UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K




(Mark
One)


x           ANNUAL
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934




For the
fiscal year ended December 31, 2008




OR




 ̈           TRANSITION REPORT UNDER SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934




For the
transition period from ______________________________ to
______________________________




Commission
file number 000-19724




PROTEIN
POLYMER TECHNOLOGIES, INC.


(Exact
name of registrant as specified in its charter)




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





11494
Sorrento Valley Road, San Diego, CA 92121


(Address
of principal executive offices) (Zip Code)




Issuer’s
telephone number: (858) 558-6064




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




Securities
registered pursuant to Section 12(g) of the Exchange Act:


Common
Stock


(Title of
Class)




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.    Yes   ̈    No  x




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the
Act.    Yes   ̈    No  x




Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 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   ̈




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  x




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




Large
      accelerated filer   ̈
                Accelerated
      Filer   ̈
                Non-accelerated
      filer   ̈
                Smaller
      reporting company  x





Indicate
by check mark whether the registrant is a shell company(as defined in Rule 12b-2 of the
Act).    Yes   ̈    No  x




The
aggregate market value of the voting common equity held by non-affiliates
computed by reference to the price at which the common equity sold, or the
average bid and asked price of such common equity, as of June 30, 2009, the last
business day of the issuer’s most recently completed second fiscal quarter, was
$974,497. Stock held by directors, officers, and shareholders owning 5% or more
of the outstanding common equity (as reported on Schedules 13D and 13G) were
excluded as they may be deemed to be affiliates. This determination of affiliate
status is not a conclusive determination for any other purpose. The number of
shares of the registrant’s common equity outstanding as of June 30, 2009 was
112,959,272.




Documents
Incorporated by Reference: None








PROTEIN
POLYMER TECHNOLOGIES, INC.




FORM
10-K


FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2008




TABLE
OF CONTENTS




PagePART
      IItem
      1.
                          Business
                          
                          2Item
      1A.
                          Risk
      Factors
                          
                          14Item
      1B.
                          Unresolved
      Staff Comments
                          
                          18Item
      2.
                          Properties
                          
                          18Item
      3.
                          Legal
      Proceedings
                          
                          19Item
      4.
                          Submission
      of Matters to a Vote of Security Holders
                          
                          19PART IIItem
      5.
                          Market
      for Common Equity, Related Stockholder Matters and Small Business Issuer
      Purchases of Equity Securities
                          
                          20Item
      6.
                          Selected
      Financial Data
                          
                          21Item
      7.
                          Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                          
                          21Item
      7A.
                          Quantitative
      and Qualitative Disclosures about Market Risk
                          
                          25Item
      8.
                          Financial
      Statements and Supplementary Data
                          
                          F-1Item
      9.
                          Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                          
                          26Item
      9A.
                          Controls
      and Procedures
                          
                          26Item
      9B.
                          Other
      Information
                          
                          28PART IIIItem
      10.
                          Directors
      and Executive Officers of the Registrant
                          
                          28Item
      11.
                          Executive
      Compensation
                          
                          30Item
      12.
                          Security
      Ownership of Certain Beneficial Owners and Management andRelated
      Stockholder Matters
                          
                          33Item
      13.
                          Certain
      Relationships and Related Transactions
                          
                          36Item
      14.
                          Principal
      Accountant Fees and Services
                          
                          37PART
      IVItem
      15.
                          Exhibits
      and Financial Statement Schedules
                          
                          38Signatures


1





PART
I





Item 1.
            Business




Forward
Looking Statements




Certain
statements contained or incorporated by reference in this Annual Report on Form
10-K constitute “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors which may cause
actual results, performance or achievements of the company, or industry results,
to be materially different from any future results, performance or achievements
expressed or implied by forward-looking statements. Such risks and uncertainties
include, among others, history of operating losses, raising adequate capital for
continuing operations, early stage of product development, scientific and
technical uncertainties, competitive products and approaches, reliance upon
collaborative partnership agreements and funding, regulatory testing and
approvals, patent protection uncertainties and manufacturing scale-up and
required qualifications. While these statements represent management’s current
judgment and expectations for the company, such risks and uncertainties could
cause actual results to differ materially from any future results suggested
herein. We undertake no obligation to release publicly the results of any
revisions to these forward-looking statements to reflect events or circumstances
arising after the date hereof.




Company
and Technology Background




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




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




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




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


2


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




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





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




•
            combine properties of different
      proteins found in nature;


•
            reproduce and amplify selected
      activities of natural
proteins;


•
            eliminate undesired properties of
      natural proteins; and


•
            incorporate synthetic properties
      via chemical modifications





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




Fundamental
Protein Polymers




Our
primary products under development are based on protein polymers combining
selected properties from two of the most extraordinary structural proteins found
in nature: silk and elastin. Silk, based upon its crystalline structure, has
long been known as an incredibly strong material, and has a long history of
medical use in humans as a material for sutures. Elastin fibers are one of the
most remarkable rubber-like materials ever studied. Found in human tissues such
as skin, lungs and arteries, elastin fibers must expand and contract over a
lifetime, and can be extended nearly three times their resting length without
damaging their flexibility.


3


Despite
the incredible individual properties of silk and elastin, neither of these
natural protein materials is capable of being processed into forms other than
what nature has provided without destroying their valuable materials properties.
However, our proprietary technology has enabled the creation of polymers that
combine the repeating blocks of amino acids responsible for the strength of silk
and the elasticity of elastin. New combinations of properties suitable for
various medical applications have been created by precisely varying the number
and sequence of the different blocks in the assembled protein
polymer.




We have
also created protein polymers based on repeating blocks of amino acids found in
two other classes of structural proteins found in nature: collagen and keratin.
Collagen is the principal structural component of the body, found in some shape
or form in virtually every tissue, ranging from shock absorbing cartilage to
light transmitting corneas. Keratin is a major component in hair, nails and
skin. The development of materials based on these polymers is at an early stage
of research.




We are
focused internally on developing protein polymers that are useful in products
for (1) tissue augmentation, (2) tissue adhesives and sealants, and (3) drug
delivery devices. Our products are based on a new generation of biomaterials
designed to aid in the process of bodily repair by promoting the healing of
tissue and restoration or augmentation of its form and function. These platform
biomaterials are genetically engineered, high molecular weight proteins,
processed into products with tailored physical structure and biological
characteristics.




Our
internal product development efforts are targeted toward a variety of markets
based on a common biomaterials platform. These include: injectable disc nucleus
for the treatment of injured or degenerated spinal discs, strong and
fast-setting, resorbable surgical sealants for use in general and cardiovascular
procedures following primary wound closure, adhesion barriers, scaffolds for
wound healing and tissue engineering. Other markets of interest, which are in an
earlier stage of development, include those for drug delivery
devices.




We have
also developed coating technology that can efficiently modify and improve the
surface properties of traditional biomedical devices. Our primary goal is to
develop medical products for use inside the body with significantly improved
patient outcomes as compared to current products and practices.





Product
Candidates and Anticipated Markets for Protein Polymer Technology




Our
protein polymer technology and materials have the potential to create products
useful in a variety of medical markets. Opportunities for research and
development of product candidates for other medical uses continue to be
evaluated.




All of
these product candidates are subject to preclinical and clinical testing
requirements for obtaining FDA and international regulatory authorities’
marketing approvals. The actual development of 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.


4


Surgical Tissue Sealants
(STS): Certain tissue adhesives and sealants that seek to avoid the
limitations of sutures, staples, pins and screws have been developed and
marketed for a number of years outside the United States by other parties. In
the United States, approved products have fallen into several categories.
DermaBond® (not our trademark), a synthetic cyanoacrylate adhesive, is approved
for topical application to close skin incisions and lacerations. Cyanoacrylate
adhesives set fast and have high strength, but form brittle plastics that do not
resorb. This limitation restricts their use to bonding the outer surfaces of
skin together. Tisseel® (not our trademark), a fibrin sealant, is approved for
use as an adjunct to hemostasis in surgery. Fibrin sealants have excellent
hemostatic properties, but are derived from human and/or animal blood products,
set slowly, have low strength, and lose their strength rapidly.





A third
category of tissue adhesives combines natural proteins such as collagen or
albumin with synthetic cross-linking agents such as gluraraldehyde. Such
products were originally marketed in Europe for limited, life-threatening
indications and the FDA approved one such product, BioGlue® (not our trademark),
in 2001 for use as an adjunct to sutures and staples in open surgery to repair
large arteries. The aldehyde cross-linking agents employed in such products
(i.e., glutaraldehyde, formaldehyde) are known to cause adverse tissue
reactions. DuraSeal® (not our trademark), a sealant product composed of a
synthetic polymer called polyethylene glycol, is a relatively weak sealant
approved for use in neurosurgery. To date, none of the products available in the
U.S. for use inside the body have found widespread acceptance among surgeons,
for reasons ranging from their lack of performance based on properties such as
adhesiveness, flexibility, and resorption rate, complexity of use, or concerns
about the perceived benefit to risk.





We have
developed surgical adhesives and sealants that are easy for the surgeon to use,
and that combine the biocompatibility of fibrin glues (without the risks
associated with use of blood-derived products) with the high strength and fast
setting times of cyanoacrylates. Unique features include significant strength
and elasticity within the adhesive matrix (to move as tissues move) and the
capability of tailoring the resorption rate of the adhesive matrix to the rate
at which the wound heals. A non-resorbable adhesive or sealant can only be used
where the damaged tissues are not going to grow together. Otherwise, a barrier
to wound healing is unavoidably created.





We have
demonstrated both the adhesive performance and the biocompatibility of our
product formulations in preclinical studies, including resorption of the
adhesive matrix in conjunction with the progression of wound healing. As a
result of our evaluations of the unmet surgeon needs, the properties achievable
with our technology and the capabilities of competitive technologies, specific
applications providing the most significant opportunities have been
targeted.





Sealant
Performance/Properties





·
            Sets quickly to an adhesive
      hydrogel.


·
            Adheres well to tissue, seals gas
      and fluid
leaks.


·
            Minimal material
      swelling.


·
            Resorbable and non-resorbable
      formulations.


·
            Two absorption
      rates.


·
            Reduces post-operative
      adhesions.


5





Our
tissue adhesive technology combines a silk-elastin polymer designed specifically
to react with a biocompatible cross-linking agent under physiological
conditions. Two fluid components are mixed just prior to their delivery to the
treatment site, which can be accomplished through a fine gauge needle and in
spray form. The material then rapidly cures to a tough, elastic hydrogel that
strongly adheres to surrounding tissues.





Wound Healing & Tissue
Regeneration: 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 other parties includes fabric
dressings (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 used varies depending on the type of
wound and the extent of tissue damage, we believe that a principal treatment
goal in all instances is to stimulate wound healing while regenerating
functional (as opposed to scar) tissue.





We have
developed protein polymers that we believe may be useful in the treatment of
dermal wounds, particularly chronic wounds such as decubitous ulcers, where both
reconstruction of the extracellular matrix ("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. We believe that such materials, if successfully
developed, could improve the wound-healing process by providing physical support
in situ for cell migration and tissue regeneration and as delivery systems for
growth factors. Additionally, such materials may serve as scaffolds for the ex
vivo production of living tissue substitutes.





Urethral Bulking Agent (UBA)
- Polymer 47K: UBA effectively relieves female stress incontinence by
injecting liquid that rapidly changes to long-lasting solid bulk to the tissue
surrounding the urethra. Our UBA injection procedure, an alternative to surgery,
most often requires only one treatment. UBA is a more effective and longer
lasting bulking agent than the competition. The UBA gel is resistant to
migration. A human clinical feasibility study has been completed.





Manufacturing,
Marketing and Distribution





Preclinical
and clinical testing of potential medical device products, where the results
will be submitted to the FDA, requires compliance with the FDA’s Good Laboratory
Practices (“GLP”) and other Quality System Regulations (“QSR”). We implemented
polymer production and quality control procedures and made certain facilities
renovations to operate in conformance with FDA requirements in our former
facilities.  However, the lease on these facilities expired on April
30, 2008.  The Company did not renew the facilities lease and vacated
the premises on expiration of the lease. We have relocated our administrative
offices and are outsourcing our laboratory and production
facilities.    See “Item 2. Properties”
below.  Accordingly, we cannot assure that our polymer production
capacity will be sufficient in the future to satisfy applicable regulatory
requirements and/or supply our development programs with the required quality
and quantity of materials needed for feasibility and preclinical testing and
initial (“pilot”) clinical testing. We will require additional manufacturing
capacity to expand beyond initial clinical trials.




We are
considering several methods for increasing production of our biomedical product
candidates to meet pivotal clinical trial and commercial requirements. For
example, we may establish external contract manufacturing arrangements for
needed quantities of materials. However, we cannot assure 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 our margins or our ability to comply with applicable
governmental regulations. The actual method or combination of methods that we
may ultimately pursue will depend on a number of factors, including
availability, cost and our assessment of the ability of such production methods
to meet our commercial objectives.


6


Research
and Development




Local 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, mucosal, 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. A few materials have 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. We believe 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.




Our
tissue augmentation products, our surgical adhesive and sealant formulations,
and our wound healing matrices all provide platforms for drug delivery
applications, serving as controlled release drug depots. The protein polymer
materials we have developed exhibit exceptional biocompatibility, provide for
control over rates of resorption, and are fabricated using aqueous solvent
systems at ambient temperatures — attributes that can be critical in maintaining
the activity of the drug, particularly protein-based drugs emerging from the
biotechnology industry. This program is in the preclinical research
stage.





Collaborative
and License Agreements




Because
of the highly technical focus of our business, we must conduct extensive
research and development prior to any commercial production of our biomedical
products or the biomaterials from which they are created. During this
development stage, our ability to generate revenues is limited. Because of this
limitation, we do not have sufficient resources to devote to extensive testing
or marketing of our products. Our primary method to expand our product
development, testing and marketing capabilities is to seek to form collaborative
arrangements with selected corporate partners with specific resources that we
believe complement our business strategies and goals.




Spine Wave,
Inc.





Low back
pain is the leading cause for healthcare expenditures in the United States,
resulting in more than $50 billion in direct and indirect medical expense, and
products used to treat it are the fastest growing major segment of the
orthopedic industry, with a market of $2.1 billion in revenues and a growth rate
of more than 25% annually, according to a February 2000 Viscogliosi Bros., LLC.,
Spine Industry Analysis Series report. The leading surgical treatments for spine
include spinal fusions, discectomies, and laminectomies, but the market for disc
replacement and repair is expected to grow more rapidly than other treatments as
new products are approved over the next five years.





We are a
technology partner with Spine Wave, Inc. (hereafter “Spine Wave”). We used our
patented tissue adhesive technology to create Spine Wave’s NuCoreÔ intervertebral disc
repair material.





The spine
supports about one-half of the body’s weight and is a highly flexible structure.
The spinal disc is like a jelly-filled tire between the bony vertebrae, a key
component providing for flexibility and acting as a shock absorber. It has no
blood supply and thus is not able to repair itself. Exposure to heavy loads or
extreme twisting motions can cause tears in the outer portion of the disc,
allowing the jelly-like material (the nucleus) to extrude. Additionally, with
age the disc degenerates. Injury to the disc or degeneration of the disc,
results in fundamental changes in its mechanical properties, and also impacts
surrounding tissues in a variety of ways, which can result in persistent
pain.


7


Currently,
there are no satisfactory minimally invasive surgical treatments available for
chronic low back pain due to damaged or deteriorated discs. In extreme cases, a
spinal fusion may be performed to limit the mobility of the joint.  In
other cases, the disk maybe removed and an artificial disk
implanted.  However, these procedures require invasive surgeries, and
in some cases they result in restricted mobility, leading to further
degeneration of the spine.





A number
of products are reported to be in development, ranging from complete replacement
with an artificial disc to implantation of “pillows” within the disc space. We
and Spine Wave believe an injectable product that can be used in an outpatient
procedure, avoiding surgery required for implants and thus minimizing additional
damage to the disc and/or surrounding structures will be a preferred approach.
Collaborative feasibility studies have demonstrated that the injectable disc
nucleus product has physical properties mimicking those of the natural nucleus;
is able to withstand the large, cyclical forces seen by the human spine; and
resists expulsion under high loads due to its adherence to the disc
wall.





Spine
Wave’s NuCoreTM Injectable Nucleus device, based on our patented tissue adhesive
technology, is an injectable protein polymer formulation for repair of spinal
discs damaged as a result of injury or aging. Injected in a liquid form, the
NuCoreTM material rapidly cures to a gel that has physical properties which mimic
those of the natural nucleus. Spine Wave has enrolled patients in Degenerative
Disc Disease and microdiscectomy studies of the NuCoreTM Injectable Nucleus
device in four countries: Switzerland, Australia, Germany and the United
States.





We
created this core technology and manufactured the product for Spine Wave, Inc.’s
U.S. and European trials. Spine Wave has contracted to a third party, the
manufacture of recombinant protein for NuCoreTM Injectable Nucleus for commercial
in-market supply.





Genencor International,
Inc.




In
December 2000, we signed a broad-based, worldwide exclusive license agreement
with Genencor International, Inc. (hereafter “Genencor”) enabling Genencor,
potentially, to develop a variety of new products for industrial markets. In
October 2002, the license agreement was amended to provide Genencor with an
additional one-year option to initiate development in the field of non-medical
personal care products.




In March
2005, the license was amended to fully incorporate the field of personal care
products into the license. As a result of the agreements, Genencor may use our
patented protein polymer design and production technology, in combination with
Genencor's extensive gene expression, protein design, and large-scale
manufacturing technology, to design and develop new products with improved
performance properties for defined industrial fields and the field of
non-medical personal care products.




In return
for the licensed rights, Genencor paid the Company an up-front license fee of
$750,000, and will pay royalties on the sale of any products commercialized by
Genencor under the agreement. The licensed technology was transferred to
Genencor upon execution of the license agreement without any further product
development obligation on our part. Future royalties on the net sales of
products incorporating the technology under license and developed by Genencor
will be calculated based on a royalty rate to be determined at a later date. In
addition, we are entitled to receive up to $5 million in milestone payments
associated with Genencor’s achievement of various industrial product development
milestones incorporating the licensed technology. In March 2005 we received a
second license milestone payment of $250,000 from Genencor for Genencor’s
initiation of a product development project based on technology licensed from
us.


8


Both
warrants have subsequently expired. The agreement terminates on the date of
expiration of the last remaining patent.




On
October 9, 2006, our license agreement with Genencor was amended. The amendment
essentially provided for (i) the immediate funding of a $100,000 payment under
the existing agreement, (ii) modification of the royalty percentage from a
variable rate concept to a single rate of 2% of Genencor's net revenues earned
from the product sales subject to the license, (iii) a $100,000 payment in
January, 2007 and (iv) modification of the milestone payments earned under the
agreement. As amended, we are entitled to a milestone payment of $250,000 when a
product attains aggregate sales of $5.0 million. We are entitled to a single
milestone payment for each product.




Sanyo Chemical Industries,
Ltd.





On June
29, 2009, the Company received from Sanyo Chemical Industries, Ltd. (“Sanyo”) a
fully executed copy of a License Agreement between Sanyo and the
Company.  The effective date of the Agreement is June 18,
2009.    Pursuant to the Agreement, the Company has granted
a non-exclusive, world-wide license to Sanyo of its technology, know-how, and
intellectual property relating to recombinant, repetitive unit proteins and
peptides, for the purposes of developing and commercializing products related to
Sanyo’s specific fields of business.  The Agreement remains in effect
until the expiration of the last to expire of the Company’s patents licensed by
Sanyo under this Agreement.  The Agreement further provides the
Company with initial and ongoing license fees, technical service and training
fees, and a percentage royalty on the quarterly net sales of any new products
developed by Sanyo under this Agreement.





Other
Agreements




We are
discussing other potential collaboration agreements with prospective marketing
partners. We cannot assure that we will continue such discussions or if we will
be able to establish such agreements at all, or do so in a timely manner and on
reasonable terms, or that such agreements will lead to successful product
development and commercialization. From time to time, we are party to certain
agreements for the evaluation of materials regarding biomedical applications of
our products, 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. We cannot
assure that we will continue to be able to establish such agreements 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.




Intense
Competition




The
principal anticipated commercial uses of our biomaterials are as components of
end-use products for biomedical and other specialty applications. End-use
products using or incorporating our biomaterials would compete with other
products that rely on the use of alternative materials.




The areas
of business in which we engage and propose to engage are characterized by
intense competition and rapidly evolving technology. Competition in the
biomedical and surgical repair markets is particularly significant. Our
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 our own. Academic institutions and other
public and private research organizations are also conducting research and
seeking patent protection in the same or similar application areas, and may
commercialize products on their own or through joint ventures. Most of our
competitors depend on synthetic polymer technology rather than protein
engineering for developing products. However, we believe that DuPont,
BioElastics Research, Ltd. and several university laboratories are currently
conducting research into similar protein engineering
technology.


