<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 June 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
14,155,563 as of August 8, 2001.
<PAGE>

                        FUSION MEDICAL TECHNOLOGIES, INC.
                                    INDEX TO
                               REPORT ON FORM 10-Q
                         FOR QUARTER ENDED June 30, 2001
<TABLE>
<CAPTION>


                                                                                   Page
                                                                                   ----
<S>                                                                                <C>
PART I.    FINANCIAL INFORMATION

Item 1.      Financial Statements:

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

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

                 Statements of Condensed Consolidated Cash Flows - Six Months
                 Ended June 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 4.      Submission of Matters to a Vote of Security Holders ...............   23

Item 6.      Exhibits and Reports on Form 8-K...................................   24

             Signatures.........................................................   25
</TABLE>

                                       2
<PAGE>

PART I - FINANCIAL INFORMATION

I.         FINANCIAL STATEMENTS


                      FUSION MEDICAL TECHNOLOGIES, INC.
                    CONDENSED CONSOLIDATED BALANCE SHEETS
                               (In thousands)
<TABLE>
<CAPTION>
                                                                          June 30               December 31
                                                                            2001                    2000
                                                                     --------------------    -------------------
                                                                         (Unaudited)
                                   ASSETS
<S>                                                                   <C>                    <C>
Current assets:
       Cash and cash equivalents                                       $           3,626       $          3,668
       Available-for-sale securities                                               5,115                  4,489
       Accounts receivable, net                                                    1,444                    978
       Inventory                                                                   1,791                  1,018
       Prepaids and other current assets                                             195                    197
                                                                     --------------------    -------------------
            Total current assets                                                  12,171                 10,350

 Property and equipment, net                                                       5,569                  5,483
 Restricted cash deposit                                                           1,398                  1,661
 Other long-term assets                                                              223                    215
                                                                     --------------------    -------------------

            Total assets                                               $          19,361       $         17,709
                                                                     ====================    ===================

                     LIABILITIES AND STOCKHOLDERS' EQUITY

 Current liabilities                                                   $           3,151       $          2,089
 Long-term obligations                                                               766                    799
                                                                     --------------------    -------------------
              Total liabilities                                                    3,917                  2,888
                                                                     --------------------    -------------------
 Contingencies (Note 4)

 Common stock and other stockholders' equity                                      74,228                 66,092
 Accumulated deficit                                                             (58,784)               (51,271)
                                                                     --------------------    -------------------
              Total stockholders' equity                                          15,444                 14,821
                                                                     --------------------    -------------------

              Total liabilities and stockholders' equity               $          19,361       $         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                           Six Months Ended
                                                              June 30                                       June 30
                                                 --------------------------------------      --------------------------------------
                                                       2001                 2000                   2001                 2000
                                                 -----------------    -----------------      -----------------    -----------------
<S>                                              <C>                  <C>                    <C>                  <C>
Net sales                                          $        2,802       $        1,119         $        5,198       $        1,834
Cost of sales and start-up manufacturing costs              2,345                1,274                  4,313                2,363
                                                 -----------------    -----------------      -----------------    -----------------
                Gross profit (loss)                           457                 (155)                   885                 (529)
                                                 -----------------    -----------------      -----------------    -----------------
Operating expenses:
      Research and development                              1,410                1,509                  3,098                2,530
      Marketing and selling                                 1,887                1,239                  3,634                2,202
      General and administrative                              895                  507                  1,790                1,449
                                                 -----------------    -----------------      -----------------    -----------------
           Total operating expenses                         4,192                3,255                  8,522                6,181
                                                 -----------------    -----------------      -----------------    -----------------
                Loss from operations                       (3,735)              (3,410)                (7,637)              (6,710)

      Interest income                                         115                  171                    189                  341
      Interest expense                                        (31)                  (5)                   (65)                 (11)
                                                 -----------------    -----------------      -----------------    -----------------
                Net loss                                   (3,651)              (3,244)                (7,513)              (6,380)

      Other comprehensive income (loss):
      Change in unrealized gain or loss on
        available-for-sale securities                           4                   (1)                    14                   13
                                                 -----------------    -----------------      -----------------    -----------------
      Comprehensive loss                           $       (3,647)      $       (3,245)        $       (7,499)      $       (6,367)
                                                 =================    =================      =================    =================

