<PAGE>


                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    FORM 10-Q
    [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934
               For the quarterly period ended September 30, 2001
                                       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: 0-28460
                        FUSION MEDICAL TECHNOLOGIES, INC.
             (Exact name of registrant as specified in its charter)



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

                            34175 Ardenwood Boulevard
                                Fremont, CA 94555
                    (Address of principal executive offices)
                                 (510) 818-4600
              (Registrant's telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports
required 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 [_]

     The number of outstanding shares of the registrant's Common Stock was
14,164,000 as of November 7, 2001.

<PAGE>

                        FUSION MEDICAL TECHNOLOGIES, INC.
                                    INDEX TO
                               REPORT ON FORM 10-Q
                      FOR QUARTER ENDED September 30, 2001
<TABLE>
<CAPTION>
                                                                                   Page
                                                                                   ----
<S>                                                                                <C>
PART I.    FINANCIAL INFORMATION

Item 1.      Financial Statements:

                 Condensed Consolidated Balance Sheets -
                 September 30, 2001 (unaudited) and December 31, 2000.............   3

                 Condensed Consolidated Statements of Operations and
                 Comprehensive Loss - Three and Nine Months Ended September 30,
                 2001 and 2000(unaudited) ........................................   4

                 Statements of Condensed Consolidated Cash Flows - Nine Months
                 Ended September 30, 2001 and 2000 (unaudited) ...................   5

                 Notes to Condensed Consolidated Financial Statements
                 (unaudited) .....................................................   6

Item 2.      Management's Discussion and Analysis of Financial Condition
             and Results of Operations ...........................................   8

Item 3.      Quantitative and Qualitative Disclosures About Market Risk ..........  22

PART II.   OTHER INFORMATION

Item 1.      Legal Proceedings ...................................................  23

Item 2.      Exhibits and Reports on Form 8-K ....................................  23

             Signatures ..........................................................  24
</TABLE>

                                       2


<PAGE>

PART I - FINANCIAL INFORMATION

I.         FINANCIAL STATEMENTS

                      FUSION MEDICAL TECHNOLOGIES, INC.
                    CONDENSED CONSOLIDATED BALANCE SHEETS
                                (In thousands)

<TABLE>
<CAPTION>
                                                                     September 30      December 31
                                                                         2001              2000
                                                                     -------------     ------------
                                                                      (Unaudited)
                                     ASSETS
<S>                                                                  <C>               <C>
Current assets:
       Cash and cash equivalents                                     $      2,581      $     3,668
       Available-for-sale securities                                        2,384            4,489
       Accounts receivable, net                                             1,397              978
       Inventory                                                            1,467            1,018
       Prepaids and other current assets                                      156              197
                                                                     -------------     ------------
            Total current assets                                            7,985           10,350

 Property and equipment, net                                                5,837            5,483
 Restricted cash deposit                                                    1,164            1,661
 Other long-term assets                                                       196              215
                                                                     -------------     ------------

            Total assets                                             $     15,182      $    17,709
                                                                     =============     ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

 Current liabilities                                                 $      2 635      $     2,089
 Long-term obligations                                                        727              799
                                                                     -------------     ------------
              Total liabilities                                             3,362            2,888
                                                                     -------------     ------------
 Contingencies (Note 4)

 Common stock and other stockholders' equity                               74,624           66,092
 Accumulated deficit                                                      (62,804)         (51,271)
              Total stockholders, equity                                   11,820           14,821
                                                                     -------------     ------------

              Total liabilities and stockholders, equity             $     15,182      $    17,709
                                                                     =============     ============
</TABLE>

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

                                       3

<PAGE>

                        FUSION MEDICAL TECHNOLOGIES, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                             AND COMPREHENSIVE LOSS
                      (In thousands, except per share data)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                           Three Months Ended             Nine Months Ended
                                                              September 30                   September 30
                                                        ------------------------      --------------------------
                                                           2001          2000             2001           2000
                                                        ----------    ----------      -----------    -----------
<S>                                                     <C>           <C>             <C>            <C>
Net sales                                               $   2,752     $   1,297       $    7,950     $    3,131
Cost of sales and start-up manufacturing costs              2,449         1,288            6,762          3,649
                                                        ----------    ----------      -----------    -----------
                Gross profit (loss)                           303             9            1,188           (518)
                                                        ----------    ----------      -----------    -----------

