<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                 ------------

                                   FORM 10-K

  [X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934.
       For the fiscal year ended December 31, 2000.

  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)

<TABLE>
<S>                           <C>
          Delaware                                     94-3177221
(State or other jurisdiction
    of incorporation or
       organization)                      (I.R.S. Employer Identification No.)
</TABLE>

             34175 Ardenwood Boulevard, Fremont, California 94555
              (Address of principal executive offices) (Zip code)

      Registrant's telephone number, including area code: (510) 818-4600

                                 ------------

<TABLE>
           <C>                                                         <S>
           Securities registered pursuant to Section 12(b) of the Act: None

                                                                       Common Stock, $.001 par
           Securities registered pursuant to Section 12(g) of the Act: value
</TABLE>

  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 market value of voting stock held by non-affiliates of the
Registrant, based upon the closing sales price of the Common Stock on March
31, 2001 as reported on the Nasdaq National Market, was approximately $18.4
million. 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 31, 2001, the Registrant had 11,285,626 shares of Common Stock
outstanding.

                                 ------------

                      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 June 14, 2001
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

                                     INDEX

<TABLE>
<CAPTION>
                                                                   Page Number
                                                                   -----------
 <C>      <S>                                                      <C>
                                    PART I

 Item 1.  Business...............................................        3

 Item 2.  Properties.............................................       21

 Item 3.  Legal Proceedings......................................       21

 Item 4.  Submission of Matters to a Vote of Security Holders....       21

                                    PART II

 Item 5.  Market for Registrant's Common Equity and Related
          Stockholder Matters....................................       22

 Item 6.  Selected Financial Data................................       22

 Item 7.  Management's Discussion and Analysis of Financial
          Condition and Results of Operations....................       23

 Item 7A. Quantitative and Qualitative Disclosures about Market
          Risk...................................................       26

 Item 8.  Financial Statements and Supplementary Data............       27

 Item 9.  Changes In and Disagreements with Accountants on
          Accounting and Financial Disclosure....................       27

                                    PART III

 Item 10. Directors and Executive Officers of the Registrants....       28

 Item 11. Executive Compensation.................................       28

 Item 12. Security Ownership of Certain Beneficial Owners and
          Management.............................................       28

 Item 13. Certain Relationships and Related Transactions.........       28

                                    PART IV

 Item 14. Exhibits, Financial Statement Schedules................       28

 Signatures......................................................       29
</TABLE>

                                       2
<PAGE>

                          Forward-Looking Statements

  This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934, some of which are designated by an
asterisk [*] after the statement. Actual results could differ materially from
those projected in the forward-looking statements as a result of a number of
risks and uncertainties, including the risk factors set forth below and
elsewhere in this Report. See "Business--Additional Factors That Might Affect
Future Results" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" on pages 14 and 23. This Form 10-K also
contains third party estimates regarding the size and growth of surgical
specialty markets, as well as the size of the suture and staples market and
topical hemostat market and other marketing estimates. We expressly disclaim
any obligation to update any information in this Report, except as may
otherwise be required by law.

                                    PART I

Item 1. Business

Our Company

  We develop, manufacture and market proprietary surgical hemostatic sealant
products. Hemostatic products are used to stop bleeding during surgical
procedures. Bleeding must be controlled to ensure surgical wounds are
effectively closed and to avoid serious or possibly life-threatening
complications, including blood loss, tissue damage, infection and excessive
scarring.

  Our current commercial product is FloSeal(R) Matrix Hemostatic Sealant
(FloSeal). FloSeal combines a collagen-derived gelatin with thrombin, a potent
clotting agent. We believe the innovative physical structure of FloSeal
provides performance advantages over existing surgical hemostatic products.
Our advantages include:

  . fast and effective bleeding control,

  . easy on-site preparation,

  . ease of use,

  . total absorption of FloSeal by the body within six to eight weeks, and

  . shortening of time to stop bleeding, potentially resulting in cost savings
    to hospitals and doctors.

  In December 1999, the FDA approved our pre-market approval application
allowing us to market and sell FloSeal in the United States. In April 1999, we
received approval to market FloSeal in the European Union.

  For the year ended December 31, 2000, we sold $4.9 million of FloSeal world-
wide. Based on our internal market research, we estimate the potential market
for FloSeal to be approximately $650 million annually, representing
approximately 4 million surgical procedures world-wide. We are focusing our
current marketing efforts on cardiac, vascular, spinal, ear, nose and throat,
head and neck, and cranial procedures, in which we believe we will have the
most effective early market penetration. These procedures represent an
approximate $370 million market or 57% of FloSeal's potential market. Because
the advantages of FloSeal can be most easily demonstrated in these markets, we
believe they are the most likely candidates for early acceptance of FloSeal by
the medical community. Our strategy is to launch FloSeal into additional
surgical specialties over time until we are selling into the entire applicable
world-wide market. The next surgical specialties we plan to launch into are
non-spinal orthopedics and urology. We believe regulatory approval should not
be a barrier to our growth in the United States or the European Union. The
chart below illustrates the growth in potential market size as additional
surgical specialties are added to our sales and marketing operations. The
market size estimates are based on our internal market research.

                                       3
<PAGE>

[Chart missing. Chart titled, FloSeal Potential World-wide Market, illustrates
the potential size of the world-wide market for FloSeal by showing the
additional market size of the following surgical specialties: spinal, cardiac
and vascular; ear, nose, throat, head and neck; neurosurgical; non-spinal
orthopedics; urology; general surgery; and other specialties. All surgical
specialties total $650 million potential world-wide market for FloSeal.]

  Our applications and products under development include the FloSeal Femoral
Arteriotomy Sealing Technology (FAST(TM)) device, for use in catheter lab
procedures, of which there are over 3.3 million performed each year, and the
FloSeal sponge, a ready to use configuration of FloSeal for trauma and
battlefield first aid situations.

Our Strategy

  We are committed to becoming a leader in hemostatic products. Our initial
strategy is to:

  . Penetrate our Initial Target Markets--We are focusing our current sales
    and marketing efforts on cardiac, vascular, spinal, ear, nose and throat,
    head and neck, and cranial procedures. These represent approximately 57%
    of FloSeal's approximately $650 million potential market. In these markets
    we believe our customers can most easily identify the benefits of using
    FloSeal. In addition, effective penetration of these markets will provide
    us with the ability to expand the market for FloSeal.

  . Expand our Sales Efforts--FloSeal's potential market includes specialties
    other than cardiac, vascular, spinal, ear, nose and throat, head and neck,
    and cranial procedures, such as non-spinal orthopedics, urology, general
    surgery, plastic surgery, transplant and gynecology. Our broad regulatory
    approval covers the sale of FloSeal to most of these additional
    specialties. Our existing customers have expressed interest regarding the
    application of FloSeal in these additional specialties.

  . Expand Our Product Lines--We are developing additional products from our
    core FloSeal technology. These include the FloSeal FAST device and the
    FloSeal sponge. We expect our products under development will expand
    applications of the FloSeal technology and increase our potential market.

Our Industry

  The industry for hemostatic products is highly competitive and can be
categorized into three general market segments.

                                       4
<PAGE>

 Topical Hemostats

  Topical hemostatic products are topically applied agents used to control
bleeding during surgical procedures. These products include thrombin, pads and
sponges. We believe existing topical hemostats have certain limitations,
including:

  . Limited Effectiveness--Topical hemostats do not work well in cases of
    excessive bleeding. In these circumstances, it is often the pressure that
    surgeons apply that stops the bleeding.

  . Rebleeding After Application--Since topical hemostats are usually in
    sponge or pad form, a blood clot when formed, may become embedded in the
    topical hemostat. When the sponge or pad is removed, bleeding can reoccur.

  The limitations are particularly evident in procedures with sutured blood
vessels, such as in coronary artery bypass grafts, and in patients with
compromised coagulation. We estimate annual sales of topical hemostats world-
wide, including the sale Gelfoam plus thrombin, exceeded $160 million in
2000.*

 Liquid Glues; Other Surgical Sealants and Adhesives

  Liquid glues and other types of surgical sealants and adhesives, including
fibrin glue, are currently sold as hemostatic products. They also have
limitations, including:

  . Lengthy and Complex Preparation--Some fibrin glue products may require as
    much as 40 minutes to prepare. Others may require specialized equipment
    and medical procedures, like drawing a patient's blood hours before
    surgery to extract blood components for use in the glue.

  . Difficult To Use--Most fibrin glues are liquids. Placing liquid on a wet
    or bloody surface causes the liquid glue to flow off the application site.
    Surgeons are required to dry the site or stop the bleeding prior to using
    the glue, which is often not possible.

  We estimate the United States sales of fibrin glue in the United States were
$50 million in 2000 and international sales were approximately $300 million.*
We believe over 60% of those sales were attributable to bleeding control.

 Sutures and Staples

  Sutures are the most common type of product used for closing surgical
wounds. Sutures mechanically bring together the tissue on either side of a
wound to facilitate healing. In the 1960s, surgical stapling was introduced to
reduce the time-consuming and cumbersome aspects of suturing. Surgical
stapling involves drawing together tissue through the application of staples
along an incision line using a manually operated device. While sutures and
staples are sometimes used to control bleeding, we do not intend for FloSeal
to replace sutures and staples. We believe the use of FloSeal will complement
the use of sutures and staples, particularly in light of their limitations.

  Sutures and staples have a number of limitations in the area of bleeding
control including:

  . No Inherent Sealing Capabilities--Sutures and staples do not have inherent
    sealing capabilities. They do not eliminate bleeding along suture lines,
    especially when connecting blood vessels.

  . Limited Effectiveness--The physical structure of sutures and staples often
    makes them ineffective in stopping bleeding associated with fragile tissue
    and organ wounds because these sites often lack the structural integrity
    required to hold sutures or staples in place.

  . Difficult To Use--Sutures and staples are limited by the space required to
    use them. The mechanics of applying them to a wound site is also
    complicated. This makes sutures and staples difficult or impossible to use
    in surgeries where access to the surgical site is limited, particularly in
    minimally invasive procedures.

Our Products

  We believe the benefits of FloSeal and our other products under development
are not matched by the other products currently marketed in the hemostatic
products industry. The technology underlying FloSeal and our other products
under development consists of a mixture of a proprietary collagen-derived
gelatin and thrombin, a potent blood-clotting agent. When mixed, the thrombin
coats the gelatin. Together, they act together to stop bleeding. Blood
percolates through the spaces between the granules and is exposed to high
concentrations of thrombin, thereby accelerating

                                       5
<PAGE>

formation of a mechanically stable clot. The granular nature of the gelatin
allows it to conform to irregular wound geometries. In addition, we have
engineered the collagen granules to swell upon contact with the blood. By
swelling, the granules further restrict blood flow.

 FloSeal

  Our current commercial product is FloSeal. It is designed to control
bleeding in various types of surgeries. FloSeal received regulatory approval
from the FDA in December 1999 and from our Notified Body in April 1999,
allowing sales and marketing activities in the United States and the European
Union, respectively. In addition, several other European countries not part of
the European Union recognize and give effect to the European Union
certification, thereby allowing the sale of FloSeal in those countries.

  FloSeal is designed to complement sutures and staples and to overcome
limitations of other existing products used to control bleeding, including
topical hemostats, fibrin glues and other types of surgical sealants and
adhesives. Our United States clinical trial, conducted during 1998,
demonstrated the effectiveness of FloSeal in stopping bleeding in cardiac,
vascular and spinal surgeries. We believe FloSeal offers the following key
performance advantages:

  . Stops Bleeding Rapidly and Effectively--FloSeal's proprietary physical
    structure rapidly induces stable clot formation and seals the wound site,
    even in challenging surgical situations, including very wet tissue and
    heavily bleeding sites. Because of the rapid effectiveness of FloSeal, we
    believe our customers will achieve cost savings by shortening the time to
    hemostasis and therefore the time of surgical procedures.

  . Stops Various Types Of Bleeding--FloSeal stops all degrees of bleeding
    encountered, ranging from lighter "oozing" to heavier "flowing" and
    "spurting". For example, our clinical trial demonstrated that FloSeal
    stopped bleeding within three minutes in 77% of heavily bleeding cardiac
    patients, compared to 0% for those treated with Gelfoam plus thrombin,
    which is the leading commercially available topical hemostat and was used
    as the control in our clinical trial. In addition, we believe FloSeal
    addresses bleeding associated with fragile tissues, diffuse organ bleeding
    and high pressure arterial bleeding, including bleeding in patients being
    treated with anti-coagulant drugs. Data from the clinical trials are
    included below under the subsection entitled "Clinical Data."

  . Easy To Prepare--Based on our trials, FloSeal can be prepared within two
    minutes and can be used for up to two hours after preparation. No special
    equipment is required during preparation, and all materials are contained
    in one simple package. FloSeal is easy to apply using a standard
    disposable syringe and has a gel-like granular consistency, which rapidly
    conforms to the application site. The surgeon can either remove any excess
    FloSeal without difficulty by gentle irrigation of the treated area or
    leave it to be absorbed by the body. Since only minimal training is
    necessary, we have seen both surgeons and nursing teams quickly learn how
    to use FloSeal.

  . Broad Applicability--FloSeal can be used in most surgical procedures when
    control of bleeding by conventional procedures is ineffective or
    impractical.

  . Biocompatible and Safe--FloSeal is biocompatible and fully absorbed by the
    body within about six to eight weeks, consistent with the body' s normal
    healing process. Since FloSeal does not have to be removed after
    application, bleeding generally does not reoccur. In addition, the
    principal materials used in FloSeal, collagen and thrombin, are not
    derived from human blood and do not present risks typically associated
    with human blood products, such AIDS, hepatitis or other human viruses.

 Proceed

  Proceed, our product for the spinal and cranial surgical market, consists of
the same product as FloSeal. It also has the same benefits of FloSeal. In July
1999, we entered into a collaboration agreement with Sulzer Spine-Tech to
market and sell Proceed for use in spinal and cranial surgeries throughout the
world, including in the United States and the European Union but excluding
Japan. We manufacture and package Proceed in our California facilities and
ship the product directly to Sulzer Spine-Tech's customers. In addition to
allowing us to maintain control over the manufacturing and distribution
process, we are able to maintain a direct relationship with the users of our
products.

Our Other Applications and Products Under Development

  We are currently developing additional hemostatic applications and products
based on the core technology of FloSeal.

                                       6
<PAGE>

 FloSeal FAST

  We are developing a FloSeal femoral arteriotomy sealing technology (FAST)
device that will be used by interventionalists to close femoral artery
punctures following catheterization procedures, such as balloon angioplasty or
angiography. The device will incorporate a proprietary catheter-based
applicator to deliver FloSeal to the site of the arterial puncture. Currently
available suturing devices and collagen plugs can be costly, difficult to use
and may require extensive doctor training prior to use. We are designing the
FAST device to be less costly, more effective and easier to use than competing
products.

  This device is in early stages of development. We have conducted preliminary
pre-clinical studies examining the safety and effectiveness of the FAST
device. We began a pilot clinical trial for this device in December 2000 after
receiving FDA approval of an investigational device exemption. We cannot begin
the pivotal clinical trials nor can we begin marketing the device without FDA
approval and other necessary regulatory approvals. We cannot assure you that
such approvals will be granted. Initial customer shipments are at least three
years away.*

  Industry sources estimate approximately 3.3 million arterial puncture
closure procedures, including therapeutic and diagnostic procedures, were
performed in the United States in 1999.

  Statements regarding the anticipated manufacturing, marketing and sale of
our applications and products under development are forward looking. We are
not permitted to manufacture, market or sell these applications or products
until we receive necessary regulatory approvals, which cannot be guaranteed.

 FloSeal Sponge

  The FloSeal sponge as a ready-to-use application of the FloSeal technology.
The FloSeal sponge may be used in trauma and battle field emergency
applications where loss of blood often leads to patient death prior to
receiving necessary medical attention.

