UNITED STATES SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                    FORM 10-K

(Mark One)

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

         For the year ended December 31, 1999

[ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

                         Commission File Number 0-016607
                         _______________________________

                         ADVANCED TISSUE SCIENCES, INC.
             (Exact name of registrant as specified in its charter)

           Delaware                                          14-1701513
      --------------------                                   ----------
   (State or other jurisdiction                           (I.R.S. Employer
 of incorporation or organization)                       Identification No.)

 10933 North Torrey Pines Road, La Jolla, California            92037
 ---------------------------------------------------          ----------
     (Address of principal executive offices)                 (Zip Code)

       Registrant's telephone number, including area code: (858) 713-7300

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

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

                          Common Stock, $.01 par value
                         Preferred Share Purchase Rights
                         -------------------------------
                                (Title of Class)

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

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.   Yes  X     No
                                                ---       ---

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

     The aggregate market value of the Common Stock of the Registrant held by
non-affiliates on March 22, 2000 was approximately $508,164,851.

     As of March 22, 2000 there were 59,840,958 shares of Common Stock
outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on May 23, 2000, to be filed with the Commission
pursuant to Regulation 14A, are incorporated by reference into Part III of this
report.

     Certain exhibits filed with the Company's prior registration statements and
Forms 10-K, 8-K and 10-Q are incorporated herein by reference into Part IV of
this Report.


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                                     PART I

     THIS ANNUAL REPORT ON FORM 10-K MAY CONTAIN FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. SUCH STATEMENTS INCLUDE, BUT ARE NOT LIMITED
TO, STATEMENTS CONTAINING THE WORDS "BELIEVES," "ANTICIPATES," "EXPECTS,"
"ESTIMATES" AND WORDS OF SIMILAR IMPORT. THE COMPANY'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM ANY FORWARD-LOOKING STATEMENTS, WHICH REFLECT
MANAGEMENT'S OPINIONS ONLY AS OF THE DATE OF THIS REPORT, AS A RESULT OF SUCH
RISKS AND UNCERTAINTIES. THE COMPANY UNDERTAKES NO OBLIGATION TO REVISE OR
PUBLICLY RELEASE THE RESULTS OF ANY REVISIONS TO THESE FORWARD-LOOKING
STATEMENTS. READERS SHOULD CAREFULLY REVIEW THE RISK FACTORS SET FORTH BELOW IN
"FACTORS THAT MAY AFFECT FUTURE RESULTS" AND IN OTHER DOCUMENTS THE COMPANY
FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING
ITS QUARTERLY REPORTS ON FORM 10-Q.

ITEM 1.  BUSINESS

INTRODUCTION

     Advanced Tissue Sciences, Inc. (the "Company" or "Advanced Tissue
Sciences") is a leading tissue engineering company engaged in the development of
human-based tissue products for therapeutic applications. The Company is
currently focusing its efforts on wound care, orthopedics, aesthetic,
reconstructive and cardiovascular applications. Utilizing principles of cell
biology, bioengineering, biochemistry, and polymer and transplant science, the
Company has developed and is applying a proprietary core technology in which
living human cells are cultured in vivo or ex vivo in a manner that allows the
cells to develop and assemble into a functioning three-dimensional tissue. With
this proprietary technology, Advanced Tissue Sciences has successfully
replicated a variety of human tissues.

     Advanced Tissue Sciences' objective is to redefine tissue repair and
transplantation by developing, manufacturing and marketing products produced
through tissue engineering. The Company's product strategy is to utilize its
patented core technology to develop multiple products which address unmet
therapeutic needs or offer improved, cost-effective alternatives to current
treatments. By building upon its base of scientific knowledge through the
continued application of its proprietary core technology, the Company believes
it has significant synergies in the development, clinical testing and
manufacture of successive tissue products. The Company also seeks to increase
its return and the potential use of its products by identifying and pursuing
multiple indications for its products.

     Leading the Company's product development efforts are therapeutic skin
products that address the wound care (primarily burn and skin ulcer) markets.
These products are based on three-dimensional, human tissues designed by the
Company as temporary or permanent replacements for human dermis. These products
were developed for conditions where the dermis (the inner skin layer) has been
injured or destroyed, such as in severe burns and chronic skin ulcers. The
dermis is essential to normal skin function and healing and, unlike epidermis
(the outer skin layer), may not regenerate into normal tissue after injury. The
Company's two skin products, Dermagraft(R) and TransCyte(TM), are currently
being sold in certain markets and the Company has other products in various
stages of development.

     The Company's first commercial product, TransCyte, a temporary covering for
burns, was first approved for commercial sale by the U.S. Food and Drug
Administration ("FDA") in March 1997 for full-thickness, or third degree burns,
and for partial-thickness, or second degree burns, in October 1997. Dermagraft
for the treatment of diabetic foot ulcers, a living, human dermal replacement,
is currently being marketed in the United Kingdom and several other European
countries, Canada, Australia and New Zealand. Both TransCyte and Dermagraft are
being commercialized through a joint venture with Smith & Nephew plc ("Smith &
Nephew"). The Company is also pursuing FDA approval for Dermagraft for the
treatment of diabetic foot ulcers in the United States.

     In January 1998, the General and Plastic Surgery Devices Panel of the
Medical Devices Advisory Committee to the FDA recommended that the agency
approve Dermagraft for the treatment of diabetic foot ulcers with the conditions
that the Company perform a post-marketing study to confirm efficacy and provide
physician training. However, in June 1998, the FDA indicated the Premarket
Approval ("PMA") application for Dermagraft was not approvable without
supportive data from an additional clinical trial. In August 1998, the Company
received approval from the FDA for an additional clinical trial of Dermagraft in
the treatment of diabetic foot ulcers. The clinical trial began in late 1998 and
the results of a planned interim analysis of data from this trial were announced
in December 1999. These data showed that, although statistical significance was
not achieved at the interim analysis, Dermagraft was


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healing more ulcers than the control treatment in those diabetic foot ulcers
having a duration of greater than six weeks.

     In February 2000, the FDA approved an amendment to the Investigational
Device Exemption (IDE) for the additional controlled clinical trial of
Dermagraft in the treatment of diabetic foot ulcers. Based on the interim
analysis, the IDE was amended to revise the enrollment criteria and the
statistical plan for data analysis. The amended IDE allows for the modification
of the study inclusion criteria to limit future enrollment to patients with
ulcers of greater than six weeks duration. In addition, the amended statistical
plan allows the Company to integrate the interim data with additional data
generated since the interim data were analyzed from patients with ulcer duration
of greater than six weeks. If these additional data confirm the treatment
benefit that was seen in the interim analysis for patients with ulcer duration
of greater than six weeks, the Company believes it could submit an amendment to
the PMA application to the FDA as early as mid-year. See "Products - Wound Care
Products - Skin Ulcers - Diabetic Foot Ulcers."

     TRANSCYTE. TransCyte, originally developed as an alternative to human
cadaver skin to treat severely burned patients, is being used to treat both full
and partial-thickness burns. TransCyte consists of a dermal tissue with an
ultra-thin synthetic covering that acts as a protective cover. In full-thickness
burns, TransCyte is designed to help retain fluids and reduce the risk of
infection until a sufficient amount of the patient's own skin becomes available
for grafting. In partial-thickness burns, TransCyte, as compared to silver
sulfadiazine, has been shown to heal burns significantly faster.

     Of the approximately 1.25 million people who suffer burn injuries annually
in the United States, up to 13,000 are severely burned and require skin grafts.
TransCyte was initially approved to address the approximately 1,500 severely
burned patients with burns exceeding 20% body surface area. Another 30,000 to
40,000 burn victims, often children, suffer the partial to mid-dermal burns also
being addressed by TransCyte. These burns frequently result from household
hazards such as scalds from hot liquids, faulty heating pads or misuse of
ignition fluids. TransCyte is being marketed for burns in the United States, the
United Kingdom and several other European countries, Canada, Australia and New
Zealand, and will be marketed in the rest of the world subject to regulatory
approvals, through a joint venture with Smith & Nephew. See "Products - Wound
Care Products - Burns."

     The Company believes that TransCyte may also have a role in treating
pressure ulcers. There are over 19,000 nursing homes treating over
500,000 patients suffering from pressure ulcers in the United States annually.
In addition, it has been estimated that over 3% of all hospitalized patients in
the United States suffer from pressure ulcers. The Company is currently
conducting a pilot clinical trial in the United States of TransCyte in the
treatment of pressure ulcers.

     DERMAGRAFT. Dermagraft is a human dermal replacement product grown on a
bioabsorbable scaffold. It is designed to provide a healthy, metabolically
active dermal matrix in chronic ulcers to support wound closure. Healing skin
ulcers faster can potentially reduce the risk of infection (and, in the case of
diabetic foot ulcers, the subsequent risk of amputation), as well as the need
for skin grafting and reconstructive procedures. Chronic skin ulcers that may be
addressed by Dermagraft include diabetic foot ulcers, venous ulcers and pressure
ulcers. There are an estimated 300,000 to 400,000 patients with diabetic foot
ulcers that represent the target market for Dermagraft treated in the United
States each year. In addition, it is estimated that more than 1.5 million
patients are affected by pressure ulcers and approximately 700,000 patients are
diagnosed with venous ulcers in the United States each year.