Operating expenses:
      Research and development                              1,479         1,726            4,577          4,238
      Marketing and selling                                 2,118         1,495            5,752          3,700
      General and administrative                              774           622            2,564          2,089
                                                        ----------    ----------      -----------    -----------
           Total operating expenses                         4,371         3,843           12,893         10,027
                                                        ----------    ----------      -----------    -----------
                Loss from operations                       (4,068)       (3,834)         (11,705)       (10,545)

Interest income                                                78           291              267            632
Interest expense                                              (30)          (15)             (95)           (25)
                                                        ----------    ----------      -----------    -----------
                Net loss                                   (4,020)       (3,558)         (11,533)        (9,938)

Other comprehensive income (loss):
Change in unrealized gain or loss on
  available-for-sale securities                                 6             8               20             21
                                                        ----------    ----------      -----------    -----------
Comprehensive loss                                      $  (4,014)    $  (3,550)      $  (11,513)    $   (9,917)
                                                        ==========    ==========      ===========    ===========

Basic and diluted net loss per share                    $   (0.28)    $   (0.32)         $ (0.88)    $    (0.94)
                                                        ==========    ==========      ===========    ===========
Shares used in computing basic and diluted net
      loss per share                                       14,138        11,223           13,080         10,540
                                                        ==========    ==========      ===========    ===========
</TABLE>

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

                                       4

<PAGE>

                        FUSION MEDICAL TECHNOLOGIES, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                             Nine Months Ended
                                                                                               September 30
                                                                                       ----------------------------
                                                                                            2001            2000
                                                                                       ------------     -----------
<S>                                                                                    <C>              <C>
Cash flows used for operating activities:
        Net loss                                                                       $   (11,533)     $   (9,938)
        Adjustments to reconcile net loss to net cash used in
               operating activities:
               Depreciation and amortization                                                 1,116             469
               Accretion of available-for-sale securities                                        9              (8)
               Amortization of deferred compensation                                            75             115
               Deferred rent                                                                    91               -
               Changes in assets and liabilities:
                     Accounts receivable,net                                                  (419)           (467)
                     Inventories                                                              (449)           (638)
                     Prepaids and other current assets                                          41             (66)
                     Other assets                                                               19              (6)
                     Accounts payable                                                           98             788
                     Accrued expenses                                                          503              64
                                                                                       ------------     -----------
                          Net cash used in operating activities                            (10,449)         (9,687)
                                                                                       ------------     -----------

Cash flows from investing activities:
        Acquisition of property and equipment                                               (1,471)         (4,128)
        Purchases of available-for-sale securities                                          (6,914)         (8,788)
        Restricted cash                                                                        497          (1,256)
        Sales and maturities of available-for-sale securities                                9,031           9,816
                                                                                       ------------     -----------
                          Net cash provided by (used in) investing activities                1,143          (4,356)
                                                                                       ------------     -----------

Cash flows from financing activities:
        Proceeds from issuance of common stock and warrants,
        net of issuance costs                                                                7,989          13,054
        Proceeds from exercise of warrants                                                     375               -
        Proceeds from exercise of common stock options                                          73             354
        Proceeds from (repayment of) equipment financing                                      (140)            989
        Repayment of notes payable                                                             (78)            (87)
                                                                                       ------------     -----------
                          Net cash provided by financing activities                          8,219          14,310
                                                                                       ------------     -----------

Net increase (decrease) in cash and cash equivalents                                        (1,087)            267
Cash and cash equivalents, beginning of period                                               3,668           8,164
                                                                                       ------------     -----------
Cash and cash equivalents, end of period                                               $     2,581      $    8,431
                                                                                       ============     ===========

Supplemental disclosure of cash flow information:
        Cash paid for interest                                                         $        96      $       19
                                                                                       ============     ===========
</TABLE>

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



                                       5

<PAGE>

                        FUSION MEDICAL TECHNOLOGIES, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                               September 30, 2001
                                   (Unaudited)

1. Basis of presentation

     The accompanying condensed consolidated financial statements of Fusion
Medical Technologies, Inc. (the "Company", "Fusion", "Our" or "We") have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Article 10 of
Regulation S-X. The condensed consolidated balance sheet as of September 30,
2001, and the condensed consolidated statements of operations for the three and
nine month periods ended September 30, 2001 and 2000, and the condensed
consolidated statements of cash flows for the nine month periods ended September
30, 2001 and 2000 are unaudited but include all adjustments (consisting of
normal recurring adjustments) which the Company considers necessary for a fair
presentation of the financial position at such dates and the consolidated
operating results and cash flows for those periods. Although the Company
believes that the disclosures in these condensed consolidated financial
statements are adequate to make the information presented not misleading,
certain information normally included in financial statements and related
footnotes prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. The accompanying condensed consolidated
financial statements should be read in conjunction with the financial statements
as contained in the Company's Annual Report on Form 10-K405 for the year ended
December 31, 2000 filed with the United States Securities & Exchange Commission
on April 13, 2001.

