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 June 30, 2009




OR




 ̈
            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 filer  ̈
            Accelerated
      filer  ̈
            Non-accelerated
      filer  ̈
              (Do
      not check if a smaller reporting
              company)
            Smaller
      reporting company þ





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





The
number of shares of the registrant’s common stock issued and outstanding as of
August 19, 2009 was 112,959,272.





PROTEIN
POLYMER TECHNOLOGIES, INC.




FORM
10-Q — QUARTERLY REPORT


FOR
THE PERIOD ENDED JUNE 30, 2009




TABLE
OF CONTENTS




PagePART
      I.  FINANCIAL INFORMATIONItem
      1.
                Financial
      Statements
                3Condensed
      Balance Sheets as of June 30, 2009 (unaudited) and December 31,
      2008
                3Condensed
      Statements of Operations for the Three and Six Months Ended June 30, 2009
      and 2008 (unaudited)
                4Condensed
      Statements of Cash Flows for the Three and Six Months Ended June 30, 2009
      and 2008 (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
                20Item
      4T.
                Controls
      and Procedures
                20PART
      II.  OTHER INFORMATIONItem
      1.
                Legal
      Proceedings
                22Item
      2.
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                22Item
      3.
                Defaults
      Upon Senior Securities
                22Item
      4.
                Submission
      of Matters to a Vote of Security Holders
                22Item
      5.
                Other
      Information
                22Item
      6.
                Exhibits
                23SIGNATURES
                24




2


PART
I — FINANCIAL INFORMATION





Item 1.  Financial
Statements





Protein
Polymer Technologies, Inc.


Condensed
Balance Sheets





June 30, 2009
                            
                            
                            December 31,(unaudited)
                            
                            
                            2008AssetsCurrent
      assets:Cash
                            
                            $
                            54
                            
                            
                            $
                            1,291Accounts
      receivable
                            
                            
                            52,110
                            
                            
                            
                            -Prepaid
      expenses and other current assets
                            
                            
                            36,558
                            
                            
                            
                            35,011Total
      current assets
                            
                            
                            88,722
                            
                            
                            
                            36,302Deposits
                            
                            
                            29,979
                            
                            
                            
                            29,679Equipment
      and leasehold improvements, net
                            
                            
                            17,064
                            
                            
                            
                            24,429Investment
                            
                            
                            520,000
                            
                            
                            
                            520,000Total
      assets
                            
                            $
                            655,765
                            
                            
                            $
                            610,410Liabilities
      and stockholders’ deficitCurrent
      liabilities:Accounts
      payable
                            
                            $
                            1,030,136
                            
                            
                            $
                            969,435Accrued
      liabilities
                            
                            
                            1,110,996
                            
                            
                            
                            844,073Secured
      note payable – related party
                            
                            
                            6,414,837
                            
                            
                            
                            6,414,837Note
      payable – Surgica
                            
                            
                            -
                            
                            
                            
                            519,071Notes
      payable – other, net of unamortized debt discount
                            
                            
                            209,143
                            
                            
                            
                            158,589Deferred
      revenue
                            
                            
                            50,000
                            
                            
                            
                            -Fair
      value of warrant obligations
                            
                            
                            1,439,281
                            
                            
                            
                            -Total
      current liabilities
                            
                            
                            10,254,393
                            
                            
                            
                            8,906,005Commitments
      and contingenciesStockholders’
      deficit:Convertible
      preferred stock, $0.01 par value; 5,000,000 shares authorized; 20,237
      shares issued and outstanding at June 30, 2009 and December 31, 2008 –
      liquidation preference of $2,085,147 and $2,082,930 at June 30, 2009 and
      December 31, 2008, respectively.
                            
                            
                            1,834,299
                            
                            
                            
                            1,834,299Common
      stock, $0.01 par value; 1,000,000,000 shares authorized; 112,959,272 and
      109,387,843 shares issued and outstanding at June 30, 2009
      and December 31, 2008, respectively
                            
                            
                            1,129,593
                            
                            
                            
                            1,093,878Additional
      paid-in capital
                            
                            
                            59,605,884
                            
                            
                            
                            61,982,390Accumulated
      deficit
                            
                            
                            (72,168,404
                            )
                            
                            
                            (73,206,162
                            )Total
      stockholders’ deficit
                            
                            
                            (9,598,628
                            )
                            
                            
                            (8,295,595
                            )Total
      liabilities and stockholders’ deficit
                            
                            $
                            655,765
                            
                            
                            $
                            610,410





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


3


Protein
Polymer Technologies, Inc.