     Dermagraft is also being developed and commercialized through the joint
venture with Smith & Nephew. Under the joint venture agreement, Advanced Tissue
Sciences has primary responsibility for manufacturing and Smith & Nephew has
primary responsibility for the worldwide sales and marketing of Dermagraft and
TransCyte. Building upon the introduction of Dermagraft for the treatment of
diabetic foot ulcers in the United Kingdom and several other European countries,
Canada, Australia and New Zealand, the joint venture plans, assuming successful
completion of clinical trials and subject to obtaining regulatory approval, to
introduce Dermagraft in the United States through Smith & Nephew's existing
sales representatives and dedicated Dermagraft specialists. Smith & Nephew is
known in the United States for its comprehensive training and customer education
programs, and has successfully launched several advanced wound care products.
The Company has completed a pilot clinical trial in the United Kingdom and
Canada of Dermagraft in the treatment of venous ulcers and plans to present the
data from this trial in an upcoming scientific forum. In addition, the Company
is currently conducting a pilot clinical trial in the United States of
Dermagraft in the treatment of pressure ulcers. See "Products - Wound Care
Products - Skin Ulcers."


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     ORTHOPEDICS. Through a separate joint venture with Smith & Nephew, the
Company is developing tissue engineered cartilage for orthopedic applications
utilizing its proprietary three-dimensional culture system. Over the past
several years, the joint venture's activities have included the development of
human tissue-engineered articular cartilage product. Tissue-engineered articular
cartilage could provide a significant opportunity to treat patients at an
earlier stage of joint degeneration, thereby delaying, or in some cases
eliminating, the need for total joint replacements. Optimization of the product
and preclinical studies continued in 1999, and are continuing in 2000, as the
basis for advancing this product into clinical trials. With successful
preclinical studies, pilot clinical trials could begin in 2000, subject to FDA
approval. It is estimated that there are over 2 million arthroscopic knee
procedures performed annually in the United States. See "Products - Orthopedic
Products."

     FACIAL AND RECONSTRUCTIVE SURGERY. Through a strategic alliance with Inamed
Corporation, the Company is developing certain aesthetic and reconstructive
applications of its technology including products for use in cosmetic surgery
such as a temporary covering after chemical peels or laser resurfacing, human
collagen for wrinkle and cosmetic correction and as a bulking agent for the
treatment of urinary incontinence, cartilage for plastic and reconstructive
applications, and extracellular matrix for breast reconstruction. There are over
250,000 collagen injections given annually and over 1.1 million chemical peel or
laser resurfacing procedures performed annually in the United States. In
addition, the number of patients receiving injections to treat urinary
incontinence is expected to rise to over 80,000 in 2000. See "Products
- Facial and Reconstructive Surgery Products."

     CARDIOVASCULAR. Through the use of its tissue engineering technology,
Advanced Tissue Sciences is working on developing blood vessels that will grow
and repair normally. The Company's tissue-engineered products may provide
enhanced biocompatibility and improved patency with a reduced need for the
anticoagulant drugs required with currently available products. In October 1997,
Advanced Tissue Sciences was awarded a $2 million Advanced Technology Program
grant from the National Institute of Standards and Technology. In collaboration
with the Department of Bioengineering at the University of California, San Diego
("UCSD"), the Company is leading a multi-disciplinary effort to design,
construct and evaluate tissue-engineered vascular grafts produced from cells
grown on a biocompatible scaffold. The grant is structured to support this
development program over a three-year period. The project is integrating current
advances in cell culture, bioreactor technology, biomaterials and in vivo blood
vessel mechanics to create a unique, living tissue replacement for blood
vessels. The successful integration of these technologies through the
collaboration between the Company and UCSD could lead to the development of
grafts to treat coronary and peripheral artery vascular diseases. Other
potential cardiac applications include a product to promote angiogenesis that
can be used as an adjunctive therapy to cardiac assist devices as well as used
in treating myocardial infarction and angina. See "Products - Cardiovascular
Products."

     In the United States, over 900,000 people die each year from cardiovascular
disease. Approximately 12.2 million people suffer from coronary artery
disease and over 600,000 coronary artery bypass procedures are performed
annually in the United States. Likewise, each year in the United States
approximately 350,000 patients are diagnosed with peripheral vascular disease
with over 115,000 bypass procedures for the thigh vein alone being performed
annually.

     SMITH & NEPHEW PLC. In April 1996, the Company entered into an agreement
with Smith & Nephew to form a fifty-fifty joint venture for the worldwide
commercialization of Dermagraft in the treatment of diabetic foot ulcers (the
"Dermagraft Joint Venture"). In January 1998, Advanced Tissue Sciences and Smith
& Nephew expanded the Dermagraft Joint Venture to include venous ulcers,
pressure ulcers, burns and other skin tissue wounds. At that time, the Company
retained rights to market TransCyte for burns in the United States. In August
1998, the Dermagraft Joint Venture was further expanded to include the selling
and marketing of TransCyte for full and partial-thickness burns in the United
States beginning in October 1998. Smith & Nephew is a global medical device
company with established sales in 90 countries. It markets technically
innovative products principally in the areas of orthopedics, endoscopy, and
wound management to deliver cost effective solutions, significant physician
advantages and real patient benefits.

     As consideration for entering into the Dermagraft Joint Venture, Advanced
Tissue Sciences received a $10 million up front fee in 1996. In conjunction with
the expansion of the joint venture, Smith & Nephew also made a $20 million
equity investment in the Company in January 1998 and a payment to the Company
through the Dermagraft Joint Venture of $15 million in January 1999. The Company
also could receive, subject to the achievement of certain milestones related to
regulatory approvals, reimbursement and sales levels and certain minimum levels
of operating profit, additional payments of up to $136 million plus royalties on
product sales. Advanced Tissue Sciences and Smith & Nephew are continuing to
share in the revenues and expenses of the


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Dermagraft Joint Venture; however, the Company is funding the first $6 million
in expenses for conducting clinical trials and regulatory support for Dermagraft
and TransCyte in the treatment of venous ulcers and pressure ulcers and Smith &
Nephew is funding all milestone payments, if any. The Company also funded
certain manufacturing and distribution costs and certain costs related to
post-market studies of TransCyte through December 1999. See "Collaborations and
Strategic Alliances - Smith & Nephew plc."

     In 1994, Smith & Nephew and Advanced Tissue Sciences entered into a
separate fifty-fifty joint venture for the worldwide development, manufacture
and marketing of human tissue-engineered cartilage for orthopedic applications
(the "NeoCyte Joint Venture"). Under the terms of the NeoCyte Joint Venture
agreement, Advanced Tissue Sciences will be responsible for supervising the
manufacturing of cartilage tissue products. The NeoCyte Joint Venture will
execute the research and development program, develop a worldwide marketing
plan, and will utilize Smith & Nephew's established selling and distribution
network to market the products. Smith & Nephew Endoscopy, a world leader in
arthroscopy, is separately responsible for developing and manufacturing
instrumentation that could be used for the arthroscopic insertion of the joint
venture's cartilage products. As specified in the NeoCyte Joint Venture
agreement, Smith & Nephew contributed the first $10 million in NeoCyte Joint
Venture funding and the Company contributed certain technology licenses. NeoCyte
Joint Venture revenues and expenditures in excess of the first $10 million are
being shared equally by the partners. See "Collaborations and Strategic
Alliances - Smith & Nephew plc."

     INAMED CORPORATION. In May 1999, Advanced Tissue Sciences, Inc. and Inamed
Corporation ("Inamed") entered into a strategic alliance for the development and
marketing of several of Advanced Tissue Sciences' human-based, tissue-engineered
products for aesthetic and certain reconstructive applications. Specifically,
Inamed licensed rights to further develop, manufacture and sell tissue-
engineered products for use in cosmetic surgery, cartilage for plastic and
reconstructive surgery and extracellular matrix for use in breast recon-
struction. In addition, in September 1999, Inamed also received license
rights to use extracellular matrix, including human collagen, from Advanced
Tissue Sciences' three-dimensional culture system for soft tissue augmentation
(wrinkles and cosmetic correction) and as a bulking agent for the treatment of
urinary incontinence. Inamed is a global surgical and medical device company
engaged in the development, manufacturing and marketing of medical products for
aesthetic medicine, plastic and reconstructive surgery and the treatment of
obesity. See "Collaborations and Strategic Alliances - Inamed Corporation."

     Under the agreement between the parties, in exchange for worldwide
licensing rights, Inamed has paid Advanced Tissue Sciences a series of payments
totaling $10 million, including $5 million to purchase Advanced Tissue Sciences'
common stock. Inamed also received five-year warrants to purchase up to 500,000
shares of common stock. In addition to royalties on product sales, Advanced
Tissue Sciences may potentially receive up to a total of $10 million in
milestones based on product approvals in the United States. Advanced Tissue
Sciences is responsible for the funding and development of the products and the
related manufacturing processes while Inamed is responsible for clinical and
regulatory activities. Advanced Tissue Sciences, or an affiliate, may elect to
manufacture the products developed under the agreement.

     Advanced Tissue Sciences, Inc. was incorporated under the laws of the State
of Delaware in 1987. The Company maintains its executive offices at 10933 North
Torrey Pines Road, La Jolla, California 92037, and its telephone number at that
address is (858) 713-7300. Financial information regarding the Company's
financial condition and results of operations can be found in a separate section
of this Annual Report on Form 10-K beginning on page F-1.

PROPRIETARY CORE TECHNOLOGY

     The Company's tissue engineering technology involves the controlled in vivo
and ex vivo growth of living tissues and organs on three-dimensional support
structures. The Company believes that its technology represents a major advance
in medical science. Over the last several decades, technologies have been
developed that have made possible the growth of many of the over 200 different
types of cells found in the human body in laboratory containers filled with
nutrient media. When grown on two-dimensional surfaces, the ability of cells to
interact and organize themselves into functioning tissues is limited. In
contrast, a three-dimensional framework allows cells to develop and assemble
into tissues that more closely resemble their counterparts in the body.