  While the current FloSeal product requires the FloSeal gelatin granules to
be mixed with the thrombin component prior to application, the FloSeal sponge
will be packaged in a pre-mixed, dry formulation. A gelatin superstructure
dissolves very quickly upon contact with a bleeding wound leaving active
FloSeal at the bleeding site. In our laboratory tests, the FloSeal sponge has
been shown in the lab to stop bleeding as effectively as FloSeal and presents
the same benefits as FloSeal. The FloSeal sponge is in early stages of
development. We believe the FDA will require a full Pre-Market Approval
application to approve the device for sale. Initial customer shipments are at
least three years away.*

Sales And Marketing

  We are focusing our immediate sales and marketing efforts on cardiac,
vascular, spinal, ear, nose and throat, head and neck, and cranial procedures,
in which we believe we will have the most effective early market penetration.
These procedures represent 57% of FloSeal's potential market. They are the
most likely candidates for early acceptance of FloSeal by the medical
community because the advantages of FloSeal can be easily demonstrated. We
believe this market will grow because FloSeal will be used in an increasing
number of surgical procedures, and over time more surgeons will use FloSeal in
more surgical specialties in which FloSeal provides significant benefit. We
believe regulatory approval should not be a barrier to our growth in the
United States or the European Union.

  To address our current marketing efforts for FloSeal, we have adopted the
following sales strategy:

<TABLE>
<CAPTION>
                                     Cardiac, Vascular,
                                    Ear, Nose and Throat
                                      & Head and Neck      Spinal & Cranial
  -------------------------------------------------------------------------
    <C>                            <S>                     <C>
    United States                    Direct Sales Force      Sulzer Spine-
                                                                 Tech
  -------------------------------------------------------------------------
    Europe (except Germany)        Regional Distributors
  -------------------------------------------------------------------------
    Germany                          Direct Sales Force
  -------------------------------------------------------------------------
    Other Countries (except Japan)           *
  -------------------------------------------------------------------------
    Japan                                    *                     *
</TABLE>
  * Future sales efforts

                                       7
<PAGE>

  We have built a direct sales force to market FloSeal to our customers in the
cardiac, vascular, ear, nose and throat, and head and neck surgical
specialties in the United States. Initially we identified geographic areas in
the United States with the highest incidence of cardiac and vascular
procedures. Beginning in the summer of 1999, we began hiring sales
professionals in these markets. As of March 31, 2001, our direct sales force
is comprised of 28 sales professionals servicing these geographical areas.

  In July 1999, we entered into a distribution arrangement with Sulzer Spine-
Tech, pursuant to which Sulzer Spine-Tech has the right to market FloSeal
under the Proceed label for spinal and cranial procedures. Sulzer Spine-Tech
has the right to market Proceed worldwide, except Japan and certain other
markets in which we had pre-existing distributor relationships. Sulzer Spine-
Tech has a United States sales force of approximately 90 people and
relationships with most hospitals conducting spinal and neurosurgical
surgeries.

  In addition, we have regional distributors in Switzerland, the Netherlands,
Sweden, Austria, Italy, Spain, the United Kingdom, Belgium, Denmark and
Finland that market FloSeal in the European Union and the other countries in
Europe that recognize and give effect to the European Union's certification of
FloSeal. In Germany, we sell FloSeal through three direct sales people. The
decision to build a direct sales force in Germany was made following
disappointing performance by the predecessor distributor.

  We believe our sales and marketing strategy will enable us to penetrate our
potential target markets for our products quickly and to grow our sales most
effectively.

Our Competition

  The market for products that control surgical bleeding is highly
competitive. A wide variety of existing products compete directly with FloSeal
and our other products under development. Several companies have a dominant
presence in the market for products that control surgical bleeding and include
Pharmacia & Upjohn, Baxter International, Johnson & Johnson, and Bard.
Pharmacia & Upjohn makes Gelfoam, which is the leading commercially available
topical hemostat and was used in our clinical trial. Baxter makes Tisseel,
which is a leading fibrin glue product.

  We believe the principal factors in selling FloSeal and our other products
under development are the quality and reliability of the product,
applicability and ease of use of the product, safety of the product, cost of
the product, reputation of the product's manufacturer and marketing and
distribution network of the product's manufacturer. We believe we compete
favorably with these factors. Our competitors, however, have certain
competitive advantages over us, such as:

  . greater name recognition,

  . broader product lines,

  . greater marketing and sales personnel resources,

  . stronger distribution networks,

  . greater capital resources,

  . larger regulatory compliance staffs, and

  . larger technological, research and development and clinical staffs and
    facilities.

  Our largest competitors have greater resources that may give them the
ability to negotiate exclusive, long-term supply contracts and, as a result,
the ability to offer comprehensive pricing for their products. These larger
competitors may also have a significant advantage in marketing competing
products to group purchasing organizations and other managed care
organizations that seek to reduce costs through centralized purchasing. There
can be no assurance we will be able to compete successfully. In addition, we
cannot be certain that our competitors will not succeed in developing
technologies and products that are more effective or that would render our
technology or products obsolete or unable to compete.

  Our competitors may also develop future products that are more effective,
easier to use or more economical than FloSeal or our other products under
development. Our competitors may also use technologies that could render our
technology or products obsolete or unable to compete. Additionally, we cannot
assure you that our marketing or other strategic partners, such as Sulzer
Spine-Tech, will not pursue parallel development of technologies or products
that compete with FloSeal or our products under development.


                                       8
<PAGE>

  Other companies may also prove to be significant competitors, particularly
through the development of new products or through collaborative arrangements
with other companies. Academic institutions, government agencies and other
public and private research organizations also conduct research, seek patent
protection and establish collaborative arrangements for product development
and marketing. In addition, these companies and institutions compete with us
in recruiting and retaining highly qualified scientific and management
personnel.

Clinical Data

 Clinical Trials

  In March 1998, we began enrolling human subjects in a pivotal clinical trial
using FloSeal. The design and goal of the clinical trial was to address the
safety and efficacy of the product in humans. To assess the efficacy and
safety of the product, a total of 309 patients were treated with FloSeal or
Gelfoam plus thrombin during a nine-month period. The following chart provides
a summary of clinical trial results:

Summary Clinical Trial Results

<TABLE>
<CAPTION>
                                                Bleeding stops   Bleeding stops
                                                in 10 minutes     in 3 minutes
                                               ---------------- ----------------
                                               FloSeal Control* FloSeal Control*
                                               ------- -------- ------- --------
     <S>                                       <C>     <C>      <C>     <C>
     All patients.............................   96%     77%      83%     47%
     All vascular.............................   93%     76%      79%     39%
     All spinal...............................   98%     90%      97%     71%
     All cardiac patients.....................   94%     60%      69%     22%
     Cardiac: "oozing"........................   94%     66%      66%     29%
     Cardiac: "flowing or spurting"...........   92%     40%      77%      0%
</TABLE>
    ------
    * Control was Gelfoam plus thrombin

 Clinical Development

  In November 1998, we completed enrollment in a ten-center randomized
clinical trial of FloSeal involving 309 patients who underwent cardiac,
vascular or spinal surgery. One hundred fifty-six patients were treated with
FloSeal while 153 patients were treated with Gelfoam plus thrombin. At the
time the study began, Gelfoam plus thrombin was seen as the treatment
standard. The degree of intraoperative bleeding treated during the trial
ranged from lighter "oozing" to heavier "flowing" and "spurting," with nearly
one-third of the patients experiencing bleeding in the heavier, more difficult
to control ranges.

  The trial demonstrates in the combined surgical procedures that FloSeal
stopped bleeding within 10 minutes after application at least as frequently as
the Gelfoam plus thrombin control. FloSeal stopped bleeding within 10 minutes
in 96% of the 156 patients treated with FloSeal, whereas Gelfoam plus thrombin
stopped bleeding within ten minutes in 77% of the 153 patients in the control
group. In addition, the trial demonstrated that FloSeal stopped bleeding at
least two times faster than Gelfoam plus thrombin. These results were
consistent across all tested surgical specialties and bleeding classes, from
simple oozing to active arterial spurting.

  Ninety-three patients underwent cardiac surgery, the most difficult group to
treat due to the use of cardiopulmonary bypass and high levels of anti-
coagulant drugs. FloSeal stopped bleeding within ten minutes in 94% of the 48
patients treated, whereas Gelfoam plus thrombin stopped bleeding within ten
minutes in 60% of the 45 patients in the control group. In cases of heavy
cardiac bleeding, FloSeal stopped bleeding within three minutes in 77% of
patients, as compared to none for those treated with Gelfoam plus thrombin.

  In the trial, 89 patients underwent vascular surgery. FloSeal stopped
bleeding within ten minutes in 93% of the 43 patients treated with FloSeal,
versus 76% for the 46 control group patients. One hundred twenty-seven
patients underwent spinal surgery. FloSeal stopped bleeding within ten minutes
in 98% of the 65 patients treated with FloSeal, versus 90% for the 62 control
group patients. Results for the clinical trial as a whole and each of the
cardiac, vascular and spinal segments of the trial have been presented as
abstracts at various medical conferences. The results for the cardiac segment
were publicized in the Annals of Thoracic Surgery in May 2000. The results for
the spinal segment have been accepted for publication in SPINE. We anticipate
additional publications in peer-reviewed medical journals in the future.

                                       9
<PAGE>

Manufacturing And Facilities

  We have facilities in Mountain View and Fremont, California. Most of our
current manufacturing operations for FloSeal are located in our 13,200 square
foot Mountain View facility. We believe the manufacturing capacity of this
facility will be sufficient through the end of 2001, when the facility lease
expires. We are planning to complete the move to the Fremont facility during
the second half of 2001. Our decision to close the Mountain View facility
depends on receiving an approval by FDA of the Fremont facility. There can be
no assurance we will obtain this approval. If we don't receive the approval by
the end of the year, we will renew the Mountain View lease.

  In January 2000, we began improvements on the 72,500 square foot Fremont
facility, which is our corporate headquarters. We are using the Fremont
facility for executive, administrative, sales and marketing and research and
development operations. We plan to also use the Fremont facility for packaging
and shipping FloSeal and for manufacturing FloSeal. We believe the capacity of
the Fremont facility will be sufficient through December 2006. In connection
with the Fremont facility, we have spent approximately $4.9 million for the
purchase of production equipment, leasehold improvements and office
furnishings and equipment.

  The manufacturing of FloSeal consists of the following stages:

  . acquiring essential components of FloSeal, such as bovine hides, thrombin,
    sterilization services and product components from single suppliers,

  . processing raw materials internally to the appropriate form and
    composition,

  . arranging sterilization by third parties, and

  . packaging FloSeal for shipment.

  Our manufacturing facilities are subject to the FDA's Quality System
Regulation, international quality standards and other regulatory requirements.
We also have a manufacturing license from the California Department of Health
Services. We acquire raw materials and product components, such as bovine
hides and thrombin, from suppliers, process the raw materials internally to
the appropriate form and composition, package kits, arrange for sterilization
by a third party and then package the products for shipment.

Patents And Proprietary Rights

  Patents and other proprietary rights are important to our business. Our
policy is to file patent applications and protect technology, inventions and
improvements to inventions that are commercially important to the development
of our business. With respect to products, to the extent possible, we seek or
plan to seek patent protection on:

  . the product itself,

  . methods of using the product,

  . methods of manufacturing the product, and

  . methods of administering the product.

  We also rely on trade secrets, know-how, continuing technology innovations
and licensing opportunities to develop and maintain our competitive position.

  As of March 31, 2001, we have four issued patents and four pending United
States patent applications relating to FloSeal. We also have ten issued United
States patents and three pending United States patent applications relating to
other products under development and other technologies invented by our
research department. We also have filed corresponding patent applications with
the European Patent and Trademark Commission and may file additional patent
applications outside the United States at a later date. In addition, we have
licensed technology from third parties that we believe strengthens our patent
portfolio.

                                      10
<PAGE>

  We were issued two patents in May 2000. Our patent, No. 6,063,061, was
issued on May 16, 2000. This patent includes 31 claims covering the use of
fragmented hydrogels, including FloSeal made from natural or synthetic sources
in sealing, hemostasis, drug delivery, tissue tract filling, and the delivery
of compositions to a target site within the body of a patient. On May 23,
2000, we were granted a United States patent covering the composition of and
methods for delivering the FloSeal product. This patent, No. 6,066,325,
includes claims covering the composition of fragmented hydrogels that
constitute the FloSeal products. It also has claims protecting methods for
delivering the substance to a target site on the patient.

  Our patent applications may not result in issued patents. We have conducted
searches to determine whether our patent applications interfere with existing
patents. Based upon these searches, we believe our patent applications and
products do not interfere with existing patents. However, we cannot be sure
relevant patents have not been issued that could block our ability to obtain
patents or commercialize our products. Moreover, since United States patent
applications are not a matter of public record, a patent application could
currently be on file with the appropriate agency that would stand in the way
of our obtaining an issued patent. A number of medical device companies as
well as other companies, universities and research institutions have filed
patent applications or have issued patents relating to compositions and
methods for surgical sealing that could materially impact our operations.
Obtaining foreign patents may be more difficult than obtaining domestic
patents because of differences in patent laws. We believe it will be more
difficult for us to enforce our intellectual property abroad than in the
United States.

  The medical device industry is characterized by extensive litigation
regarding patents and other intellectual property rights. Many medical device
companies have employed intellectual property litigation as a way of gaining a
competitive advantage. There is no assurance that we will not be involved in
litigation regarding our patent rights, nor is there any assurance that we
will be free from third parties making claims of infringement on patents
against us. Recently, we were subjected to litigation regarding patent rights
involving a lawsuit brought by Cohesion Technologies, Inc. See "Item 3. Legal
Proceedings." An adverse determination in litigation or interference
proceedings to which we may become a party could subject us to significant
liabilities to third parties, require us to license disputed rights from third
parties or require us to cease using the disputed technology. Although patent
and intellectual property disputes in the medical device area are often
settled through licensing or similar arrangements, costs associated with these
arrangements may be substantial and could include ongoing royalties.
Furthermore, we cannot be certain that the necessary licenses would be
available to us on satisfactory terms, if at all.

Government Regulation

 United States

  FloSeal, our proposed applications and products and our research and
development activities are subject to regulation by the FDA and other
regulatory bodies. FDA regulations govern, among other things, the following
activities:

  . product development,

  . product testing,

  . product labeling,

  . product storage,

  . pre-market clearance or approval,

  . advertising and promotion,

  . product traceability, and

  . product indications.

  In the United States, medical devices are classified on the basis of
controls deemed necessary to reasonably ensure the safety and effectiveness of
the device. Class I devices are subject to general controls. These controls
include registration and listing, labeling, premarket notification and
adherence to the FDA Quality System Regulation. Class II devices are subject
to general and special controls. Special controls include performance
standards, post market surveillance, patient registries and FDA guidelines.
Class III devices are those which must receive premarket approval by the FDA
to ensure their safety and effectiveness.

                                      11
<PAGE>

  Pre-market notification clearance must be obtained for many Class I, most
Class II devices and Class III devices when the FDA has not called for
premarket approval. A pre-market approval application is required for most
Class III devices. A pre-market approval application must be supported by
valid scientific evidence to demonstrate the safety and effectiveness of the
device. The pre-market approval application typically includes:

  . results of bench and laboratory tests, animal studies, and clinical
    studies,

  . a complete description of the device and its components,

  . a detailed description of the methods, facilities and controls used to
    manufacture the device, and

  . proposed labeling.

  The approval process can be expensive, uncertain and lengthy. A number of
devices for which FDA approval has been sought by other companies have never
been approved for marketing.