     Results for any interim period are not necessarily indicative of results
for any other interim period or for the entire year.

2. Net loss per share

     Basic and diluted loss per common share are computed using the weighted
average number of shares of common stock outstanding. Common equivalent shares
from stock options and warrants are excluded from the computation of diluted net
loss per common share as their effect is anti-dilutive. Stock options to
purchase 3,018,453 and 2,469,689 shares of common stock at prices ranging from
$0.16 to $17.63 per share were outstanding at September 30, 2001 and 2000,
respectively. Warrants to purchase 585,093 and 12,785 shares of common stock at
prices ranging from $3.66 to $4.00 per share were outstanding at September 30,
2001 and 2000, respectively.

3. Inventory

     Inventory is recorded at the lower of cost or market using the FIFO method.
Inventories consist of the following (in thousands):

                                     September 30          December 31
                                          2001                2000
                                     ------------        -------------
Finished goods                       $        825        $         340
Work in process                               115                  343
Raw materials                                 527                  335
                                     ------------        -------------
                                     $      1,467        $       1,018
                                     ============        =============

                                        6

<PAGE>

                        FUSION MEDICAL TECHNOLOGIES, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                               September 30, 2001
                                   (Unaudited)

4. Legal Proceedings

     On September 13, 2001, we received notice from Sulzer Spine-Tech Inc. that
they had filed a Demand for Arbitration with the American Arbitration
Association for unspecified damages resulting from our alleged breach of
contract and invalid termination of the International Distributor Agreement
originally executed between us and Sulzer Spine-Tech on July 1, 1999. Pursuant
to the International Distributor Agreement, the decision of the arbitrator shall
be final and non-appealable and shall be delivered within nine months following
the filing of the initial Demand for Arbitration. We dispute all claims made by
Sulzer Spine-Tech.

     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. On September 5, 2001 Cohesion Technologies added patent #6,277,394
B1 to the existing patent infringement action. Cohesion Technologies is seeking
unspecified damages and permanent injunctive relief. We believe the Cohesion
Technologies claims are without merit.

5. Recent Accounting Pronouncements

     In October 2001, the Financial Accounting and Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 144 ("SFAS 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets", which is
effective for fiscal years beginning after December 15, 2001 and interim periods
within those fiscal periods. SFAS 144 supercedes FASB Statement No. 121 and APB
Opinion No. 30, however, it retains the requirement of Opinion No. 30 to report
discontinued operations separately from continuing operations and extends that
reporting to a component of an entity that either has been disposed of (by
sales, by abandonment, or in a distribution to owners) or is classified as held
for sale. SFAS 144 addresses financial accounting and reporting for the
impairment of certain long-lived assets and for long-lived assets to be disposed
of. Management does not expect the adoption of SFAS 144 to have a material
impact on the Company's financial position and results of operations.

     In July 2001, the Financial Accounting and Standards Board ("FASB") issued
Statements of Financial Accounting Standards No. 141 (SFAS 141"), "Business
Combinations," and No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets."
SFAS 141 requires that all business combinations initiated after June 30, 2001
be accounted for under a single method----the purchase method. Use of the
pooling-of-interests method is no longer permitted. SFAS 142 requires that
goodwill no longer be amortized to earnings, but instead be reviewed for
impairment upon initial adoption of the Statement and on an annual basis going
forward. The amortization of goodwill will cease upon adoption of SFAS 142. The
provisions of SFAS 142 will be effective for fiscal years beginning after
December 15, 2001. The Company is required to adopt SFAS 142 in the first
quarter of fiscal year 2002. The Company believes that the adoption of these
standards will have no impact on its financial statements.