     In normal growth and development, the body uses specialized connective
tissue cells to form "stroma" or a living matrix that provides the
three-dimensional structure for each organ. Stroma also provides attachment
sites and produces growth factors that promote the development of organ cells
into functioning tissues. While the specific components and configuration of
stroma may differ from organ to organ, the basic principle of three-dimensional
stromal support applies to most organs in the body.


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     The Company has developed a proprietary core technology that combines the
principles of cell biology, biochemistry and polymer science to create a
three-dimensional living support stroma ex vivo. The support stroma is made by
first seeding stromal cells (cell biology) onto a mesh framework (polymer
science) in an environment that simulates the body. The cells attach, divide and
secrete extracellular matrix proteins and growth factors (biochemistry), using
the mesh as a scaffolding. This process results in a completely human stromal
tissue that, in turn, may support the growth of organ specific cells into
functional tissue. Advanced Tissue Sciences has been issued numerous United
States and foreign patents covering its core technology and has several patent
applications pending related to this technology. In addition, the Company has an
exclusive license in particular fields of use to patents issued to the
Massachusetts Institute of Technology ("MIT") covering the growth of
vascularized human tissues or organs on three-dimensional biocompatible,
biodegradable and non-biodegradable polymer scaffolds inside the body (in vivo).

     The Company believes that its tissue-engineered products may offer some or
all of the following benefits, depending upon the particular application of the
product:

*  Physiological Human Tissue -- The Company's patented core technology allows
   the cells to grow on a scaffold and develop into a three-dimensional human
   tissue.  The Company's products may then be transplanted as a physiological
   tissue, as contrasted with the transplantation of cells or scaffolds alone.

*  Multiple Factors For Healing -- The human cells produce multiple growth
   factors and tissue matrix proteins, all of which the Company believes are
   important in the tissue repair process.  Living, metabolically active cells
   may also respond to the surrounding environment.

*  Human Tissue -- The tissue matrix proteins naturally secreted by the cells
   consist of human collagens, glycosaminoglycans and other human proteins,
   rather than animal-derived matrix proteins, which may cause allergic or
   immune reactions.

*  Safety Tested -- The human tissue materials used in the manufacture of the
   Company's products are extensively tested at independent laboratories for
   potential pathogens such as Hepatitis B and HIV.  All final product is tested
   for sterility by performing United States Pharmacopeia (U.S.P.) sterility
   tests on each product's growth medium.

*  Off-the-Shelf Products -- Medical research has shown that several tissues,
   including dermal tissue and certain cartilage tissue applications, are not
   subject to rejection by a recipient's body. These tissue-engineered products
   may, therefore, be utilized as universal, permanent replacement products in
   such applications.

*  Prolonged Shelf Life -- The Company's dermal products can be frozen for
   long-term storage.  Similarly, it is expected that cartilage and some of the
   other tissues in development will be able to be cryopreserved for a long
   shelf life.

*  Ease of Use -- The Company's dermal products are easy for surgeons to apply
   using routine surgical techniques.  In addition, the ultimate objective is to
   deliver tissue-engineered cartilage in a single arthroscopic procedure.

PRODUCTS

     The Company has a number of therapeutic tissue products that are in various
stages of commercialization, clinical trials, preclinical studies and research.
Currently, its primary product focus is directed toward wound care (for burns
and skin ulcers), orthopedic, aesthetic, reconstructive and cardiovascular
applications. In addition, based on available resources, clinical results,
regulatory approvals, markets and other cost benefit considerations, the Company
intends to bring other potential products to market in the future.

WOUND CARE PRODUCTS

     BURNS. Although there have been many advances in the care and treatment of
severely burned patients, available alternatives remain fairly limited and
success is highly dependent on the skills of burn surgeons and nurses. As a
result of the need for improvements in patient care and the ability to closely
monitor product performance, the Company selected severe burns, often referred
to as third-degree burns, as the target for its first therapeutic use of the
Company's tissue engineering technology. In addition, dermal tissue has several
advantages over other tissues or organs in that it is grown from fibroblasts,
which are both readily available and not subject to rejection by the body.

     Currently, to treat large full-thickness burns (where both the epidermis
and the dermis are destroyed), burn surgeons typically excise the damaged tissue
and cover the wound as soon as possible. Conventional treatment for


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large full-thickness burns usually involves the use of temporary coverings to
limit infection, reduce pain and prevent the loss of body fluids, followed by
grafting of the patient's own skin ("autograft") as it becomes available. In
most cases, permanent closure of severe burn wounds is achieved with autografts
obtained by surgically harvesting areas of the patient's skin which are still
intact ("donor sites"). The dermis at the donor site is typically "split" so
that the removed graft consists of the entire epidermis and the upper portion of
the dermis (a "split-thickness" graft), leaving the bottom portion of the dermis
in the donor site to facilitate healing.

     In partial-thickness burns, commonly known as second-degree burns, the
dermis has not been entirely destroyed and grafting is generally not required.
In partial-thickness burns, the effort is to close the wound as quickly as
possible to reduce pain, the incidence of infection and scarring.
Partial-thickness burns are generally treated with antimicrobial agents, the
most common being silver sulfadiazine which is applied topically. Dressing
changes are generally performed twice a day and can be quite painful. At each
dressing change, the surgeons will typically remove any damaged tissue. Goals in
the treatment of these patients include achieving rapid healing and reducing
pain, inflammation and scarring.

     BURN MARKET. Of the approximately 45,000 burn patients hospitalized
annually in the United States, up to 13,000 are severely burned and require skin
grafts. TransCyte was initially approved to address the approximately 1,500
severely burned patients requiring skin grafts with burns exceeding twenty
percent of body surface area. Another 30,000 to 40,000 burn victims, often
children and the elderly, suffer partial to mid-dermal, or second degree, burns
each year in the United States. These burns frequently result from household
hazards such as scalds from hot liquids, faulty heating pads or misuse of
ignition fluids.

     FULL-THICKNESS BURNS. Patients with extensive full-thickness burns have
only a limited amount of undamaged skin that can be used as donor sites for
autografts. This shortage of donor sites prevents rapid closure of the burn
wounds leaving the patient susceptible to infections and fluid loss, both of
which can be life-threatening. When sufficient autograft is not available, human
cadaver skin is often used as a temporary covering for the excised burns.
However, cadaver skin may transmit infection and is immunologically rejected
generally within several weeks of application. As a result, the patient may
require additional surgical procedures to cover the wound, increasing the
overall cost of treatment. Rejection can also give rise to complicating
infections of the burn wounds and, in addition, repeated applications of cadaver
skin can cause more rapid rejection. Removal of cadaver skin prior to
autografting can be difficult and cause significant bleeding.

     TransCyte was developed as an alternative to human cadaver skin. TransCyte
consists of a dermal tissue grown on scaffold with an ultra-thin synthetic
covering that acts as a temporary epidermis that helps to retain fluids and
prevent infections of the wound bed. As with cadaver skin, TransCyte must
ultimately be removed from the wound bed prior to grafting. However, the Company
believes that TransCyte offers significant advantages over cadaver skin. Cadaver
skin has a number of limitations, such as limited availability, the potential
for immunological rejection that necessitates repeat applications, significant
bleeding and inflammation of the wound bed and the potential for disease
transmission. However, TransCyte is manufactured, cryopreserved and ready for
use as needed, has reduced bleeding on removal and the human tissue materials
used in the manufacture of the Company's skin products, including TransCyte, are
extensively tested for potential pathogens.

     In March 1997, the FDA gave the Company approval to begin commercial sales
of TransCyte in the United States for use as a temporary covering for severe
burn wounds. The approval was based on a pivotal clinical trial that
demonstrated that TransCyte was successful in adequately preparing the wound bed
for autografting, performing equal to or better than the cadaver skin control.
In addition, TransCyte performed significantly better than the control with
respect to important secondary endpoints such as ease of removal, amount of
excision required, amount of bleeding upon excision and overall satisfaction
rating as a temporary covering among clinical investigators. Under the approval,
the Company is conducting post-marketing surveillance to generate additional
information relative to infection rates.

     PARTIAL THICKNESS BURNS. In October 1997, the Company also received
approval from the FDA to begin commercial sales of TransCyte in the United
States for partial-thickness burns. In a clinical trial under a physician's IDE,
TransCyte was evaluated as an alternative to silver sulfadiazine in the
treatment of patients with limited to moderate partial-thickness burns. In the
trial, TransCyte was affixed to the burns with adhesive strips and remained
until the wound was closed. TransCyte was compared to silver sulfadiazine which
had twice daily dressing changes and wound debridement as per the burn center's
standard practice. The clinical trial results indicated that TransCyte showed a
substantially reduced time to 90% healing or epithelialization, and required
less time to heal. Under this approval, the Company is conducting post-market
studies to compare TransCyte to another currently used treatment.


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     TransCyte can offer several advantages in the treatment of partial-
thickness burns. As compared to silver sulfadiazine, TransCyte may reduce the
pain, time and cost associated with once or twice daily dressing changes and
excision. More rapid healing can also reduce the costs and time associated with
treatment and can potentially reduce the hypertropic scarring often seen in
these burn wounds.

