<PAGE>
 
================================================================================


                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                AMENDMENT NO. 1
                                ---------------
                               ON FORM 10-KSB/A

(Mark One)
[X]  ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 
     1934 [FEE REQUIRED]
     For the fiscal year ended December 31, 1996

                                      OR

[_]  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT 
     OF 1934 [NO FEE REQUIRED]
     For the transition period from               to 
                                   --------------    --------------

                        Commission file number 0-19724

                         PROTEIN POLYMER TECHNOLOGIES, INC.
      (Exact name of small business issuer as specified in its charter)

                Delaware                                 33-0311631
(State or Other Jurisdiction of                (IRS Employer Identification No.)
Incorporation or Organization)

               10655 Sorrento Valley Road, San Diego, CA  92121
                   (Address of Principal Executive Offices)

                  Issuer's Telephone Number:  (619) 558-6064

       Securities registered pursuant to Section 12(b) of the Act: None

          Securities registered pursuant to Section 12(g) of the Act:
                       Common Stock, Redeemable Warrants
                               (Title of Class)

Check whether the issuer (1) filed all reports required to be filed by Section 
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter 
period that the registrant was required to file such reports), and (2) 
has been subject to such filing requirements for the past 90 days. Yes X  No
                                                                       _    __

Check if there is no disclosure of delinquent filers pursuant to Item 405 of 
Regulation S-B contained herein, and no disclosure will be contained, to the 
best of the registrant's knowledge, in definitive proxy or information 
statements incorporated by reference in Part III of this Form 10-KSB/A or any 
amendment to this Form 10-KSB/A. [X]
                                    

The issuer's revenues for the most recent fiscal year were $755,751.

The aggregate market value of the voting stock held by non-affiliates of the 
issuer on February 3, 1998 was $9,681,000.

State the number of shares outstanding of each of the issuer's classes of 
common equity, as of the latest practicable date:  As of February 3, 1998, 
10,429,094 shares of common stock were outstanding.

                     DOCUMENTS INCORPORATED BY REFERENCE:

Definitive Proxy Statement filed March 24, 1997 pursuant to Regulation 14A with
respect to the Registrant's 1997 Annual Meeting of Stockholders (incorporated by
reference in Part III).

Transitional Small Business Disclosure Format:  Yes     No X
                                                    --     -
                

<PAGE>
 
                                    PART II

Item 6.  Management's Discussion and Analysis of Financial Condition and
         Results of Operations

General Overview

     Incorporated in 1988, Protein Polymer Technologies, Inc. ("Protein" or "the
Company") has concentrated its research and development efforts on establishing 
a scientific and technical leadership position in the production of unique 
protein-based materials.  The Company has identified biomedical market and 
product opportunities for further research and development that management 
believes will exploit the unique properties of the Company's technology to 
competitive advantage.  The Company has been unprofitable to date, and as of 
December 31, 1996 has an accumulated deficit of $19,207,000.

     The Company's medical product candidates for surgical repair and 
regeneration of tissues are in various stages of research and development.  Its 
more advanced programs are in the areas of tissue adhesives and sealants, and 
tissues augmentation, where the Company is devoting over 90% of its scientific 
effort currently.  The Company's first commercial products, ProNectin F and 
SmartPlastic, are used by biologists and cell culture laboratories, principally 
to grow mammalian cells for biomedical research purposes.

     In 1995 the Company entered into a collaborative relationship with Ethicon
regarding its tissue adhesives and sealants program. The Company's strategy with
most of its other programs is to enter into similar collaborative development
agreements with major medical product marketing and distribution companies.
Although these relationships may provide significant near-term revenues through
up-front licensing fees, research and development reimbursements and milestone
payments, the Company expects to incur continuing operating losses for the next
several years.
 
     On December 16, 1997, Ethicon elected to terminate the agreements with 
Protein, based upon Ethicon's determination that the timelines to clinical
trials and to market were too lengthy to continue. Although Ethicon remains
interested in this product opportunity, and will monitor our continued progress,
the Company has decided to discuss the opportunity with other potential
partners. Protein's relationship with Ethicon continues to remain good, and
Johnson & Johnson subsidiaries are currently evaluating the Company's materials
regarding other product opportunities. (See Note 5 - Research and Development
Contracts and Royalties - in the Notes to Financial Statements elsewhere
herein.)

Results of Operations

     Contract research revenue for the year ended December 31, 1996 was 
$610,000, compared to $810,000 and $100,000 for 1995 and 1994, respectively. 
During 1996 the Company received research and development reimbursements 
totaling $600,000 from Ethicon related to the Company's tissue adhesives and 
sealants program.  In September 1995 the Company received a payment of $800,000 
from Ethicon upon the signing of the various agreements related to the Company's
tissue adhesives and sealants program.  The 1994 revenues were derived from 
materials evaluation agreements entered into with divisions of J&J.

     Interest income was $87,000 for the year ended December 31, 1996, as 
compared to $59,000 for 1995 and $95,000 for 1994.  The year-to-year variability
resulted from timing differences with regard to the receipt of equity capital
and the amounts of excess cash available for investment.

                                       2
<PAGE>
 
     Product sales for the years ended December 31, 1996 were $58,000, compared 
to $118,000 and $94,000 in 1995 and 1994, respectively. Product sales consist of
ProNectin F related product revenues and licensing fees. Sales in 1995 reflect 
the launch of the SmartPlastic line of ProNectin F Activated Cultureware and the
resultant distributor stocking orders. Additionally, during 1995 the Company 
stopped promotional expenditures for these products.

     Cost of sales was $47,000 for the year ended December 31, 1996, versus 
$125,000 and $57,000 for the years 1995 and 1994, respectively. The 1996 and 
1995 totals reflect certain inventory adjustments and reserves. Royalty expenses
paid to Stanford University and Telios Pharmaceuticals, Inc. aggregated $35,000 
for each of the three years ended December 31, 1996, 1995 and 1994.

     Research and development expenses for the year ended December 31, 1996 were
$2,021,000, compared to $1,722,000 in 1995, an increase of 17%. This increase in
1996 spending over 1995 was due to expanded activities, including the 
establishment of a quality assurance department as part of the Company's efforts
to implement GLP. The 1995 expenses decreased 12% compared to $1,951,000 
incurred in 1994. This decrease in 1995 spending versus 1994 resulted from the 
continued focusing of the Company's research and development efforts, with fewer
programs sponsored and the consequent lowering of expenses incurred. The Company
expects its research and development expenses will increase in the future due to
the expansion of product directed research and development efforts, an increased
number of programs funded, laboratory upgrading and expansion, and increased 
outside product testing.

     Selling, general and administrative expenses for the year ended December 
31, 1996 were $1,516,000, as compared to $1,329,000 for 1995, an increase of 
14%. This increase in 1996 spending over 1995 was due to additional legal, 
patent and risk insurance expenses, and increased investor relations activities.
The 1995 expenses decreased 12% compared to $1,512,000 incurred in 1994. This 
decrease in 1995 spending versus 1994 was due to reduced product marketing, 
legal and investor relations expenses. The Company expects its selling, general 
and administrative expenses will increase in the future consistent with 
supporting its research and development efforts and as business development, 
patent and investor relations activities require.

