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

                                      FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
    ACT OF 1934.  For the fiscal year ended December 31, 1996.

                                          or

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
    EXCHANGE ACT OF 1934.  For the transition period from __________________ to
    ____________________.

                           Commission File Number:000-28460

                          FUSION MEDICAL TECHNOLOGIES, INC.
                (Exact name of registrant as specified in its charter)

              Delaware                                            96662349
   (State or other jurisdiction of                           (I.R.S. employer
    incorporation or organization)                        identification number)

1804 N. Shoreline Blvd., Mountain View, CA                          94043
 (Address of principal executive offices)                        (Zip code)

         Registrant's telephone number, including area code:  (415) 903-4000
          Securities registered pursuant to Section 12(b) of the Act:  None
             Securities registered pursuant to Section 12(g) of the Act:
                            Common Stock, $0.001 par value
                                   (Title of class)

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 disclosures 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]

The aggregate value of voting stock held by non-affiliates of the Registrant,
based upon the closing sales price of the Common Stock on March 15, 1997, was
approximately $10.7 million based upon the average of the high and low prices of
the Registrant's Common Stock reported for such date on the Nasdaq National
Market.  Shares of Common Stock held by each executive officer and director and
by each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates.  The determination
of affiliate status is not necessarily a conclusive determination for other
purposes.  As of March 15, 1997, the Registrant had 6,998,517 shares of Common
Stock outstanding.


Fusion, Fusion Medical Technologies, Inc., RapiSeal and SilverBullet are
trademarks of Fusion Medical Technologies, Inc. Any use is strictly prohibited
without the prior written consent of Fusion Medical Technologies, Inc.


<PAGE>


                         DOCUMENTS INCORPORATED BY REFERENCE
    The information called for in Part III is incorporated by reference from
the Proxy Statement relating to the Annual Meeting of Stockholders of the
Registrant to be held on May 22, 1997.


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<PAGE>

                          FUSION MEDICAL TECHNOLOGIES, INC.

                                        INDEX


                                                                          PAGE
                                                                         NUMBER
                                                                         ------

Part I.................................................................    4
    Item 1.  BUSINESS..................................................    4
    Item 2.  PROPERTIES................................................   17
    Item 3.  LEGAL PROCEEDINGS.........................................   18
    Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......   18


Part II................................................................   20
    Item 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND
             RELATED STOCKHOLDER MATTERS...............................   20
    Item 6.  SELECTED FINANCIAL DATA...................................   20
    Item 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
             FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............   21
    Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...............   29
    Item 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
             ACCOUNTING AND FINANCIAL DISCLOSURE.......................   29


Part III...............................................................   29
    Item 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......   29
    Item 11.  EXECUTIVE COMPENSATION...................................   29
    Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
              AND MANAGEMENT...........................................   29
    Item 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
              REPORTS ON FORM 8-K......................................   30


Part IV................................................................   30
    Item 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
              REPORTS ON FORM 8-K......................................   30


                                                                              3


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                                        PART I

ITEM 1.  BUSINESS

    THE BUSINESS SECTION AND OTHER PARTS OF THIS REPORT CONTAIN FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES.  THE COMPANY'S ACTUAL RESULTS
MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING
STATEMENTS.  FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT
LIMITED TO, THOSE DISCUSSED IN THE SECTION ENTITLED "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ---FACTORS AFFECTING
OPERATING RESULTS AND MARKET PRICE OF COMMON STOCK" COMMENCING ON
PAGE 21.

THE COMPANY

    Fusion Medical Technologies, Inc. ("Fusion" or the "Company") was
incorporated in Delaware in 1993.  The Company is developing proprietary wound
closure products which the Company believes may have broad application in a
variety of surgical procedures, including lung resections for cancer and
emphysema, procedures requiring anastomoses, and minimally invasive surgeries.
The Company's RapiSeal bioresorbable patch and Fusion liquids are designed to
effectively treat surgical wounds in a wide variety of organs and blood vessels
by rapidly forming flexible seals across the targeted tissue.  The Company
believes that its wound closure products have the potential to reduce
post-operative complications associated with air and fluid leaks and
consequently reduce hospital costs.  In a twenty-six patient, multi-center
trial, the Company's initial product, RapiSeal, was effective in treating 96% of
the previously untreatable air leaks identified during lung resection surgery.

    The Company received 510(k) pre-market clearance from the United States
Food and Drug Administration (FDA) to market its RapiSeal patch in connection
with lung surgery in June 1996.  In February 1997, the Company also received
510(k) pre-market clearance to sell a patch product for the treatment of
bleeding which occurs in solid organ surgeries, such as liver, spleen and kidney
surgeries.  The Company's patch product is designed to effectively treat
surgical wounds by creating barriers across the targeted tissue. The Company
believes that its patch products have the potential to reduce post-operative
complications associated with air and fluid leaks and consequently reduce
hospital costs.

    To expand its product offerings, the Company is  developing a
collagen-based flowable-gel product to enable surgeons to quickly and easily
stop bleeding which occurs in connection with a wide variety of surgeries, such
as those performed by cardiac, vascular and general surgeons. Pre-clinical tests
indicate the Company's flowable-gel product may be effective in quickly stopping
heavy active bleeding. The first version of the flowable-gel product will be
targeted for open surgery, and work has begun on a device appropriate for use in
minimally invasive surgery.  The Company currently believes it will begin
clinical testing of this product in open surgical procedures in the second half
of 1997.

BACKGROUND

    Over 20 million surgical procedures are performed annually in the United
States.  Effective closure of surgical wounds, including incisions, tears,
and leaks in the patients' organs, is critical for the restoration of the
physical integrity and function of injured or diseased tissue and,
ultimately, the success of the surgical procedure.  Failure to optimally
close surgical wounds can result in serious or possibly life threatening
complications, including blood loss, air and fluid leakage from organs,
infection, and excessive scarring. A variety of devices have been developed
to assist the surgeon with surgical closure of tissue, including sutures,
staples and fibrin glues.

    Historically, the most common method of wound closure has been the use of
sutures.  Suturing involves stitching together the tissues on either side of an
incision to facilitate healing.  In the 1960's, surgical stapling was introduced
to reduce the time-consuming and cumbersome


                                                                              4


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aspects of suturing.  Surgical stapling involves drawing together tissue through
the application of staples along the line of incision using a manually operated
device.  The Company believes the worldwide market for sutures and staples in
1995 was approximately $2.0 billion.

    Sutures and staples, however, have a number of limitations when applied to
certain organs and vessels.  Sutures and staples do not have inherent sealing
capabilities and, as a result, cannot eliminate air and fluid leakage at the
wound site.  In organs such as the lung, liver, spleen and kidney the friable
tissue often lacks the basic integrity necessary to support sutures or staples.
As a result, sutures and staples can pull through these tissues, causing damage
to the organ and increasing the risk of post-surgical complications.  For
example, in a patient undergoing surgery for the treatment of emphysema, tears
in the lungs may result in air leakage which is a major source of complications,
including pneumonia.  These post-surgical complications can dramatically extend
hospital stays or even lead to death.  In addition, sutures and staples are not
effective in closing leaks associated with broad, rough tissue surfaces which
often result from surgical manipulations in lung and other surgeries.  Finally,
sutures and staples can also be difficult to place, particularly when used in
endoscopic or minimally invasive surgical procedures where the surgeon is
operating through trocars and in the limited space provided by body cavities.

    In recent years, numerous products, including fibrin glues have been used,
often in conjunction with sutures and staples, to stem blood leakage.  However,
fibrin glues do not fully address air leaks or leakage of certain types of
fluid, such as lymphatic fluids.  These products are ineffective against
extensive bleeding and may require manual pressure to be effective, requiring
removal before the surgery is finished to avoid bacterial or other infection, or
being awkward and difficult to place precisely. Commercially available fibrin
glues are derived from pooled human plasma and, because of concerns over
possible viral transmissions, have not been approved for use in the United
States.  Despite these limitations, industry sources estimate that worldwide
sales for commercially available fibrin glues in 1995 were approximately $250
million.  While fibrin glues can be produced from a patient's own blood
(autologous glues), these typically adhere even less effectively than
commercially available glues and must be prepared by the physician prior to the
surgery, irrespective of whether they are actually used in the procedure.

    The limitations of traditional wound closure technologies have been
particularly pronounced in the surgical treatment of lung cancer, Lung Volume
Reduction (LVR) surgery for emphysema and procedures involving anastomoses, and
have slowed the adoption of certain minimally invasive surgical approaches.

    LUNG CANCER SURGERY.  Industry sources estimated that in 1995,
approximately 100,000 pulmonary resection procedures (removal of portions of the
lung), including certain open thoracic biopsies, were performed in the United
States, primarily for the treatment of lung cancer.  Air leaks in the lung are
created in many of these surgeries due to surgical incision, organ handling of
the delicate lung tissue during the procedure or the use of sutures or staples.
As air leaks from the lung, it accumulates in the pleural cavity causing serious
complications, or even death, if left untreated.  Chest tubes are the only
treatment available to vent the accumulated air from the pleural cavity.  Chest
tubes prolong pain, diminish mobility and increase the risk of infection.
Moreover, the patient's immobility increases the risk of post-surgical
complications such as pneumonia.  Patients are generally precluded from leaving
the hospital while the chest tubes remain in place, contributing to lengthy
hospital stays.  Medicare records indicate that the average hospital stay for
pulmonary resection procedures in 1995 was approximately 10 to 12 days.  For
lung cancer patients who also have emphysema, the hospital stay can be
significantly longer, and the use of chest tubes can cause even more pain and,
in some cases, life-threatening complications.


                                                                              5


<PAGE>

    LUNG VOLUME REDUCTION FOR EMPHYSEMA.  Emphysema, most often caused by
cigarette smoking, is a progressive disease of the lungs characterized by
destruction of normal lung tissue and the formation of nonfunctional pockets of
air that compress the remaining normal lung tissue, severely limiting the
patient's breathing capacity.  Non-surgical therapies for patients suffering
from emphysema, such as bronchodilators and oxygen supplements, offer only
temporary relief and become less effective as the disease progresses.  Lung
transplantation, the only known cure for emphysema, is costly, involves a high
degree of risk and typically is only used as a last resort.  LVR is a surgical
procedure that has gained increasing acceptance with the thoracic surgical
community as a potential treatment for the symptoms of late-stage emphysema.
Based upon communications with the thoracic surgical community, the Company
believes that up to 250,000 patients worldwide could potentially benefit from
the LVR procedure.  In performing this operation, the surgeon removes the most
diseased lung tissue, then uses a stapler to rejoin the incised areas which
simultaneously cuts the targeted tissue and staples the remaining tissue to
close the surgical wound.  However, multiple air leaks are typically created in
the patient's lung during this procedure, primarily from the use of the staples
and the necessary handling of the lung which, in its diseased condition, tears
easily.  These air leaks increase the risk of serious complications, slow the
recovery period and result in longer hospital stays.  To address the small
perforations created by the staples and to alleviate some of the tension along
the staple line, surgeons often apply pericardial strips in conjunction with
staples.  While pericardial strips may address air leaks occurring on the staple
line, they cannot address air leaks that often occur elsewhere on the lung.

    While LVR surgery is not a cure for emphysema, the results of the procedure
to date are encouraging.  Independent published studies of patients who have
undergone the LVR procedure suggest that these patients have reduced shortness
of breath, improved exercise tolerance and improved quality of life.  The
operation has been recently endorsed by the Society of Thoracic Surgeons for
treatment of certain late-stage emphysema patients and is being performed in
many of the major lung treatment centers in the United States.  However, the
number of patients who have undergone the LVR procedure in the United States and
for whom a clinically acceptable post-operative evaluation period has elapsed is
relatively small.  As a result, there can be no assurance concerning the safety,
effectiveness and long-term outcomes associated with the LVR procedure.  The
Health Care Financing Administration (HCFA) has suspended payment, and is
reviewing the appropriate reimbursement, if any, for LVR.  In connection with
such review, HCFA has announced it is collaborating with the National Institutes
of Health (NIH) on a 2,500 patient, multi-center clinical trial to be conducted
by the NIH to evaluate the long-term benefits of the LVR procedure for patients
with late-stage emphysema.  The NIH has indicated that the clinical trial will
begin in the third quarter of 1997.  It has estimated that evaluation of results
will not be completed until late 2003, although positive results could lead to
an earlier conclusion.  There can be no assurance that reimbursement for LVR
will be reinstated or, if reinstated, that HCFA will not impose limitations on
reimbursement.

    LIVER/SPLEEN SURGERY.  In February 1997 the Company received clearance from
the Food and Drug Administration to market in the United States a patch product
for the treatment of bleeding in solid organs, such as the spleen and liver.
Bleeding frequently occurs during surgery on these organs for treatment of
trauma or cancer.  The Company submitted its 510(k) application for this
application in December 1996 based on the results of animal studies
demonstrating its safety and effectiveness.  This patch product, when used in
conjunction with an energy source was effective in providing a means to
approximate and close wounds in solid organs such as the spleen, and its use
resulted in complete cessation of bleeding at the wound site.  Marketing studies
are scheduled to begin in the second quarter of 1997.

    ANASTOMOSIS.  Anastomosis is a surgical technique in which two vessels or
hollow tubular organs such as the esophagus are joined.  One of the most
common types of anastomoses are those performed to joint blood vessels.


                                                                              6


<PAGE>

Such anastomoses generally require the use of staples or multiple layers of
sutures to ensure the integrity of the seal, but even with good surgical
technique there is a risk of leakage across the staple or suture line. Fluid
leakage can cause serious infection, require re-operation, prolong
hospitalization, and may even be fatal.  Furthermore, for seriously ill
patients, such as those with compromised immune systems, the risk of leakage
from anastomoses performed with sutures and staples can preclude operative
therapies.

    Vascular anastomoses connect blood vessels and are used in such procedures
as Coronary Artery Bypass Graft ("CABG") and repair of abdominal aortic
aneurysms.  Industry sources have estimated that approximately 650,000 vascular
anastomoses were performed in 1995.  Such anastomoses are typically performed
with a single layer of sutures and are technically demanding since they are
immediately challenged by high pressures of blood flow inherent within the
arterial system.  Leakage from such anastomoses can be abrupt and catastrophic,
necessitating immediate re-operation to stem or slow dangerous hemorrhaging.

    MINIMALLY INVASIVE SURGERY.  Minimally invasive surgery entails operating
through trocars placed through small incisions made in the patient.  During
these procedures, the surgeon manipulates surgical instruments through the
trocars while viewing the procedure on a video screen.  In comparison with
traditional open surgical procedures, minimally invasive surgical procedures are
generally less traumatic to the patient, result in shorter recovery periods and
reduce hospital stays.  As a result of these benefits, there has been a marked
trend toward adoption of minimally invasive procedures in place of other
surgical procedures.  While the conversion of each open procedure into a
minimally invasive surgical approach involves specific limitations and
challenges, the single largest impediment to conversion, according to several
independent marketing studies, is the difficulty of reliably suturing and
stapling surgical wounds as a result of the severe space constraints frequently
encountered when operating through trocars and in the limited space provided by
body cavities.  The Company believes that its products may reduce the
difficulties associated with sutures and staples.

THE FUSION SOLUTION

    Fusion has developed proprietary wound closure products, which the Company
believes may have broad application in lung resections for cancer and emphysema,
as well as procedures requiring anastomoses and minimally invasive surgery.  The
Company's products are designed to treat surgical wounds in a wide variety of
organs and blood vessels by forming a flexible seal across the targeted tissue.
The Rapiseal patch and the Fusion flowable-gel products have been designed to
function in conjunction with the proteins common to all organ tissue.  In
preclinical studies, the Company has bonded RapiSeal to virtually all organs as
well as to most muscle tissue.  Determination of the clinical utility of the
RapiSeal patch for any particular procedure, beyond those already approved by
appropriate regulatory authorities, may require additional testing.