9


The
primary elements of competition in the biomedical and surgical repair products
market are




o
            performance,


o
            cost,


o
            safety,


o
            reliability,


o
            convenience,
      and


o
            commercial production
      capabilities.





We
believe that our ability to compete in this market will be enhanced by the
breadth of our issued patent claims, our other pending patent applications, our
early entry into the field and our experience in protein
engineering.




Patents
and Trade Secrets




We are
aggressively pursuing domestic and international patent protection for our
technology, making claim to an extensive range of recombinantly prepared
structural and functional proteins, the DNA encoding these proteins, methods for
preparing this synthetic repetitive DNA, methods for the production and
purification of protein polymers, end-use products incorporating such materials
and methods for their use. Due to this multi-layered patent strategy, each of
our products under development is protected by multiple patents claiming
different aspects of the underlying inventions.




We have
been issued twenty-eight patents by the United States Patent and Trademark
Office. Additionally, we have three U.S. patent applications
pending.





We have
been granted four U.S. patents that broadly cover the polymer compositions used
in our product development efforts and/or the DNA encoding these polymers. These
polymers are generally defined by the use of repetitive amino acid sequences
found in naturally occurring proteins (e.g., silk, elastin, collagen, and
keratin). The last of these patents will expire in 2015. Additionally, we have
been granted two U.S. patents that specifically cover polymer compositions based
on repetitive silk and elastin units and the DNA encoding these polymers. The
last of these patents will expire in 2014.




The
silk/elastin copolymers used in our tissue augmentation products and our tissue
adhesive products, including the spinal disc repair product, and the genes used
to produce them have amino acid and/or DNA sequences within the claims of all
six of these patents. We also have been granted two U.S. patents that cover
methods of using polymers such as these silk/elastin copolymers for tissue
augmentation. This patent will expire in 2017.




We have
been granted ten U.S. patents covering our tissue adhesive and sealant
technology. Four of these patents cover the cross-linked polymer compositions
and/or methods of using our polymers and a cross-linking agent to adhere or seal
tissues, including the filling of defects in tissues. The spinal disc repair
product under development, as well as other anticipated products based on our
adhesive and sealant technology fall within the claims of these patents. These
patents will expire in 2015. The remaining five patents cover the special case
where primers are used to enhance the mechanical strength of protein-based
tissue adhesives and sealants. These patents will expire in
2017.


10


We have
been granted two U.S. patents covering the methods used to construct the
synthetic DNA encoding proteins having repetitive amino acid sequences. The
claims of these patents are not limited by the specific amino acid sequence of
the polymers produced using the methods. Therefore, they provide very broad
coverage of our core technology. Both of these patents will expire in
2014.




We have
been granted ten U.S. patents that are not currently central to our product
development focus. However, they either do or may support the interests of
licensees of our technology or may support our future product development
efforts. Three of the patents specifically cover DNA encoding polymers useful
for in vitro cell culture, the last of which will expire in 2015. Two of the
patents specifically cover collagen-like proteins and the DNA encoding them,
both of which will expire in 2013. One of the patents specifically covers a
purification method for silk-like proteins, developed for large-scale industrial
use, which will expire in 2010. Two of the patents specifically cover
compositions, formed objects and methods of making such objects, combining
traditional thermoplastic resins and proteins providing chemical or biological
activity. Both of these patents will expire in 2015. Two of the patents
specifically cover our water-insoluble polymers that have been chemically
modified to make them water-soluble. Both of these last two patents will expire
in 2015.





Although
we believe our existing issued patent claims provide a competitive advantage, we
cannot assure that the scope of our patent protection is or will be adequate to
protect our technology or that the validity of any patent issued will be upheld
in the future. Additionally, with respect to our pending applications, we cannot
assure that any patents will be issued, or that, if issued, they will provide
substantial protection or be of commercial benefit to us.





Although
we do not currently have any operations outside the U.S., we anticipate that our
potential products will be marketed on a worldwide basis, with possible
manufacturing operations outside the U.S. Additionally, current or potential
products of our licensees are, or are expected to be, marketed on a worldwide
basis with current or potential manufacturing operations outside the U.S.
Accordingly, we have filed international patent applications corresponding to
the major U.S. patents described above in foreign countries. Due to translation
costs and patent office fees, international patents are significantly more
expensive to obtain and maintain than U.S. patents. Additionally, there are
differences in the requirements concerning novelty and the types of claims that
can be obtained compared to U.S. patent laws, as well as the nature of the
rights conferred by a patent grant. We carefully consider these factors in
consultation with our patent counsel, as well as the size of the potential
markets represented, in determining the foreign countries in which to file
patents.




Because
of the uncertainty concerning patent protection and the unavailability of patent
protection for certain processes and techniques, we also rely upon trade secret
protection and continuing technological innovation to maintain our competitive
position. Although all our employees have signed confidentiality agreements,
there can be no assurance that our proprietary technology will not be
independently developed by other parties, or that secrecy will not be breached.
Additionally, we are 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. We
cannot predict whether we may have to obtain licenses to use any technology
developed by third parties or whether such licenses can be obtained on
commercially reasonable terms, if at all.




In the
course of our business, we employ various trademarks and trade names in
packaging and advertising our products. We have assigned the federal
registration of our ProNectin® trademark and our SmartPlastic® trademark for
ProNectin F Activated Cultureware to Sanyo Chemical Industries, Ltd. in
connection with the sale to Sanyo of our cell culture business in February 2000.
We intend to protect and promote all of our trademarks and, where appropriate,
will seek federal registration of our trademarks.


11


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. Our 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, our activities are subject principally to
regulation under the Occupational Safety and Health Act and the Food, Drug and
Cosmetic Act (including amendments and updates) of both the U.S. and the State
of California.




Extensive
preclinical and clinical testing and pre-market approval from the FDA is
required for new medical devices, drugs or vaccines, which is generally a costly
and time-consuming process. To support the development of such products, we are
required to be in compliance with many of the FDA’s regulations to conduct
testing in support of product approvals; in particular, compliance with the
FDA’s Good Laboratory Practices (GLP) and applicable Quality System Regulations
(QSR). Where we have conducted such testing, our company may choose to file
product approval submissions ourselves or for our partners.





We cannot
assure that we, or our customers, will be able to obtain or maintain the
necessary approvals from the FDA or corresponding international regulatory
authorities.  Our anticipated business could be adversely affected if
we are unable to obtain and maintain these approvals and/or comply with these
regulations. To the extent we manufacture medical devices, or a component
material supplied to a medical device manufacturer, we will be required to
conform commercial manufacturing operations to the FDA’s QSR requirements. We
would also be required to register our facility with the FDA as an establishment
involved in the manufacture of medical devices. QSR requirements are rigorous,
and there can be no assurance that compliance could be obtained in a timely
manner and without the expenditure of substantial resources, if at all.
International quality system requirements, (e.g., ISO 13485 issued by the
International Organization for Standardization) is the quality model used by
medical product manufacturers and is required for the sale of medical devices in
Europe. ISO 13485 standards are similar to the FDA’s QSR.




Our
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, discharge, storage, transportation and disposal of toxic and
hazardous substances. Our future activities may be subject to regulation under
the Toxic Substances Control Act, which requires us to obtain pre-manufacturing
approval for any new “chemical material” we produce for commercial use that does
not fall within the FDA’s regulatory jurisdiction. We believe we are currently
in substantial compliance with all applicable laws and regulations. Although we
intend to use our best efforts to comply with all environmental laws and
regulations in the future, we cannot assure that we will be able to fully comply
with such laws, or that full compliance will not require substantial capital
expenditures.




Product
Liability and Absence of Insurance




Our
business may expose us to potential product liability risks whenever human
clinical testing is performed, or upon the use of any commercially marketed
medical product. Prior to beginning human clinical testing of our
investigational devices, we procured product liability insurance. Prior to
shipping the products, we obtained the applicable product liability insurance.
We are maintaining the insurance with coverage appropriate for the development
and use of our products. We cannot assure, however, that we will be able to
continue to obtain such insurance on acceptable terms or that such insurance
will provide adequate coverage against potential liabilities. A successful
product liability claim or series of claims could result in a material adverse
effect on our business.


12


Executive
Officers of the Registrant





Name
                    
                    Age
                    
                    Position
      with the CompanyJames
      B. McCarthy, M.B.A., J.D.
                    
                    57
                    
                    Interim
      Chief Executive Officer, Interim Principal Accounting Officer, and Interim
      Corporate SecretaryJoseph
      Cappello, Ph.D.
                    
                    52
                    
                    Vice
      President, Research and Development, Chief Technical Officer and Director,
      Clinical ResearchFranco
      A. Ferrari, Ph.D.
                    
                    57
                    
                    Vice
      President, Laboratory Operations and Polymer Production and Director,
      Molecular
Genetics




Mr.
McCarthy is our Interim Chief Executive Officer, Interim Principal Accounting
Officer, and Interim Corporate Secretary, positions he has held since October,
2007. Mr. McCarthy has served as a director since April 2005. Mr. McCarthy also
serves as the Chairman and Chief Executive Officer of Gemini Consulting Group,
Inc., a health care consulting firm, a position he has held since 1991. Mr.
McCarthy is also a member of the Board of Directors for Sirigen Group Ltd.,
London, England, and StemCyte, Inc., Covina, CA, with offices in New Jersey,
Taiwan, and India. He is also a member of the Board of Trustees of the
University of San Diego, San Diego, California.





Dr.
Cappello has been our Vice President, Research and Development since February
1993 and Chief Technical Officer since February 1997. He has been our Director,
Clinical Research, since July 2002. From September 1988 to February 1993, he was
our Senior Research Director, Protein Engineering.




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




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




Employees




As of
December 31, 2008, we had 2 full-time employees, both of whom hold Ph.D.
degrees. We are highly dependent on the services of our executive officers and
scientists. The loss of the services of any one of these individuals would have
a material adverse effect on the achievement of our development objectives, our
business opportunities and prospects. The recruitment and retention of
additional qualified management and scientific personnel is also critical to our
success. We cannot assure that we 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.


13





Item 1A.
            Risk
    Factors





Risks
Related to Our Business and Industry





If
we continue to incur operating losses, and are unable to raise additional
operating capital, we may be unable to continue our operations at planned levels
and be forced to curtail or cease our operations.





We have incurred operating losses since
our inception in 1988, and will continue to do so for at least several more
years. As of December 31, 2008, our accumulated deficit was approximately
$73,206,000, and we have continued to incur losses since that date. The losses
have resulted principally from expenses of research and development and from
general and administrative expenses. If these losses continue, they could cause
the value of our stock to decline.





We
believe our existing available cash, cash equivalents and accounts receivable,
in combination with anticipated contract research payments and revenues received
from the transfer of clinical testing materials, will not be sufficient to meet
our anticipated capital requirements during 2009. Substantial additional capital
resources will be required to fund continuing expenditures related to our
research, development, manufacturing and business development activities. If we
do not raise adequate funds, we will be required to significantly curtail or
cease our operations, and may have to sell or license out significant portions
of our technology or potential products.





We
believe there may be a number of alternatives to meeting the continuing capital
requirements of our operations, including additional collaborative agreements
and public or private financings. However, these alternatives may not be
consummated in the necessary time frames needed for continuing operations or on
terms favorable to us, if at all. From April, 2006 to September 2007, one of our
stockholders provided financing to us to support our operations (see references
to Szulik loan). As of January 9, 2008, we issued a new note in the principal
amount of $6,415,000.  This note replaced the previous note and
included the then $5,876,000 outstanding principal balance plus the then
$539,000 outstanding in accrued interest on the old note.  On
September 1, 2008, the scheduled maturity date of the 1/09/08 Note was extended
to March 31, 2009, and on March 31, 2009, the 1/09/08 Note was extended to
September 30, 2009.  In September 2007, the Company entered into a
stock purchase agreement that has been used to fund operations since that time.
In addition, from October 2008 through June 2009, the Company has entered into
debt financing agreements to fund operations.  In the event that
future funding through the stock purchase agreement or other debt financing
agreements fail to materialize, on a timely basis, we will be forced to further
curtail or cease operations.





Our
year end audited financial statements contain a “going concern” explanatory
paragraph, in which our independent auditors have expressed substantial doubt
regarding our ability to continue operating as a going concern.




Our
financial statements for the years ended December 31, 2008 and 2007 included
herein have been prepared on the basis of accounting principles applicable to a
going concern.  Our auditors’ report on the financial statements contained
herein includes an additional explanatory paragraph following the opinion
paragraph on our ability to continue as a going concern.  A note to these
financial statements describes the reasons why there is substantial doubt about
our ability to continue as a going concern and our plans to address this
issue.  Our December 31, 2008 financial statements do not include any
adjustments that might result from the outcome of this uncertainty.  Our
inability to continue as a going concern will likely result in a ceasing of our
operations.  See, “Part II. Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations; Liquidity and Capital
Resources.”


14


If
we fail to establish and manage strategic partnerships, we may be prevented from
developing potential products or the time required for commercializing potential
products may be increased.





Our
principal strategy is to enter into partnerships or licensing arrangements with
medical or pharmaceutical companies with appropriate marketing and distribution
capabilities to reduce the time and costs for developing and commercializing our
potential products. We may not be able to establish additional strategic
partnerships or licensing arrangements, or, if available, they may not be on
terms and conditions favorable to our business. Additionally, these arrangements
generally may be terminated under various circumstances, including termination
at the discretion of the strategic partner without cause or without prior
notice. Termination of the arrangements could seriously harm our business and
financial condition. Furthermore, our strategy may lead to multiple alliances
regarding different product opportunities that are active at the same time. We
may not be able to successfully manage multiple arrangements in various stages
of development.





We are
discussing other potential collaboration agreements with prospective marketing
partners. Furthermore, from time to time, we are party to certain materials
evaluation agreements regarding biomedical applications of our products,
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. We may not be
able to establish these agreements at all or do so in a timely manner and on
reasonable terms. In addition, these agreements may not lead to successful
product development and commercialization.





We
may not be able to produce commercially acceptable products because our
technology is unproven. If we cannot prove our technology, we will not succeed
in commercializing our products.





Our
technological strategy of designing and producing unique products based on
genetically engineered proteins that do not have a harmful effect on biological
systems, such as the human body, is commercially unproven. The process of
developing products and achieving regulatory approvals is time consuming and
prone to delays. We have completed only a few products that require
collaboration and marketing partners, and have not generated any significant
revenues from product sales.





The
products we are currently pursuing will require substantial further development,
testing and regulatory approvals. Our research and development activities may
not be successful and as such, we may not be able to produce commercially
acceptable products.





We
must prove our products' effectiveness in clinical trials. If we are unable to
successfully complete clinical trials, we may not be able to produce marketable
products.





Before
obtaining regulatory clearance for the commercial sale of any of our products,
we must demonstrate through preclinical studies and clinical trials that the
potential product is safe and effective for use in humans for each particular
use. Due to the inherent difficulties associated with clinical trials, we cannot
guarantee that:





o
            we will be able to complete the
      clinical trials successfully, if at
all;





o
            we will be able to demonstrate
      the safety and efficacy necessary to obtain the requisite regulatory
      approvals of product candidates;
or





o
            the product candidates will
      result in marketable
products.


15


The
biomedical and surgical repair industry involves intense competition and rapid
technological changes. Our business may suffer if our competitors develop
superior technology.





We
operate in the biomedical and surgical repair markets that involve intense
competition. Our competitors in those 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 ours. Our biomaterials are used primarily in the
manufacture of end-use products for medical applications that compete with other
products that rely on the use of alternative materials or components. As a
result, we compete with diverse, complex and numerous rapidly changing
technologies. We believe that our ability to compete will be enhanced by the
breadth of our issued patent claims, our other pending patent applications and
our experience in protein engineering. However, we currently do not have the
resources to compete commercially without the use of collaborative agreements
with third parties.





Our
product technology competes for corporate development and marketing partnership
opportunities with numerous other biotechnology companies, research institutes,
academic institutions and established pharmaceutical companies. We also face
competition from academic institutions and other public and private research
organizations that are conducting research and seeking patent protection, and
may commercialize products on their own or through joint ventures. Although most
of our competitors depend on technology other than protein engineering for
developing products, we believe that several university laboratories are
currently conducting research into similar protein engineering technology. Our
competitors may succeed in developing products based on our technology or other
technologies that are more effective than the ones we are developing, or that
would render our technology and products obsolete and non-competitive, which may
harm our business.





We have not developed a process to
manufacture our products on a commercially viable scale. We will lose potential
revenues if we cannot manufacture products on a commercial
scale.





To date,
we have manufactured only limited amounts of our biomedical products for
internal testing, initial human clinical testing and, in certain cases,
evaluation and testing by corporate partners and other third parties. To obtain
manufacturing approvals from the FDA for the development and commercialization
of certain biomedical products, we would be required to upgrade our
manufacturing facilities.





We have
not yet developed a process to manufacture our products on a commercial scale
and may not be able to, or have another party on our behalf, develop a process
at a cost or in quantities necessary to become commercially viable. We may need
to evaluate alternative methods to produce commercial quantities of our
products. We may not be able to successfully assess the ability of other
production methods or establish contract-manufacturing arrangements to meet
commercial objectives.





Our
business is subject to substantial regulation and may be harmed if we are unable
to comply with the applicable laws.





Regulation
by governmental authorities in the United States and other countries affects the
success of products resulting from biotechnological research. Our current
operations and products are, and anticipated products and operations will be,
subject to substantial regulation by a variety of local, state, federal and
foreign agencies, particularly those products and operations related to
biomedical applications. A few examples of the laws that govern our products and
operations are:





o
            FDA’s
      Good Laboratory Practices;


o
            FDA Quality System
      Regulations;


o
            Food,
      Drug & Cosmetic Act, as amended;
and


o
            Occupational
      Safety and Health Act;


16


Compliance
with the applicable laws and regulations is a costly and time-consuming process.
We believe we are currently in substantial compliance with the laws and
regulations applicable to our current operations. Although we intend to use our
best efforts to comply with all applicable laws and regulations in the future,
we may not be able to fully comply with the laws and regulations and as such,
our business operations would be seriously harmed.





Our
business may be harmed if we are not able to retain key employees.





As of
December 31, 2008, we had two full-time employees, neither of whom have
employment contracts with us, and both of whom hold Ph.D. degrees. Our success
will depend largely upon the efforts of our scientists and certain of our
executive officers who understand our technology and business objectives. The
loss of the services of any one of these individuals would seriously harm our
business opportunities and prospects. Our success also depends on the retention
of scientific personnel. We may not be able to attract and retain required
personnel on acceptable terms, due to the competition for experienced personnel
from other biotechnology, pharmaceutical and chemical companies, universities
and non-profit research institutions. We do not maintain "key-man" or similar
life insurance policies with respect to these persons to compensate us in the
event of their deaths, which may harm our business.





We
may be sued for product liability and may not have sufficient protection under
our insurance policies.





We may
face product liability claims with respect to our technology or products either
directly or through our strategic partners. We may also be exposed to potential
product liability risks whenever human clinical testing is performed or upon the
use of any commercially marketed medical product. We believe that our prior
sales of SmartPlastic(R), ProNectin (R) F and ProNectin(R) L products do not
pose any material product liability risk. To our knowledge no product liability
claims have ever been made against us. Before initiating human clinical testing
of our technology, we procured product liability insurance that is limited to
coverage of $1,000,000 per occurrence and in the aggregate $5
million.  Our current product liability insurance is limited to
coverage of $1,000,000 per occurrence and in the aggregate $1,000,000 and our
umbrella liability insurance is limited to coverage of $2,000,000 per occurrence
and in the aggregate $2,000,000. If plaintiffs succeed in their claims against
us, if any, and if the coverage under our insurance policies is insufficient,
our business would be seriously harmed.





If
we are unable to protect our proprietary technology, we may not be able to
compete as effectively.





We have
been issued 28 United States patents and 14 foreign patents, and have 3
additional pending United States patent applications. We have not yet marketed,
sold, or developed our products outside the United States, except for limited
amounts of ProNectin(R) F, ProNectin(R) L, and SmartPlastic(R) cell culture
products. The patent position of biotechnology companies, such as ours, is
highly uncertain and involves complex legal, scientific, and factual factors.
For example:




o
            patents issued to us may be
      challenged, invalidated or
circumvented;





o
            patents may not issue from any of
      our pending patent applications or, if issued, may not be sufficiently
      broad to protect our technology and products or provide us with any
      proprietary protection or competitive
  advantage;





o
            our competitors may have filed
      patent applications or may have obtained patents and other proprietary
      rights relating to products or processes similar to and competitive with
      ours. The scope and validity of such patents may not be known or the
      extent to which we may be required to obtain licenses under these patents
      or other proprietary rights. If required, we may not be able to obtain any
      licenses on acceptable terms, if at
all;





o
            certain foreign intellectual
      property laws may not be as protective as those of the United States;
      or





o
            we may enter into collaborative
      research and development arrangements with our strategic partners that may
      result in the development of new technologies or products, but may also
      get us involved in a dispute over the ownership of rights to any
      technology or products that may be so
  developed.