Condensed
Statements of Operations


(unaudited)




Three months ended
                                    
                                    
                                    Six months endedJune 30,
                                    
                                    
                                    June 30,2009
                                    
                                    
                                    2008
                                    
                                    
                                    2009
                                    
                                    
                                    2008Revenues:Product
      and other income
                                    
                                    $
                                    2,110
                                    
                                    
                                    $
                                    6,755
                                    
                                    
                                    $
                                    2,645
                                    
                                    
                                    $
                                    6,755Total
      revenues
                                    
                                    
                                    2,110
                                    
                                    
                                    
                                    6,755
                                    
                                    
                                    
                                    2,645
                                    
                                    
                                    
                                    6,755Operating
      expenses:Research
      and development
                                    
                                    
                                    29,153
                                    
                                    
                                    
                                    573,516
                                    
                                    
                                    
                                    58,156
                                    
                                    
                                    
                                    1,125,490Selling,
      general and administrative
                                    
                                    
                                    331,127
                                    
                                    
                                    
                                    302,181
                                    
                                    
                                    
                                    600,873
                                    
                                    
                                    
                                    511,492Total
      expenses
                                    
                                    
                                    360,280
                                    
                                    
                                    
                                    875,697
                                    
                                    
                                    
                                    659,029
                                    
                                    
                                    
                                    1,636,982Net
      loss from operations
                                    
                                    
                                    (358,170
                                    )
                                    
                                    
                                    (868,942
                                    )
                                    
                                    
                                    (656,384
                                    )
                                    
                                    
                                    (1,630,227
                                    )Other
      income (expenses):Interest
      expense
                                    
                                    
                                    (184,597
                                    )
                                    
                                    
                                    (208,314
                                    )
                                    
                                    
                                    (353,157
                                    )
                                    
                                    
                                    (378,242
                                    )Gain
      on sale of equipment
                                    
                                    
                                    -
                                    
                                    
                                    
                                    40,646
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    40,646Gain
      on settlement of note payable – Surgica
                                    
                                    
                                    638,380
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    638,380
                                    
                                    
                                    
                                    -Gain/(loss)
      from change in fair value of warrants
                                    
                                    
                                    566,101
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (38,204
                                    )Total
      other income (expense)
                                    
                                    
                                    1,019,884
                                    
                                    
                                    
                                    (167,668
                                    )
                                    
                                    
                                    247,019
                                    
                                    
                                    
                                    (337,596
                                    )Net
      income (loss)
                                    
                                    
                                    661,714
                                    
                                    
                                    
                                    (1,036,610
                                    )
                                    
                                    
                                    (409,365
                                    )
                                    
                                    
                                    (1,967,823
                                    )Dividends
      on preferred stock
                                    
                                    
                                    1,114
                                    
                                    
                                    
                                    69,030
                                    
                                    
                                    
                                    2,216
                                    
                                    
                                    
                                    138,060Net
      income (loss) applicable to common shareholders
                                    
                                    $
                                    660,600
                                    
                                    
                                    $
                                    (1,105,640
                                    )
                                    
                                    $
                                    (411,581
                                    )
                                    
                                    $
                                    (2,105,883
                                    )Net
      income (loss) per common shareBasic
                                    
                                    $
                                    0.006
                                    
                                    
                                    $
                                    (0.012
                                    )
                                    
                                    $
                                    (0.004
                                    )
                                    
                                    $
                                    (0.024
                                    )Diluted
                                    
                                    $
                                    0.006
                                    
                                    
                                    $
                                    (0.012
                                    )
                                    
                                    $
                                    (0.004
                                    )
                                    
                                    $
                                    (0.024
                                    )Weighted
      average number of common shares outstandingBasic
                                    
                                    
                                    112,959,272
                                    
                                    
                                    
                                    94,582,408
                                    
                                    
                                    
                                    112,722,492
                                    
                                    
                                    
                                    87,380,889Diluted
                                    
                                    
                                    114,821,814
                                    
                                    
                                    
                                    94,582,408
                                    
                                    
                                    
                                    112,722,492
                                    
                                    
                                    
                                    87,380,889




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


4





Protein
Polymer Technologies, Inc.


Condensed
Statements of Cash Flows


(unaudited)





Six months endedJune 30,2009
                                
                                
                                2008Operating
      activitiesNet
      loss
                                
                                $
                                (409,365
                                )
                                
                                $
                                (1,967,823
                                )Adjustments
      to reconcile net loss to net cash used for operating
      activities:Depreciation
                                
                                
                                7,365
                                
                                
                                
                                35,349Stock-based
      compensation expense
                                
                                
                                2,423
                                
                                
                                
                                4,257Debt
      discount amortization
                                
                                
                                65,540
                                
                                
                                
                                89,978Loss
      from change in fair value of warrant obligations
                                
                                
                                38,204
                                
                                
                                
                                -Gain
      on sale of fixed assets
                                
                                
                                -
                                
                                
                                
                                (40,646
                                )Gain
      on settlement of note payable – Surgica
                                
                                
                                (638,380
                                )Changes
      in operating assets and liabilities:Deposits
                                
                                
                                (300
                                )
                                
                                
                                -Prepaid
      expenses and other current assets
                                
                                
                                (1,547
                                )
                                
                                
                                (10,296
                                )Accounts
      receivable
                                
                                
                                (52,110
                                )
                                
                                
                                -Accounts
      payable
                                
                                
                                60,701
                                
                                
                                
                                298,850Accrued
      liabilities
                                
                                
                                386,232
                                
                                
                                
                                254,987Deferred
      revenue
                                
                                
                                50,000
                                
                                
                                
                                -Net
      cash used for operating activities
                                
                                
                                (491,237
                                )
                                