    Fusion's initial product, RapiSeal, is a thin, collagen-based,
bioresorbable patch which can be custom cut to size by the surgeon and is easily
applied to the tissue surface using an enhanced argon coagulation generator (a
radio frequency energy source), or equivalent energy source found in many
hospitals.  When applied, Fusion's patch product bonds with the underlying
tissue to create a seal which is fully resorbed by the body over time.  The
application of the patch does not perforate or mechanically stress neighboring
tissue, and the flexible characteristics of the collagen-based material make it
suitable for use on dynamic organs such as the lung.

    The Company is also currently developing collagen-based liquid products
which do not require an energy source to effect attachment to the underlying
tissue.  The products emerging from these efforts are designed to be easily
applied to the targeted tissue with a delivery device being developed by the
Company, and to seal heavy, active bleeding.  The Company believes the
flowable-gel formulations now emerging from the liquid program may enable
surgeons to


                                                                              7


<PAGE>

quickly and easily seal heavy active bleeding which occurs in surgical areas
that are difficult to access and may provide surgeons with an additional margin
of safety when used with sutures and staples.

    The Company believes its products offer the following key benefits:

      -  EFFECTIVE CLOSURE AND SEALING.  The Company's products form a strong
    adhesive bond to the underlying tissues, providing effective wound closure
    and sealing without perforating or placing compromised tissue under
    tension.  The elasticity and flexibility of the Company's RapiSeal patch
    permit the natural expansion and contraction of dynamic organs such as the
    lung.  Both the RapiSeal patch and the Fusion flowable-gel are capable of
    bonding with and sealing fragile tissues, such as those in the lung, liver
    and spleen.

      -  RESORPTION.  The Company's proprietary, collagen-based, bioresorbable
    materials have been engineered to be resorbed by the body.  The
    adaptability of the Company's technology permits Fusion to modify the
    resorption period of its products to suit a variety of surgical
    applications.  In the case of RapiSeal, the Company has engineered the
    patch to be fully resorbed by the body within approximately 28 days.

      -  USEFUL IN MINIMALLY INVASIVE SURGERY. The Company's flowable-gel
    product is compatible with instruments and techniques used in minimally
    invasive surgeries.  The Company expects to begin conducting clinical
    evaluations to increase the exposure of surgeons to the flowable-gel to
    demonstrate surgeon acceptance of the flowable-gel.

      -  BROAD APPLICABILITY.  The Company's products have, in preclinical
    animal models, effectively demonstrated their effectiveness in a wide
    variety of organs such as the heart, liver, spleen, lung and esophagus.  As
    a result, the Company believes that its products may be applicable to a
    variety of surgical procedures, including lung resections, surgeries
    involving anastomoses and minimally invasive surgery.

      -  SAFETY.  The materials used in the Company's wound closure products
    are derived from naturally occurring biomaterials and polymers that have a
    long history of device use in humans.  These products contain no
    human-derived components such as blood.

      -  EASE OF USE.  The Company's wound closure products can be easily
    applied and are designed to require minimal training for successful
    application.  The Company believes that surgeons will quickly learn how to
    use the Company's wound closure products effectively.

 STRATEGY

    The Company's objective is to become a leading provider of proprietary
wound closure products.  Key elements of the Company's strategy include the
following:

    MARKET DRIVEN PRODUCT DEVELOPMENT.  The Company conducts active market
research by observing surgical procedures and maintaining frequent contact with
leading surgeons in order to identify specific surgical needs and significant
market opportunities.  Only after identifying these opportunities does the
Company commence its research and development efforts.  As a result, the Company
believes its market focus should accelerate the adoption of its products once
they become commercially available.  In addition, the Company expects to
maintain an active dialogue with surgeons to ascertain the most desirable
enhancements for its products.

    PRODUCT POSITIONING.  The Company plans to initially market its products as
complementary to sutures or staples for wound closure.  Where suture and staple
use is appropriate, the Company's patch products offer surgeons an additional
margin of safety in


                                                                              8


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wound closure.  Where compromised tissue would otherwise preclude surgery for
patients with sutures and staples alone, the Company's products are designed to
enable the surgeon in some cases to consider surgery for these patients.

    BUILD LEADING MARKET SHARE.  The Company's goal is to rapidly develop a
leading market position in the thoracic surgery market with its initial product,
RapiSeal.  The Company launched the product in the United States through its own
direct sales force, focusing initially on the 50 largest volume thoracic surgery
centers.  The Company intends to educate surgeons on the clinical benefits of
using RapiSeal for the treatment of air leaks which frequently occur as a result
of lung resections.  The Company believes that the expansion of its relationship
with the thoracic surgical community, as a result of the introduction of
RapiSeal, will facilitate the launch of the Fusion flowable-gel.

    LEVERAGE PROPRIETARY TECHNOLOGY.  The Company received 510(k) pre-market
clearance from the FDA to market its RapiSeal patch in connection with lung
surgery in June 1996. Subsequently, in February 1997, the Company obtained
510(k) pre-market clearance for indications in abdominal organs, such as the
liver and spleen. The Company believes that its proprietary products' sealant
and wound closure capabilities may have application beyond these indications and
is evaluating those areas where they may offer benefits, including general and
cardiovascular surgery.

PRODUCTS

    RAPISEAL PATCH.  The Company's initial product, RapiSeal, is a thin
collagen-based, bioresorbable patch.  The patch measures four by four
centimeters that can be cut by the surgeon to the desired size prior to use.  In
the presence of normal body fluids, the RapiSeal patch becomes soft, elastic and
flexible to facilitate placement over irregular surfaces.  The application of
energy to the RapiSeal patch causes the material of the patch to flow into
irregularities and fissures in the underlying tissue.  At the same time, the
energy causes the patch to fuse with the proteins from this tissue, creating a
strong, adhesive bond with the patch.  This process results in a flexible seal
that does not stress the neighboring tissue and achieves the elasticity
necessary for a dynamic organ like the lung.  After approximately 28 days, the
body resorbs the patch.  Similar to a number of other commonly used medical
products, the RapiSeal patch requires refrigeration while in storage.  RapiSeal
currently has a shelf life of approximately one-year.

    The Company initially targeted the RapiSeal patch for use in treating air
leaks that frequently occur during pulmonary surgery.  In June 1996, Fusion
received clearance from the FDA to market the patch for this application, and
the Company began its sales launch in October 1996.  See "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
Unlike pericardial strips, which are frequently used in LVR procedures, RapiSeal
can be applied independent of staples, and therefore its utility is not limited
to leaks on the staple line.  Moreover, RapiSeal creates its bond with the
underlying tissue without perforating or stressing the neighboring tissue.  This
may be particularly significant in LVR surgery because emphysema patients have
especially fragile and friable lung tissue.

    In its submission to the FDA for 510(k) pre-market clearance in April 1996,
the Company reported on the results of its 26 patient, multi-center clinical
trial. The study evaluated 52 air leaks that existed after the exhaustion of
conventional options for closure, if any, such as the application of staples.
In all cases the surgeon would normally have closed the operative site with
these leaks still active.  When measured by the study's end points, RapiSeal was
able to effectively treat 96% of these air leaks, whether occurring on the
suture or staple line or elsewhere on the lung.

    Based upon the results of its 26 patient, multi-center clinical trial in
the United States, the Company applied for a CE Mark to sell RapiSeal in Europe.
In February 1997, the Company


                                                                              9
<PAGE>

received a CE Mark to market the RapiSeal patch throughout the European Union.
The Company is currently entering into agreements with country specific
distributors to market the product in Europe.

    In February 1997, the Company received FDA clearance to market a patch
product for use in connection with solid abdominal surgeries, including liver
and spleen surgeries.  The Company has conducted tests of the patch in animals,
and based on these results believes the product will be effective in people who
undergo cancer or trauma surgeries in these organs.  See "Background -
Liver/spleen surgeries."  Fusion will conduct test-marketing studies of the
patch product before it fully launches the product.

    The flowable-gel products emerged from the Company's liquids research
program. The Company will be required to undertake time consuming and costly
development activities and seek regulatory approvals for these products.  There
can be no assurance that product development will be successfully completed, or
that regulatory approval, if applied for, will be granted on a timely basis, if
at all, or that these products will achieve commercial acceptance.

RESEARCH AND DEVELOPMENT

    The Company's research and development activities are focused on enhancing
RapiSeal, and expanding the applications of the flowable gel and developing
other liquid sealants to broaden the potential markets for the Company's wound
closure technology.  Since introducing the RapiSeal patch, the Company has
established an active dialogue with surgeons to ascertain the most desirable
product enhancements.  In March 1997, Fusion filed with the Food and Drug
Administration (FDA) for 510(k) pre-market clearance to market the SilverBullet,
an inexpensive electro-cautery accessory designed to allow for the application
of the RapiSeal patch using standard electro-surgery units commonly present in
operating rooms.  There can be no assurance as to when any such clearance will
be received, if at all. There also can be no assurance that if such clearance is
received, the accessory will be adopted by surgical facilities as an extension
to their existing electro-surgical procedures, or that the accessory can be
delivered cost-effectively or in sufficient quantity to support potential
demand.

    In pre-clinical studies the Company has successfully sealed high-pressure
leaks in vascular anastomoses and heavy active bleeding in diffuse bleeding
situations using the flowable-gel. The Company believes a significant
opportunity may exist for sealing anastomoses and treatment of heavy active
bleeding in a broad array of surgeries, including minimally invasive
procedures performed by specialists such as cardiovascular and general
surgeons. There can be no assurance that the Company will develop products
for any of these procedures, that any of the Company's products will receive
regulatory approvals or, if received, that such products will achieve
successful commercialization.

    The Company's research and development department consisted of 22 employees
at March 15, 1997.  See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for additional information regarding the
Company's Research and Development expenses for the year ended 1996.

SALES AND MARKETING

    Fusion's sales and marketing activities are currently focused on the sale
of RapiSeal for use in lung resections to treat cancer and emphysema.  The
Company is selling the RapiSeal patch in the United States through its own
direct sales force of three persons.  The Company plans to add two additional
sales representatives in the second quarter 1997 to increase the market exposure
of the RapiSeal patch.  The Company's principal marketing strategy is to educate
surgeons on


                                                                             10


<PAGE>

the clinical benefits of using the RapiSeal patch for the treatment of air leaks
that frequently occur during lung resections.

    The Company is establishing relationships with distributors for
international sales and marketing in several countries outside the United
States.  The Company believes these distributors are familiar with the thoracic
surgical communities in these countries.  There can be no assurance that the
Company will be able to successfully commercialize any of its products in any
international market.  If the marketing trials in liver/spleen surgeries prove
successful the Company's sales force will begin marketing this product to the
major surgery centers. The medical facilities performing the greatest number of
liver and spleen surgeries are accessible to the Company sales force in both
elective liver cancer surgeries and trauma.

MANUFACTURING

    The Company's manufacturing operations are located in a 13,200 square foot
in-house facility in Mountain View, California.  Fusion acquires product
components from suppliers, processes the materials internally to the appropriate
form and compositions, arranges for sterilization by a third party and then
packages the products for shipment.  The Company acquires several components of
its product from single suppliers.  Generally, the Company believes that there
are alternative suppliers of equivalent materials available and that the Company
could substitute suppliers with only minimal regulatory consequences from this
substitution.  However, there can be no assurance that such substitute supplies
will be available or that such substitutions could be made in a timely manner,
on commercially reasonable terms, if at all.  In the event the Company is unable
to acquire sufficient supplies from current sources or locate alternate sources
on commercially reasonable terms, the Company may not be able to manufacture its
products on a timely and cost-competitive basis, or at all. This would have a
material adverse effect on the Company's business, financial condition and
results of operations.

    In the case of collagen, there are only a few suppliers that could meet the
Company's requirements. The Company currently relies exclusively on one supplier
of collagen, Kensey Nash Corporation, and expects to continue to do so through
at least the end of 1997.  Fusion and this supplier have entered into a
long-term supply agreement.  Should any problems with this supplier and/or its
product arise in the future, the Company has the right to assume manufacturing
of the collagen under the terms of an agreement with the supplier.  The Company
has evaluated the feasibility of, and the techniques used for manufacturing
collagen at its own facilities using raw materials available from several
suppliers. However, there can be no assurance that the Company would be able to
secure sufficient inventory of collagen to produce sufficient product to meet
its customers' needs.  A transition to alternate arrangements would involve
additional costs and delays in production.  There can be no assurance that such
transition would be successfully achieved on a cost-effective or timely basis,
if at all, or that the Company would be successful in entering into alternate
arrangements on commercially reasonable terms, if at all.  Sterilization of the
Company's products is out-sourced to a single provider.  While the Company
believes alternative sterilization providers are readily available, there can be
no assurance that such providers would be available or that such a transition
could be made in a timely, cost-effective manner.  Although the Company has
taken the actions that it believes are reasonable to assure that its contract
manufacturer and suppliers are in compliance with applicable regulations, there
can be no assurance that the FDA or a state, local or foreign regulator will not
take action against a contract manufacturer or supplier.


                                                                             11


<PAGE>

PATENTS AND PROPRIETARY RIGHTS

    The Company has pursued its own patents covering its technologies in
various forms.  In addition, the Company has licensed additional technology
to further broaden its patent portfolio. The Company owns one and has licensed 2
issued United States patents, and has 14 pending United States patent
applications related to its patch technology and liquid formulations. The
Company has also licensed 1 United States patent related to the manufacture of
its patch technology.  There can be no assurance that the pending patent
applications will issue or that the issued patent or any patents which may issue
will provide any competitive advantages for the Company's products or that they
will not be successfully challenged, invalidated or circumvented in the future.
The Company has filed certain corresponding patent applications in certain
foreign countries and may file additional patent applications outside the United
States.  The Company believes that obtaining foreign patents may be more
difficult than obtaining domestic patents because of differences in patent laws
and believes the protection provided by foreign patents, if obtained, and any
other foreign intellectual property protection may be weaker than that provided
domestically.  In addition, there can be no assurance that competitors will not
seek to apply for and obtain patents that will prevent, limit or interfere with
the Company's ability to make, use and sell its products either in the United
States or in international markets.  A number of medical device and other
companies, universities and research institutions have filed patent applications
or have issued patents relating to compositions and methods for wound closure.
The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights.  Many companies in the
medical device industry have employed intellectual property litigation to gain a
competitive advantage, and there can be no assurance that suit will not be
brought against the Company in the future.  Moreover, litigation or interference
proceedings associated with enforcing or defending patents or trade secrets is
expensive and can divert the efforts of technical and management personnel.

    The Company's policy is to execute confidentiality agreements with its
employees and consultants upon the commencement of an employment or consulting
relationship with the Company.  These agreements generally require that all
confidential information developed or made known to the individual by the
Company during the course of the individual's relationship with the Company be
kept confidential and not disclosed to third parties.  These agreements also
generally provide that inventions conceived by the individual in the course of
rendering services to the Company shall be the exclusive property of the
Company.  There can be no assurance that such agreements will not be breached,
that the Company would have adequate remedies for any breach or that the
Company's trade secrets will not be otherwise become known to or be
independently developed by competitors.