17





If
we are unable to obtain patent protection, enforce our patent rights or maintain
trade secrets and other protection for our products and technology, our business
may be seriously harmed.





We also
seek to protect our intellectual property in part by confidentiality agreements
with our employees and consultants. These agreements may be breached or
terminated. We may not have an adequate remedy for any breach, and our trade
secrets may otherwise become known or independently discovered by competitors,
which would harm our business.





Our
common stock was delisted from the NASDAQ and OTC Bulletin Board and will be
difficult to sell.





Our
common stock was delisted from the NASDAQ Small Cap Market on September 20,
1999, and was delisted from the OTC Bulletin Board on May 19,
2009.  Our common stock now trades on the OTC Pink
Sheets.  As a consequence of the delistings, it is more difficult to
dispose of, or to obtain accurate quotations as to the market value of, our
common stock. In addition, the delisting made our common stock substantially
less attractive as collateral for margin and purpose loans, for investment by
financial institutions under their internal policies or state investment laws,
or as consideration in future capital raising transactions.





Our
common stock is also subject to regulation as a "penny stock." The Securities
and Exchange Commission has adopted regulations that generally define "penny
stock" to be any equity security that has a market price or exercise price less
than $5.00 per share, subject to certain exceptions, including listing on the
NASDAQ Small Cap Market. For transactions covered by the penny stock rules, the
broker-dealer must consider the suitability of the purchaser, receive the
purchaser's written consent before the purchase, deliver a risk disclosure
document before the purchase and disclose the commission payable for the
purchase. Additionally, if the broker-dealer is the sole market maker, the
broker-dealer must disclose this fact and the broker-dealer's presumed control
over the market. Finally, monthly statements must be sent disclosing recent
price information for the penny stock held in the account and information on the
limited market in penny stocks.





The
requirements of the penny stock rules restrict the ability to sell our common
stock in the secondary market and the price at which our common stock can be
sold. Since our common stock was delisted from the NASDAQ Small Cap Market and
OTC Bulletin Board, we have seen a decline in our average daily trading volume,
and as a result, the trading price of our common stock has experienced wide
fluctuations.





Item 1B.
            Unresolved Staff
      Comments





There were no unresolved staff comments
as of 12/31/08.





Item 2.
            Properties





We do not
own any real property.  Through April 30, 2008, we leased
approximately 27,000 square feet of office and laboratory space in San Diego.
The leased property included our administrative offices, which encompassed
approximately 4,000 square feet, and our laboratory facilities, which
encompassed approximately 23,000 square feet. The annual rent for this space was
approximately $680,000. This lease expired on April 30, 2008 and our Board
determined not to renew it.





We
currently lease approximately 180 square feet of administrative office space in
San Diego. The lease term began on June 15, 2009 and expires on February 28,
2010.  The lease can be terminated at any time with one month’s
notice.  The current annual rent for this space is approximately
$4,300.  We are currently outsourcing our laboratory and production
facilities.


18





Item 3.
            Legal
      Proceedings





On
October 15, 2008, certain alleged noteholders instituted suit against the
Company in Superior Court of California, County of Sacramento, seeking payment
of outstanding notes payable allegedly owed by the Company. The name of the case
is Lou Matson, Mary Matson, and Don Brandon v Protein Polymer Technologies, Inc,
Case Number 34-2008-00022190.  On May 19, 2009, the plaintiffs filed a
request for dismissal with prejudice of the action against the Company, and the
Company paid nothing to plaintiffs in exchange for the dismissal.




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
2008.


19


PART
II




Item 5.
            Market for Common Equity, Related
      Stockholder Matters and Small Business Issuer Purchases of Equity
      Securities.





NASDAQ
and OTC Bulletin Board Delisting




Prior to
September 1999, our common stock traded on The NASDAQ Stock Market under the
symbol “PPTI”. Our common stock was delisted from the NASDAQ Small Cap Quotation
System, effective September 20, 1999. The reasons for the delisting were failure
to maintain the minimum bid requirement of $1.00 per share for our common stock
and failure to meet the minimum net asset requirement of $2
million.  Our common stock was then traded on the OTC Bulletin Board
under the symbol “PPTI.OB”.





On May 19, 2009, the Company was
delisted from the OTC Bulletin Board.  The reason for the delisting
was failure to file required SEC reports in a consistently timely
manner.  Our common stock is now traded on the OTC Pink
Sheets.  To access the quotations for our common stock, use the call
letters “PPTI.PK”.





The high
and low prices set forth below represent inter-dealer prices without retail
markups, markdowns or commissions, and may not represent actual transactions.
The source of the high and low information set forth below was provided by Yahoo
Finance (http://finance.yahoo.com).




Trade Prices2008
                          
                          High
                          
                          
                          LowFirst
      Quarter
                          
                          $
                          0.08
                          
                          
                          $
                          0.04Second
      Quarter
                          
                          
                          0.07
                          
                          
                          
                          0.03Third
      Quarter
                          
                          
                          0.06
                          
                          
                          
                          0.02Fourth
      Quarter
                          
                          
                          0.04
                          
                          
                          
                          0.012007First
      Quarter
                          
                          $
                          0.18
                          
                          
                          $
                          0.12Second
      Quarter
                          
                          
                          0.19
                          
                          
                          
                          0.10Third
      Quarter
                          
                          
                          0.21
                          
                          
                          
                          0.11Fourth
      Quarter
                          
                          
                          0.16
                          
                          
                          
                          0.06




As of
December 31, 2008, we had approximately 167 shareholders of record of our common
stock; we estimate we had approximately nine beneficial holders as of that date.
We have never paid cash dividends on our common stock. We currently intend to
retain earnings, if any, for use in the operation and expansion of our business
and therefore do not anticipate paying any cash dividends on our common stock in
the foreseeable future




Recent
Sales of Unregistered Securities





During the last quarter of 2008, we
received an aggregate of $57,500 for the purchase of 1,545,795 common shares and
1,545,795 warrants to purchase common shares.  Additionally, we
received aggregate proceeds of $230,000 from the issuance of unsecured notes
during the fourth quarter of 2008.  As consideration for the notes,
the Company granted 5,250,000 warrants to purchase common shares to the
noteholders.  Reference is made to Liquidity and Capital resources
under Management’s Discussion and Analysis of Financial Condition and Results of
Operations for information relating to these sales.  The sales of
common shares and issuance of notes were made pursuant to the exemption form the
registration provisions of the Securities Act of 1933 provided by Section 4 (2)
thereof.


20


Equity Compensation
Plan Information




The
following table provides information as of December 31, 2008 regarding equity
compensation plans (including individual compensation arrangements) under which
our equity securities are authorized for issuance.





Plan Category
                          
                          
                          Number of
                            securities
                            to be issued upon
                            exercise of
                            outstanding
                            options, warrants
                            and
                            rights
                          
                          Weighted-average
                            exercise price of
                            outstanding
                            options, warrants
                            and rights
                          
                          Number of
                            securities
                            remaining available
                            for future issuance
                            under equity
                            compensation plans
                            (excluding
                            securities reflected
                            in column (a))(a)
                          
                          (b)
                          
                          (c)Equity
      Compensation Plans approved by security holdersStock
      Option Plans1
                          
                          
                          3,333,200
                          
                          $
                          0.678
                          
                          6,380,000Employee
      Stock Purchase Plan2
                          
                          
                          —
                          
                          
                          —
                          
                          —Equity
      Compensation Plans not approved by security holders3
                          
                          
                          174,300
                          
                          $
                          0.749
                          
                          n/a







1Includes
shares of common stock to be issued upon exercise of stock options granted under
the 1989 Employee Stock Option Plan, the 1992 Employee Stock Option Plan, the
2002 Employee Stock Option Plan, and the 1996 Non-employee Director’s Stock
Option Plan.


2 Includes
shares of common stock available for future issuance under the Employee Stock
Purchase Plan.


3Includes
shares of common stock to be issued upon exercise of out-of-plan non-qualified
options granted.




Item 6.
            Selected Financial
      Data





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





Item 7.
            Management’s Discussion and
      Analysis of Financial Condition and Results of
      Operations





General
Overview




Protein
Polymer Technologies, Inc. is a biotechnology company engaged in the research,
development, production and clinical testing of medical products based on
materials created from our patented technology to produce proteins of unique
design. Additionally, we are committed to the acquisition of faster-to-market
medical products in certain complementary growth markets. Since 1992, we have
focused primarily on developing technology and products to be used for tissue
adhesives and sealants; wound healing support; and drug delivery
devices.




Results
of Operations





Operating
Results for the Year Ended December 31, 2008 as compared to 2007





Revenue. We earned $25,000 in
contract revenue for the year ended December 31, 2008 as compared to $287,000
for the year ended December 31, 2007.  Revenue generated in 2008 was
earned through material transfer agreements with our clients, and revenue
generated in 2007 was earned primarily through contract and licensing
agreements.


21


Research and Development
Expenses. Research and development expenses for the year ended December
31, 2008 were approximately $1,257,000, compared to $2,503,000 for 2007. The
decline from 2007 resulted from our inability to raise additional capital, and
the closing of our laboratory and administrative facility, and the subsequent
sub-contracting of the laboratory function in 2008.  We expect our
research and development expenses will increase in the future only to the extent
that additional capital is obtained or future collaborative development and
licensing agreements are secured.





Selling, General and Administrative
Expenses. Selling, general and administrative expenses for the year ended
December 31, 2008 were approximately $1,040,000, as compared to $809,000 for
2007.  The increase from 2007 was due to the reallocation of certain
expenses previously associated with our research and development
efforts.  To the extent possible, we continue to concentrate on
controlling costs in this area. We expect our selling, general and
administrative expenses will increase in the future only to the extent that
additional capital is obtained or future collaborative development and licensing
agreements are secured.





The
following discusses items which were incurred in each year that are
non-recurring or of particular significance. During 2007 we made significant
changes in the operating structure of the Company in order to reduce non-core
functions and focus our efforts on basic revenue and scientific results. During
2008, we continued to make significant reductions in operations and focus our
attention on methods of producing revenue from the numerous patents, trade
secrets and other proprietary techniques we have developed over the life of the
Company.





Interest
Expense.  Interest expense increased from $442,000 in 2007 to
$710,000 in 2008. This increase was the direct result of interest accruals on
the debt financing loans during 2007 and 2008 from a shareholder (described in
Liquidity and Capital Resources below) to sustain our operations.





Operating
Losses. For the year ended
December 31, 2008, we recorded a net loss applicable to common shareholders of
$3,147,000 or $0.03 per share, as compared to a loss of $3,538,000 or $0.05 per
share for 2007. The differences in the net losses are as discussed in detail
previously. The weighted average number of shares outstanding increased by
approximately 29,093,000 due to the net effect of the share repurchase in the
fourth quarter of 2008 and the issuance of additional shares during 2008 in
connection with new equity funding used  to sustain operations.





Liquidity
and Capital Resources





As of
December 31, 2008, we had cash and cash equivalents totaling approximately
$1,300, as compared to $22,000 at December 31, 2007. As of December 31, 2008, we
had a working capital deficit of approximately $8,870,000 compared to a working
capital deficit of $7,862,000 at December 31, 2007.





We do not have any off balance sheet
financing activities and do not have any special purpose entities. We had no
long-term capital lease obligations as of December 31, 2008 or December 31,
2007. For the years ended December 31, 2008 and December 31, 2007, we did not
have any cash expenditures for capital equipment and leasehold
improvements.  We do not anticipate significant expenditures for
capital equipment or leasehold improvements for 2009.





We
believe our existing available cash, cash equivalents, and accounts receivable,
in combination with anticipated contract research payments and revenues received
from the transfer of clinical testing materials, will not be sufficient to meet
our anticipated capital requirements during 2009. Substantial additional capital
resources are required to fund continuing expenditures related to our operating,
research, development, manufacturing and business development activities. As
discussed in Note 6 to the financial statements, the Company entered into a
common stock purchase agreement (hereafter “SPA”) in September 2007 and has
raised $2,357,500 as of June 30, 2009, as a result of that SPA.  Pursuant
to the SPA, which has been our main source of external financing since September
2007, the investors purchase shares of our common stock at the closing price of
the stock on the day the investment is made. In addition, we issued a five-year
warrant to each investor to purchase the same number of shares as those
purchased by such investor at 110% of the price at which the shares are
purchased.  As of November 28, 2007, the SPA was amended so that
warrants issued on and after that date are exercisable at 100% of the price at
which the shares are purchased.  We have also granted the investors
demand and piggy-back registration rights covering the shares purchased and the
sharers issuable upon exercise of the warrants.


22


Prior to
the SPA, required funding was provided to us through a note payable agreement
(known as the Szulik Loan) by Matthew Szulik, one of our stockholders. This loan
was outlined in previous filings and is further described in Note 5 to the
financial statements. As with the Escrow Agreement relating to the Szulik Loan,
the Stock Purchase Agreement provides that TAG Virgin Islands, Inc. (hereafter
“TAG”), as agent for the equity investors, will advise the Board as to which of
the Company’s expenses will be paid with the funds invested by these
investors.





On
January 9, 2008, we replaced the Szulik Loan by issuing to Mr. Szulik a new note
in the principal amount of $6,415,000.  This amount included the then
$5,876,000 outstanding principal balance plus the then outstanding $539,000 in
accrued interest on the old note.  The new note bears annual interest
at the rate 8%, the same as did the old note, matures on September 1, 2008 and
is secured in the same manner as was the old note.  On September 1,
2008, the scheduled maturity date of the 1/09/08 Note was extended to March 31,
2009, and on March 31, 2009, the scheduled maturity date was extended to
September 30, 2009.  As consideration for Mr. Szulik agreeing to
accept the new note, we issued him three-year warrants to purchase an aggregate
of 2,438,000 shares of our common stock at $0.061 per share and lowered the
exercise price of warrants to purchase 500,000 shares of our common stock that
we had previously issued to him from $0.30 per share to $0.061 per
share.





Between
October 2, 2008 and June 5, 2009, the Company received proceeds of $645,000 as
loans from clients of TAG.  These loans are represented by unsecured
notes issued by the Company.  These notes are due one year after
issuance and bear an annual interest rate of 8%.  The interest and
principal are payable on the maturity dates, either in cash or common stock, at
the discretion of the Company, at rates ranging from $0.02 to $0.05 per
share.  As consideration for the loans, the Company granted warrants
to the noteholders to purchase an aggregate of 25,423,077 shares of the
Company’s common stock at exercise prices ranging from $0.02 to $0.05 per
share.





TAG is a
registered investment advisor and advises a number of our stockholders,
including certain members of our Board of Directors, in investment decisions,
including decisions about whether to invest in our stock.  Based upon
our stock records and data supplied to us by our stockholders, we believe that
clients of TAG beneficially own approximately 67.8% of our common stock as of
June 30, 2009.  TAG has discretionary authority to vote or dispose of
the shares of our common stock held in its client accounts and, therefore, may
be deemed to be the beneficial owner of such shares in accordance with the
Commission's Rules.  TAG has informed us that James Tagliaferri is the
natural person at TAG with such discretionary authority.  TAG
expressly disclaims beneficial ownership of any shares owned by its
clients.




As noted
above, we believe our existing available cash as of December 31, 2008 will not
be sufficient to meet our anticipated capital requirements during
2009.  We are unable to pay certain vendors in a timely manner and
remain over 90 days past due with certain critical vendors, such as outside
laboratories and law firms. Additionally, we are currently outsourcing
administrative and accounting functions as a result of cutbacks necessitated by
insufficient monetary resources. We are attempting to remedy this problem. Our
ability to continue operating is dependent on the receipt of additional funding
and substantial additional capital resources will be required to fund continuing
expenditures related to our research, development, manufacturing and business
development activities. If adequate funds are not available, we will be required
to significantly curtail our operating plans and most likely cease operations.
We are still in discussions with other potential financing sources and
collaborative partners, and are seeking additional funding in the form of equity
investments, license fees, loans, milestone payments or research and development
payments. We cannot assure that any of these other sources of funding will be
consummated in the timeframes needed for continuing operations or on terms
favorable to us, if at all.





Inflation





To date,
we believe that inflation and changing prices have not had a material impact on
our continuing operations. However, we have experienced increased general and
product liability insurance costs over the past two years, and these increases
are expected to continue for the foreseeable future.


23


Use
of Estimates and Critical Accounting Policies





We have
identified the policies below as critical to our business operations and to
understanding our results of operations. Our accounting policies are more fully
described in our financial statements and related notes located in “Item 8.
Financial Statements and Supplementary Data.”





The
preparation of our financial statements requires management to make estimates
and assumptions that affect reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. On an ongoing basis, management evaluates its estimates and
assumptions. Management bases its estimates and judgments on historical
experience of operations and on various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.





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





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





Impairment of
Long Lived Assets.Long-lived assets and certain identifiable intangibles
are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable. If the fair value is less than
the carrying amount of the asset, a loss is recognized for the difference. Fair
value is determined based on market quotes, if available, or is based on
valuation techniques.





Cost-Method
Investment.The investment balance at December 31, 2008 and 2007
represents shares of common stock owned by the Company in a privately held
company which were acquired pursuant to a license agreement.  Based on
the Company’s limited ownership percentage, the investment is reported using the
cost method.  Under the cost method, the Company does not record its
proportional share of earnings and losses of the investee, and income on the
investment is only recorded to the extent of dividends distributed from earnings
of the investee received subsequent to the date of acquisition.





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


24


When an
impairment test demonstrates that the fair value of an investment is less than
its cost, Company management will determine whether the impairment is either
temporary or other-than-temporary.  Examples of factors which may be
indicative of an other-than-temporary impairment include i) the length of time
and extent to which market value has been less than cost, ii) the financial
condition and near-term prospects of the issuer, iii) and the intent and ability
of the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in market value.





If the
decline in fair value is determined by management to be other-than-temporary,
the cost basis of the investment is written down to its estimated fair value as
of the balance sheet date of the reporting period which the assessment is made.
This fair value becomes the investment’s new cost basis, which is not changed
for subsequent recoveries in fair value.  Any recorded impairment
write-down will be included in earnings as a realized loss in the period such
write-down occurs





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





Excluded
from diluted loss per common share as of December 31, 2008 and 2007 were
5,847,656 and 41,214,734 shares, respectively, issuable upon conversion of
convertible preferred stock, and options and warrants to purchase 66,753,814 and
33,268,706 shares of common stock, respectively, because the effect of the
inclusion of these shares would be anti-dilutive.  For purposes of this
calculation, net loss in 2008 and 2007 has been adjusted for imputed,
accumulated and/or paid dividends on the preferred stock.





Income Taxes.In determining the carrying value of our net deferred tax assets, we must
assess the likelihood of sufficient future taxable income in certain tax
jurisdictions, based on estimates and assumptions, to realize the benefit of
these assets. If these estimates and assumptions change in the future, we may
record a reduction in the valuation allowance, resulting in an income tax
benefit in our Statements of Operations. Management evaluates the realizability
of the deferred tax assets and assesses the valuation allowance
quarterly.





Effective
January 1, 2007, we adopted the provisions of Financial Accounting Standards
Board (“FASB”) Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in
Income Taxes - an interpretation of FASB Statement No. 109. The implementation
of FIN 48 had no impact on our financial statements.





We are
primarily subject to U.S. federal and state income tax. Tax years subsequent to
December 31, 2003 remain open to examination by U.S. federal and state tax
authorities. In addition, our policy is to recognize interest and penalties
related to income tax matters in income tax expense. As of December 31, 2008, we
had no accruals for interest or penalties related to income tax
matters.





Recent
Accounting Pronouncements





A number
of new pronouncements have been issued for future implementation as discussed in
the notes to our financial statements located in “Item 8. Financial Statements
and Supplementary Data.” See page F-10 of our consolidated financial statements
for further discussion





Item 7A.
              Quantitative and Qualitative
      Disclosures about Market
Risk





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





25


Item
      8.
              Financial
      Statements and Supplementary
Data


Filed
herewith are the following Audited Financial Statements for Protein Polymer
Technologies, Inc.




Description
                      
                      PageReport
      of Independent Registered Public Accounting Firm
                      
                      F-2Balance
      Sheets at December 31, 2008 and 2007
                      
                      F-3Statements
      of Operations for the years ended December 31, 2008 and
    2007
                      
                      F-4Statements
      of Stockholders’ Deficit for the years ended December 31, 2008 and
      2007
                      
                      F-5Statements
      of Cash Flows for the years ended December 31, 2008 and
    2007
                      
                      F-6Notes
      to Financial Statements
                      
                      F-7


F-1





REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Stockholders


Protein
Polymer Technologies, Inc.





We have
audited the accompanying balance sheets of Protein Polymer Technologies,
Inc.  as of December 31, 2008 and 2007, and the related statements of
operations, stockholders’ deficit, and cash flows for the years then ended.
These financial statements are the responsibility of the Company’s management.
Our responsibility is to express an opinion on the financial statements based on
our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company was not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that were
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the financial statements. 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.
as of December 31, 2008 and 2007, and the results of their operations and their
cash flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of America.