 FDA Review Process

  When the FDA receives a premarket approval application, it determines
whether the application is complete. If the application is complete, the
application is filed and the FDA begins an in-depth review. Currently, FDA
review time is approximately 12 months, but timing is uncertain and the
process may take significantly longer. The review time is often extended by
the FDA asking for more information or clarification of information already
provided in the submission. An advisory committee may be convened to review
and evaluate the application and provide a recommendation to the FDA as to
whether the device should be approved. The FDA gives substantial weight to the
recommendation but is not bound by it. Before granting approval, the FDA will
generally conduct an inspection of the manufacturer's facilities to ensure
compliance with applicable Quality System Regulation requirements.

  The FDA may issue either an approval letter or an approvable letter. An
approvable letter will contain a number of conditions that must be met in
order to secure final approval. When and if those conditions are met, an
approval letter will be issued. The FDA can also deny approval or issue a "not
approvable" letter that will detail the deficiencies.

  The FDA may determine that additional clinical trials are necessary. This
may delay approval for one or more years while additional clinical trials are
conducted and submitted. Any additional information must be submitted in an
amendment to the application. Certain modifications to the device, labeling or
manufacturing process may require premarket approval or approval of a
supplement to a premarket approval. Premarket approval supplements often
require the submission of information only needed to support the proposed
change.

  If clinical trials involve a "significant risk," the sponsor of the trail
must file an Investigational Device Exemption application prior to commencing
the study. The FDA must approve the clinical trial before the study may
commence. If the device presents a "non-significant risk" to the patient, the
clinical trial may commence without an Investigational Device Exemption.
Institutional Review Board approval must be obtained for all investigational
studies. Submission of an Investigational Device Exemption application does
not give assurance that the FDA will approve the application. If the
application is approved, there can be no assurance that FDA will determine
that data derived from the studies will support the safety and efficacy of the
device. A supplement must be approved by the FDA before a sponsor or
investigator may make a significant change to the investigational plan.

  The FDA determined FloSeal would be regulated as a Class III medical device.
The FDA issued a pre-market approval for FloSeal on December 8, 1999.
Additional Investigational Device Exemptions, pre-market approvals or pre-
market approval supplements may be required for other applications of FloSeal,
including the use of FloSeal for urologic surgeries, the FloSeal femoral
arteriotomy sealing technology (FAST) device and the FloSeal sponge. There can
be no assurance a pre-market approval supplement application will be accepted
for our additional products. In the event we are unable to file a pre-market
approval supplement for our additional products, we will be required to file
pre-market approval applications.

 Manufacturing

  Manufacture and distribution of FloSeal will be subject to continuing
regulation by the FDA. We will also be subject to routine inspections by the
FDA to determine compliance with the following:

  . Quality System Regulations,

                                      12
<PAGE>

  . medical device reporting regulations, and

  . FDA restrictions on promoting products for unapproved or off-label uses.

  In addition to regulations enforced by the FDA, we are also subject to
regulations under the Occupational Safety and Health Act, the Environmental
Protection Act and other federal, state and local regulations.

 International

  To market products in the European Union and countries other than the United
States, we must obtain regulatory approval similar to that required by the
FDA. FloSeal is classified as a Class III device under the European Medical
Devices Directive. Therefore, we were required to obtain a "CE Mark"
certification from a "Notified Body" in one of the member countries in the
European Union. CE Mark certification is an international symbol of adherence
to quality assurance standards and compliance with the applicable European
Medical Devices Directive.

  Approval by a Notified Body typically includes a detailed review of the
following:

  . description of the device and its components,

  . safety and performance of the device,

  . clinical evaluations with respect to the device,

  . methods, facilities and quality controls used to manufacture the device,
    and

  . proposed labeling for the devise.

  Manufacturing and distribution of a device is subject to continued
inspection and regulation by the Notified Body after CE Mark certification to
ensure compliance with quality control and reporting requirements.

  In February 1997, we received ISO 9001 and EN 46001 qualification of our
processes, a principal step in the CE Mark certification process. We obtained
CE Mark certification to market FloSeal in the European Union on April 20,
1999. There can be no assurance, however, that we will be successful in
completing the CE Mark Certification process or obtaining CE Mark
Certification in a timely manner for our products under development.

  In addition to CE Mark certification, each member country of the European
Union maintains the right to impose additional regulatory requirements. In
France, for example, we have not yet obtained required approval of the
Biological Safety Committee. Accordingly, we are not yet authorized to market
or sell FloSeal in France. With the exception of France, the CE mark allows
for marketing in each member of the European Union.

  Outside of the European Union, regulations vary significantly from country
to country. The time required to obtain approval to market products may be
longer or shorter than that required in the United States or the European
Union. Certain European countries outside of the European Union do recognize
and give effect to the CE Mark certification. We are permitted to market and
sell FloSeal in those countries.

Litigation

  See Item 3. Legal Proceedings.

Product Liability Insurance

  The manufacture and sale of medical products entail significant risk of
product liability claims. We purchased product liability insurance prior to
beginning our clinical trials. We currently maintain product liability
insurance with combined coverage limits of $3.0 million on a claims made
basis. We cannot assure you that this coverage will be adequate to protect us
from any liabilities we might incur in connection with the sale or testing of
our products. In addition, we may require increased product liability coverage
as products are commercialized. This insurance is expensive and in the future
may not be available on acceptable terms, if at all.

                                      13
<PAGE>

Employees

  As of March 31, 2001, we had 89 regular full time employees, 20 who were
engaged in sales, 5 in marketing, 35 in operations, 14 in research and
development, 6 in regulatory affairs and quality assurance, and 9 in finance
and administration. We also had 12 temporary employees. No employees are
covered by collective bargaining agreements, and we believe we maintain good
relations with our employees.

Additional Factors That Might Affect Future Results

  The following factors represent some of our challenges that create risk and
uncertainty. If any of the following risks actually occur, our business,
financial condition or results of operations could be materially adversely
affected.

 We have a history of losses. We expect losses to continue in the future, and
 we may never achieve profitability.*

  We have not been profitable since our inception in 1992. For the year ended
December 31, 2000, we generated $4.9 million of revenues. We incurred net
losses of $7.7 million in 1998, $8.3 million in 1999, and $13.7 million in
2000. As of December 31, 2000, we had an accumulated deficit of $51.3 million.
We do not expect our operating expenses to decrease as we continue to market
our current commercial product, FloSeal, and to develop other products.* The
amount of future net losses and the time required to achieve profitability are
highly uncertain. We do not expect to achieve profitability before at least
2002, and we may never achieve profitability.* If we do achieve profitability
in any period, we may not be able to sustain or increase such profitability on
a quarterly or annual basis.*

 We expect quarterly revenue and operating results to vary significantly in
 future periods, which could cause our stock price to fluctuate.*

  Our operating results have varied widely in the past, and we expect they
will continue to vary significantly from quarter to quarter as we commercially
produce FloSeal and our other products under development in the market.* Our
quarterly results may fluctuate for many reasons, including:

  . our limited operating history,

  . our dependence on FloSeal to provide future revenue,

  . our dependence on Sulzer Spine-Tech to sell Proceed into the spinal and
    cranial surgical specialties, and

  . our limited experience in manufacturing and marketing FloSeal in
    commercial quantities.

  As a result of these fluctuations and uncertainties in our operating
results, we believe quarter-to-quarter or annual comparisons of our operating
results are not a good indication of our future performance. In addition, at
some point in the future, these fluctuations may likely cause us to perform
below the expectations of public market analysts and investors. If our results
were to fall below market expectations, the price of our common stock would
likely fall.

 We cannot be certain that we will be able to manufacture FloSeal in
 sufficiently high volumes at commercially reasonable costs.

  We have been manufacturing FloSeal for commercial sale only since December
1999 and have limited experience manufacturing our other products in the
quantities necessary to achieve significant commercial sales. We cannot be
certain we will be capable of reliable, high-volume manufacturing at
commercially reasonable costs. We could encounter problems relating to:

  . capacity constraints,

  . production yields,

  . quality control,

  . shortages of qualified personnel, and

  . raw materials supply.

  These problems could affect our ability to adequately increase and maintain
uninterrupted production of our products and fill customer orders on a timely
basis, in which case we may not be able to increase revenues or increase gross
profits from sales. Furthermore, the adverse consequences

                                      14
<PAGE>

of these problems could have a disproportionately large effect on us because
the manufacturing of FloSeal is centralized in a single facility. Because we
plan to move all manufacturing to the new Fremont, California facility by
December 31, 2001, we will continue to manufacture FloSeal in a single
facility.

  In addition, our manufacturing facilities are subject to the Quality System
Regulation of the FDA, international quality standards and other regulatory
requirements. Our failure to implement and maintain our facilities in
accordance with these regulatory requirements and standards will result in a
delay or termination of production. Any delay or termination of production
would materially and adversely affect our ability to manufacture commercially
necessary volumes and our ability to generate revenue.

 We may not be able to increase revenues from the sale of FloSeal to achieve
 profitability by the end of 2002, if ever.

  We depend on the success of FloSeal, our lead product and currently only
commercial source of revenue. Our success, if any, will depend on the medical
community's continued acceptance of FloSeal and our ability to increase
revenues from the sale of FloSeal through our current sales, marketing and
distribution capability. We cannot guarantee sufficient growth in revenues to
allow us to achieve profitability in 2002, if at all. A surgeon's use of
FloSeal requires a change from more familiar products that are currently
available. We cannot assure you of our ability to cause such a change. FloSeal
will have to be priced competitively and offer clinically significant
advantages over other commercially available products in order to achieve
market acceptance. Even if the market generally accepts FloSeal, surgeons may
choose to use it in fewer procedures than we project. If FloSeal does not
achieve significant sales growth or we are unsuccessful in increasing
commercial manufacturing, we may not be able to significantly increase our
revenues.

 We derive a substantial portion of our revenue from Sulzer Spine-Tech, and
 any disruption of this relationship may cause our revenues to decline.

  During the year ended December 31, 2000, sales to Sulzer Spine-Tech of
Proceed accounted for 60% of our product revenues. In July 1999, we entered
into a world wide distribution agreement granting Sulzer Spine-Tech rights to
sell the product configuration of FloSeal known as Proceed in all world wide
spinal and cranial surgical specialty markets except for Japan and a few other
small markets where we already had distributor relationships in place. The
agreement extends through June 30, 2002 and contains provisions for both
minimum annual sales and termination in the event of change in control. We
expect Sulzer Spine-Tech will continue to account for a significant portion of
our revenue in the future.* Our future success will depend upon the timing and
size of future purchase orders by Sulzer Spine-Tech as well as their ability
to distribute Proceed through their sales force. Sulzer Spine-Tech may be
unable to satisfy minimum sales requirements, under the distribution
agreement, or achieve projected sales levels, which could result in the
termination of the agreement and a material adverse affect on our business,
financial condition and results of operations.

 Our ability to achieve significant revenue will depend on our ability to grow
 our sales, marketing and distribution capabilities.

  Our ability to achieve significant revenue will depend heavily on our
success in growing our sales and marketing capabilities. Our sales strategy
combines a direct sales force and collaboration and distribution arrangements.
We have built our own sales force to initially address only the cardiac,
vascular, ear, nose and throat, and head and neck surgical markets for FloSeal
in the United States. We cannot be certain we can continue to grow and manage
an effective direct sales force for FloSeal. To the extent we rely on our
direct sales force, we compete with other companies that have greater
experience and better-funded marketing and sales operations.

  We have a distribution arrangement with Sulzer Spine-Tech for the worldwide,
except for Japan, distribution of Proceed, which is a configuration of FloSeal
for the spinal and cranial surgical markets. We have entered into distribution
agreements with European regional distributors for the distribution of FloSeal
in the cardiac and vascular surgical markets in the European Union. Our
distributors may be unable to satisfy minimum purchase agreement requirements
or achieve projected sales levels under the distribution agreements, which
could result in the termination of their agreements and a material adverse
affect on our business, financial condition and results of operations. In
addition, several of our agreements with regional distributors have one-year
terms. The distributors are under no obligation to renew these agreements. As
a result, we may need to seek new arrangements to sell and distribute FloSeal
and our other products under development or to expand our own direct sales
capabilities. Securing new partners or distributors is a time-consuming
process, and there is no guarantee that the negotiations with new distributors
will result in arrangements

                                      15
<PAGE>

on commercially reasonable terms. There can be no assurance that the terms of
new arrangements will be favorable to us. In addition, there can be no
assurance that our distributors will not distribute other products that
compete directly with FloSeal or new products developed by competitors that
may prove to be more effective or cost efficient alternatives than our
products.

  We recently began selling FloSeal through a small direct sales force in
Germany after terminating our agreement with the regional distributor. There
can be no assurance that our sales in Germany will be more favorable to us
than sales through a regional distributor or that sales in Germany will ever
be sufficient to obtain a profitable operation in that country.

 We may be unable to increase FloSeal revenues effectively because the market
 for hemostatic products is highly competitive.

  The market for products that control surgical bleeding is highly
competitive. FloSeal and our other products under development compete with a
variety of products, such as topical hemostats, fibrin glues and other types
of surgical sealants and adhesives.

  Competing products are manufactured and sold by several companies, including
Pharmacia & Upjohn (maker of Gelfoam), Baxter International (maker of Tisseel,
a fibrin glue product) and Johnson & Johnson. We cannot be certain that
FloSeal or our other products under development will be able to compete
successfully against these existing products or any other products that may
enter the marketplace.

  Our major competitors have several competitive advantages over us, such as:

  . greater name recognition,

  . broader product lines,

  . greater marketing and sales personnel resources,

  . stronger distribution networks,

  . greater capital resources,

  . larger regulatory compliance staffs, and

  . larger technological, research and development and clinical staffs and
    facilities.

  Our competitors may develop future products that are more effective, easier
to use or more economical than FloSeal or our other products under
development. Our competitors may also use technologies that could render our
technology or products obsolete or unable to compete. Additionally, we cannot
assure you that our marketing or other strategic partners, such as Sulzer
Spine-Tech, will not pursue parallel development of technologies or products
that compete with FloSeal or our other products under development.

  Smaller companies, such as Bard and CryoLife may also prove to be
significant competitors, particularly through collaborative arrangements with
large companies. Academic institutions, government agencies and other public
and private research organizations also conduct research, seek patent
protection and establish collaborative arrangements for product development
and marketing. In addition, these companies and institutions compete with us
in recruiting and retaining highly qualified scientific and management
personnel.

 We purchase key raw materials from single suppliers, with whom we do not have
 long term supply arrangements.

  We currently purchase essential elements of FloSeal and sterilization
services from single suppliers. We purchase bovine hides from Spear Products
and thrombin from GenTrac, Inc. We do not have long-term supply arrangements
with these suppliers. In the event that raw materials from any of our current
single-source suppliers become unavailable for any reason, we will be required
to identify alternative suppliers. Identifying and utilizing additional or
replacement suppliers for any of the components in FloSeal may not be
accomplished quickly and could involve significant additional costs. In
addition, FDA approval of any new supplier of a critical component would be
required if that component was no longer available from the specified
supplier. The qualification of a new supplier could delay our development and
marketing efforts. Our failure to obtain any of the components used to
manufacture FloSeal from alternative suppliers or any delay in qualifying a
new supplier could limit our ability to manufacture FloSeal and would have a
material adverse affect on our business, financial condition and results of
operations.

                                      16
<PAGE>

 We manufacture FloSeal in two manufacturing facilities, both located in the
 San Francisco Bay Area in California. A natural disaster or power shortage is
 possible and could result in prolonged interruption of our business.

  We currently manufacture FloSeal in our Mountain View, California and
Fremont, California facilities. After FDA approval of our Fremont facility, we
intend to centralize all manufacturing operations at the Fremont facility.
Both facilities are located in the San Francisco Bay Area in California, which
is a seismically active area. With our manufacturing centralized in this area,
a natural disaster, such as an earthquake, fire or flood, could substantially
disrupt our manufacturing operations or destroy our facilities. Further,
California is currently experiencing power outages due to a shortage in the
supply of power within the state. If the power outages increase in severity,
the outages could disrupt our manufacturing operations. This could cause
delays and cause us to incur additional expenses and adversely affect our
reputation with our customers and our distributors. In addition, since the
real estate market in the San Francisco Bay Area is extremely competitive and
is likely to remain competitive, an alternative facility may not be available
on commercially reasonable terms if we suffer a catastrophic loss from a
natural disaster.

