requirements during 2008. We
      are
      unable to pay certain vendors in a timely manner and remain over 90 days past
      due with certain critical vendors, such as outside laboratories and law firms.
      We currently owe our former chief executive officer's firm, R. I. Heller &
Co., LLC, $175,000 for his services. Additionally, we are currently outsourcing
      administrative and accounting functions as a result of cutbacks necessitated
      by
      insufficient monetary resources. We are attempting to remedy this problem.
      Our
      ability to continue operating is dependent on the receipt of additional funding
      and substantial additional capital resources will be required to fund continuing
      expenditures related to our research, development, manufacturing and business
      development activities. If adequate funds are not available, we will be required
      to significantly curtail our operating plans and most likely cease operations.
      We are still in discussions with other potential financing sources and
      collaborative partners, and are seeking additional funding in the form of equity
      investments, license fees, loans, milestone payments or research and development
      payments. We cannot assure that any of these other sources of funding will
      be
      consummated in the timeframes needed for continuing operations or on terms
      favorable to us, if at all.





**Caution
      on Forward-Looking Statements**





Any
      statements in this report about our expectations, beliefs, plans, objectives,
      assumptions or future events or performance are not historical facts and are
      forward-looking statements. You can identify these forward-looking statements
      by
      the use of words or phrases such as “believe,” “may,” “could,” “will,”
“estimate,” “continue,” “anticipate,” “intend,” “seek,” “plan,” “expect,”
“should” or “would.” Among the factors that could cause actual results to differ
      materially from those indicated in the forward-looking statements are risks
      and
      uncertainties inherent in our business including, without limitation: the
      potential for the FDA to impose non-clinical, clinical or other requirements
      to
      be completed before or after use of any of our intellectual property or
      methodology; our ability to demonstrate to the satisfaction of potential
      collaborative development partners of the feasibility of utilizing our
      intellectual property or methodology; the failure to generate the potential
      to
      enter into and the terms of any strategic transaction relating to our
      intellectual property or methodology; the scope, validity and duration of patent
      protection and other intellectual property rights for our intellectual property
      or methodology ; estimates of the potential markets for our intellectual
      property or methodology and our ability to compete in these markets; our
      products, our expected future revenues, operations and expenditures and
      projected cash needs; our ability to raise sufficient capital and other risks
      detailed in this report. Although we believe that the expectations reflected
      in
      our forward-looking statements are reasonable, we cannot guarantee future
      results, events, levels of activity, performance or achievement. We undertake
      no
      obligation to publicly update or revise any forward-looking statements, whether
      as a result of new information, future events or otherwise, unless required
      by
      law. This caution is made under the safe harbor provisions of the Private
      Securities Litigation Reform Act of 1995.


20


**Item 3.
      Quantitative and Qualitative Disclosures about Market
      Risk**




As
      a
      Smaller Reporting Company as defined by Rule 12b-2 of the Exchange Act and
      in
      item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting
      obligations and therefore are not required to provide the information requested
      by this Item.





**Item 4T.
      Controls and Procedures**




We
      maintain disclosure controls and procedures that are designed to ensure that
      information required to be disclosed by the Company in the reports we file
      or
      submit under the Securities Exchange Act of 1934, is recorded, processed,
      summarized and reported within the time periods specified in the Securities
      and
      Exchange Commission’s rules and forms, and that such information is accumulated
      and communicated to our management, including our Interim Chief Executive
      Officer and Interim Principal Financial Officer, who is the same person, to
      allow timely decisions regarding required disclosure. As reported in our Annual
      Report on Form 10-KSB for the year ended December 31, 2007 (filed on May 12,
      2008), Company management identified material weaknesses in our internal
      accounting control over financial reporting as of December 31, 2007,
      including:





·
            Pervasive,
                entity-level control deficiencies across key COSO components in the
                Company’s control environment, including:





o
            Controls
                over the period-end financial closing and reporting
                processes;


o
            Controls
                over managerial override;


o
            Controls
                to prevent or reduce the risk of fraudulent
                activity;


o
            Controls
                to monitor other controls, including the role of the Board of Directors;
                and


o
            Controls
                related to risk assessment.





·
            An
                absence of independence and financial expertise on the Board of Directors,
                limiting its ability to provide effective
                oversight.


·
            An
                absence of a formalized process to manage the Company’s internal controls
                over financial reporting and become compliant with Section 404 of
                the
                Sarbanes-Oxley Act.


·
            Inadequate
                controls over the period-end financial close and reporting
                processes;


·
            Insufficient
                personnel resources and technical accounting expertise within the
                accounting function to provide for adequate segregation of duties
                and
                resolve non-routine or complex accounting matters;
                and


·
            Inadequate
                documentation of policies, procedures, and controls related to finance
                and
                accounting, including inadequate procedures for appropriately identifying,
                assessing, and applying accounting
                principles.





As
      a
      result of these material weaknesses, management concluded that the Company’s
      internal control over financial reporting was not effective as of December
      31,
      2007.


21





As
      of
      September 30, 2008, our management, including our Interim Chief Executive
      Officer and Interim Principal Financial Officer, who is the same person,
      evaluated the effectiveness of our disclosure controls and procedures (as
      defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange
      Act
      of 1934). As part of its evaluation, management evaluated whether the previously
      reported material weaknesses in internal control over financial reporting
      continue to exist. Company management has determined that it cannot assert
      that
      the reported material weaknesses have been effectively remediated as of
      September 30, 2008. Accordingly, Company management, including our Interim
      Chief
      Executive Officer and Interim Principal Financial Officer, who is the same
      person, has concluded that Company’s disclosure controls and procedures were not
      effective as of September 30, 2008.