The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has minimal cash balances and a significant working
capital deficit as of December 31, 2008, and has incurred significant recurring
net losses through December 31, 2008. These factors raise substantial doubt
about the Company’s ability to continue as a going concern. Management’s plans
as to these matters are described in Note 1. The accompanying financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.





/s/
      SQUAR, MILNER, PETERSON, MIRANDA & WILLIAMSON, LLPSan
      Diego, CaliforniaJuly
      24, 2009


F-2


Protein
Polymer Technologies, Inc.


Balance
Sheets





December
      31,2008
                  
                  
                  2007AssetsCurrent
      assets:Cash
                  
                  $
                  1,291
                  
                  
                  $
                  21,936Prepaid
      expenses and other current assets
                  
                  
                  35,011
                  
                  
                  
                  33,419Total
      current assets
                  
                  
                  36,302
                  
                  
                  
                  55,355Deposits
                  
                  
                  29,679
                  
                  
                  
                  29,679Equipment
      and leasehold improvements, net
                  
                  
                  24,429
                  
                  
                  
                  128,100Investment
                  
                  
                  520,000
                  
                  
                  
                  520,000Total
      assets
                  
                  $
                  610,410
                  
                  
                  $
                  733,134Liabilities
      and stockholders' deficitCurrent
      liabilities:Accounts
      payable
                  
                  $
                  969,435
                  
                  
                  $
                  827,626Accrued
      liabilities
                  
                  
                  844,073
                  
                  
                  
                  794,312Secured
      note payable - related party
                  
                  
                  6,414,837
                  
                  
                  
                  5,876,000Notes
      payable – Surgica
                  
                  
                  519,071
                  
                  
                  
                  419,071Notes
      payable – other, net of unamortized debt discount
                  
                  
                  158,589
                  
                  
                  
                  -Total
      current liabilities
                  
                  
                  8,
      906,005
                  
                  
                  
                  7,917,009Notes
      payable, net of current maturities
                  
                  
                  -
                  
                  
                  
                  100,000Commitments
      and contingencies (Note 9)Stockholders'
      deficit:Convertible
      preferred stock, $0.01 par value; 5,000,000 shares authorized; 20,237 and
      65,645 shares issued and outstanding at December 31, 2008 and 2007 -
      liquidation preference of $2,082,930 and $9,464,500 at December 31, 2008
      and 2007, respectively.
                  
                  
                  1,834,299
                  
                  
                  
                  6,019,917Common
      stock, $0.01 par value; 1,000,000,000 authorized; 109,387,843 and
      73,722,232 shares issued and outstanding at December 31, 2008
      and 2007, respectively
                  
                  
                  1,093,878
                  
                  
                  
                  737,222Additional
      paid-in capital
                  
                  
                  61,982,390
                  
                  
                  
                  56,227,221Accumulated
      deficit
                  
                  
                  (73,206,162
                  )
                  
                  
                  (70,268,235
                  )Total
      stockholders' deficit
                  
                  
                  (8,295,595
                  )
                  
                  
                  (7,283,875
                  )Total
      liabilities and stockholders’ deficit
                  
                  $
                  610,410
                  
                  
                  $
                  733,134




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


F-3


Protein
Polymer Technologies, Inc.


Statements
of Operations





Years
      ended December 31,2008
                    
                    
                    2007Revenues:Contract
      revenue
                    
                    $
                    24,868
                    
                    
                    $
                    287,118Total
      revenues
                    
                    
                    24,868
                    
                    
                    
                    287,118Operating
      Expenses:Research
      and development
                    
                    
                    1,256,662
                    
                    
                    
                    2,503,035Selling,
      general and administrative
                    
                    
                    1,040,363
                    
                    
                    
                    809,446Total
      expenses
                    
                    
                    2,297,025
                    
                    
                    
                    3,312,481Loss
      from operations
                    
                    
                    (2,272,157
                    )
                    
                    
                    (3,025,363
                    )Other
      expense:Interest
      and other income
                    
                    
                    3,413
                    
                    
                    
                    21,513Interest
      expense
                    
                    
                    (709,829
                    )
                    
                    
                    (442,235
                    )Gain
      from sale of assets
                    
                    
                    40,646
                    
                    
                    
                    -Gain
      on settlement of accounts payable
                    
                    
                    -
                    
                    
                    
                    193,917Total
      other expense
                    
                    
                    (665,770
                    )
                    
                    
                    (226,805
                    )Net
      loss
                    
                    
                    (2,937,927
                    )
                    
                    
                    (3,252,168
                    )Undeclared
      and imputed and/or paid dividends on preferred stock
                    
                    
                    208,973
                    
                    
                    
                    285,976Net
      loss applicable to common shareholders
                    
                    $
                    (3,146,900
                    )
                    
                    $
                    (3,538,144
                    )Basic
      and diluted net loss per common share
                    
                    $
                    (0.03
                    )
                    
                    $
                    (0.05
                    )Shares
      used in computing basic and diluted net loss per common
    share
                    
                    
                    97,409,563
                    
                    
                    
                    68,316,641




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


F-4


Protein
Polymer Technologies, Inc.


Statements
of Stockholders' Deficit




Additional
                    
                    
                    
                    
                    
                    TotalCommon Stock
                    
                    
                    Preferred Stock
                    
                    
                    Paid-in
                    
                    
                    Accumulated
                    
                    
                    Stockholders'Shares
                    
                    
                    Amount
                    
                    
                    Shares
                    
                    
                    Amount
                    
                    
                    Capital
                    
                    
                    Deficit
                    
                    
                    DeficitBalance
      at December 31, 2006
                    
                    
                    67,409,204
                    
                    
                    
                    674,092
                    
                    
                    
                    65,645
                    
                    
                    
                    6,019,917
                    
                    
                    
                    55,760,511
                    
                    
                    
                    (67,007,742
                    )
                    
                    
                    (4,553,222
                    )Share
      based compensation expense
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (109,552
                    )
                    
                    
                    –
                    
                    
                    
                    (109,552
                    )Imputed
      dividend on extension of warrant
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    8,325
                    
                    
                    
                    (8,325
                    )
                    
                    
                    –Issuance
      of common stock for dispute settlement
                    
                    
                    400,000
                    
                    
                    
                    4,000
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    57,067
                    
                    
                    
                    –
                    
                    
                    
                    61,067Issuance
      of common stock pursuant to stock purchase agreement
                    
                    
                    5,913,028
                    
                    
                    
                    59,130
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    510,870
                    
                    
                    
                    –
                    
                    
                    
                    570,000Net
      loss
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (3,252,168
                    )
                    
                    
                    (3,252,168
                    )Balance
      at December 31, 2007
                    
                    
                    73,722,232
                    
                    
                    $
                    737,222
                    
                    
                    
                    65,645
                    
                    
                    $
                    6,019,917
                    
                    
                    $
                    56,227,221
                    
                    
                    $
                    (70,268,235
                    )
                    
                    $
                    (7,283,875
                    )Share
      based compensation expense
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    4,255
                    
                    
                    
                    –
                    
                    
                    
                    4,255Imputed
      dividend on extension of warrant
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    18,231
                    
                    
                    
                    –
                    
                    
                    
                    18,231Debt
      discount for warrants issued
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    196,221
                    
                    
                    
                    –
                    
                    
                    
                    196,221Issuance
      of common stock pursuant to stock purchase agreement
                    
                    
                    36,586,091
                    
                    
                    
                    365,861
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    1,346,639
                    
                    
                    
                    –
                    
                    
                    
                    1,712,500Stock
      repurchase
                    
                    
                    (920,480
                    )
                    
                    
                    (9,205
                    )
                    
                    
                    (45,408
                    )
                    
                    
                    (4,185,618
                    )
                    
                    
                    4,189,823
                    
                    
                    
                    –
                    
                    
                    
                    (5,000
                    )Net
      loss
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (2,937,927
                    )
                    
                    
                    (2,937,927
                    )Balance
      at December 31, 2008
                    
                    
                    109,387,843
                    
                    
                    $
                    1,093,878
                    
                    
                    
                    20,237
                    
                    
                    $
                    1,834,299
                    
                    
                    $
                    61,982,390
                    
                    
                    $
                    (73,206,162
                    )
                    
                    $
                    (8,295,595
                    )




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


F-5


Protein
Polymer Technologies, Inc.


Statements
of Cash Flows





Years
      ended December 31,2008
                  
                  
                  2007Operating
      activitiesNet
      loss
                  
                  $
                  (2,937,927
                  )
                  
                  $
                  (3,252,168
                  )Adjustments
      to reconcile net loss to net cash used for operating
      activities:Gain
      on sale of assets
                  
                  
                  (40,646
                  )
                  
                  
                  -Gain
      on settlement of accounts payable
                  
                  
                  -
                  
                  
                  
                  (193,917
                  )Depreciation
      and amortization
                  
                  
                  43,317
                  
                  
                  
                  100,375Debt
      discount amortization
                  
                  
                  143,041
                  
                  
                  
                  -Share-based
      compensation expense
                  
                  
                  4,255
                  
                  
                  
                  (109,552
                  )Other
      income
                  
                  
                  -
                  
                  
                  
                  (21,368
                  )Changes
      in operating assets and liabilities:Contracts
      receivable
                  
                  
                  -
                  
                  
                  
                  21,068Rent
      receivable
                  
                  
                  -
                  
                  
                  
                  39,527Prepaid
      expenses and other current assets
                  
                  
                  (1,593
                  )
                  
                  
                  16,521Accounts
      payable
                  
                  
                  141,809
                  
                  
                  
                  (210,127
                  )Accrued
      liabilities
                  
                  
                  588,599
                  
                  
                  
                  578,047Deferred
      rent
                  
                  
                  -
                  
                  
                  
                  (4,449
                  )Net
      cash used for operating activities
                  
                  
                  (2,059,145
                  )
                  
                  
                  (3,036,043
                  )Investing
      activitiesProceeds
      from sale of equipment
                  
                  
                  101,000
                  
                  
                  
                  -Net
      cash provided by investing activities
                  
                  
                  101,000
                  
                  
                  
                  -Financing
      activitiesNet
      proceeds from sale of common stock
                  
                  
                  1,712,500
                  
                  
                  
                  -Repurchase
      of common and preferred stock
                  
                  
                  (5,000
                  )
                  
                  
                  -Net
      proceeds from subscriptions to purchase common stock
                  
                  
                  -
                  
                  
                  
                  570,000Proceeds
      from issuance of debt - related party
                  
                  
                  -
                  
                  
                  
                  2,414,484Proceeds
      from issuance of notes payable
                  
                  
                  230,000
                  
                  
                  
                  -Net
      cash provided by financing activities
                  
                  
                  1,937,500
                  
                  
                  
                  2,984,484Net
      decrease in cash
                  
                  
                  (20,645
                  )
                  
                  
                  (51,559
                  )Cash
      at beginning of the period
                  
                  
                  21,936
                  
                  
                  
                  73,495Cash
      at end of the period
                  
                  $
                  1,291
                  
                  
                  $
                  21,936Supplemental
      disclosures of cash flow informationInterest
      paid
                  
                  $
                  2,703
                  
                  
                  $
                  5,263Non
      cash investing and financing activityImputed
      dividend on extension of warrants
                  
                  $
                  18,231
                  
                  
                  $
                  8,325Debt
      discount recorded related to warrants issued in connection with notes
      payable - other
                  
                  $
                  79,000
                  
                  
                  $
                  -Debt
      discount recorded related to warrants issued in connection with extension
      of tern of secured note payable – related party
                  
                  $
                  135,000
                  
                  
                  $
                  -Reclassification
      of accrued interest to secured note payable – related
party
                  
                  $
                  538,837
                  
                  
                  $
                  -




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


F-6


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements





1.
              Organization
      and Significant Accounting
Policies




Organization
and business activities





Protein
Polymer Technologies, Inc. (the “Company”) is a biotechnology company focused on
the design, clinical development, and commercialization of genetically
engineered protein polymers for a variety of biomedical and specialty materials
applications. The Company was incorporated in Delaware on July 6,
1988.





Going
Concern and Liquidity





The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. For the year ended December 31, 2008, the
Company incurred net losses and negative cash flows from operating activities of
approximately $2,938,000 and $2,059,000, respectively, and at December 31, 2008,
the Company had a working capital deficit of approximately $8,870,000 and an
accumulated deficit of approximately $73,206,000. Our cash balance as of
December 31, 2008 was approximately $1,300 and, in combination with anticipated
additional contract, license, and material transfer payments, are insufficient
to meet our on-going capital requirements.





Between
April 2006 and September 2007, the Company relied primarily on borrowings
pursuant to a note payable from a related party for capital needed to fund its
operations and working capital requirements (see Note 5). The maturity of the
note reflecting these borrowings, for which the outstanding principal balance at
December 31, 2008 was approximately $6,415,000, is September 30, 2009. There is
no assurance this maturity date will be extended if required by the Company. As
of the end of December 2008, additional borrowings under the Company’s existing
debt financing provided by a related party are unavailable and the lender
continues to hold essentially all of the Company’s assets as
collateral.





Since
September 27, 2007, required operating capital has been obtained primarily
through proceeds totaling $2,357,500 as of June 30, 2009 from sales of common
stock and warrants pursuant to a Stock Purchase Agreement entered into on that
date.  During the year ended December 31, 2008 and the period ended
June 30, 2009, operating capital obtained from the Stock Purchase Agreement
totaled $1,712,500 and $75,000, respectively.  Additionally, during
the period from October 2, 2008 and December 31, 2008 and the subsequent period
ended June 30, 2009, the Company received proceeds of $230,000 and $415,000,
respectively, as unsecured loans from clients of TAG Virgin Islands, Inc.
(hereafter “TAG”).  There is no assurance that additional capital
required to continue to fund operations will be available under these
agreements. See Notes 6 and 12.





Management
believes that additional required funding during 2009 may be available through
either the September 27, 2007 Stock Purchase Agreement or through additional
unsecured loans from clients of TAG.  In addition, Management is
currently in discussions with other potential financing sources and
collaborative partners and is investigating other sources of funding in the form
of equity investments and license fees.  However, no assurances can be
given that the Company will receive additional funding from any of these sources
required to meet its liquidity needs for 2009.  If adequate funds are
not available, the Company will be required to significantly curtail operations,
sell or license out significant portions of its technology, or possibly cease
operations.  The financial statements do not include any adjustments
that might result should the Company be unable to continue as a going
concern.





Cash





The
Company’s cash balances are maintained in checking accounts with a
bank.  As of December 31, 2008 and 2007, there were no cash
equivalents.


F-7


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





Equipment
and Leasehold Improvements





Equipment
and leasehold improvements are stated at cost, less accumulated depreciation and
amortization. Equipment is depreciated over the estimated useful life of the
asset, typically three to seven years, using the straight-line method. Leasehold
improvements are amortized over the shorter of the lease term or the estimated
useful life of the asset.





Impairment
of Long-Lived Assets





Long-lived
assets and certain identifiable intangibles are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount may not be
recoverable. If the fair value is less than the carrying amount of the asset, a
loss is recognized for the difference.





Revenue
and Expense Recognition





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





Stock-Based
Compensation





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





Under the
modified prospective approach, SFAS No. 123R applies to new awards and to awards
that were outstanding on January 1, 2006 that are subsequently modified,
repurchased or cancelled. Under the modified prospective approach, compensation
cost recognized during the years ended December 31, 2008 and 2007,, includes
compensation cost for all share-based payments granted prior to, but not yet
vested on, January 1, 2006, based on the grant-date fair value estimated in
accordance with the pro forma provisions of SFAS No. 123R, and compensation cost
for all share-based payments granted subsequent to January 1, 2006, based on the
grant-date fair value estimated in accordance with the provisions of SFAS No.
123R. Periods prior to January 1, 2006 were not restated to reflect the impact
of adopting the new standard.


F-8


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





Fair
Value Measurement





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





Cost
Method Investment





The
investment balance at December 31, 2008 and 2007 represents shares of common
stock owned by the Company in a privately held company which were acquired
pursuant to a license agreement.  Based on the Company’s limited
ownership percentage, the investment is reported using the cost method. 
Under the cost method, the Company does not record its proportional share of
earnings and losses of the investee, and income on the investment is only
recorded to the extent of dividends distributed from earnings of the investee
received subsequent to the date of acquisition.





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





When an
impairment test demonstrates that the fair value of an investment is less than
its cost, Company management will determine whether the impairment is either
temporary or other-than-temporary.  Examples of factors which may be
indicative of an other-than-temporary impairment include i) the length of time
and extent to which market value has been less than cost, ii) the financial
condition and near-term prospects of the issuer, iii) and the intent and ability
of the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in market value.





If the
decline in fair value is determined by management to be other-than-temporary,
the cost basis of the investment is written down to its estimated fair value as
of the balance sheet date of the reporting period which the assessment is made.
This fair value becomes the investment’s new cost basis, which is not changed
for subsequent recoveries in fair value.  Any recorded impairment
write-down will be included in earnings as a realized loss in the period such
write-down occurs.





Net
Loss per Common Share





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





Excluded
from diluted loss per common share as of December 31, 2008 and 2007 were
5,847,656 and 41,214,734 shares, respectively, issuable upon conversion of
convertible preferred stock, and options and warrants to purchase 69,753,814 and
33,268,706 shares of common stock, respectively, because the effect of the
inclusion of these shares would be anti-dilutive.  For purposes of this
calculation, net loss in 2008 and 2007 has been adjusted for imputed,
accumulated and/or paid dividends on the preferred stock.





Use
of Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, 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.


F-9


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





Revenue
Concentration





During
the year ended December 31, 2008, the Company had material transfer agreements
with two customers that accounted for 75% and 11% of contract
revenue.  During the year ended December 31, 2007, the Company had
material contract research agreements with four customers that accounted for
35%; 24%; 17%; and 16% of the contract revenues,
respectively.





Income
Taxes





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





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





Reclassification





Certain
reclassifications have been made to the financial statements of the prior year
in order to conform to the current year presentation. These reclassifications
had no effect on previously reported results of operations or accumulated
deficit.





Recently Issued Accounting
Pronouncements





In
September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 157, Fair Value
Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value,
establishes a framework for measuring fair value, and expands disclosures about
fair value measurements. This Statement focuses on creating consistency and
comparability in fair value measurements. SFAS No. 157 is effective with
respect to financial assets and liabilities for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years.  For
non-financial assets and liabilities, the effective date of SFAS No. 157 has
been deferred until fiscal years beginning after November 15,
2008.  Our adoption of SFAS No. 157 with respect to financial assets
and liabilities on January 1, 2008 did not have a material affect on our
financial statements.  The Company is required to adopt SFAS No. 157
with respect to non-financial assets and liabilities no later than January 1,
2009. The Company does not believe that the adoption of SFAS No. 157 with
respect to non-financial assets and liabilities will have a material impact on
its financial position, results of operations or cash flows.


F-10


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





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





In
October 2008, the FASB issued FSP SFAS No. 157-3, Determining the Fair Value of a
Financial Asset When The Market for That Asset Is Not Active (“FSP
157-3”), to clarify the application of the provisions of SFAS 157 and how an
entity would determine fair value in an inactive market. FSP 157-3 is effective
immediately and applies to the Company’s December 31, 2008 financial statements.
The application of the provisions of FSP 157-3 did not materially impact the
Company’s consolidated financial position, results of operations and cash flows
as of and for the period ended December 31, 2008.





In
December 2007, the FASB issued Emerging Issues Task Force (“EITF”) Issue No.
07-1, Accounting for Collaborative Arrangements, (“EITF 07-1”), which is
effective for fiscal years beginning after December 15, 2008.  EITF
07-1 defines collaborative arrangements and establishes reporting requirements
for transactions between participants in a collaborative arrangement and between
participants in the arrangement and third parties.  EITF 07-1 also
establishes the appropriate income statement presentation and classification for
joint operating activities and payments between participants, as well as the
sufficiency of the disclosures related to these arrangements.  EITF No
07-1 is effective for the Company on January 1, 2009. The Company has not yet
determined the impact that EITF No. 07-1 may have on our financial position,
results of operations, or cash flows.





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





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


F-11


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





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





In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment of FASB Statement No.
133 (“SFAS No. 161”), as amended and interpreted, which requires
enhanced disclosures about an entity’s derivative and hedging activities and
thereby improves the transparency of financial reporting. Disclosing the fair
values of derivative instruments and their gains and losses in a tabular format
provides a more complete picture of the location in an entity’s financial
statements of both the derivative positions existing at period end and the
effect of using derivatives during the reporting period. Entities are required
to provide enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under Statement 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows. SFAS No. 161 is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008. Early adoption is permitted.  SFAS No. 161 is
effective for the Company on January 1, 2009. The Company does not believe that
its adoption of SFAS No. 161 will have a material impact on its financial
position, results of operations or cash flows.