 If we are unable to effectively develop and commercialize new products, our
 revenues may decline.

  To be successful, we will need, in part, to develop, market and sell
products other than FloSeal. Our other products under development include our
FloSeal FAST device and the FloSeal sponge. There can be no assurance we will
be able to successfully develop these products or, if developed, we will
generate revenues or profits from these products. Successful marketing and
sale of our products under development depends, in significant part, on our
ability to:

  . complete product development in a timely fashion,

  . obtain and maintain patents or other proprietary protections,

  . obtain required regulatory approvals from the FDA and other regulatory
    authorities,

  . implement efficient, commercial-scale manufacturing processes,

  . gain early entry into relevant markets,

  . establish sales, marketing, distribution and development collaborations,
    and

  . demonstrate the efficacy and competitiveness of our products.

  If new industry standards emerge that we do not anticipate or adapt to, our
products could be rendered obsolete and our revenues may decline. A number of
factors, including research and development or manufacturing difficulties,
could delay or prevent us from developing, introducing or marketing new
products. In addition, our competitors may introduce new products before we do
and achieve a competitive advantage in our targeted markets.

 We may incur significant costs in maintaining compliance with regulations
 governing our manufacturing operations.

  We are required to maintain compliance with the good manufacturing practice
requirements of the FDA's Quality System Regulation for medical devices, as
well as regulatory authorities in the European Union. The Quality System
Regulation and the European regulatory requirements relate to product testing
and quality assurance, as well as the maintenance of records and
documentation. The FDA and the European regulatory authorities enforce their
regulatory requirements through periodic inspections. We can provide no
assurance that we will be able to maintain compliance on an on-going basis. If
we or any third-party manufacturer of our products or active ingredients do
not conform to the Quality System Regulation or the requirements of the
European regulatory authorities, we will be required to find alternative
manufacturers that do conform to the Quality System Regulation. This may be a
long and costly process. The FDA must approve alternative third-party
manufacturers before they can commercially manufacture our products or some
critical components, such as thrombin. We may have to incur significant costs
to comply with laws and regulations and our failure to comply could lead to
penalties that could have a material and adverse affect on our operating
results or financial condition.

                                      17
<PAGE>

 If we fail to maintain regulatory clearances and approvals for FloSeal, we
 may be unable to commercialize our products and our revenues may decline.

  Although we have obtained regulatory clearance and approval of FloSeal in
the United States for almost all surgical applications and in the European
Union for all surgical applications, we continue to be subject to extensive
regulatory requirements. These regulations are wide-ranging and govern, among
other things:

  . product changes or modifications,

  . product manufacturing,

  . manufacturing quality control requirements,

  . reporting requirements to regulatory agencies,

  . unapproved, off-label uses, and

  . product traceability.

  If we fail to comply with medical device laws or regulations, we may be
fined and restricted from selling our products. If the FDA believes we are not
complying with the law, it can:

  . detain or seize our products,

  . issue a recall,

  . enjoin future violations, and

  . assess civil and criminal penalties against us.

  In addition, regulations are subject to change. We cannot predict the
effect, if any, that such changes might have on our business. Our failure to
comply with regulatory requirements could have a material adverse effect on
our business.

  Our regulatory clearance and approval for the sale of FloSeal in the United
States and the European Union could also be rescinded. For example, one of our
principal competitors has claimed that FloSeal was improperly certified for
sale in Germany as a medical device. The competitor claimed that FloSeal
should be regulated as a drug. While no regulatory authority determined that
our competitor's claim was correct, an adverse determination could restrict
our ability to market and sell FloSeal in the United States or the European
Union.

 We may not be able to expand the international sale of our products without
 further approvals, which could significantly harm our ability to generate
 revenue.

  Marketing of FloSeal outside of the United States requires compliance with
local regulatory requirements. We have obtained regulatory approval for the
commercial sale of FloSeal as a medical device in the European Union and in
Switzerland, Canada, and Hong Kong. We have not yet received approval in other
international markets. Without approval we will not be able to expand our
international sales. In addition, if the regulatory approval we obtained for
the commercial sale of FloSeal in the European Union is rescinded or otherwise
becomes unavailable to us, we would not be able to market and sell FloSeal in
the European Union without subsequent regulatory approval.

 Failure to obtain regulatory approval for additional configurations of
 FloSeal and our other products under development could significantly harm our
 ability to generate revenue.

  The Center for Devices and Radiological Health, a division of the FDA,
regulates applications of FloSeal technology. Before we can market additional
configurations of FloSeal or any of our other products under development in
the United States, we must show that our products are safe and effective. We
must also obtain approval from the FDA, which cannot be guaranteed. We may be
required to complete clinical trials and obtain approval for additional
applications of FloSeal technology before they may be marketed. The FDA may
also limit the commercial claims and uses of any of our future products.

                                      18
<PAGE>

  Similar requirements or restrictions apply in the European Union and
elsewhere to the marketing and sale of additional configurations of FloSeal
and our other products under development. If we are unable to obtain
regulatory approval, our anticipated revenues would be materially and
adversely affected, as well as our results of operations and financial
condition.

 Our future success will depend in part on our ability to protect our
 intellectual property rights. Our inability to enforce these rights could
 cause us to lose sales and any competitive advantage we have.

  We have four issued United States patents relating to FloSeal. We also have
ten issued United States patents and four pending patent applications relating
to our other products under development and other technologies invented by our
research department. We also have corresponding international patent
applications filed under the Patent Cooperative Treaty, which provides certain
rights overseas with respect to our patents. Our success depends to a
significant degree on our ability to protect and preserve our intellectual
property. To protect our intellectual property rights, we rely on the patent
laws of the United States and the other countries where we market and sell
FloSeal or intend to market and sell FloSeal or our other products under
development. However, we cannot be certain that the steps we have taken will
prevent third parties from using our technology without our authorization or
independently developing technology without our authorization or independently
developing technology that is similar to ours, particularly in those countries
where the laws do not protect our proprietary rights as fully as in the United
States In addition, we cannot assure you that patents will issue from our
applications or that any patent will issue on technology arising from
additional research or, if patents do issue, that claims allowed will be
sufficient to protect our technologies.

  The use of our technology or similar technology by others could reduce or
eliminate any competitive advantage we have developed, cause us to lose sales
and otherwise harm our business. Although we do have several issued United
States patents and several pending United States patent applications, our
competitors may already have applied for patents that, once issued, will
prevail over our patent rights or otherwise limit our ability to sell our
products in the United States or elsewhere. Our competitors also may attempt
to design around our patents or copy or otherwise obtain and use our
proprietary technology. We may not be able to secure registration with respect
to our pending patent applications. Failure to secure these registrations may
limit our ability to protect the intellectual property rights that these
applications are intended to cover.

 We may be prevented from marketing and selling FloSeal or our other products
 under development if they infringe existing patents or patents that have not
 yet issued.

  Although we have conducted searches, there can be no assurance that third-
party patents or other intellectual property rights will not cover FloSeal or
our products under development. If they do, the continued development and
marketing of our products would require a license under those patents or other
intellectual property rights. There can be no assurance that required licenses
will be available to us on commercially reasonable terms, if at all. If we do
not obtain the licenses, we could encounter delays in product introductions
while we attempt to design around the third-party patents, or we could be
completely blocked from developing, manufacturing or selling products
requiring the licenses.

  Moreover, since United States patent applications are not a matter of public
record, a patent application could currently be on file that would stand in
our way of obtaining an issued patent. Interference proceedings declared by
the United States Patent and Trademark Office may be necessary to determine
the priority of inventions with respect to our patent applications. Litigation
or interference proceedings could result in substantial costs to us and a
diversion of management focus, and could have a material adverse effect on our
business, financial condition and results of operations. In addition, a number
of medical device and other companies, universities and research institutions
have filed patent applications or may have been issued patents relating to
compositions and methods for surgical sealing. The issuance of any of these
potentially competing patents could materially and adversely affect our
business, results of operations and financial condition.

 FloSeal and our other products under development may infringe the
 intellectual property rights of others, which may cause us to become subject
 to expensive litigation, cause us to incur substantial damages, require us to
 pay significant license fees or prevent us from selling our products.

  On December 19, 2000, Cohesion Technologies, Inc. filed a patent
infringement action against us in United States District Court, Northern
District of California (San Jose) claiming we infringed on Cohesion
Technologies' "Collagen-Polymer Matrices With Differential Biodegradability"
patent (Patent #6,110,484), which claims a method for forming fibrin matrix at
a tissue site. Cohesion Technologies is seeking unspecified damages and
permanent injunctive relief.

                                      19
<PAGE>

  We believe the Cohesion Technologies' claim is without merit. Nevertheless,
Cohesion Technologies' infringement claim may result in costly and protracted
litigation, may divert the efforts of our management personnel, may cause
product shipment delays, may require us to enter into a costly royalty or
licensing agreements, may require us to pay damages, may harm our reputation
or may prevent us from manufacturing, marketing or selling FloSeal or any of
our other products under development. Moreover, if we are found to have
violated Cohesion Technologies' intellectual patent rights, we may be subject
to damages and other remedies. In addition, we may be required to either
redesign our FloSeal products in order to avoid violating Cohesion
Technologies' intellectual property or we need to obtain a license to use
Cohesion Technologies' intellectual property. In addition, we may be subject
to litigation from other third-parties in which we would have to defend
against claims of infringement of the rights of others or to determine the
scope and validity of the intellectual property rights that may conflict with
our business. These infringement claims would result in costly litigation,
divert the efforts of our management personnel, cause product shipment delays,
require us to enter into royalty or licensing agreements, require us to pay
damages, harm our reputation or prevent us from manufacturing, marketing or
selling FloSeal or any of our other products under development. Moreover, if
we were to discover that FloSeal or any of our products under development
violated third-party intellectual property rights, we might be unable to
redesign it to avoid violating their rights or to obtain a license to use the
third-party intellectual property on commercially reasonable terms.

 Failure by our customers to obtain adequate third-party reimbursement for the
 procedures utilizing FloSeal could adversely affect our ability to market and
 sell FloSeal and generate revenues.

  Our United States customers generally rely on third-party insurers, such as
federal Medicare, state Medicaid and private health insurance plans, to
reimburse some or all of the cost of a procedure in which FloSeal will be
used. We expect to sell FloSeal based on a prospective payment system.* In a
prospective payment system, the cost of FloSeal would be incorporated in the
overall cost of the surgical procedures that use FloSeal instead of providing
for a separate reimbursement for our products. However, we cannot assure you
that third-party insurers will reimburse our customers for the cost of
FloSeal. Our financial success depends, in part, on our customers obtaining
satisfactory reimbursement for surgical procedures that use FloSeal. Failure
by our customers to obtain sufficient reimbursement for these procedures or
adverse changes in governmental and private insurance policies toward
reimbursement for these procedures could result in reduction or elimination of
purchases of FloSeal, which would materially and adversely affect our
revenues. Since FloSeal is priced at a premium to corresponding widely used
hemostats, our business may also be materially and adversely affected by the
continuing efforts of third-party insurers to contain or reduce healthcare
costs.

  International market acceptance of FloSeal and other products that we may
develop in the future is dependent, in part, on the availability of
reimbursement for the prevailing healthcare payment systems for our products
or procedures that use our products. Reimbursement and healthcare payment
systems in international markets vary significantly and include both
government-sponsored healthcare and private insurance. We intend to seek
reimbursement approvals where applicable.* We cannot be certain any such
approvals will be obtained in a timely manner, if at all. Failure to receive
reimbursement approvals in the international market could materially and
adversely affect our ability to market and sell FloSeal and generate revenue.

 The use of product derived from cows could adversely impact our ability to
 market and sell our products.

  There is uncertainty as to the continued acceptance in the European Union of
products that incorporate products derived from cows. This uncertainty is due
to concerns about "mad cow disease". This disease is believed to be
transmitted from cows to humans and may cause serious illness or death.
FloSeal and our other products under development contain thrombin, extracted
from the blood and lungs of cows and gelatin derived from the hides of cows. A
reversal of European acceptance of FloSeal could materially and adversely
affect our ability to market and sell FloSeal and our other products under
development.

  Our European Notified Body has advised us that the safety of all medical
products containing materials of animal origins must be re-evaluated with
respect to bovine spongiform encephalopathy (BSE). We must submit to our
European Notified Body the results of our re-evaluation on FloSeal by mid-
April 2001. There is no assurance the Notified Body will allow us to continue
to sell FloSeal in Europe based on the results of our re-evaluation. In
addition, if the Notified Body does allow us to continue to sell FloSeal in
Europe, it is possible that individual European countries could place their
own requirements or restrictions on products containing material of animal
origin. There is no assurance FloSeal could meet those requirements or
restrictions. We could be required to stop selling FloSeal in those European
countries whose requirements or restrictions we did not meet.

                                      20
<PAGE>

  Recently various news sources have reported an outbreak of foot and mouth
disease in Europe. Should foot and mouth disease reach herds in the United
States and the destruction of those infected herds impacts the availability of
our raw materials, the prices for our raw materials could increase.
Significant price increases in our raw materials may have a material adverse
affect on our business, financial condition and results of operations.

 We may face product liability claims related to the use or misuse of our
 products. Our insurance coverage is limited.

  We face risk of product liability claims. There can be no assurance that we
will not experience losses due to product liability claims. We currently
maintain liability insurance with combined coverage limits of $3.0 million on
a claims-made basis. We cannot be certain that the size or the coverage of our
insurance is adequate. The insurance is expensive, difficult to obtain and may
not be available in the future on acceptable terms, if at all. Any claims
against us, regardless of their merit, could materially and adversely affect
our business, results of operations and financial condition due to the cost of
defending against such claims and diversion of management attention.

 We may be unable to attract and retain qualified employees, who we need to be
 successful.

  We are highly dependent on our executive management team and staff. The loss
of any of these persons, or our inability to recruit additional personnel
necessary for our business, could substantially impair our manufacturing,
marketing and sales, and research and development efforts and impede our
ability to commercialize FloSeal and our other products under development.
Recruiting and retaining qualified technical and managerial personnel will
continue to be critical to our success. Our business is located in the San
Francisco Bay Area in California, where demand for experienced personnel is
extremely high and is likely to remain high. As a result, competition for and
retention of personnel, particularly for employees with technical expertise,
is intense and the turnover rate for these people is high. We may not be able
to recruit and retain qualified employees on commercially reasonable terms,
which could materially and adversely affect our ability to achieve
profitability.

Item 2. Properties

  We have facilities in Mountain View and Fremont, California. In November
1999, we entered into a lease for a new headquarters and manufacturing
facility of approximately 72,500 square feet in Fremont, California.
Approximately 50% of our manufacturing operations have been moved to Fremont
while 50%, primarily processes housed in our clean room, remain in our 13,200
square foot Mountain View facility. With our current manufacturing
configuration, we believe our manufacturing capacity will be sufficient
through the end of 2001, when the Mountain View facility lease expires. We are
currently planning to be completely moved to Fremont by the end of 2001.
Should we be delayed in that move, we will renew the Mountain View lease. We
can not predict the terms under which such a renewal could occur. The renewal
terms would depend on the commercial real estate market and the term of the
renewed lease among other factors.

  In January 2000, we began improvements on the 72,500 square foot Fremont
facility, which now serves as our corporate headquarters. We are currently
housing the executive, administrative, finance, sales and marketing, research
and development, and a portion of operations in the Fremont building. We plan
to use the Fremont facility for packaging and shipping FloSeal and, by the end
of 2001, for manufacturing FloSeal.* The lease for the Fremont facility began
January 1, 2000 and extends through December 31, 2006.