                                
                                (1,335,344
                                )Investing
      activities:Proceeds
      from sale of equipment
                                
                                
                                -
                                
                                
                                
                                101,000Net
      cash provided by investing activities
                                
                                
                                -
                                
                                
                                
                                101,000Financing
      activities:Proceeds
      from sale of common stock
                                
                                
                                75,000
                                
                                
                                
                                1,220,000Proceeds
      from issuance of note payable
                                
                                
                                415,000
                                
                                
                                
                                -Net
      cash provided by financing activities
                                
                                
                                490,000
                                
                                
                                
                                1,220,000Net
      decrease in cash
                                
                                
                                (1,237
                                )
                                
                                
                                (14,344
                                )Cash
      at beginning of the period
                                
                                
                                1,291
                                
                                
                                
                                21,936Cash
      at end of the period
                                
                                $
                                54
                                
                                
                                $
                                7,592Supplemental
      disclosures of cash flow informationInterest
      paid
                                
                                $
                                985
                                
                                
                                $
                                1,647Non
      cash investing and financing activityDebt
      discount recorded in connection with issuance/amendment of
      warrants
                                
                                $
                                -
                                
                                
                                $
                                135,449Warrant
      obligation on warrants issued with common stock and debt
                                
                                $
                                472,501
                                
                                
                                $
                                -Settlement
      of note payable - Surgica
                                
                                $
                                638,380
                                
                                
                                $
                                -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, 2008 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-K for the year ended December
31, 2008, as filed with the U.S. Securities and Exchange
Commission.  The results of operations for the three and six months
ended June 30, 2009 are not necessarily indicative of the results expected for
the fiscal year ending December 31, 2009.





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 six months ended June 30, 2009, the
Company incurred net losses and negative cash flows from operating activities of
approximately $409,000 and $491,000, respectively, and at June 30, 2009, the
Company had a working capital deficit of approximately $10,196,000 and an
accumulated deficit of approximately $72,168,000. The Company’s cash balance as
of June 30, 2009 was approximately $50 and, in combination with anticipated
additional contract and license payments, is insufficient to meet our ongoing
capital requirements.





From
January 1, 2009 through June 30, 2009, required operating capital has been
obtained through proceeds totaling $75,000 from equity purchases and proceeds
totaling $415,000 from issuance of debt.





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.





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.


6


Protein
Polymer Technologies, Inc.


Notes
to Condensed Financial Statements


(unaudited)





Cost
Method Investment





The
investment balance at June 30, 2009 and December 31, 2008 represents shares of
common stock owned by the Company in a privately held company which were
acquired pursuant to a license agreement.  Based on the Company’s
limited ownership percentage, the investment is reported using the cost
method.  Under the cost method, the Company does not record its
proportional share of earnings and losses of the investee, and income on the
investment is only recorded to the extent of dividends distributed from earnings
of the investee received subsequent to the date of acquisition.





The
Company reviews the carrying value of its cost-method investment for impairment
each reporting period unless i) the investment’s fair value has not been
estimated for any purpose, including estimates of fair value used to satisfy
other financial reporting requirements and ii) there are no impairment
indicators present for the investment during the period under review which would
indicate there has been an event or change in circumstances that could have a
negative effect on the investment’s fair value.





When an
impairment test demonstrates that the fair value of an investment is less than
its cost, Company management will determine whether the impairment is either
temporary or other-than-temporary.  Examples of factors which may be
indicative of an other-than-temporary impairment include i) the length of time
and extent to which market value has been less than cost, ii) the financial
condition and near-term prospects of the issuer, iii) and the intent and ability
of the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in market value.  If
the decline in fair value is determined by management to be
other-than-temporary, the cost basis of the investment is written down to its
estimated fair value as of the balance sheet date of the reporting period which
the assessment is made. This fair value becomes the investment’s new cost basis,
which is not changed for subsequent recoveries in fair value.  Any recorded
impairment write-down will be included in earnings as a realized loss in the
period such write-down occurs.





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 Statement 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.


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 accrued expenses
approximate their respective fair values because of the short maturities of
these instruments. The carrying value of the Company’s notes payable obligations
approximates their fair value as the stated interest rates of these instruments
reflect rates currently available to the Company.





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. The standard describes three levels of
inputs that may be used to measure fair value:




Level 1:
Quoted prices in an active market for identical assets or
liabilities.




Level 2:
Observable inputs other than Level 1 prices such as quoted prices for
similar assets or liabilities; quoted prices in markets that are not active; or
other inputs that are observable or can be corroborated by observable market
data for substantially the full term of the assets or liabilities.




Level 3:
Unobservable inputs that are supported by little or no market activity and that
are significant to the fair value of the assets or liabilities.





The
Company’s adoption of SFAS No. 157 with respect to nonfinancial assets and
liabilities on January 1, 2008 did not have a material effect on the Company’s
financial statements.