     For the year ended December 31, 1996, the Company recorded a net loss
applicable to common shareholders of $3,356,000, or $.51 per share, as compared
to $2,610,000, or $.45 per share for 1995, and $3,353,000, or $.58 per share for
1994. The 1996, 1995 and 1994 losses and per share calculations include
$492,000, $385,000 and $108,000, respectively, of accumulated and/or paid
dividends from the Company's Preferred Stock. The Company expects to incur
increasing operating losses for the next several years, to the extent additional
capital is raised, based upon the successful continuation of the tissue
adhesives program and the tissue augmentation program, as well as expected
increases in the Company's other research and development, manufacturing and
business development activities. The Company's results depend on its ability to
establish strategic alliances and generate contract revenues, increased
research, development and manufacturing efforts, preclinical and clinical
product testing and commercialization expenditures, expenses incurred for
regulatory compliance and patent prosecution, and other factors. The Company's
results will also fluctuate from period to period due to timing differences.

     To date the Company believes that inflation and changing prices have not
had a material impact on its continuing operations. Effective January 1, 1994,
the Company adopted Statement No. 109, "Accounting for Income Taxes". There is
no current year or cumulative impact of the adoption of Statement No. 109. Based
upon Company earnings history, a valuation allowance of $7,363,000 is required
to reduce the Company's net deferred tax assets to the amount realizable.

                                       3
<PAGE>
 
Liquidity and Capital Resources

    As of December 31, 1996, the Company had cash, cash equivalents and 
short-term investments totaling $1,260,000, as compared to  $2,011,000 at 
December 31, 1995. As of December 31, 1996, the Company had working capital of 
$840,000, compared to $1,803,000 at December 31, 1995. These decreases in 1996 
as compared to 1995 were due to increased operating expenses, reduced revenues 
and less equity capital raised. During the first week of January 1997 the 
Company received $4,760,000 before expenses of approximately $160,000 from a 
private placement of common stock to institutional and qualified individual 
investors. Accounting on a pro forma basis as though this capital influx had 
occurred on December 31, 1996, the Company's cash, cash equivalents and 
short-term investments would have totaled $6,020,000, and working capital would 
have increased to $5,600,000.

    The Company had no long-term debt obligations as of December 31, 1996 and 
December 31, 1995. For the twelve month period ending December 31, 1996 the 
Company's expenditures for capital equipment and leasehold improvements totaled 
$184,000, compared with $84,000 for the same period last year. The Company 
anticipates that these expenditures will increase as laboratory renovations and 
additional equipment are required to meet current GLP regulations and production
requirements. The Company currently has no equipment lease lines of credit, 
although it may enter into such arrangements in the future if available at 
appropriate rates and terms.

    The Company believes its existing available cash, cash equivalents and
short-term investments, including the equity capital received during the first
week of January 1997, will be sufficient to meet its anticipated capital
requirements until April 1998. Substantial additional capital resources will be
required to fund continuing expenditures related to the Company's research,
development, manufacturing and product marketing activities. The Company
believes there may be a number of alternatives available to meet the continuing
capital requirements of its operations, such as additional collaborative
agreements and public or private financings, and is actively pursuing all
available approaches. However, there can be no assurance that the requisite
fundings will be consummated in the necessary time frame or on terms favorable
to the Company. If adequate funds are not available, the Company will be
required to significantly curtail its operating plans and may have to relinquish
rights to significant portions of the Company's technology or potential
products.
                                       4
<PAGE>
 
Item 7.   Financial Statements


     Filed herewith are the following Audited Financial Statements for Protein
Polymer Technologies, Inc. (a development stage company):
<TABLE>
<CAPTION>
 
        Description                                                                   Page
        -----------                                                                   ----
        <S>                                                                            <C>
        Report of Ernst & Young LLP, Independent Auditors...........................    F-2
 
        Balance Sheets at December 31, 1996 and 1995................................    F-3
 
        Statements of Operations for the years ended December 31, 1996, 1995
           and 1994 and the period July 6, 1988 (inception) to December 31, 1996....    F-4
 
        Statements of Stockholders Equity for the period July 6, 1988 (inception)
           to December 31, 1996.....................................................    F-5
 
        Statements of Cash Flows for the years ended December 31, 1996, 1995
           and 1994 and the period July 6, 1988 (inception) to December 31, 1996....    F-7
 
        Notes to Financial Statements...............................................    F-8
</TABLE>

                                      F-1
<PAGE>
 
               Report of Ernst & Young LLP, Independent Auditors



The Board of Directors and Stockholders
Protein Polymer Technologies, Inc.


          We have audited the accompanying balance sheets of Protein Polymer
Technologies, Inc. (a Development Stage Company) as of December 31, 1996 and
1995, and the related statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1996 and for
the period July 6, 1988 (inception) to December 31, 1996.  These financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these financial statements based on
our audits.

          We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

          In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Protein Polymer
Technologies, Inc. (a Development Stage Company) at December 31, 1996 and 1995,
and the results of its operations and its cash flows for each of the three years
in the period ended December 31, 1996 and for the period July 6, 1988
(inception) to December 31, 1996 in conformity with generally accepted
accounting principles.

          As discussed in Note 1 to the financial statements, Protein Polymer 
Technologies, Inc. (a Development Stage Company) has reported accumulated losses
during the development stage aggregating $19,207,237 and without additional
financing, lacks sufficient working capital to fund operations through April 30,
1998, which raises substantial doubt about its ability to continue as a going
concern.  Management's plans as to these matters are described in Note 1.  The
1996 financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.



                                           ERNST & YOUNG LLP

San Diego, California
January 30, 1997, except for paragraph 2 of Note 1,
       as to which the date is January 30, 1998

                                      F-2
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)

                                Balance Sheets

<TABLE> 
<CAPTION>
                                                                                             December 31,       
                                                                                         1996         1995     
                                                                                     -------------------------- 
<S>                                                                                  <C>          <C>          
Assets                                                                                                          
Current assets:                                                                                                 
 Cash and cash equivalents (Note 2)                                                  $    267,357  $   471,296  
 Short-term investments (Note 2)                                                          993,042    1,540,000  
 Inventory, net                                                                            20,694       54,534  
 Other current assets                                                                      56,561       48,277  
                                                                                     -------------------------- 
Total current assets                                                                    1,337,654    2,114,107  
                                                                                                                
 Deposits                                                                                  22,257       22,257  
 Deferred offering costs                                                                   17,356            -  
 Equipment and leasehold improvements, net (Note 1)                                       369,314      302,795  
                                                                                     -------------------------- 
                                                                                                                
                                                                                     $  1,746,581  $  2,439,159 
                                                                                     ========================== 
                                                                                                                
Liabilities and stockholders' equity                                                                            
Current liabilities:                                                                                             
 Accounts payable                                                                    $    251,321  $    157,971 
 Accrued employee benefits                                                                117,612       101,284 
 Other accrued expenses                                                                    53,525        51,598 
 Deferred revenue                                                                          75,000             - 
                                                                                     -------------------------- 
Total current liabilities                                                                 497,458       310,853 
                                                                                                                
Commitments (Note 4)                                                                            -             -  

Stockholders' equity (Note 3):
  Series D convertible preferred stock, $.01 par value, 71,600 shares
    authorized, 49,187 shares issued and outstanding at December 31,
    1996 and 1995, respectively - liquidation preference $4,918,700                     4,764,745     4,764,745 
  Common stock, $.01 par value, 25,000,000 shares authorized,
    7,233,228 and 5,832,925 shares issued and outstanding at
    December 31, 1996 and 1995, respectively                                               72,333        58,330
  Additional paid-in capital                                                           15,619,282    13,648,036
  Deficit accumulated during development stage                                        (19,207,237)  (16,342,805)
                                                                                     -------------------------- 
Total stockholders' equity                                                              1,249,123     2,128,306
                                                                                     --------------------------

                                                                                     $  1,746,581  $  2,439,149
                                                                                     ==========================
</TABLE> 
See accompanying notes.