                                        7

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

     This quarterly report, including the following sections, contains
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. This quarterly report includes statements
relating to products in development, the fluctuations in our revenues and
expenses as our business expands, our plans to reach profitability, our plans to
achieve third party reimbursements for our products and our ability to fund
current and planned operations. These forward-looking statements involve risks
and uncertainties. The cautionary statements set forth below and those contained
in "Additional Factors that Might Affect Future Results," found on pages 12 to
21 in our quarterly report, identify important factors that could cause actual
results to differ materially from those predicted in any such forward-looking
statements. Such factors include, but are not limited to, a failure to reach
profitability, fluctuations in our operating results, a failure to efficiently
manufacture our product, termination of our distribution agreement with Sulzer
Spine-Tech, failure to grow our sales and distribution capabilities, increased
competition, dependence on single suppliers for raw materials, natural
disasters, failure to develop new products, failure to improve operational
efficiencies, failure to obtain regulatory approvals, failure to maintain and
comply with regulatory rules, risks associated with foreign operations, failure
to protect our intellectual property, infringement of third-party intellectual
property rights, failure to obtain third-party reimbursement for our product,
dependence on products derived from cows, reclassification of our product in
Europe, product liability claims and the failure to attract and retain key and
qualified employees.

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(R) Matrix Hemosatatic Sealant ("FloSeal"), was approved on
December 8, 1999 by the United States Food and Drug Administration 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. In July 2001, the second generation FloSeal, a dry
formulation, was approved by the United States Food and Drug Administration for
marketing in the United States. The second generation product is considered to
be as effective as the first product with the advantages of a longer shelf life
and a projected lower cost of production.

     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 former
distribution partner, Sulzer Spine-Tech, represented approximately 60% of total
revenue or $2.9 million. We have reported $7,950,000 and $3,131,000 in revenue
for the first nine months of 2001 and 2000, respectively, primarily from sales
into the cardiac, vascular, ear, nose and throat, head and neck, and spinal
surgical specialties. Effective September 12, 2001 the distribution agreement
with Sulzer Spine-Tech was terminated and we began selling to spinal surgery
customers through our direct sales force. As of September 30, 2001, we had an
accumulated deficit of $62.8 million.

     We anticipate sales increasing as FloSeal is used more often by doctors
currently using 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, while research and
development expenses should remain relatively flat We have not achieved, nor do
we expect to achieve, profitability before 2002.

     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

                                        8

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

approximately $6.4 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(TM)) device for use following vascular
interventional procedures. We completed feasibility clinical trials for the
FloSeal FAST device in August 2001. Another early stage product is the FloSeal
sponge, a dry, sponge-like formulation of FloSeal requiring no mixing, for
potential use in trauma surgery and battlefield first-aid applications. Our
future products currently in development require approvals by United States Food
and Drug Administration and other regulators, which cannot be guaranteed.

RESULTS OF OPERATIONS

Three and Nine Months Ended September 30, 2001 and 2000
-------------------------------------------------------

NET SALES

     We recorded sales of $2,752,000 and $1,297,000 for the three months ended
September 30, 2001 and 2000 respectively. We recorded sales of $7,950,000 and
$3,131,000 for the nine months ended September 30, 2001 and 2000 respectively.
We commenced selling FloSeal in December 1999 in the United States. Sales
increased in 2001 principally due to increased usage of FloSeal by doctors and
hospitals. Approximately 26% of total sales in the third quarter of 2001 and 43%
of sales for the nine months ended September 30, 2001 were transacted with our
former distribution partner, Sulzer Spine-Tech.

COST OF SALES AND START-UP MANUFACTURING COSTS

     We recorded cost of sales and start-up manufacturing costs of $2,449,000
and $1,288,000 for the three months ended September 30, 2001 and 2000,
respectively. We recorded cost of sales and start up manufacturing costs of
$6,762,000 and $3,649,000 for the nine months ended September 30, 2001 and 2000,
respectively. Cost of sales increased due to increased shipments of products
following regulatory approval in the United States. Cost of sales per product
unit is expected to decrease as greater unit volume is produced. However, we
anticipate cost of sales will increase in future periods in connection with the
increase in sales of FloSeal.