    An adverse determination in litigation or interference proceedings to which
the Company may become a party could subject the Company to significant
liabilities to third parties, require disputed rights to be licensed from third
parties or require the Company to cease using such technology.  Although patent
and intellectual property disputes in the medical device area have often been
settled through licensing or similar arrangements, costs associated with such
arrangements may be substantial and could include ongoing royalties.
Furthermore, there can be no assurance that necessary licenses would be
available to the Company on satisfactory terms, if at all.  Adverse
determinations in a judicial or administrative proceeding or failure to obtain
necessary licenses on satisfactory terms, if at all, could prevent the Company
from manufacturing and selling its products, which would have a material adverse
effect on the Company's business, financial condition and results of operations.


                                                                             12


<PAGE>

GOVERNMENT REGULATION

UNITED STATES

    The research, development, manufacture, labeling, distribution and
marketing of the Company's products are subject to extensive and rigorous
regulation by the FDA and, to varying degrees, by state and foreign regulatory
agencies.  The Company's products are regulated in the United States as medical
devices by the FDA under the Federal Food, Drug, and Cosmetic Act (the "FDC
Act") and require clearance or approval by the FDA prior to commercialization.
In addition, material changes or modifications to labeling, manufacturing and
design also are subject to regulatory review and clearance or approval.  Under
the FDC Act, the FDA regulates the research, clinical testing, manufacturing,
safety, labeling, storage, record keeping, advertising, distribution, sale and
promotion of medical devices in the United States.  In addition, the FDA has
promulgated regulations, effective June 1997, to extend its oversight of medical
devices to design and development activities. The testing for, preparation of
and subsequent review of applications by the FDA and foreign regulatory
authorities is expensive, lengthy and uncertain.  The failure by the Company to
comply with FDA requirements could result in warning letters, fines,
injunctions, civil penalties, recall or seizure of products, total or partial
suspension of production, the government's refusal to grant pre-market clearance
or pre-market approval for devices and criminal prosecution.

    The FDA also has the authority to require clinical testing of certain
medical devices.  If clinical testing of a device is required and if the device
presents a "significant risk," an application for an investigational device
exemption ("IDE") must be cleared prior to commencing clinical trials.  The IDE
application must be supported by data, typically including the results of
laboratory and animal testing.  If the IDE application is cleared by the FDA,
clinical trials may begin at a specific number of investigational sites with a
maximum number of patients, as cleared by the agency.  Sponsors of clinical
trials are permitted to sell those devices distributed in the course of the
study provided such costs do not exceed recovery of the costs of manufacture,
research, development and handling.  The clinical trials must be conducted under
the auspices of an institutional review board ("IRB") pursuant to FDA
regulations.

    Generally, before a new device can be introduced into the market in the
United States, the manufacturer or distributor must obtain FDA clearance of a
510(k) or approval of a PMA application.  If a medical device manufacturer or
distributor can establish, among other things, that a device is "substantially
equivalent" in intended use and technological characteristics to certain legally
marketed devices, for which the FDA has not required a PMA, the manufacturer or
distributor may seek clearance from the FDA to market the device by filing a
510(k).  The 510(k) will need to be supported by appropriate data establishing
to the satisfaction of the FDA the claim of substantial equivalence to the
predicate device.  In recent years, the FDA has been requiring a more rigorous
demonstration of substantial equivalence.

    Following submission of the 510(k), the manufacturer or distributor may not
place the device into commercial distribution unless and until an order is
issued by the FDA finding the product to be substantially equivalent.  In
response to a 510(k), the FDA may declare that the device is substantially
equivalent to another legally marketed device and allow the proposed device to
be marketed in the United States.  The FDA, however, may require further
information, including clinical data, to make a determination regarding
substantial equivalence, or may determine that the proposed device is not
substantially equivalent and requires a PMA.  Such a request for additional
information or determination that the device is not substantially equivalent
would delay market introduction of the products that are the subject of the
510(k).

    If a manufacturer or distributor of medical devices cannot establish that a
proposed device is substantially equivalent to a legally marketed device, the
manufacturer or distributor must seek pre-market approval of the proposed device
through submission of a PMA.  A PMA must be supported by extensive data,
including, laboratory, preclinical and clinical trial data to prove the safety
and effectiveness of the device as well as extensive manufacturing information.
The PMA approval process can be lengthy, expensive and uncertain and is
typically longer than that


                                                                             13


<PAGE>

required for a 510(k).  If granted, the approval of the PMA may include
significant limitations on the indicated uses for which a product may be
marketed.

    The Company received a 510(k) clearance to market its RapiSeal patch in
lung surgeries in June 1996 and to market a patch product to treat bleeding in
liver/spleen surgeries in March 1997.  PMA approval may be required for its
liquid sealant products.  There can be no assurance that the Company will be
able to obtain necessary 510(k) clearances or PMA approvals to market its
products, other than those already obtained, for the intended uses on a timely
basis, if at all.  Moreover, regulatory clearances and approvals, if obtained,
may include significant limitations on the indicated uses for which a product
may be marketed.  Delays in receipt of or failure to receive such approvals or
clearances, the loss of previously obtained approvals or clearances, or failure
to comply with existing or future regulatory requirements would have a material
adverse effect on the Company's business, financial condition and results of
operations.  See "Business--Products."

    The Company is also required to register as a medical device manufacturer
with the FDA and state agencies, such as the California Department of Health
Services ("CDHS"), and to list its products with the FDA.  As such, the Company
will be inspected by both the FDA and CDHS for compliance with GMP and other
applicable regulations.  These regulations require that the Company manufacture
its products and maintain its documents in a prescribed manner.  Prior to
approval of a PMA, the FDA will conduct an inspection of the Company's
manufacturing facility to assure compliance with GMP regulations.  The FDA has
not  inspected the Company for GMP compliance.  In August 1995, the Company's
Mountain View facility was inspected by the CDHS with no violative observations,
and the Company was subsequently granted a California medical device
manufacturing license.

    The Company is required to provide information to the FDA on death or
serious injuries that its medical devices have allegedly caused or contributed
to, as well as product malfunctions that would likely cause or contribute to
death or serious injury if the malfunction were to recur.  In addition, the FDA
strictly prohibits the marketing of approved devices for uses other than those
specifically cleared for marketing by the FDA.  If the FDA believes that a
Company is not in compliance with the law or regulations, it can institute
proceedings to detain or seize products, issue a recall, enjoin future
violations and assess civil and criminal penalties against the Company, its
officers and its employees.  Failure to comply with the regulatory requirements
could have a material adverse effect on the Company's business, financial
condition and results of operations.

    The promotion of most products regulated by the FDA is subject to both FDA
and Federal Trade Commission jurisdiction.  The Company is also subject to
regulation by the Occupational Safety and Health Administration and by other
government entities.  Regulations regarding the manufacture and sale of the
Company's products are subject to change.  The Company cannot predict what
impact, if any, such changes might have on its business, financial condition or
results of operations.

INTERNATIONAL

    Sales of medical devices outside the United States are subject to foreign
regulatory requirements that vary widely from country to country.  The time
required to obtain clearance required by foreign countries may be longer or
shorter than that required for FDA clearance, and requirements for licensing may
differ significantly from FDA requirements.  Some countries have historically
permitted human studies earlier in the product development cycle than
regulations in the United States permit.  Other countries, such as Japan, have
requirements similar to those of the United States.  This disparity in the
regulation of medical devices may result in more rapid product clearance in
certain countries than in others.


                                                                             14


<PAGE>

    The European Union has promulgated rules which require that medical devices
receive by mid-1998 the right to affix the CE Mark, an international symbol of
adherence to quality assurance standards and compliance with applicable European
Union Medical Devices Directives.  The ISO 9000 series of standards for quality
operations have been developed to ensure that companies know the standards of
quality to which they must adhere to receive European Union certification.  ISO
9000 certification is one of the CE mark certification requirements.  Fusion
received the right to affix the CE Mark to the RapiSeal patch in February 1997.
The Company received ISO 9001 qualification of its processes in February 1997.

    Once a manufacturer has satisfactorily completed the regulatory compliance
tasks required by the directives and received favorable determinations by the
Notified Body, it is then eligible to affix the CE Mark on its products.  The
quality system will be subject to periodic audit and recertification, and
serious adverse events must be reported to the authorities in the country where
the incident takes place.  If such incidents occur, the manufacturer may be
required to take remedial action, including withdrawal of the product from the
EU market.  New products may be required to undergo similar testing and
inspection, prior to being eligible for CE Marking.

    While additional pre-market approvals are not required by individual
countries, practical complications and various other differences have arisen
among member countries, such as labeling requirements.  Moreover, since the
directives do not cover reimbursement and distribution practices, differences
may occur in these and other areas as well.

    An unapproved PMA device may be exported to any country, without prior FDA
approval, provided the unapproved product is in compliance with the laws of that
country and has been approved in a listed country, as defined in Section 802 of
the FD&C Act.  An unapproved PMA device, intended only for investigational use
in a listed country, may be exported in accordance with the laws of that country
and is exempt from the investigational device provisions of the FD&C Act.  An
exporter must notify the FDA upon commencing export of an unapproved PMA device.
An unapproved 510(k) device may be exported to any country without prior FDA
approval, provided the device accords to the specifications of the foreign
purchaser, is not in conflict with the laws of the importing country, is labeled
for export, and is not offered for sale in domestic commerce.  PMA and 510(k)
devices that have been cleared by the FDA do not require FDA export approval or
notification.

THIRD-PARTY REIMBURSEMENT

    In the United States, health care providers that purchase medical devices,
such as RapiSeal, generally rely on third-party payors, principally federal
Medicare, state Medicaid and private health insurance plans, to reimburse all or
part of the cost of the procedure in which the medical device is being used.
The Company's success will be dependent, in part, upon its ability to obtain
satisfactory third-party reimbursement from health care payors for surgical
procedures that may use RapiSeal and the Fusion liquids.  Reimbursement for
thoracic procedures performed using devices that have received FDA approval has
generally been available in the United States.  However, HCFA has temporarily
suspended payment for, and is reviewing the appropriate reimbursement, if any,
for LVR.  See "Background - LVR".   In connection with such reviews, HCFA has
announced its intention to collaborate with the NIH on a large-scale,
multi-center clinical trial to be conducted by the NIH to evaluate the long-term
benefits of the LVR procedure for patients with late-stage emphysema.  There can
be no assurance as to when this trial will be completed or whether the results
of the trial will demonstrate the safety or long-term efficacy of LVR.  It is
not known when HCFA will make a final determination as to reimbursement for LVR,
and it may take several years before a determination is made.  There can be not
assurance that reimbursement for LVR will be reinstated or, if reinstated, that
HCFA will not impose limitations on reimbursement.  The Company believes a
significant portion of the candidates for the LVR procedure could be affected by
HCFA's determination with respect


                                                                             15


<PAGE>

to reimbursement.  Availability of reimbursement of the LVR procedure will also
depend, in part, on the clinical effectiveness and cost of the Company's
products.  Failure to reinstate reimbursement or the imposition of limitations
on reimbursement would have a material adverse effect on the Company's business
prospects.  The LVR procedure has recently been endorsed by the Society of
Thoracic Surgeons for certain patients with late-stage emphysema, and several
third-party payors continue to reimburse for the surgery.  However, there can be
no assurance that such endorsement or reimbursement will continue.  If
reimbursement were not available for LVR procedures, it would have a material
adverse effect on the Company's business, financial condition and results of
operations.

    The Company anticipates that in a prospective payment system, such as the
Diagnostic Related Group system utilized by Medicare and in many managed care
systems used by private health care payors, the cost of the Company's products
will be incorporated into the overall cost of the procedures and that there will
not be separate additional reimbursement for the Company's products.  Regardless
of the type of reimbursement system, the Company believes that surgeon advocacy
of RapiSeal and the Fusion liquids will be required to obtain reimbursement.
Availability of reimbursement for the LVR procedure will also depend, in part,
on the clinical effectiveness and cost of the Company's products.  While the
Company believes that its products offer cost savings and clinical benefits over
that of competitive products, there can be no assurance that any reimbursement
will be sufficient to assure profitability.

    In February 1997 the Company obtained CE mark approval for Rapiseal,
however, market acceptance of RapiSeal and other Company's products in
international markets will be dependent, in part, upon the availability of
reimbursement within prevailing health care payment systems for the Company's
products or the procedures in which the products are used.  Reimbursement and
health care payment systems in international markets vary significantly by
country and include both government-sponsored health care and private insurance.
The Company intends to seek international reimbursement approvals.  There can be
no assurance that any such approvals will be obtained in a timely manner, if at
all, and failure to receive international reimbursement approvals could have a
material adverse effect on market acceptance of the Company's products in the
international markets in which such approvals are sought.  Failure by
physicians, hospitals and other users of the Company's products to obtain
sufficient reimbursement from health care payors for procedures in which the
Company's products are used or adverse changes in governmental and private
third-party payors' policies toward reimbursement for such procedures would have
a material adverse effect on the Company's business, financial condition and
results of operations.

COMPETITION

    The wound closure market is highly competitive, and the Company expects
competition in its targeted markets to intensify.  Direct product competition
includes pericardial and synthetic strips and fibrin glues.  Several large
companies involved in wound closure technologies may be developing products that
would compete with the Company's products.  The Company is also aware of several
potential competitors who are working on biological tissue sealants.  Many of
these competitors or potential competitors have greater name recognition,
broader product lines, greater distribution capabilities, substantially greater
capital resources and larger marketing, research and development staffs and
facilities than the Company.  Broad product lines give many of the Company's
competitors or potential competitors the ability to negotiate exclusive,
long-term medical device supply contracts and, consequently, the ability to
offer comprehensive pricing for their products, including those that may compete
with the Company's products.  By offering a broader product line in the general
field of medical devices and supplies, these competitors or potential
competitors may also have a significant advantage in marketing competing
products to group purchasing organizations and other managed care organizations
that increasingly seek to reduce costs through centralization of purchasing
functions.  There can be no assurance that the Company can effectively compete
against such competitors or potential


                                                                             16


<PAGE>

competitors.  In addition, there can be no assurance that the Company's current
competitors or other companies will not succeed in developing technologies and
products that are more effective than the Company's or that would render the
Company's technology or products obsolete or NOT competitive.

    The Company believes that the primary competitive factors in the wound
closure market are effectiveness, price and ease of use.  In addition, the
length of time required for products to be developed and to receive regulatory
and reimbursement approval, and proprietary position are important competitive
factors.  The Company believes it is positioned to compete favorably with
respect to these factors, although there can be no assurance it will be able to
do so.

PRODUCT LIABILITY AND INSURANCE

    The development, manufacture and sale of medical products entail
significant risk of product liability claims.  The Company faces an inherent
business risk of financial exposure to product liability claims in the event
that use of its products results in personal injury or death, and there can be
no assurance that the Company will not experience losses due to product
liability claims.  The Company currently maintains product liability insurance
coverage with a limit of $3.0 million on a claims-made basis; however, there can
be no assurance that existing coverage limits of the Company's product liability
insurance will be adequate.  Increased product liability coverage may be
required if any potential products are successfully commercialized.  Product
liability insurance is expensive and in the future may not be available to the
Company on acceptable terms, if at all.  Any product liability claims or series
of claims brought against the Company, regardless of their merit or eventual
outcome, could have a material adverse effect on the Company's business,
financial condition and results of operations.

EMPLOYEES

    As of March 15, 1997, the Company had 57 employees, 22 of whom were engaged
in research and development, 10 in finance and administration, 3 in regulatory
affairs, 10 in marketing and sales and 12 in manufacturing and quality
assurance.  The Company also had consulting arrangements with 19 persons.  No
employees are covered by collective bargaining agreements, and the Company
believes it maintains good relations with its employees.