     TransCyte is currently available for sale in the United States, the United
Kingdom and several other European countries, Canada, Australia and New Zealand
through the Dermagraft Joint Venture and will be introduced in additional
countries subject to regulatory approval. Although some countries regulate
TransCyte as a pharmaceutical, this product is regulated as a device in the
United States and Canada. See "Government Regulation."

     Based upon TransCyte's performance in treating patients with partial-
thickness burns, the Company believes that LaserDerm(TM), which is being
developed with Inamed, may reduce the pain, erythema, possible infection and
time to healing in patients who have undergone laser resurfacing or chemical
peel procedures which in effect burn the skin. LaserDerm represents a new
application for the Company's TransCyte technology. See "Facial and
Reconstructive Surgery Products."

     SKIN ULCERS. Chronic skin ulcers were also selected as one of the Company's
first therapeutic targets. The Company believes that its Dermagraft product
provides a healthy, metabolically active dermal matrix in the ulcer bed that
will support growth of the patient's epidermis from the edges of the wound and
promote wound closure and, thereby, reduce the time required to heal these
wounds and potentially reduce the need for skin grafting and reconstructive
procedures. The Company has benefited by applying the experience it has gained
with TransCyte to Dermagraft as both products use similar raw materials (e.g.,
cell source and growth media), manufacturing processes, freezing procedures,
storage methods and packaging concepts. No evidence has been seen in any
clinical trials of Dermagraft of any safety issues and no incidents of
immunologic rejections have been observed with Dermagraft. Dermagraft is
regulated by the United States, Canada, Australia and New Zealand as a medical
device. Many European and other countries are regulating Dermagraft as a
pharmaceutical and some countries have not yet determined how they will regulate
Dermagraft.

     Traditionally, there have been two approaches to skin ulcer treatment. The
most common treatment for less advanced ulcers is to allow normal healing to
occur by using dressings and topical medications to protect the wound. Even when
successful, this therapy can require many months of repeated treatments to
achieve healing. The second approach utilizes conventional skin grafts and is
typically used for more advanced skin ulcers. However, the difficulty of healing
donor sites and the risks associated with general anesthesia in the elderly, who
suffer the large majority of chronic skin ulcers, often prevents the use of skin
grafts. Both treatment approaches have a high failure rate.

     Dermagraft is a dermal replacement product grown on a bioabsorbable
scaffold. It is designed to provide a healthy, metabolically active dermal
matrix in ulcers to support wound closure. Healing skin ulcers faster can
potentially reduce the risk of infection (and, in the case of diabetic foot
ulcers, the subsequent risk of amputation), as well as the need for skin
grafting and reconstructive procedures. Skin ulcers that may be addressed by
Dermagraft include diabetic foot ulcers, venous ulcers and pressure ulcers. The
Company also believes that TransCyte may have a market as a temporary covering
in pressure ulcers.

     ULCER MARKET. Over 3 million cases of chronic, slow-healing or non-healing
skin ulcers are treated in the United States each year. In these wounds, the
skin breaks down as a result of disruption of blood flow caused either by
prolonged pressure over a localized area or by chronic diseases that affect the
circulatory or peripheral nervous systems. In many of these patients, skin
ulcers are open, often painful, wounds that are resistant to healing for many
months or years. In part because current therapies for skin ulcers are often
ineffective, the treatment of skin ulcers is an expensive process. Individual
patient treatment can cost thousands of dollars per year.

     In the United States, approximately 300,000 to 400,000 diabetics suffer
each year from full-thickness plantar ulcers that represent the Company's target
market for Dermagraft. Ulcers that do not heal leave the patients susceptible to
infection, which may lead to amputation of the foot or leg. More than 56,000
amputations occur each year in the United States among people with diabetes, 85%
of which are preceded by a diabetic foot ulcer. The five-year survival rate
following amputation ranges from approximately 40 to 70 percent. It is estimated
that more than 1.5 million patients are affected annually by pressure ulcers in
the United States with over 500,000 nursing home patients suffering from
pressure ulcers each year. In addition, approximately 700,000 patients suffer
with venous ulcers in the United States each year.


                                       7

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     DIABETIC FOOT ULCERS. Many diabetic patients experience circulatory
deficiencies and decreased nerve sensation in their legs and feet, which
prevents the normal shifting of weight in response to wound-provoking pressure.
The patient may be unaware of some injuries and can leave wounds unattended for
days, resulting in an ulcer. Once the ulcer forms, it may heal poorly due to the
effects of diabetes on normal healing processes. Unhealed diabetic ulcers can
result in gangrenous infection that may lead to amputation of the limb. Over the
course of their disease, patients with diabetes lose their ability to form
normal collagens, glycosaminoglycans and growth factors. Dermagraft is designed
as a replacement to address these deficiencies in the diabetic patient's own
dermal tissue. Dermagraft contains extracellular matrix proteins, growth factors
and glycosaminoglycans normally found in healthy human dermal tissue.

     In January 1998, the General and Plastic Surgery Devices Panel of the
Medical Devices Advisory Committee to the FDA recommended that the agency
approve Dermagraft for the treatment of diabetic foot ulcers in the United
States, with the conditions that the Company perform a post-marketing study to
confirm efficacy and provide physician training. The recommendation was based on
the results of a pivotal clinical trial enrolling 281 patients and a 50-patient
supplemental trial. The supplemental trial was performed to confirm the results
of the pivotal clinical trial with product produced in the Company's commercial
manufacturing systems and to commercial specifications.

     In the pivotal clinical trial, 38.5% of the evaluable patients who received
Dermagraft healed completely in twelve weeks as compared to 31.7% of the
evaluable patients treated with conventional therapy. In addition, 50.8% of
those evaluable Dermagraft patients receiving product in the pivotal clinical
trial produced to commercial specifications (i.e., within a specific
"therapeutic range") achieved complete wound closure within twelve weeks. In
addition, at thirty-two weeks, or six months after the last application of
Dermagraft, 57.5% of the evaluable Dermagraft patients receiving product in the
pivotal trial manufactured to commercial specification achieved complete wound
closure as compared to only 42.4% of those receiving conventional therapy alone.
In August 1997, approval was received from Canadian regulatory authorities for
the marketing of Dermagraft in the treatment of diabetic foot ulcers based on
the results of this trial. The results of the supplemental trial at twelve weeks
were closely consistent with those seen in the pivotal clinical trial for the
product produced to commercial specifications.

     In June 1998, the FDA requested that an additional controlled clinical
trial be completed in support of the Company's PMA application of Dermagraft in
the treatment of diabetic foot ulcers. As had been previously reported, the FDA
stated concerns about basing approval on a retrospective analysis on a subset of
the data together with a post-marketing study to confirm efficacy. The FDA
indicated the PMA application was not approvable without supportive data from
the additional clinical trial.

     In connection with its review of the PMA application for Dermagraft, the
FDA suggested that a Treatment Investigational Device Exemption ("Treatment
IDE") application be submitted. The Treatment IDE is a new regulatory provision
for devices that permits companies to make available promising new products
under an agreed clinical protocol to patients with serious diseases for which
there is no satisfactory alternative. In October 1998, the FDA approved the
Company's application for a Treatment IDE for Dermagraft in the treatment of
diabetic foot ulcers. Under a Treatment IDE, companies are allowed to recover
manufacturing and distribution costs.

     In August 1998, the FDA granted approval of the Company's application for
the additional controlled clinical trial for Dermagraft in the treatment of
diabetic foot ulcers. The additional clinical trial was to include approximately
thirty centers and provided for enrollment of a total of 330 patients (165 per
arm). The study has the same primary endpoint, complete wound closure by twelve
weeks, used in the previously conducted pivotal trial. Unlike the previous
trial, a thirty-two week follow-up is not required.

     The clinical trial began in late 1998 and the results of a planned interim
analysis of data from this trial were announced in December 1999. These data
showed that, although statistical significance was not achieved at the interim
analysis, Dermagraft was healing more ulcers than the control treatment in those
diabetic foot ulcers having a duration of greater than six weeks. On an
intent-to-treat basis for patients with ulcer duration greater than six weeks,
28% of patients who received Dermagraft healed completely in twelve weeks as
compared to 14% of the patients treated with conventional therapy.

     In February 2000, the FDA approved an application for an amendment to the
IDE for the additional controlled clinical trial of Dermagraft in the treatment
of diabetic foot ulcers. Based on the previous data submitted to the FDA in
December from the planned interim analysis, the IDE was amended to revise the
enrollment criteria and the


                                        8

<PAGE>


statistical plan for data analysis. The amended IDE allows for the modification
of the study inclusion criteria to limit future enrollment to patients with
ulcers of greater than six weeks duration. In addition, the amended statistical
plan allows the Company to integrate the interim analysis data presented to the
FDA in December with additional data generated since that time from patients
with ulcer duration of greater than six weeks. If these additional data confirm
the treatment benefit that was seen in the interim analysis for patients with
ulcer duration greater than six weeks, the Company believes it could submit an
amendment to the PMA application to the FDA as early as mid-2000.

     Dermagraft for the treatment of diabetic foot ulcers is approved for sale
in Canada and Australia and has been commercially introduced in New Zealand, the
United Kingdom and several other European countries. Dermagraft is to be
marketed worldwide, subject to regulatory approvals, through the Dermagraft
Joint Venture with Smith & Nephew. See "Collaborations and Strategic Alliances."
Failure of the Company to gain FDA approval of Dermagraft for the treatment of
diabetic foot ulcers in the United States in a timely manner or, if approved, to
achieve significant market acceptance of the product would have a material
adverse effect on the Company's business. See "Government Regulation."

