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

                                  FORM 10-KSB
(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 or any
amendment to this Form 10-KSB.  [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 March 17, 1997 was $17,059,000.

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:  As of March 17, 1997, 9,141,228
shares of common stock were outstanding.

                     DOCUMENTS INCORPORATED BY REFERENCE:

Definitive Proxy Statement to be filed no later than April 30, 1997 pursuant to
Regulation 14A with respect to the Registrant's 1996 Annual Meeting of
Stockholders (incorporated by reference in Part III).

Transitional Small Business Disclosure Format:  Yes      No  X
                                                   -----   -----
<PAGE>
 
                       PROTEIN POLYMER TECHNOLOGIES, INC.
                       ----------------------------------

                                  FORM 10-KSB
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                Page No.
                                                                                --------
<S>                                                                                <C>
PART I..........................................................................     2

  Item 1.  Business.............................................................     2

  Item 2.  Properties...........................................................    12

  Item 3.  Legal Proceedings....................................................    12

  Item 4.  Submission of Matters to a Vote of Security Holders..................    13


PART II.........................................................................    13

  Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters    13

  Item 6.  Management's Discussion and Analysis of Financial Condition and
           Results of Operations................................................    15

  Item 7.  Financial Statements.................................................   F-1

  Item 8.  Changes in and Disagreements with Accountants on Accounting and
           Financial Disclosure.................................................    18

PART III........................................................................    18

  Items 9, 10, 11 and 12 - Incorporated by Reference

  Item 13. Financial Statements, Exhibits and Reports on Form 8-K...............    18

  Signatures....................................................................    21
</TABLE>

                                       i
<PAGE>
 
                                     PART I


Item 1.   Business

Company Background

     Protein Polymer Technologies, Inc., a Delaware corporation ("PPTI" or "the
Company"), is a development-stage biotechnology company engaged in the research,
development and production of proprietary protein-based biomaterials with
targeted applications in biomedical and specialty use markets.  Since 1992, the
Company has primarily focused on developing materials technology and products to
be used in the surgical repair of tissue: tissue adhesives and sealants; wound
healing materials; and surgical adhesion barriers. The Company has also
developed technology that can efficiently modify and improve the surface
properties of traditional synthetic polymers used in the fabrication of
biomedical products.  A common goal is to develop materials that beneficially
interact with human cells, enabling cell growth and the regeneration of tissues
with improved outcomes as compared to current products and practices.

     Since late 1994, the Company has concentrated predominantly on the
development of its surgical tissue adhesive and sealant technology.  As part of
this effort, the Company targeted the establishment of a strategic alliance with
a market leader in the field of surgical wound closure products, leading to the
execution of comprehensive license, supply, and development agreements in
September, 1995, with Ethicon, Inc. ("Ethicon"), a subsidiary of the Johnson &
Johnson Company ("J&J").  While PPTI continues to concentrate its development
efforts in this area, in late 1996 the PPTI initiated studies to identify its
most promising soft tissue augmentation product candidates for use in cosmetic
and reconstructive surgery.  This product application is an extension of the
biomaterials platform developed in the tissue adhesives and sealants program.
The Company, to the extent resources are available, is researching the use of
its protein polymers for other surgical tissue repair and medical device
applications, including the potential development of delivery devices for the
targeted, controlled release of drugs to various body tissues.

     Specialty use products currently being marketed by the Company include
SmartPlastic(TM) and ProNectin(R) F Cell Attachment Factor. ProNectin F was
launched commercially in 1991. SmartPlastic is ProNectin F Activated Cultureware
where ProNectin F is presented in ready to use form on the surfaces of
disposable plastic labware for culturing human and animal cells. SmartPlastic
was launched commercially in late 1994.

     Prior to 1992, the Company's scientists had successfully demonstrated the
ability to create and produce novel protein polymer materials having important
physical, biological and chemical properties.  During this period, most of the
Company's efforts were dedicated to supplying E. I. DuPont de Nemours & Co.
("DuPont") with materials under contract for its proprietary research and
testing purposes.

     In early 1992, the Company raised approximately $8.9 million through its
initial public offering of common stock and redeemable warrants.  The Company
used a major portion of these proceeds to generate substantive in vitro
laboratory evidence and in vivo animal test data demonstrating the
biocompatibility and performance of its protein polymers and derived
biomaterials, and to establish a materials science group which has developed
important materials modification and fabrication technology.  In July 1994 the
Company raised approximately $2.1 million from the sale of its unregistered
Series C Preferred Stock to private investors.  In September 1995, and related
to the signing of various development agreements with Ethicon, the Company
raised approximately $2.4 million from the sale of its unregistered Series D
Preferred Stock to the same private investors.  Also at this time these
investors exchanged all of their holdings of Series C Preferred Stock and
accumulated dividends into Series D Preferred Stock.

                                       2
<PAGE>
 
The Company's Technology

     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 and involves the response of the living system to the
materials (e.g., an immune response) and the response of the materials to the
living system (e.g., degradation).  This biological performance requirement has
been a critical factor in limiting the myriad of possible metal, polymer, and
ceramic compositions to a relatively small number that to date have been proven
useful as medical devices.

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

     PPTI is focused on developing a new generation of biomaterials which are
recognized and accepted by human cells for directing their growth and,
ultimately, the regeneration of tissues.  The Company believes that the
successful development of such biomaterials could 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 its proprietary core technology, the Company produces high
molecular weight polymers than can be processed into a variety of materials
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.  The Company has demonstrated that its polymers can mimic the
biological and chemical functions of natural proteins, such as the attachment of
cells through specific membrane receptors and the bonding of tissues by
enzymatic cross-linking, thus overcoming a critical limitation of conventional
biomaterials.  In addition, in animal tests the Company has conducted its
polymers have demonstrated excellent biocompatibility.

     These attributes of PPTI's protein polymers are achieved by combining the
advantages of both modern biotechnology and traditional polymer science.  The
techniques of biotechnology are used to create synthetic genes which direct the
biological synthesis of protein polymers in recombinant microorganisms.  The
design concepts of traditional polymer science are used to create novel
materials for specific applications by combining the properties of individual
"building block" components.