ITEM 2.  PROPERTIES

FACILITIES

    The Company leases 13,200 square feet in Mountain View, California, which
comprise the Company's manufacturing and warehousing space.  The Company's lease
for this facility extends through June 1998, and the Company has the option to
extend it until the end of 1998.  The Company also leases 7,051 square feet in
Mountain View, California, which comprise the Company's administrative, sales
and marketing offices.  The Company's lease for this facility extends through
October 1999.  The Company believes that its existing facilities will be
sufficient for its operational purposes through 1998.

    The Company's manufacturing facilities are subject to GMP regulations,
international quality standards and other regulatory requirements.  Difficulties
encountered by the Company in manufacturing scale-up or failure by the Company
to implement and maintain its facilities in accordance with GMP regulations,
international quality standards or other regulatory requirements could entail a
delay or termination of production, which would have a material adverse effect
on the Company's business, financial condition and results of operations.  The
Company received a manufacturing license from CDHS and commenced shipment of
product for sale in August 1996.  However, the Company has no experience
manufacturing its product in the volumes necessary to achieve significant
commercial sales, and there can be no assurance that


                                                                             17


<PAGE>

reliable, high-volume manufacturing can be achieved at a commercially reasonable
cost.  Any manufacturing difficulties involving production yields, quality
control and assurance, supplies of components or shortages of qualified
personnel encountered by the Company could have a material adverse effect on its
business, financial condition and results of operations.  There can be no
assurance that the Company will be able to manufacture and supply sufficient
quantities of products to meet product requirements for United States and
International clinical trials and commercial sales.

ITEM 3.  LEGAL PROCEEDINGS

    The Company does not have any on-going litigation.  A complaint filed
against the Company and two of its founders was settled for an amount that was
not material to the Company.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.


                                                                             18

<PAGE>

                          EXECUTIVE OFFICERS OF THE COMPANY

The executive officers of the Company and their ages as of March 19, 1997 are as
follows:

Name                    Age       Position with Fusion
----                    ---       --------------------
Philip M. Sawyer        32        President, Chief Executive Officer & Director
Gary A. Curtis          49        Executive Vice President, Sales & Marketing
Debera A. Brown         44        Vice President, Regulatory & Clinical Affairs
Cary A. Reich, Ph.D.    48        Vice President Research & Development
Louis S. Fries          49        Vice President, Operations

MR. SAWYER, a founder of the Company, has served as President and Chief
Executive Officer since April 1993.  From 1991 to 1993, Mr. Sawyer was a Product
Manager and Manager of Business Development at the Stryker Endoscopy Division of
Stryker Corporation ("Stryker Endoscopy"), a manufacturer of endoscopic surgical
devices.  From 1987 to1989, Mr. Sawyer worked at Patricof & Co. Ventures Inc.
From 1986 to 1987, Mr. Sawyer worked in the health care corporate finance group
at E.F. Hutton and Co.  Mr. Sawyer holds an M.B.A. from the Harvard Business
School.

MR. CURTIS, joined the Company in February 1996 as Executive Vice President,
Sales and Marketing.  From 1994 to 1995, Mr. Curtis was Vice President, Sales
and Marketing, and a Director of Biometric Imaging, Inc., a private
biotechnology company specializing in cellular diagnostics.  From 1983 to 1988,
Mr. Curtis was Vice President, Sales with Advanced Cardiovascular Systems
("ACS"), a leader in coronary angioplasty.  From 1988 to August 1993, he was
General Manager for ACS's Peripheral Systems Group.

MS. BROWN, joined the Company in May 1995 as Vice President, Regulatory and
Clinical Affairs.  From 1990 to 1995, Ms. Brown was Vice President, Medical and
Regulatory Affairs, of Celtrix Pharmaceuticals ("Celtrix"), a manufacturer of
biopharmaceutical products from recombinant proteins.  From 1974 to 1990, Ms.
Brown held various positions in regulatory, quality assurance and project
management at Collagen Corporation ("Collagen"), a manufacturer of
collagen-derived medical devices.  Her most recent position at Collagen was
Program Director, Hard Tissue Projects.

DR. REICH, joined the Company in May 1995 as Vice President, Research and
Development.  From 1987 to 1995, Dr. Reich held various positions at Chiron
Vision, a manufacturer of devices and pharmaceuticals to correct, improve and
restore vision, with his most recent position being Vice President, Research and
Development.  Dr. Reich holds a Ph.D. in Physical Organic Chemistry from
Stanford University.

MR. FRIES, joined the Company in March 1997 as Vice President of Operations.
From 1992 to 1997, Mr. Fries was a Senior Director at Matrix Pharmaceuticals,
where he directed process development, scale up and technology transfer.  From
1987 to 1992, Mr. Fries was Director of Process Development and Engineering for
Collagen Corporation.  Mr. Fries holds a B.S., Chemical Engineering from Rutgers
University and a M.S., Chemical Engineering from Lehigh University.


                                                                             19


<PAGE>

                                       PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock trades on the Nasdaq National Market under the symbol
FSON. The Company has not paid any dividends since its inception and does not
intend to pay any dividends in the foreseeable future.

The Company completed an initial public offering of 2,100,000 shares of Common
Stock in June 1996.  Prior to the initial public offering, the Company's Common
Stock was not publicly traded.

Quarterly high and low stock prices are as follows:

Common Stock Price
------------------
Quarter Ended                                     High           Low
-------------                                     ----           ---
June 30, 1996 (from June 7, 1996)                $13.00         $7.375
September 30, 1996                               $10.125        $5.375
December 31, 1996                                $10.125        $4.00

The last closing price of the Common stock, as reported on the Nasdaq National
market on March 14, 1997 was $3.6275 per share.  As of March 15, 1997 there were
approximately 88 record holders of the Common stock.

ITEM 6.  SELECTED FINANCIAL DATA

    The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements and Notes thereto included elsewhere in
this Report.  The selected financial data set forth below with respect to the
Company's Statements of Operations for the years ended December 31, 1993, 1994,
1995 and 1996 and for the period October 14, 1992 (date of inceptions) to
December 31, 1996 and the balance sheet data as of December 31, 1994, 1995, and
1996 audited financial statements of the Company that have been included
elswhere herein and are qualified by reference to such Financial Statements and
Notes thereto.  The balance sheet data as of December 31, 1993 are derived from
audited financial statements not included herein.  The historical results are
not necessarily indicative of the results of operations to be expected in the
future.  The selected financial data for October 14, 1992 (date of inception) is
derived from unaudited financial statements of the Company included elsewhere
herein.  These unaudited financial statements have been prepared on the same
basis as the audited financial statements and, in the opinion of management,
include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the operating results and financial
position for such periods.   The operating results.


                                                                             20


<PAGE>


<TABLE>
<CAPTION>
                                                                                                            Cumulative
                                                                                                           Period from
                                                                                                         October 14, 1992
                                                             Year ended December 31,                    (Date of Inception)
                                             --------------------------------------------------------     to December 31,
                                                 1996           1995           1994           1993             1996
                                             -----------    -----------    -----------     ---------     ----------------
<S>                                          <C>            <C>            <C>              <C>          <C>
Statements of Operations Data:
     Net revenues                          $   31,000     $         -    $         -      $       -     $        31,000
     Cost of goods                             196,344              -              -              -             196,344
  Operating Expenses:
     Research and development                4,692,921      2,649,705        755,664        104,566           8,202,856
     Sales and marketing                     1,581,343        142,174         66,518                          1,790,035
     General and administrative              1,426,174        840,990        349,357        102,549           2,719,070
                                           -----------    -----------    -----------      ---------
        Loss from operations                 7,865,782      3,632,869      1,171,539        207,115          12,906,305
  Other income, net                             15,992           (920)        (2,000)                            13,072
  Interest income, net                        (926,185)      (351,236)       (16,246)        (3,901)         (1,297,568)
                                           -----------    -----------    -----------      ---------

        Net loss                           $(6,955,589)   $(3,280,713)   $(1,153,293)     $(203,214)    $(11,623,809.00)
                                           -----------    -----------    -----------      ---------    ----------------
                                           -----------    -----------    -----------      ---------    ----------------
        Net loss per share                 $     (1.45)   $     (1.69)   $     (.059)     $             $         (5.19)

        Shares used in computing net
        loss per share                       4,786,605      1,942,637      1,950,932                          2,235,422

        Pro forma net loss per share       $     (1.13)   $     (0.65)   $     (0.40)     $   (0.29)    $         (2.47)
                                           -----------    -----------    -----------      ---------    ----------------
                                           -----------    -----------    -----------      ---------    ----------------

        Shares used in computing pro
        forma net loss per share              6,163,770      5,023,621      2,877,694        712,282           4,710,591
                                            -----------    -----------    -----------      ---------    ----------------
                                            -----------    -----------    -----------      ---------    ----------------

<CAPTION>
                                                                                                December 31,
                                                                            1996            1995            1994           1993
                                                                       -------------    ------------    -----------    -----------
<S>                                                                    <C>              <C>             <C>            <C>
Balance Sheet Data:
  Cash, cash equivalents and available-for-sale securities            $  23,485,180    $  5,918,030    $   222,480    $ 1,207,443
  Working capital                                                        22,633,000       5,314,070        (79,985)     1,166,743
  Total assets                                                           25,062,791       6,629,492        436,358      1,216,815
  Long-term debt, including current portion                                 188,889         322,222        200,000              -
  Deficit accumulated during development stage                          (11,592,778)     (4,637,220)    (1,356,507)      (203,214)
  Total stockholders' equity                                             23,742,368       5,768,442        125,928      1,175,315

</TABLE>



ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
         CONDITION AND RESULTS OF OPERATIONS

THIS SECTION AND OTHER PARTS OF THIS REPORT CONTAIN FORWARD-LOOKING STATEMENTS
THAT INVOLVE RISKS AND UNCERTAINTIES.  THE COMPANY'S ACTUAL RESULTS MAY DIFFER
SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO,
THOSE DISCUSSED IN THE SUBSECTION ENTITLED "FACTORS AFFECTING OPERATING RESULTS
AND MARKET PRICE OF COMMON STOCK" COMMENCING ON PAGE 24.

OVERVIEW

    Since its inception in October 1992, Fusion has been primarily engaged in
the research and development of its wound closure products. As of December 31,
1996, the Company had an accumulated deficit of approximately $11.6 million.
Operating losses are expected to continue at least through 1999 as the Company
continues to expend substantial resources to fund clinical trials in support of
regulatory approvals and clearances, research and development, and expansion of
its sales and marketing activities.

    The Company commenced clinical trials of its first product, the RapiSeal
patch, in the United States in November 1995.  In April 1996, the Company
filed a 510(k) pre-market notification with the FDA seeking clearance to
market RapiSeal in the United States and received such clearance in June
1996.  The Company began the recruiting of its direct sales force in the
second quarter 1996 and commenced selling of the RapiSeal in the third
quarter 1996.  The Company recorded revenues of $31,000 for the year ended
December 31, 1996.  The Company completed the formation of a wholly owned
subsidiary, Fusion Medical Technologies, GmbH, headquartered in Munich,
Germany. The Company filed an application for CE Mark approval for the sale
of RapiSeal in the fourth quarter 1996 and received approval to


                                                                             21


<PAGE>

commence selling throughout Europe in February 1997.  The Company expects to
generate substantially all of its operating revenue for the next several
years from the United States and European sales of its patch product.  The
Company has also been engaged in research and development of liquid products,
and anticipates commencing initial human clinical trials of a liquid product
in the second half 1997.  In March 1997, the Company filed a 510(k)
pre-market notification with the FDA seeking clearance to allow for the use
of its electro-cautery accessory, the "SILVER BULLET-TM-", to assist in the
application of the RapiSeal using a standard electro-cautery device. There
can be no assurance that any addition products of the Company will be cleared
or approved for marketing by the appropriate United States or foreign
authorities or that such products will achieve market acceptance.

    Future revenues, if any, and results of operations may fluctuate
significantly from quarter to quarter and will depend upon, among other factors,
the extent to which the Company's product or products gain market acceptance,
the rate at which the Company establishes its distribution network, the timing
and size of any distributor purchases, the progress of clinical trials, the
introduction of competitive products for wound closure, and actions relating to
regulatory and reimbursement matters.

RESULTS OF OPERATIONS

    THE YEARS ENDED DECEMBER 31, 1996 AND 1995

    REVENUES
    The Company recorded revenue of $31,000 and $0 for the years ended December
31, 1996 and 1995, respectively.  The Company's sales representatives commenced
full-scale selling activities of RapiSeal in October 1996.

    RESEARCH AND DEVELOPMENT
    Research and development expenses were approximately $4.7 million and $2.6
million for the years ended December 31, 1996 and 1995, respectively.  The
increase was attributable to increased staff and associated personnel costs,
related use of supplies and equipment; increased use of consultants for
research, regulatory analysis and manufacturing; development of the
manufacturing process and facilities; continued development and improvements of
the RapiSeal product, design and development of the SilverBullet accessory, and
liquid product development. The Company anticipates that costs for research and
development of the Fusion flowable-gel and costs associated with the preparation
of manufacturing the flowable-gel product for use in clinical trials will
increase in 1997 and 1998.

    SALES AND MARKETING
    Sales and marketing expenses were approximately $1.6 million and $142,000
for the years ended December 31, 1996 and 1995, respectively.  The increase was
attributable to increased staff and personnel costs and related use of supplies
and equipment, expanded facilities, and increased costs associated with the
development of the RapiSeal selling effort. The Company anticipates that these
costs will continue to increase in 1997 and 1998 as the Company continues to
build its sales force and marketing staff in connection with the
commercialization of its products. The Company expects to add two additional
sales representatives in the second quarter 1997, bringing the total number of
sales representatives to five, to assist in expanding the Company's selling
efforts related to the RapiSeal and the introduction of the SilverBullet
accessory.

    GENERAL AND ADMINISTRATIVE
    General and administrative expenses were approximately $1.4 million and
$841,000 for the years ended December 31, 1996 and 1995, respectively.  The
increase was due to an increase in management and administrative staff, related
facilities costs, and costs associated with the Company's reporting
responsibilities as a public Company.  The Company anticipates that these costs
will increase marginally in 1997.


                                                                             22


<PAGE>

    DEFERRED COMPENSATION
    The Company recorded deferred compensation of approximately $1.5 million
for the difference between the option exercise price and the deemed fair market
value of the Company's Common Stock for options granted in 1996.  The deferred
compensation is being amortized to operating expenses over four years, the
related vesting period of the shares, and will, therefore, continue to have an
adverse effect on the Company's results of operations.  The Company amortized
approximately $378,000 of deferred compensation in the year ended December 31,
1996. The Company estimates the cost of deferred compensation for 1997 to be
$350,000, with additional amortized costs continuing in 1998 and 1999, at which
time the original $1.5 million in deferred compensation shall have been fully
amortized and expensed against earnings or losses.

    INTEREST INCOME
    Interest income was approximately  $926,000 and $382,000 for the years
ended December 31, 1996 and 1995, respectively.  The increase was due primarily
to increased balances of cash and cash equivalents resulting from the Company's
initial public offering in June 1996. The Company received net offering proceeds
of approximately $27.3 million before issuance costs of $2.9 million.  The
Company makes no predictions concerning the future yield or market performance
of the securities in which it invests its excess cash and cash equivalents.
Current and former investment performance should not be considered an indicator
of future performance and the interest income which might result therefrom.

YEARS ENDED DECEMBER 31, 1995 AND 1994

    REVENUES
    Prior to the year ended December 31, 1996, the Company recorded no
revenues.