     VENOUS ULCERS. Venous ulcers result when damage to the valves of the deep
leg veins reduces their ability to return blood to the upper body, leading to
pooling of blood in the legs and subsequent breakdown of the skin. Venous ulcers
that do not respond to medical treatment often must be closed surgically by the
use of skin grafts.

     In 1994, the Company completed a pivotal clinical trial in venous ulcers of
a single application of Dermagraft under an Investigational Device Exemption
from the FDA. In that trial, patients were tracked for a period of twenty-four
weeks to evaluate wound closure. Analysis of the data from the pivotal trial
showed no statistical differences between the patients in the control group and
those treated with a single application of Dermagraft; however, analysis of the
six-month follow-up data from patients in this trial did show a statistically
significant difference in the recurrence rate of Dermagraft-treated patients
(6%) versus control patients (20%) indicating a positive effect on the quality
and durability of the ulcers healed by Dermagraft.

     Through the Dermagraft Joint Venture with Smith & Nephew, the Company began
a pilot clinical trial of multiple applications of Dermagraft in the treatment
of venous ulcers in March 1999. The trial was completed and the Company is
evaluating the number of pieces or doses of Dermagraft that might be needed to
achieve wound closure. In this trial, the Company is applying the knowledge
gained from its trials of Dermagraft in diabetic foot ulcers to venous ulcers.
The data from this trial will be presented in an upcoming scientific forum. The
joint venture expects to begin a pivotal clinical trial of Dermagraft in the
treatment of venous ulcers later in the year.

     PRESSURE ULCERS. Pressure ulcers are common in hospital and nursing home
patients. Pressure ulcers form in skin that is continually compressed under the
weight of a bedridden or wheelchair-bound patient, who does not periodically
turn or roll to relieve the compressed skin. The compressed skin does not
receive blood flow for an excessive time, ultimately forming a wound. Severe
pressure ulcers frequently must be closed by the use of skin grafts or major
reconstructive surgery.

     The Company, through the Dermagraft Joint Venture with Smith & Nephew,
began separate pilot clinical trials using Dermagraft and TransCyte in the
treatment of pressure ulcers in late 1999.

ORTHOPEDIC PRODUCTS

     Knowledge gained from developing the Company's existing skin products has
also been applied to the growth of orthopedic tissues. The Company believes that
its core technology and proprietary manufacturing systems allow the regulation
of critical environmental factors, including oxygen tension, pressure and media
composition, that may provide the necessary conditions for the production of a
high tensile-strength cartilage capable of withstanding the high shear and load
forces present in human joints.

     Traumatic injuries often cause permanent damage to tissues in human joints
such as cartilage, ligaments, tendon and bone. The body has a limited ability to
repair these tissues on its own, and there are few treatment options available
to replace damaged tissue. The Company is focusing its initial product
development efforts on tissue-engineered cartilage. Cartilage and cartilage-like
tissue serves diverse functions in many parts of the body such as providing a
gliding surface for smooth joint motion (articular cartilage), and serving to
absorb both impact and load-


                                       9

<PAGE>


force transmitted to the axial skeleton (meniscus). In many cases, damage to
cartilage tissue subsequently leads to further deterioration and osteoarthritis
which can eventually require a total joint replacement.

     The Company is developing its orthopedic cartilage products through the
NeoCyte Joint Venture with Smith & Nephew. See "Collaborations and Strategic
Alliances." The NeoCyte Joint Venture also has a right of first negotiation to
develop other tissue-engineered products for orthopedic applications such as
ligament, tendon and bone.

     ORTHOPEDIC MARKETS. It is estimated that in the United States in 1999,
there were approximately 2 million arthroscopic procedures of the knee
performed, including procedures involving articular cartilage, meniscus and
ligaments. By intervening early in the degenerative process, the NeoCyte Joint
Venture hopes to delay or perhaps even avoid some of the total knee replacement
surgeries performed annually in the United States. There were an additional
estimated 1 million arthroscopic procedures performed in the United States in
joints such as the shoulder, wrist, and ankle in 1999 which could also be
candidates for the joint venture's articular cartilage products.

     ARTICULAR CARTILAGE. Articular (joint) cartilage covers the opposing
surfaces of all moving joints in the body. Even small defects in the articular
cartilage can cause pain and subsequent restriction of joint motion. These
defects greatly increase the probability of degenerative cartilage problems,
such as arthritis, later in life. The primary treatment for these articular
defects is to trim away intruding cartilage fragments via arthroscopy, which
increases joint mobility but does not prevent long-term degenerative changes.
Injuries resulting from sports trauma are a common cause of these cartilage
defects. Tissue-engineered articular cartilage could provide a significant
opportunity to treat patients at an earlier stage of joint degeneration, thereby
delaying, or in some cases eliminating, the need for total joint replacements.
Products to repair articular cartilage may ultimately be used in any joint in
the body, such as knees, shoulders, elbows, wrists, hips and ankles.

     The Company, as part of the NeoCyte Joint Venture with Smith & Nephew,
submitted an IDE in December 1996 requesting approval to begin a pilot clinical
trial with human tissue-engineered articular cartilage for the repair of
articular surfaces in knee joints. The FDA requested additional information with
respect to the IDE. The IDE submission was based on a preclinical safety study
using a small animal model. In this model, through twenty-four months of
follow-up, no adverse events were observed with the product. Additionally,
significant improvement in the repair of defects was observed in grafted versus
ungrafted control sites. The grafted tissue had a significantly more
hyaline-like appearance, greater content of sulfate glycosaminoglycans and a
smoother articular surface as compared to the untreated defects. These results
demonstrated the safety of the product and also that the repair tissue was of
better quality and more closely resembled adjacent normal tissue than allowing
the defects to heal by natural processes.

     The NeoCyte Joint Venture has been working to further develop and identify
those critical factors believed necessary for the clinical success of an
articular cartilage product in a large animal model. The results of this study
thus far have demonstrated that untreated defects heal with scar tissue, as has
been shown in humans, and, therefore, the model may be representative of the
effect of tissue-engineered cartilage on progressions of degenerative joint
diseases. Additionally, clincally relevant methods of fixation have been
developed and tested using this model. With successful preclinical trials, pilot
clinical studies could begin in 2000, subject to FDA approval.

     MENISCAL CARTILAGE. The meniscus is a cushion that acts as a shock absorber
in the knee. It is frequently damaged or destroyed by sports injury or other
trauma. Current repair procedures for avascular meniscal injuries have limited
success in producing a long-term repair. The Company believes that its tissue
engineering approach could offer a benefit in the repair and eventual total
replacement of the meniscus. The NeoCyte Joint Venture has conducted
collaborative preclinical studies with scientists under a sponsored research
program which has shown that successful repair was achieved using
tissue-engineered meniscal allografts, in comparison to failure to heal in a
control group. In pilot preclinical studies, further sponsored research
performed at Children's Hospital in Boston ("Children's Hospital") showed that
tissue-engineered meniscus can be generated and may be used for total meniscal
replacement. The joint venture has developed a prototype for a tissue-engineered
meniscus. Laboratory and preclinical studies showed the technical feasibility of
growing and implanting a tissue-engineered meniscus. The NeoCyte Joint Venture
is currently focusing its resources on articular resurfacing rather than
tissue-engineered menicus.


                                       10

<PAGE>


AESTHETIC AND RECONSTRUCTIVE SURGERY PRODUCTS

     The technology used in developing the Company's existing skin products and
its research into the growth of orthopedic tissues is also being used in the
development of products for asthetic and reconstructive surgery applications.
This includes products for use as a temporary covering after laser resurfacing
or chemical peels, human collagen for wrinkle and cosmetic correction and as a
bulking agent for the treatment of urinary incontinence, cartilage for plastic
and reconstructive applications, and extracellular matrix for breast
reconstruction following a mastectomy or lumpectomy, or to treat deformities.

     LASER RESURFACING AND CHEMICAL PEELS. In 1998, over 160,000 patients
underwent laser resurfacing in the United States. In addition, another 950,000
had chemical peels. Current issues with these types of procedures include pain
and erythema (redness or inflammation) for up to 30 days and the patient may
need to stay at home for up to two weeks. Based upon TransCyte's performance in
treating patients with partial-thickness burns, the Company believes that
LaserDerm, a new application for the Company's TransCyte technology, may reduce
the pain, erythema, infection and time to healing in patients who have undergone
these laser resurfacing or chemical peel procedures.

     HUMAN COLLAGEN. Collagen is a family of naturally occurring proteins that
serve as the basic structural building blocks of the tissues found in skin,
cartilage, bone, tendons, ligaments, arterial walls, and other organs and
tissues of the body. Collagen is a major component of the skin products that are
currently manufactured at Advanced Tissue Sciences. The Company intends to apply
its existing technology, processes and expertise to manufacture human collagen
and is currently developing a process for the bulk production of collagen. The
objective of the Company's collagen program is to develop a fibrous collagen
product which, after its purification, can be sterilized and easily injected or
implanted into the human body.

     There are several uses and applications for bioengineered human collagen.
Collagen can potentially be used for the correction of wrinkles and lip
enhancement, as a bulking agent for the treatment of urinary incontinence and
combined with extracellular matrix to be used in breast reconstruction following
lumpectomies or to treat deformities. Human collagen may offer important
advantages over the collagen currently marketed which is produced from animals.
The Company believes that advantages of using human collagen may include the
potential elimination of reactivity of some patients to foreign animal proteins
and increased persistence in the body. In addition, bioengineered human collagen
is derived from fibroblasts which have been extensively tested for a variety of
viruses and pathogens. Additional applications of collagen may include medical
device coatings, as an additive to cosmetics or use as a natural vehicle for
drug delivery.