     In contrast to natural proteins, either isolated from natural sources or
produced using traditional genetic engineering techniques, PPTI's technology
results in the creation of new proteins with unique properties.  PPTI has
demonstrated its capability 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 capability is fundamental to PPTI's 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, through the ability to structure a cell's ECM environment, the cell's
activity can be controlled though the protein messages it receives.  Similar to
what nature has demonstrated to be essential in creating, maintaining and
restoring the body's functions, PPTI's patented core technology enables messages
that direct activities of cells to be precisely formulated and presented in a
structured environment.

                                       3
<PAGE>
 
Product Candidates and Anticipated Markets

     The Company's technology and materials have the potential to create
products and product applications in a variety of medical and specialty use
markets.  Although the Company's current development efforts are principally
focused on tissue sealants and adhesives, efforts are also now being applied to
the development of gels for soft tissue augmentation. Additionally, PPTI
continues to evaluate opportunities for research and development of product
candidates for other medical and specialty uses.  With the exception of the use
of ProNectin F for in vitro cell culture, all of the Company's product
candidates are in early stages of research and development.

     The actual development of other product candidates, if any, will depend on
a number of factors, including:  the availability of funds required to research,
develop, test and obtain necessary regulatory approvals; the anticipated time to
market; the potential revenues and margins that may be generated if a product
candidate is successfully developed and commercialized; and the Company's
assessment of the potential market acceptance of a product candidate.

     Each of PPTI's principal targeted markets, and related product candidates,
are set forth below.  There can be no assurance that such research and
development efforts will be successful or that any products, if developed, could
be effectively marketed or produce significant revenues.  Further, additional
scientific progress depends upon the Company's ability to raise significant
amounts of additional capital (see "Management Discussion and Analysis -
Liquidity and Capital Resources", Item 6, below).

     Tissue Adhesives and Sealants

     Every surgical operation requires closure of a wound site.  Current wound
closure techniques depend primarily on sutures and, in some applications,
staples.  The principal inherent limitations with sutures and staples in certain
procedures are: lack of hemostatic and sealant properties to prevent fluid loss;
the length of time and difficulty in closing the wound site; and the need for
post-operative removal.

     Certain tissue adhesives and sealants that seek to avoid these limitations,
such as fibrin glues and cyanoacrylates, have been developed and marketed
outside the United States.  However, these adhesives and sealants have not been
approved by the FDA for domestic use in humans.  Additionally, the Company
believes that these adhesives and sealants have their own limitations:  fibrin
glues are derived from human and animal blood products, set slowly and have low
strength; cyanoacrylates that set fast and have high strength are toxic to
certain tissues, which have limited their use to date to bonding the outer
surfaces of skin together.

     The Company is seeking to develop tissue adhesives and sealants that
combine the biocompatibility of fibrin glues (without the risks associated with
use of blood-derived products) with the high strength and desired setting times
of cyanoacrylates. The Company has successfully demonstrated the feasibility of
two different proprietary approaches to achieving biocompatibility, desired
strength and accelerated setting time.

     In September 1995 PPTI entered into a licensing and development agreement
and a supply agreement with Ethicon regarding this program.  (See "Collaborative
Agreements" section, below.)  Tests performed by Ethicon have confirmed the
potential suitability of the Company's approach. Ethicon and the Company have
agreed to extend the time available for further development of candidate tissue
adhesives and sealants and, correspondingly, Ethicon's acceptance of such
candidates for clinical development, until December 14, 1997.

                                       4
<PAGE>
 
     Soft Tissue Augmentation

     Conditions where there is a need to augment the body's soft tissues include
both cosmetic and medical applications.  In the former, for example, current
procedures include the injection of collagen-based materials to smooth out
facial wrinkles, acne scars and to modify lip contours.  The latter segment
includes the repair of tissue defects associated with tumor removal, congenital
deformities, trauma, degenerative diseases and stress incontinence.  PPTI
believes there is a lack of materials with suitable properties for these
applications, principally because materials having the required durability in
vivo either lack the requisite biocompatibility or the ability to be easily
applied.

     The Company has developed protein polymers that demonstrate excellent
biocompatibility, are soluble in water at room temperature, and are easily
injected into body tissues, forming soft, durable gels at body temperature.
Previously, PPTI has shown gels to have persisted at least 18 months in an
animal model.  Currently, the Company is conducting studies to identify specific
product formulations for the most attractive clinical indications.
Subsequently, formal preclinical testing will be initiated to obtain FDA
approval for beginning human clinical testing.

     Wound Healing Matrices

     The current market for wound care products is highly segmented, involving a
variety of different approaches to wound care.  Products currently marketed and
being developed by third parties include fabric dressing (such as gauze),
synthetic materials (such as polyurethane films) and biological materials (such
as growth factors and living tissue skin graft substitutes).  While the type of
product varies depending on the type of wound and extent of tissue damage, the
Company believes that a principal treatment goal in all instances is to
stimulate wound healing while regenerating functional (as opposed to scar)
tissue.

     The Company has developed protein polymers which it believes may be useful
in the treatment of dermal wounds, particularly chronic wounds such as
decubitous ulcers, where both reconstruction of the ECM and re-establishment of
its function are desired.  These polymers, based on key ECM protein sequence
blocks, are biocompatible, fully resorbable and have been processed into gels,
sponges, films and fibrous sheets.  The Company believes that such materials, if
successfully developed, could improve the wound-healing process through their
inherent properties, as delivery systems for growth factors, and as scaffolds
for the production of living tissue skin graft substitutes.  This program is in
the early stages of research.

     Surgical Adhesion Barriers

     Adhesions are essentially the formation of unwanted bonds or scar tissue,
occurring when surgically manipulated tissues are healing. They are a common
surgical complication causing post-operative discomfort and disability.
Adhesions occur in almost two out of three abdominal procedures, and if bowel
obstruction results, surgical repair is needed.  Infertility can result from
adhesions, which occur in over 50% of gynecological procedures.  A successful
anti-adhesion product has the potential of both reducing the cost of medical
care by reducing the number of necessary second surgeries, and easing the
suffering of surgical patients.