At June
30, 2009, the Company remeasured the fair value of warrants to purchase shares
of common stock that were classified as liabilities (see Note 8). These warrants
were valued using Level 3 inputs because there are certain unobservable inputs
associated with them. The following table reconciles the liability for these
warrants measured at fair value on a recurring basis using Level 3 inputs for
the six months ended June 30, 2009:




Balance
      at December 31, 2008
                    
                    $
                    -Cumulative
      effect of accounting change (Note 8)
                    
                    
                    933,000Issuance
      of new warrants
                    
                    
                    468,000Loss
      on change in fair value included in net income
                    
                    
                    38,000Balance
      at June 30, 2009
                    
                    $
                    1,439,000





Fair
Value of Warrant Obligations





In June
2008, the FASB ratified the consensus reached on EITF Issue No. 07-5,
Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity’s Own Stock (“EITF No. 07-5”).  EITF No. 07-5 clarifies the
determination of whether an instrument (or an embedded feature) is indexed to an
entity’s own stock, which would qualify as a scope exception under SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities.





As a
result of adopting EITF 07-05 on January 1, 2009, 50,687,119 of the Company’s
warrants to purchase common stock previously treated as equity pursuant to the
derivative treatment exemption were no longer afforded equity treatment due to
exercise price reset and anti-liquidation features.


8


Protein
Polymer Technologies, Inc.


Notes
to Condensed Financial Statements


(unaudited)





On
January 1, 2009, the Company reduced additional paid-in capital by $2,380,000
and decreased the beginning accumulated deficit by $1,447,000 as a cumulative
effect to establish a long-term warrant liability of $933,000 to recognize the
fair value of such warrants.





These
common stock purchase warrants were initially issued in connection with
placement of the Company’s common stock. The common stock purchase warrants were
not issued with the intent of effectively hedging any future cash flow, fair
value of any asset, liability or any net investment in a foreign operation. The
warrants do not qualify for hedge accounting, and as such, all future changes in
the fair value of these warrants will be recognized currently in earnings until
such time as the warrants are exercised or expire. These common stock purchase
warrants do not trade in an active securities market, and as such, we estimate
the fair value of these warrants using the Black-Scholes option pricing model
using the following assumptions:





June
      30,2009Annual
      dividend yield
                      
                      
                      0
                      %Expected
      life (years)
                      
                      
                      1.6
      – 4.6Risk-free
      interest rate
                      
                      
                      1.2%
      - 2.7
                      %Expected
      volatility
                      
                      
                      236% - 285
                      %





Expected
volatility is based primarily on historical volatility. Historical volatility
was computed using daily pricing observations for recent periods that correspond
to the expected life of the warrants. We believe this method produces an
estimate that is representative of our expectations of future volatility over
the expected term of these warrants. We currently have no reason to believe
future volatility over the expected remaining life of these warrants is likely
to differ materially from historical volatility. The expected life is estimated
by management based on the remaining term of the warrants. The risk-free
interest rate is based on the rate for U.S. Treasury securities over the
expected life.





Net
Income/Loss per Common Share





Basic
income/loss per share is calculated using the weighted-average number of
outstanding common shares during the period. Diluted income/loss 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 income/loss per common share as of June 30, 2009 and 2008 were 77,129,
821 and 52,782, 938 shares, respectively.





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.


9


Protein
Polymer Technologies, Inc.


Notes
to Condensed Financial Statements


(unaudited)





Reclassifications





Certain
prior year amounts have been reclassified to conform to the 2009
presentation.





Recent
Accounting Pronouncements




In
December 2007, the FASB issued SFAS No. 141 (revised), Business Combinations
(“SFAS No. 141I”). 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. SFAS No. 141(R) was effective for the
Company on January 1, 2009. The adoption of SFAS No. 141(R) on January 1, 2009
did not have a material effect on the Company’s financial
statements.





In April
2008, the FASB issued FASB Staff Position (“FSP”) FAS No. 142-3, Determination of Useful Life of
Intangible Assets (“FSP FAS 142-3”). FSP FAS No. 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 SFAS
No. 142, “Goodwill and Other Intangible Assets.” FSP FAS No. 142-3 also requires
expanded disclosure related to the determination of intangible asset useful
lives. The adoption of FSP FAS No. 142-3 on January 1, 2009 did not have a
material effect on the Company’s financial statements.





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. The adoption of FSP APB 14-1 on January 1,
2009 did not have a material effect on the Company’s financial
statements.





In April
2009, the FASB issued FSP SFAS No. 107-1 and Accounting Principles Board (“APB”)
28-1, Interim Disclosures
about Fair Value of Financial Instruments(“FSP SFAS 107-1 and APB
28-1”). FSP SFAS 107-1 and APB 28-1 amends SFAS No. 107, Disclosures about Fair Value of
Financial Instruments(“SFAS 107”), and APB Opinion No. 28, Interim Financial Reporting(“APB 28”),to
require publiccompanies to comply
with the disclosure requirements in SFAS 107 related to the fair value of
financial instruments in interim financialstatements. Prior to
the issuance of FSP SFAS 107-1 and APB 28-1, these disclosures were only
required in annual financial statements. ThisFSP is effective for
interim reporting periods ending after June 15, 2009, with early adoption
permitted for periods ending after March 15,2009. This FSP does not
require disclosures for earlier periods presented for comparative purposes at
initial adoption. In periods after initial adoption, this FSP requires
comparative disclosures only for periods ending after initial adoption. The
adoption of FSP SFAS 107-1 did not have a material effect on the Company’s
financial position, results of operations, and cash flows.