                                      F-3
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)


                           Statements of Operations

<TABLE> 
<CAPTION>
                                                                                         For the period
                                                                                          July 6, 1988 
                                                                                         (inception) to 
                                                    Years ended December 31,             December 31,
                                              1996            1995           1994           1996
                                            ------------------------------------------------------------
<S>                                         <C>            <C>            <C>            <C> 
Revenues:
  Contract revenue (Note 5)                  $   610,000    $   810,000    $   100,000    $  3,845,455
  Interest income                                 87,317         58,702         94,941         759,420
  Product and other income                        58,434        117,991        114,294         482,251
                                             --------------------------------------------------------- 
Total revenues                                   755,751        986,693        309,235       5,087,126

Expenses:
  Cost of sales                                   47,364        124,824         56,843         249,380
  Research and development                     2,021,413      1,721,776      1,951,120      14,120,011
  Selling, general and administrative          1,516,406      1,329,497      1,511,631       9,440,926
  Royalties                                       35,000         35,000         35,000         230,171
                                             ---------------------------------------------------------  
Total expenses                                 3,620,183      3,211,097      3,554,594      24,040,488
                                             ---------------------------------------------------------  

Net loss                                      (2,864,432)    (2,224,404)    (3,245,359)    (18,953,362) 
Undeclared and/or paid dividends on 
 preferred stock                                (491,867)      (385,143)      (108,000)       (985,010)
                                             ---------------------------------------------------------  
Net loss applicable to common
 shareholders                                $(3,356,299)   $(2,609,547)   $(3,353,359)   $(19,938,372)
                                             =========================================================

Net loss per common share                    $      (.51)   $      (.45)   $      (.58)
                                             =========================================

Shares used in computing net loss
 per common share                              6,638,814      5,831,446      5,830,925
                                             =========================================
</TABLE> 

See accompanying notes.

                                      F-4
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)

                      Statements of Stockholders' Equity

         For the period July 6, 1988 (inception) to December 31, 1996
<TABLE> 
<CAPTION> 

                                                                             Common stock         Preferred stock
                                                                          -------------------   -------------------    Additional
                                                                           Shares     Amount     Shares     Amount   paid-in capital
                                                                          --------   --------   --------   --------  ---------------
<S>                                                                     <C>         <C>         <C>       <C>          <C> 
  Issuance of common stock at $.01 per share for cash                      400,000    $ 4,000         --   $       --   $        --
  Issuance of common stock at $.62 per share for cash and receivables    1,116,245     11,162         --           --       681,838
  Receivables from sale of common stock                                         --         --         --           --            --
  Net loss                                                                      --         --         --           --            --
                                                                         ---------    -------    -------   ----------   -----------
Balance at December 31, 1988                                             1,516,245     15,162         --           --       681,838
  Repayment of receivables from sale of common stock                            --         --         --           --            --
  Issuance of common stock at $.62 per share                               359,136      3,594         --           --       219,358
  Net loss                                                                      --         --         --           --            --
                                                                         ---------    -------    -------   ----------   -----------
Balance at December 31, 1989                                             1,875,381     18,756         --           --       901,196
  Exercise of common stock options at $.01 per share for cash               60,000        600         --           --            --
  Issuance of common stock at $.68 per share for cash and compensation       5,000         50         --           --         3,350
  Common stock repurchased at $.01 per share for cash                      (25,000)      (250)        --           --            --
  Common stock issued at $.68 per share for cash and compensation           25,000        250         --           --        16,750
  Net loss                                                                      --         --         --           --            --
                                                                         ---------    -------    -------   ----------   -----------
Balance at December 31, 1990                                             1,940,381     19,406         --           --       921,296
  Exercise of common stock options at $.68 per share for cash                5,000         50         --           --         3,350
  Exercise of warrants for common stock                                    483,755      4,837         --           --       295,493
  Conversion of notes payable to common stock                              339,230      3,391         --           --       508,414
  Conversion of notes payable to preferred stock                                --         --    278,326        2,783       553,869
  Issuance of preferred stock at $2.00 per share for cash, net of               
   issuance costs                                                               --         --    400,000        4,000       703,475
  Issuance of warrants for cash                                                 --         --         --           --         3,000 
  Issuance of warrants in connection with convertible notes payable             --         --         --           --        28,000 
  Net loss                                                                      --         --         --           --            --
                                                                         ---------    -------    -------   ----------   ----------- 
Balance at December 31, 1991                                             2,768,366     27,684    678,326        6,783     3,016,897
  Initial public offering at $6.50 per unit, net of issuance costs       1,667,500     16,676         --           --     8,911,024
  Conversion of Series B preferred stock into common stock in connection                                                   
   with initial public offering                                            678,326      6,783   (678,326)      (6,783)           --
  Conversion of Series A preferred stock into common stock at 1.13342                                                      
   per share                                                               713,733      7,137         --           --     1,717,065 
  Net loss                                                                      --         --         --           --            --
                                                                         ---------    -------    -------   ----------   ----------- 
Balance at December 31, 1992                                             5,827,925     58,280         --           --    13,644,986
  Exercise of common stock options at $.68 per share                         3,000         30         --           --         2,010 
  Net loss                                                                      --         --         --           --            --
                                                                         ---------    -------    -------   ----------   -----------
Balance at December 31, 1993                                             5,830,925     58,310         --           --    13,646,996
  Issuance of preferred stock at $100 per share for cash, net of                                                     
    issuance costs                                                              --         --     21,600    2,073,925            --
  Net loss                                                                      --         --         --           --            --
                                                                         ---------    -------    -------   ----------   -----------
Balance at December 31, 1994                                             5,830,925     58,310     21,600    2,073,925    13,646,996
  Issuance of preferred stock at $100 per share for cash, net of                                                     
   issuance costs                                                               --         --     25,000    2,432,150            --
  Series C dividends paid in Series D preferred stock                           --         --      2,539      253,875            --
  Interest paid in Series D stock                                               --         --         48        4,795            --
  Exercise of common stock options at $.53 per share                         2,000         20         --           --         1,040
  Net loss                                                                      --         --         --           --            --
                                                                         ---------    -------    -------   ----------   -----------
Balance at December 31, 1995                                             5,832,925     58,330     49,187    4,764,745    13,648,036
</TABLE> 