     Two anti-adhesion products are currently marketed in the U.S., but their
efficacy is limited.  The Company believes that other adhesion barrier products
currently in development are promising, but as with the currently marketed
products, have properties which may constrain their use -- rapid resorption by
the body and limited mechanical strength.  PPTI has developed biocompatible
films from protein polymers that are "tough" and whose resorption by the body
can be controlled.  In vivo studies of these protein polymer films have
demonstrated their ability to block cellular adhesions.  The Company is working
to determine the clinical indications where its potential products would have
the greatest advantage versus competing technologies, so as to better focus
further research efforts.

                                       5
<PAGE>
 
     Controlled Release Drug Delivery

     Oral delivery of drugs is the most preferred route of administration.
However, for many drugs this is not possible and alternative drug delivery
routes are required.  Alternative routes include transdermal, mucousal, and by
implantation or injection.  For implantation or injection, it is often desirable
to extend the availability of the drug in order to minimize the frequency of
these invasive procedures.  Materials exist, and in a few instances been
commercialized, which act as depots for a drug when implanted or injected,
releasing the drug over periods ranging from one month to several years.  Other
material and drug combinations are being developed by third parties.  PPTI
believes that the properties of these materials for such applications can be
substantially improved upon, making available the use of depot systems for a
wider range of drugs and applications.

     The Company has developed unique and proprietary protein polymer material
systems that function as drug depots and can be implanted or injected.  They
exhibit exceptional biocompatibility, provide for control over their rate of
resorption in the body, and are fabricated using aqueous solvent systems at low
temperatures -- attributes which can be critical in maintaining the activity of
the drug, particularly protein-based drugs emerging from the biotechnology
industry.

     PPTI is collaboratively exploring the targeted delivery of FDA-approved
analgesic drugs in a controlled release format directly to nerve tissue for the
relief of chronic pain.  Due to their particularly powerful and sometimes
addictive nature, such drugs are typically delivered by frequent injections of
relatively low dosage.  PPTI's targeted approach may avoid systemic release of
these powerful drugs, thus potentially allowing for the delivery of a more
potent payload of pain-killer over a substantially longer time frame.  Other
collaborations are also being considered.

     Cell Culture Products

     The market for products used to culture mammalian cells encompasses the
production of pharmaceuticals and vaccines, ex vivo cell therapy, and basic and
applied research on the cellular mechanisms of human and animal development and
disease.  The common element is the need to culture cells outside the body in an
artificial, controlled environment.  With the culture of many types of mammalian
cells, fetal bovine serum, animal sera factors or attachment factors must be
added to the culture medium or coated on the culture surface to enable cells to
attach and spread, initiating cell growth.

     Unlike standard tissue culture treated labware, these products primarily
present to cells the RGD cell attachment ligand (protein sequence) of the serum
protein fibronectin, which is an essential requirement for the growth, proper
morphology and fully-differentiated function of many different cells.  However,
the Company believes that there are disadvantages to using such products which,
depending on the application, result in variable performance, lack of storage
stability, undesirable contaminants, excessive media protein, high costs and
lost time.

     PPTI developed ProNectin F to address these limitations.  This product
presents multiple copies of the RGD ligand within a chemically and thermally
stable protein polymer.  ProNectin F is free of animal-derived contaminants and
has a long shelf-life.  Moreover, tests conducted by third parties and the
Company confirm that, compared with standard tissue culture treated labware,
labware coated with ProNectin F enhances the cell attachment process.

     Since March 1991 the Company has commercially marketed ProNectin F as a
cell culture reagent for use by cell biologists and cell culture laboratories.
In December 1994 the Company launched SmartPlastic, where ProNectin F is
presented on the surfaces of disposable plastic labware in ready to use form for
culturing human and animal cells.  To date, the Company has generated over
$450,000 in revenues and license fees from the marketing of these products. The

                                       6
<PAGE>
 
Company is seeking new marketing and distribution alliances to increase the
sales of the product line and to support the development of new products and
formats.

Manufacturing, Marketing and Distribution

     ProNectin F

     PPTI currently produces ProNectin F in its laboratory facilities, and
believes its current production facilities are sufficient for the anticipated
demand of ProNectin F in the foreseeable future.  The Company markets and
distributes ProNectin F and SmartPlastic directly and through foreign and
domestic distribution arrangements.

     Biomedical Product Candidates

     To date, PPTI has manufactured limited amounts of its biomedical materials
and products for internal testing and, in certain cases, evaluation and testing
by corporate partners and other third parties.  Preclinical and clinical testing
of potential medical device products, where the results will be submitted to the
United States Food and Drug Administration ("FDA"), requires compliance with the
FDA's Good Laboratory Practices ("GLP"). The Company is currently working to
implement polymer production and quality control procedures, including certain
facilities renovations, to conform to GLP requirements.  It is anticipated that
these efforts will be sufficient for supplying a number of development programs
with the required quality and quantity of materials needed for preclinical and
clinical testing.

     In addition, the Company is considering alternative methods for increasing
production of its biomedical and other product candidates to meet clinical and
commercial requirements.  For example, the Company may expand its existing
facility to produce needed quantities of materials under FDA's Good
Manufacturing Practice ("GMP") regulations for clinical and commercial use.
However, there can be no assurance that, if desired, the Company could
adequately develop, fund, implement and manage such a manufacturing facility.
Alternatively, the Company may establish external contract manufacturing
arrangements for needed quantities; however, there can be no assurance that such
arrangements, if desired, could be entered into or maintained on acceptable
terms, if at all, or that the existence or maintenance of such arrangements
would not adversely affect the Company's margins or its ability to comply with
applicable governmental regulations. The actual method, or combination of
methods, that the Company may ultimately pursue will depend on a number of
factors, including availability, cost, and the Company's assessment of the
ability of such production methods to meet its commercial objectives.

     The development and commercialization of certain biomedical products will
require the Company, pursuant to applicable governmental regulations, to upgrade
its manufacturing facilities and to obtain manufacturing approvals from the FDA
(see "Regulatory Matters", below).

     The Company currently expects that its initial biomedical products, if any
are developed, would be marketed and distributed by a corporate partner.  While
this arrangement would minimize the Company's marketing costs and facilitate
wider distribution of any biomedical products it may develop, these arrangements
may adversely affect the Company's profit margins with respect to these
products.

Research and Development

     Information regarding Company-sponsored research and development activities
and contract research and development revenue is set forth below under the
heading "Management's Discussion and Analysis of Financial Condition and Results
of Operations".