GROSS PROFIT (LOSS)

     We recorded a gross profit for the three months ended September 30, 2001 of
$303,000, 11% of net sales, compared to a gross profit of $9,000 in the same
period in 2000. For the nine months ended September 30, 2001 we recorded a gross
profit of $1,188,000, 15% of net sales, compared to a gross loss of $518,000 in
the same period in 2000. The improvement in gross profit for both the three and
nine month periods are a result of greater absorption of production overhead by
an increasing number of production units. Gross profit per product unit is
expected to continue to increase as we produce greater unit volumes, convert to
the second generation product and sell primarily through our direct sales force.

RESEARCH AND DEVELOPMENT

     Research and development expenses decreased 14% to $1,479,000 in the three
months ended September 30, 2001, compared to $1,726,000 in the three months
ended September 30, 2000. For the nine months ended September 30, 2001, research
and development expenses increased 8% to $4,577,000 compared to $4,238,000 for
the nine months ended September 30, 2000. The decrease for the three months
ended September 30, 2001 was due to a reduction in costs related to the design
and development of the FloSeal Fast device. The increase for the nine months
ended September 30, 2001 was due to the facility

                                        9

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

overhead costs related to our new Fremont facility. 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 through
at least the end of 2001.

MARKETING AND SELLING

     Marketing and selling expenses increased 42% to $2,118,000 in the three
months ended September 30, 2001, compared to $1,495,000 for the three months
ended September 30, 2000. For the nine months ended September 30, 2001,
marketing and selling expenses increased 55% to $5,752,000, compared to
$3,700,000 for the nine months ended September 30, 2000. The increases were
primarily due to personnel costs of our sales department, currently 27 people,
and to marketing spending to boost the sales of FloSeal into the spinal,
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. 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 increased 24% to $774,000 in the three
months ended September 30, 2001, compared to $622,000 for the three months ended
September 30, 2000. For the nine months ended September 30, 2001, general and
administrative expenses increased 23% to $2,564,000, compared to $2,089,000 for
the nine months ended September 30, 2000. The increases were primarily due to
legal fees, personnel costs and facility overhead costs related to our new
Fremont facility.

     We are currently involved in ongoing legal proceedings that could result in
costly legal fees or judgments. In addition, as we grow 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

     Interest income decreased 73% to $78,000 for the three months ended
September 30, 2001 compared to $291,000 for the three months ended September 30,
2000. For the nine months ended September 30, 2001, interest income decreased
58% to $267,000, compared to $632,000 for the nine months ended September 30,
2000. The decrease was attributable to a decrease in our cash, cash equivalents
and available-for-sale securities balances as well as a general decline in
domestic interest rates.

INTEREST EXPENSE

     Interest expense increased to $30,000 for the three months ended September
30, 2001 compared to $15,000 for the three months ended September 30, 2000. For
the nine months ended September 30, 2001 interest expense increased to $95,000,
compared to $25,000 for the nine months ended September 30, 2000. The increase
is due to an additional equipment loan received from Transamerica Business
Credit Corporation during 2000.

NET LOSS

     As a net result of the items discussed above, net loss was $4,020,000 for
the three months ended September 30, 2001 as compared to the net loss of
$3,558,000 for the three months ended September 30,

                                       10

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

2000. For the nine months ended September 30, 2001 the net loss was $11,533,000
as compared to the net loss of $9,938,000 for the nine months ended September
30, 2000.

LIQUIDITY AND CAPITAL RESOURCES

     At September 30, 2001, our cash, cash equivalents and available-for-sale
securities were $4,965,000 compared to $8,157,000 at December 31, 2000.

     For the nine months ended September 30, 2001 and 2000, our operating
activities consumed cash of $10,449,000 and $9,687,000, respectively. The
increase in cash consumed by operations was due primarily to the increase in the
net loss.

     For the nine months ended September 30, 2001 and 2000, our investing
activities generated cash of $1,143,000 and used cash of $4,356,000,
respectively. The change from cash used to cash generated of $5,499,000 was
primarily due to a reduction in the acquisition of property and equipment of
$2,657,000 and a change of $1,753,000 in restricted cash.

     On April 9, 2001, we completed a private financing of 2,730,375 shares of
common stock at a purchase price of $2.93 per share to Alloy Ventures, the State
of Wisconsin Investment Board and the Asset Management Company. Net proceeds,
after deducting legal fees and other costs associated with the offering, total
approximately $7.9 million, which should be sufficient to meet our capital and
operating requirements until positive cash flow from operations is achieved. 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 expires on April 2, 2006.