In April
2008, the FASB issued FASB Staff Position (“FSP”) FAS No. 142-3, Determination of Useful Life of
Intangible Assets (“FSP FAS 142-3”). FSP FAS No. 142-3 amends the factors
that should be considered in developing the renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under SFAS
No. 142, “Goodwill and Other Intangible Assets.” FSP FAS No. 142-3 also requires
expanded disclosure related to the determination of intangible asset useful
lives. FSP FAS No. 142-3 is effective for fiscal years beginning after December
15, 2008. FSP FAS No. 142-3 is effective for the Company on January 1, 2009. The
Company does not believe that its adoption of FSP FAS No. 142-3 will have a
material impact on its financial position, results of operations or cash
flows.





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





In May
2008, the FASB issued FSP Accounting Principles Board Opinion (“APB”) No. 14-1,
Accounting for Convertible
Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial
Cash Settlement) (“FSP APB 14-1”), which requires the issuer of certain
convertible debt instruments that may be settled in cash (or other assets) on
conversion to separately account for the liability (debt) and equity (conversion
option) components of the instrument in a manner that reflects the issuer’s
nonconvertible debt borrowing rate. FSP APB 14-1 will be effective for the
Company on January 1, 2009 and will require retroactive disclosure. FSP APB 14-1
is effective for the Company on January 1, 2009. The Company has not yet
determined the impact FSP APB 14-1 may have on its financial position, results
of operations or cash flows.


F-12





Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





In May
2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee
Insurance Contracts—an interpretation of FASB Statement No. 60 (“SFAS No.
163”), which requires recognition of an insurance claim liability prior to an
event of default when there is evidence that credit deterioration has occurred
in an insured financial obligation.  SFAS No. 163 is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and all interim periods within those fiscal years. SFAS No. 163 is effective for
the Company on January 1, 2009. The Company does not believe its adoption on
SFAS No. 163 will have a material impact on its financial position, results of
operations or cash flows.





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





In June
2008, the FASB ratified the consensus reached on EITF Issue No. 07-5,
Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity's Own Stock ("EITF No. 07-5").  EITF No. 07-5 clarifies the
determination of whether an instrument (or an embedded feature) is indexed to an
entity's own stock, which would qualify as a scope exception under SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. EITF No. 07-5 is
effective for financial statements issued for fiscal years beginning after
December 15, 2008. EITF No. 07-5 is effective for the Company on January 1,
2009. The Company has not yet determined the impact EITF No. 07-5 may have on
its financial position, results of operations or cash flows.





In
November 2008, the FASB ratified EITF Issue No. 08-6, Equity Method Investment Accounting
Considerations(EITF No. 08-6), which is effective for financial
statements issued for fiscal years beginning after December 15, 2008. EITF No.
08-6 applies to all investments accounted for under the equity method and
clarifies the accounting for certain transactions and impairment considerations
involving equity method investments. EITF 08-6 is effective for the Company on
January 1, 2009. The Company does not believe its adoption of EITF 08-6 will
have a material impact on its financial position, results of operations, and
cash flows.





In
November 2008, the FASB ratified EITF Issue No. 08-7, Accounting for Defensive Intangible
Assets (EITF No. 08-7), which is effective for intangible assets acquired
by the Company on or after January 1, 2009.  EITF No. 08-7 applies to
defensive intangible assets, which are acquired intangible assets that an entity
does not intend to actively use but does intend to prevent others from obtaining
access to the asset. EITF No. 08-7 requires an entity to account for defensive
intangible assets as a separate unit of accounting. Defensive intangible assets
should not be included as part of the cost of an entity’s existing intangible
assets because the defensive intangible assets are separately identifiable.
Defensive intangible assets must be recognized at fair value in accordance with
SFAS No. 141(R) and SFAS No. 157. The Company does not believe that the adoption
of EITF 08-7 will have a material impact on its financial position, results of
operations, and cash flows.





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


F-13


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





2.
              Equipment
      and Leasehold Improvements





Equipment
and leasehold improvements consist approximately of the following:




December
      31,2008
                    
                    
                    2007Laboratory
      equipment
                    
                    $
                    298,000
                    
                    
                    $
                    1,378,000Office
      equipment
                    
                    
                    60,000
                    
                    
                    
                    220,000Leasehold
      improvements
                    
                    
                    -
                    
                    
                    
                    360,000358,000
                    
                    
                    
                    1,958,000Less
      accumulated depreciation and amortization
                    
                    
                    (334,000
                    )
                    
                    
                    (1,830,000
                    )$
                    24,000
                    
                    
                    $
                    128,000




Proceeds
and gains from the sale of equipment were approximately $101,000 and $41,000,
respectively, during 2008.  The Company did not sell any equipment in
2007.





Depreciation
and amortization expense was approximately $43,000 and $100,000 for the years
ended December 2008 and 2007, respectively.





3.
              Investment




The
investment included on our balance sheets at December 31, 2008 and 2007
represents our cost basis in shares of common stock of Spine Wave, Inc. (“Spine
Wave”), a privately held company focused on the development and
commercialization of innovative products and technologies for the treatment of
spinal disorders, which we acquired between 2001 and 2006 in connection with our
licensing and development agreements with Spine Wave which we entered into in
2001.  Based on its limited ownership percentage, the Company accounts
for its investment in Spine Wave as a cost method investment.  As a
cost method investment, the Company does not record its proportional share of
the earnings or losses of Spine Wave, and income related to the investment would
be recognized only to the extent that dividends are distributed from earnings of
Spine Wave.  To date, no such dividends have been
received.





Based on
adverse changes in market values of companies in the medical device/equipment
industry during the second half of 2008, as evidenced by the steep declines in
stock market values of publicly traded companies in this sector and in the
overall stock market, the Company evaluated its investment in Spine Wave for
impairment as of December 31, 2008.  Since there are no quoted prices
of Spine Wave’s common stock, and since it was not practicable for the Company
to otherwise estimate the fair value of Spine Wave’s common stock at December
31, 2008, the Company was unable to quantify the specific amount of potential
impairment.  However, because the Company believes there may be
potential impairment, it completed an evaluation to determine if the potential
impairment was other-than-temporary.  This evaluation was based on a
number of factors including: i) the length of time and the extent to which the
market value has been less than the cost; ii) the financial condition and near
term prospects of Spine Wave: and iii) the Company’s intent and ability to
retain its investment in Spine Wave for a period of time sufficient to allow for
a recovery in market value.  In connection with this evaluation, the
Company determined that any potential impairment in its investment in Spine Wave
was primarily a function of the impact on the stock market and the medical
device/equipment sector of the deterioration of global economic conditions
during the second half of 2008, and that any potential impairment was not a
function of factors specifically relating to Spine Wave’s business or its near
term prospects.  Based on the Company's evaluation of Spine Wave’s
near term prospects (which the Company believes to be very strong), the partial
recovery of stock market values subsequent to December 31, 2008 and on
management's intention to hold the investment in Spine Wave for a sufficient
period of time to allow for a recovery in the market value, the Company
determined that any potential impairment was not other-than-temporary, and
accordingly, no impairment was recorded at December 31, 2008.





F-14





Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





As of
December 31, 2007 the Company was not aware of any indicators of impairment with
respect to its investment in Spine Wave, and it was not practicable for the
Company to estimate the fair value of this investment because of the lack of
quoted market prices and the inability to otherwise estimate fair value without
incurring excessive costs.  Management believed that the carrying
amount of its investment in Spine Wave was not impaired at December 31,
2007.





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




4.
              Accrued
      Liabilities




Accrued
liabilities consist approximately of the following:




December 31,2008
                      
                      
                      2007Payroll
      and employee benefits
                      
                      $
                      67,000
                      
                      
                      $
                      82,000Professional
      fees
                      
                      
                      -
                      
                      
                      
                      23,000Accrued
      interest
                      
                      
                      610,000
                      
                      
                      
                      585,000Insurance
      premium financing
                      
                      
                      27,000
                      
                      
                      
                      22,000Directors
      fees
                      
                      
                      100,000
                      
                      
                      
                      60,000Other
                      
                      
                      40,000
                      
                      
                      
                      22,000$
                      844,000
                      
                      
                      $
                      794,000




5.
              Secured
      Notes Payable – Related Party





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


F-15


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





Pursuant
to the terms of the Security Agreement, the Company entered into a patent
security agreement, an escrow agreement, a patent assignment, and a registration
rights agreement, each dated as of April 13, 2006. According to the terms of the
Security Agreement, the Company entered into the Escrow Agreement with an escrow
agent for the shareholder. The Escrow Agreement provides for the disbursement of
the funds held in escrow for application to Company expenses at the sole
discretion of the shareholder’s designee. The Escrow Agreement terminates upon
the event that the amount borrowed is paid in full and no event of default has
occurred.





As
consideration for the Loan, the Company granted a warrant to the shareholder to
purchase an aggregate of 500,000 shares of the Company’s common stock at an
exercise price of $0.30 per share. The shareholder’s counsel acts as the escrow
agent and now serves as our outside general counsel.





Effective
January 9, 2008, the Company replaced the 4/13/06 Note by issuing a new note
(the “1/09/08 Note”) in the principal amount of $6,415,000.  This
amount included the then $5,876,000 outstanding balance plus the then
outstanding $539,000 of accrued interest on the 4/13/06 Note.  The
1/09/08 Note bears annual interest at the rate 8%, the same as did the 4/13/06
Note, and matures on September 1, 2008.  The 1/09/08 Note is secured
in the same manner as was the 4/13/06 Note.  On September 1, 2008, the
scheduled maturity date of the 1/09/08 Note was extended to March 31,
2009.  On March 31, 2009, the scheduled maturity date of the 1/09/08
Note was further extended to September 30, 2009.  As of December 31,
2008, the amount due on the 1/09/08 Note includes the original $6,415,000
outstanding balance plus $500,000 of accrued interest.





As consideration for the lender
agreeing to accept the 1/09/08 Note as payment for the 4/13/06 Note, the Company
i) issued the lender three-year warrants to purchase an aggregate of 2,438,000
shares of the Company’s common stock at $0.061 per share, ii) lowered the
exercise price of the 4/13/06 Warrant from $0.30 per share to $0.061 per share,
and iii) extended the term of the 4/13/06 Warrant from April 30, 2009 to January
31, 2011.  See
Note 12.





The
relative fair value of the warrants issued in connection with the 1/09/08 Note,
estimated to be approximately $117,000, was recorded as debt discount. In
addition, the change in fair value of the 4/13/06 Warrant resulting from the
modification of the terms, estimated at $18,000, was also recorded as debt
discount. The fair value of these warrants was estimated on the date of grant
using the Black Scholes option valuation model with the following
assumptions:





April 2006
                    Issuance
                  
                  January 2008
                    Modification
                  
                  January 2008
                    Issuance4/13/06
                    Warrant
                  
                  4/13/06
                    Warrant
                  
                  1/09/08
                    WarrantExpected
      annual dividends
                  
                  
                  0
                  %
                  0
                  %
                  0
                  %Risk-free
      interest rate
                  
                  
                  4.9
                  %
                  3.0
                  %
                  2.7
                  %Expected
      term (in years)
                  
                  
                  3.0
                  
                  1.3
                  
                  3.1Expected
      Volatility
                  
                  
                  90.0
                  %
                  157.0
                  %
                  157.0
                  %





The total
debt discount recorded was amortized as interest expense over the original term
of the 1/09/08 Note using the effective interest method, and, as of December 31,
2008, the debt discount was fully amortized.


F-16


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





6.
              Notes
      Payable - Other




TAG
Client Notes





On the
following dates, the Company has received proceeds in the following amounts
pursuant to note payable agreements entered into with clients of
TAG:





Date
                          
                          AmountOctober
      2, 2008
                          
                          $
                          100,000November
      3, 2008
                          
                          
                          105,000December
      11, 2008
                          
                          
                          25,000Total
                          
                          $
                          230,000





These
loans are represented by unsecured notes issued by the Company.  These
notes have a maturity term of one year, and bear an annual interest rate of
8%.  The interest and principal are payable on the maturity
dates.  At the Company’s option, the principal and accrued interest
due at maturity may be paid in shares of its common stock based on a price per
share of $0.05 with respect to the October 2, 2008 note and $0.04 with respect
to the November 3, 2008 and December 11, 2008 notes.  As consideration
for the loans, the Company granted warrants to the noteholders to purchase
shares in the following aggregate amounts and exercise prices:





Date
                      
                      Amount
                      
                      
                      Exercise
                        PriceOctober
      2, 2008
                      
                      
                      2,000,000
                      
                      
                      $
                      0.05November
      3, 2008
                      
                      
                      2,625,000
                      
                      
                      
                      0.04December
      11, 2008
                      
                      
                      625,000
                      
                      
                      
                      0.04Total
                      
                      
                      5,250,000





TAG is a
registered investment advisor and advises a number of our stockholders,
including certain members of our Board of Directors, in investment decisions,
including decisions about whether to invest in our stock.  Based upon
our stock records and data supplied to us by our stockholders, we believe that
clients of TAG beneficially own approximately 67.8% of our common stock. TAG has
discretionary authority to vote or dispose of the shares of our common stock
held in its client accounts and, therefore, may be deemed to be the beneficial
owner of such shares in accordance with the Commission's Rules. TAG has informed
us that James Tagliaferri is the natural person at TAG with such discretionary
authority. TAG expressly disclaims beneficial ownership of any shares owned by
its clients.





The
relative fair values of the warrants issued in connection with these notes,
estimated to be approximately $79,100, were recorded as debt
discount.  The fair value of these warrants was estimated on the date
of grant using the Black-Scholes option valuation model with the following
assumptions:





10/02/08
                    Warrant
                  
                  
                  11/03/08
                    Warrant
                  
                  
                  12/11/08
                    WarrantExpected
      annual dividends
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %Risk-free
      interest rate
                  
                  
                  1.9
                  %
                  
                  
                  1.5
                  %
                  
                  
                  1.1
                  %Expected
      term (in years)
                  
                  
                  3.0
                  
                  
                  
                  3.0
                  
                  
                  
                  3.0Expected
      Volatility
                  
                  
                  111.9
                  %
                  
                  
                  63.7
                  %
                  
                  
                  56.7
                  %





The
carrying value of the notes payable - other at December 31, 2008, is comprised
of the following:





TotalPrincipal
      value of notes
                    
                    $
                    230,000Less:
      Unamortized debt discount
                    
                    
                    (71,400
                    )$
                    158,600


F-17


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





The total
debt discount recorded is being amortized as interest expense over the expected
term of the notes using the effective interest method.  During 2008,
the Company recorded non-cash interest expense of approximately $7,600 based on
the debt discount amortization of these warrants.





Surgica
Notes





In
December 2005, in connection with a license agreement with Surgica Corporation
for the rights to certain intellectual property, the Company assumed several
notes payable agreements with an aggregate principal balance of $519,000. The
notes bear interest at rates ranging from 6% to 10%, and were scheduled to
mature through January 2009 as shown below:





Year Ending
                          December 31,
                        
                        Notes Payable
                          Maturities2008
                        
                        419,0002009
                        
                        
                        100,000Total
      maturities
                        
                        $
                        519,000





In March
2007, the license agreement with Surgica was terminated.  On October
15, 2008, the noteholders instituted suit against the Company in Superior Court
of California, County of Sacramento seeking payment of these
notes.  The name of the case is Lou Matson, Mary Matson, and Don
Brandon v. Protein Polymer Technologies, Inc, Case Number
34-2008-00022190.  The Company defended this action, alleging, among
other things, that it had no liability for these notes.  Until a final
determination was made with respect to the disposition of the notes, the Company
continued to carry them on its balance sheet.  Accordingly, as of
December 31, 2008, the entire balance of the outstanding notes payable and
related accrued interest of $106,000 is reflected in the accompanying financial
statements as a current liability.  On May 19, 2009, the plaintiffs
filed a request for dismissal with prejudice of the action against the Company,
and the Company paid nothing to plaintiffs in exchange for the
dismissal.





7.
              Stockholders’
      Deficit





Common
Stock





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





As of
November 28, 2007, the SPA was amended so that on and after that date the
warrants are exercisable at 100% of the price of the shares that are purchased.
The SPA can be terminated at any time by TAG. The purchasers have certain
registration rights, as provided by the RRA, to require the Company, at its
cost, to file an effective registration statement with the Securities and
Exchange Commission.





During
2008, the Company received an aggregate of $1,712,500 in subscriptions for the
purchase of 36,586,091 shares of common stock and 36,586,091 warrants, subject
to the terms of the SPA and RRA.


F-18





Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





Convertible
Preferred Stock





Series
D and Series F 10% Cumulative Preferred Stock





At
December 31, 2008 and 2007 there were a total of 447 and 1,344 shares,
respectively, of Series D 10% Cumulative Convertible Preferred Stock (“Series D
Stock”).  At December 31, 2008 and 2007 there were a total
of    -0- and 26,420 shares, respectively, of Series F 10%
Cumulative Convertible Preferred Stock (“Series F
Stock”).    Each share of Series D and F Stock earns a
cumulative dividend at the annual rate of $10 per share, payable if and when
declared by the Company’s Board of Directors, in the form of cash, common stock
or any combination thereof. As of December 31, 2008, the accumulated dividends
were approximately $2,985,000. The Series D Stock is convertible into common
stock 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 Stock is redeemable at the
Company’s option. 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) the holders of a majority thereof elect to convert. 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 of $100
per share plus accumulated dividends, which is senior to any outstanding share
of Series G Convertible Preferred Stock, Series H Convertible Preferred Stock or
common stock.  The Series D Stock has been designated as non-voting
stock.





Series
G Convertible Preferred Stock





At
December 31, 2008 and 2007 there were a total of 11,700 shares of Series G
Convertible Preferred Stock (“Series G Stock”) outstanding.  Each
share of Series G Stock can be converted at any time by the holder into common
stock at a price of $0.50 per share, subject to certain anti-dilution
adjustments.  The Series G Stock is redeemable, in whole or in part at
the Company’s option, at any time, at a redemption price of $100 per share,
provided that the Company has sufficient funds available to redeem those shares
of Series G Stock being redeemed.  Automatic conversion of all of the
Series G Stock will occur if: (a) the Company completes a public offering of
common stock at a price of $2.50 or higher in which the minimum offering is for
at least $10 million; or (b) the holders of a majority thereof elect to convert.
The Series G Stock has a liquidation preference of $100 per share, which is
senior to any outstanding shares of common stock. Holders of Series G Stock are
entitled to receive dividends, when and as declared by the Board of Directors,
provided however, that no such dividends shall be declared or paid on the Series
G Stock until the preferential cumulative dividends on the Series D and Series F
Preferred Stock have been first fully paid or declared and set
apart.


F-19


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





Series
H Convertible Preferred Stock





At
December 31, 2008 and 2007 there were a total of 4,090 and 12,181 shares,
respectively, of Series H Convertible Preferred Stock (“Series H Stock”)
outstanding.  Each share of Series H Stock is convertible at any time
at the election of the holder into 133.33 shares of common stock at a conversion
price of $0.75 per share, subject to certain anti-dilution
adjustments.  Automatic conversion of all of the Series H Stock will
occur if: (a) the Company completes a public offering of common stock at a price
of $5.00 or higher in which the minimum offering is for at least $10 million; or
(b) the holders of a majority thereof elect to convert. The Series H Stock has a
liquidation preference, which is senior to any outstanding Series G Preferred
Stock or common stock, of $100 per share.  Holders of Series H Stock
are entitled to receive dividends, when and as declared by the Board of
Directors, provided however, that no such dividends shall be declared or paid on
the Series H Stock until the preferential cumulative dividends on the Series D
and Series F Preferred Stock have been first fully paid or declared and set
apart.  The Series H Stock has been designated as
non-voting.





Series
I Convertible Preferred Stock





At
December 31, 2008 and 2007 there were a total of 4,000 and 14,000 shares,
respectively of Series I Convertible Preferred Stock (“Series I Stock”)
outstanding.  Each share of Series I Stock is convertible at any time
at the election of the holder into approximately 181 shares of common stock at a
conversion price of $0.55 per share, subject to certain anti-dilution
adjustments.  Automatic conversion of all of the Series H Stock will
occur if: (a) the Company completes a public offering of common stock at a price
of $3.00 or higher in which the minimum offering is for at least $10 million; or
(b) the holders of a majority thereof elect to convert.   The
Series I Stock has a liquidation preference, which is senior to any other
outstanding series of preferred stock or common stock, of $100 per
share.  Holders of Series I Stock are entitled to receive dividends,
when and as declared by the Board of Directors, provided however, that no such
dividends shall be declared or paid on the Series I Stock until the preferential
cumulative dividends on the Series D and Series F Preferred Stock have been
first fully paid or declared and set apart.