                                       7
<PAGE>
 
Collaborative Agreements

     Because of the highly technical focus of its business, the Company must
conduct extensive research and development prior to any commercial production of
its biomaterials.  During this development stage, PPTI's ability to generate
revenues is limited.  Because of this limitation, the Company does not have
sufficient resources to devote to extensive testing or marketing of its
products.  The Company's primary method of expanding its product development,
testing and marketing capabilities is to form collaborative arrangements with
selected corporate partners with specific resources that the Company believes
complement its business strategies and goals.

     The Ethicon Agreements

     In September 1995 PPTI entered into a licensing and development agreement
and a supply agreement with Ethicon regarding its tissue adhesives and sealants
program.  Under these agreements, Ethicon receives exclusive worldwide
development, marketing and distribution rights to such products under PPTI's
proprietary technology rights in exchange for contract research and development
payments, milestone fees, and manufacturing and royalty payments to PPTI.  The
market for such products is considered large and potentially could replace the
use of sutures and staples in certain surgical procedures.

     A total of almost $11 million could be paid to PPTI under these agreements;
$1.4 million has been received through December 31, 1996.  The payments are
contractually segregated into two categories --ongoing research efforts and
milestone payments.  A first milestone payment to the Company is due upon
achieving product candidate acceptance, which is determined solely by Ethicon,
and could range from $1.4 million to $1.9 million, depending on whether both an
adhesive candidate and a sealant candidate were accepted.  Ethicon and the
Company have agreed to extend the time available for further development of
candidate tissue adhesives and sealants and, correspondingly, Ethicon's
acceptance of such candidates for clinical development, until December 14, 1997.
Although the Company believes it can develop suitable product candidates before
this date, there can be no assurance that it will actually do so, or that if it
does, Ethicon will accept such product candidates.  In conjunction with this
extension, Ethicon committed additional funds to support the ongoing R & D
efforts.  Subsequent to candidate acceptance, and during the ensuing year,
research payments of from $1.3 million to $1.7 million may be received; and from
$500,000 to $800,000 may be received in the year following that.  Additional
milestone payments of from $575,000 to $1,075,000 would be received upon
initiation of clinical trials, from $750,000 to $1,375,000 upon filing of a PMA,
and from $1.0 million to $2.0 million upon FDA approval.

     In addition to receiving a royalty on worldwide product sales, PPTI also
retains the option of manufacturing both the protein polymer component and a
portion or all of the final product.  However, there is no guarantee that
Ethicon or PPTI will continue to meet their obligations under the terms of the
agreements, that a product will be successfully developed for commercial use or,
if having done so, that Ethicon will market the resulting product(s) to the
fullest extent possible.  PPTI retains the right, under certain conditions and
after a certain number of years have elapsed, to make other marketing
arrangements in geographic areas Ethicon chooses to abandon.

     Other Agreements
 
     PPTI is a party to other agreements, and is discussing potential
agreements, with other entities regarding additional biomedical and specialty
use applications of its polymers and technology, including applications in areas
other than those identified as product candidates above. These agreements
provide, or are intended to provide, for the evaluation of product feasibility.
There can be no assurance that the Company will be able to establish such
arrangements at all, or do so in a timely manner and on reasonable terms, or
that such agreements will lead to joint product development and
commercialization agreements. Certain information regarding the Company's
collaborative agreements is set forth in Note 5 to the Company's Financial
Statements included herein.

                                       8
<PAGE>
 
Competition

     The principal anticipated commercial uses of PPTI's biomaterials are as
components of end-use products for biomedical and other specialty applications.
End-use products using or incorporating the Company's biomaterials would compete
with other products which rely on the use of alternative materials.  For
example, the use of ProNectin F in cell culture systems competes with the use of
fetal bovine serum, fibronectin, collagen and other compounds. Similarly, all
targeted applications of the Company's potential products will compete with
other products having the same or similar applications.

     The areas of business in which the Company engages and proposes to engage
are characterized by rapidly evolving technology and intense competition;
competition in the biomedical and surgical repair markets is particularly
significant.  The Company's competitors in the biomedical and surgical repair
markets include major pharmaceutical, surgical product, chemical and specialized
biopolymer companies, many of which have financial, technical, research and
development and marketing resources significantly greater than those of the
Company.  Academic institutions and other public and private research
organizations are also conducting research and seeking patent protection, and
may commercialize products on their own or through joint ventures.  The Company
believes that research into similar types of protein engineering technology is
currently being conducted by DuPont and several university laboratories.

     The primary elements of competition in the biomedical and surgical repair
products market are performance, cost, safety, reliability, convenience and
commercial production capabilities.  The Company believes that its ability to
compete in this market will be enhanced by its issued patent claims, the breadth
of its other pending patent applications, its early entry into its field and its
experience in protein engineering.  However, the Company currently does not have
production capabilities or resources to compete commercially without the use of
collaborative agreements with third parties.

Patents and Trade Secrets

     PPTI is aggressively pursuing domestic and international patent protection
for its technology, making claim to an extensive range of recombinantly prepared
structural and functional proteins, methods for preparing synthetic repetitive
DNA, methods for the production and purification of protein polymers, and end-
use products incorporating such materials.

     The United States Patent and Trademark Office ("USPTO") has issued five
patents to the Company.  U.S. Patent 5,235,041 (1993) relates to the Company's
method for purifying structurally ordered recombinant protein polymers.  U.S.
Patent 5,243,038 (1993) covers the Company's synthetic DNA compositions that
encode polymers and copolymers comprising the amino acid "building blocks" of
silk and elastin.  U.S. Patent 5,496,712, issued in March 1996, covers the
Company's family of high molecular weight collagen like polymers and the DNA
sequences encoding them.  U.S. Patent 5,514,581, issued in May 1996, covers DNA
sequences encoding silk-like structural building blocks with an intervening
sequence coding for the key cell attachment ligand from human fibronectin.  One
of the claimed sequences encodes ProNectin F. U.S. Patent 5,606,019 issued in
February 1997, covers the protein compositions comprising copolymers of the
amino acid "building blocks" of silk and elastin. These are the primary
materials used in the Company's current product development efforts.