Item 3. Legal Proceedings

  On December 19, 2000, Cohesion Technologies, Inc. filed a patent
infringement action against us in United States District Court, Northern
District of California (San Jose) claiming we infringed on Cohesion
Technologies' "Collagen-Polymer Matrices With Differential Biodegradability"
patent (Patent #6,110,484), which claims a method for forming fibrin matrix at
a tissue site. Cohesion Technologies is seeking unspecified damages and
permanent injunctive relief. We believe the Cohesion Technologies' claim is
without merit.

  We have received correspondence from Baxter Deutschland GmbH, a subsidiary
of Baxter International, Inc., in which Baxter argues that FloSeal should be
regulated as a drug in Germany. FloSeal is currently regulated as a medical
device in Germany, as well as the other countries in which we have obtained
regulatory approval. Baxter has indicated that it may challenge the issuance
of the CE Mark Certification for FloSeal. We will vigorously pursue a
litigation strategy with respect to any attempt to alter the regulatory nature
of FloSeal or our other products in Germany and elsewhere.

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

  Not applicable.

                                      21
<PAGE>

                                    PART II

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

  Our common stock is quoted on the Nasdaq National Market under the symbol
"FSON." The following table sets forth, for the periods indicated, the high
and low sales prices per share of our common stock, as reported on the Nasdaq
National Market for the periods stipulated.

<TABLE>
<CAPTION>
                                                                    High   Low
                                                                   ------ ------
       <S>                                                         <C>    <C>
       1999
         First Quarter............................................  7.750  5.125
         Second Quarter...........................................  7.938  5.125
         Third Quarter............................................ 13.500  7.547
         Fourth Quarter........................................... 14.500  9.500
       2000
         First Quarter............................................ 25.750 11.875
         Second Quarter........................................... 21.125 10.000
         Third Quarter............................................ 16.000  8.625
         Fourth Quarter........................................... 11.250  2.250
       2001
         First Quarter (through March 31, 2001)...................  7.063  2.156
</TABLE>

  As of March 31, 2001, the last reported sale price of our common stock on
the Nasdaq National Market was $3.031 per share and, on March 31, 2001 there
were 93 stockholders of record.

  On June 7, 2000, we sold 1,100,000 shares of common stock at a purchase
price of $12.00 per share to the State of Wisconsin Investment Board and the
Franklin Biotechnology Discovery Fund. Net proceeds, after commissions and
fees along with other costs associated with the offering, totaled $12,964,000.

  On April 9, 2001, we completed the sale of 2,730,375 shares of common stock
at a purchase price of $2.93 per share, which was the average closing price of
Fusion's common stock over the 10 trading days preceding the execution of the
private placement agreement, to Alloy Ventures, the State of Wisconsin
Investment Board and the Asset Management Company. Net proceeds, after
deducting estimated legal fees and other estimated costs associated with the
offering, total approximately $7.9 million, which should be sufficient to meet
our capital and operating requirements for at least the next 12 months. As
part of the transaction, each purchaser also received a warrant exercisable
for up to an additional 25 percent of the total shares purchased. The exercise
price of the warrants is 125 percent of the purchase price, or $3.66 per
share. The warrant agreement terminates on April 2, 2006.

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 Consolidated Financial Statements and Notes thereto
included elsewhere in this Prospectus. The statements of operations data for
the years ended December 31, 2000, 1999 and 1998 and the balance sheet data as
of December 31, 2000 and 1999 have been derived from audited consolidated
financial statements included elsewhere in this report. The consolidated
statement of operations data for the years ended December 31, 1997 and 1996
and the balance sheet data as of December 31, 1998, 1997 and 1996 have been
derived from audited consolidated financial statements that are not included
in this report. All amounts for net sales have been adjusted to reflect the
retroactive adoption of EITF 00-10, "Accounting for Shipping and Handling Fees
and Costs." The historical results are not necessarily indicative of the
results of operations to be expected in the future.

                                      22
<PAGE>

<TABLE>
<CAPTION>
                                         Year Ended December 31
                              ------------------------------------------------
                                2000      1999      1998      1997      1996
                              --------  --------  --------  --------  --------
                                 (in thousands, except per share data)
   <S>                        <C>       <C>       <C>       <C>       <C>
   Statements of Operations
    Data:
   Net sales................  $  4,949  $    254  $    --   $    153  $     31
   Cost of sales and
    manufacturing start-up
    cost....................     5,235       731       --        968       196
                              --------  --------  --------  --------  --------
     Gross Loss.............      (286)     (477)      --       (815)     (165)
                              --------  --------  --------  --------  --------
   Operating Expenses:
     Research and
      development...........     6,013     5,095     6,145     5,647     4,693
     Sales and marketing....     5,244     1,441       614     2,421     1,582
     General and
      administrative........     3,007     1,799     1,470     2,053     1,426
                              --------  --------  --------  --------  --------
       Total operating
        expenses............    14,264     8,335     8,229    10,121     7,701
                              --------  --------  --------  --------  --------
   Loss from operations.....   (14,550)   (8,812)   (8,229)  (10,936)   (7,866)
   Interest income, net.....       836       487       542       984       910
                              --------  --------  --------  --------  --------
   Net loss.................  $(13,714) $ (8,325) $ (7,687) $ (9,952) $ (6,956)
                              ========  ========  ========  ========  ========
   Basic and diluted net
    loss per share..........  $  (1.28) $  (0.96) $  (1.08) $  (1.41) $  (1.52)
                              ========  ========  ========  ========  ========
   Shares used in computing
    basic and diluted net
    loss per share..........    10,728     8,707     7,145     7,070     4,563
                              ========  ========  ========  ========  ========

   Balance Sheet Data:
   Cash, cash equivalents
    and available for sale
    securities..............  $  8,157  $ 14,066  $  7,164  $ 14,459  $ 23,485
   Working capital..........     8,261    11,550     6,242    11,850    21,072
   Total assets.............    17,709    16,216     8,088    15,540    25,063
   Long term debt, including
    current portion.........     1,031       204       321        43       189
   Accumulated deficit......   (51,271)  (37,557)  (29,232)  (21,545)  (11,593)
   Total stockholders'
    equity..................    14,821    14,786     6,827    14,224    23,742
</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. Our actual results may differ
materially from those anticipated in the forward-looking statements. Factors
that might cause such a difference include, but are not limited to, those
discussed in the section entitled "Business--Additional Factors That Might
Affect Future Results" commencing on page 14 and elsewhere in this Form 10-K.

Overview

  We are commercializing and developing proprietary collagen gel-based
products for use in controlling bleeding in a variety of surgeries. Our lead
product, FloSeal, was approved on December 8, 1999 by the FDA for marketing in
the United States. FloSeal combines a gelatin derived from collagen with
thrombin, a potent clotting agent, to control surgical bleeding. FloSeal is
approved for surgical procedures, other than in ophthalmic and urologic, as an
adjunct to hemostasis when control of bleeding by sutures and staples or
topical hemostats, fibrin glues and other types of surgical sealants and
adhesives are ineffective or impractical.

  The year ended December 31, 2000 was our first full year of sales of
FloSeal. We reported a total of approximately $4.9 million in revenue based on
shipments of approximately 56,000 units of product. Sales to our distribution
partner, Sulzer Spine-Tech, represented approximately 60% of total revenue or
$2.9 million. The distribution agreement with Sulzer Spine-Tech was executed
in June 1999. The agreement grants exclusive rights to market and sell FloSeal
world wide, except for Japan and a few smaller markets where we already had
distribution agreements in place, in the spinal and cranial surgical markets.
Sulzer Spine-Tech markets a configuration of FloSeal called Proceed Hemostatic
Sealant.

  We have reported $4,949,000 and $254,000 in revenue for the years ended
December 31, 2000 and December 31, 1999, respectively, primarily from sales
into the cardiac, vascular, ear, nose and throat, head and neck, and spinal
surgical specialties. As of December 31, 2000, we had an accumulated deficit
of $51.3 million.

  In late September 2000, we began commercializing FloSeal in the United
States for use in the ear, nose, throat, head and neck markets, in addition to
the existing cardiac, vascular and spinal markets. We anticipate sales
increasing as FloSeal is used more often by doctors currently using

                                      23
<PAGE>

FloSeal, as additional doctors in hospitals where FloSeal is currently being
used begin using FloSeal, and as we add new hospitals as customers.* We
anticipate incurring increased expenses relating to FloSeal sales, marketing,
manufacturing, and general and administrative, and moderately decreasing
expenses in research and development.* We have not achieved, nor do we expect
to achieve, profitability before 2002.*

  During 2000, we established a 24 person direct sales force in the United
States and invested in marketing activities to support the launch of FloSeal
into the cardiac, vascular, ear, nose, throat, head and neck surgical
specialties. In April 1999, we received the CE mark that allows us to
commercialize FloSeal in the European Union. Revenues from the sale of FloSeal
in the European Union totaled approximately $860,000 in 2000.

  We have been expanding our manufacturing capacity to be able to meet the
anticipated product supply requirements for commercial sale of FloSeal. In
April 2000, we first occupied a portion of a 72,500 square feet building in
Fremont, California. In conjunction with this new facility, we have spent a
total of approximately $5.0 million for the purchase of equipment for
production and research & development, office furnishings and equipment and
leasehold improvements.

  We are also developing additional bleeding control products based upon the
core technology underlying FloSeal. These products include the FloSeal Femoral
Arteriotomy Sealing Technology (FAST) device for use following vascular
interventional procedures and the FloSeal sponge, a dry, sponge-like
formulation of FloSeal requiring no mixing, for use in trauma surgery and
battlefield first-aid applications. We began feasibility clinical trials for
the FloSeal FAST device in December 2000. Our future products currently in
development require approvals by FDA and other regulators, which cannot be
guaranteed.

Results of Operations

 Years Ended December 31, 2000, 1999 and 1998

 Revenues

  We recorded revenues of $4,949,000, $254,000 and none for the years ended
December 31, 2000, 1999 and 1998, respectively. We commenced selling FloSeal
in May 1999 in the European Union and in December 1999 in the United States.
We had no sales in 1998. Revenues increased in 2000 principally due to
obtaining regulatory approval in the United States. Approximately 60% of total
revenues in 2000 were sales to our distribution partner, Sulzer Spine-Tech.

 Gross Loss

  We had a gross loss of $286,000, $477,000 and none for the years ended
December 31, 2000, 1999 and 1998, respectively. The increase in the gross loss
in 2000 is primarily due to the increase in total unit shipments in 2000 over
1999. The increase in gross loss in 1999 over 1998 is primarily due to the
first shipments of FloSeal occurring in 1999 and expenses associated with
starting up commercial manufacturing. The third quarter of 2000 was the first
quarter we reported a gross profit. The fourth quarter of 2000 resulted in
gross profit of $232,000, or 13% gross margin. We expect the positive gross
margin to grow on a quarterly basis throughout 2001 as the fixed costs of
production are spread over an increasing number of units produced.*

 Research and Development

  Research and development expenses were $6,013,000, $5,095,000 and $6,145,000
for the years ended December 31, 2000, 1999 and 1998, respectively. The
increase of $918,000 in 2000 was primarily due to the development of the
FloSeal FAST device in preparation of beginning feasibility clinical trials by
the end of the year. The decrease in 1999 of $1,050,000 was due primarily to
the conclusion of the clinical trial and development expenses related to
FloSeal. While we do not anticipate significant increases in research and
development spending in 2001, we believe investment in research and
development is essential to our future success. We expect research and
development expenses will remain near current levels in future periods.*

 Sales and Marketing

  Sales and marketing expenses were $5,244,000, $1,441,000 and $614,000 for
the years ended December 31, 2000, 1999 and 1998, respectively. The increase
of $3.8 million in 2000 over 1999 was primarily due to building our direct
sales force up to 24 people and to marketing spending to

                                      24
<PAGE>

support the launches of FloSeal into the cardiac, vascular, ear, nose and
throat, and head and neck surgical specialties. These marketing expenses
include costs of marketing personnel, participating in major national and
regional medical conferences, and advertising in various surgical specialty
journals. The increase of $827,000 in 1999 was the result of sales and
marketing efforts to establish FloSeal in Europe and initial efforts to build
a direct sales force in the United States in late 1999. We anticipate sales
and marketing expenditures will increase in future periods in connection with
the continuing growth of FloSeal in existing markets and the commercial launch
of FloSeal into additional surgical specialties.*

 General and Administrative

  General and administrative expenses were $3,007,000, $1,799,000 and
$1,470,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
The increase of $1.2 million in 2000 was primarily due to paying a full year
salaries for employees hired in 1999 and paying additional rent on the new
facility in Fremont, California. The increase of $329,000 in 1999 was the
result of hiring an experienced team to support the drive to attract new
capital and make preparations for the commercialization of FloSeal and support
our growth. The Fremont facility was unoccupied during construction
improvements from January through March 2000. Occupancy by management, sales
and marketing, administrative and limited research personnel began in April
2000. Additional personnel and manufacturing activities were phased into the
Fremont facility through the first quarter 2001.

  In December 2000, Cohesion Technologies, alleging infringement of a Cohesion
patent, named us in a patent suit. We believe this suit has no merit.
Nevertheless, Cohesion's infringement claim may result in costly and
protracted litigation. Also, as we have grown in size, we will require
additional resources to support our financial and administrative functions.
Thus, we believe general and administrative expenses will increase in future
periods*.

 Interest income and expense, net

  Net interest income and expense was $836,000, $487,000 and $542,000 for the
years ended December 31, 2000, 1999 and 1998, respectively. The increase of
$349,000 in 2000 was primarily due to greater amounts of cash, cash
equivalents and available-for-sale securities during 2000 due to the proceeds
from the sale of common stock in June 2000 and November 1999. The decrease of
$55,000 in 1999 was the result of shift in mix of investments, decreasing long
term investments in favor of short-term investments and decreases in interest
rates offset by increases in cash, cash equivalents and available-for-sale
securities resulting from the November 1999 private placement financing and
the April 1999 follow-on public offering.

 Liquidity and Capital Resources

  From inception to December 31, 2000, we incurred net losses resulting in an
accumulated deficit of $51,271,000. We have financed our operations primarily
through private sales of equity securities and an initial public offering of
common stock in June 1996 together aggregating net proceeds of $24,419,000. In
June 2000 and November 1999, we concluded two private placement financings. In
April 1999, we concluded a follow-on public offering. These three offerings
together aggregated net proceeds of $28,725,000.

  Cash, cash equivalents and available-for-sale securities totaled $8,157,000
and $12,978,000 as of December 31, 2000 and 1999, respectively. Cash flows
used in operating activities were $13,467,000 and $8,299,000 for the years
ended December 31, 2000 and 1999, respectively. These cash outflows resulted
primarily from funding our net losses. During the year ended December 31,
2000, we also made investments in inventory of $436,000 and in accounts
receivable of $831,000. In 1999, we invested $582,000 in inventories, $147,000
in accounts receivable and $147,000 in other current assets.

  Net cash used by investing activities was $5,387,000 and $3,647,000 for the
years ended December 31, 2000 and 1999. Cash was used for the acquisition of
property and equipment of $5,157,000 and $735,000 for the years ended December
31, 2000 and 1999, respectively. During 2000, restricted cash increased by
$573,000 to fund the leasehold improvements and new equipment for the Fremont,
California facility. During 1999, restricted cash increased by $1,088,000 to
collateralize a letter of credit related to the facility lease in the Fremont
facility.

  Net cash provided by financing activities were $14,358,000 and $15,959,000
for the years ended December 31, 2000 and 1999, respectively. The primary
source of this cash were the net proceeds from the private sale of common
stock in June 2000, November 1999 and April 1999.