October
2008 Stock Re-Purchase Agreement





On
October 30, 2008, the Company repurchased 920,480 common shares and a collective
total of 45,408 Series D, F, H, and I preferred shares held by Johnson &
Johnson Development Corporation for $5,000 (“October 2008 Stock Re-Purchase
Agreement). To the Company’s knowledge, these shares represent all outstanding
shares held by this shareholder.  Subject to this agreement, 897
shares of Series D Stock, 26,420 shares of Series F Stock, 8,091 shares of
Series H Stock and 10,000 shares of Series I Stock were
repurchased.  In connection with the repurchase of these shares, the
Company recorded a reduction of the carrying values of common stock and
preferred stock of $920,480 and $4,185,618, respectively,  and an
aggregated increase of $4,189,823 in additional paid in capital.





Employee
Stock Purchase Plan





In
September 1996 the Company established the Protein Polymer Technologies, Inc.,
Employee Stock Purchase Plan (the “Plan”). The Plan commenced 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 who are
members of the Compensation Committee. The Company’s Board of Directors may
modify the Plan at any time. During 2007 and 2008, no shares were purchased
under the plan.  There are no additional shares available for purchase
under the Plan.




F-20


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





Stock
Options





The
Company adopted the 1989 Stock Option Plan, which provided 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 1989
Stock Option Plan expired as of March 17, 1999. The options granted will expire
ten years from their respective dates of grant. Options granted in the plan
became exercisable ratably over periods of up to five years from the date of
grant. At December 31, 2008, zero options to purchase common stock had been
granted under the 1989 Plan with zero options exercisable.





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 1,500,000
shares of common stock to its key employees and certain other individuals. The
1992 Stock Option Plan expired as of December 31, 2002. The options granted 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.
The purchase price of each option approximated the fair market value of the
common stock on the date of grant. At December 31, 2008, 192,500 options to
purchase common stock had been granted under the 1992 Plan with 192,500
options outstanding and exercisable.





In April
2002, the Company adopted the 2002 Stock Option Plan, which provides for the
issuance of incentive and non-statutory stock options for the purchase of up to
1,500,000 shares of common stock to its key employees and certain other
individuals. In April 2003, the plan was amended to increase the number of
options available for grant to 9,000,000. The options will expire ten years from
their respective dates of grant. Options become exercisable ratably over periods
of up to three years from the dates of grant. The purchase price of each option
approximated the fair market value of the common stock on the date of grant. At
December 31, 2008, options to purchase 2,620,000 shares of common stock had been
granted under the 2002 Plan with 2,620,000 options outstanding and
exercisable.





In June
1996, the Company adopted the 1996 Non-Employee Directors Stock Option Plan
(“1996 Plan”), which provides for the granting of nonqualified options to
purchase up to 250,000 shares of common stock to directors of the Company. In
April 2003, the 1996 Plan was amended to increase the number of options
available for grant to 1,750,000, and the annual award to each Director to
80,000. Such grants of options to purchase 80,000 shares of common stock are
awarded automatically on the first business day of June during each calendar
year to every Participating Director then in office, subject to certain
adjustments. No Participating Director is eligible to receive more than one
grant per year. The purchase price of each option is set at the fair market
value of the common stock on the date of grant. Each option has a duration of
ten years, and becomes exercisable ratably over periods of up to three years
from the date of grant. As of December, 31, 2008, the annual award to each
Director of 80,000 stock options had not been issued for 2007 or 2008. In
addition, the Board in their annual Proxy Statement dated August 17, 2007 stated
its intent to issue shares valued at $10,000 each to Messrs. Kuhn and McCarthy
as payment for outstanding directors fees for 2006. As of December 31, 2008,
these shares had not been issued. The Company’s Compensation Committee
administers the 1996 Plan. At December 31, 2008, 520,700 options to purchase
common stock had been granted under the 1996 Plan with 498,636 options
outstanding and exercisable.





Since
inception, the Company has granted non-qualified options outside the option
plans to employees, directors and consultants. At December 31, 2008, a total of
3,507,500 options to purchase common stock are outstanding and 3,498,587 are
exercisable.





Compensation
cost recorded related to the above referenced options was a charge of
approximately $4,000 and a gain of approximately $110,000 for the years ended
December 31, 2008 and 2007, respectively.   As of December 31,
2008, there was $2,400 of total unrecognized compensation cost related to
non-vested options.  This cost is expected to be recognized during
2009.





F-21


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





The
Company did not grant options during the years ended December 31, 2008 or
2007.  The aggregate intrinsic value for both options outstanding and
options exercisable at December 31, 2008 was $0.





Stock
option activity for the year ended December 31, 20087 and 2007 is as
follows:





Options
                      Outstanding
                    
                    
                    Weighted
                      Average
                      Exercise
                      Price
                    
                    
                    Weighted
                      Average
                      Remaining
                      Contractual
                      Term (Years)Outstanding at
      December 31, 2006
                    
                    
                    12,454,582
                    
                    
                    
                    0.66
                    
                    
                    
                    6.5Issued
                    
                    
                    -
                    
                    
                    
                    -Cancelled/Expired
                    
                    
                    (957,096
                    )
                    
                    
                    0.52Exercised
                    
                    
                    —
                    
                    
                    
                    —Outstanding
      at December 31, 2007
                    
                    
                    11,497,486
                    
                    
                    $
                    0.65
                    
                    
                    
                    5.3Issued
                    
                    
                    -
                    
                    
                    
                    -Cancelled/Expired
                    
                    
                    (7,989,986
                    )
                    
                    
                    0.64Exercised
                    
                    
                    —
                    
                    
                    
                    —Outstanding
      at December 31, 2008
                    
                    
                    3,507,500
                    
                    
                    $
                    0.68
                    
                    
                    
                    4.4Exercisable
      at December 31, 2008
                    
                    
                    3,485,436
                    
                    
                    $
                    0.68
                    
                    
                    
                    4.4





Warrants





The
Company has reserved for issuance, out of currently authorized and unissued
shares of common stock, shares underlying outstanding warrants to purchase
common stock. Upon exercise of the warrants, shares of common stock will be
issued out of currently authorized and unissued shares.





During
the last quarter of 2007 and during 2008, the Company granted warrants to
purchase an aggregate of 5,913,028 and 36,586,091, respectively, of the
Company’s common stock pursuant to the terms of a Stock Purchase Agreement dated
September 27, 2007.  Such warrants are exercisable at prices ranging
from $0.17 to $0.03 per share and expire at various times through December
2013.





On
January 9, 2008, we replaced the Szulik Loan and issued Mr. Szulik three-year
warrants to purchase an aggregate of 2,438,000 shares of our common stock at
$0.061 per share.  Additionally, we lowered the exercise price of
warrants to purchase 500,000 shares of our common stock that we had previously
issued to him from $0.30 per share to $0.061 per share.





During
2008, the Company granted warrants to purchase an aggregate of 5,250,000 of the
Company’s common stock pursuant to the terms of unsecured note
agreements.  Such warrants are exercisable at prices ranging from
$0.04 to $0.05 per share and expire after one year.





During
2008 and 2007, 2,798,996 and 1,320,302 warrants, respectively,
expired.  No warrants were exercised during 2007 or
2008.


F-22


Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





A summary
of warrant activity for 2008 and 2007 is as follows:




Number of
                      Warrants
                      Outstanding
                      and
                      Exercisable
                    
                    
                    Weighted-
                      Average
                      Exercise
                      PriceOutstanding, December 31, 2006
                    
                    
                    17,178,494
                    
                    
                    $
                    0.55Granted
                    
                    
                    5,913,028
                    
                    
                    $
                    0.10Exercised
                    
                    
                    —
                    
                    
                    $
                    —Expired
                    
                    
                    (1,320,302
                    )
                    
                    $
                    (0.92
                    )Outstanding,
      December 31, 2007
                    
                    
                    21,771,220
                    
                    
                    $
                    0.41Granted
                    
                    
                    44,274,091
                    
                    
                    $
                    0.05Exercised
                    
                    
                    —
                    
                    
                    $
                    —Expired
                    
                    
                    (2,798,997
                    )
                    
                    $
                    (0.64
                    )Outstanding,
      December 31, 2008
                    
                    
                    63,246,314
                    
                    
                    $
                    0.14




At
December 31, 2008, the weighted-average remaining contractual life of the
warrants was approximately 3.3 years.





8.
              Stockholder
      Protection Agreement




In 1997,
the Company’s Board of Directors adopted a Stockholder Protection Agreement
(“Rights Plan”) that distributes Rights to stockholders of record as of
September 10, 1997. The Rights Plan contains provisions to protect stockholders
in the event of an unsolicited attempt to acquire the Company. The Rights trade
together with the common stock, and generally become exercisable ten business
days after a person or group acquires or announces the intention to acquire 15%
or more of the Company’s outstanding shares of common stock, with certain
permitted exceptions. The Rights then generally allow the holder to acquire
additional shares of the Company’s capital stock at a discounted price. The
issuance of the Rights is not a taxable event, does not affect the Company’s
reported earnings per share, and does not change the manner in which the
Company’s common stock is traded.




9.
              Commitments
      and Contingencies




Facilities
Lease Agreement





We
currently lease approximately 180 square feet of administrative office space in
San Diego. The lease term began on June 15, 2009 and expires on February 28,
2010.  The lease can be terminated at any time with one month’s
notice.  The current annual rent for this space is approximately
$4,300.  We are currently outsourcing our laboratory and production
facilities.  Rent expense was approximately $351,000 and $672,000
for the years ended December 31, 2008 and 2007, respectively.





Annual
future minimum operating lease payments are as follows:





Year Ending
                      December 31,
                    
                    Operating
                      Leases2009
                    
                    $
                    2,3402010
                    
                    
                    720Total
      minimum operating lease payments
                    
                    $
                    3,060





F-23





Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





In
connection with our former lease for laboratory and administrative offices which
expired in 2008, the Company has accrued $25,000 as of December 31, 2008 based
on a claim for damages from the former landlord, which the Company is
contesting.





Legal
Proceedings





On
October 15, 2008, holders of notes assumed by the Company in connection with the
Surgica Technology License Agreement and the Supply Agreement instituted suit
against the Company in Superior Court of California, County of Sacramento,
seeking payment of outstanding notes payable allegedly owed by the Company. The
name of the case is Lou Matson, Mary Matson, and Don Brandon v Protein Polymer
Technologies, Inc, Case Number 34-2008-00022190.  On May 19, 2009, the
plaintiffs filed a request for dismissal with prejudice of the action against
the Company, and the Company paid nothing to plaintiffs in exchange for the
dismissal.





Agreements
with Surgica Corporation




Supply
and Services Agreement




In March
2007, the Company received notification from Surgica’s legal counsel alleging
that the Company had breached the Technology License Agreement and the Supply
Agreement, and based thereon, Surgica was terminating these agreements. The
Company does not believe it has breached these
agreements.  Subsequently, Surgica filed for bankruptcy protection
under Chapter 7 of the U.S. Bankruptcy laws.  At this time, the final
discharge has not been received but court documents dated August 22, 2007
indicate that the bankruptcy will be considered a ‘no asset’ case, thus no
recovery is anticipated.





F-24





Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





10.         Income
Taxes




In July
2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109,(“FIN 48”). FIN 48
clarifies the accounting for uncertainty in tax positions and requires that a
Company recognize in its financial statements the impact of a tax position, if
that position is more likely than not of being sustained upon audit by the
relevant taxing authority, based on the technical merits of the position.
Additionally, FIN 48 provides guidance on derecognition, measurement
classification, interest and penalties, accounting in interim periods,
disclosure and transition. The provisions of FIN 48 are effective for fiscal
years beginning after December 15, 2006.





The
Company adopted the provisions of FIN 48 on January 1, 2007, and commenced
analyzing filing positions in all of the federal and state jurisdictions where
it was required to file income tax returns, as well as all open tax years in
these jurisdictions.  As a result of adoption, the Company has recorded no
additional tax liability.  As of
December 31, 2008, the Company has not yet completed its analysis of the
deferred tax assets for net operating losses of $16.9 million and research and
development credits of $3.2 million generated in years prior to 2008, and net
operating losses of $1.4 million and research and development credits of
approximately $84,000 generated in 2008.   As such, these
amounts and the offsetting valuation allowance have been removed from the
Company’s deferred tax assets.  Due to the existence of the valuation
allowance, future changes in our unrecognized tax benefits will not impact the
Company’s effective tax rate.





The
Company is subject to taxation in the U.S. and state jurisdictions. The
Company’s tax years for 2003 and forward are subject to examination by the U.S.
and California tax authorities due to the carry-forward of unutilized net
operating losses and research and development credits.  The Company is
currently not under examination by any taxing authorities.





The
Company’s practice is to recognize interest and/or penalties related to income
tax matters in income tax expense.  During the twelve months ended
December 31, 2008, the Company did not recognize any interest or
penalties.  Upon adoption of FIN 48 on January 1, 2007, the Company
did not record any interest or penalties.





The
adoption of FIN 48 did not impact the Company’s financial condition, results of
operations or cash flows.  At December 31, 2008, the Company had net
deferred tax assets of $1.7 million.  The Company’s deferred tax
assets are primarily composed of stock-based compensation/warrants expense,
impairment of licenses, and basis differences in fixed assets. Due to
uncertainties surrounding the Company’s ability to generate future taxable
income to realize these assets, a full valuation has been established to offset
the net deferred tax asset. Additionally, the future utilization of the
company’s net operating loss to offset future taxable income may be subject to
an annual limitation, pursuant to Internal Revenue Code Section 382, as a result
of ownership changes that may have occurred previously or that could occur in
the future.  The Company has not yet determined whether such an ownership
change has occurred. Additionally, the Company has not performed a comprehensive
review of the components of its research and development credit. Until this
analysis and review have been completed, the Company has removed the deferred
tax assets associated with these carry-forwards from its deferred tax asset
schedule and has recorded a corresponding decrease to its valuation allowance.
Once the appropriate analysis and review of these matters are completed, the
Company plans to update its unrecognized tax benefits under FIN 48. At this
time, the Company cannot estimate how much the unrecognized tax benefit may
change, if any.





F-25





Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





Significant
components of the Company's deferred tax assets as of December 31, 2008 and 2007
are shown below. A valuation allowance of $1,687,000 and $1,819,000 has been
recognized to offset the deferred tax assets as of December 31 2008 and 2007,
respectively, as realization of such assets is uncertain.





2008
                                    
                                    
                                    2007Deferred
      tax assets:Allowances
                                    
                                    
                                    174,000
                                    
                                    
                                    
                                    161,000Stock-based
      compensation/warrants
                                    
                                    
                                    511,000
                                    
                                    
                                    
                                    509,000Amortization/impairment
      of license
                                    
                                    
                                    308,000
                                    
                                    
                                    
                                    334,000Basis
      difference fixed assets
                                    
                                    
                                    639,000
                                    
                                    
                                    
                                    790,000Accrued
      expenses
                                    
                                    
                                    40,000
                                    
                                    
                                    
                                    -Other,
      net
                                    
                                    
                                    15,000
                                    
                                    
                                    
                                    25,000Total
      deferred tax assets
                                    
                                    
                                    1,687,000
                                    
                                    
                                    
                                    1,819,000Valuation
      allowance for deferred tax assets
                                    
                                    
                                    (1,687,000
                                    )
                                    
                                    
                                    (1,819,000
                                    )Net
      deferred tax assets
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    -





The
provision for income tax on earnings subject to income taxes differs from the
statutory federal income tax rate at December 31, 2008 and 2007, due to the
following:





2008
                                                                              
                                                                              
                                                                              2007Expected
      federal income tax benefit
                                                                              
                                                                              $
                                                                              (999,000
                                                                              )
                                                                              
                                                                              $
                                                                              (1,105,900
                                                                              )Expected
      state income tax benefit, net of federal benefit
                                                                              
                                                                              
                                                                              76,000
                                                                              
                                                                              
                                                                              
                                                                              (181,600
                                                                              )Decrease
      in valuation allowance
                                                                              
                                                                              
                                                                              (132,000
                                                                              )
                                                                              
                                                                              
                                                                              171,500FIN
      48 adjustments
                                                                              
                                                                              
                                                                              1,006,900
                                                                              
                                                                              
                                                                              
                                                                              1,069,100Stock
      options
                                                                              
                                                                              
                                                                              -
                                                                              
                                                                              
                                                                              
                                                                              53,900Other
                                                                              
                                                                              
                                                                              48,100
                                                                              
                                                                              
                                                                              
                                                                              (7,000
                                                                              )Provision
      for income taxes
                                                                              
                                                                              $
                                                                              -
                                                                              
                                                                              
                                                                              $
                                                                              -





At
December 31, 2008, the Company had federal and California tax net operating
loss carry-forwards of approximately $49.1 million and $25.9 million,
respectively.  The federal and California tax loss carry-forwards begin to
expire in 2009 and 2012, respectively, unless previously utilized.





The
Company also had federal and California research and development tax credit
carry-forwards of approximately $2.0 million and $1.3 million, respectively. The
federal credit carry-forward began to expire in 2008. The Company also has
California Manufacturers’ Investment Credit carry-forward of approximately
$62,000. The California credits do not expire.





Pursuant
to Internal Revenue Code Sections 382 and 383, use of the Company’s net
operating loss carry-forwards may be limited if a cumulative change in ownership
of more than 50% occurs within a three-year period.





F-26





Protein
Polymer Technologies, Inc.


Notes to
Financial Statements (Continued)





11.         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, subject to legislated
annual limits. Each year the Company may provide a discretionary matching
contribution. During the year ended December 31, 2008, and 2007, the
Company did not make a contribution to the 401(k) Savings Plan.





12.         Subsequent
Events





Between
January 1, 2009 and June 30, 2009, the Company received aggregate proceeds of
$75,000 for the purchase of 3,571,429 shares of common stock and 3,571,429
warrants, subject to the terms of the SPA.





Between
January 1, 2009 and June 30, 2009, the Company received proceeds of $415,000
pursuant to note payable agreements entered into with clients of
TAG.  These loans are represented by unsecured notes issued by the
Company.  These notes are due one year after issuance and bear an
annual interest rate of 8%.  The interest and principal are payable on
the maturity dates, either in cash or common stock, at the discretion of the
Company, at rates ranging from $0.02 to $0.03 per share.  As
consideration for the loans, the Company granted warrants to the noteholders to
purchase an aggregate of 20,173,077 shares of the Company’s common stock at
exercise prices ranging from $0.02 to $0.03 per share.





On June
29, 2009, the Company received from Sanyo Chemical Industries, Ltd. (“Sanyo”) a
fully executed copy of a License Agreement between Sanyo and the
Company.  The effective date of the Agreement is June 18,
2009.    Pursuant to the Agreement, the Company has granted
a non-exclusive, world-wide license to Sanyo of its technology, know-how, and
intellectual property relating to recombinant, repetitive unit proteins and
peptides, for the purposes of developing and commercializing products related to
Sanyo’s specific fields of business.  The Agreement remains in effect
until the expiration of the last to expire of the Company’s patents licensed by
Sanyo under this Agreement.  The Agreement further provides the
Company with initial and ongoing license fees, technical service and training
fees, and a percentage royalty on the quarterly net sales of any new products
developed by Sanyo under this Agreement.





F-27




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





None.




Item
9A(T). Controls And Procedures





Evaluation
of Disclosure Controls





As of
December 31, 2008, Company management, with the participation of the Company's
Interim Chief Executive Officer and Interim Principal Financial Officer,
evaluated the effectiveness of the Company's disclosure controls and procedures
as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”).  Based on this evaluation, the Company's
Interim Chief Executive Officer and Interim Principal Financial Officer, who is
the same person, concluded that as of December 31, 2008, the Company's
disclosure controls and procedures were not effective for the purposes of
recording, processing, summarizing and timely reporting of material information
relating to the Company required to be included in its periodic
reports.





For the
reasons discussed in “Management’s Report on Internal Control over Financial
Reporting” below, Company management, including the Interim Chief Executive
Officer and Interim Principal Financial Officer concluded that, as of
December 31, 2008, the Company’s internal control over financial reporting
was not effective due to material weaknesses in internal
control.  Notwithstanding the identified control deficiencies,
Management has concluded that the consolidated financial statements included in
this annual report present fairly, in all material respects, the Company’s
financial position, results of operations, and cash flows for the periods
presented in conformity with accounting principles generally accepted in the
United States.





Changes
in Internal Control over Financial Reporting





There
have been no changes in the Company’s internal control over financial reporting
(as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the
quarter ended December 31, 2008, that have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over
financial reporting.





Management’s
Report on Internal Control Over Financial Reporting





Company
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) under the
Securities Exchange Act of 1934.  The Company’s internal control over
financial reporting is designed to provide reasonable assurance to the Company’s
management and Board of Directors regarding the reliability of financial
reporting and the preparation and fair presentation of financial statements for
external purposes in accordance with generally accepted accounting
principles.





A
Company’s internal control over financial reporting includes those policies and
procedures that (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a
material effect on the financial statements.





26





The
effectiveness of any system of internal control over financial reporting is
subject to inherent limitations, including the exercise of judgment in
designing, implementing, operating and evaluating the controls and
procedures.  Because of these inherent limitations, internal control
over financial reporting cannot provide absolute assurance regarding the
reliability of financial reporting and may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may
deteriorate.