Basic and diluted net loss per share               $        (0.26)      $        (0.31)        $        (0.60)      $        (0.63)
                                                 =================    =================      =================    =================
Shares used in computing basic and diluted net
      loss per share                                       13,788               10,363                 12,542               10,195
                                                 =================    =================      =================    =================
</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>
                                                                                             Six Months Ended
                                                                                                 June 30
                                                                                    -----------------------------------
                                                                                         2001                2000
                                                                                    ---------------     ---------------
<S>                                                                                 <C>                 <C>
Cash flows used for operating activities:
        Net loss                                                                      $     (7,513)       $     (6,380)
        Adjustments to reconcile net loss to net cash used in
               operating activities:
               Depreciation and amortization                                                   788                 274
               Accretion of available-for-sale securities                                        5                   -
               Amortization of deferred compensation                                            53                 183
               Deferred rent                                                                    61                   -
               Changes in assets and liabilities:
                     Accounts receivable,net                                                  (466)               (198)
                     Inventories                                                              (773)               (568)
                     Prepaids and other current assets                                           2                 (26)
                     Other assets                                                               (8)                 (4)
                     Accounts payable                                                          803                 152
                     Accrued expenses                                                          317                 260
                                                                                    ---------------     ---------------
                          Net cash used in operating activities                             (6,731)             (6,307)
                                                                                    ---------------     ---------------
Cash flows from investing activities:
        Acquisition of property and equipment                                                 (874)             (1,626)
        Purchases of available-for-sale securities                                          (6,381)             (7,396)
        Restricted cash                                                                        263                   -
        Sales and maturities of available-for-sale securities                                5,764               4,386
                                                                                    ---------------     ---------------
                          Net cash used in investing activities                             (1,228)             (4,636)
                                                                                    ---------------     ---------------
Cash flows from financing activities:
        Proceeds from issuance of common stock and warrants,
        net of issuance costs                                                                8,022              13,270
        Proceeds from exercise of common stock options                                          47                   2
        Proceeds from (repayment of) equipment financing                                       (93)                269
        Repayment of notes payable                                                             (59)                (58)
                                                                                    ---------------     ---------------
                          Net cash provided by financing activities                          7,917              13,483
                                                                                    ---------------     ---------------

Net increase (decrease) in cash and cash equivalents                                           (42)              2,540
Cash and cash equivalents, beginning of period                                               3,668               8,164
                                                                                    ---------------     ---------------
Cash and cash equivalents, end of period                                              $      3,626        $     10,704
                                                                                    ===============     ===============
Supplemental disclosure of cash flow information:
        Cash paid for interest                                                        $         66        $          5
                                                                                    ===============     ===============
</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
                                  June 30, 2001
                                   (Unaudited)

1. Basis of presentation

         The accompanying condensed consolidated financial statements of Fusion
Medical Technologies, Inc. (the "Company","Fusion" 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 June 30, 2001,
and the condensed consolidated statements of operations for the three and six
month periods ended June 30, 2001 and 2000, and the condensed consolidated
statements of cash flows for the six month periods ended June 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 3,096,198 and 2,397,846 shares of common stock at prices ranging from
$0.16 to $17.63 per share were outstanding at June 30, 2001 and 2000,
respectively. Warrants to purchase 687,094 and 12,785 shares of common stock at
prices ranging from $3.66 to $4.00 per share were outstanding at June 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):



                                        June 30            December 31
                                          2001                2000
                                     --------------       -------------
Finished goods                       $        534         $        340
Work in process                               466                  343
Raw materials                                 791                  335
                                     -------------        -------------
                                     $      1,791         $      1,018
                                     =============        =============

                                       6
<PAGE>

                        FUSION MEDICAL TECHNOLOGIES, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  June 30, 2001
                                   (Unaudited)
4. 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.

5. Recent Accounting Pronouncements

         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 Report on Form 10-Q contains, in addition to historical
information, forward-looking statements that involve risks and uncertainties,
which are designated by an asterisk [*] after the statement. Our actual results
could differ materially from those anticipated by these forward-looking
statements as a result of certain factors, including those set forth in
"Additional Factors That Might Affect Future Results" commencing on page 12 and
those set forth under Item 1 in our Annual Report filed on Form 10-K405 for the
Year Ended December 31, 2000 filed with the United States Securities & Exchange
Commission on April 13, 2001.

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 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 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. In February 2001, following the United States Food and Drug
Administration's approval of a Pre-market Approval (PMA) application supplement,
we began selling Proceed for use in neurosurgical/cranial surgical procedures
through Sulzer Spine-Tech.

         We have reported $5,198,000 and $1,834,000 in revenue for the first
half of 2001 and 2000, respectively, primarily from sales into the cardiac,
vascular, ear, nose and throat, head and neck, and spinal surgical specialties.
As of June 30, 2001, we had an accumulated deficit of $58.8 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 approximately $5.8 million for the purchase of equipment for production
and research & development, office furnishings and equipment and leasehold
improvements.