                                      25
<PAGE>

  In the course of our development, we have sustained operating losses and
expect such losses to continue through at least 2001. Management believes its
cash balances as of March 31, 2001 were not be sufficient to meet our capital
and operating requirements for the next 12 months.

  On April 9, 2001, we completed the sale of 2,730,375 shares of common stock
at a purchase price of $2.93 per share, which was the average closing price of
Fusion's common stock over the 10 trading days preceding the execution of the
private placement agreement, to Alloy Ventures, the State of Wisconsin
Investment Board and the Asset Management Company. Net proceeds, after
deducting estimated legal fees and other estimated costs associated with the
offering, total approximately $7.9 million, which should be sufficient to meet
our capital and operating requirements for at least the next 12 months. As
part of the transaction, each purchaser also received a warrant exercisable
for up to an additional 25 percent of the total shares purchased. The exercise
price of the warrants is 125 percent of the purchase price, or $3.66 per
share. The warrant agreement terminates on April 2, 2006.

  In April 2000, we accepted a commitment from Transamerica Business Credit
Corporation--Technology Finance Division to finance up to a total of
$3,000,000 toward production equipment, research & development equipment,
computer equipment and office furnishings. A maximum of $900,000 of this total
could be used to finance tenant improvements. Each loan term commences upon
delivery of the equipment having an aggregate cost of $75,000 or more and will
continue for 48 months. The interest rate is variable and based on 4-year
United States Treasury Securities plus 737 basis points. The interest rate
becomes fixed at the commencement of each loan for the complete term. A
balloon payment of 10% of the original principal amount of each loan is due at
the end of each loan term. Borrowings under this facility expired in December
2000. As of December 31, 2000, we had drawn approximately $989,000 against the
original $3.0 million commitment. No additional drawdowns are available on
this loan.

  Our future capital requirements will depend on numerous factors, including
the rate of acceptance of FloSeal in the market as evidenced by increasing
revenues, our ability to manufacture increasing quantities of product and
achieve commercially acceptable gross profits, our ability to control expenses
while developing our products, and the nature, timing and success of our other
products under development. We have committed substantial capital resources to
the development of commercial-scale manufacturing for FloSeal. In November
1999, we entered into a lease for a 72,500 square foot building in Fremont,
California. We have committed approximately $5.5 million for manufacturing
equipment, research and development equipment, office furnishings and
equipment and leasehold improvements to improve the Fremont facility. The
associated working capital requirements for ongoing manufacturing and
commercial launch into additional surgical specialties and those of new
products are also expected to be substantial. The timing and amount of capital
requirements cannot be accurately predicted. Existing cash, cash equivalents
and available-for-sale securities balances, proceeds from the April 2001
financing and future product sales should provide adequate liquidity for at
least the next 15 months.

  At December 31, 2000, we had approximately $34,120,000 in federal and in
$35,953,000 state net operating loss carry forwards that expire in the years
2001 through 2019, respectively. Utilization of federal income tax net
operating loss carry forwards 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.

Recent Accounting Pronouncements

  In June 1998, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 133, "Accounting for Derivative Instruments and Hedging
Activities", which establishes accounting and reporting standards for
derivative instruments and hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. To date, we
have not engaged in derivative and hedging activities. Fusion will adopt SFAS
No. 133, as amended, for the first quarter of fiscal year 2001. We do not
believe the adoption will have a material impact on these financial
statements.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

  Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio and bank borrowings. We do not use derivative
financial instruments in our investment portfolio, and our investment
portfolio only includes highly liquid instruments with an original maturity to
us of generally less than one year. We have primarily entered into debt
obligations for capital expenditures. We are subject to fluctuating interest
rates that may impact, adversely or otherwise, our results of operations or
cash flows for our variable rate bank borrowings, available-for-sale
securities and cash and cash equivalents.


                                      26
<PAGE>

  The table below presents principal amounts and related weighted average
interest rates by year of maturity for our investment portfolio and debt
obligations:

<TABLE>
<CAPTION>
                                                      Fiscal Year
                                             --------------------------------
                                              2001   2002   Thereafter Total
                                             ------  -----  ---------- ------
   <S>                                       <C>     <C>    <C>        <C>
   Assets:
     Cash and cash equivalents.............. $3,668    --       --     $3,668
     Average interest rate..................   2.09%   --       --       2.09%
     Available-for-sale securities.......... $4,489    --       --     $4,489
     Average interest rate..................   6.63%   --       --       6.63%

   Liabilities:
     Bank borrowings (including current
      portion).............................. $   88    --       --     $   88
     Average interest rate..................  11.00%   --       --      11.00%
     Equipment financing (including current
      portion).............................. $  191  $ 223    $ 529    $  943
     Average interest rate..................  14.70% 14.70%   14.70%    14.70%
</TABLE>

  The estimated fair value of our cash and cash equivalents approximates the
principal amounts reflected above based on the short maturities of these
financial instruments. The estimated fair value of our debt obligations
approximates the principal amounts reflected above based on rates currently
available to us for debt with similar terms and remaining maturities.

  Although payments under the operating lease for our facility are tied to
market indices, we are not exposed to material interest rate risk associated
with the operating lease.

Item 8. Financial Statements and Supplementary Data.

  This information is incorporated herein by 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.

  None

                                      27
<PAGE>

                                    PART III

  Certain information required by Part III is omitted from this Report because
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 stockholders to be held on June 14, 2001 and the
information therein is incorporated herein by reference.

Item 10. Directors and Executive Officers of the Registrant.

  The information concerning our directors required by this item is
incorporated by reference to our Proxy Statement.

Item 11. Executive Compensation.

  The information required by this Item is incorporated by reference to our
Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

  The information required by this Item is incorporated by reference to our
Proxy Statement.

Item 13. Certain Relationships and Related Transactions.

  The information required by this Item is incorporated by reference to our
Proxy Statement.
                                    PART IV

Item 14. Exhibits, Financial Statement Schedules

<TABLE>
   <C> <C> <S>                                                   <C>
   (a) 1.  Financial Statements                                    Page(s)
                                                                 -----------
           Report of Independent Accountants..................       F-2
           Consolidated Balance Sheets, December 31, 2000 and
            1999..............................................       F-3
           Consolidated Statements of Operations and
            Comprehensive Loss, Years Ended December 31, 2000,
            1999 and 1998.....................................       F-4
           Consolidated Statements of Stockholders' Equity,
            Years Ended December 31, 2000, 1999 and 1998......       F-5
           Consolidated Statements of Cash Flows, Years Ended
            December 31, 2000, 1999 and 1998..................       F-6
           Notes to Consolidated Financial Statements.........   F-7 to F-16

       2.  Financial Statement Schedule

           All schedules are omitted because they are not applicable or the
           required information is shown in the Consolidated 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.
</TABLE>

                                       28
<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.              Date: April 13, 2001

By: /s/ PHILIP M. SAWYER
  ----------------------------
  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 and Larry J. Strauss his
attorneys-in-fact, and each 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 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.

<TABLE>
<CAPTION>
                     Signature                               Title                 Date
                     ---------                               -----                 ----
 <C>                                                <S>                      <C>
              /s/ PHILIP M. SAWYER                  President, Chief          April 13, 2001
 __________________________________________________  Executive Officer and
                 (Philip M. Sawyer)                  Director
                                                     (Principal Executive
                                                     Officer)
</TABLE>

<TABLE>
 <C>                                                <S>                        <C>
               /s/ LARRY J. STRAUSS                 Vice President, Finance     April 13, 2001
 __________________________________________________  and Chief Financial
                 (Larry J. Strauss)                  Officer
                                                     (Principal Accounting
                                                     Officer)

              /s/ GORDON W. RUSSELL                 Chairman of the Board of    April 13, 2001
 __________________________________________________  Directors
                (Gordon W. Russell)

               /s/ OLAV B. BERGHEIM                 Director                    April 13, 2001
 __________________________________________________
                 (Olav B. Bergheim)

               /s/ VAUGHN D. BRYSON                 Director                    April 13, 2001
 __________________________________________________
                 (Vaughn D. Bryson)

               /s/ J. MICHAEL EGAN                  Director                    April 13, 2001
 __________________________________________________
                 (J. Michael Egan)

              /s/ RONALD A. ELENBAAS                Director                    April 13, 2001
 __________________________________________________
                (Ronald A. Elenbaas)

            /s/ DOUGLAS E. KELLY, M.D.              Director                    April 13, 2001
 __________________________________________________
              (Douglas E. Kelly, M.D.)
</TABLE>

                                      29
<PAGE>

                               INDEX TO EXHIBITS

(a) Exhibits

<TABLE>
 <C>        <S>
  3.1(1)    Certificate of Incorporation of Fusion Medical Technologies, Inc.
  3.3(1)    Amended and Restated By-laws of Fusion Medical Technologies, Inc.
  4.1(8)    Preferred Shares Rights Agreement dated October 10, 1997 between
            Fusion Medical Technologies, Inc. and Bank of Boston, N.A.,
            including the form of Rights Certificate, the Certificate of
            Designation and the Summary of Rights attached thereto as Exhibits
            A, B and C, respectively.
  4.2(9)    First Amendment to the Preferred Shares Rights Agreement dated
            March 30, 1999 between Fusion Medical Technologies, Inc. and Bank
            of Boston, N.A.
  4.3(6)    Stock Purchase Agreement dated as of June 7, 2000.
  4.4(10)   Second Amendment to the Preferred Shares Rights Agreement dated
            April 11, 2001 between Fusion Medical Technologies, Inc. and
            EquiServe Trust Company, N.A.
 10.1(1)    Restated Shareholder Rights Agreement dated as of January 17, 1995.
 10.2(1)    1993 Stock Option Plan, as amended, and form of stock option
            agreement.
 10.3(1)    1996 Employee Stock Purchase Plan.
 10.4(1)    1996 Director Stock Option Plan, and form of stock option
            agreement.
 10.5(1)    Form of Director and Officer Indemnification Agreements.
 10.6(a)(1) Lease Agreement dated June 15, 1994 between Fusion Medical
            Technologies, Inc. and James R. Benson.
 10.6(b)(1) Extension of Lease Agreement dated July 10, 1996 between Fusion
            Medical Technologies, Inc. and James R. Benson.
 10.6(c)(1) Extension of Lease Agreement dated March 25, 1998 between Fusion
            Medical Technologies, Inc. and James R. Benson.
 10.6(d)(1) Extension of Lease Agreement dated December 15, 1998 between Fusion
            Medical Technologies, Inc. and James R. Benson.
 10.7(2)    Loan and Security Agreements dated December 21, 1997 between Fusion
            Medical Technologies, Inc. and Imperial Bank.
 10.8(2)    First Amendment to Warrant to Purchase Stock dated December 21,
            1997 between Fusion Medical Technologies, Inc. and Imperial Bank.
</TABLE>
<TABLE>
 <C>       <S>
 10.9(2)   Warrant to Purchase Stock dated December 21, 1997 between Fusion
           Medical Technologies, Inc. and Imperial Bank.
 10.10(3)  Purchase Agreement dated January 1, 1997 between Fusion Medical
           Technologies, Inc. and Spear Products.
 10.11(1)  Manufacturing Agreement dated September 28, 1998 between Fusion
           Medical Technologies, Inc. and GenTrac, Inc.
 10.12(4)* Distribution Agreement dated July 1, 1999 between Fusion Medical
           Technologies, Inc. and Sulzer Spine-Tech, Inc.
 10.13(5)  Lease Agreement dated October 15, 1999 between Fusion Medical
           Technologies, Inc. and Tarlton/Wohl Venture Nine LLC.
 10.14(7)  Finance Agreement dated June 6, 2000 between Fusion Medical
           Technologies, Inc. and Transamerica Business Credit Corporation.
 10.15(1)  Form of Employment Letter Agreement between Fusion Medical
           Technologies, Inc. and Debera M. Brown, Cary J. Reich, Scott A. Huie
           and Joseph F. Rondinone.
 23.1      Consent of PricewaterhouseCoopers LLP, Independent Accountants.
</TABLE>
------
 (1) Incorporated by reference to exhibits filed with our Registration
     Statement on Form S-1 SEC filed on February 9, 1999.
 (2) Incorporated by reference to exhibits filed with our Annual Report on Form
     10-K for the fiscal year ended December 31, 1997.
 (3) Incorporated by reference to exhibits filed with our Form 10-Q for the
     quarter ended March 31, 1999.
 (4) Incorporated by reference to exhibits filed with our Form 10-Q for the
     quarter ended June 30, 1999.
 (5) Incorporated by reference to exhibits filed with our Form 10-Q for the
     quarter ended September 30, 1999.
 (6) Incorporated by reference to exhibits filed with our Registration
     Statement on Form S-3 filed on June 26, 2000.
 (7) Incorporated by reference to exhibits filed with our Form 10-Q for the
     quarter ended September 30, 2000.
 (8) Incorporated by reference to exhibits filed with our Form 8-A filed on
     November 5, 1997.
 (9) Incorporated by reference to exhibits filed with our Form 8-K filed on
     April 8, 1999.
(10) Incorporated by reference to exhibits filed with our Form 8-A12G/A filed
     on April 11, 2001.
(*) Confidential treatment granted for portions of this Exhibit.

  Fusion(TM), Fusion Medical Technologies, Inc.(TM), FloSeal Matrix(TM),
FloSeal, Proceed(TM) RapiSeal Patch(TM) and SilverBullet(TM) are trademarks of
Fusion Medical Technologies, Inc. Any use is strictly prohibited without the
prior written consent of Fusion Medical Technologies, Inc.

                                       30
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                         <C>
Report of Independent Accountants.......................................... F-2
Consolidated Balance Sheets................................................ F-3
Consolidated Statements of Operations and Comprehensive Loss .............. F-4
Consolidated Statements of Stockholders' Equity............................ F-5
Consolidated Statements of Cash Flows...................................... F-6
Notes to Consolidated Financial Statements................................. F-7
</TABLE>

                                      F-1
<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of Fusion Medical Technologies,
Inc.