     On July 20, 2001, The State of Wisconsin Investment Board exercised
warrants for 102,389 shares of common stock at a price of $3.66 per share for
net proceeds of $0.4 million.

     In April 2000, we accepted a commitment from Transamerica Business Credit
Corporation to finance existing equipment and future equipment purchases of up
to $3,000,000. Of the total commitment, $1,029,035 was drawn down and as of
September 30, 2001, we had a balance of $803,000 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.

     In the course of our development, we have sustained operating losses and
expect such losses to continue through at least 2002. 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 spent
approximately $6.4 million and have committed an additional $100,000 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, and future product sales should provide adequate liquidity
until positive cash flow from operations is achieved. In the event that we are
unable to achieve positive cash flow from operations, we

                                       11

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)


will need to obtain additional debt or equity financing. It is possible that we
will not be able to obtain sufficient debt or equity financing to maintain the
liquidity necessary to sustain operations.

RECENT ACCOUNTING PRONOUNCEMENTS

     In October 2001, the Financial Accounting and Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 144 ("SFAS 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets", which is
effective for fiscal years beginning after December 15, 2001 and interim periods
within those fiscal periods. SFAS 144 supercedes FASB Statement No. 121 and APB
Opinion No. 30, however, it retains the requirement of Opinion No. 30 to report
discontinued operations separately from continuing operations and extends that
reporting to a component of an entity that either has been disposed of (by
sales, by abandonment, or in a distribution to owners) or is classified as held
for sale. SFAS 144 addresses financial accounting and reporting for the
impairment of certain long-lived assets and for long-lived assets to be disposed
of. Management does not expect the adoption of SFAS 144 to have a material
impact on the Company's financial position and results of operations.

     In July 2001, the Financial Accounting and Standards Board ("FASB") issued
Statements of Financial Accounting Standards No. 141 (SFAS 141"), "Business
Combinations," and No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets."
SFAS 141 requires that all business combinations initiated after June 30, 2001
be accounted for under a single method----the purchase method. Use of the
pooling-of-interests method is no longer permitted. SFAS 142 requires that
goodwill no longer be amortized to earnings, but instead be reviewed for
impairment upon initial adoption of the Statement and on an annual basis going
forward. The amortization of goodwill will cease upon adoption of SFAS 142. The
provisions of SFAS 142 will be effective for fiscal years beginning after
December 15, 2001. The Company is required to adopt SFAS 142 in the first
quarter of fiscal year 2002. The Company believes that the adoption of these
standards will have no impact on its financial statements.

ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS

     THE FOLLOWING FACTORS REPRESENT SOME OF OUR CHALLENGES WHICH CREATE RISK
AND UNCERTAINTY. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS,
FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE HARMED. THIS FORM 10-Q
ALSO CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES.

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 revenues of $4.9 million and $8.0 million for
the first nine months of 2001. We incurred net losses of $7.7 million in 1998,
$8.3 million in 1999, $13.7 million in 2000 and $11.5 million in the first nine
months of 2001. As of September 30, 2001, we had an accumulated deficit of $62.8
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. Therefore, we do not expect to achieve profitability
before 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.

                                       12

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)


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 conversion to the use of our direct sales force from the use of our
      former distributor, Sulzer Spine-Tech to sell FloSeal 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,
  .   shortage 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 of these
problems could have a disproportionately large effect on us because the
manufacturing of FloSeal is centralized in our Fremont, California facility.

      In addition, our manufacturing facilities are subject to the Quality
System Regulation of the United States Food and Drug Administration,
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

                                       13

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

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 that surgeons will change from using current products to
FloSeal. 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 HAVE DERIVED A SUBSTANTIAL PORTION OF OUR REVENUE FROM SULZER SPINE-TECH, AND
TERMINATION OF THE DISTRIBUTION AGREEMENT 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 and 43% for the nine months
ended September 30, 2001. 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 most world wide spinal and cranial
surgical specialty markets excluding Japan and a few other small markets where
we already had distributor relationships in place. The agreement, which extended
through June 30, 2002, was terminated on September 12, 2001, and sales to spinal
surgery customers are now being conducted by our direct sales force. Our future
success will depend upon our ability to convert existing spinal surgery
customers to purchase directly from Fusion and to establish relationships with
new customers in the spinal and cranial surgical specialties. This change could
result in a decline in revenue and may impede our ability to develop a revenue
base that is sufficient to achieve profitability levels.