<TABLE> 
<CAPTION> 
                                                                              Deficit
                                                                            accumulated   
                                                                              during         Receivables from
                                                                            development       sale of common    Total stockholders'
                                                                               stage              stock               equity   
                                                                            -----------      ---------------    -----------------  
<S>                                                                     <C>                 <C>                   <C> 
  Issuance of common stock at $.01 per share for cash                      $        --                 --                4,000
  Issuance of common stock at $.62 per share for cash and receivables               --                 --              693,000
  Receivables from sale of common stock                                             --            (86,000)             (86,000)
  Net loss                                                                    (322,702)                --             (322,702)
                                                                           -----------          ---------          ----------- 
Balance at December 31, 1988                                                  (322,702)           (86,000)             288,298
  Repayment of receivables from sale of common stock                                --             86,000               86,000
  Issuance of common stock at $.62 per share                                        --                 --              222,952
  Net loss                                                                    (925,080)                --             (925,080)
                                                                           -----------          ---------          ----------- 
Balance at December 31, 1989                                                (1,247,782)                --             (327,830) 
  Exercise of common stock options at $.01 per share for cash                       --                 --                  600
  Issuance of common stock at $.68 per share for cash and compensation              --                 --                3,400
  Common stock repurchased at $.01 per share for cash                               --                 --                 (250)
  Common stock issued at $.68 per share for cash and compensation                   --                 --               17,000
  Net loss                                                                  (1,501,171)                --           (1,501,171)   
                                                                           -----------          ---------          ----------- 
Balance at December 31, 1990                                                (2,748,953)                --           (1,808,251)
  Exercise of common stock options at $.68 per share for cash                       --                 --                3,400 
  Exercise of warrants for common stock                                             --                 --              300,330
  Conversion of notes payable to common stock                                       --                 --              511,805
  Conversion of notes payable to preferred stock                                    --                 --              556,652
  Issuance of preferred stock at $2.00 per share for cash, net of
   issuance costs                                                                   --                 --              707,475   
  Issuance of warrants for cash                                                     --                 --                3,000
  Issuance of warrants in connection with convertible notes payable                 --                 --               28,000
  Net loss                                                                  (1,143,119)                --           (1,143,119)
                                                                           -----------          ---------          -----------  
Balance at December 31, 1991                                                (3,892,072)                --             (840,708)
  Initial public offering at $6.50 per unit, net of issuance costs                  --                 --            8,927,700 
  Conversion of Series B preferred stock into common stock in connection                                                       
   with initial public offering                                                     --                 --                   -- 
  Conversion of Series A preferred stock into common stock at 1.13342                                                          
   per share                                                                        --                 --            1,724,202 
  Net loss                                                                  (3,481,659)                --           (3,481,659)
                                                                           -----------          ---------          -----------  
Balance at December 31, 1992                                                (7,373,731)                --            6,329,535
  Exercise of common stock options at $.68 per share                                --                 --                2,040
  Net loss                                                                  (3,245,436)                --           (3,245,436)
                                                                           -----------          ---------          ----------- 
Balance at December 31, 1993                                               (10,619,167)                --            3,086,139
  Issuance of preferred stock at $100 per share for cash, net of
    issuance costs                                                                  --                 --            2,073,925
  Net loss                                                                  (3,245,359)                --           (3,245,359)
                                                                           -----------          ---------          ----------- 
Balance at December 31, 1994                                               (13,864,526)                --            1,914,705
  Issuance of preferred stock at $100 per share for cash, net of
   issuance costs                                                                   --                 --            2,432,150 
  Series C dividends paid in Series D preferred stock                         (253,875)                --                   --
  Interest paid in Series D stock                                                   --                 --                4,795
  Exercise of common stock options at $.53 per share                                --                 --                1,060
  Net loss                                                                  (2,224,404)                --           (2,224,404)
                                                                           -----------          ---------          ----------- 
Balance at December 31, 1995                                               (16,342,805)                --            2,128,306
</TABLE> 


                                                                F-5
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)

                      Statements of Stockholders' Equity

         For the period July 6, 1988 (inception) to December 31, 1996

<TABLE> 
<CAPTION> 
                                                                         Common stock                   Preferred stock
                                                                  ----------------------------------------------------------
                                                                     Shares        Amount            Shares        Amount
                                                                  ---------------------------------------------------------- 
<S>                                                               <C>            <C>               <C>         <C> 
 Exercise of common stock warrants at $1.25 per share               932,960      $ 9,330                  -    $        -
 Exercise of common stock warrants at $2.50 per share, net of   
   issuance costs of $24,020                                        322,663        3,226                  -             -
 Exercise of common stock warrants at $1.00 per share                25,000          250                  -             -
 Exercise of common stock options                                   136,000        1,360                  -             -
 Stock repurchases                                                  (16,320)        (163)                 -             -
 Net loss                                                                 -            -                  -             -
                                                                  ---------------------------------------------------------- 
Balance at December 31, 1996                                      7,233,228      $72,333             49,187    $4,764,745
                                                                  ==========================================================
<CAPTION> 
                                                                                    Deficit
                                                                                  accumulated
                                                                                    during    Receivables from
                                                                    Additional    development  sale of common   Total stockholders'
                                                                  paid-in capital    stage          stock             equity
                                                                  -----------------------------------------------------------------
<S>                                                               <C>            <C>             <C>            <C>
 Exercise of common stock warrants at $1.25 per share             $ 1,156,870     $          -   $       _       $ 1,166,200
 Exercise of common stock warrants at $2.50 per share, net of    
   issuance costs of $24,020                                          779,413                -           -           782,639
 Exercise of common stock warrants at $1.00 per share                  24,750                -           -            25,000
 Exercise of common stock options                                      91,650                -           -            93,010
 Stock repurchases                                                    (81,437)               -           -           (81,600)
 Net loss                                                                   -       (2,864,432)          -        (2,864,432)
                                                                  -----------------------------------------------------------------
Balance at December 31, 1996                                      $15,619,282     $(19,207,237)  $       -       $ 1,249,123
                                                                  =================================================================
</TABLE> 

See accompanying notes.

                                      F-6
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)

                           Statements of Cash Flows

<TABLE> 
<CAPTION> 
                                                                                                     For the period
                                                                                                      July 6, 1988
                                                                                                     (inception) to
                                                         Years ended December 31,                      December 31,
                                                  1996          1995             1994                     1996
                                               ---------------------------------------------------------------------
<S>                                            <C>            <C>             <C>                    <C> 
Operating activities
Net loss                                       $(2,864,432)    $(2,224,404)   $(3,245,359)           $(18,953,362)
Adjustments to reconcile net loss to net cash
 used for operating activities:
   Stock issued for compensation                         -               -              -                  20,100
   Stock issued for interest                             -           4,795              -                   4,795
   Increase in inventory reserve                    20,717          50,805              -                  71,522
   Depreciation and amortization                   117,203         138,866        171,588               1,075,419
   Write-off of purchased technology                     -               -              -                 503,500
   Changes in assets and liabilities:
    Inventory                                       13,123         (63,173)       (36,006)                (92,216)
    Deposits                                             -           6,300         (6,300)                (22,257)
    Other current assets                            (8,284)         (8,770)        (3,061)                (56,561)
    Accounts payable                                93,350         (75,189)        82,052                 251,321
    Accrued employee benefits                       16,328          21,977         18,361                 117,612
    Other accrued expenses                           1,927         (32,320)        56,661                  53,525
    Deferred revenue                                75,000          (5,000)           834                  75,000
                                               ---------------------------------------------------------------------
Net cash used for operating activities          (2,535,068)     (2,186,113)    (2,961,230)            (16,951,602)

Investing activities
Purchase of technology                                   -               -              -                (570,000)
Purchase of equipment and improvements            (183,722)        (84,192)      (209,320)             (1,291,476)
Short-term investments                             546,958      (1,052,972)    (1,011,575)               (993,042)
                                               ---------------------------------------------------------------------
Net cash provided by (used for) investing
 activities                                        363,236      (1,137,164)       802,255              (2,854,518)

Financing activities
Net proceeds from issuance of warrants and
 sale of common stock                            1,985,249           1,060              -              11,843,051
Net proceeds from issuance and conversion
 of preferred stock                                      -       2,432,150      2,073,925               6,937,752
Proceeds from convertible notes and
 detachable warrants                                     -               -              -               1,068,457
Payment on note payable                                  -               -              -                 (92,750)
Proceeds from note payable                               -               -              -                 334,323
Deferred offering costs                            (17,356)              -              -                 (17,356)
                                               ---------------------------------------------------------------------
Net cash provided by financing activities        1,967,893       2,433,210      2,073,925              20,073,477

Net increase (decrease) in cash and cash
 equivalents                                      (203,939)       (890,067)       (85,050)                267,357
Cash and cash equivalents at beginning of
 the period                                        471,296       1,361,363      1,446,413                       -
                                               ---------------------------------------------------------------------
Cash and cash equivalents at end of the
 period                                        $   267,357     $   471,296    $ 1,361,363            $    267,357
                                               =====================================================================
Supplemental disclosures of cash flow
 information                 
Interest paid                                  $         -     $         -    $         -            $     63,473
Series D stock issued for Series C stock       $         -     $ 2,073,925    $         -            $  2,073,925
Series C dividends paid with Series D stock    $         -     $   253,875    $         -            $    253,875
                                               =====================================================================
</TABLE> 

See accompanying notes.