10


Protein
Polymer Technologies, Inc.


Notes
to Condensed Financial Statements


(unaudited)





In May
2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS No.
165”), which is effective for fiscal years beginning after June 15,
2009.  SFAS No. 165 establishes general standards of accounting for
and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. In particular,
this Statement sets forth the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements, the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and the
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date.





In June
2009, the FASB issued SFAS No. 168, The “FASB Accounting Standards Codification”
and the Hierarchy of Generally Accepted Accounting Principles. SFAS No. 168
establishes the FASB Accounting Standards Codification (Codification) to become
the source of authoritative U.S. generally accepted accounting principles (U.S.
GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules
and interpretive releases of the SEC under authority of federal securities laws
are also sources of authoritative U.S. GAAP for SEC registrants. SFAS No. 168
and the Codification are effective for financial statements issued for interim
and annual periods ending after September 15, 2009. The Company is currently
evaluating the impact that the adoption of SFAS No. 168 may have on its
financial position, results of operations, and cash flows.





Note
2.    Accounts Receivable





On June
29, 2009, the Company received from Sanyo Chemical Industries, Ltd. (“Sanyo”) a
fully executed copy of a License Agreement between Sanyo and the
Company.  The effective date of the Agreement is June 18,
2009.    Pursuant to the Agreement, the Company has granted
a non-exclusive, world-wide license to Sanyo of its technology, know-how, and
intellectual property relating to recombinant, repetitive unit proteins and
peptides, for the purposes of developing and commercializing products related to
Sanyo’s specific fields of business.  The Agreement remains in effect
until the expiration of the last to expire of the Company’s patents licensed by
Sanyo under this Agreement.  The Agreement further provides the
Company with initial and ongoing license fees, technical service and training
fees, and a percentage royalty on the quarterly net sales of any new products
developed by Sanyo under this Agreement.  As of June 30, 2009, the
accounts receivable related to this contract totaled $50,000. The Company has
not yet provided for the deliverables under the Agreement.





Note
3.    Investment




The
investment included on our balance sheets at June 30, 2009 and December 31, 2008
represents the Company’s cost basis in shares of common stock of Spine Wave,
Inc. (“Spine Wave”), a privately held company focused on the development and
commercialization of innovative products and technologies for the treatment of
spinal disorders.


11


Protein
Polymer Technologies, Inc.


Notes
to Condensed Financial Statements


(unaudited)





Based on
adverse changes in market values of companies in the medical device/equipment
industry during the second half of 2008, as evidenced by the steep declines in
stock market values of publicly traded companies in this sector and in the
overall stock market, the Company evaluated its investment in Spine Wave for
impairment as of June 30, 2009.  Since there are no quoted prices of
Spine Wave’s common stock, and since it was not practicable for the Company to
otherwise estimate the fair value of Spine Wave’s common stock at June 30, 2009,
the Company was unable to quantify the specific amount of potential
impairment.  However, because the Company believes there may be
potential impairment, it completed an evaluation to determine if the potential
impairment was other-than-temporary.  This evaluation was based on a
number of factors including: i) the length of time and the extent to which the
market value has been less than the cost; ii) the financial condition and near
term prospects of Spine Wave: and iii) the Company’s intent and ability to
retain its investment in Spine Wave for a period of time sufficient to allow for
a recovery in market value.  In connection with this evaluation, the
Company determined that any potential impairment in its investment in Spine Wave
was primarily a function of the impact on the stock market and the medical
device/equipment sector of the deterioration of global economic conditions
during the second half of 2008, and that any potential impairment was not a
function of factors specifically relating to Spine Wave’s business or its near
term prospects.  Based on the Company's evaluation of Spine Wave’s
near term prospects, the partial recovery of stock market values subsequent to
June 30, 2009 and on management's intention to hold the investment in Spine Wave
for a sufficient period of time to allow for a recovery in the market value, the
Company determined that any potential impairment was not other-than-temporary,
and accordingly, no impairment was recorded at June 30, 2009.





As of
June 30, 2009 the Company was not aware of any indicators of impairment with
respect to its investment in Spine Wave, and it was not practicable for the
Company to estimate the fair value of this investment because of the lack of
quoted market prices and the inability to otherwise estimate fair value without
incurring excessive costs.  Management believed that the carrying
amount of its investment in Spine Wave was not impaired at June 30,
2009.





As
discussed in Note 5, a portion of the Spine Wave shares owned by the Company
serve as collateral for a currently outstanding note payable.





Note
4.    Accrued Liabilities





Accrued
liabilities consist approximately of the following:





June 30,
                          December 31,2009
                          
                          2008Payroll
      and employee benefits
                          
                          $
                          96,000
                          
                          67,000Professional
      Fees
                          
                          
                          42,000
                          
                          -Accrued
      interest
                          
                          
                          777,000
                          
                          610,000Insurance
      premium financing
                          
                          
                          23,000
                          
                          27,000Directors
      fees
                          
                          
                          120,000
                          
                          100,000Other
                          
                          
                          53,000
                          
                          40,000$
                          1,111,000
                          
                          844,000




12




Protein
Polymer Technologies, Inc.
 Notes
to Condensed Financial Statements
 (unaudited)
 
 Note
5.    Notes Payable
 
 Secured
Notes Payable – Related Party
 
 As of
June 30, 2009, the amount due on this note includes the $6,415,000 outstanding
balance plus $757,000 of accrued interest.  On March 31, 2009, the
Company extended the maturity date of its secured notes payable – related party
to September 30, 2009.
 