     The Company also received notices of allowance from the USPTO in 1995 and
1996 on two other patent applications.  Additionally, PPTI has fourteen U.S.
patent applications pending covering related aspects of its core technology.
Corresponding international patent applications based on PPTI's technology have
been submitted in major market areas worldwide and are beginning to issue.

                                       9
<PAGE>
 
     Although the Company believes its existing issued patent claims may provide
a competitive advantage, there can be no assurance that the scope of the
Company's patent protection is or will be adequate to protect its technology or
that the validity of any patent issued will be upheld in the future.
Additionally, with respect to the Company's allowed and pending applications,
there can be no assurance that any patents will be issued, or that, if issued,
they will provide substantial protection or be of commercial benefit to the
Company.  The two patents issued to PPTI in 1993 will expire in 2010, as will
one of the patents issued in 1996.  The other patents issued in 1996 will expire
in 2013 and the patent issued in 1997 will expire in 2014.

     Because of the uncertainty concerning patent protection and the
unavailability of patent protection for certain processes and techniques, PPTI
also relies upon trade secret protection and continuing technological innovation
to maintain its competitive position.  Although all of the Company's employees
have signed confidentiality agreements, there can be no assurance that the
Company's proprietary technology will not be independently developed by other
parties, or that secrecy will not be breached.  Additionally, the Company is
aware that substantial research efforts in protein engineering technology are
taking place at universities, government laboratories and other corporations and
that numerous patent applications have been filed.  The Company cannot predict
whether it may have to obtain licenses to use any technology developed by third
parties or whether such licenses can be obtained on commercially reasonable
terms, or at all.

     In the course of its business, PPTI employs various trademarks and trade
names in packaging and advertising its products.  The Company has obtained
federal registration of its ProNectin(R) trademark and has applied for federal
registration of its SmartPlastic(TM) trademark for ProNectin F Activated
Cultureware.  The Company intends to protect and promote all of its trademarks
and, where appropriate, will seek federal registration of its trademarks.

Regulatory Matters

     Regulation by governmental authorities in the United States and other
countries is a significant factor affecting the success of products resulting
from biotechnological research.  The Company's current operations and products
are, and anticipated products and operations will be, subject to substantial
regulation by a variety of agencies, particularly those products and operations
related to biomedical applications.  Currently, the Company's activities are
subject to regulation primarily under the Occupational Safety and Health Act,
which requires the Company to provide a "material data safety sheet" to its
customers setting forth certain information regarding the Company's products.

     Pre-market approval from the FDA is required for new medical devices, drugs
or vaccines, a generally costly and time-consuming process.  If the Company does
not directly produce and sell medical devices, drugs or vaccines, it will not be
directly affected by these regulations.  However, the Company's anticipated
customers and corporate partners would be required to obtain such approvals.
Additionally, the Company may be required to file and maintain with the FDA a
"Master File" containing information regarding the Company's products.  There
can be no assurance that the Company's customers will be able to obtain or
maintain the necessary approvals from the FDA or that the Company will be able
to maintain a Master File in accordance with FDA regulations.  In either case,
the Company's anticipated business could be adversely affected.

     Because PPTI intends for its biomaterials to be used as medical devices, it
may be required to conform its operations to the FDA's GMP regulations.  GMP
regulatory requirements are rigorous, and there can be no assurance that GMP
status could be obtained in a timely manner and without the expenditure of
substantial resources, if at all.  The Company may also be required to register
its facility with the FDA as an establishment involved in the manufacture of
medical devices.

     The Company's research, development and production activities are, or may
be, subject to various federal and state laws and regulations relating to
environmental quality and the use, 

                                       10
<PAGE>
 
discharge, storage, transportation and disposal of toxic and hazardous
substances. The Company's future activities may be subject to regulation under
the Toxic Substances Control Act, which requires the Company to obtain pre-
manufacturing approval for any new "chemical material" the Company produces for
commercial use that does not fall within the FDA's regulatory jurisdiction. The
Company believes it is currently in substantial compliance with all such laws
and regulations. Although the Company intends to use its best efforts to comply
with all environmental laws and regulations in the future, there can be no
assurance that the Company will be able to fully comply with such laws, or that
full compliance will not require substantial capital expenditures.

Executive Officers of the Registrant
<TABLE>
<CAPTION>
 
Name                            Age   Position with the Company
----                            ---   -------------------------                     
<S>                             <C>   <C>                               
 
J. Thomas Parmeter               57   Chairman of the Board of Directors,
                                      President and Chief Executive Officer
 
Joseph Cappello, Ph.D.           40   Vice President, Research and Development,
                                      Chief Technical Officer and Director,
                                      Polymer Research
 
Philip J. Davis                  66   Corporate Secretary
 
Franco A. Ferrari, Ph.D.         45   Vice President, Laboratory Operations and     
                                      Polymer Production and Director, Molecular
                                      Genetics
 
John E. Flowers                  40   Vice President, Planning and Operations and
                                      Director, Business Development
 
Janis Y. Neves                   45   Controller and Assistant Secretary
 
Erwin R. Stedronsky, Ph.D.       52   Vice President, Product Formulation and       
                                      Engineering and Director, Materials Science
 
Aron P. Stern                    43   Vice President, Finance and Administration,   
                                      and Chief Financial Officer
 </TABLE>

     Mr. Parmeter has been the Company's President, Chief Executive Officer and
Chairman of the Board of Directors since its inception in July 1988 (and, from
July 1988 to July 1992, its Chief Financial Officer). From 1982 to November
1987, Mr. Parmeter was President, Chief Executive Officer and, from June 1987 to
June 1988, Chairman of the Board of Syntro Corporation.

     Dr. Cappello has been the Company's Vice President, Research and
Development since February 1997 and Director, Polymer Research and Chief
Technical Officer since February 1993. From September 1988 to February 1993, he
was the Company's Senior Research Director, Protein Engineering.

     Mr. Philip J. Davis has been the Company's Secretary since January 1989.
Mr. Davis has been a director of the Company since April 1994; he previously
served as a director of the Company from January 1989 until October 1991.  Mr.
Davis has been a Senior Vice President with Donaldson, Lufkin & Jenrette since
March 1994.  He was Director, Institutional Sales at Merrill Lynch, Inc.
(formerly Merrill Lynch Capital Markets) from February 1991 to March 1994, and
was a Vice President at Merrill Lynch, Inc. from 1986 to 1994.