Notwithstanding
      the identified material weaknesses, Company management has concluded that the
      financial statements included in this Quarterly Report present fairly, in all
      material respects, the Company’s financial position, results of operations and
      cash flows for the periods presented in conformity with accounting principles
      generally accepted in the United States.





There
      have been no changes in our internal control over financial reporting that
      occurred during the quarter ended September 30, 2008 that have materially
      affected, or are reasonably likely to materially affect, our internal control
      over financial reporting.


22


**PART
      II — OTHER INFORMATION**




**Item 1.
      Legal Proceedings**





From
      time
      to time, we are involved in litigation and proceedings in the ordinary course
      of
      our business. We are not currently involved in any legal proceeding that we
      believe would have a material adverse effect on our business or financial
      condition.





On
      October 15, 2008, certain noteholders instituted suit against the Company in
      Superior Court of California, County of Sacramento, seeking payment of
      outstanding notes payable allegedly owed by the Company. The Company is
      defending this action, and believes that it has no liability for these notes,
      based on, among other things, a failure of consideration for the related
      December 2005 licensing agreement with Surgica Corporation. Until a final
      determination is made with respect to the disposition of the notes, the Company
      will continue to carry them on its balance sheet.





**Item 1A.
      Risk Factors**





Investing
      in our common stock involves a high degree of risk. You should consider
      carefully the risks and uncertainties described under Item 1A – “Risk
      Factors” of Part 1 of our Annual Report on Form 10-KSB for the year ended
      December 31, 2007, which is incorporated by reference into this report. The
      risks described in our Annual Report have not materially changed.





You
      should carefully consider the risk factors discussed in our Annual Report on
      Form 10-KSB as well as the other information in this report before deciding
      whether to invest in shares of our common stock. The occurrence of any of the
      risks discussed in the Annual Report on Form 10-KSB or this report could harm
      our business, financial condition, results of operations or growth prospects.
      In
      that case, the trading price of our common stock could decline, and you may
      lose
      all or part of your investment.





**Item 2.
      Unregistered Sales of Equity Securities and Use of
      Proceeds**





During
      the nine months ended September 30, 2008, we received an aggregate of $1,655,000
      for the purchase of 35,040,296 common shares. On October 2, 2008 and November
      3,
      2008 we sold notes in the principal amounts of $100,000 and $105,000 and issued
      warrants in connection therewith to purchase 2,000,000 and 2,625,000 shares
      of
      our common stock, respectively. In addition, between October 1, 2008 and
      November 17, 2008, we further received an aggregate of $20,000 for the purchase
      of 608,295 common shares. Reference is made to Liquidity and Capital resources
      under Management’s Discussion and Analysis of Financial Condition and Results of
      Operations or information relating to these sales. The sales were made pursuant
      to the exemption from the registration provisions of the Securities Act of
      1933
      provided by Section 4 (2) thereof.





As
      of
      November 18, 2008, we had used substantially all of the net proceeds which
      were
      generated from the sale of our securities pursuant to the SPA to fund ongoing
      operations. We have no remaining proceeds from these sales and will require
      further sales or other financing transactions or collaborative development
      agreements to maintain ongoing operations.




**Item 3.
      Defaults upon Senior Securities**





Not
      applicable.





**Item 4.
      Submission of Matters to a Vote of Security Holders**




Not
      applicable.





**Item 5.
      Other Information**





Not
      applicable.


23


**Item 6.
      Exhibits**





The
      following documents are included or incorporated by reference:





Exhibit Number
            
            Description10.6.1*
            
            Secured
                Promissory Note Replacement Agreement, dated as of January 9, 2008,
                between the Company and Matthew J. Szulik.10.6.2*
            
            Secured
                Promissory Note issued to Matthew J. Szulik, dated as of January
                9,
                2008.10.6.3*
            
            Form
                of Warrant to Purchase Shares of Common Stock of the Company in connection
                with the Secured Promissory Note issued to Matthew J. Szulik, dated
                as of
                January 9. 2008.10.6.4
            
            Form
                of Promissory Note issued to noteholders, dated as of October 2,
                2008 and
                November 3, 2008.10.6.5
            
            Form
                of Warrant to Purchase Shares of Common Stock of the Company in connection
                with the Promissory Note issued to noteholders, dated as of October
                2,
                2008 and November 3, 2008.31.1
            
            Certification
                of Interim Chief Executive Officer pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.31.2
            
            Certification
                of Interim Principal Financial Officer pursuant to Section 302 of
                the
                Sarbanes-Oxley Act of 2002.32.1
            
            Certification
                of Interim Chief Executive Officer pursuant to 18 U.S.C. Section
                1350, as
                adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002.32.2
            
            Certification
                of Interim Principal Financial Officer pursuant to 18 U.S.C. Section
                1350
                as adopted pursuant to Section 960 of the Sarbanes-Oxley Act of
                2002.










*
            Incorporated
                by reference to Registrant’s Report on Form 10-KSB for the fiscal year
                ended December 31, 2007, SEC File No. 000-19724, as filed with the
                Commission on May 12, 2008.




24





**SIGNATURES**





In
      accordance with the requirements of the Securities Exchange Act of 1934, the
      registrant caused this report to be signed on its behalf by the undersigned,
      thereunto duly authorized.




PROTEIN
                POLYMER TECHNOLOGIES, INC.Date:
                November 19, 2008
            By:
            /s/
                James B. McCarthyJames
                B. McCarthyInterim
                Chief Executive OfficerDate:
                November 19, 2008
            By:
            /s/
                James B. McCarthyJames
                B. McCarthyInterim
                Principal Financial Officer




25