    RESEARCH AND DEVELOPMENT
    Research and development expenses were approximately $2.6 million and
$756,000 for the years ended December 31, 1995 and 1994, respectively.  The
increase was attributable to the costs of a multi-site clinical trial that began
in November 1995, the commencement of research and development of the Fusion
liquids, and costs incurred in connection with the preparation for the
manufacture of RapiSeal for use in clinical trials.

    SALES AND MARKETING
    Sales and marketing expenses were approximately $142,000 and $67,000 for
the years ended December 31, 1995 and 1994, respectively.  The increase was
attributable to consulting costs and additional management and marketing staff
and associated personnel costs.

    GENERAL AND ADMINISTRATIVE
    General and administrative expenses were approximately $841,000 and
$349,000 for the years ended December 31, 1995 and 1994, respectively.  The
increase was due to an increase in management and associated personnel costs.

    INTEREST INCOME
    Interest income was approximately  $382,000 and $19,000 for the years ended
December 31, 1995 and 1994, respectively.  The increase was primarily due to
increased balances of cash and cash equivalents resulting from the sale of
shares of the Company's Series B Preferred Stock of approximately $8.9 million
consummated in January 1995.

LIQUIDITY AND CAPITAL RESOURCES

    Since inception, the Company's cash expenditures have significantly
exceeded its revenues, resulting in an accumulated deficit of approximately
$11.6 million at December 31, 1996.  The Company has financed its operations
primarily through private sales of equity securities and an


                                                                             23


<PAGE>

initial public offering in June 1996 aggregating approximately $34.1 million.
See the Company's registration on form SB-2 (No. 333-3970-LA) which became
effective June 7, 1996 and the related prospectus contained therein.

    The Company had cash, cash equivalents and available-for-sale securities of
approximately $23.5 million, $5.9 million and $222,000 as of December 31, 1996,
1995 and 1994, respectively. The increase in 1996 was due primarily to the
Company's sale of 2,100,000 shares of common stock at an initial public offering
in June 1996. The Company received net offering proceeds of approximately $24.4.
The increase in 1995 as compared to 1994 was primarily due to the sale of
Preferred Stock for approximately $8.9 million.

    Cash used by the Company's operations was approximately $6.1 million, $2.9
million and $1.1 million for the years ended December 31, 1996, 1995 and 1994.
The increase in cash used in 1996 was due primarily to increased research and
development related to RapiSeal and Fusion liquids, capital expenditures,
expenses related to the public offering in June 1996, and the development of a
direct sales force.  The increased cash used in 1995 as compared to 1994 was due
primarily to increased research and development expenses.  The Company
anticipates that it will continue to consume cash in increased amounts as it
continues its efforts to develop and commercialize the RapiSeal, SilverBullet
and Fusion liquid products.

    In 1994, the Company negotiated a $600,000 line of credit with Imperial
Bank.  At December 31, 1994, the Company had borrowed $200,000 under this
facility.  During May 1995, the line of credit was converted into a term loan.
The $400,000 term loan is payable in monthly installments through May 1998
bearing interest at the rate of prime plus 1.5% per annum with substantially all
of the Company's tangible assets secured as collateral.

    The Company believes that the Company's existing cash, cash equivalents and
available-for-sale securities will be sufficient to fund its operations at least
through 1998.  However, the Company's future capital requirements will depend on
numerous factors, including the successful marketing of RapiSeal and the Fusion
liquids, and the extent to which the Company's products achieve market
acceptance and demand and other factors.  The Company expects to devote
substantial capital resources to research and development and increasing the
number of sales representatives within its direct sales forces.  The timing and
amount of such capital requirements cannot be accurately predicted.  As such,
there can be no assurance that the Company will not be required to raise
additional funds in this time frame through public or private financing,
strategic partnerships or otherwise.  Additional funding may not be available
when needed or on terms acceptable to the Company, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.  Any additional equity financing may be dilutive to stockholders,
and debt financing, if available, may include restrictive covenants.

    At December 31, 1996, the Company had approximately $1.3 million in federal
and $233,000 in state net operating loss carryforwards, which expire in the
years 2001 through 2011.  Utilization of federal income tax carryforwards is
subject to certain limitations under Section 382 of the Internal Revenue Code of
1986, as amended. These annual limitations may result in expirations of net
operating losses and research and development credits before they can be fully
utilized.

FACTORS AFFECTING OPERATING RESULTS AND MARKET PRICE OF COMMON STOCK

The following factors represent some of the current challenges to the Company,
which create risk and uncertainty.  Failure to adequately overcome any of the
following changes, either singly or in combination, could have a material
adverse effect on the Company's results of operations, business, or financial
position.


                                                                             24


<PAGE>

NEAR-TERM DEPENDENCE UPON RAPISEAL.  In June 1996, the Company received
clearance from the FDA to market the RapiSeal patch for lung surgery, including
lung cancer and lung volume reduction ("LVR") surgeries.  The Company
anticipates that, for the foreseeable future, it will be substantially dependent
on the successful commercialization of this product.  The Company would
experience a material adverse effect on its business, financial condition and
results of operations if the RapiSeal patch were not successfully
commercialized.

RISKS ASSOCIATED WITH LVR.  To date, a statistically significant body of
clinical data does not currently exist from which to draw final conclusions
concerning the efficacy and long-term outcomes associated with the LVR
procedure.  Independent studies of patients who have undergone the LVR procedure
reported that patients experienced reduced shortness of breath, improved
exercise tolerance and improved quality of life.  However, the number of
patients who have undergone the LVR procedure in the United States and for whom
a clinically acceptable post-operative evaluation period has elapsed is
relatively small.  As a result, there can be no assurance concerning the safety,
effectiveness and long-term outcomes associated with the LVR procedure.  The
Health Care Financing Administration ("HCFA") has suspended payment for, and is
reviewing the appropriate reimbursement, if any, for LVR.  In connection with
such review, HCFA has announced its intention to collaborate with the National
Institutes of Health ("NIH") on a large-scale, multi-center trial to be
conducted by the NIH to evaluate the long-term benefits of the LVR procedure for
patients with late-stage emphysema.  There can be no assurance as to when this
trial will be completed or whether the results of the trial will demonstrate the
safety or long-term efficacy of LVR.  It is not known when HCFA will make a
final determination as to reimbursement for LVR, and it may be several years
before a determination is made.  There can be no assurance that reimbursement
for LVR will be reinstated or, if reinstated that HCFA will not impose
limitations on reimbursement.  The Company believes a significant portion of the
candidates for the LVR procedure could be affected by HCFA's determination with
respect to reimbursement.  Failure to reinstate reimbursement or the imposition
of limitations on reimbursement would have a material adverse effect on the
Company's business prospects.  If reimbursement is not available for LVR
procedures, if the LVR procedure is not widely adopted or if RapiSeal cannot be
used successfully in LVR procedures, it would have a material adverse effect on
the Company's business, financial condition and results of operations.

UNCERTAINTY OF MARKET ACCEPTANCE.  The Company's success will dependent upon the
medical community's active sponsorship and ultimate acceptance of the RapiSeal
patch and the Fusion liquid products.  The Company is unable to predict how
quickly, if at all, the medical community will accept its products or, if
accepted, the number of products that will be used.  Use of the Company's
products may require changes in surgical practices, and there can be no
assurance that surgeons will be willing to make such changes.  To achieve market
acceptance of its products, the Company must also demonstrate that it's products
offer clinically significant advantages.  The Company conducted its multi-center
clinical trial of RapiSeal in support of its 510K application in only 26
patients, which may not provide sufficient data to demonstrate clinically
significant advantages, if any, to surgeons.  Moreover, this limited experience
with patients may initially make it difficult for the Company to ascertain those
factors most relevant to the surgeon's decision whether to use the Company's
products.  Air leaks associated with lung resections require the insertion of
chest tubes in the patient.  While the Company believes that the RapiSeal patch
may reduce hospital costs by shortening the duration of patient dependence on
chest tubes, RapiSeal will not eliminate the need for chest tubes.  In addition,
air leaks may occur in the patient after the lung resection procedure, and
RapiSeal cannot address such leaks.  Failure of the RapiSeal patch and the
Fusion liquids to achieve significant clinical adoption would have a material
adverse effect on the Company's business, financial condition and results of
operations.

DEPENDENCE ON PATENTS AND PROPRIETARY TECHNOLOGY.  The Company's ability to
compete effectively will depend in part on its ability to develop and maintain
the


                                                                             25


<PAGE>

proprietary aspects of its technology.  The Company owns one issued United
States patent and has eight pending United States patent applications related to
its patch technology and has one pending United States patent application
relating to its liquid formulations.  There can be no assurance that the pending
patent applications will issue, or that the issued patent or any patents that
may issue in the future will provide any competitive advantages for the
Company's products or that they will not be successfully challenged, invalidated
or circumvented in the future.  Moreover, litigation or interference proceedings
associated with enforcing or defending patents or trade secrets is expensive and
can divert the efforts of technical and management personnel.  The Company has
filed certain corresponding patent applications in certain foreign countries and
may file additional patent applications outside the United States.  The Company
believes that obtaining foreign patents may be more difficult than obtaining
domestic patents because of differences in patent laws and believes the
protection provided by foreign patents, if obtained, and any other foreign
intellectual property protection may be weaker than that provided domestically.
In addition, there can be no assurance that competitors will not seek to apply
for and obtain patents that will prevent, limit or interfere with the Company's
ability to make, use and sell its products.  A number of medical device and
other companies, universities and research institutions have filed patent
applications or have issued patents relating to the compositions and methods for
wound closure.  In addition, the medical device industry has been characterized
by extensive litigation regarding patents and other intellectual property
rights, and many companies in the medical device industry have employed
intellectual property litigation to gain competitive advantage.  There can be no
assurance that suits will not be brought against the Company in the future
challenging its patent rights or claiming infringement on patents held by third
parties.

An adverse determination in litigation or interference proceedings to which the
Company may become a party could subject the Company to significant liabilities
to third parties, require disputed rights to be licensed from third parties or
require the Company to cease using such technology.  Although patent and
intellectual property disputes in the medical device area have often been
settled through licensing or similar arrangements, costs associated with such
arrangements may be substantial and could include ongoing royalties.
Furthermore, there can be no assurance that necessary licenses would be
available to the Company on satisfactory terms, if at all.  Adverse
determinations in a judicial or administrative proceeding or failure to obtain
necessary licenses on satisfactory terms, if at all, could prevent the Company
from manufacturing and selling its products, which would have a material adverse
effect on the Company's business, financial condition and results of operation.

UNCERTAINTY RELATING TO THIRD-PARTY REIMBURSEMENT.  In the United States,
health care providers that purchase medical devices, such as the RapiSeal
patch and the Fusion liquids, generally rely on third-party payors,
principally federal Medicare, state Medicaid and private health insurance
plans to reimburse all or part of the cost of the procedure in which the
medical device is being used. The Company's success will be dependent, in
part, upon its ability to obtain satisfactory third-party reimbursement from
health care payors for surgical procedures that may use RapiSeal and the
Fusion liquids.  HCFA has suspended payment for, and is reviewing the
appropriate reimbursement, if any, for LVR. See "Risks Associated with LVR."
The Company anticipates that in a prospective payment system, such as the
Diagnostic Related Group System utilized by Medicare, and in many managed
care systems used by private health care payors, the cost of the Company's
products will be incorporated into the overall cost of the procedures and
that there will not be separate reimbursement for the Company's products.
Regardless of the type of reimbursement system, the Company believes that
surgeon advocacy of the RapiSeal patch and the Fusion liquids will be
required to obtain reimbursement.  There can be no assurance that any
reimbursement will be sufficient to assure profitability.  Failure by
physicians, hospitals and other users of the Company's products to obtain
sufficient reimbursement from health care payors for procedures in which the
Company's products are used or adverse changes in governmental and private
third-party payors' policies toward

                                                                             26


<PAGE>

reimbursement for such procedures would have a material adverse effect on the
Company's business, financial condition and results of operations.

If the Company obtains the necessary foreign regulatory approvals, market
acceptance of the Company's products in international markets would be
dependent, in part, upon the availability of reimbursement within prevailing
health care payment systems for the Company's products or the procedures in
which the products are used.  Reimbursement and health care payment systems in
international markets vary significantly by country, and include both
government-sponsored health care and private insurance.  The Company intends to
seek international reimbursement approvals.  There can be no assurance that any
such approvals will be obtained in a timely manner, if at all, and failure to
receive international reimbursement approvals could have a material adverse
effect on market acceptance of the Company's products in the international
markets in which such approvals are sought.

LIMITED MANUFACTURING EXPERIENCE; SCALE-UP RISK.  The Company received a
manufacturing license from the CDHS and commenced shipment of RapiSeal for use
in its clinical trial in November 1995.  However, the Company has no experience
manufacturing RapiSeal or any other products in the volumes necessary to achieve
significant commercial sales, and there can be no assurance that reliable,
high-volume manufacturing can be achieved at a commercially reasonable cost.
The Company may encounter difficulties in scaling up production, including
problems involving production yield, quality control and assurance, and
shortages of qualified personnel.  The Company's manufacturing facilities will
be subject to GMP regulations, international quality standards and other
regulatory requirements.  Difficulties encountered by the Company in
manufacturing  scale-up or failure by the Company to implement and maintain its
facilities in accordance with GMP regulations, international quality standards
or other regulatory requirements would entail a delay or termination of
production, which could have a material adverse effect on the Company's
business, financial condition and results of operations.  Any manufacturing
difficulties involving production yields, quality control and assurances,
supplies of components or shortages of qualified personnel encountered by the
Company could also have a material adverse effect on its business, financial
condition and results of operations.  There can be no assurance that the Company
will be able to manufacture and supply sufficient quantities of products to meet
product requirements for United States and international clinical trials and
commercial sales.

DEPENDENCE ON SINGLE SOURCE SUPPLIERS.  The Company acquires several components
of its products from single source suppliers.  Generally, the Company believes
that there are alternative suppliers of equivalent materials available, and that
the Company could substitute suppliers with minimal regulatory consequences from
this substitution.  However, there can be no assurance that such substitute
suppliers will be available, that such substitutions could be made in a timely
manner or on commercially reasonable terms.  In the case of collagen, there are
only a few suppliers that could meet the Company's requirements.  The company
currently relies exclusively on one supplier of collagen, Kensey Nash
Corporation, and expects to continue to do so through at least the end of 1997.
Fusion and this supplier have entered into a long-term supply agreement.
However, if this supplier were unable to meet the Company's demands there can be
no assurance that the Company would be able to secure alternative sources of
collagen to produce sufficient product to meet its customers' needs.  A
transition to alternate arrangements could involve additional costs and delays
in production.  There can be no assurance that such transition would be
successful in entering into alternate arrangements on commercially reasonable
terms if at al.  Sterilization of the Company's product is out-sourced to a
single vendor.  While the Company believes alternative sterilization vendors are
readily available, there can be no assurance that such vendors would be
available or that such a transition could be made in a timely, cost-effective
manner.  In the event the Company is not able to acquire sufficient supplies
from its current sources or to locate alternate sources on commercially
reasonable terms, the Company may not be able to manufacture its products on a


                                                                             27


<PAGE>

timely and cost-competitive basis, or at all, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.

LIMITED SALES, MARKETING AND DISTRIBUTION EXPERIENCE.  The Company has no sales
and only has a small sales and marketing organization.  The Company intends to
sell the RapiSeal patch for use in lung surgeries in the United States through a
direct sales force.  In other markets, the Company intends to sell its products
primarily through agreement with distributors or by means of collaborative
arrangements, although the Company has not entered into any such agreements or
arrangements to date.  There can be no assurance that the Company will be able
to build a direct sales force or marketing organization, that establishing a
direct sales force or marketing organization will be cost effective, or that the
Company's sales and marketing efforts will be successful.  There can be no
assurance that the Company will be able to enter into agreements with
distributors or collaborative arrangements on a timely basis or at all, or that
such distributors or collaborators will devote adequate resources to selling the
Company's products.  In addition, to the extent that the Company enters into
distribution agreements or collaborative arrangements for the sale of its
products, the Company will be dependent upon the efforts of third parties, and
there can be no assurance that such efforts will be successful.  Failure to
build an effective sales and marketing organization or to establish effective
distribution or collaborative arrangements would have a material adverse effect
on the Company's business, financial condition and results of operations.

COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE.  The wound closure market is
highly competitive, and the Company expects competition in its targeted markets
to intensify.  The Company expects to encounter direct competition from
companies offering pericardial strips, synthetic strips, and synthetic fibrin
glues.  In addition, several large companies targeting the wound closure market
may be developing products that would compete with the Company's products.  The
Company is also aware of several potential competitors that are working on
biological tissue sealants.  Many of the competitors or potential competitors
have greater name recognition, broader product lines, greater distribution
capabilities, substantially greater capital resources and larger marketing
research and development staffs and facilities than the Company.  Broad product
lines may give the Company's competitors or potential competitors the ability to
negotiate exclusive, long-term medical device supply contracts and,
consequently, the ability to offer comprehensive pricing for their products,
including those that may compete with the Company's products.  By offering a
broader product line, these potential competitors may also have a significant
advantage in marketing competing products to group purchasing organizations and
other managed care organizations that increasingly seek to reduce costs through
centralization of purchasing functions.  There can be no assurance that the
Company will be able to effectively compete against such competitors or
potential competitors.  In addition, there can be no assurance that the
Company's current competitors or other companies will not succeed in developing
technologies and products that are more effective than the Company's or that
would render the Company's technology or products obsolete or uncompetitive.

PRODUCT LIABILITY RISK; LIMITED INSURANCE COVERAGE.  The medical device industry
has historically been litigious, and the Company faces an inherent business risk
of financial exposure to product liability claims in the event that the use of
its products results in personal injury.  Although the Company has not
experienced any claims to date, there can be no assurance that the Company will
not experience losses due to product liability claims in the future.  The
Company currently maintains liability insurance with coverage limits of $3.0
million on a claims-made basis.  There can be no assurance that the coverage
limits of the Company's insurance policies will be adequate.  Such insurance is
expensive, difficult to obtain and may not be available in the future as
acceptable terms, or at all.  Any claims against the Company regardless of their
merit or eventual outcome, could have a material adverse impact upon the
Company's business, financial condition and results of operations.


                                                                             28


<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

    This information is incorporated hereby reference to the financial
statements listed in Item 14 of Part IV of this Report.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
         ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

                                       PART III

Certain information required by Part III is omitted from this Report in that the
registrant will file a definitive proxy statement within 120 days after the end
of its fiscal year pursuant to Regulation 14A (the "Proxy Statement") for its
annual meeting of shareholders to be held in June 1996 and the information
therein is incorporated herein by reference.

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

    The information concerning the Company's directors required by this item is
incorporated by reference to the Company's Proxy Statement.  Information
regarding executive officers is included in Part I hereof under the caption
"Executive Officers of the Company" and is hereby incorporated by reference into
this Item 10.


ITEM 11.  EXECUTIVE COMPENSATION

    The information required by this Item is incorporated by reference to the
Company's Proxy Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is incorporated by reference to the
Company's Proxy Statement.


                                                                              29


<PAGE>

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

    The information required by this Item is incorporated by reference to the
Company's Proxy Statement.


                                       Part IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
          FORM 8-K

         The following documents are filed as part of this Report of
Independent Accountants.

(a) 1.   FINANCIAL STATEMENTS
                                                                        PAGE(S)
                                                                        ------
         Report of Independent Accountants.                              F-2
         Balance Sheets, December 31, 1996 and 1995.                     F-3
         Statements of Operations, Years Ended December 31, 1996
         and 1995 and the period from November 1993 (Date of
         Inception) to December 31, 1994.                                F-4

         Statements of Stockholders' Equity (Deficit), Years Ended
         December 31, 1996 and 1995 and period from November 1993
         (Date of Inception to December 31, 1994).                       F-5

         Statements of Cash Flows, Years Ended December 31, 1996
         and 1995 and period from November 1993 (Date of Inception)
         to December 31, 1994.                                           F-6

         Notes to Financial Statements                                F-7 - F-19

    2.   FINANCIAL STATEMENT SCHEDULES
                                                                        PAGE(S)
                                                                        ------

         All schedules are omitted because they are not applicable
         or the required information is shown in the Financial
         Statements or the notes thereto.

 3.   EXHIBITS

         The Exhibits listed on the accompanying index immediately
         following the signature page are filed as part of this Report.

(b) REPORTS ON FORM 8-K

         Not applicable.

(c) EXHIBITS

         See Item 14 (a) (3) above.


                                                                             30


<PAGE>


                                      SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) the Securities Exchange Act
of 1934, the Registrant has duly caused this Report on Form 10-K to be signed on
its behalf by the undersigned, thereunto duly authorized.


                          FUSION MEDICAL TECHNOLOGIES, INC.


                                       By:
                                           ------------------------------------
                                           Philip M. Sawyer
                                           President and Chief Executive Officer

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Philip M. Sawyer, jointly and severally, his or
her attorney-in-fact, with the power of substitution, for him in any and all
capacities, to sign any amendments to this Report on Form 10-K, and to file the
same, with exhibits thereto and other documents in connection therewith, with
the Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his or her substitute or substitutes, may do
or cause to be done by virtue thereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
on Form 10-K has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

   SIGNATURE                            TITLE                         DATE

---------------------------  President, Chief Executive Officer, March 31, 1997
Philip M. Sawyer             Chief Financial Officer and
                             Director (Principal Executive
                             Officer)

---------------------------  Chairman of the Board of Directors  March 31, 1997
Gordon W. Russell

---------------------------  Director                            March 31, 1997
Olav B. Bergheim

---------------------------  Director                            March 31, 1997
Vaughn D. Bryson

---------------------------  Director                            March 31, 1997
Douglas E. Kelly, M.D.

---------------------------  Director                            March 31, 1997
Lawrence G. Mohr, Jr.

---------------------------  Director                            March 31, 1997
Richard S. Schneider, Ph.D.


                                                                             31


<PAGE>

                                  INDEX TO EXHIBITS

EXHIBITS
--------
 3.1*    Certificate of Incorporation of Registrant.

 3.2*    Form of Certificate of Amendment of Certificate of Incorporation of
         Registrant to effect reverse stock split.

 3.3*    Form of Restated Certificate of Incorporation of Registrant to become
         effective at the closing of this offering.

 3.4*    Amended and Restated By-laws of the Registrant.

10.1*    Restated Shareholder Rights Agreement dated as of January 17, 1995.

10.2*    1993 Stock Option Plan, as amended, and form of stock option
         agreement.

10.3*    1996 Employee Stock Purchase Plan.

10.4*    1996 Director Stock Option Plan, and form of stock option agreement.

10.5*    Form of Director and Officer Indemnification Agreements.

10.6*    Lease Agreement dated June 15, 1994 between the Registrant and
         James R. Benson.

10.9*    Warrant to Purchase Shares of Series A Preferred Stock.

10.10*   Warrant to Purchase Shares of Series B Preferred Stock.

11.1     Computation of Net Loss per Share.

23.1     Consent of Coopers & Lybrand L.L.P., Independent Accountants.

24.1     Power of Attorney (included on page 31)

27       Financial Data Schedule.

* Previously filed as exhibits to the Company's Registration Statement on
  Form SB-2 (File No. 33-3990-LA), filed with the Securities and Exchange
  Commission on April 22, 1996.


                                                                             32

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                             INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                       Page
                                                                       ----
<S>                                                                   <C>
Report of Independent Accountants..................................     F-2

Balance Sheets.....................................................     F-3

Statement of Operations ...........................................     F-4

Statement of Stockholders' Equity .................................     F-5

Statement of Cash Flows ...........................................     F-6

Notes to Financial Statements......................................     F-7
</TABLE>


                                    F-1
<PAGE>

                      REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors
Fusion Medical Technologies, Inc.:

We have audited the accompanying balance sheets of Fusion Medical
Technologies, Inc. (a company in the development stage) as of December 31,
1996 and 1995, and the related statements of operations, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
1996, and for the cumulative period from October 14, 1992 (date of inception)
to December 31, 1996.  These financial statements are the responsibility of
the Company's management.  Our responsibility is to express an opinion on
these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Fusion Medical Technologies,
Inc. (a company in the development stage) as of December  31, 1996 and 1995,
and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 1996, and for the cumulative period
from October 14, 1992 (date of inception) to December 31, 1996, in conformity
with generally accepted accounting principles.

Coopers & Lybrand L.L.P.

San Jose, California
March 12, 1997


                                    F-2

<PAGE>

                      FUSION MEDICAL TECHNOLOGIES, INC.
                    (a company in the development stage)
                  BALANCE SHEETS, December 31, 1996 and 1995


<TABLE>
<CAPTION>
               ASSETS                                             1996                      1995
                                                              -------------             -----------
<S>                                                          <C>                       <C>
Current assets:
     Cash and cash equivalents                                $  10,778,423             $  4,381,999
     Available-for-sale securities                               11,145,226                1,536,031
     Accounts receivable                                             22,859                      -
     Inventories                                                     83,201                      -
     Prepaids and other current assets                              307,297                   68,201
                                                              -------------             ------------
          Total current assets                                   22,337,006                5,986,231

Available-for-sale securities                                     1,561,531                      -
Property and equipment, net                                       1,120,572                  610,761
Other assets                                                         43,682                   32,500
                                                              -------------             ------------
               Total assets                                   $  25,062,791             $  6,629,492
                                                              -------------             ------------
                                                              -------------             ------------
               LIABILITIES

Current liabilities:
     Accounts payable                                         $     878,874             $    475,275
     Accrued expenses                                               252,660                   63,553
     Long-term debt, current portion                                133,333                  133,333
                                                              -------------             ------------
               Total current liabilities                          1,264,867                  672,161

Long-term debt, net of current portion                               55,556                  188,889
                                                              -------------             ------------
     Total liabilities                                            1,320,423                  861,050
                                                              -------------             ------------
Commitments (Note 7).

          STOCKHOLDERS' EQUITY

Convertible preferred stock, par value $0.001:
     Authorized:  5,000,000 shares in 1996 and
      15,700,000 shares in 1995;
     Issued and outstanding: none in 1996 and
      7,658,994 shares in 1995                                            -                    7,659
Common stock, par value $0.001:
     Authorized:  50,000,000 shares;
     Issued and outstanding:  6,998,517 shares
      in 1996 and 1,519,575 in 1995                                   6,999                    1,520

Additional paid-in capital                                       36,578,757               10,415,816
Notes receivable from stockholder                                   (48,400)
Deferred compensation                                            (1,191,104)                 (19,333)
Unrealized loss on investments                                      (11,106)
Deficit accumulated during the
 development stage                                              (11,592,778)              (4,637,220)
                                                              -------------             ------------
               Total stockholders' equity                        23,742,368                5,768,442
                                                              -------------             ------------
               Total liabilities and stockholders' equity     $  25,062,791             $  6,629,492
                                                              -------------             ------------
                                                              -------------             ------------
</TABLE>

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


                                      F-3

<PAGE>

                        FUSION MEDICAL TECHNOLOGIES, INC.
                      (a company in the development stage)
                            STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                                                 Cumulative
                                                                                                Period from
                                                                                                October 14,
                                                                                               1992 (date of
                                                          Year Ended December 31,              inception) to
                                                  ----------------------------------------      December 31,
                                                      1996         1995           1994              1996
                                                  -----------  ------------    -----------    --------------
<S>                                              <C>          <C>            <C>             <C>
Net sales                                      $      31,031                                $      31,031
Cost of sales and start-up manufacturing
 costs                                               196,344                                      196,344
                                               -------------                                -------------
     Gross profit (loss)                            (165,313)                                    (165,313)

Operating expenses:
     Research and development                      4,692,921  $   2,649,705  $     755,664      8,202,856
     Sales and marketing                           1,581,343        142,174         66,518      1,790,035
     General and administrative                    1,426,174        840,990        349,357      2,719,070
                                               -------------  -------------  -------------  -------------
          Total operating expenses                 7,700,438      3,632,869      1,171,539     12,711,961
                                               -------------  -------------  -------------  -------------
               Loss from operations               (7,865,751)    (3,632,869)    (1,171,539)   (12,877,274)

Other expense (income)                                     -            920          2,000          2,920
Interest expense                                     (15,992)       (30,750)        (2,915)       (49,657)
Interest income                                      926,185        381,986         19,161      1,331,233
                                               -------------  -------------  -------------  -------------
          Net loss                             $  (6,955,558) $  (3,280,713) $  (1,153,293) $ (11,592,778)
                                               -------------  -------------  -------------  -------------
                                               -------------  -------------  -------------  -------------
Net loss per share                             $       (1.45) $       (1.69) $       (0.59) $       (5.19)
                                               -------------  -------------  -------------  -------------
                                               -------------  -------------  -------------  -------------
Shares used in computing net loss per share        4,786,605      1,942,637      1,950,932      2,235,422
                                               -------------  -------------  -------------  -------------
                                               -------------  -------------  -------------  -------------
Proforma net loss per share                    $       (1.13) $       (0.65)
                                               -------------  -------------
                                               -------------  -------------
Shares used in computing proforma net loss
 per share                                         6,163,770      5,023,621
                                               -------------  -------------
                                               -------------  -------------
</TABLE>

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


                                    F-4
<PAGE>

                           FUSION MEDICAL TECHNOLOGIES, INC.
                         (a company in the development stage)
                          STATEMENT OF STOCKHOLDERS' EQUITY
              for the period from October 14, 1992 (date of inception) to
                                    December 31, 1996

<TABLE>
<CAPTION>
                                                      Series A Convertible        Series B Convertible
                                                         Preferred Stock             Preferred Stock
                                                    -------------------------   -------------------------
                                                       Shares        Amount        Shares        Amount
                                                    ------------   ----------   ------------   ----------
<S>                                                 <C>            <C>          <C>            <C>
  Issuance of common stock at $0.0024 per share
    for cash in October 1993
  Issuance of common stock in October 1993 in
    exchange for technology
  Issuance of Series A convertible preferred stock
    at $0.65 per share in November 1993                1,861,542   $   1,861
  Issuance of Series A convertible preferred stock
    in November 1993 in exchange for cancellation
    of note payable                                      253,846         254
  Net loss
                                                    ------------   ----------
Balances, December 31, 1993                            2,115,388       2,115
  Issuance of Series A convertible preferred stock
    during March 1994 at $0.65 per share                 153,847         154
  Common stock repurchased and canceled
  Issuance of common stock upon exercise of stock
    options
  Net loss
                                                    ------------   ----------
Balances, December 31, 1994                            2,269,235       2,269
  Issuance of Series B convertible preferred stock
    during January 1995 at $1.66 per share, net of
    offering costs of $32,645                                                      5,389,759   $   5,390
  Issuance of common stock upon exercise of stock
    options
  Deferred compensation related to issuance of
    common stock and grants of stock options
  Amortization of deferred compensation
  Net loss
                                                    ------------   ----------
Balances, December 31, 1995                            2,269,235       2,269       5,389,759       5,390
  Issuance of common stock:
    Upon exercise of stock options
    In exchange for notes receivable
    From initial public offering in June 1996, net
      of issuance costs of $2,881,488
    Upon exercise of warrants
    Under employee stock purchase plan
  Conversion of preferred stock in connection with
    initial public offering                           (2,269,235)     (2,269)     (5,389,759)     (5,390)
  Unrealized loss on investments
  Deferred compensation related to issuance of
    common stock and grants of stock options
  Amortization of deferred compensation
  Net loss
                                                    ------------   ----------   ------------   ----------
Balances, December 31, 1996                                    -   $       -               -   $       -
                                                    ------------   ----------   ------------   ----------
                                                    ------------   ----------   ------------   ----------