     RECONSTRUCTIVE CARTILAGE. Studies sponsored by the Company have shown that
cartilage implants retain their shape for up to one year after implantation into
the facial regions of animals. In addition, reseachers in this collaboration
have developed an injectable cartilage product that has been successfully
utilized to construct total ear and nose implants. Such implants have persisted
in animals for over twelve months.

     The Company is to develop its facial and reconstructive surgery products
through its strategic alliance with Inamed. See "Collaborations and Strategic
Alliances - Inamed Corporation."

CARDIOVASCULAR PRODUCTS

     Cardiovascular tissue consists of a number of cell types including cardiac
fibroblasts, smooth muscle cells and endothelial cells. Cardiac fibroblasts are
closely related to the dermal fibroblasts that the Company uses to manufacture
its existing skin products. Accordingly, dermal fibroblasts may be useful in the
growth of vascular grafts and other cardiovascular products. The Company is also
investigating the utility of smooth muscle cells, a functional component of the
native artery, to add strength to the tissue-engineered vessels. Endothelial
cells line the interior of blood vessels and are important to avoid clotting and
the build up of plaque, or atherosclerosis. Matrix proteins and growth factors
secreted by fibroblasts or smooth muscle cells may induce endothelial cell
migration into the tissue-engineered grafts. In addition, research studies in
animal models show that Dermagraft may stimulate blood vessel growth, or
angiogenesis, in the heart muscle following coronary occlusion or obstruction of
coronary arteries causing ischemia (decreased blood flow).

     CARDIOVASCULAR MARKET. In 1997 in the United States, over 900,000 people
died from cardiovascular disease. At the same time, it was estimated that 12.2
million people were suffering from coronary artery disease and over 600,000 had
coronary artery bypass procedures performed. Likewise, approximately 350,000
patients were


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diagnosed with peripheral vascular disease and over 115,000 bypass procedures
for the thigh vein alone were performed. The successful development of a
tissue-engineered vascular graft could provide these patients with a viable
alternative treatment. Another 70,000 heart valve replacement procedures were
performed in 1996. While there are many effective treatments for these patients,
there are also many problems to be overcome such as biocompatibility, durability
and availability. An aging population is likely to increase the incidence of
these diseases and the need for cost-effective treatments in the future.
Tissue-engineered cardiovascular products, such as an epicardial angiogenesis
patch, and off-the-shelf blood vessels may potentially solve some of these
issues.

     ANGIOGENESIS PATCH. Research studies show that Dermagraft stimulates
site-specific new blood vessel formation, or angiogenesis. Adequate blood flow
to damaged tissue is a vital part of the wound healing process. Studies indicate
that the improvement in blood flow reflects angiogenesis, most likely enhanced
by a sustained and appropriate supply of angiogenic growth factors provided by
Dermagraft. Preclinical studies have shown Dermagraft's potential for inducing
new blood vessels into damaged heart tissue. Such an epicardial angiogenesis
patch may be able to be used to stimulate new tissue and blood vessel growth and
remodeling in a heart following coronary occlusion or ischemia. When
insufficient oxygen reaches the heart muscle as a result of restricted blood
flow, an injury (myocardial ischemia) occurs that may result in a heart attack
and death. Restoring blood flow is the most effective method to relieve painful
ischemic symptoms and to reduce the long-term risk of a heart attack.

     BLOOD VESSELS. Vascular grafts are used to repair or replace segments of
arterial and venous blood vessels that are weakened, damaged or obstructed due
to trauma or disease such as aneurysms and atherosclerosis. Grafts are either
autografts (the patient's own veins or arteries), prosthetic grafts made of
synthetic materials such as polyesters or other composite materials, or
non-viable preserved biological tissue from cadavers or other species. The
harvesting of autografts requires extensive surgery which is time consuming,
costly and traumatic. In addition, patients requiring multiple bypass surgeries
may not have enough suitable vessels to harvest. Cyropreserved allograft veins
from cadavers are sometimes used, but availability is limited and patency rates
are lower than autograft vessels. Prosthetic vascular grafts are generally used
for large or medium diameter (>6mm) grafts as small diameter synthetic grafts
have generally demonstrated poor performance. Prosthetic vascular grafts often
show insufficient tissue integration and re-endothelization. Problems associated
with small diameter synthetic grafts include stenosis (or a narrowing),
pseudoaneurysm formation, and acute occlusion due to platelet aggregation.

     Many companies are attempting to develop small diameter vascular grafts
(3mm to 5mm) with characteristics similar to biological grafts. These companies
are employing a variety of technologies to reduce thrombosis and promote a rapid
ingrowth of tissue such as different weaves and knits, chemical coatings and
gelatins, and freeze drying. Advanced Tissue Sciences' research has focused on
using specialized polymer constructs, bioreactor design and colonization
techniques to create a human vessel. Bioreactors have been developed to generate
the mechanical forces similar to that encountered in the body to stimulate the
cells to align concentrically, to absorb stress as in a normal vasculature, and
to establish a matrix similar to native blood vessels. Imposing such forces is
believed to allow for greater structural and mechanical integrity in the
tissue-engineered vascular grafts. Biochemical and immunohistochemical analysis
of bioengineered blood vessels demonstrates an increase in tissue deposition
over time in culture and the synthesis of elastin and other matrix proteins
which are essential to blood vessel formation and function. These matrix
proteins, along with various growth factors that are naturally secreted by the
grafts, may also induce endothelial cell migration and host cell integration.

     The Company has worked, both internally and through collaborations with The
Georgia Institute of Technology ("Georgia Tech"), MIT and Children's Hospital,
on the development of tissue-engineered blood vessels in vitro that have
adequate biomechanical and structural properties to function in vivo and to
minimize or eliminate the potential for clotting or thrombogenecity. Through
sponsored research with MIT and Children's Hospital, feasibility studies showed
that tissue-engineered large diameter (15mm) blood vessels could be formed by
seeding a synthetic biodegradable tube with fibroblasts and other vascular cell
types. These large diameter autologous tissue-engineered grafts persisted,
remained durable and grew normally in preclinical studies for up to five months.

     In 1997, Advanced Tissue Sciences was awarded a $2 million Advanced
Technology Program grant from the National Institute of Standards and
Technology. The grant is structured to support development of an allogeneic
vascular graft over a three-year period that began in 1998. In collaboration
with the Department of Bioengineering at the University of California, San Diego
(UCSD) and the University of Arizona, the Company is leading a
multi-disciplinary effort to design, construct and evaluate allogeneic small
diameter tissue-engineered vascular grafts (3 to 4mm inner diameter) produced
from cells grown on a biocompatible scaffold. The collaboration integrates
current advances in cellular mechanics, bioreactor technology, and blood vessel
mechanics to create a unique living tissue


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<PAGE>


replacement for blood vessels. Using the Company's proprietary bioreactor, blood
vessels consisting of smooth muscle cells with an endothelial cell lining have
been developed that maintain function in vivo for up to four weeks. Preclinical
studies are continuing in collaboration with the University of Arizona.

     STENTS. Stents are generally synthetic materials that are inserted in a
vessel after angioplasty (the mechanical removal of an occlusion by the
insertion of a catheter) in an attempt to prevent restenosis or re-occlusion of
the vessel. Without stent intervention, approximately 40% of patients will
experience restenosis of the vessel within two years of plaque removal. Using a
living, bioengineered stent comprised of healthy human cells, either alone or in
conjunction with a mechanical stent, could potentially provide a more stable
vascular lining, thereby preventing or reducing thrombosis or restenosis. The
Company envisions developing living, bioengineered stents or coating stents with
human matrix to reduce restonosis or narrowing of blood vessels.

     HEART VALVES. The valves open and close with every beat of the heart. When
a valve becomes damaged or diseased, the heart must work harder to pump the same
volume of blood. As the condition worsens, the valve has to be replaced.
Currently, either mechanical or porcine valves are used to replace the native
human valves; however, each has its drawbacks. With mechanical valves, patients
are required to take anticoagulant medication for the rest of their lives to
reduce the likelihood of thromboembolic events (i.e., blood clots). Porcine
valves have problems with durability and calcification, frequently requiring
additional and costly surgery to implant replacement valves. These drawbacks
associated with currently available products have created a growing need for
biological alternatives.  The Company believes that potential benefits of heart
valves developed with its human-based tissue engineering technology may include
increased durability, a reduced need for anticoagulant therapy and an ability
to grow with the patient over time.

OTHER THERAPEUTIC TISSUES

     Many other organ tissues have been successfully grown using the Company's
technology that could potentially be developed into therapeutic products.
Further development and commercialization of these or other tissues, such as
pancreas, gastrointestinal and blood/brain barrier tissues, is dependent on a
number of factors, including the Company's assessment of each tissue type's
market potential and the availability of sufficient resources, either internally
or through collaborations with future corporate partners.

     OTHER RECONSTRUCTIVE APPLICATIONS. There may be several applications for
tissue-engineered bone and tendon or ligament products in reconstructive
surgery. Reconstructive implants could offer an important alternative at a time
when silicon, Teflon, and other implant materials are being taken off the
market. Under Company-sponsored research, scientists have performed pilot
preclinical studies with engineered cartilage and bone for reconstructive
applications and have even constructed an entire joint consisting of bone,
cartilage and ligament. Certain other reconstructive cartilage applications are
discussed under "Products - Aesthetic and Reconstructive Surgery Products."