 The note
is 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.
 
 Notes
Payable - Other
 
 On April
20, 2009, May 7, 2009, and June 5, 2009, the Company received proceeds of
$100,000, $50,000 and $100,000, respectively, as loans.  These notes
are due on April 19, 2010, May 6, 2010, and June 4, 2010, 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 $0.020,
$0.026, and $0.020 per share, respectively, at the discretion of the
Company.  In connection with the loans, the Company granted warrants
to the noteholders to purchase an aggregate of 5,000,000, 1,923,077, and
5,000,000 shares, respectively, of the Company’s common stock at an exercise
price of $0.020, $0.026, and $0.020 per share, respectively.  As of
June 30, 2009 the total amount of accrued interest owed was
$20,000.
 
 A portion
of the proceeds totaling $243,000 were allocated to the warrant liabilities and
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:
 
 4/20/09
                        Warrant
                      
                      
                      5/07/09
                        Warrant
                      
                      
                      6/5/09
                        WarrantExpected
      annual dividends
                      
                      
                      0
                      %
                      
                      
                      0
                      %
                      
                      
                      0
                      %Risk-free
      interest rate
                      
                      
                      1.3
                      %
                      
                      
                      1.4
                      %
                      
                      
                      1.8
                      %Expected
      term (in years)
                      
                      
                      3.0
                      
                      
                      
                      3.0
                      
                      
                      
                      3.0Expected
      Volatility
                      
                      
                      234
                      %
                      
                      
                      246
                      %
                      
                      
                      280
                      %
 
 The
carrying value of the notes payable - other at June 30, 2009, is comprised of
the following:
 
 Principal
      value of notes
                      
                      $
                      645,000Less:
      Unamortized debt discount
                      
                      
                      (436,000
                      )$
                      209,000
 
 The total
debt discount recorded is being amortized as interest expense over the expected
term of the notes using the effective interest method.  During the six
months ended June 30, 2009, the Company recorded non-cash interest expense of
approximately $66,000 based on the debt discount amortization of these
warrants.
  13
  Protein
Polymer Technologies, Inc.
 Notes
to Condensed Financial Statements
 (unaudited)
 
 Surgica
Notes
 
 In
December 2005, in connection with a license agreement with Surgica Corporation
for the rights to certain intellectual property, the Company assumed several
notes payable agreements with an aggregate principal balance of
$519,000.
 
 In March
2007, the license agreement with Surgica was terminated.  On October
15, 2008, the noteholders instituted suit against the Company in Superior Court
of California, County of Sacramento seeking payment of these
notes.  Until a final determination was made with respect to the
disposition of the notes, the Company continued to carry them on its balance
sheet.
  On May
19, 2009, the plaintiffs filed a request for dismissal with prejudice of the
action against the Company, and the Company paid nothing to plaintiffs in
exchange for the dismissal.  The dismissal was granted, and the
Company reversed the principal liability balance of $519,000 and the accrued
interest of $119,000 relating to this license agreement and recorded a gain on
extinguishment of $638,000 for the three-month period ended June 30,
2009.  As such, neither the liability nor the related accrued interest
appears on the Company’s balance sheet as of June 30, 2009.
 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 and amended on November 28, 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 the Company’s
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,
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 100% of the purchase price paid by the
purchase.  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.
 
 For the
six months ended June 30, 2009, the Company received an aggregate of $75,000 in
subscriptions for the purchase of 3,571,429 shares of common stock and 3,571,429
warrants, subject to the terms of the SPA and RRA.   Between
September 27, 2007 and June 30, 2009, the Company received proceeds of
$2,357,500 for the purchase of 46,070,548 shares of common stock and 46,070,548
warrants pursuant to this Stock Purchase Agreement.
  14
  Protein
Polymer Technologies, Inc.
 Notes
to Condensed Financial Statements
 (unaudited)
 
 Note
7.    Stock Options
 
 The
Company did not grant options during the six months ended June 30,
2009.  Stock option activity for the three months ended June 30, 2009
is as follows:
 
 Options
                                        Outstanding
                                      
                                      
                                      Weighted
                                        Average
                                        Exercise
                                        Price
                                      
                                      
                                      Weighted
      Average
                                        Remaining
                                        Contractual
      Term
                                        (Years)Outstanding
      at December 31, 2008
                                      
                                      
                                      3,507,500
                                      
                                      
                                      $
                                      0.68
                                      
                                      
                                      
                                      4.40Issued
                                      
                                      
                                      -Cancelled
                                      
                                      
                                      -Exercised
                                      
                                      
                                      (72,500
                                      )Outstanding
      at June 30, 2009
                                      
                                      
                                      3,435,000
                                      
                                      
                                      
                                      0.67
                                      
                                      
                                      
                                      3.98Exercisable
      at June 30, 2009
                                      
                                      
                                      3,435,000
                                      
                                      
                                      $
                                      0.69
                                      
                                      
                                      
                                      3.98
 
 During
the three and six month periods ended June 30, 2009, the Company recognized
$1,000 and $2,400 in stock-based compensation expense.  The charges in
the comparable periods ended June 30, 2008 were $3,000 and $4,300,
respectively.  As of June 30, 2009, all unrecognized compensation
expense related to unvested share-based compensation arrangements was fully
recognized.  There was no intrinsic value related to the stock options
outstanding as of June 30, 2009.
 