OUR ABILITY TO ACHIEVE SIGNIFICANT REVENUE WILL DEPEND ON OUR ABILITY TO GROW
OUR DOMESTIC AND INTERNATIONAL 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 in collaboration with 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. With the termination of the Sulzer Spine-Tech distribution
agreement, we are now also selling FloSeal into the spinal and cranial markets,
relying primarily upon our direct sales force for all domestic and international
customers previously served by Sulzer Spine-Tech. Our future success will depend
on our ability to absorb these additional customers and to sell and market
effectively into the spinal and cranial markets. 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 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 harm our business. 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 we cannot guarantee
that the negotiations with new distributors will result in arrangements on
commercially reasonable terms. We cannot assure you that the terms of new
arrangements will be favorable to us. In addition, we cannot assure you that our
distributors will not distribute other products that compete directly

                                       14

<PAGE>


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

with FloSeal or new products developed by competitors that may prove to be more
effective or cost efficient alternatives than our products.

     We are now selling FloSeal through a small direct sales force in Germany
after terminating our agreement with the regional distributor. We cannot be
certain 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 attain 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 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.

     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 King Pharmaceuticals, 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, the United States Food and Drug Administration approval of any new
supplier of a critical component would be required if that component was no
longer available from the specified supplier. The

                                       15

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

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 harm our business.

WE MANUFACTURE FLOSEAL IN ONE MANUFACTURING FACILITY, 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 Fremont, California facility, which
is part of the seismically active San Francisco Bay 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
facility. 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 damage our reputation
with our customers and our distributors. In addition, the real estate market in
the San Francisco Bay Area is both competitive and costly, an alternative
facility in the same area 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. We cannot assure you that we will be
able to successfully develop these products or, if developed, that 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 United States Food and Drug
       Administration 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, WHICH COULD INCREASE OUR LOSSES.

     We are required to maintain compliance with the good manufacturing practice
requirements of the United States Food and Drug Administration'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 United States Food and Drug
Administration and the European regulatory authorities

                                       16

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

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 United States Food and Drug Administration must
approve alternative third- party manufacturers before they can commercially
manufacture our products or some critical components, such as thrombin. We may
incur significant costs to comply with laws and regulations and our failure to
comply could lead to penalties that could impair our operating results or
financial condition.

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 trace-ability.


     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.

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 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, Switzerland, Canada, and Hong
Kong is rescinded or otherwise becomes unavailable to us, we would not be able
to market and sell FloSeal in the those countries 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 United
States Food and Drug Administration, 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 United
States Food and Drug Administration, 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 United

                                       17

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

States Food and Drug Administration may also limit the commercial claims and
uses of any of our future products.

     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, results of operations and financial
condition would be harmed.

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,
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,
or 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. We cannot be certain 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, because United States patent applications are not a matter of
public record, a patent application could currently be on file that would
prevent us from obtaining an issued patent. Litigation or 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

                                       18

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

proceedings could result in substantial costs to us and a diversion of
management focus, and could harm our business. 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 damage our business.

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. On September 5, 2001 Cohesion Technologies added patent #6,277,394
B1 to the existing patent infringement action. Cohesion Technologies is seeking
unspecified damages and permanent injunctive relief.

     We believe the Cohesion Technologies' claims are 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 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
discovered 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 IMPAIR 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 would be used.
We are selling FloSeal based on a prospective payment system. In a prospective
payment system, the cost of FloSeal is 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 continue to 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 reduce our revenues. Because

                                       19

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

FloSeal is priced at a premium to corresponding widely used hemostats, our
business may also be harmed 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 impair our ability to
market and sell FloSeal and generate revenue.

THE USE OF PRODUCTS 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 tissues of animal
origin. This uncertainty is due to concerns about bovine spongiform
encephalopathy (BSE), otherwise known as "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,
produced from the blood of cows, and gelatin, derived from the hides of cows. A
reversal of European acceptance of FloSeal could harm 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 devices containing materials of animal origin must be re-evaluated with
respect to BSE transmission. Our re-evaluation report was completed and
submitted to our Notified Body for their review in April 2001. We have been
informed that the Notified Body review is complete and that our CE mark for
FloSeal will remain valid; however we are awaiting the final written report.
Even if the results of their report continue to support the validity of our CE
mark for FloSeal, the individual EU member states can legally place their own
requirements or restrictions on products containing materials of animal origin.
We cannot assure you that FloSeal would meet all the requirements or
restrictions placed on the device by the individual member states. We could be
required to stop selling FloSeal in those European countries whose requirements
or restrictions we do not meet.