     LIGAMENT/TENDON. Frequently, sports injuries involve damage to ligaments
and tendons, particularly injury to the anterior cruciate ligament. The Company
has successfully utilized degradable polymers shaped into tendon-like structures
combined with fibroblasts to engineer a living ligament. Through sponsored
research with scientists at MIT and Children's Hospital, the Company has
explored growth conditions that may allow it to grow tissue-engineered ligament
and tendon in the future with biomechanical properties similar to those found in
the human body.

     BONE. An engineered bone tissue could be useful in joint replacement, bone
grafting and facial bone reconstruction. Scientists have shown that
three-dimensional bone grown in vitro secreted extracellular matrix proteins and
retained biomechanical properties analogous to those tissues in the human body.
Research has also advanced in the growth of bone/cartilage composites which
could offer additional solutions to reconstructive surgery. Studies have shown
that full thickness cranial bone defects in animals can be corrected by
implantation of tissue-engineered bone. Scientists have successfully replaced
long bones, such as the femur, in preclinical studies.

    LIVER. The liver is the body's major metabolic organ. The only treatment
for liver failure today is a liver transplant and currently there is an
insufficient supply of transplantable livers. While almost 4,000 liver
transplants are performed each year, it is estimated that 26,000 people die each
year from chronic liver disorders, including many who are waiting for a
transplant.


                                       13

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     Advanced Tissue Sciences has demonstrated the ability to culture
enzymatically active animal and human liver cells (hepatocytes) in long-term
cultures. The Company's system allows for the active growth of liver cells which
retain their ability to manufacture a variety of liver proteins and enzymes
required for normal hepatic function. The Company has reported successful
engraftment and persistence of liver tissue implanted in various regions in
rats, including subcutaneous, intraperitoneal, and supra hepatic sites. In
addition, the Company has conducted pilot preclinical trials that involved the
implantation of engineered liver tissue into both small and large animal models.
In these trials, the implants functioned well for approximately three months
(the duration of the experiment).

     BONE MARROW. Bone marrow is ultimately responsible for the production of
all of the body's blood and immune cells. The Company believes that a universal
bone marrow cultured ex vivo could be used as a replacement in patients whose
bone marrow has been damaged or destroyed during radiation or chemotherapy
treatments. The Company has successfully replicated animal and human bone marrow
and natural killer cells (a component of the immune system) and has conducted
pilot preclinical trials involving the infusion of replicated bone marrow cells.
In addition, the Company has also grown and grafted bone marrow cultures with
high percentages of stem cells on biodegradable polymer scaffolds.

     GENE THERAPY. During 1998, the Company received a U.S. patent covering
three-dimensional, tissue-engineered products made with genetically-modified
cells for gene therapy applications. Under the technology described in the
patent, genetically-modified tissue can be grown on a biocompatible scaffold
using genetically-engineered stromal cells, genetically-engineered parenchymal
cells or both. Genetically-modified tissue products could potentially provide a
safe, unique delivery vehicle for such indications as hemophilia (Factor VIII),
short stature (growth hormone), anemia (erythropoietin), cancer or
cardiovascular disease. Research utilizing this approach has shown expression of
a genetically-engineered protein for up to 150 days in vivo.

     Tissue engineering may provide a safe and effective means of delivering
therapeutic proteins to patients using state of the art gene therapy techniques.
Delivering genes in three-dimensional tissue may allow long-term expression in
vivo. Obtaining long-term expression is one of the key technical hurdles that
the gene therapy industry is facing today. Although gene therapy has been
recognized as a revolutionary way to treat disease, progress has been slow due
to the many challenges associated with gene delivery and in obtaining long-term
expression.

COLLABORATIONS AND STRATEGIC ALLIANCES

     The Company's strategy for the development, clinical testing, manufacture
and commercialization of certain of its proposed tissue replacement products
includes entering into various collaborations with corporate partners, licensees
and others from time to time. The Company is currently involved in a number of
collaborative arrangements in connection with its product development
activities.

     SMITH & NEPHEW PLC. In April 1996, the Company entered into an agreement
with Smith & Nephew to form a fifty-fifty joint venture for the worldwide
commercialization of Dermagraft, the Company's tissue-engineered dermal
replacement, for the treatment of diabetic foot ulcers (the "Dermagraft Joint
Venture). Smith & Nephew is a global medical device company. It markets
technically innovative products principally in the areas of orthopedics,
endoscopy, and wound management to deliver cost effective solutions, significant
physician advantages and real patient benefits. In January 1998, the Company and
Smith & Nephew expanded the Dermagraft Joint Venture to include, with certain
exceptions, any products using the Company's technology for the medical care and
treatment of skin tissue wounds, such as pressure and venous ulcers, burns and
skin tissue defects. The Dermagraft Joint Venture was further expanded in August
1998 giving the Dermagraft Joint Venture the exclusive right to market TransCyte
as a temporary covering for full and partial-thickness burns in the United
States, beginning in October 1998. Under the terms of the Dermagraft Joint
Venture agreements, Advanced Tissue Sciences is responsible for supervising the
manufacturing of Dermagraft and TransCyte. Smith & Nephew's existing wound care
sales force and distribution network in over ninety countries is to be used to
market the products.

     As consideration for entering into the Dermagraft Joint Venture, Advanced
Tissue Sciences received a $10 million up front fee in 1996. In conjunction with
the expansion of the joint venture, Smith & Nephew also made a $20 million
equity investment in the Company in January 1998 and a payment to the Company
through the Dermagraft Joint Venture of $15 million in January 1999. The Company
also could receive, subject to the achievement of certain milestones related to
regulatory approvals, reimbursement and sales levels and certain minimum levels
of operating profit, additional payments of up to $136 million plus royalties on
product sales. Advanced Tissue Sciences and Smith & Nephew are continuing to
share in the revenues and expenses of the


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Dermagraft Joint Venture, and the Company is funding the first $6 million in
expenses for conducting clinical trials and regulatory support for Dermagraft
and TransCyte in the treatment of venous ulcers and pressure ulcers and Smith &
Nephew is funding all milestone payments, if any. In June 1999, a $10 million
loan from Smith & Nephew related to the Dermagraft Joint Venture was converted
into approximately 2.8 million shares of Advanced Tissue Sciences' common stock
as allowed under the terms of the loan agreement. The Company also funded
certain manufacturing and distribution costs and certain costs related to
post-market studies of TransCyte through December 1999.

     In 1994, Smith & Nephew and the Company entered into a separate fifty-fifty
joint venture (the "NeoCyte Joint Venture") for the worldwide development,
manufacture and marketing of human-based, tissue-engineered cartilage for
orthopedic applications. Under the agreement, Smith & Nephew contributed the
first $10 million in funding and the Company contributed certain technology
licenses. Joint venture revenues and expenditures in excess of the first $10
million are being shared equally by the partners. In addition, the Company has
been drawing against a $10 million loan commitment from Smith & Nephew to fund
the Company's share of the joint venture's expenditures. The NeoCyte Joint
Venture also has the right of first negotiation to develop tissue-engineered
bone, tendon and ligament for orthopedic applications.

     Under the terms of the NeoCyte Joint Venture agreement, Advanced Tissue
Sciences will be responsible for supervising the manufacturing of the cartilage
tissue products. The NeoCyte Joint Venture will execute the research and
development program, develop a worldwide marketing plan, and will utilize Smith
& Nephew's established selling and distribution network to market the products.
Smith & Nephew Endoscopy, a world leader in arthroscopy, is separately
responsible for developing and manufacturing instrumentation that could be used
for the arthroscopic insertion of the joint venture's cartilage products. The
NeoCyte Joint Venture's initial product development efforts are being focused on
the repair or replacement of damaged articular cartilage in knee joints.

     INAMED CORPORATION. In May 1999, Advanced Tissue Sciences, Inc. and Inamed
Corporation entered into a strategic alliance for the development and
marketing of several of Advanced Tissue Sciences' human-based, tissue-engineered
products for aesthetic and certain reconstructive applications. Specifically,
Inamed licensed rights to further develop, manufacture and sell tissue
engineered products for use in cosmetic surgery, cartilage for plastic and
reconstructive surgery, and extracellular matrix for use in breast
reconstruction. In addition, in September 1999, Inamed also received license
rights to use extracellular matrix, including human collagen, from Advanced
Tissue Sciences' three-dimensional culture system for soft tissue augmentation
(wrinkles and cosmetic correction) and as a bulking agent for the treatment of
urinary incontinence. Inamed is a global surgical and medical device company
engaged in the development, manufacturing and marketing of medical products for
aesthetic medicine, plastic and reconstructive surgery and the treatment of
obesity.

     Under the agreement between the parties, in exchange for worldwide
licensing rights, Inamed made a series of payments totaling $10 million,
including $5 million to purchase Advanced Tissue Sciences' common stock. Inamed
also received five-year warrants to purchase up to 500,000 shares of common
stock. In addition to royalties on product sales, Advanced Tissue Sciences may
potentially receive up to a total of $10 million in milestones based on product
approvals in the United States.

     Advanced Tissue Sciences will be responsible for the funding and
development of the products and the related manufacturing processes while Inamed
will be responsible for clinical and regulatory activities. Advanced Tissue
Sciences, or an affiliate, may elect to manufacture the products developed under
the agreement. Fees for licensing rights and milestone payments will be
recognized into revenues as the related financial commitments for product
development and manufacturing processes are incurred.