  In our opinion, the consolidated financial statements listed in the
accompanying index appearing under Item 14(a)(1) on page 28 present fairly, in
all material respects, the financial position of Fusion Medical Technologies,
Inc. and its subsidiaries (the "Company") at December 31, 2000 and 1999 and
the results of its operations and its cash flows for each of the three years
in the period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States of America. 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 of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

                                       /s/ PricewaterhouseCoopers LLP

San Jose, California
February 7, 2001, except as to
 Note 14 which is as of April 9, 2001

                                      F-2
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

                          CONSOLIDATED BALANCE SHEETS
                     (in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                 December 31
                                                              -----------------
                                                                2000     1999
                                                              -------- --------
<S>                                                           <C>      <C>
ASSETS
Current assets:
  Cash and cash equivalents.................................. $  3,668 $  8,164
  Available-for-sale-securities..............................    4,489    3,818
  Accounts receivable........................................      978      147
  Inventory..................................................    1,018      582
  Prepaids and other current assets..........................      197      182
                                                              -------- --------
    Total current assets.....................................   10,350   12,893
Restricted cash deposits.....................................    1,661    1,088
Available-for-sale securities................................      --       996
Property and equipment, net..................................    5,483    1,038
Other assets.................................................      215      201
                                                              -------- --------
    Total assets............................................. $ 17,709 $ 16,216
                                                              ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable........................................... $    921 $    719
</TABLE>
<TABLE>
<S>                                                         <C>       <C>
  Accrued expenses.........................................      889       507
  Current portion of equipment financing...................      191       --
  Current portion of bank borrowings.......................       88       117
                                                            --------  --------
    Total current liabilities..............................    2,089     1,343
  Deferred rent............................................       47       --
  Bank borrowings, net of current portion..................      --         87
  Equipment financing, net of current portion..............      752       --
                                                            --------  --------
      Total liabilities....................................    2,888     1,430
                                                            --------  --------
Commitments and contingencies (Note 6)

Stockholders' equity:
  Preferred stock, par value $0.001: Authorized: 5,000
   shares; issued and outstanding: none....................      --        --
  Common stock, par value $0.001: Authorized: 50,000
   shares; issued and outstanding: 11,274 in 2000 and
   10,009 shares in 1999...................................       11        10
  Additional paid-in capital...............................   66,436    52,564
  Deferred compensation....................................     (359)     (202)
  Accumulated other comprehensive income (loss)............        4       (29)
  Accumulated deficit......................................  (51,271)  (37,557)
                                                            --------  --------
    Total stockholders' equity.............................   14,821    14,786
                                                            --------  --------
      Total liabilities and stockholders' equity........... $ 17,709  $ 16,216
                                                            ========  ========
</TABLE>

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

                                      F-3
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

          CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
                     (in thousands, except per share data)

<TABLE>
<CAPTION>
                                                     Year Ended December 31
                                                    --------------------------
                                                      2000     1999     1998
                                                    --------  -------  -------
<S>                                                 <C>       <C>      <C>
Net sales.......................................... $  4,949  $   254  $   --
Cost of sales and start-up manufacturing costs.....    5,235      731      --
                                                    --------  -------  -------
    Gross loss.....................................     (286)    (477)     --
                                                    --------  -------  -------
Operating Expenses:
  Research and development.........................    6,013    5,095    6,145
  Sales and marketing..............................    5,244    1,441      614
  General and administrative.......................    3,007    1,799    1,470
                                                    --------  -------  -------
    Total operating expenses.......................   14,264    8,335    8,229
                                                    --------  -------  -------
      Loss from operations.........................  (14,550)  (8,812)  (8,229)
  Interest income..................................      889      513      581
  Interest expense.................................      (53)     (26)     (39)
                                                    --------  -------  -------
      Net loss.....................................  (13,714)  (8,325)  (7,687)
Other comprehensive income (loss):
  Change in unrealized gain or loss on available
   for sale securities.............................       33      (31)     --
      Comprehensive loss........................... $(13,681) $(8,356) $(7,687)
                                                    ========  =======  =======
</TABLE>
<TABLE>
<S>                                                <C>       <C>      <C>
Basic and diluted net loss per share.............. $  (1.28) $ (0.96) $ (1.08)
                                                   ========  =======  =======
Shares used in computing basic and diluted net
 loss per share...................................   10,728    8,707    7,145
                                                   ========  =======  =======
</TABLE>


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

                                      F-4
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                  For the three years ended December 31, 2000
                                 (in thousands)

<TABLE>
<CAPTION>
                                                      Notes                  Accumulated
                          Common Stock  Additional Receivable                   Other
                          -------------  Paid-To      From       Deferred   Comprehensive   Deficit
                          Shares Amount  Capital   Shareholder Compensation Income (Loss) Accumulated  Total
                          ------ ------ ---------- ----------- ------------ ------------- ----------- --------
<S>                       <C>    <C>    <C>        <C>         <C>          <C>           <C>         <C>
Balances, January 1,
 1998...................   7,118  $  7   $36,096      $(54)       $(282)        $  2       $(21,545)  $ 14,224
Issuance of common
 stock:
  Upon exercise of stock
   options..............      65   --         29       --           --           --             --          29
  Under employee stock
   purchase plan........      28   --         73       --           --           --             --          73
Payment of notes
 receivable.............     --    --        --         54          --           --             --          54
Adjustment for
 cancellation of stock
 options................     --    --        (61)      --            61          --             --         --
Amortization of deferred
 compensation...........     --    --        --        --           134          --             --         134
Net loss................     --    --        --        --           --           --          (7,687)    (7,687)
                          ------  ----   -------      ----        -----         ----       --------   --------
Balances, December 31,
 1998...................   7,211     7    36,137       --           (87)           2        (29,232)     6,827
Issuance of common
 stock:
  Follow-on public
   offering, net of
   issuance costs.......   1,800     2     8,143       --           --           --             --       8,145
  Private placement, net
   of issuance costs....     872     1     7,615       --           --           --             --       7,616
  Upon exercise of stock
   options..............     109   --        212       --           --           --             --         212
  Under employee stock
   purchase plan........      17   --        103       --           --           --             --         103
</TABLE>
<TABLE>
<S>                       <C>    <C>    <C>        <C>         <C>          <C>           <C>         <C>
Change in unrealized
 gain/loss on available
 for sale securities....     --    --        --        --           --           (31)           --         (31)
Deferred compensation...     --    --        354       --          (354)         --             --         --
Amortization of deferred
 compensation...........     --    --        --        --           239          --             --         239
Net loss................     --    --        --        --           --           --          (8,325)    (8,325)
                          ------ -----   -------      ----        -----         ----       --------   --------
Balances, December 31,
 1999...................  10,009    10    52,564       --          (202)         (29)       (37,557)    14,786
Issuance of common
 stock:
  Private placement, net
   of issuance costs....   1,100     1    12,963       --           --           --             --      12,964
  Upon exercise of stock
   options..............     134   --        373       --           --           --             --         373
  Under employee stock
   purchase plan........      31   --        194       --           --           --             --         194
Change in unrealized
 gain/loss on
 available-for-sale
 securities.............     --    --        --        --           --            33            --          33
Deferred compensation...     --    --        342       --          (342)         --             --         --
Amortization of deferred
 compensation...........     --    --        --        --           185          --             --         185
Net loss................     --    --        --        --           --           --         (13,714)   (13,714)
                          ------ -----   -------      ----        -----         ----       --------   --------
Balances, December 31,
 2000...................  11,274 $  11   $66,436      $--         $(359)        $  4       $(51,271)  $ 14,821
                          ====== =====   =======      ====        =====         ====       ========   ========
</TABLE>

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

                                      F-5
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                     Year Ended December 31
                                                    --------------------------
                                                      2000     1999     1998
                                                    --------  -------  -------
<S>                                                 <C>       <C>      <C>
Cash flows used for operating activities:
  Net loss......................................... $(13,714) $(8,325) $(7,687)
  Adjustments to reconcile net loss to net cash
   used in operating activities:
    Depreciation and amortization..................      712      432      319
    Accretion of available-for-sale securities.....       15       (8)      16
    Amortization of deferred compensation..........      185      239      134
    Deferred rent..................................       47      --       --
  Changes in assets and liabilities:
    Accounts receivable............................     (831)    (147)      21
    Inventories....................................     (436)    (582)     --
    Prepaids and other current assets..............      (15)     (47)      72
    Other assets...................................      (14)    (147)     (10)
    Accounts payable...............................      202      562     (441)
    Accrued expenses...............................      382     (276)     108
                                                    --------  -------  -------
      Net cash used in operating activities........  (13,467)  (8,299)  (7,468)
                                                    --------  -------  -------
Cash flows from investing activities:
  Acquisition of property and equipment............   (5,157)    (735)    (245)
</TABLE>
<TABLE>
<S>                                                <C>       <C>      <C>
  Purchases of available-for-sale-securities......  (14,264)  (7,513)  (1,996)
  Restricted cash.................................     (573)  (1,088)     --
  Sales of available-for-sale securities..........   14,607    5,689    5,953
                                                   --------  -------  -------
      Net cash provided by (used in) investing
       activities.................................   (5,387)  (3,647)   3,712
                                                   --------  -------  -------
Cash flows from financing activities:
  Proceeds from issuance of common stock, net of
   issuance costs.................................   13,531   16,076      102
  Proceeds from equipment financing...............      989      --       --
  Payments on equipment financing.................      (46)     --       278
  Repayment of notes payable......................     (116)    (117)     --
  Payment received on note receivable from
   stockholder....................................      --       --        54
                                                   --------  -------  -------
      Net cash provided by financing activities...   14,358   15,959      434
                                                   --------  -------  -------
Net increase (decrease) in cash and cash
 equivalents......................................   (4,496)   4,013   (3,322)
Cash and cash equivalents, beginning of year......    8,164    4,151    7,473
                                                   --------  -------  -------
Cash and cash equivalents, end of year............ $  3,668  $ 8,164  $ 4,151
                                                   ========  =======  =======
Supplemental disclosure of cash flow information:
  Cash paid for interest.......................... $     53  $    26  $    80
                                                   ========  =======  =======
Supplemental disclosure of noncash investing and
 financing activities:
  Adjustment for cancellation of stock options.... $    --   $   --   $    61
                                                   ========  =======  =======
  Deferred compensation........................... $    342  $   354  $   --
                                                   ========  =======  =======
</TABLE>

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

                                      F-6
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1. Formation and Business of the Company

  Fusion Medical Technologies, Inc. (the "Company") was incorporated in the
State of Delaware in 1992. The Company is developing and commercializing
proprietary collagen gel-based products used to stop bleeding during surgical
procedures. Since its inception, the Company 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 $24,419,000. Upon completion of the offering, all
outstanding shares of preferred stock (a total of 7,659,000 shares) were
converted into shares of common stock.

  In April 1999, the Company sold 1,800,000 shares of common stock at $5.125
per share in a follow-on public offering. Net proceeds, after commissions and
fees along with other costs associated with the offering, were $8,145,000. In
November 1999, the Company closed a private placement financing with selected
accredited investors of 872,000 shares of common stock at $9.50 per share. Net
proceeds, after commissions and fees along with other costs associated with
the offering, were $7,616,000.

  In June 2000, the Company closed a private placement financing with selected
accredited investors of 1,100,000 shares of common stock at $12.00 per share.
Net proceeds, after commissions and fees along with other costs associated
with the offering, were $12,964,000.

  These financial statements contemplate the realization of assets and the
satisfaction of liabilities in the normal course of business. In the course of
its development, the Company has sustained operating losses and expects such
losses to continue through at least 2001. Management believes its cash and
available-for-sale securities balances as of December 31, 2001 will not be
sufficient to meet the Company's capital and operating requirements for the
next 12 months. The Company will require additional funding and may sell
additional shares of its common stock or preferred stock through private
placement or further public offerings, see note 14.

  The Company may require additional financing in the future. There can be no
assurance that the Company will be able to obtain additional debt or equity
financing, if and when needed, on terms acceptable to the Company. Any
additional equity or debt financing may involve substantial dilution to the
Company's stockholders, restrictive covenants or high interest costs. The
failure to raise needed funds on sufficiently favorable terms could have a
material adverse effect on the Company's business, operating results and
financial condition.

  The Company's long term liquidity also depends upon its ability to increase
revenues from the sale of its products and achieve profitability, and its
ability to develop and market new products and obtain sufficient manufacturing
capacity. The failure to achieve these goals could have a materially adverse
effect on the Company's business, operating results and financial condition.

2. Summary of Significant Accounting Policies

 Basis of Consolidation

  The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary. All significant intercompany accounts and
transactions have been eliminated.

 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.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Long-Lived Assets

  The Company reviews long-lived assets and certain identifiable intangible
assets to be held and used, or disposed of, for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The Company assesses the impairment of long-lived assets,
based upon the estimated future cash flows from these assets.

 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 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 "interest income." The cost of securities sold is based upon the
specific identification method.

 Inventories

  Inventories are stated at lower of cost or market, with cost determined on a
first-in, first-out basis.

 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.

 Advertising Expenses

  The Company recognizes advertising expenses as they are incurred.
Advertising expenses for the years ended December 31, 2000, 1999 and 1998 were
$46,000, $12,000, and none respectively.

 Revenue Recognition

  The Company recognizes revenue in accordance with SEC Staff Accounting
Bulletin No.101 " Revenue Recognition in Financial Statements". Revenue from
product sales is recognized upon shipment to the customer against a valid
purchase order provided no significant obligations remain and collection of
the receivables is probable.

 Shipping & Handling Costs

  In fiscal 2000, the company adopted the provisions of EITF 00-10 "Accounting
for Shipping and Handling Fees and Costs". For all periods presented, amounts
billed to customers relating to shipping and handling costs have been
classified as revenues and all related costs are classified as cost of sales
on the accompanying statement of operations.

 Research and Development Expenditures

  Research and development expenditures are expensed as incurred.

 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

                                      F-8
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 two financial institutions. Deposits in these institutions may
exceed the amount of insurance provided on such deposits.

  At December 31, 2000 one customer accounted for 55% of the total accounts
receivable and 60% of the Company's revenues for the year ended December 31,
2000.

 Risks and Uncertainties

  The Company is dependant upon the success of its first commercial product
FloSeal Matrix Hemostatic Sealant (FloSeal). The Company's future success
depends upon its ability to increase revenues from the sale of FloSeal, its
ability to develop, introduce and market new products, its ability to obtain
components from key suppliers, and to obtain sufficient manufacturing
capacity.

  The Company's products under development 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 under development 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 bank borrowings
approximate fair value. Estimated fair values for available-for-sale
securities, which are separately disclosed elsewhere, are based on quoted
market prices for the same or similar instruments.

 Computation of Basic and Diluted Net Loss Per Share

  Basic and diluted net loss per share are computed using the weighted average
number of shares of common stock outstanding. Common equivalent shares from
stock options are excluded from the computation of diluted net loss per share,
as their effect is anti-dilutive.

  Stock options to purchase 2,447,000, 1,850,000, and 1,079,000 shares of
common stock at prices ranging from $0.16 to $17.63 per share were outstanding
at December 31, 2000, 1999, and 1998, respectively, but were not included in
the computation of diluted net loss per share because they were anti-dilutive.
Warrants to purchase 4,500, 12,785 and 12,785 shares of common stock at $4.00
per share were outstanding at December 31, 2000, 1999 and 1998, respectively,
but were not included in the computation of diluted net loss per share because
they were anti-dilutive. There were 5,339 shares of common stock relating to
the exercise of a warrant during fiscal 2000 that were excluded from the
computation of basic and diluted net loss per share as they had not been
issued at December 31, 2000. The aforementioned stock options and warrants
could potentially dilute earnings per share in the future.

                                      F-9
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Recent Accounting Pronouncements

  In June 1998, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 133, "Accounting for Derivative Instruments and Hedging
Activities", which establishes accounting and reporting standards for
derivative instruments and hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The Company,
to date, has not engaged in derivative and hedging activities. The Company
will adopt SFAS No. 133, as amended, for the first quarter of fiscal year
2001. The Company does not believe the adoption will have a material impact on
these financial statements.

3. Available-for-Sale Securities

  The following summarizes the Company's available-for-sale securities (in
thousands):

<TABLE>
<CAPTION>
                                          Unrealized  Accrued   Fair   Maturity
                                    Cost  Gain/(Loss) Interest Value    Dates
                                   ------ ----------- -------- ------ ----------
<S>                                <C>    <C>         <C>      <C>    <C>
December 31, 2000
-----------------
Corporate Bonds................... $2,936    $  5       $ 5    $2,946 2/01--1/02
Federal Agencies.................. $1,534    $ (1)      $10    $1,543 1/01--3/01
                                   ------    ----       ---    ------
  Total........................... $4,470    $  4       $15    $4,489
                                   ======    ====       ===    ======
December 31, 1999
-----------------
Corporate Bonds................... $4,851    $(29)      $(8)   $4,814 4/00--3/01
                                   ======    ====       ===    ======
</TABLE>

4. Balance Sheet Details

<TABLE>
<CAPTION>
                                                                 December 31
                                                               ----------------
                                                                2000     1999
                                                               -------  -------
                                                               (In Thousands)
<S>                                                            <C>      <C>
Inventory:
  Raw materials............................................... $   335  $   237
  Work in progress............................................     343      150
  Finished goods..............................................     340      195
                                                               -------  -------
    Total..................................................... $ 1,018  $   582
                                                               =======  =======
Property and equipment:
  Computer equipment.......................................... $   517  $   366
  Office furniture and equipment..............................     931      146
  Machinery and equipment.....................................   2,431    1,210
  Leasehold improvements......................................   3,638      758
  Construction in progress....................................     120       --
                                                               -------  -------
    Total.....................................................   7,637    2,480
  Less accumulated depreciation and amortization..............  (2,154)  (1,442)
                                                               -------  -------
    Net property and equipment................................ $ 5,483  $ 1,038
                                                               =======  =======
Accrued expenses:
  Accrued compensation........................................ $   641  $   269
  Accrued general and administrative..........................     248      195
  Other.......................................................     --        43
                                                               -------  -------
                                                               $   889  $   507
                                                               =======  =======
</TABLE>

                                     F-10
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


5. Debt

  In December 1997, the Company signed a loan agreement with a bank to finance
existing equipment and future equipment purchases up to $2,500,000. Subject to
certain terms and conditions, the facility finances a percentage of the
invoice cost of existing equipment and all of the invoice cost of future
equipment purchases. The equipment purchased serves as collateral. Borrowings
under the facility, as amended, expired in February 1998. As of December 31,
2000, the Company had a current balance of $88,000 outstanding. The loan is
payable in monthly installments bearing interest at the rate of prime plus
1.5% per annum (11.0% at December 31, 2000). This borrowing agreement contains
covenants restricting the payment of dividends.