         During the past year, 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 harm our
business.

THE CLASSIFICATION OF FLOSEAL AS A MEDICAL DEVICE MAY BE CHANGED TO THAT OF A
MEDICINAL PRODUCT IN EUROPE, JEOPARDIZING THE ABILITY TO MARKET AND SELL FLOSEAL
IN EUROPE.

         Our regulatory clearance and approval for the sale of FloSeal in the
United States and the European Union could be rescinded. For example, the
European Commission is reviewing the classification of all hemostatic products
containing thrombin to determine if they should be classified as medicinal
products (drugs) in Europe. Although no decision has been made at this time to
re-classify FloSeal as a medicinal product, we may be required to stop selling
FloSeal in Europe if this occurs. Alternatively, Fusion may need to demonstrate
compliance with the medicinal products directive in Europe in order to keep
FloSeal on the market. Under this scenario, we may be required to incur
additional expenditures related to approval of the product. We cannot be certain
that we will be able to achieve compliance with the requirements of a new
regulatory classification, if at all.

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<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

WE MAY FACE PRODUCT LIABILITY CLAIMS RELATED TO THE USE OR MISUSE OF OUR
PRODUCTS, BUT OUR INSURANCE COVERAGE IS LIMITED AND MAY BE INADEQUATE TO COVER
POTENTIAL CLAIMS.

         We face the risk of product liability claims. We cannot assure you 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 harm our business 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 BUILD
OUR BUSINESS.

         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. In addition,
recruiting and retaining qualified technical and managerial personnel is
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 impair our
ability to achieve profitability.

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<PAGE>

 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio, bank borrowings and equipment financing.
Reference is made to Part II, Item 7A, Quantitative and Qualitative Disclosures
About Market Risk, in our Annual Report on Form 10-K for the year ended December
31, 2000. The average interest rate for our available-for-sale securities, for
the quarter ended September 30, 2001 was 4.97 % compared to 6.63% reported in
the Form 10-K for the year ended December 31, 2000. The average interest rate
for our cash and cash equivalents for the quarter ended September 30, 2001 was
2.57% compared to 2.09% reported in the Form 10-K for the year ended December
31, 2000. No other material changes have occurred since the filing of our Annual
Report on Form 10-K for the year ended December 31, 2000.

         Fusion Medical Technologies Inc. and FloSeal are registered trademarks
of Fusion Medical Technologies, Inc. Proceed Matrix and FAST are trademarks of
Fusion Medical Technologies, Inc.

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<PAGE>

                            PART II-OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

         On September 13, 2001, we received notice from Sulzer Spine-Tech Inc.
that they had filed a Demand for Arbitration with the American Arbitration
Association in California for unspecified damages resulting from our alleged
breach of contract and invalid termination of the International Distributor
Agreement originally executed between us and Sulzer Spine-Tech on July 1, 1999.
Pursuant to the International Distributor Agreement, the decision of the
arbitrator shall be final and non-appealable and shall be delivered within nine
months following the filing of the initial Demand for Arbitration. We dispute
all claims made by Sulzer Spine-Tech. 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. On September 5, 2001Cohesion Technologies added
patent #6,277,394 B1 to the existing patent infringement action. Cohesion
Technologies is seeking unspecified damages and permanent injunctive relief. We
believe the Cohesion Technologies' claim is without merit.

ITEM 2. EXHIBITS AND REPORTS ON FORM 8-K

         (a) Exhibits. None.

         (b) Reports on Form 8-K. The Company filed a Report on Form 8-K dated
October 2, 2001, regarding a notice from Sulzer Spine-Tech Inc. that they filed
a demand for Arbitration for unspecified damages resulting from the alleged
breach of contract and invalid termination of the International Distributor
Agreement.

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<PAGE>

                                   SIGNATURES

         Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto.

                        FUSION MEDICAL TECHNOLOGIES, INC.

Date:  November 8, 2001      By:    /s/  LARRY J. STRAUSS
                             ---------------------------------------------------
                                      Larry J. Strauss

                             Vice President, Finance and Chief Financial Officer
                             (Chief Accounting Officer and Duly Authorized
                             Officer of the Registrant)

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