Company
management, with the participation of the Interim Chief Executive Officer and
the Interim Principal Financial Officer, assessed the effectiveness of the
Company’s internal control over financial reporting as of December 31,
2008.  In making this assessment, Management used the criteria set
forth by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) in Internal Control – Integrated Framework.  Based on this
assessment, management, with the participation of the Interim Chief Executive
Officer and Interim Principal Financial Officer, believes that, as of December
31, 2008, the Company’s internal control over financial reporting was not
effective based on those criteria.





A
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting such that there is a reasonable possibility
that a material misstatement of the Company’s interim or annual financial
statements will not be prevented or detected on a timely basis.





Specifically,
Company management identified certain matters involving internal control and the
Company’s operations that it considered to be material weaknesses under the
standards of the Public Company Accounting Oversight Board (PCAOB),
including:





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





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


o
            Controls
      over managerial override;


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


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


o
            Controls
      related to risk assessment.





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


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


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


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


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





Company
management is taking steps to remediate these weaknesses in the Company’s
internal control environment, including:





·
              Working
      with the Board of Directors to recruit an independent financial expert who
      will formalize roles and responsibilities over the Company’s internal
      controls over financial reporting for the Board and
      Management.


·
            Implementing
      a formal process to manage its internal controls over financial reporting
      as part of its efforts to become compliant with Section 404 of the
      Sarbanes-Oxley Act.  Management has retained the services of a
      third-party consulting firm to assist Company management with compliance
      with Section 404 of the Sarbanes-Oxley Act of 2002 (SOX);
    and


·
            Retaining
      the services of a third-party consulting firm with sufficient expertise to
      assist Company management with:





27





o
                Overseeing the daily
      accounting function, including cash receipts and disbursements, billing,
      payroll, and month-end bookkeeping
processes;


o
            Identifying
      and resolving non-routine or complex accounting
  matters;


o
            Controlling
      period-end financial closing and reporting processes;
  and


o
            Identifying,
      assessing, and applying accounting
principles.


o
            Formalizing
      its accounting policies and procedures, including defined roles and
      responsibilities and required managerial reviews and
      approvals,





Company
management will continue to monitor and evaluate the effectiveness of our
disclosure controls and procedures and our internal controls over financial
reporting on an ongoing basis and are committed to taking further action and
implementing additional improvements, as necessary and as funds
allow.





This Form
10-K does not include an attestation report of the Company’s registered public
accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management’s report in this 10-K





Item
9B.      Other Information




None





PART
III





Item
10.      Directors and  Executive
Officers of the Registrant





The table
below sets forth certain information regarding our directors, our executive
officers, and other significant employees as of June 30, 2009.





Name
                
                Age
                
                Position
      with the CompanyJames
      B. McCarthy, M.B.A., J.D. (2)
                
                57
                
                Director,
      Interim Chief Executive Officer, Interim Principal Accounting Officer, and
      Interim Corporate SecretaryAllan
      Farber (1)(2)
                
                62
                
                DirectorKerry
      L. Kuhn, M.D. (1)
                
                59
                
                DirectorRichard
      Adelson (1)(2)
                
                52
                
                DirectorWilliam
      N. Plamondon III
                
                61
                
                DirectorJoseph
      Cappello, Ph.D.
                
                52
                
                Vice
      President, Research and Development, Chief Technical Officer and Director,
      Clinical ResearchFranco
      A. Ferrari, Ph.D.
                
                57
                
                Vice
      President, Laboratory Operations and Polymer Production and Director,
      Molecular Genetics





(1)
Member of the Compensation Committee of Board of Directors.


(2)
Member of the Audit Committee of Board of Directors.





James B. McCarthy is our
Interim Chief Executive Officer, Interim Principal Accounting Officer, and
Interim Corporate Secretary,  positions he has held since November
2007. He has served as a director of the Company since April 2005. Mr. McCarthy
is the founder, Chairman and Chief Executive Officer of Gemini Consulting Group,
Inc., a U.S. based, privately held holding company with affiliated companies in
the United States and the United Kingdom. Mr. McCarthy’s areas of key expertise
include the development of hospital and ambulatory surgery center joint ventures
both domestically and internationally, development and implementation of
hospital and physician joint venture strategies and implementation of domestic
and international medical supply and equipment arrangements.





28





Mr.
McCarthy received his B.A. from the University of Notre Dame, his J.D. from the
Loyola University School of Law, and his M.B.A. from the Keller Graduate School
of Management. He is a member of various state and national organizations,
including the American Health Lawyers Association and the National Strategy
Forum. He also serves on the National Advisory Council of the Keller Graduate
School of Management in Chicago, IL. Mr. McCarthy is also a member of the Board
of Directors for Sirigen Group Ltd., London, England, and StemCyte, Inc.,
Covina, CA, with offices in New Jersey, Taiwan and India. He is also a member of
the Board of Trustees of the University of San Diego, San Diego,
California.





Allan Farber has served as a
director of the Company since January 2007. He has been a private investor for
more than the past five years.





Kerry L. Kuhn, M.D. has
served as a director of the Company since April 2000. Dr. Kuhn is currently a
partner and Board certified practicing physician at the Omega Obstetrics and
Gynecology Center in Coral Springs, Florida, a position he has held since 1986.
Dr . Kuhn serves on the Board of Directors of Vital MD, a physician organization
consisting of medical LLC's who employ 120 obstetricians and
gynecologists.





Richard Adelson has served as
a director of the Company since January 2007. He has been a private investor for
more than the past five years. Mr. Adelson also served as a director of the
Company from September 1999 to April 25, 2003.





William N. Plamondon III has
served as a director of the Company since March 2005. Mr. Plamondon served as
our President and Chief Executive Officer from April 2005 to November 2007. Mr.
Plamondon also serves as the President and Chief Executive Officer of R.I.
Heller & Co., LLC, a management-consulting firm, a position he has held
since 1998. Previously, Mr. Plamondon served as President and CEO of ANC Rental
Corporation, from October 2001 until October 2003, and as CEO of First Merchants
Acceptance Corp., from May 1997 until May 1998. Mr. Plamondon is also on the
Board of Trustees of North Central College. He is an eight-year member of the
Executive Advisory Committee for Give Kids the World, and is an active member of
the American Bankruptcy Institute and the Turnaround Management
Association.





Joseph Cappello, Ph.D., has
been the Company’s Vice President, Research and Development since February 1997
and Chief Technical Officer since February 1993. He has been the Company’s
Director, Clinical Research, since July 2002. From September 1988 to February
1993, he was the Company’s Senior Research Director, Protein
Engineering.




Franco Ferrari, Ph.D., 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.




Currently,
all directors hold office until the next annual meeting of stockholders and
until their successors have been duly elected and qualified. Officers are
elected by and serve at the discretion of the Board of Directors. There are no
family relationships among our directors and officers. There currently are no
legal proceedings, and during the past five years there have been no legal
proceedings, that are material to the evaluation of the ability or integrity of
any director or director nominee of the Company.





The Board
of Directors has determined that the audit committee does not have an “audit
committee financial expert” as that term is defined in Item 407(h)(2) of
Regulation S-K because the Board of Directors did not believe that any of the
members of the Audit Committee met the qualifications of an “audit committee
financial expert.” and does not believe, given the Company's current financial
condition, that the expense is warranted at this time.




In fiscal
year ended December 31, 2008, the Board had an Audit Committee established in
accordance with section 3(a)(58)(A) of the Securities Exchange Act of 1934. The
Audit Committee currently consists of Messrs. McCarthy, Adelson, and
Farber.





29





Section
16(a) Beneficial Ownership Reporting Compliance




Section
16(a) of the Securities Exchange Act of 1934 requires our officers and
directors, and persons who own more than ten percent of a registered class of
our equity securities (“Section 16 Participants”), to file reports of ownership
and changes in ownership with the SEC. Such persons are required to furnish the
Company with copies of all forms they file pursuant to Section 16(a). To
our knowledge, during the fiscal year ended December 31, 2008, based solely on a
review of such materials as are required by the SEC, no Section 16 Participants
failed to timely file with the Securities and Exchange Commission any form or
report required to be so filed pursuant to Section 16(a), except that one of our
holders of more than ten percent of our common stock may have failed to file
certain reports under Section 16(a).





Code
of Ethics




We have
adopted a written Code of Conduct that applies to everyone in the Company,
including our Chief Executive Officer (our principal executive officer and
principal financial officer).  A copy of our Code of Conduct is
incorporated by reference as exhibit 14.1 to the Company’s Annual Report on Form
10-K for the fiscal year ended December 31, 2008.





Item
10.      Executive
Compensation





Compensation
of Non-Employee Directors





Non-employee, non-affiliate directors
are entitled to receive $10,000 for their services as directors during the 2008
fiscal year. All directors were reimbursed for their out-of-pocket expenses in
attending meetings of the Board or committees thereof.  Neither the
2008 directors' fees payable of $10,000 each to Messrs. Adelson, Farber, Kuhn,
and Plamondon nor the 2007 directors’ fee payable of $10,000 each to Messrs.
Adelson, Farber, Kuhn, and McCarthy had been paid as of December 31,
2008.  We anticipate satisfying those obligations with the issuance of
stock or stock options during 2009. In addition, the Board in their annual
Proxy Statement dated August 17, 2007 stated its intent to issue shares valued
at $10,000 each to Messrs. Kuhn and McCarthy as payment for outstanding
directors fees for 2006. As of December 31, 2008, these shares had not been
issued.





Directors
who are also not employees of the Company are granted options to purchase
Company common stock under the Company’s 1996 Non-Employee Directors’ Stock
Option Plan (the "1996 Option Plan"). Under the 1996 Option Plan, each such
director is granted an annual option to purchase 80,000 shares of common stock
of the Company upon his or her election to the Board and on the first business
day in June of each calendar year thereafter. Such options have a duration of
ten years and are exercisable six months after the date of grant at a price
equal to the fair market value of the Company’s common stock on the date of
grant. As of December 31, 2008, the annual award to each Director of 80,000
stock options had not been issued for either 2007 or 2008.




Employment
Agreements




We had an
unwritten agreement with R.I. Heller & Co., LLC (hereafter “Heller”), Mr.
Plamondon's affiliated consulting company, pursuant to which we paid Heller
$25,000 per month for Mr. Plamondon's services. This agreement was terminated on
November 29, 2007, the date of Mr. Plamondon’s resignation as our Chief
Executive Officer, President, and Principal Accounting Officer.  In
June 2005, we issued to Mr. Plamondon and his designees, including Erin Davis,
who is now his wife, warrants to purchase an aggregate of two million shares of
our common stock at $0.67 per share, subject to adjustment pursuant to anti
dilution provisions. Mr. Plamondon received 1,575,000 of these warrants and Ms.
Davis received 75,000 of these warrants. The warrants expired on June 30,
2008.





We have
an unwritten agreement with Gemini Consulting Group, Inc., Mr. McCarthy’s
affiliated consulting company, pursuant to which we pay Gemini $15,000 per month
for Mr. McCarthy’s services.




All other
employment agreements that the Company had with any of its named executive
officers has expired.





30





The
following table shows for the periods indicated the compensation paid to or
accrued to, or for the benefit of, each of the named executive officers of the
Company for services rendered to the Company for the year ended December 31,
2008.




Summary
Compensation Table – 2008


Name and Principal
                                                    Position
                                                  
                                                  Salary
                                                  
                                                  
                                                  Bonus
                                                  
                                                  
                                                  Stock
                                                    Award
                                                  
                                                  
                                                  Option
                                                    Award
                                                  
                                                  
                                                  Non-Equity
                                                    Incentive Plan
                                                    Compensation
                                                  
                                                  
                                                  Change in
                                                    Pension Value
                                                    and
                                                    Nonqualified
                                                    Deferred
                                                    Compensation
                                                    Earnings
                                                  
                                                  
                                                  All Other
                                                    Compensation
                                                  
                                                  
                                                  TotalJames
      B. McCarthy, Interim Chief Executive Officer/ Interim Principal Accounting
      Officer/ Interim Corporate Secretary, effective November 29,
      2007
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  180,000
                                                  (1)
                                                  
                                                  
                                                  180,000Joseph
      Cappello, Ph.D, VP, Research and Development, Chief Technical Officer and
      Director, Clinical Research
                                                  
                                                  
                                                  167,860
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  167,860Franco
      A. Ferrari, Ph.D, VP, Laboratory Operations and Polymer Production and
      Director, Molecular Genetics
                                                  
                                                  
                                                  154,780
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  154,780




(1)
            Mr.
      McCarthy’s compensation for the year ended December 31, 2008 consisted of
      consulting fees payable to Gemini Consulting Group, Inc., of which he is
      the chief executive officer. The monthly fee is $15,000 of which the
      entire annual fee of $180,000 was paid in cash during
  2008.





31





Outstanding
Equity Awards at Year End - 2008





Option/Warrants
      Awards
                                    
                                    Stock
      AwardsName
                                    
                                    Number
      of
                                      Securities
                                      Underlying
                                      Unexercised
                                      Options
      (#)
                                      Exercisable
                                    
                                    Number
      of
                                      Securities
                                      Underlying
                                      Unexercised
                                      Options
      (#)
                                      Unexercisable
                                    
                                    Equity
                                      Incentive
                                      Plan
                                      Awards
                                      Number
      of
                                      Securities
                                      Underlying
                                      Unexercised
                                      Unearned
                                      Options
      (#)
                                    
                                    Option
                                      Exercise
                                      Price
                                    
                                    Option
                                      Expiration
                                      Date
                                    
                                    Number
                                      of
                                      Shares
                                      or
      Units
                                      of
      Stock
                                      That
                                      Have
                                      Not
                                      Vested
                                      (#)
                                    
                                    Market
                                      Value
                                      of
                                      Shares
                                      or
      Unit
                                      That
                                      Have
                                      Not
                                      Vested
                                    
                                    Equity
                                      Incentive
                                      Plan
                                      Awards:
                                      Number
                                      of
                                      Unearned
                                      Shares,
                                      Units
      or
                                      Other
                                      Rights
                                      That
                                      Have
      Not
                                      Vested
                                      (#)
                                    
                                    Equity
                                      Incentive
                                      Plan
                                      Awards:
                                      Market
                                      or
      Payout
                                      Value
      of
                                      Unearned
                                      Shares,
                                      Units
      or
                                      Other
                                      Rights
                                      That
                                      Have
      Not
                                      VestedJames
      B.
                                      McCarthy
                                    
                                    
                                    80,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.77
                                    
                                    
                                    6/01/2015
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -80,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.20
                                    
                                    
                                    6/01/2016
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -Joseph
      Cappello, Ph.D.
                                    
                                    
                                    10,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.88
                                    
                                    
                                    9/26/2010
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -50,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.80
                                    
                                    
                                    4/12/2011
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -20,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.85
                                    
                                    
                                    5/29/2011
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -50,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.37
                                    
                                    
                                    11/25/2012
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -1,350,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.73
                                    
                                    
                                    4/25/2013
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -25,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.65
                                    
                                    
                                    1/03/2015
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -Franco
      A. Ferrari, Ph.D.
                                    
                                    
                                    10,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.88
                                    
                                    
                                    9/26/2010
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -50,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.80
                                    
                                    
                                    4/12/2011
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -20,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.85
                                    
                                    
                                    5/29/2011
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -50,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.37
                                    
                                    
                                    11/25/20121,200,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.73
                                    
                                    
                                    4/25/2013
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    -
                                    
                                    
                                    -25,000
                                    
                                    0
                                    
                                    
                                    0
                                    
                                    0.65
                                    
                                    
                                    1/03/2015




32




Item 12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters





The
following table sets forth certain information regarding beneficial ownership as
of June 30, 2009 by





(i)
              all persons known by the Company
      to be the beneficial owner of more than 5% of the common stock, Series D
      Preferred Stock (on an as converted basis), Series F Preferred Stock (on
      an as converted basis), Series G Preferred Stock (on an as converted
      basis), Series H Preferred Stock (on an as converted basis) and Series I
      Preferred Stock (on an as converted
  basis),





(ii)
            all directors and nominees for
      directors,





(iii)
            each executive officer named
      below, and





(iv)
            all directors and executive
      officers as a group.





As of the
foregoing date, there were no other persons, individually or as a group, known
to us to be deemed the beneficial owners of five percent or more of the issued
and outstanding common stock.





This
table is based upon information supplied by Schedules 13D and 13G, if any, filed
with the Securities and Exchange Commission, and information obtained from our
directors and named executives. For purposes of this table, a person or group of
persons is deemed to have “beneficial ownership” of any shares of common stock
that such person has the right to acquire within 60 days of June 30, 2009,
including, but not limited to shares of common stock issuable upon conversion of
preferred stock and/or exercise of options. For purposes of computing the
percentage of outstanding shares of common stock held by each person or group of
persons named in the table, any security which such person or persons has or
have the right to acquire within such date is deemed to be outstanding but is
not deemed to be outstanding for the purpose of computing the percentage
ownership of any other person. Except as indicated in the footnotes to this
table and pursuant to applicable community property laws, we believe, based on
information supplied by such persons, that the persons named in this table have
sole voting and investment power with respect to all shares common stock which
they beneficially own. The business address of each of the Company’s directors
and named executive officers is the Company’s address unless otherwise stated in
the table below.





33




Name and Address
                              
                              Amount & Nature
                                of Beneficial
                              
                              
                              Approximateof Beneficial Owner
                              
                              Ownership
                              
                              
                              Percentage*William
      N. Plamondon, III(1)
                              
                              
                              -0-
                              
                              
                              
                              **Richard
      Adelson(1)
                              
                              
                              389,181
                              (3)
                              
                              
                              **Allan
      Farber(1)
                              
                              
                              985,607
                              (4)
                              
                              
                              **Kerry
      L. Kuhn, MD(1)
                              
                              
                              820,000
                              (5)
                              
                              
                              **James
      B. McCarthy(1)(2)
                              
                              
                              160,000
                              (6)
                              
                              
                              **Joseph
      Cappello, Ph.D.(2)
                              
                              
                              1,580,748
                              (7)
                              
                              
                              1.4
                              %Franco
      A. Ferrari, Ph.D.(2)
                              
                              
                              1,456,359
                              (8)
                              
                              
                              1.3
                              %Redec
      & Associates, LLC
                                c/o
      Protein Polymer Technologies, Inc.
                                11494
      Sorrento Valley Road
                                San
      Diego, California 92121
                              
                              
                              11,432,036
                              (9)
                              
                              
                              10.1
                              %Hunter
      & Co.
                                c/o
      Protein Polymer Technologies, Inc.
                                11494
      Sorrento Valley Road
                                San
      Diego, California 92121
                              
                              
                              27,940,935
                              (10)
                              
                              
                              20.3
                              %Matthew
      Szulik
                                c/o
      Protein Polymer Technologies, Inc.
                                11494
      Sorrento Valley Road
                                San
      Diego, California 92121
                              
                              
                              89,027,350
                              (11)
                              
                              
                              57.8
                              %All
      Officers and Directors as a Group
                              
                              
                              5,391,895
                              (3)-(8)
                              
                              
                              4.7
                              %





34










*
            Based upon 112,959,272 shares
      issued and outstanding as of June 30, 2009 except as otherwise provided in
      the footnotes.





**
            Less than
    1%.





(1)
            Director.





(2)
            Executive
      Officer.





(3)
            Includes i) 50,000 shares subject
      to options exercisable within 60 days and ii) 3,400 shares owned by the
      stockholder’s spouse. Excludes 1,392,372 shares of common stock held in
      trust for the stockholder’s mother. The stockholder disclaims beneficial
      ownership of the shares owned in trust for his
    mother.





(4)
            All shares are owned by the
      stockholder’s spouse. Includes 45,455 shares issuable upon conversion of
      Series I Preferred Stock within 60
days.





(5)
            Includes (i) 365,000 shares
      subject to options exercisable within 60 days and (ii) 80,000 shares
      issuable upon conversion of Series G Preferred Stock convertible within 60
      days.





(6)
            Includes 160,000 shares subject
      to options exercisable within 60
days.




(7)
            Includes 1,505,000 shares subject
      to options exercisable within 60
  days.





(8)
            Includes 1,355,000 shares subject
      to options exercisable within 60
days.





(9)
            Includes 554,545 shares issuable
      upon conversion of shares of Series I Preferred Stock convertible within
      60 days.





(10)
            Includes
      24,369,506 shares subject to warrants exercisable within 60
      days.





(11)
            Includes (i) 127,273 shares
      issuable upon conversion of the Company’s Series I Preferred Stock
      convertible within 60 days and (ii) 40,946,038 shares subject to warrants
      exercisable within 60 days.