  In April 2000, the Company accepted a commitment to finance existing
equipment and future equipment purchases up to $3,000,000 towards production
equipment, research and development equipment, computer equipment and office
furnishings. As of December 31, 2000, the Company had a balance of $943,000
outstanding. The loan is payable in monthly installments bearing interest at
14.7% per annum. A balloon payment of 10% of the original principal amount is
due at the end of each loan term. No additional drawdowns are available under
this agreement.

  Future payments of principal under this loan agreement are as follows:

<TABLE>
<CAPTION>
                   Year                                   Amount
                   ----                                   ------
                   <S>                                    <C>
                   2001..................................  $191
                   2002..................................   223
                   2003..................................   256
                   2004..................................   273
                                                           ----
                                                           $943
                                                           ====
</TABLE>

6. Commitments and contingencies

  The Company leases office, laboratory and manufacturing space under various
operating leases, the latest expiring in December 2006. The Company recognizes
rent expense on a straight line basis over the lease term.

  The Company issued a letter of credit to the landlord of the Fremont
building in the amount of $1,087,500. The letter of credit is cash
collateralized in an interest bearing account and is reflected as restricted
cash on the accompanying balance sheet. In exchange for the letter of credit,
the landlord is providing improvements to the site equal to or greater than
$1,087,500. Repayment to the landlord for these improvements are deemed rental
payments and are payable during the initial term of the lease. The letter of
credit extends through the initial lease term.

  In July 2000, the Company reserved funds in a escrow account for leasehold
improvements for the Company's Fremont building. The Company agreed to escrow
monies into an interest bearing bank account at the fiduciary care of the
landlord as the reserve fund. Upon the final completion and payment for the
Phase II construction, the landlord agrees to refund to the tenant all
residual monies in the bank account. The balance at December 31, 2000 was
$573,000 and is reflected as restricted cash on the accompanying balance
sheet.

  Rent expense for the years ended December 31, 2000, 1999, and 1998 was
approximately $1,417,000, $436,000, and $304,000, respectively.

  Minimum future lease payments under the lease agreements at December 31,
2000 are as follows (in thousands):

<TABLE>
<CAPTION>
                   Year                                   Amount
                   ----                                   ------
                   <S>                                    <C>
                   2001.................................. $1,947
                   2002..................................  1,591
                   2003..................................  1,591
                   2004..................................  1,591
                   2005..................................  1,573
                   More than 5 years.....................  1,573
                                                          ------
                                                          $9,866
                                                          ======
</TABLE>

                                     F-11
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  On December 19, 2000, Cohesion Technologies, Inc. filed a patent
infringement action against us in United States District Court, Northern
District of California (San Jose) claiming the Company infringed on Cohesion
Technologies' "Collagen-Polymer Matrices With Differential Biodegradability"
patent (Patent #6,110,484), which claims a method for forming fibrin matrix at
a tissue site. Cohesion Technologies is seeking unspecified damages and
permanent injunctive relief. We believe the Cohesion Technologies' claim is
without merit.

7. 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, 2000, 5,000,000
shares of preferred stock were authorized and no preferred stock was issued or
outstanding. The previously outstanding preferred 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 per share. 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. In 1997, this
warrant was modified to $4.00 per share and the expiration date was extended
to September 2000.

  In December 1997, in connection with bank borrowings, the Company issued a
warrant to purchase 4,500 common shares at an exercise price of $4.00 per
share. This warrant expires in five years. The value of these warrants was
calculated using the Black Scholes Model. The calculated value was deemed to
be insignificant. These warrants were outstanding as of December 31, 2000.

  On August 18, 2000, a warrant holder exercised 8,285 warrants through the
conversion right included in the warrant agreement. The holder converted the
total 8,285 shares into 5,339 shares in accordance with the stipulated
conversion formula. As of December 31, 2000, the shares of common stock were
not yet issued.

 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 non-
qualified stock options (NSOs) to be granted to employees and consultants. All
options under the Plan 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 other 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, 2000, 149 shares are subject to repurchase. The Company has
reserved 3,590,000 shares of common stock for issuances to employees, and
officers under the Plan. As of December 31, 2000, there were 652,000 shares of
common stock available for issuance under the Plan.

                                     F-12
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


8. Stockholders' Equity (continued)

  Activity under the Plan is as follows (in thousands, except per share data):

<TABLE>
<CAPTION>
                           Shares Available Number of Weighted Average
                              for Grant      Shares    Exercise Price   Total
                           ---------------- --------- ---------------- -------
<S>                        <C>              <C>       <C>              <C>
Balances, December 31,
 1997.....................        242           992        $2.86       $ 2,836
  Additional shares
   authorized under the
   Plan...................        400           --           --            --
  Options granted.........       (354)          354         4.73         1,676
  Options cancelled.......        240          (240)        4.31        (1,034)
  Options exercised.......        --            (65)        0.45           (29)
                                 ----         -----        -----       -------
Balances, December 31,
 1998.....................        528         1,041         3.31         3,449
  Additional shares
   authorized under the
   Plan...................        750           --           --            --
  Options granted.........       (926)          926         8.08         7,481
  Options cancelled.......         65           (65)        4.41          (286)
  Options exercised.......        --           (109)        1.94          (212)
                                 ----         -----        -----       -------
Balances, December 31,
 1999.....................        417         1,793         5.82        10,432
  Additional shares
   authorized under the
   Plan...................        950           --           --            --
  Options granted.........       (731)          731        12.81         9,364
  Options cancelled.......         16           (16)        9.04          (145)
  Options exercised.......        --           (134)        2.78          (373)
                                 ----         -----        -----       -------
Balances, December 31,
 2000.....................        652         2,374        $8.12       $19,278
                                 ====         =====        =====       =======
</TABLE>

  For the years ended December 31, 2000, 1999 and 1998, the weighted average
fair value of options granted was $9.47, $4.36, and $1.67 per share,
respectively.

  During 1999, the Company granted 30,000 non-qualified stock options to
consultants at exercise prices ranging from $3.25 to $8.97. The Company
determined the fair market value of these options using the Black Scholes
option pricing model with the following assumptions: expected life of ten
years, a weighted average risk-free interest rate of 5.0%, expected dividend
yield of zero and volatility of 90%.

  During 2000, the Company granted 3,500 non-qualified stock options to
consultants at exercise prices ranging from $11.00 to $11.31. The Company
determined the fair market value of these options using the Black Scholes
option pricing model with the following assumptions: expected life of ten
years, a weighted average risk-free interest rate of 6.1%, expected dividend
yield of zero and volatility of 104%.

 Director Option Plan

  In May 1996, the Company approved the Director Option Plan and reserved
120,000 shares of common stock for issuance. Options to purchase 20,800 and
16,000 shares were granted in 1999 and 2000. A total number of 75,200 shares
have been granted under the Director Option Plan. Shares are granted under the
plan at 100% of the fair value of the Company's common stock on the date of
the grant. The options are vested immediately and equally over 48 months until
fully vested. These options expire ten years from the date of grant and are
only exercisable upon vesting. As of December 31, 2000, 1999 and 1998, the
number of options outstanding were, 72,668, 56,668 and 38,400, respectively.

 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. In 2000, a total of
30,408 shares of common stock were purchased under the plan at prices ranging
from $6.35--$11.05 per share. In 1999, 17,288 shares of

                                     F-13
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

common stock were purchased under the plan at prices ranging from $5.42--$6.43
per share. Shares are purchased through employee's payroll deductions at
purchase prices equal to 85% of the lesser of the fair value of the Company's
common stock at either the beginning or the end of the six-month purchase
period.

 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 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 1998, 1999 and 2000 consistent with the
provisions of SFAS No. 123, the Company's net loss and basic and diluted net
loss per share for the years ended December 31, 1998, 1999 and 2000 would have
been increased to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                     2000     1999     1998
                                                   --------  -------  -------
   <S>                                             <C>       <C>      <C>
   Net loss--as reported.......................... $(13,714) $(8,325) $(7,687)
                                                   ========  =======  =======
   Net loss--pro forma............................ $(16,752) $(9,176) $(8,051)
                                                   ========  =======  =======
   Basic and diluted net loss per share-as
    reported...................................... $  (1.28) $ (0.96) $ (1.08)
                                                   ========  =======  =======
   Basic and diluted net loss per share-pro
    forma......................................... $  (1.56) $ (1.05) $ (1.13)
                                                   ========  =======  =======
</TABLE>

  The above pro forma disclosures are not necessarily representative of the
effects on reported net income or loss for future years.

  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:

<TABLE>
<CAPTION>
                                                2000        1999        1998
                                             ----------- ----------- -----------
     <S>                                     <C>         <C>         <C>
     Risk-free interest rate................ 5.97%-6.79% 4.67%-6.80% 5.39%-5.77%
     Expected life..........................   4 years     4 years     4 years
     Expected dividends.....................     --          --          --
     Expected volatility....................     104%        80%         83%
</TABLE>

  The options outstanding and currently exercisable by exercise price at
December 31, 2000 are as follows (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                           Options Currently
                               Options Outstanding            Exercisable
                         -------------------------------- --------------------
                                      Weighted
                                       Average   Weighted             Weighted
                                      Remaining  Average              Average
            Exercise       Number    Contractual Exercise   Number    Exercise
              Price      Outstanding Life (Yrs)   Price   Exercisable  Price
          -------------  ----------- ----------- -------- ----------- --------
          <S>            <C>         <C>         <C>      <C>         <C>
          $ 0.16-- 0.41       136       4.06      $ 0.34       136     $ 0.34
          $ 1.00-- 2.41        19       5.09        2.39        20       2.39
          $ 3.25-- 4.38       393       6.34        4.24       361       4.25
          $ 4.50-- 7.13       655       7.70        5.45       371       5.34
          $ 7.56--14.00     1,181       8.92       11.41       320      11.01
          $14.50--17.63        63       9.26       16.28         6      14.66
                            -----                            -----
                            2,447       7.89        8.10     1,214       5.94
                            =====                            =====
</TABLE>

  As of December 31, 1999 and 1998, options to purchase 799,000 and 525,000
shares of common stock were exercisable at weighted average exercise prices of
$3.78 and $2.55, respectively.

                                     F-14
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


9. 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.

10. Related Parties

  The Company has a consulting contract with a retired surgeon and medical
device designer. The contract pays a maximum of $750 per month for consulting
services and reimburses him for related expenses. The retired surgeon is a
shareholder of an affiliate of the Company and related to an executive
officer. Total payments under this contract were $20,626, $30,098 and $25,814
for 2000, 1999 and 1998 respectively.

11. Income Taxes

  The tax effects of the significant temporary differences, which comprise
deferred tax assets (liabilities) at December 31, 2000 and 1999 are as follows
(in thousands):

<TABLE>
<CAPTION>
                                                              2000     1999
                                                            -------- --------
     <S>                                                    <C>      <C>
     Capitalized start-up and research and development
      costs................................................ $  5,148 $  4,198
     Research and development credit.......................    1,567    1,023
     Depreciation..........................................      248      138
</TABLE>
<TABLE>
     <S>                                                     <C>       <C>
     Net operating loss carryforwards.......................   13,562     9,869
     Other accrued expenses.................................      271        99
                                                             --------  --------
     Net deferred tax asset.................................   20,796    15,327
     Less valuation allowance...............................  (20,796)  (15,327)
                                                             --------  --------
     Net deferred income taxes.............................. $    --   $    --
                                                             ========  ========
</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 $34,120,000 and $35,953,000, respectively, at December 31, 2000,
available to offset future regular and alternative minimum taxable income. The
Company's net operating loss carryforwards expire in 2001 through 2019, if not
utilized. The Company has federal and state research and development credit
carryforwards of $970,000 and $446,000, respectively, expiring in the years
2007 through 2019, 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-15
<PAGE>

                       FUSION MEDICAL TECHNOLOGIES, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


12. Segment Information

  The company has one operating segment based in the United States of America.
During the years ended December 31, 2000, 1999 and 1998 the company recorded
revenues of $860,000, $136,000 and none from customers domiciled outside of
the United States. The Company has no long-lived assets in countries other
than the United States.

13. Selected Quarterly Financial Data (Unaudited)

  The follow tables present selected unaudited quarterly financial data for
each of the eight quarters ended December 31, 2000. In the opinion of the
Company's management, this quarterly information has been prepared on the same
basis as the consolidated financial statements and includes all adjustments.
All amounts for revenues have been adjusted to reflect the retroactive
adoption of EITF 00-10, "Accounting for Shipping and Handling Fees and Costs".
The results of operations for any quarter are not necessarily indicative of
results for the full year or for any future period.

  (Dollar amounts in thousands except per-share data.)

<TABLE>
<CAPTION>
                                                        2000
                                           ----------------------------------
                                            First   Second    Third   Fourth
                                           Quarter  Quarter  Quarter  Quarter
                                           -------  -------  -------  -------
     <S>                                   <C>      <C>      <C>      <C>
     Net revenues......................... $   715  $ 1,119  $ 1,297  $ 1,818
     Gross profit (loss).................. $  (374) $  (155) $     9  $   234
     Net loss............................. $(3,136) $(3,244) $(3,558) $(3,776)
     Basic and diluted net loss per
      share............................... $ (0.31) $ (0.31) $ (0.32) $ (0.34)
     Shares used in computing basic and
      diluted net loss per share..........  10,026   10,363   11,223   11,260
</TABLE>

<TABLE>
<CAPTION>
                                                        1999
                                           ----------------------------------
                                            First   Second    Third   Fourth
                                           Quarter  Quarter  Quarter  Quarter
                                           -------  -------  -------  -------
     <S>                                   <C>      <C>      <C>      <C>
     Net revenues......................... $     0  $    25  $    56  $   173
     Gross profit (loss).................. $     0  $  (120) $  (178) $  (179)
     Net loss............................. $(1,582) $(1,897) $(2,150) $(2,696)
     Basic and diluted net loss per
      share............................... $ (0.22) $ (0.21) $ (0.24) $ (0.28)
     Shares used in computing basic and
      diluted net loss per share..........   7,225    8,886    9,004    9,540
</TABLE>

14. Subsequent Event

  On April 9, 2001, the Company sold 2,730,375 shares of common stock at a
purchase price of $2.93 per share, which was the average closing price of
Fusion's common stock over the 10 trading days preceding the execution of the
private placement agreement, to Alloy Ventures, the State of Wisconsin
Investment Board and the Asset Management Company. Net proceeds, after
deducting estimated legal fees and other estimated costs associated with the
offering, total approximately $7.9 million to the Company, which should be
sufficient to meet the Company's capital and operating requirements for at
least the next 12 months. As part of the transaction, each purchaser also
received a warrant exercisable for up to an additional 25 percent of the total
shares purchased. The exercise price of the warrants is 125 percent of the
purchase price or $3.66 per share. The warrant agreement terminates on April
2, 2006.

                                     F-16