<CAPTION>

                                                                                                    Notes
                                                         Common Stock            Additional      Receivable
                                                    -------------------------      Paid-In          From
                                                       Shares        Amount        Capital       Shareholder
                                                    ------------   ----------   -------------   -------------
<S>                                                 <C>             <C>            <C>            <C>
  Issuance of common stock at $0.0024 per share
    for cash in October 1993                             621,248   $     621    $         879
  Issuance of common stock in October 1993 in
    exchange for technology                              878,210         878            1,242
  Issuance of Series A convertible preferred stock
    at $0.65 per share in November 1993                                             1,208,048
  Issuance of Series A convertible preferred stock
    in November 1993 in exchange for cancellation
    of note payable                                                                   164,746
  Net loss
                                                    ------------   ----------   -------------
Balances, December 31, 1993                            1,499,458       1,499        1,374,915
  Issuance of Series A convertible preferred stock
    during March 1994 at $0.65 per share                                               99,847
  Common stock repurchased and canceled                  (28,997)        (29)             (41)
  Issuance of common stock upon exercise of stock
    options                                               47,638          48            3,927
  Net loss
                                                    ------------   ----------   -------------
Balances, December 31, 1994                            1,518,099       1,518        1,478,648
  Issuance of Series B convertible preferred stock
    during January 1995 at $1.66 per share, net of
    offering costs of $32,645                                                       8,908,964
  Issuance of common stock upon exercise of stock
    options                                                1,476           2              229
  Deferred compensation related to issuance of
    common stock and grants of stock options                                           27,975
  Amortization of deferred compensation
  Net loss
                                                    ------------   ----------   -------------
Balances, December 31, 1995                            1,519,575       1,520       10,415,816
  Issuance of common stock:
    Upon exercise of stock options                       122,966         123           33,141
    In exchange for notes receivable                      40,000          40           48,360   $    (48,400)
    From initial public offering in June 1996, net
      of issuance costs of $2,881,488                  2,100,000       2,100       24,416,412
    Upon exercise of warrants                             25,810          26           40,473
    Under employee stock purchase plan                    17,427          17           70,344
  Conversion of preferred stock in connection with
    initial public offering                            3,172,739       3,173            4,486
  Unrealized loss on investments
  Deferred compensation related to issuance of
    common stock and grants of stock options                                        1,549,725
  Amortization of deferred compensation
  Net loss
                                                    ------------   ----------   -------------   -------------
Balances, December 31, 1996                            6,998,517   $   6,999    $  36,578,757   $    (48,400)
                                                    ------------   ----------   -------------   -------------
                                                    ------------   ----------   -------------   -------------

<CAPTION>

                                                                                     Deficit
                                                                                   Accumulated
                                                                     Unrealized     During the
                                                      Deferred        Loss on      Development
                                                    Compensation    Investments       Stage           Total
                                                    -------------   ------------   ------------   -------------
<S>                                                 <C>            <C>          <C>            <C>
  Issuance of common stock at $0.0024 per share
    for cash in October 1993                                                                      $       1,500
  Issuance of common stock in October 1993 in
    exchange for technology                                                                               2,120
  Issuance of Series A convertible preferred stock
    at $0.65 per share in November 1993                                                               1,209,909
  Issuance of Series A convertible preferred stock
    in November 1993 in exchange for cancellation
    of note payable                                                                                     165,000
  Net loss                                                                         $  (203,214)        (203,214)
                                                                                   ------------   -------------
Balances, December 31, 1993                                                           (203,214)       1,175,315
  Issuance of Series A convertible preferred stock
    during March 1994 at $0.65 per share                                                                100,001
  Common stock repurchased and canceled                                                                     (70)
  Issuance of common stock upon exercise of stock
    options                                                                                               3,975
  Net loss                                                                          (1,153,293)      (1,153,293)
                                                                                   ------------   -------------
Balances, December 31, 1994                                                         (1,356,507)         125,928
  Issuance of Series B convertible preferred stock
    during January 1995 at $1.66 per share, net of
    offering costs of $32,645                                                                         8,914,354
  Issuance of common stock upon exercise of stock
    options                                                                                                 231
  Deferred compensation related to issuance of
    common stock and grants of stock options        $    (27,975)                                             -
  Amortization of deferred compensation                    8,642                                          8,642
  Net loss                                                                          (3,280,713)      (3,280,713)
                                                                                   ------------   -------------
Balances, December 31, 1995                              (19,333)                   (4,637,220)       5,768,442
  Issuance of common stock:
    Upon exercise of stock options                                                                       33,264
    In exchange for notes receivable                                                                          -
    From initial public offering in June 1996, net
      of issuance costs of $2,881,488                                                                24,418,512
    Upon exercise of warrants                                                                            40,499
    Under employee stock purchase plan                                                                   70,361
  Conversion of preferred stock in connection with
    initial public offering                                                                                   -
  Unrealized loss on investments                                    $   (11,106)                        (11,106)
  Deferred compensation related to issuance of
    common stock and grants of stock options          (1,549,725)                                             -
  Amortization of deferred compensation                  377,954                                        377,954
  Net loss                                                                          (6,955,558)      (6,955,558)
                                                    -------------   ------------   ------------   -------------
Balances, December 31, 1996                         $ (1,191,104)   $   (11,106)   $(11,592,778)  $  23,742,368
                                                    -------------   ------------   ------------   -------------
                                                    -------------   ------------   ------------   -------------
</TABLE>

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


                                    F-5

<PAGE>

                        FUSION MEDICAL TECHNOLOGIES, INC.
                      (a company in the development stage)
                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                                                Cumulative
                                                                                                               Period from
                                                                                                                October 14,
                                                                                                               1992 (date of
                                                                        Year Ended December 31,                inception) to
                                                           ---------------------------------------------        December 31,
                                                                  1996            1995           1994               1996
                                                           -------------    -------------   -------------    ---------------
<S>                                                      <C>              <C>              <C>              <C>
Cash flows from operating activities:
  Net loss                                                 $  (6,955,558)   $  (3,280,713)  $  (1,153,293)   $  (11,592,778)
  Adjustments to reconcile net loss to net
   cash used in operating activities:
     Depreciation and amortization                               259,151          104,714          17,355           382,284
     Amortization of deferred compensation                       377,954            8,642                           386,596
     Accretion of available-for-sale securities                 (379,900)                                          (379,900)
     Write-off of acquired in-process research
      and development                                                                                                 2,120
     Changes in assets and liabilities:
        Accounts receivable                                      (22,859)                                           (22,859)
        Inventories                                              (83,201)                                           (83,201)
        Prepaids and other current assets                       (239,096)         (60,236)         (7,163)         (307,297)
        Other assets                                             (11,182)           1,436         (32,443)          (43,682)
        Accounts payable                                         403,599          273,641          94,310           878,874
        Accrued expenses                                         189,107           47,433         (25,380)          252,660
                                                           -------------      -----------    ------------      ------------
          Net cash used in operating activities               (6,461,985)      (2,905,083)     (1,106,614)      (10,527,183)
                                                           -------------      -----------    ------------      ------------
Cash flows from investing activities:
  Acquisition of property and equipment                         (768,962)        (436,174)       (182,255)       (1,502,856)
  Purchases of  available-for-sale securities                (77,975,121)      (2,491,116)                      (80,466,237)
  Sales of available-for-sale securities                      67,173,189          955,085                        68,128,274
                                                           -------------      -----------    ------------      ------------
          Net cash used in investing activities              (11,570,894)      (1,972,205)       (182,255)      (13,840,819)
                                                           -------------      -----------    ------------      ------------
Cash flows from financing activities:
  Proceeds from issuance of common stock,
   net of issuance costs                                      24,562,636              231           3,975        24,568,342
  Proceeds from issuance of preferred stock,
   net of issuance costs                                                        8,914,354         100,001        10,224,264
  Repurchase of common stock                                                                          (70)              (70)
  Proceeds from notes payable                                                                                       165,000
  Proceeds of note payable                                                        200,000                           200,000
  Repayment of notes payable                                    (133,333)         (77,778)                         (211,111)
  Proceeds from bank line of credit                                                               200,000           200,000
                                                           -------------      -----------    ------------      ------------
          Net cash provided by financing activities           24,429,303        9,036,807         303,906        35,146,425
                                                           -------------      -----------    ------------      ------------
Net increase in cash and cash equivalents                      6,396,424        4,159,519        (984,963)       10,778,423

Cash and cash equivalents, beginning of period                 4,381,999          222,480       1,207,443               -
                                                           -------------      -----------    ------------      ------------
Cash and cash equivalents, end of period                   $  10,778,423      $ 4,381,999    $    222,480      $ 10,778,423
                                                           -------------      -----------    ------------      ------------
                                                           -------------      -----------    ------------      ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
   Cash paid for interest                                  $      15,992      $    28,889    $      1,131      $     46,012
                                                           -------------      -----------    ------------      ------------
                                                           -------------      -----------    ------------      ------------
   Cash paid for taxes                                     $         800      $       800    $          -      $      3,200
                                                           -------------      -----------    ------------      ------------
                                                           -------------      -----------    ------------      ------------
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
 FINANCING ACTIVITIES:
   Capital expenditures accrued but not paid                                  $   107,324                      $    107,324
                                                                              -----------                      ------------
                                                                              -----------                      ------------
   Issuance of common stock in exchange for technology                                                         $      2,120
                                                                                                               ------------
                                                                                                               ------------
   Issuance of preferred stock for repayment of notes
    payable                                                                                                    $    165,000
                                                                                                               ------------
                                                                                                               ------------
   Issuance of common stock in exchange for notes
    receivable                                             $      48,400                                       $     48,400
                                                           -------------                                       ------------
                                                           -------------                                       ------------
   Conversion of bank line of credit into bank term
    loan                                                                      $   200,000                      $    200,000
                                                                              -----------                      ------------
                                                                              -----------                      ------------
   Conversion of preferred stock to common stock in
    connection with the Company's initial public offering
    in June 1996                                           $   1,477,031                                       $  1,477,031
                                                           -------------                                       ------------
                                                           -------------                                       ------------
</TABLE>

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


                                    F-6

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                             NOTES TO FINANCIAL STATEMENTS


1.  FORMATION AND BUSINESS OF THE COMPANY:

Fusion Medical Technologies, Inc. (the Company) was incorporated in the State
of Delaware on October 14, 1992 to develop, manufacture and market products
for wound closures and began operations during 1993.  The Company is in the
development stage and, since its inception, has devoted substantially all of
its efforts to developing products, raising capital and recruiting personnel.

The Company sold 2,100,000 shares of common stock at $13.00 per share through
an initial public offering in June 1996.  Net proceeds (after underwriter's
commissions and fees along with other costs associated with the offering)
totaled $24,418,512.  Upon completion of the offering, all outstanding shares
of preferred stock (a total of 7,658,994 shares) were converted into shares
of common stock on a one-for-one basis.

In the course of its development, the Company has sustained operating losses
and expects such losses to continue through at least December 31, 1998.  The
Company will finance its operations primarily through its cash, cash
equivalents and available-for-sale securities together with future revenues
from product sales.  There can be no assurance that the Company will not
require additional funding and should this prove necessary, the Company may
sell additional shares of its common stock or preferred stock through private
placement or further public offerings.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

STOCK SPLIT:

In May 1996, the Company effected a 1-for-2.414 reverse split of the
Company's common stock and a corresponding change in the preferred stock
conversion rates.  All common shares and per share amounts in these financial
statements have been adjusted retroactively to give effect to the split.

USE OF ESTIMATES:

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


                                     F-7

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued:

CASH AND CASH EQUIVALENTS AND AVAILABLE-FOR-SALE SECURITIES:

The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.  Cash and
cash equivalents include money market funds and various deposit accounts.

The Company has classified its investments as "available-for-sale."  Such
investments are recorded at fair value and unrealized gains and losses, if
material, are recorded as a separate component of equity until realized.
Interest income is recorded using an effective interest rate, with associated
premium or discount amortized to "investment income."  The cost of securities
sold is based upon the specific identification method.

INVENTORIES:

Inventories are stated at the lower of cost (determined on a first-in
first-out basis) or market value.

DEPRECIATION AND AMORTIZATION:

Property and equipment are recorded at cost and are depreciated on a
straight-line basis over their estimated lives of three to five years.
Maintenance and repairs are charged to operations as incurred.  Leasehold
improvements are amortized over their estimated useful lives, or the lease
term, if shorter.

REVENUE RECOGNITION:

The Company recognizes revenue upon shipment of product to the customer, upon
fulfillment of acceptance terms, if any, and when no significant contractual
obligations remain outstanding.

RESEARCH AND DEVELOPMENT EXPENDITURES:

Research and development expenditures are expensed as incurred.


                                 Continued
                                    F-8

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued:

INCOME TAXES:

Income taxes are accounted for under the liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax basis.  Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled.  Valuation allowances are established
when necessary to reduce deferred tax assets to the amounts expected to be
realized.

CONCENTRATION OF CREDIT RISK:

The company's cash, cash equivalents and available-for-sale securities are
maintained at three financial institutions. Deposits in these institutions
may exceed the amount of insurance provided on such deposits.

For accounts receivable, management of the Company performs ongoing credit
evaluations of its customers and maintains allowances for doubtful accounts.
As of December 31, 1996, four customers accounted for 62% of gross accounts
receivable.

RISKS AND UNCERTAINTIES:

The Company's products require approvals from the Food and Drug
Administration (FDA) and international regulatory agencies prior to the
commencement of commercialized sales.  There can be no assurance that the
Company's products will receive the required approvals.  If the Company was
denied such approvals, or such approvals were delayed, it would have a
materially adverse impact on the Company.

FAIR VALUE OF FINANCIAL INSTRUMENTS:

Carrying amounts of certain of the Company's financial instruments including
cash and cash equivalents, accounts receivable, accounts payable, accrued
expenses and other liabilities approximate fair value due to their short
maturities. Based upon borrowing rates currently available to the Company for
loans with similar terms, the carrying value of the Company's notes payable
approximate fair value.


                                 Continued
                                    F-9

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued:

NET LOSS PER SHARE:

The net loss per share, on a historical basis, is computed using the weighted
average number of shares of common stock outstanding.  Common equivalent
shares from stock options and preferred stock are excluded from the
computation as their effect is anti-dilutive, except that, pursuant to the
Securities and Exchange Commission Staff Accounting Bulletin No. 83, common
and common equivalent shares issued at prices below the initial public
offering price during the twelve months immediately preceding the initial
filing date have been included in the calculation as if they were outstanding
for all periods prior to the initial filing date (using the treasury stock
method and the initial public offering price).

PROFORMA NET LOSS PER SHARE:

The pro forma calculation of net loss per share has been computed as
described above but also gives retroactive effect from the date of issuance
to the conversion of the convertible preferred stock which automatically
converted to common shares upon the closing of the Company's initial public
offering.