                                       11
<PAGE>
 
     Mr. Flowers has been the Company's Vice President, Planning and Operations,
since February 1993.  From September 1988 to February 1993, he was the Company's
Vice President, Commercial Development.

     Dr. Ferrari has been the Company's Vice President, Laboratory Operations
and Director, Molecular Genetics since February 1993.  From September 1988 to
February 1993, he was the Company's Senior Research Director, Genetic
Engineering.

     Ms. Neves has been the Company's Controller and Assistant Secretary since
January 1990.  From July 1988 until January 1990, Ms. Neves was the Company's
Business Office Manager.

     Dr. Stedronsky has been the Company's Vice President, Product Formulation
and Engineering since February 1997 and Director of Materials Science since
September 1992. For approximately 20 years prior to joining PPTI, Dr. Stedronsky
held increasingly responsible R&D positions in Corporate Research at Monsanto
Company.

     Mr. Stern has been the Company's Vice President, Finance and Administration
and Chief Financial Officer since July 1992.  Previously Mr. Stern served as
Director, Finance and Administration of Isis Pharmaceuticals, Inc. (a
biopharmaceutical company) from May 1989 to June 1992, and as Controller and
Assistant Treasurer of Teknowledge, Inc., an expert systems company, from
November 1985 to April 1989.

     All executive officers of the Company were elected by the Board of
Directors and serve at its discretion.  No family relationships exist between
any of the officers or directors of the Company.

Employees

     As of March 21, 1997, PPTI has 26 full-time, two part-time and three
temporary employees, of whom four hold Ph.D. degrees in the chemical or
biological sciences.  The Company is highly dependent on the services of its
management and scientific staff.  The loss of the services of any of its staff
may significantly hinder the achievement of the Company's development
objectives.  The recruitment and retention of additional qualified management
and scientific personnel is also critical to the Company's success.  There can
be no assurance that the Company will be able to attract and retain required
personnel on acceptable terms, due to the competition for such experienced
personnel from other biotechnology, pharmaceutical, medical device and chemical
companies, universities and non-profit research institutions.


Item 2.   Properties

     PPTI does not own any real property.  The Company rents approximately
21,000 square feet in San Diego, California from Sycamore/San Diego Investors
under two leases.  The leased property includes the Company's administrative
offices, which encompass approximately 4,000 square feet, and its laboratory
facilities, which encompass approximately 17,000 square feet.  The current
annual rent is approximately $410,000. The leases expire in December 1998.

     The Company believes that its current facilities are adequate to meet its
needs until the end of 1998.  The Company retains the option to extend its
leases for an additional five years.


Item 3.   Legal Proceedings

     On or about January 17, 1997, the Company received correspondence (the
"Letters") from or on behalf of persons who hold the Company's Underwriter Unit
Warrants (the "Unit Warrants").  The Letters allege that the Company is in
breach of its obligations under the 

                                       12
<PAGE>
 
Underwriter Unit Warrant Certificates (the "Certificates"), particularly
concerning the calculation and notification of anti-dilution adjustments to be
made to the number of shares of the Company's common stock representred by each
Unit Warrant, the corresponding reduction of the per share exercise price for
such Unit Warrants, and notification of registration rights under the
Certificates. By their terms, the Unit Warrants expired on January 21, 1997. The
Company disagrees with the interpretation of the anti-dilution provisions cited
in the Letters and believes that this dispute will not have a material adverse
effect on the Company.


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

     No matter was submitted to a vote of security holders during the fourth
quarter of 1996.


                                    PART II


Item 5.   Market for Registrant's Common Equity and Related Stockholder
          Matters.

     The Company's Common Stock trades on the Small-Cap market of NASDAQ under
the symbol "PPTI".  The trade prices set forth below represent inter-dealer
prices without retail markups, markdowns or commissions.
<TABLE>
<CAPTION>
 
                                            Trade Prices
                                            ------------
     1996                              High              Low  
     ----                             ------            ------
<S>                                   <C>               <C>   
     First Quarter                    $3.297            $1.563
     Second Quarter                    5.375             2.000
     Third Quarter                     4.500             2.125
     Fourth Quarter                    3.500             2.000
                                                              
     1995                                                     
     ----                                                     
     First Quarter                    $0.750            $0.438
     Second Quarter                    0.625             0.156
     Third Quarter                     2.000             0.500
     Fourth Quarter                    2.125             1.500 
</TABLE>

     As of March 21, 1997, the Company had approximately 156 shareholders of
record; it estimates it has approximately 1,868 beneficial holders.  The Company
has never paid cash dividends on its Common Stock.  The Company currently
intends to retain earnings, if any, for use in the operation and expansion of
its business and therefore does not anticipate paying any cash dividends on the
Common Stock in the foreseeable future.

Unregistered Offerings

     On January 7, 1997, the Company received $4,760,000, less estimated
expenses of approximately $160,000, from a private placement of 1,904,000 shares
of the Company's common stock, at $2.50 per share, with a number of accredited
investors. No underwriters were engaged by the Company in connection with such
issuance and, accordingly, no underwriting discounts or commissions were paid.
The issuance was exempt from registration under Section 4(2) of the Securities
Act of 1933, as amended (the "Securities Act"), and met the requirements of Rule
506 of Regulation D promulgated under the Securities Act. 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.

                                       13
<PAGE>
 
     On September 14, 1995, the Company issued 49,187 shares of its Series D
Convertible Preferred Stock in a private placement to certain accredited
investors. Of this amount, 24,139 shares of Series D Convertible Preferred Stock
were issued in exchange for 21,600 shares of the  Company's Series C Convertible
Preferred Stock, plus accrued and unpaid dividends thereon. An additional 5,048
shares of the Series D Convertible Preferred Stock were issued in exchange for
cancellation of a $500,000 bridge loan, plus accrued interest thereon. The
remaining 20,000 shares of Series D Convertible Preferred Stock were issued to
the same investors for cash at a price of $100.00 per share. No underwriters
were engaged by the Company in connection with such issuance and, accordingly,
no underwriting discounts or commissions were paid. The issuance was exempt from
registration under Section 4(2) of the Securities Act and met the requirements
of Rule 506 of Regulation D promulgated under the Securities Act.