                                      F-7
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)


                         Notes to Financial Statements
                               December 31, 1996


1.   Organization and Significant Accounting Policies

Organization and business activities

Protein Polymer Technologies, Inc. (the "Company") was incorporated in Delaware 
on July 6, 1998.  The Company was established for the purpose of designing, 
producing and marketing genetically engineered protein polymers for a variety of
biomedical and specialty materials applications.  For the period from its 
inception to date, the Company has been a development stage enterprise, and 
accordingly, the Company's operations have been directed primarily toward 
developing business strategies, raising capital, exploring marketing channels, 
recruiting personnel, and research and development activities.

Liquidity

The accompanying financial statements have been prepared assuming that the 
Company will continue as a going concern.  In January 1997 the Company received 
$4.76 million, before expenses of approximately $160,000, from a private 
placement of common stock to certain qualified institutions and individuals (see
Note 8.  Subsequent Event, below).  The Company believes that these funds, 
combined with its cash, cash equivalents and short-term investments of $1.26 
million as of December 31, 1996, and anticipated contract revenues and interest 
income, will be sufficient to meet its anticipated capital requirements until 
April 1998.  Substantial additional capital resources will be required to fund 
continuing expenditures related to the Company's research, development and 
product marketing activities.  The Company believes there may be a number of 
alternatives available to meet the continuing capital requirements of its 
operations, such as additional collaborative agreements and public or private 
financings, and is actively pursuing all of these approaches.  However, there 
can be no assurance that the requisite fundings will be consummated in the 
necessary time frame or on terms favorable to the Company.  If adequate funds 
are not available, the Company will be required to significantly curtail its 
operating plans and relinquish rights to significant portions of the Company's 
technology or potential products.

Net loss per common share

Net loss per common share is computed using the weighted average number of 
common shares outstanding during the period as adjusted for the effects of 
certain rules of the Securities and Exchange Commission for the period prior to 
the Company's initial public offering.  For purposes of this calculation, net 
loss in 1996 and 1995 have been adjusted for cumulative dividends on the Series 
C and D Preferred Stock.

Research and development revenues and expenses

Research and development contract revenues are recorded as earned based on the 
performance requirements of the contracts. Payments received in advance of 
amounts earned are recorded as deferred revenue.  Research and development costs
are expensed as incurred.

Product revenue recognition

Revenue from product sales are recognized when orders are shipped.

                                      F-8
<PAGE>
 
                       Protein Polymer Technologies, Inc.
                         (A Development Stage Company)

                   Notes to Financial Statements (continued)

1.  Organization and Significant Accounting Policies (continued)

Use of estimates

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilites, the disclosure of
contingent assets and liabilities at the date of the financial statements and
the amount of revenue and expense reported during the period. Actual results
could differ form those estimates.

Cash equivalents and short-term investments

Short-term investments consist primarily of commercial paper, notes and short-
term U.S. Government securities with original maturities beyond three months and
are stated at estimated fair value. Similar items with original maturities of
three months or less are considered cash equivalents. The Company has
established guidelines relative to diversification and maturities that maintain
safety and liquidity. The Company has not experienced any losses on its short-
term investments.

Inventory

Inventory is stated at the lower of cost (first-in, first-out method) or market.

Equipment and leasehold improvements

Equipment and leasehold improvements are stated at cost.  Equipment is 
depreciated over the estimated useful life of the asset, typically one to seven 
years, using the straight-line method.

Leasehold improvements are amortized over the shorter of the lease term or life 
of the asset.  Equipment and leasehold improvements consist of the following:

<TABLE> 
<CAPTION> 
                                                             December 31,
                                                           1996        1995
                                                        ----------------------
<S>                                                     <C>         <C> 
Laboratory equipment                                    $1,079,945  $  917,080
Office equipment                                           131,801     128,440
Leasehold Improvements                                      79,730      62,234
                                                        ----------------------
                                                         1,291,476   1,107,754
Less accumulated depreciation and amortization             922,162     804,959
                                                        ----------------------
                                                        $  369,314  $  302,795
                                                        ======================
</TABLE> 
                                      F-9
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)


                   Notes to Financial Statements (continued)


2.   Investments

The following is a summary of the estimated fair value of available-for-sale 
securities by balance sheet classification:

<TABLE> 
<CAPTION> 
                                                      December 31,
                                                    1996           1995
                                                 ------------------------
              <S>                                <C>            <C> 
              Cash and cash equivalents:
                Commercial paper                  $250,000       $        -
                Money market funds                  17,357          471,296
                                                  -------------------------
                                                  $267,357       $  471,296
                                                  =========================

              Short-term investments:
                Commercial paper                  $908,042       $1,200,000
                U.S. Treasury obligations           85,000          340,000
                                                  -------------------------
                                                  $993,042       $1,540,000
                                                  =========================
</TABLE> 

All of the available-for-sale securities are due in one year or less.

The estimated fair value of each investment approximates the amortized cost, and
therefore, there are no unrealized gains or losses as of December 31, 1996.

3.   Stockholders' Equity

Series D Preferred Stock

During 1995 a total of 49,187 shares of Series D Stock were issued, including 
the exchange of Series C Stock for Series D Stock (see "Series C Preferred 
Stock" below).  Each share of Series D Stock earns a cumulative dividend at the 
annual rate of $10 per share payable as and when declared by the Company in the 
form of cash, common stock or any combination thereof.  The Series D Stock is 
convertible into common stock after two years at the stockholder's option.  The 
conversion price at the time of conversion is the lesser of $3.75 or the market 
price.  The Series D Stock is redeemable at the Company's option after four 
years.  Automatic conversion of all of the Series D Stock will occur if: (a) the
Company completes a public offering of common stock at a price of $2.50 or 
higher; or (b) a majority of stockholders decide to convert their stock.  The 
Company has the option to demand conversion of the Series D Stock if the average
market price of its common stock equals or exceeds $5.00 per share over a period
of twenty business days.  The Series D Stock has a liquidation preference value
of $100.00 per share.

                                     F-10
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)

                   Notes to Financial Statements (continued)

3. Stockholders' Equity (continued)

In addition, the Series D stockholders received warrants to purchase, at an 
exercise price of $1.25 per share, twenty shares of the Company's common stock 
for each share of Series D Stock acquired.  Warrants to acquire a total of 
500,960 shares of common stock were issued.  All of the warrants have been 
exercised during 1996.

The Series D stockholders were granted certain registration rights relating to 
their shares of common stock issuable upon conversion of the Series D Stock or 
upon exercise of their warrants.

Series C Preferred Stock

In July 1994 the Company received $2,160,000 form the sale of 21,600 shares of 
unregistered Series C Convertible Preferred Stock ("Series C Stock") to JJDC and
certain investors.  The terms of the sale were similar to those of the Company's
Series D Stock.