35




Item
13.       Certain Relationships and Related
Transactions





As
described in Note 5 to the financial statements, the loan issued to us on April
13, 2006 by Matthew J. Szulik, one of our stockholders, (hereafter “Szulik
Loan”), has been amended ten times so that as of December 31, 2008, the
outstanding Principal balance was $6,415,000 and the Maturity Date September 30,
2009. At December 31, 2008, the outstanding indebtedness subject to the Note and
Security Agreement was $6,415,000 and accrued interest payable was $500,000. The
Szulik Loan is secured, in accordance with the terms of a security agreement
(hereafter “Security Agreement”), by a continuing security interest in and a
general lien upon (i) 2,000,000 shares of Spine Wave, Inc. common stock owned by
the Company; and (ii) all U.S. patents owned by the Company. The original Note
and the Security Agreement are both dated April 13, 2006, but the current note
is dated January 9, 2008.





Pursuant
to the terms of the Security Agreement, the Company entered into a patent
security agreement, an escrow agreement, a patent assignment, and a registration
rights agreement, each dated as of April 13, 2006. According to the terms of the
Security Agreement, the Company entered into the Escrow Agreement with an escrow
agent for the shareholder. The Escrow Agreement provides for the disbursement of
the funds held in escrow for application to Company expenses at the sole
discretion of the shareholder’s escrow agent. Mr. Szulik’s counsel was the
original escrow agent and now serves as our outside general counsel. The current
escrow agent is TAG Virgin Islands, Inc. (hereafter “TAG”). The Escrow Agreement
terminates upon the event that the amount borrowed is paid in full and no event
of default has occurred.





As
consideration for Mr. Szulik agreeing to accept the new note on January 9, 2008,
we issued him three-year warrants to purchase an aggregate of 2,438,000 shares
of our common stock at $0.061 per share and lowered the exercise price of
warrants to purchase 500,000 shares of our common stock that we had previously
issued to him from $0.30 per share to $0.061 per share.





As
discussed in Note 6 to the financial statements, the Company entered into a
common stock purchase agreement (hereafter “SPA”) in September 2007. The SPA
provides for the Company selling, from time to time, shares of its common stock,
par value $0.01, to the purchasers at a purchase price determined as the closing
price of the stock on the sale date. In addition, we issue a five-year warrant
to each investor to purchase the same number of shares as those purchased by
such investor at 110% of the price at which the shares are purchased. As of
November 28, 2007, the SPA was amended so that warrants issued on and after that
date are exercisable at 100% of the price at which the shares are purchased. We
have also granted the investors demand and piggy-back registration rights
covering the shares purchased and the sharers issuable upon exercise of the
warrants.





This
funding was arranged by TAG. The SPA provides that TAG, as agent for the equity
investors, will advise the Board as to which of the Company’s expenses will be
paid with the funds invested by these investors. TAG can terminate the SPA at
any time.





Between
September 27, 2007 and December 31, 2008, the Company received an aggregate of
$2,282,500 in subscriptions for the purchase of 42,499,119 shares of common
stock and 42,499,119 warrants, subject to the terms of the
SPA.  During 2008, the Company received an aggregate of $1,712,500 in
subscriptions for the purchase of 36,586,091 shares of common stock and
36,586,091 warrants, subject to the terms of the SPA and RRA. Between January 1,
2009 and June 30, 2009, the Company received proceeds of $75,000 for the
purchase of 3,571,429 shares of common stock and 3,571,429 warrants, subject to
the terms of the SPA.





Between
October 2, 2008 and June 5, 2009, the Company received proceeds of $645,000 as
loans from clients of TAG.  These loans are represented by unsecured
notes issued by the Company.  These notes are due one year after
issuance and bear an annual interest rate of 8%.  The interest and
principal are payable on the maturity dates, either in cash or common stock, at
the discretion of the Company, at rates ranging from $0.02 to $0.05 per
share.  As consideration for the loans, the Company granted warrants
to the noteholders to purchase an aggregate of 25,423,077 shares of the
Company’s common stock at exercise prices ranging from $0.02 to $0.05 per
share.





36





Material
Relationship with the Company





Mr.
Szulik has no material relationship with us apart from his ownership of our
securities. Based upon our stock records and data supplied to us by our
stockholders, we believe that Mr. Szulik is the beneficial owner of
approximately 44.1% of our common stock, including the shares underlying the
warrants he has acquired from us in connection with the Szulik Loan and the SPA.
We determine beneficial ownership in accordance with the Commission's rules,
which generally include voting power and/or investment power with respect to
securities. Our shares of common stock issuable upon conversion of debt
securities or preferred stock or subject to options or warrants exercisable
within 60 days after the date on which we make our filing with the Commission in
which such beneficial ownership information is disclosed are deemed outstanding
for computing the stock ownership percentage of a person holding such
convertible debt, preferred stock, options or warrants but are not deemed
outstanding for computing the percentage of any other person.





TAG
Virgin Islands, Inc. is a registered investment advisor and advises a number of
our stockholders in investment decisions, including decisions about whether to
invest in our stock. These clients include Messrs, Adelson and Farber and Dr.
Kuhn, who are members of our Board of Directors, and Mr. Szulik and Redec &
Associates, LLC. Based upon our stock records and data supplied to us by our
stockholders, we believe that clients of TAG beneficially own approximately
67.8% of our common stock. TAG has discretionary authority to vote or dispose of
the shares of our common stock held in its client accounts and, therefore, may
be deemed to be the beneficial owner of such shares in accordance with the
Commission's Rules. TAG has informed us that James Tagliaferri is the natural
person at TAG with such discretionary authority. TAG expressly disclaims
beneficial ownership of any shares owned by its clients.




Item
14.       Principal Accountant Fees and
Services





During
the fiscal years ended December 31, 2007 and December 31, 2008, Squar, Milner,
Peterson, Miranda & Williamson, LLP provided various audit and non-audit
services to us as follows:





·
            Audit
      Fees: Aggregate fees billed for professional services rendered for the
      audit of our annual financial statements for the fiscal years ended
      December 31, 2007 and December 31, 2008, for review of our financial
      statements included in our quarterly reports on Form 10-QSB or Form 10-Q
      for those years, and services normally provided in connection with
      statutory and regulatory filings and engagements for those years, were
      approximately $136,100 and $112,900,
  respectively.





·
            Audit-Related
      Fees: There were no fees billed for assurance and related services
      reasonably related to the performance of the audit or review of our
      financial statements and not reported under “Audit Fees” above in the
      fiscal years ended December 31, 2007 and December 31,
  2008.





·
            Tax
      Fees. Aggregate fees billed for tax services were approximately $5,900 and
      $6,800 in the fiscal years ended December 31, 2007 and December 31, 2008,
      respectively. These fees were primarily for compliance fees for the
      preparation of tax returns, assistance with tax planning strategies, and
      tax advice.





·
            All
      Other Fees: There were no fees billed for services other than those
      described above in the fiscal years ended December 31, 2007 and December
      31, 2008.





The Audit
Committee approved in advance or ratified each of the major professional
services provided by Squar, Milner, Peterson, Miranda & Williamson, LLP. The
Audit Committee has considered the nature and amount of the fees billed by
Squar, Milner, Peterson, Miranda & Williamson, LLP and believes that the
provision of the services for activities unrelated to the audit is compatible
with maintaining the independence of Squar, Milner, Peterson, Miranda &
Williamson, LLP.





37





PART
IV





Item
15.      Exhibits





The
following documents are included or incorporated by reference:





Exhibit Number
                
                Description3.1.1
      (1)
                
                Certificate
      of Incorporation of the Company, as amended through September 30,
      1995.3.1.2
      (26)
                
                Amendment
      to the Certificate of Incorporation, dated September 20,
    2007.3.2
      (2)
                
                Bylaws
      of the Company, as amended through December 31, 1998.4.1
      (26)
                
                Registration
      Rights Agreement between the Company and TAG Virgin Islands, Inc., as
      Agent for the Purchasers named therein, dated as of September 27,
      2007.10.1
      (3)
                
                1989
      Stock Option Plan, together with forms of Incentive Stock Option Agreement
      and Nonstatutory Option Agreement.10.2
      (4)
                
                1992
      Stock Option Plan of the Company, together with forms of Incentive Stock
      Option Agreement and Nonstatutory Option Agreement.10.3
      (3)
                
                Form
      of Employee’s Proprietary Information and Inventions
      Agreement.10.4
      (3)
                
                Form
      of Consulting Agreement.10.5
      (3)
                
                Form
      of Indemnification Agreement.10.6
      (4)
                
                License
      Agreement, dated as of April 15, 1992, between the Board of Trustees of
      the Leland Stanford Junior University and the Company.10.7
      (5)
                
                Securities
      Purchase Agreement related to the sale of the Company’s Series D Preferred
      Stock.10.8
      (6)
                
                1996
      Non-Employee Directors’ Stock Option Plan.10.9
      (7)
                
                Stockholder
      Protection Agreement, dated August 22, 1997, between the Company and
      Continental Stock Transfer & Trust Company as rights
      agent.10.10
      (8)
                
                Employee
      Stock Purchase Plan, together with Form of Stock Purchase
      Agreement.10.11
      (9)
                
                Lease,
      with rider and exhibits, dated April 13, 1998, between the Company and
      Sycamore/San Diego Investors.10.12
      (10)
                
                First
      Amendment to Stockholder Protection Agreement dated April 24, 1998,
      between the Company and Continental Stock Transfer & Trust Company as
      rights agent.10.13
      (11)
                
                Letter
      of Agreement dated April 13, 1998 between the Company and Johnson &
      Johnson Development Corporation for the exchange of up to 27,317 shares of
      Series D Preferred Stock for a like number of shares of Series F Preferred
      Stock.10.14
      (12)
                
                Securities
      Purchase Agreement related to the sale of the Company’s Series G
      Convertible Preferred Stock.10.15
      (12)
                
                Second
      Amendment to Stockholder Protection Agreement, dated July 26, 1999 between
      the Company and Continental Stock Transfer and Trust Company as rights
      agent.10.16
      (13)**
                
                License
      and Development Agreement dated as of January 26, 2000 between the Company
      and Prospectivepiercing Limited, to be known as Femcare Urology
      Limited.10.17
      (13)**
                
                Supply
      Agreement dated as of January 26, 2000 between the Company and Femcare
      Urology Limited.10.18
      (13)**
                
                Escrow
      Agreement dated as of January 26, 2000 between the Company and Femcare
      Urology Limited.10.19
      (13)
                
                License
      Agreement dated as of February 18, 2000 between the Company and Sanyo
      Chemical Industries, Ltd.10.20
      (14)**
                
                License
      Agreement dated December 21, 2000 between the Company and Genencor
      International, Inc.





38




10.21
      (14)
              
              Form
      of Warrant to Purchase Common Stock issued in connection with License
      Agreement between the Company and Genencor International,
    Inc.10.22
      (15)
              
              Securities
      Purchase Agreement related to the sale of the Company’s Series H Preferred
      Stock.10.23
      (17)**
              
              Founder
      Stock Purchase Agreement dated April 12, 2001 between the Company and
      Spine Wave Inc.10.24
      (17)**
              
              License
      Agreement dated April 12, 2001 between the Company and Spine Wave,
      Inc.10.25
      (17)**
              
              Escrow
      Agreement dated April 12, 2001 between the Company and Spine Wave,
      Inc.10.26
      (17)**
              
              Supply
      and Services Agreement dated April 12, 2001 between the Company and Spine
      Wave, Inc.10.27
      (18)**
              
              Amendment
      No. 1 to Supply and Services Agreement dated February 12, 2002 between the
      Company and Spine Wave, Inc.10.28
      (18)**
              
              Stock
      Purchase and Vesting Agreement dated March 21, 2002 between the Company
      and Spine Wave, Inc.10.29
      (16)
              
              Warrant
      to Purchase Shares of Common Stock of Spine Wave, Inc. issued to the
      Company.10.30
      (19)
              
              First
      Amendment to the License Agreement dated October 1, 2002 between the
      Company and Genencor International, Inc.10.31
      (19)
              
              Employment
      Agreement, dated as of December 31, 2002, between the Company and J.
      Thomas Parmeter.10.32
      (19)
              
              Employment
      Agreement, dated as of December 31, 2002, between the Company and John E.
      Flowers.10.33
      (19)
              
              Employment
      Agreement, dated as of December 31, 2002, between the Company and Joseph
      Cappello.10.34
      (19)
              
              Employment
      Agreement, dated as of December 31, 2002, between the Company and Franco
      A. Ferrari.10.35
      (20)
              
              2002
      Stock Option Plan, and forms of Incentive Stock Option Agreement and
      Non-Statutory Stock Option Agreement.10.36
      (21)**
              
              Amendment
      No. 2 to Supply and Services Agreement dated October 1, 2003 between the
      Company and Spine Wave, Inc.10.37
      (22)
              
              Securities
      Purchase Agreement, dated as of March 31, 2005, by and among the Company
      and certain investors.10.38
      (22)
              
              Form
      of Warrant to Purchase Shares of Common Stock of the Company in connection
      with Securities Purchase Agreement dated as of March 31,
    2005.10.39
      (23)
              
              Form
      of Warrant to Purchase Shares of Common Stock of the Company issued to
      William N. Plamondon, III.10.44
      (24)
              
              Irrevocable
      Proxy, dated as of November 23, 2005, executed by Louis R. Matson in favor
      of the Company.10.40
      (25)**
              
              Asset
      Purchase Option Agreement, dated as of November 23, 2005, by and between
      the Company and Surgica Corporation.10.41
      (25)**
              
              License
      Agreement, dated as of December 19, 2005, between the Company and Surgica
      Corporation.10.42
      (25)**
              
              Supply
      and Services Agreement, dated as of December 19, 2005, between the Company
      and Surgica Corporation.10.43
      (25)**
              
              Voting
      Agreement, dated as of November 23, 2005, between the Company and Louis R.
      Matson.10.44
      (26)
              
              Common
      Stock Purchase Agreement between the Company and TAG Virgin Islands, Inc.,
      as Agent for the Purchasers named therein, dated as of September 27,
      2007.10.45
      (26)
              
              Amendment
      No. 7 to Secured Promissory Note issued to Matthew J. Szulik, dated
      November 10, 2007.





39








10.46
      (27)
              Amendment
      1 to the Common Stock Purchase Agreement between the Company and TAG
      Virgin Islands, Inc., as Agent for the Purchasers named therein, dated as
      of November 28, 2007.10.47
      (27)
              Secured
      Promissory Note Replacement Agreement, dated as of January 9, 2008,
      between the Company and Matthew J. Szulik.10.48
      (27)
              Secured
      Promissory Note issued to Matthew J. Szulik, dated as of January 9,
      2008.10.49
      (27)
              Form
      of Warrant to Purchase Shares of Common Stock of the Company in connection
      with the Secured Promissory Note issued to Matthew J. Szulik, dated as of
      January 9. 2008.10.50
      (28)
              Form
      of Promissory Note issued to noteholders on October 2, 2008, November 3,
      2008, December 11, 2008, February 6, 2009, March 18, 2009, April 20, 2009,
      May 7, 2009, and June 5, 2009.10.51
      (28)
              Form
      of Warrant to Purchase Shares of Common Stock of the Company in connection
      with the Promissory Notes issued to noteholders on October 2, 2008,
      November 3, 2008, December 11, 2008, February 6, 2009, March 18, 2009,
      April 20, 2009, May 7, 2009, and June 5, 2009.10.52**
              Technology
      License Agreement between the Company and Sanyo Chemical Industries, Ltd.,
      dated as of June 18,  2009.14.1
      (29)
              Code
      of Conduct.31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
              Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
              Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.32.2
              Certification
      of Principal Financial Officer pursuant to Section 960 of the
      Sarbanes-Oxley Act of 2002.





(1)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB for the quarter ended September 30,
      1995, SEC File No. 000-19724, as filed with the Commission on October 25,
      1995.





(2)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      1998, as filed with the Commission on March 5,
  1999.





(3)
            Incorporated by reference to the
      Company's Registration Statement on Form S-1 (No. 33-43875), SEC File No.
      033-43875, filed with the Commission on November 12, 1991, as amended by
      Amendments Nos. 1, File No. 033-43875, 2, SEC File No. 033-43875, 3, SEC
      File No. 033-43875, and 4, SEC File No. 033-43875, thereto filed on
      November 25, 1991, December 23, 1991, January 17, 1992 and January 21,
      1992, respectively.





(4)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      1992, SEC File No. 000-19724, as filed with the Commission on March 31,
      1993.





(5)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB for the quarter ended September 30,
      1995, SEC File No. 000-19724, as filed with the Commission on October 25,
      1995.





(6)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      1996, SEC File No. 000-19724, as filed with the Commission on March 27,
      1997.





40





(7)
            Incorporated by reference to
      Registrant’s Current Report on Form 8-K, SEC File No. 000-19724, as filed
      with the Commission on August 27,
1997.





(8)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      1997, SEC File No. 000-19724, as filed with the Commission on April 15,
      1998.





(9)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB for the quarter ended March 31, 1998,
      SEC File No. 000-19724, as filed with the Commission on May 15,
      1998.





(10)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB for the Quarter ended June 30, 1998,
      SEC File No. 000-19724, as filed with the Commission on August 14,
      1998.





(11)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      1998, as filed with the Commission on March 5,
  1999.





(12)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB for the quarter ended September 30,
      1999, SEC File No. 000-19724, as filed with the Commission on November 12,
      1999.





(13)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      1999, SEC File No. 000-19724, as filed with the Commission on March 24,
      2000.





(14)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      2000, SEC File No. 000-19724, as filed with the Commission on February 22,
      2001.





(15)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB for the quarter ended September 30,
      2001, SEC File No. 000-19724, as filed with the Commission on November 14,
      2001.





(16)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB for the quarter ended September 30,
      2002, SEC File No. 000-19724, as filed with the Commission on November 13,
      2002.





(17)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB/A for the fiscal year ended December
      31, 2001, SEC File No. 000-19724, as filed with the Commission on March 5,
      2003.




(18)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB/A for the period ended September 30,
      2002, SEC File No. 000-19724, as filed with the Commission on March 5,
      2003.





(19)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      2002, SEC File No. 000-19724, as filed with the Commission on March 28,
      2003.





(20)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB for the period ended March 31, 2003,
      SEC File No. 000-19724, as filed with the Commission on May 14,
      2003.





(21)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      2003, SEC File No. 000-19724, as filed with the Commission on March 28,
      2003.




(22)
            Incorporated by reference to
      Registrant’s Current Report on Form 8-K, SEC File No. 000-19724, as filed
      with the Commission on April 7,
2005.





(23)
            Incorporated by reference to
      Registrant’s Report on Form 10-QSB for the quarter ended June 30, 2005,
      SEC File No. 000-19724, as filed with the Commission on August 17,
      2005.





(24)
            Incorporated by reference to
      Registrant's Current Report on Form 8-K, SEC File No. 000-19724, as filed
      with the Commission on December 22,
2005.





41





(25)
            Incorporated by reference to
      Registrant's Report on Form 10-KSB for the fiscal year ended December 31,
      2005, SEC File No. 000-19724, as filed with the Commission on March 31,
      2006.





(26)
            Incorporated by reference to
      Registrant's Report on Form 10-QSB for the quarter ended September 30,
      2007, SEC File No. 000-19724, as filed with the Commission on November 19,
      2007.





27)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      2007, SEC File No. 000-19724, as filed with the Commission on May 12,
      2008.





(28)
            Incorporated by reference to
      Registrant’s Report on Form 10-Q for the quarter ended September 30, 2008,
      SEC File No. 000-19724, as filed with the Commission on November 19,
      2008.





(29)
            Incorporated by reference to
      Registrant’s Report on Form 10-KSB for the fiscal year ended December 31,
      2004, SEC File No. 000-19724, as filed with the Commission on March 31,
      2005.





**
            Portions of this document have
      been redacted pursuant to a Request for Confidential Treatment filed with
      the Securities and Exchange
Commission.





42





SIGNATURES




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




PROTEIN
      POLYMER TECHNOLOGIES, INC.July
      24, 2009
              By:
              /S/ JAMES B. MCCARTHYJames
      B. McCarthyInterim
      Chief Executive Officer





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




Signature
                  
                  Capacity
                  
                  Date/S/ JAMES B. MCCARTHY
                  
                  Interim
      Chief Executive Officer,
                  
                  July
      24, 2009James
      B. McCarthy
                  
                  Interim
      Principal Financial Officer, andInterim
      Corporate Secretary/S/ ALLAN FARBER
                  
                  Director
                  
                  July
      24, 2009Allan
      Farber/S/ KERRY L. KUHN
                  
                  Director
                  
                  July
      24, 2009Kerry
      L. Kuhn, M.D./S/ RICHARD ADELSON
                  
                  Director
                  
                  July
      24, 2009Richard
      Adelson/S/ WILLIAM N. PLAMONDON
III
                  
                  Director
                  
                  July
      24, 2009William
      N. Plamondon III





43





EXHIBIT
INDEX





10.1
            Technology
      License Agreement between the Company and Sanyo Chemical Industries, Ltd.,
      dated as of June 18, 2009.





31.1
            Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.





31.2
            Certification of Principal
      Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.





32.1
            Certification of Chief Executive
      Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.





32.2
            Certification of Principal
      Financial Officer pursuant to Section 960 of the Sarbanes-Oxley Act of
      2002.





44