     Each share of Series D Convertible Preferred Stock earns a cumulative
dividend at the annual rate of $10 per share, payable as and when declared by
the Company's Board of Directors in the form of cash, common stock or any
combination thereof. The Series D Convertible Preferred Stock is convertible
into common stock after two years from the date of issuance at the holder's
option. The conversion price at the time of conversion is the lesser of $3.75 or
the market price. The Series D Convertible Preferred Stock is redeemable at the
Company's option after four years from the date of issuance. Automatic
conversion of all of the Series D Convertible Preferred Stock will occur if: (a)
the Company completes a public offering of common stock at a price of $2.50 or
higher; or (b) the holders of a majority thereof elect to convert. The Company
has the option to demand conversion of the Series D Convertible Preferred 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 Convertible Preferred
Stock has a liquidation preference of $100.00 per share.

     In addition, the Series D Convertible Preferred 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 Convertible Preferred
Stock acquired for cash, or upon conversion of the outstanding bridge loan and
accrued interest thereon, described above. Warrants to acquire a total of
500,960 shares of common stock were issued. All of these warrants were exercised
during 1996, from which the Company received aggregate gross proceeds of
$626,200. The Series D Convertible Preferred stockholders were granted certain
registration rights relating to their shares of common stock issuable upon
conversion of the Series D Convertible Preferred Stock and upon the exercise of
their warrants.

     In July 1994, the Company received $2,160,000 from a private placement of
the Company's Series C Convertible Preferred Stock with certain accredited
investors, consisting of 21,600 shares at $100.00 per share. No underwriters
were engaged by the Company in connection with such issuance and, accordingly,
no underwriter discounts or commissions were paid. The issuance was exempt from
registration under Section 4(2) of the Securities Act and met the requirements
under Rule 506 of Regulation D promulgated under the Securities Act. As
described above, the investors exchanged 21,600 shares of Series C Convertible
Preferred Stock, plus accrued and unpaid dividends thereon, for 24,139 shares of
Series D Convertible Preferred Stock. There are currently no shares of Series C
Convertible Preferred Stock outstanding.

     Each share of Series C Convertible Preferred Stock earned a cumulative
dividend at the annual rate of $10 per share payable as and when declared by the
Company's Board of Directors in the form of cash, common stock or any
combination thereof. The Series C Convertible Preferred Stock was convertible
into common stock one year after issuance at the holder's option. The conversion
price ranged between $1.25 and $3.75 per share, depending on market price. The
Series C Convertible Preferred Stock was redeemable at the Company's option five
years after issuance. Automatic conversion of all of the Series C Convertible
Preferred Stock would have occurred if :  (a) the Company completed a public
offering of common stock at a price of $2.50 or higher; or (b) holders of a two-
thirds majority thereof decided to convert their stock. The Company had the
option to demand conversion of the Series C Convertible Preferred Stock if the
average market price of its common stock equaled or exceeded $5.00 per share
over a period of twenty 

                                       14
<PAGE>
 
business days. The Series C Convertible Preferred Stock had a liquidation
preference of $100.00 per share.

     In connection with the issuance of the Series C Convertible Preferred
Stock, warrants were also issued to acquire a total of 432,000 shares of the
Company's common stock at a price of $1.25 per share. All of these warrants were
exercised during 1996, from  which the Company received aggregate gross proceeds
of $540,000.

     In July 1996, holders of warrants to acquire 322,663 shares of common stock
(all of whom were accredited investors) exercised such warrants at $2.50 per
share, resulting in approximately $807,000 in gross proceeds to the Company.
These warrants were originally issued in 1991 in connection with the issuance of
the Company's Series B Convertible Preferred Stock. The issuance upon exercise
of these warrants was exempt from registration under Section 4(2) of the
Securities Act and met the requirements under Rule 506 of Regulation D
promulgated under the Securities Act. The Company agreed to register the resale
of the common stock received upon exercise of these warrants, and the applicable
registration was declared effective on July 19, 1996.


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

General Overview

     Incorporated in 1988, Protein Polymer Technologies, Inc. has concentrated
its research and development efforts on establishing a scientific and technical
leadership position in the manufacture 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
tissue 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.

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 

                                       15
<PAGE>
 
differences with regard to the receipt of equity capital and the amounts of
excess cash available for investment.

     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.

                                       16
<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 mid 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 reasonable alternatives to meet the continuing financial
needs 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 products.

                                       17
<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 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 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.