                                       8
<PAGE>

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

         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 began feasibility clinical trials for the
FloSeal FAST device in December 2000. Another early stage product is the FloSeal
sponge, a dry, sponge-like formulation of FloSeal requiring no mixing, for 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 Six Months Ended June 30, 2001 and 2000
-------------------------------------------------

NET SALES

         We recorded sales of $2,802,000 and $1,119,000 for the three months
ended June 30, 2001 and 2000 respectively. We recorded sales of $5,198,000 and
$1,834,000 for the six months ended June 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 49% of total sales in the second quarter of 2001and 50% of sales
for the six months ended June 30, 2001 were transacted with our distribution
partner, Sulzer Spine-Tech.

COST OF SALES AND START-UP MANUFACTURING COSTS

         We recorded cost of sales and start-up manufacturing costs of
$2,345,000 and $1,274,000 for the three months ended June 30, 2001 and 2000,
respectively. We recorded cost of sales and start up manufacturing costs of
$4,313,000 and $2,363,000 for the six months ended June 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 June 30, 2001 of
$457,000, 16% of net sales, compared to a gross loss of $155,000 in the same
period in 2000. For the six months ended June 30, 2001 we recorded a gross
profit of $885,000, 17% of net sales, compared to a gross loss of $529,000 in
the same period in 2000. The improvement in gross profit for both the three and
six 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.*

RESEARCH AND DEVELOPMENT

         Research and development expenses decreased 7% to $1,410,000 in the
three months ended June 30, 2001, compared to $1,509,000 in the three months
ended June 30, 2000. For the six months ended June 30, 2001, research and
development expenses increased 22% to $3,098,000 compared to $2,530,000 for the
six months ended June 30, 2000. The decrease for the three months ended June 30,
2001 was due to a reduction in costs related to the introduction of the second
generation FloSeal formulation. The increase for the six months ended June 30,
2001 was due to the facility 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.*

                                       9
<PAGE>

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

MARKETING AND SELLING

         Marketing and selling expenses increased 52% to $1,887,000 in the three
months ended June 30, 2001, compared to $1,239,000 for the three months ended
June 30, 2000. For the six months ended June 30, 2001, marketing and selling
expenses increased 65% to $3,634,000, compared to $2,202,000 for the six months
ended June 30, 2000. The increases were primarily due to personnel costs of our
direct sales force, currently 28 people, and to marketing spending to boost the
sales 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. 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 77% to $895,000 in the
three months ended June 30, 2001, compared to $507,000 for the three months
ended June 30, 2000. For the six months ended June 30, 2001, general and
administrative expenses increased 24% to $1,790,000, compared to $1,449,000 for
the six months ended June 30, 2000. The increases were primarily attributable to
the facility overhead costs related to our new Fremont facility.

         In December 2000, Cohesion Technologies, alleging infringement of a
Cohesion patent, filed a patent infringement action against us. 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

         Interest income decreased 33% to $115,000 for the three months ended
June 30, 2001 compared to $171,000 for the three months ended June 30, 2000. For
the six months ended June 30, 2001, interest income decreased 45% to $189,000,
compared to $341,000 for the six months ended June 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 $31,000 for the three months ended June
30, 2001 compared to $5,000 for the three months ended June 30, 2000. For the
six months ended June 30, 2001 interest expense increased to $65,000, compared
to $11,000 for the six months ended June 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 $3,651,000
for the three months ended June 30, 2001 as compared to the net loss of
$3,244,000 for the three months ended June 30, 2000. For the six months ended
June 30, 2001 the net loss was $7,513,000 as compared to the net loss of
$6,380,000 for the six months ended June 30, 2000.

                                      10
<PAGE>

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

LIQUIDITY AND CAPITAL RESOURCES

         At June 30, 2001, our cash, cash equivalents and available-for-sale
securities were $8,741,000 compared to $8,157,000 at December 31, 2000.

         For the six months ended June 30, 2001 and 2000, our operating
activities consumed cash of $6,731,000 and $6,307,000, respectively. The
increase in cash consumed by operations was due primarily to the increase in the
net loss.

         For the six months ended June 30, 2001 and 2000, our investing
activities used cash of $1,228,000 and $4,636,000, respectively. The reduction
in cash used was due to a drop of approximately $1,000,000 in the purchases of
available-for-sale securities and an increase of approximately $1,400,000 in the
sales and maturities of available-for-sale securities.

         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 for 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 expires on April 2, 2006.