 Note
8.    Warrants to Purchase Common Stock
  The
Company has reserved for issuance, out of currently authorized and unissued
shares of common stock, shares underlying outstanding warrants to purchase
common stock.  The fair values of the warrant obligations were
recorded as liabilities on the dates of issuance, in accordance with EITF 07-05
(see Note 9 below).  Upon exercise of the warrants, shares of common
stock will be issued out of currently authorized and unissued
shares.
 A summary
of warrant activity for the three months ended June 30, 2009 is as
follows:
 
 Number
      of
                            Warrants
                            Outstanding
                            and
                            Exercisable
                          
                          
                          Weighted-
                            Average
                            Exercise
                            PriceOutstanding,
      December 31, 2008
                          
                          
                          63,246,315
                          
                          
                          $
                          0.14Granted
                          
                          
                          23,744,506
                          
                          
                          $
                          0.04Exercised
                          
                          
                          -
                          
                          
                          $
                          -Expired
                          
                          
                          (12,468,589
                          )
                          
                          $
                          0.50Outstanding,
      June 30, 2009
                          
                          
                          74,522,232
                          
                          
                          $
                          0.04
 
 At June
30, 2009, the weighted-average remaining contractual life of the warrants was
approximately 3.36 years.
  15
  Protein
Polymer Technologies, Inc.
 Notes
to Condensed Financial Statements
 (unaudited)
  Note
9.    Change in Accounting Principle: Warrant
Obligations
 
 As a
result of adopting EITF 07-5, the Company reclassified the fair value of
warrants to purchase common stock as follows:
  Additional
                        Paid-in
                      
                      
                      AccumulatedCapital
                      
                      
                      DeficitBalances
      at December 31, 2008
                      
                      $
                      61,982,000
                      
                      
                      
                      (73,206,000
                      )Cumulative
      effect of warrants reclassified
                      
                      
                      (2,380,000
                      )
                      
                      
                      1,447,000Stock
      issuance
                      
                      
                      2,000
                      
                      
                      
                      -Stock-based
      compensation expense
                      
                      
                      2,000
                      
                      
                      
                      -Net
      loss
                      
                      
                      -
                      
                      
                      
                      (409,000
                      )Balances
      at June 30, 2009
                      
                      $
                      59,606,000
                      
                      
                      
                      (72,168,000
                      )
 
 Note
10.    Subsequent Events
  On July
7, 2009 and August 14, 2009, the Company received proceeds of $50,000 and
$30,000, respectively, pursuant to note payable agreements entered into with
clients of TAG.  These loans are represented by unsecured notes issued
by the Company.  These notes are due one year after issuance and bear
an annual interest rate of 8%.  The interest and principal are payable
on the maturity date, either in cash or common stock, at the discretion of the
Company, at a rate of $0.034 and $0.025 per share, respectively.  As
consideration for these loans, the Company granted warrants to the noteholders
to purchase 1,492,537 and 1,200,000 shares of the Company’s common stock at an
exercise price of $0.034 and $0.025 per share.  The Company evaluated
subsequent events through August 19, 2009, which is the date the financial
statements were issued.
  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,
2008, 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-K for the year ended December 31, 2008. 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-K for the year ended
December 31,2008. 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”, “our” 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 extracellular 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
 
 Revenue. Revenues from product sales
for the three and six months ended June 30, 2009 were approximately $2,000 and
$3,000, respectively, compared to $7,000 for revenue from product sales for the
comparable periods in 2008.
 
 Research and
Development Expenses. Research and development
expenses for the three and six months ended June 30, 2009 were $29,000 and
$58,000, respectively, compared to $574,000 and $1,125,000, respectively, for
the comparable periods in 2008.  The decline resulted from our
inability to raise additional capital, and the closing of our laboratory and
administrative facility, and the subsequent sub-contracting of the laboratory
function.  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 six months ended June 30, 2009 were
$331,000 and $601,000, respectively, as compared to $302,000 and $511,000,
respectively, for the comparable periods in 2008.  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.
 