At the time of the sale of the Series D Stock, JJDC and these investors
exchanged 21,600 shares of Series C Stock, plus accumulated dividends, for
24,139 shares of Series D Stock. There are currently no remaining shares of
Series C Stock outstanding.

In connection with the Series C offering, warrants were also issued to acquire a
total of 432,000 shares of the Company's common stock at an exercise price of 
$1.25 per share. All of the warrants have been exercised during 1996.

Stock option plans

The Company has elected to follow APB 25 and related accounting Interpretations.
Under APB 25 whenever the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant no
compensation expense is recognized. The effects of using the fair value
accounting method, as described in FASB Statement No. 123, "Accounting for 
Stock-Based Compensation", are described below under its own subheading to 
Note 3.

The Company adopted the 1989 Stock Option Plan which provides for the issuance 
of incentive and non-statutory stock options for the purchase of up to 500,000 
shares of common stock to key employees and certain other individuals.  The 
options will expire ten years from their respective dates of grant.  Options 
become exercisable ratably over periods of up to five years from the date of 
grant.  At December 31, 1996, options for 310,500 shares were exercisable, and 
179,500 shares were available for future grant.

                                     F-11
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)

                   Notes to Financial Statements (continued)

3. Stockholders' Equity (continued)

The Company adopted the 1992 Stock Option Plan which provides for the issuance
of incentive and non-statutory stock options for the purchase of up to 1,000,000
shares of common stock to its key employees and certain other individuals. The
options will expire ten years from their respective dates of grant. Options
become exercisable ratably over periods of up to five years from the dates of
grant. At December 31, 1996, options for 93,500 shares were exercisable, and
279,000 shares were available for future grant.

Since inception, the Company has granted non-qualified options outside the Plan 
to purchase a total of 525,100 shares of common stock (net of options cancelled)
to employees, directors and consultants of the Company.  At December 31, 1996, 
options for 293,100 shares were exercisable.

In June 1996 the Company adopted the 1996 Non-Employee Directors Stock Option 
Plan ("Plan"), which provides for the granting of nonqualified options to 
purchase up to 250,000 shares of common stock to directors of the Company.  Such
grants shall be awarded automatically on the first business day of June during
each calendar year to every Participating Director then in office, and consist
of 5,000 shares of common stock, subject to certain adjustments. No
Participating Director shall receive more than one grant per year. The purchase
price of each option shall be the fair market value of the common stock on the
date of grant. Each option has a duration of ten years, and is exercisable six
months after the grant date. The Board (or a designated committee of the Board)
shall administer the Plan. On June 3, 1996, an initial grant of 35,000 shares
was made to all non-employee directors then eligible.

In September 1996 the Board of Directors approved, subject to stockholder 
approval at the 1997 Annual Meeting of Stockholders, the Protein Polymer 
Technologies, Inc. Employee Stock Purchase Plan ("Plan").  The Plan commences 
January 2, 1997, and allows for offering periods of up to two years with
quarterly purchase dates occurring the last business day of each quarter. The
purchase price per share is generally calculated at 85% of the lower of the fair
market value on an eligible employee's entry date or the quarterly purchase
date. The maximum number of shares available for issuance under the Plan is
500,000; an eligible employee may purchase up to 5,000 shares per quarter. The
Plan Administrator consists of a committee of at least two non-employee
directors of the Company. The Board may modify the Plan at any time.

In November 1993 the Company repriced a total of 272,500 outstanding stock 
options to $1.00 per share, the then current fair market value.

                                     F-12
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)


                   Notes to Financial Statements (continued)

3. Stockholders' Equity (continued)

The following table summarizes the Company's stock option activity:

<TABLE> 
<CAPTION> 
                                             Years ended December 31,
                   ---------------------------------------------------------------------------
                             1996                      1995                      1994  
                   -----------------------     --------------------       --------------------
                                  Weighted                 Weighted                   Weighted   
                                   Average                  Average                    Average   
                                  Exercise                 Exercise                   Exercise   
                   Options          Price      Options       Price        Options       Price     
                   -------        --------     -------     --------       --------    ----------  
<S>                <C>            <C>          <C>         <C>            <C>         <C>         
Outstanding -                                                                                     
 beginning of                                                                                     
 year                1,064,600      $ 0.90         910,600   $ 0.91         885,600     $ 1.40    
                                                                                                  
  Granted              465,000      $ 2.27         183,500   $ 0.86          90,000     $ 0.82    
                                                                                                  
  Exercised           (136,000)     $(0.68)         (2,000)  $(0.53)              -          -    
                                                                                                  
  Forfeited                  -           -         (27,500)  $(0.93)        (65,000)    $(0.96)   
                    ----------     -------      ----------  -------        --------     ------   
Outstanding -                                                                                     
 end of year         1,393,600     $  1.38       1,064,600   $ 0.90         910,600      $0.91    
                    ==========     =======      ==========  =======        ========     ======   
Exercisable -                                                                                     
 end of year           732,100     $  1.08         714,500   $ 0.87         612,880     $ 0.84    
                    ==========     =======      ==========  =======        ========     ======    
</TABLE> 

The exercise prices for options outstanding as of December 31, 1996 range from 
$0.53 to $3.75. The weighted average remaining contractual life of these options
is approximately 6.5 years.

Statement 123 pro forma information

Pro forma information regarding net income and net income per share is required 
by Statement 123. This information has been calculated as if the Company has 
accounted for its stock options granted under the fair value method as described
in this Statement, using the Black-Scholes option pricing model. The following 
were the weighted average assumptions used for 1996 and 1995: risk-free interest
rates of 5.6% to 7.1% for 1996 and 5.7% to 7.7% for 1995; a volatility factor of
the expected market price of the Company's common stock of 110%; expected option
lives of 7.9 years; and dividend yields of 0% for both years.

The Black-Scholes option valuation model was originally developed for use in 
estimating the fair value of traded options which have no vesting restrictions 
and are fully transferable. In addition, option valuation models require the 
input of highly subjective assumptions including the expected stock price 
volatility. Because the Company's employee stock options have characteristics 
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in 
management's opinion, the existing models do not necessarily provide a reliable 
single measure of the fair value of its employee stock options.

                                     F-13
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)


                   Notes to Financial Statements (continued)


     3.   Stockholders' Equity (continued)

     For purposes of pro forma disclosures, the estimated fair value of the 
     options is amortized to expense over the expected life of the options.  The
     Company's pro forma information is as follows:

<TABLE> 
<CAPTION> 
                                                1996                 1995     
                                            -----------------------------------
<S>                                         <C>                 <C>           
     Net loss as reported                    $(3,356,299)        $(2,609,547) 
                                                                              
     Net loss per share as reported          $     (0.51)        $     (0.45) 
                                                                              
     Net loss pro forma                      $(3,492,030)        $(2,632,144)  

     Net loss per share pro forma                  (0.53)        $     (0.45)

     Weighted average fair value per share
       of options granted during the year    $      2.06         $      0.84
</TABLE> 

     The pro forma effect on net loss for 1996 and 1995 is not representative of
     the pro forma effect on net loss in future years because it does not take
     into consideration pro forma compensation expense from option grants made
     prior to 1995.

     Common stock warrants

     As a result of the Company's initial public offering, unit holders were 
     granted redeemable warrants for 1,667,500 shares of common stock, which are
     exercisable at $8.00 per share until January 21, 1997, and are redeemable 
     at the option of the Company at a redemption price of $.10 at any time 
     after January 21, 1993, based on the price of the common stock and other 
     requirements.  In November 1996 the Company extended the expiration date of
     these warrants one year, to January 21, 1998.  The underwriter was granted 
     warrants to purchase 145,000 units at $8.06 per unit, subject to certain 
     antidilution adjustments.