         In April 2000, we accepted a commitment from Transamerica Business
Credit Corporation 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 June 30, 2001, we
had a balance of $850,000 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 $5.8 million and have committed an additional $.6 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, and future product sales should provide adequate liquidity
for the next 12 months.*

                                      11
<PAGE>

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

RECENT ACCOUNTING PRONOUNCEMENTS

         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 $5.2 million
for the first half of 2001. We incurred net losses of $7.7 million in 1998,
$8.3 million in 1999, $13.7 million in 2000 and $7.5 million in the first half
of 2001. As of June 30, 2001, we had an accumulated deficit of $58.8 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 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.

                                      12
<PAGE>

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

         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 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 our 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 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
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.

                                      13
<PAGE>

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

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 and 50% for the six months
ended June 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 extends through June 30,
2002 and contains provisions for both minimum annual sales and termination in
the event of change in control. 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 harm on our business, financial condition and results of
operations.

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 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.

         In addition to the Proceed distribution arrangement with Sulzer
Spine-Tech, we have also 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 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. 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.

                                      14
<PAGE>

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

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. 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, 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 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.

                                      15
<PAGE>

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

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 the United States Food and Drug
Administration 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 damage our reputation with our customers and our
distributors. In addition, the real estate market in the San Francisco Bay Area
is extremely competitive and is likely to remain competitive, 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.

                                      16
<PAGE>

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

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 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 traceability.

        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.

                                      17
<PAGE>

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

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
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.

                                      18
<PAGE>

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

         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 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. Cohesion Technologies is seeking unspecified damages and permanent
injunctive relief.

         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 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,

                                      19
<PAGE>

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

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 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 reduce our revenues. Because 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.

                                      20
<PAGE>

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


          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 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.

         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
can not be certain that we will be able to achieve compliance with the
requirements of a new regulatory classification, if at all.

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.

                                      21
<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 June 30, 2001 was 4.31 % 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 June 30, 2001 was 4.03% 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.

                                      22
<PAGE>

                            PART II-OTHER INFORMATION

ITEM 1. 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.

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

         Our Annual Meeting of Stockholders (the "Annual Meeting") was held on
June 14, 2001 at 9:30 a.m. local time, at our principal corporate offices
located at 34175 Ardenwood Blvd., Fremont, CA. The Annual Meeting was held for
the purpose of (a) electing one Class II director to serve for two years
expiring upon the 2003 Annual Meeting of the Stockholders and electing three
Class III directors to serve for three years expiring upon the 2004 Annual
Meeting of the Stockholders, (b) approving an amendment to Fusion's 1993 Stock
Option Plan increasing the number of shares of common stock by 710,000 shares
and (c) ratifying the appointment of PricewaterhouseCoopers LLP as our
independent accountants for the fiscal year ending December 31, 2001. The three
matters were voted upon and approved:

         1) Ronald A. Elenbaas was duly elected as a Class II director to serve
         for two years expiring upon the 2003 Annual Meeting of the
         Stockholders, or until a successor is duly elected and qualified, with
         11,850,710 votes cast for election and 247,940 votes withheld. Gordon
         W. Russell, Philip M. Sawyer and Michael L. Eagle were duly elected as
         Class III directors to serve for three years expiring upon the 2004
         Annual Meeting of the Stockholders, or until a successor is duly
         elected and qualified. Gordon W. Russell received 11,858,020 votes for
         election and 240,630 votes were withheld. Philip M. Sawyer received
         11,666,660 votes for election and 431,990 votes were withheld. Michael
         L. Eagle received 11,861,970 votes for election and 236,680 votes were
         withheld.

         2) The Amendment to the 1993 Stock Option Plan increasing the number of
         shares of Common Stock authorized for issuance by 710,000 shares to
         4,300,492 shares was approved with 6,646,103 votes cast for the
         increase, 2,330,316 votes against, 23,145 votes abstaining, and
         3,099,086 votes subject to a broker non-vote.

         3) PricewaterhouseCoopers LLP was appointed the independent accountants
         for the fiscal year ended December 31, 2001 with 12,070,900 votes cast
         for the appointment, 18,415 votes against, and 9,335 votes abstaining.

Three directors were not up for election at the June 2001 meeting. Their names
and term expiration are as follows:

     Olav B. Bergheim - term expires at the 2002 Annual Meeting of the
     Stockholders;

     J. Michael Egan - term expires at the 2002 Annual Meeting of the
     Stockholders;

     Douglas E. Kelly, M.D. - term expires at the 2003 Annual Meeting of the
     Stockholders.

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<PAGE>

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K


         (a) Exhibits. None.


         (b) Reports on Form 8-K. The Company did not file any Reports on Form
8-K during the quarter ended June 30, 2001.

                                      24
<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:  August 9, 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)

                                      25