 Gain/Loss
from change in fair value of warrants
 
 On
January 1, 2009 we reclassified the fair value of warrants to purchase
common stock from equity to liability status as if these warrants were treated
as a derivative liability since their date of issue. The fair value of these
common stock purchase warrants decreased to $1,440,000 as of June 30, 2009 due
to a decrease in the Company’s stock price. We recognized a $566,000 non-cash
gain from the change in fair value of these warrants for the three months ended
June 30, 2009, and a $38,000 loss from the change in fair value of these
warrants for the six months ended June 30, 2009.
  18
  Operating Gains
and Losses. For the three months ended June 30, 2009, we recorded a net
gain applicable to common shareholders of $661,000 or $0.006 per share, as
compared to a loss of $1,106,000 or $0.012 per share for the comparable period
in 2008. For the six months ended June 30, 2009, we recorded a net loss
applicable to common shareholders of $412,000 or $0.004 per share, as compared
to a loss of $2,106,000 or $0.024 per share for the comparable period in
2008.
 
 Liquidity
and Capital Resources
 
 As of
June 30, 2009, we had cash totaling approximately $50, as compared to $1,000 at
December 31, 2008. As of June 30, 2009, we had a working capital deficit of
$10,196,000 compared to a working capital deficit of $8,870,000 at December 31,
2008.
 
 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 June 30,
2009. During the six months ended June 30, 2009, we did not purchase or sell any
capital equipment or leasehold improvements.  We do not anticipate
significant expenditures for capital equipment or leasehold improvements for the
remainder of 2009.
 
 We
believe our existing available cash, cash equivalents, and accounts receivable,
in combination with anticipated contract research payments and revenues received
from the transfer of clinical testing materials, will not be sufficient to meet
our anticipated capital requirements during 2009. 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 $2,357,500 as of June 30, 2009, as a result of that SPA.  The SPA
has been our main source of external financing since September
2007.
 
 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. On
January 9, 2008, we replaced the Szulik Loan by issuing to Mr. Szulik a new note
in the principal amount of $6,415,000.  On March 31, 2009, the
scheduled maturity date was extended to September 30, 2009.
 
 Between
October 2, 2008 and August 19, 2009, the Company received proceeds of $725,000
as loans from clients of TAG.  These loans are represented by
unsecured notes issued by the Company.  These notes are due one year
after issuance 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 the discretion of the Company, at rates ranging from $0.02 to $0.05 per
share.
 
 As noted
above, we believe our existing available cash as of June 30, 2009 will not be
sufficient to meet our anticipated capital requirements during
2009.  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. 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.
  19
 
 Inflation
 
 To date,
we believe that inflation and changing prices have not had a material impact on
our continuing operations. However, we have experienced increased general and
product liability insurance costs over the past two years, and these increases
are expected to continue for the foreseeable future.
 
 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.
 
 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-K for the year ended December 31, 2008 (filed on
July 24, 2009), Company management identified material weaknesses in our
internal accounting control over financial reporting as of December 31, 2008,
including:
  20
 
 ·
              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 to
      properly account for 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,
2008.
 
 As of
June 30, 2009, 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 June 30, 2009.
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 June
30, 2009.
 
 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 June 30, 2009 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
  21
  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 alleged 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. On May 19, 2009, the
plaintiffs filed a request for dismissal with prejudice of the action against
the Company, and the Company paid nothing to plaintiffs in exchange for the
dismissal.  The request for dismissal was granted, and no subsequent
related legal proceedings have surfaced.
 
 Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 During
the six months ended June 30, 2009, we received an aggregate of $75,000 for the
purchase of 3,571,429 common shares and 3,571,429 warrants to purchase our
common stock.  Between January 1, 2009 and August 14, 2009, we sold
notes in the aggregate principal amount of $495,000 and issued warrants in
connection therewith to purchase 22,865,614 shares of our common
stock.  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
August 19, 2009, we had used substantially all of the net proceeds which were
generated from the sale of our securities described in the preceding paragraph
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.
  22
  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,
      November 3, 2008, December 11, 2008, February 6, 2009, March 18, 2009,
      April 20, 2009, May 7, 2009, June 5, 2009, and July 7,
    2009.10.6.5**
                  
                  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, November 3, 2008, December 11, 2008, February 6, 2009, March 18,
      2009, April 20, 2009, and May 7, 2009, June 5, 2009, and July 7,
      2009.10.6.6***
                  
                  Secured
      Promissory Note Replacement Agreement, dated as of March 31, 2009, between
      the Company and Matthew J. Szulik.10.6.7****
                  
                  License
      Agreement, effective June 18, 2009 and dated June 29, 2009, between the
      Company and Sanyo Chemical Industries, Ltd.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.
 **
              Incorporated
      by reference to Registrant’s Report on Form 10-Q for the quarter ended
      September 30, 2008, SEC File No. 000-19724, as filed with the Commission
      on November 19, 2008.
 ***
              Incorporated
      by reference to Registrant’s Report on Form 10-Q/A for the quarter ended
      March 31, 2009, SEC File No. 000-19724, as filed with the Commission on
      August 19, 2009.
 ****
              Incorporated
      by reference to Registrant’s Report on Form 10-K for the fiscal year ended
      December 31, 2008, SEC File No. 000-19724, as filed with the Commission on
      July 24, 2009.
  23
  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:
      August 19, 2009
                By:
                /s/ James B.
  McCarthyJames
      B. McCarthyInterim
      Chief Executive OfficerDate:
      August 19, 2009
                By:
                /s/ James B. McCarthyJames
      B. McCarthyInterim
      Principal Financial Officer
  24