     At December 31, 1996, including the unit and underwriter warrants, there 
     were outstanding warrants to purchase a total of 2,007,500 shares of common
     stock at a weighted average exercise price of $7.95 per share.  All of 
     these warrants were exercisable at December 31, 1996, and as of January 
     21, 1997 the underwriter warrants expired.

     4.   Commitments

     The Company leases its office and research facilities under two operating 
     leases that expire in December 1998.  During 1996 the Company leased 
     additional laboratory space.

                                     F-14
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)


                   Notes to Financial Statements (continued)



4.   Commitments (continued)

Future minimum payments under operating leases as of December 31, 1996 are as 
follows:

<TABLE> 
                    <S>                <C> 
                     1997               $412,200
                     1998                412,200
                                        --------
                                        $824,400
                                        ========
</TABLE> 

Rent expense was approximately $320,000, $306,000, $300,000 and $2,366,000 for 
the years ended December 31, 1996, 1995 and 1994 and for the period July 6, 1988
(inception) through December 31, 1996, respectively.

5.   Research and Development Contracts and Royalties

On September 14, 1995, the Company signed supply, licensing and development 
agreements with Ethicon, Inc., a subsidiary of the Johnson & Johnson Company, 
whose affiliate is a preferred stockholder, related to the Company's tissue 
adhesives and sealants program.  The licensing and development agreement calls 
for Ethicon to make licensing, milestone and contract revenue payments to the 
Company as certain scientific progress is achieved.  Such payments could total 
almost $11 million over the next several years if all milestones are met.  In 
1996 and 1995, the Company recognized $600,000 and $800,000 of revenue 
respectively, related to these agreements.  In December 1996 Ethicon extended 
the research phase of these agreements for one year, until December 1997, and 
will pay the Company $75,000 every three months for one year in advance of the 
research work to be performed.  The Company received its first installment in 
December 1996, and classified it as deferred revenue.

On December 16, 1997 Ethicon elected to terminate the agreements with the 
Company, based upon Ethicon's determination that the timelines to clinical 
trials and to market were too lengthy to continue. Although Ethicon remains 
interested in this product opportunity, and will monitor our continued progress,
the Company has decided to discuss the opportunity with other potential 
partners. The Company's relationship with Ethicon continues to remain good, and 
Johnson & Johnson subsidiaries are currently evaluating the Company's materials 
regarding other product opportunities.

The management of the Company believes the technology is sufficiently advanced 
to be of interest to other potential partners, and has begun the process of
determining which potential applications make the most sense to pursue. However,
until the program is partnered, continued development efforts will be slowed to
conserve available cash.

In 1994 the Company entered into agreements with subsidiaries of the Johnson & 
Johnson Company.  These agreements concluded in the first quarter of 1995.  
Total contract revenue recognized from these agreements was $100,000 for the 
year ended December 31, 1994.

Under an agreement completed in October 1991 with Telios Pharmaceuticals, Inc., 
("Telios"), now a wholly-owned subsidiary of Integra Life Sciences Corp., Telios
granted the Company a worldwide, exclusive sublicense to use Telios patent 
rights to develop and sell protein polymers containing RGD amino acid sequence 
in two or more polymer segments for the purpose of in vitro cell culture.  In 
exchange for this sublicense, the Company has agreed to pay Telios royalties on 
net revenues derived by the Company from its sales of RGD containing polymers at
a rate equal to 5% of net revenues, until such net revenues reach $500,000, and
3.5% of net revenues in excess of $500,000. There is a required minimum royalty
payment by the Company of $25,000 per year.

                                     F-15
<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)

                   Notes to Financial Statements (continued)

5. Research and Development Contracts and Royalties (continued)

In 1992 Stanford University granted the Company a non-exclusive, non-
transferable right to use their recombinant DNA technology patents to develop
and sell protein polymers. In exchange for this license, the Company has agreed
to pay royalties on products sold employing this technology ranging from 1/2% to
10%, depending on the product. There is a required minimum royalty payment by
the Company of $10,000 per year.

6. Income Taxes

At December 31, 1996, the Company had net operating loss carryforwards of 
approximately $17,090,000 for federal income tax purposes, which may be applied 
against future income, if any, and will begin expiring in 2004 unless previously
utilized. In addition, the Company has California net operating loss 
carryforwards of approximately $7,891,000 for California tax purposes which have
begun expiring in 1996. The difference between the tax loss carryforwards for
federal and California purposes is attributable to the capitalization of
research and development expenses for California tax purposes and a required 50%
limitation in the utilization of California loss carryforwards.

The Company also has federal and California research and development tax credit 
carryforwards of approximately $496,000 and $200,000, respectively, which will 
begin expiring in 2004 unless previously utilized.

Because of the ownership change that occurred in January 1992 as a result of the
Company's initial public offering, approximately $2,700,000 of the Company's 
federal net operating loss carryforwards will be subject to an annual limitation
regarding utilization against taxable income in future periods. However, the 
Company believes that such limitations will not have a material impact upon the 
utilization of the carryforwards.

Significant components of the Company's deferred tax assets as of December 31, 
1996 are shown below. A valuation allowance of $7,363,000 has been recognized to
offset the deferred tax assets as realization of such assets is uncertain.

<TABLE> 
<CAPTION> 
                                                      1996          1995      
                                                  ----------------------------
<S>                                               <C>           <C>           
Deferred tax assets:                                                          
 Net operating loss carryforwards                 $ 6,455,000   $ 5,343,000   
 Research and development credits                     626,000       597,000   
 Other                                                282,000       445,000   
                                                  ---------------------------- 
Total deferred tax assets                           7,363,000     6,385,000    
Valuation allowance for deferred tax assets        (7,363,000)   (6,385,000)
                                                  ---------------------------- 
Net deferred tax assets                           $         -   $         -
                                                  ============================
</TABLE> 

                                     F-16


<PAGE>
 
                      Protein Polymer Technologies, Inc.
                         (A Development Stage Company)

                   Notes to Financial Statements (continued)



7. Employee Benefits Plan

On January 1, 1993, the Company established a 401(k) Savings Plan for 
substantially all employees who meet certain service and age requirements. 
Participants may elect to defer up to 20% of their compensation per year. Each 
year the Company may provide a discretionary matching contribution. As of 
December 31, 1996, the Company had not made a contribution to the Savings Plan.

8. Subsequent Event

During the first week of January 1997 the Company received $4.76 million, less
estimated expenses of approximately $160,000, from a private placement of the
Company's common stock with a number of institutional and qualified individual
investors, consisting of 1,904,000 shares at $2.50 per share. The Company agreed
to register the shares with the Securities and Exchange Commission promptly
after the closing. The registration was declared effective on January 24, 1997.

                                     F-17
<PAGE>
 
   
                                   PART III



     Items 9, 10, 11 and 12 are incorporated by reference from the Company's 
definitive Proxy Statement to be filed by the Company with the Commission no 
later than April 30, 1997.

Item 13.        Exhibits, Financial Statements and Reports on Form 8-K

(a)(1) and (2)  Financial Statements and Schedules

                The Financial Statements are incorporated herein as a part of 
                Item 7.

(a)(3)          Exhibits

                The following documents are included or incorporated by 
                reference:

        
<TABLE> 
<CAPTION> 

      Exhibit
      Number                           Description
      -------                          -----------
     <S>                <C> 
      3.1 (6)            Certificate of Incorporation of the Company, as 
                         amended.