3.  AVAILABLE-FOR-SALE SECURITIES:

The following summarizes the Company's available-for-sale securities:

<TABLE>
<CAPTION>
                                                      Unrealized    Accrued      Estimated
                                           Cost          Loss       Interest     Fair Value
                                       ------------   ---------    ----------   ------------
<S>                                   <C>            <C>          <C>          <C>
     December 31, 1996:
         Corporate Bonds               $ 12,717,863   $ (11,106)   $       -    $ 12,706,757
                                       ------------   ---------    ---------    ------------
                                       ------------   ---------    ---------    ------------
     December 31, 1995:
         U.S. Government Securities    $  1,495,931   $       -    $  40,082    $  1,536,013
                                       ------------   ---------    ---------    ------------
                                       ------------   ---------    ---------    ------------
</TABLE>


                                  Continued
                                    F-10

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


3.  AVAILABLE-FOR-SALE SECURITIES,  Continued:

Maturities of debt securities at December 31, 1996 are as follows:

<TABLE>
<CAPTION>
                                                  Amortized           Market
                                                     Cost              Value
                                                  ----------          ------
<S>                                              <C>                <C>
Less than one year                              $  11,148,538     $  11,145,226
Due in one to two years                             1,569,325         1,561,531
                                                -------------     -------------
                                                $  12,717,863     $  12,706,757
                                                -------------     -------------
                                                -------------     -------------
</TABLE>

4.  INVENTORIES:

Inventories at December 31, 1996 comprise:

<TABLE>
<S>                                                             <C>
Work in progress                                                      $  17,801
Finished goods                                                           65,400
                                                                  -------------
                                                                      $  83,201
                                                                  -------------
                                                                  -------------
</TABLE>

5.  PROPERTY AND EQUIPMENT:

Property and equipment comprise:

<TABLE>
<CAPTION>
                                                            December 31,
                                                   ----------------------------
                                                       1996              1995
                                                   ----------        ----------
<S>                                            <C>               <C>
Computer equipment                                 $  273,341        $  139,926
Office furniture and equipment                        203,523            83,950
Machinery and equipment                               804,075           407,955
Leasehold improvements                                221,917           102,063
                                                -------------     -------------
                                                    1,502,856           733,894
Less accumulated depreciation and
 amortization                                        (382,284)         (123,133)
                                                -------------     -------------
                                                 $  1,120,572        $  610,761
                                                -------------     -------------
                                                -------------     -------------
</TABLE>


                                 Continued
                                    F-11

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


6.  DEBT:

During May 1995, the Company's $600,000 line of credit was converted into a
term loan.  The $400,000 term loan is payable in monthly installments bearing
interest at the rate of prime plus 1.5% per annum (8.25% at December 31,
1996).  The term loan is collateralized by substantially all of the Company's
assets.  The debt agreement contains covenants relating to minimum tangible
net worth and cash balances, dividend limitations and other financial
restrictions.

Minimum payments under the term loan are as follows:

     1997                       $  133,333
     1998                           55,556
                                ----------
                                   188,889
     Less current portion         (133,333)
                                ----------
                                 $  55,556
                                ----------
                                ----------

7.  COMMITMENTS:

The Company leases office, laboratory and manufacturing space under operating
leases expiring in June 1998 through October 1999.  The lease also requires
the Company to pay property taxes, insurance and ordinary maintenance and
repairs.  Rent expense for the years ended December 31, 1996, 1995 and 1994
and the cumulative period from October 14, 1992 (date of inception) through
December 31, 1996 was approximately $244,000, $134,000, $55,000 and $435,000,
respectively.

Minimum future lease payments under these lease agreements at December 31,
1996 are as follows:

     1997                       $  362,553
     1998                          379,875
     1999                          151,597
                                ----------
                                $  894,025
                                ----------
                                ----------


                                  Continued
                                    F-12

<PAGE>


                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


8.  CONTINGENCY:

The Company, two of its founders, and another party were sued in May 1996 in
California Superior Court by an individual stockholder and former marketing
consultant of the Company alleging an additional ownership interest in the
Company.  The suit sought unspecified damages as well as the rescission of a
stock purchase agreement and a consulting agreement entered into by the
Company and the individual.

In February 1997, both parties to the suit agreed to a settlement with
prejudice.  At December 31, 1996, the Company had adequately reserved for the
anticipated liability.

9.  STOCKHOLDERS' EQUITY:

PREFERRED STOCK:

Under the Company's Restated Articles of Incorporation, the Company's
preferred stock is issuable in series.  As of December 31, 1996, 5,000,000
shares of preferred stock were authorized and no preferred stock was issued
or outstanding.  The previously outstanding stock was converted into common
stock in connection with the Company's initial public offering in June 1996.

WARRANTS:

During September 1994, in connection with the issuance of a note payable, the
Company issued a warrant to purchase 20,000 shares of Series B preferred
stock at an exercise  price of $1.66.  Upon the close of the Company's
initial public offering and conversion of the Company's previously
outstanding preferred stock into common stock, the warrant became exercisable
for 8,285 shares of common stock at an exercise price of $4.80 per share.  As
of December 31, 1996, the warrant is exercisable and expires on September 15,
1999.

In connection with the Company's initial public offering, warrants to
purchase 62,307 shares of Series A preferred stock were converted into 25,810
shares of common stock and exercised upon close of the initial public
offering at an exercise price of $40,499.


                                 Continued
                                    F-13

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


9.  STOCKHOLDERS' EQUITY, continued:

STOCK OPTION PLAN:

In November 1993, the Company established the 1993 Stock Option Plan (the
Plan), which provides for both incentive stock options (ISOs) and
nonqualified stock options (NSOs) to be granted to employees and consultants.
All NSOs allow for the purchase of common stock at prices not less than 85%
of the fair market value as determined by the Board of Directors at the date
of grant.  ISOs allow for the purchase of common stock at prices not less
than 100% of the fair market value as determined by the Board of Directors at
the date of grant.  If at the time the Company grants an option the optionee
owns more than 10% of the total combined voting power of all the classes of
stock of the Company, the option price shall be at least 110% of the fair
value and the term of the options shall be five years from the date of grant.
All options must be exercised within ten years from the date of grant.
Options vest as determined by the Board of Directors, generally over four
years.  In the event that options are exercised prior to vesting, upon
termination of service, the Company has the right to repurchase the issued
common stock at the original issuance price.  Shares are released from the
Company's repurchase option over periods consistent with the original
options' vesting period.  As of December 31, 1996, no shares were subject to
repurchase.


                                  Continued
                                     F-14

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


9.  STOCKHOLDERS' EQUITY, continued:

STOCK OPTION PLAN, continued:

Activity under the Plan is as follows:

<TABLE>
<CAPTION>
                                                                              Outstanding Options
                                                   Shares        ------------------------------------------
                                                  Available           Number       Price Per
                                                  for Grant         of Shares        Share         Total
                                                 -----------       -----------    -----------     --------
<S>                                             <C>              <C>             <C>           <C>
    Options reserved at Plan inception              545,982
    Options granted                                 (41,425)           41,425            $0.07     $  3,000
                                                  ---------        ----------                    ----------
Balances, December 31, 1993                          504,557           41,425            $0.07        3,000
     Options granted                                (148,476)         148,475            $0.16       23,297
     Options exercised                                                (47,638)     $0.07-$0.16        3,975
     Options canceled                                 22,784          (22,784)           $0.16       (3,575)
                                                  ---------        ----------                    ----------
Balances, December 31, 1994                          378,865          119,478            $0.16       26,697
     Additional shares authorized by the Plan        207,125
     Options granted                                (295,567)         295,567            $0.41      121,295
     Options canceled                                  1,838           (1,838)     $0.16-$0.41         (498)
     Options exercised                                                 (1,476)           $0.16          231
                                                  ---------        ----------                    ----------
Balances, December 31, 1995                          292,261          411,731      $0.16-$0.41      147,725
     Additional shares authorized by the Plan        557,385
     Options granted                                (438,223)         438,223     $0.41-$11.50      946,962
     Options canceled                                108,966         (108,966)     $0.16-$8.00     (360,120)
     Options exercised                                               (122,966)     $0.16-$2.41      (33,264)
                                                  ---------        ----------                    ----------
Balances, December 31, 1996                          520,389          618,022     $0.16-$11.50   $  701,303
                                                  ---------        ----------                    ----------
                                                  ---------        ----------                    ----------
</TABLE>

At December 31, 1996, options to purchase 155,412 shares of common stock were
exercisable.

DIRECTOR OPTION PLAN:

In May 1996, the Company approved the Director Option Plan and reserved
120,000 shares of common stock for issuance.  No options to purchase shares
of the Company's common stock were granted during fiscal 1996.

EMPLOYEE STOCK PURCHASE PLAN:

In May 1996, the Company approved the Employee Stock Purchase Plan and
reserved 280,000 shares of common stock for issuance. As of December 31,
1996, 17,427 shares of common stock had been purchased under this plan at
$4.0375 per share.


                                 Continued
                                   F-15

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


9.  STOCKHOLDERS' EQUITY, continued:

STOCK-BASED COMPENSATION:

The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standard No. 123 (SFAS No. 123) "Accounting for
Stock-Based Compensation."  Had compensation cost for the 1993 Plan, the
Director Option Plan and the Employee Stock Purchase Plan been determined
based on the fair value at the grant date for awards in 1996 and 1995
consistent with the provisions of SFAS No. 123, the Company's net loss and
net loss per share for the years ended December 31, 1996 and 1995 would have
been increased to the pro forma amounts indicated below:

                                                  1996           1995
                                             ------------   ------------
     Net loss - as reported                  $  6,955,558   $  3,280,713
                                             ------------   ------------
                                             ------------   ------------
     Net loss - pro forma                    $  6,989,519   $  3,289,502
                                             ------------   ------------
                                             ------------   ------------
     Net loss per share - as reported             $  1.45        $  1.69
                                             ------------   ------------
                                             ------------   ------------
     Net loss per share - pro forma               $  1.46        $  1.69
                                             ------------   ------------
                                             ------------   ------------

The fair value of each option grant is estimated on the date of grant using
the Black Scholes model with the following weighted average assumptions:

     Risk-free interest rate               5.49%-7.40%
     Expected life                             4 years
     Expected dividends                              -
     Expected volatility                  0.00%-79.52%

The effects of applying SFAS 123 for providing pro forma disclosures for 1996
and 1995 are not likely to be representative of the effects on reported net
loss and net loss per share for future years, because options vest over
several years and additional awards generally are made for each year.


                                 Continued
                                    F-16

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


9.  STOCKHOLDERS' EQUITY, continued:

STOCK-BASED COMPENSATION, continued:

The options outstanding and currently exercisable by exercise price at
December 31, 1996 are as follows:

<TABLE>
<CAPTION>

             Options Outstanding                              Options Currently Exercisable
    -------------------------------------------      ---------------------------------------------
                                     Weighted
                                      Average           Weighted                        Weighted
                                     Remaining          Average                         Average
    Exercise          Number        Contractual         Exercise        Number          Exercise
      Price         Outstanding        Life              Price        Exercisable         Price
    ---------      ------------     -----------       -----------   --------------    ------------
<S>                 <C>              <C>              <C>             <C>               <C>
      $0.16           64,069            7.51             $0.16           29,080           $0.16
      $0.41          311,786            8.39             $0.41          125,815           $0.41
      $1.00           25,924            9.28             $1.00                -               -
      $1.21          125,700            9.14             $1.21                -               -
      $2.41           31,793            9.07             $2.41             517            $2.41
      $5.00           53,050            9.74             $5.00                -               -
      $6.00            1,800            9.40             $6.00                -               -
      $7.06              250            9.49             $7.06                -               -
      $7.25            1,400            9.52             $7.25                -               -
      $7.38            1,000            9.54             $7.38                -               -
      $7.75              250            9.56             $7.75                -               -
     $11.50            1,000            9.46            $11.50                -               -
</TABLE>

The difference between the exercise price and fair market value of the
Company's common stock at the date of issue of the stock options, totaling
$1,577,700 has been recorded as deferred compensation as a component of
stockholders' equity.  Of this amount $386,596 of compensation expense has
been recognized as an expense through December 31, 1996.  The remaining
$1,191,104 will be recognized as an expense as the shares and options vest
over a period of up to four years.

10.  EMPLOYEE BENEFIT PLAN:

During 1995, the Company established a Retirement Savings and Investment Plan
(the 401(k) Plan) under which employees may defer a portion of their salary
up to the maximum allowed under IRS rules.  The Company has the discretion to
make contributions to the 401(k) Plan.  To date, the Company has not made any
contributions to the 401(k) Plan.


                                  Continued
                                    F-17

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


11.  RELATED PARTIES:

In November 1993, the Company entered into a consulting agreement with an
individual who serves on the Company's Scientific Advisory Board.  The
individual was contracted to be available for medical and clinical
consultations up to ten days per month.  The contract is renewable in annual
terms and can be terminated by either party with thirty days notice. Under
this agreement, the individual receives $4,500 plus expenses per month.
Consulting fees paid to this individual for the years ended December 31,
1996, 1995 and 1994 and for the cumulative period from October 14, 1992 (date
of inception) through December 31, 1996 were $54,000, $54,000, $54,000 and
$166,500 (includes expenses for all years), respectively.

In November 1993, the Company entered into a consulting agreement with an
individual who serves on the Company's Scientific Advisory Board.  The
individual was contracted to be available for medical and clinical
consultations up to 30 hours per month.  The agreement automatically renews
in two year periods and can be terminated by either party with thirty days
notice.  In connection with this agreement in November 1993, the individual
purchased 57,995 shares of common stock at a purchase price of $0.0024 per
share which were subject to a repurchase option of the Company with shares
being released from the Company's repurchase option based on specific
milestones as defined by the Board of Directors.  In June 1994, 28,997 of
such shares were repurchased and canceled by the Company based on the terms
of the stock purchase agreement.  Consulting fees paid to this individual for
the years ended December 31, 1996, 1995 and 1994, and for the cumulative
period from October 14, 1992 (date of inception) to December 31, 1996 were
none, $12,289, $7,497 and $19,786, respectively.

                                    Continued
                                      F-18

<PAGE>

                            FUSION MEDICAL TECHNOLOGIES, INC.
                          (a company in the development stage)
                        NOTES TO FINANCIAL STATEMENTS, Continued


12.  INCOME TAXES:

The tax effects of the significant temporary differences which comprise
deferred tax assets (liabilities) at December 31 are as follows:

<TABLE>
<CAPTION>
                                                               1996           1995
                                                            ----------     ----------
<S>                                                        <C>            <C>
Capitalized start-up and research and development costs    $ 3,046,000    $ 1,433,000
Research and development credit                                290,000        140,000
Depreciation                                                   (39,000)       (27,000)
Net operating loss carryforwards                             1,477,000        431,000
Other accrued expenses                                          82,000          9,000
                                                           -----------    -----------
Net deferred tax asset                                       4,856,000      1,986,000
Less valuation allowance                                    (4,856,000)    (1,986,000)
                                                           -----------    -----------
Net deferred asset                                         $         -    $         -
                                                           -----------    -----------
                                                           -----------    -----------
</TABLE>

The Company has established a valuation allowance to the extent of its
deferred tax assets since it is more likely than not that a benefit can not
be realized in the future due to the Company's recurring operating losses.

The Company had federal and state net operating loss carryforwards of
approximately $1,254,000 and $233,000, respectively, at December 31, 1996,
available to offset future regular and alternative minimum taxable income.
The Company's net operating loss carryforwards expire in 2001 through 2011,
if not utilized.

The Company has federal and state research and development credit
carryforwards of $164,000 and $126,000, respectively, expiring in the years
2009 through 2011, respectively, if not utilized.

For federal and state tax purposes, a portion of the Company's net operating
loss carryforwards are subject to certain limitations on annual utilization
in case of changes in ownership, as defined by federal and state tax law.


                                    F-19