                                           ERNST & YOUNG LLP

San Diego, California
January 30, 1997

                                      F-2
<PAGE>
 
                          Protein Polymer Technologies
                         (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    $  2,439,159
                                        ===============================
</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                   
                                     ----------------------------------------------------------------            
                                          SHARES       AMOUNT                SHARES       AMOUNT                 
                                     -----------------------------------------------------------------           
  <S>                                      <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              --              --             
  Receivables from sale of                                                                                       
   common stock                                   --              --              --              --             
  Net loss                                        --              --              --              --             
                                     ----------------------------------------------------------------            
Balance at December 31, 1988               1,516,245          15,162              --              --             
  Repayment of receivables                                                                                       
   from sale of common stock                      --              --              --              --             
  Issuance of common stock at                                                                                    
   $.62 per share                            359,136           3,594              --              --             
  Net loss                                        --              --              --              --             
                                     ----------------------------------------------------------------            
Balance at December 31, 1989               1,875,381          18,756              --              --             
  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              --              --             
  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              --              --             
  Net loss                                        --              --              --              --             
                                     ----------------------------------------------------------------            
Balance at December 31, 1990               1,940,381          19,406              --              --             
  Exercise of common stock                                                                                       
   options at $.68 per share                                                                                     
   for cash                                    5,000              50              --              --             
  Exercise of warrants for                                                                                       
   common stock                              483,755           4,837              --              --             
  Conversion of notes payable                                                                                    
   to common stock                           339,230           3,391              --              --             
  Conversion of notes payable                                                                                    
   to preferred stock                             --              --         278,326           2,783             
  Issuance of preferred stock                                                                                    
   at $2.00 per share for                                                                                        
   cash, net of                                                                                                  
   issuance costs                                 --              --         400,000           4,000             
  Issuance of warrants for cash                   --              --              --              --             
  Issuance of warrants in                                                                                        
   connection with convertible                                                                                   
   notes payable                                  --              --              --              --             
  Net loss                                        --              --              --              --             
                                     ----------------------------------------------------------------            
Balance at December 31, 1991               2,768,366          27,684         678,326           6,783             
  Initial public offering at                                                                                     
   $6.50 per unit, net of                                                                                        
   issuance costs                          1,667,500          16,676              --              --             
  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              --              --             
  Net loss                                        --              --              --              --             
                                     ----------------------------------------------------------------            
Balance at December 31, 1992               5,827,925          58,280              --              --             
  Exercise of common                                                                                            
   stock options at $.68                                                                                        
   per share                                   3,000              30              --              --             
  Net loss                                        --              --              --              --             
                                     ----------------------------------------------------------------            
Balance at December 31, 1993               5,830,925          58,310              --              --             
  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             
  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              --              --             
  Net loss                                        --              --              --              --             
                                     ----------------------------------------------------------------            
Balance at December 31, 1995               5,832,925          58,330          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>                      
  Issuance of common stock at                                                                                    
   $.01 per share for cash              $        --     $        --     $        --     $     4,000              
  Issuance of common stock at                                                                                    
   $.62 per share for cash and                                                                                   
   receivables                              681,838              --              --         693,000              
  Receivables from sale of                                                                                       
   common stock                                  --              --         (86,000)        (86,000)             
  Net loss                                       --        (322,702)             --        (322,702)             
                                        ------------------------------------------------------------------               
Balance at December 31, 1988                681,838        (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                           219,358              --              --         222,952              
  Net loss                                       --        (925,080)             --        (925,080)             
                                        ------------------------------------------------------------------               
Balance at December 31, 1989                901,196      (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                               3,350              --              --           3,400              
  Common stock repurchased at                                                                                    
   $.01 per share for cash                       --              --              --            (250)             
  Common stock issued at $.68                                                                                    
   per share for cash and                                                                                        
   compensation                              16,750              --              --          17,000              
  Net loss                                       --      (1,501,171)             --      (1,501,171)             
                                        ------------------------------------------------------------------               
Balance at December 31, 1990                921,296      (2,748,953)             --      (1,808,251)             
  Exercise of common stock                                                                                       
   options at $.68 per share                                                                                     
   for cash                                   3,350              --              --           3,400              
  Exercise of warrants for                                                                                       
   common stock                             295,493              --              --         300,330              
  Conversion of notes payable                                                                                    
   to common stock                          508,414              --              --         511,805                              
  Conversion of notes payable                                                                                    
   to preferred stock                       553,869              --              --         556,652              
  Issuance of preferred stock                                                                                    
   at $2.00 per share for                                                                                        
   cash, net of issuance costs              703,475              --              --         703,475
  Issuance of warrants for cash               3,000              --              --           3,000              
  Issuance of warrants in                                                                                        
   connection with convertible                                                                                   
   notes payable                             28,000              --              --          28,000              
  Net loss                                       --      (1,143,119)             --      (1,143,119)             
                                        ------------------------------------------------------------------               
Balance at December 31, 1991              3,016,897      (3,892,072)             --        (840,708)             
  Initial public offering at                                                                                     
   $6.50 per unit, net of                                                                                        
   issuance costs                         8,911,024              --              --       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             1,717,065              --              --       1,724,202              
  Net loss                                       --      (3,481,659)             --      (3,481,659)             
                                        ------------------------------------------------------------------               
Balance at December 31, 1992             13,644,986      (7,373,731)             --       6,329,535              
  Exercise of common                                                                                            
   stock options at $.68                                                                                        
   per share                                  2,010              --              --           2,040              
  Net loss                                       --      (3,245,436)             --      (3,245,436)             
                                        ------------------------------------------------------------------               
Balance at December 31, 1993             13,646,996     (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             13,646,996     (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                  1,040              --              --           1,060              
  Net loss                                       --      (2,224,404)             --      (2,224,404)             
                                        ------------------------------------------------------------------               
Balance at December 31, 1995             13,648,036     (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 $25,020                               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 $25,020                               779,413             --             --              782,639           
  Exercise of common stock                   24,750             --             --               25,000           
   warrants at $1.00 per share                                                                                   
  Exercise of common stock                   91,650             --             --               93,010           
   options                                                                                                       
  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, 1988.  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
mid 1998.  Substantial additional capital resources will be required to fund
continuing expenditures related to the Company's research, development and
product marketing activities.

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 liabilities, 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 from 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 from 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>
<CAPTION>

                           <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.

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>
 
Item 8.   Changes in and Disagreements with Accountants on Accounting and
          Financial Disclosure

          None.



                                    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:

     Exhibit
     Number                       Description
     ------                       -----------

     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.

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

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

     10.24          1996 Non-Employee Directors' Stock Option Plan.

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

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

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

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

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

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

     23.1           Consent of Ernst & Young LLP, Independent Auditors.

     27             Financial Data Schedule


  (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.


(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.


March 17, 1997                            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.
<TABLE>
<CAPTION>
 
Signature                    Capacity                               Date
---------                    --------                               ----
<S>                          <C>                                <C>
/S/  J. THOMAS PARMETER      Chairman of the Board, Chief       March 17, 1997
-----------------------      Executive Officer, President
J. Thomas Parmeter           
 
/S/  ARON P. STERN           Vice President, Chief Financial    March 17, 1997
------------------           Officer (Principal Accounting  
Aron P. Stern                Officer)
                             
/S/  EDWARD E. DAVID         Director                           March 17, 1997
--------------------
Edward E. David
 
/S/  PHILIP J. DAVIS         Director                           March 17, 1997
--------------------
Philip J. Davis
 
/S/  EDWARD J. HARTNETT      Director                           March 17, 1997
-----------------------
Edward J. Hartnett
 
/S/  BRENT R. NICKLAS        Director                           March 17, 1997
---------------------
Brent R. Nicklas
 
/S/  BERTRAM I. ROWLAND      Director                           March 17, 1997
-----------------------
Bertram I. Rowland
 
/S/  RUSSELL T. STERN        Director                           March 17, 1997
---------------------
Russell T. Stern
 
/S/  GEORGE R. WALKER        Director                           March 17, 1997
---------------------
George R. Walker
</TABLE>

                                       21