      3.2 (6)            Bylaws of the Company, as amended.

      4.1 (4)            Warrant Agreement, dated January 21, 1992, between the
                         Company and Continental Stock Transfer and Trust
                         Company.

      4.2 (1)            Revised Form of Redeemable Warrant.

      10.1 (2)           Lease, with exhibits, dated October 16, 1991, between
                         the Company and Sycamore/San Diego Investors, together
                         with an amendment thereto dated April 21, 1992.

      10.2 (3)           Amendment to lease, between the Company and 
                         Sycamore/San Diego Investors, dated June 22, 1992.

      10.3 (1)           Sublicense Agreement for RGD-Containing Engineered
                         Protein Polymers, with exhibit attached, dated 
                         October 1, 1991, between the Company and Telios
                         Pharmaceuticals, Inc.

      10.4 (1)           1989 Stock Option Plan, together with forms of
                         Incentive Stock Option Agreement and Nonstatutory
                         Option Agreement.

      10.5 (4)           1992 Stock Option Plan of the Company, together with
                         forms of Incentive Stock Option Agreement and
                         Nonstatutory Option Agreement.

</TABLE> 
                                      18

 
<PAGE>
 
10.6 (1)       Form of Employee's Proprietary Information and Inventions
               Agreement.

10.7 (1)       Form of Consulting Agreement.

10.8 (1)       Form of Indemnification Agreement.

10.9 (4)       License Agreement, dated as of April 15, 1992, between the Board
               of Trustees of the Leland Stanford Junior University and the
               Company.

10.10 (5)      Replacement ProNectin F License Agreement between Cellco, Inc. 
               and the Company, dated February 15, 1995.

10.11 (6)      License and Development Agreement between the Company and 
               Ethicon, Inc. dated September 14, 1995.

10.12 (6)      Supply Agreement between the Company and Ethicon, Inc., dated 
               September 14, 1995.

10.13 (6)      Escrow Agreement between Protein Polymer Technologies, Inc. and 
               Ethicon, Inc., dated September 14, 1995.

10.14 (6)      Amended and Restated Registration Rights Agreement dated
               September 14, 1995 among the Company and the holders of its
               Series D Preferred Stock.

10.15 (6)      Securities Purchase Agreement related to the sale of the 
               Company's Series D Preferred Stock.

10.16 (6)      Form of Warrant to Purchase Common Stock issued in connection 
               with the Series D Preferred Stock.

10.17 (7)      Letter Agreement dated as of October 4, 1996 between the Company
               and MBF I, LLC ("MBF") relating to the provision of consulting
               and advisory services.

10.18 (7)      Form of Warrant with respect to a warrant for 50,000 shares
               issued to MBF, and to be used with respect to additional warrants
               which may be issued to MBF.

10.19 (7)      Registration Rights Agreement dated as of October 4, 1996 between
               the Company and MBF.

10.20 (7)      Letter Agreement dated December 9, 1996 between the Company and
               Ethicon, Inc. with respect to an extension of the License and
               Development Agreement between them dated September 14, 1995.

10.21 (7)      Securities Purchase Agreement dated as of January 6, 1997 among
               the Company and the investors named therein relating to the sale
               and purchase of 1,904,000 shares of the Company's common stock.

10.22 (8)      Lease, with exhibits, dated March 1, 1996 between the Company and
               Sycamore/San Diego Investors.

                                      19
<PAGE>
 
     10.23(8)      Second Amendment to Lease between the Company and
                   Sycamore/San Diego Investors, dated March 1, 1996.

     10.24(8)      1996 Non-Employee Directors' Stock Option Plan.

     10.25(8)      Employment Agreement, dated as of November 1, 1996, between
                   the Company and J. Thomas Parmeter.

     10.26(8)      Employment Agreement, dated as of November 1, 1996, between 
                   the Company and John E. Flowers.

     10.27(8)      Employment Agreement, dated as of November 1, 1996, between 
                   the Company and Joseph Cappello.

     10.28(8)      Employment Agreement, dated as of November 1, 1996, between
                   the Company and Franco A. Ferrari.

     10.29(8)      Employment Agreement, dated as of November 1, 1996, between
                   the Company and Erwin R. Stedronsky.

     10.30(8)      Employment Agreement, dated as of November 1, 1996, between 
                   the Company and Aron P. Stern.

     23.1*         Consent of Ernst & Young LLP, Independent Auditors.

(1)  Incorporated by reference to the Company's Registration Statement on Form
     S-1 (No. 33-43875) filed with the Commission on November 12, 1991, as
     amended by Amendments Nos. 1, 2, 3 and 4 thereto filed on November 25,
     1991, December 23, 1991, January 17, 1992 and January 21, 1992,
     respectively.

(2)  Incorporated by reference to Registrant's Report on Form 10-Q for the 
     quarter ended March 31, 1992, as filed with the Commission on May 14, 1992.

(3)  Incorporated by reference to Registrant's Report on Form 10-Q for the
     quarter ended September 30, 1992, as filed with the Commission on November
     13, 1992.

(4)  Incorporated by reference to Registrant's Report on Form 10-K for the
     fiscal year ended December 31, 1992, as filed with the Commission on March
     31, 1993.

(5)  Incorporated by reference to Registrant's Report on Form 10-KSB for the
     fiscal year ended December 31, 1994, as filed with the Commission on March
     30, 1995.

(6)  Incorporated by reference to Registrant's Report on Form 10-Q for the
     quarter ended September 30, 1995, as filed with the Commission on October
     24, 1995.

(7)  Incorporated by reference to Registrant's current Report on Form 8-K, as 
     filed with the Commission on January 7, 1997.

(8)  Previously filed.

* Filed herewith.

(b)       Reports on Form 8-K.

          None.

                                      20
<PAGE>
 
                                   SIGNATURE


     In accordance with Section 13 or 15(d) of the Exchange Act, the registrant 
has caused this report to be signed on its behalf by the undersigned, thereunto 
duly authorized.


                                            PROTEIN POLYMER TECHNOLOGIES, INC.


February 5, 1998                            By /s/ J. THOMAS PARMETER
                                               ---------------------------------
                                               J. Thomas Parmeter
                                               Chairman of the Board, Chief
                                               Executive Officer, President

     In accordance with the Exchange Act, this report has been signed below by 
the following persons on behalf of the registrant and in the capacities and on 
the dates indicated.


Signature                    Capacity                                Date
---------                    --------                                ----

/s/ J. THOMAS PARMETER       Chairman of the Board, Chief       February 5, 1998
------------------------     Executive Officer, President
J. Thomas Parmeter         


/s/ ARON P. STERN            Vice President, Chief Financial    February 5, 1998
------------------------     Officer (Principal Accounting
Aron P. Stern                Officer)


/s/ PATRICIA J. CORNELL      Director                           February 5, 1998
------------------------     
Patricia J. Cornell


/s/ EDWARD E. DAVID          Director                           February 5, 1998
------------------------
Edward E. David


/s/ PHILIP J. DAVIS          Director                           February 5, 1998
------------------------
Philip J. Davis


/s/ EDWARD J. HARTNETT       Director                           February 5, 1998
------------------------
Edward J. Hartnett


/s/ BRENT R. NICKLAS         Director                           February 5, 1998
------------------------
Brent R. Nicklas


/s/ BERTRAM I. ROWLAND       Director                           February 5, 1998
------------------------     
Bertram I. Rowland


/s/ GEORGE R. WALKER         Director                           February 5, 1998
------------------------
George R. Walker

                                      21