     MASSACHUSETTS INSTITUTE OF TECHNOLOGY/CHILDREN'S HOSPITAL IN BOSTON. In
connection with an acquisition in September 1992, the Company entered into a
license agreement with the MIT and Children's Hospital. Under the license
agreement, the Company has rights to certain MIT and Children's Hospital patents
and technology which relate to tissue engineering, organ transplantation and
polymer science. To retain these rights, the Company is required to meet certain
diligence requirements with respect to advancing the licensed technology. The
Company also remains responsible for associated patent costs and related
maintenance fees.

     GEORGIA TECH. Georgia Tech is recognized as having a leading academic
program in biomedical engineering. In 1997, the Company entered into a research
agreement providing for the investigation of the effect of fluid flow on
chondrocyte metabolism. In 1998, the Company entered into additional research
collaborations that end in 2000 with Georgia Tech relating to the study of
bioreactor fluid mechanics. Georgia Tech has also collaborated with the


                                       15

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Company on its cardiovascular program, performing biomechanical property tests
of bioengineered vascular grafts as compared to native coronary vessels. The
relationship between the Company and Georgia Tech is further strengthened by the
Company's participation in an internship program for students in the
Bioengineering Program at Georgia Tech. The Company is also an active member of
the Georgia Tech Educational Partners Program.

     UNIVERSITY OF CALIFORNIA, SAN DIEGO. In October 1997, Advanced Tissue
Sciences was awarded a three-year Advanced Technology Program grant from the
National Institute of Standards and Technology to develop tissue-engineered
vascular grafts for the treatment of coronary and peripheral artery vascular
diseases. The grant proposal was submitted in collaboration with the Department
of Bioengineering at University of California, San Diego (UCSD). Under the
award, the Company is leading a multi-disciplinary effort in collaboration with
the UCSD Bioengineering Department to design, construct and evaluate
tissue-engineered vascular grafts produced from cells grown on a biocompatible
scaffold. The collaboration is integrating current advances in cellular
mechanics, bioreactor technology, and blood vessel mechanics to create unique
living tissue replacements for blood vessels.

SALES AND MARKETING

     TransCyte was approved in the United States for use as a temporary covering
for excised full-thickness burns in March 1997 and for use in partial-thickness
burns in October 1997. Prior to October 1998, TransCyte was marketed through the
Company's direct sales force in the United States where the markets are
relatively concentrated in specialized burn centers. TransCyte has also been
approved in Canada and is being introduced in Australia, New Zealand and several
European countries including the United Kingdom for severe and partial-thickness
burns. In October 1998, the Company eliminated its direct sales force and
TransCyte is now being marketed for burns in the United States, Canada and in
the rest of the world, subject to regulatory approvals, through the Dermagraft
Joint Venture by Smith & Nephew.

     It is estimated that there are approximately 300,000 to 400,000 diabetic
foot ulcer patients treated each year in the United States which represent
Dermagraft's target market. Subject to regulatory approvals, Dermagraft for
diabetic foot ulcers will be marketed through the Dermagraft Joint Venture by
Smith & Nephew. Dermagraft is currently being marketed through the Dermagraft
Joint Venture by Smith & Nephew in Canada, Australia, New Zealand, the United
Kingdom and several other European countries.

     The Company has collected health economics data with respect to the
treatment of diabetic foot ulcers during clinical trials. Utilizing the data
collected from the trials, economic models for each key country have been
completed or are being prepared to support the commercial introduction of
Dermagraft. The Company believes that doctors and third party payors recognize
the high cost of treating diabetic foot ulcers, and the Dermagraft Joint Venture
intends to price Dermagraft to be cost effective to the customer.

     During 1999, Inamed Corporation licensed rights to several of the Company's
human-based, tissue-engineered products for aesthetic and certain reconstructive
applications. In connection with these licensed rights, Inamed will be
responsible for all sales and marketing activities.

RESEARCH AND DEVELOPMENT

     The Company has invested a substantial portion of its resources into
research related to the Company's core technology, the development and clinical
trials of products related to such technology, and the development of
manufacturing systems and processes. The Company has incurred research and
development costs of $16,300,000, $15,096,000 and $18,437,000 in the years ended
December 31, 1999, 1998 and 1997, respectively, of which approximately
$12,681,000, $8,509,000 and $10,975,000 represent costs incurred for customer
sponsored research. The Company expects to continue to incur substantial
research and development costs related to its core technology, clinical trials
of products related to such technology and the development of manufacturing
processes and systems.

     The Company has established its own research and development laboratory
facilities, is collaborating with academic and medical institutions, and has
entered into agreements with several other companies and institutions to assist
in developing its technology. In the event the Company is unable to obtain or
maintain these arrangements, the Company may need to expand its own facilities
for research and development, and clinical testing. The Company may also enter
into additional arrangements with third parties for certain proposed
applications of its technology; however, there can be no assurance that such
arrangements can be obtained. The failure to obtain or maintain such
arrangements on desirable terms could have an adverse impact on the Company.


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EMPLOYEES

     As of March 16, 2000, the Company employed 196 people, of whom 61 were
engaged in research and development, 89 in operations, and 46 in marketing and
administrative functions. The Company's staff includes eighteen employees with
Ph.D. or M.D. degrees. None of the Company's employees are represented by a
labor union, and the Company believes that its employee relations are good.

DEPENDENCE ON CERTAIN SUPPLIERS

     Although most of the raw materials used in the manufacture of the Company's
Dermagraft products are available from more than one supplier, changes in
certain critical components could cause the FDA to require the Company to prove
equivalency of the materials or potentially to modify or perform additional
clinical trials for its Dermagraft and TransCyte products, which could have the
effect of restricting product available for sale. To date, the Company has not
experienced difficulty in obtaining necessary raw materials.

     The mesh framework used by the Company in Dermagraft is available under a
supply agreement with only one FDA-approved manufacturing source. Similarly, the
synthetic mesh framework used by the Company in TransCyte is only available
under a supply agreement with a different FDA-approved manufacturing source.
Because the FDA approval process requires manufacturers to specify their
proposed suppliers of active ingredients and certain component parts and
packaging materials in their applications, FDA approval of a new supplier would
be required if these materials become unavailable from the current supplier.

     Although the Company has not experienced difficulty acquiring these
materials for the manufacture of its Dermagraft and TransCyte products, no
assurance can be given that interruptions in supplies will not occur in the
future or that the Company would not have to obtain substitute vendors for these
materials. Any significant supply interruption would adversely affect the
Company's clinical trials as well as its product development and marketing
programs. In addition, an uncorrected impurity or supplier's variation in a raw
material, either unknown to the Company or incompatible with the Company's
manufacturing process, could have a material adverse effect on the Company's
ability to manufacture products.

GOVERNMENT REGULATION

     Regulation by governmental authorities in the United States and foreign
countries is a significant factor in the manufacture and marketing of the
Company's present and proposed products and in its ongoing research and product
development activities. The Company's preclinical studies and clinical trials
and the manufacturing and marketing of its products are subject to extensive,
costly and rigorous regulation by various governmental authorities in the United
States and other countries. Many of the Company's proposed products will require
regulatory approval prior to commercialization. In particular, human therapeutic
products are subject to rigorous preclinical and clinical testing as a condition
of approval by the FDA and by similar authorities in foreign countries. The
process of obtaining required regulatory approvals by the FDA and other
regulatory authorities often takes many years, is expensive and can vary
significantly based on the type, complexity and novelty of the product. There
can be no assurance that any products developed by the Company, independently or
in collaboration with others, will meet applicable regulatory criteria to
receive the required approvals for manufacturing and marketing.

     In the United States, the FDA regulates the clinical testing, manufacture,
distribution and promotion of medical devices, biologics and pharmaceuticals
pursuant to the Federal Food, Drug and Cosmetic Act (the "FD&C Act") and
regulations promulgated thereunder. The Company's TransCyte and Dermagraft
products and cartilage products are subject to regulation by the FDA as medical
devices. The Company's other tissue products, currently in various stages of
development, could be regulated as medical devices, biologic products or
pharmaceutical products. Legislative and regulatory initiatives concerning the
regulation of tissue and organ transplants are ongoing and could possibly affect
the future regulation of the Company's tissue-engineered products. It is not
possible at the present time to predict accurately either the time frame for
such action, or the ultimate effect that such initiatives could have, if any, on
the products under development by the Company. Unlike premarket approval ("PMA")
submissions for medical devices, the FDA has no regulatory time limit within
which it must review and act upon submissions treated as biologics. As a result,
the time period for final action often takes several years from submission,
usually exceeding that expected for a PMA application.

     To obtain FDA approval to market medical devices that are not substantially
equivalent to existing devices, the FDA requires proof of safety and efficacy in
human clinical trials performed under an Investigational Device


                                       17

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Exemption (an "IDE"). An IDE application must contain preclinical test data
demonstrating the safety of the product for human investigational use,
information on manufacturing processes and procedures, and proposed clinical
protocols. If the IDE application is approved, human clinical trials may begin.
The results obtained from these trials, if satisfactory, are accumulated and
submitted to the FDA in support of a PMA application. Premarket approval or
clearance from the FDA is required before commercial distribution of medical
devices can be undertaken in the United States.

     The PMA application for a medical device must be supported by extensive
data, including preclinical and human clinical trial data, to prove the safety
and efficacy of the device, and information about the device and its components
including, among other things, manufacturing, labeling and promotion. By
regulation, the FDA has 180 days to review a PMA application and during that
time an advisory committee may evaluate the application and provide
recommendations to the FDA. While the FDA has responded to PMA applications
within the allotted time period, reviews more often occur over a significantly
protracted period, often twelve to thirty-six months, and a number of devices
for which a PMA application was submitted by other companies have never been
approved for marketing. The 180-day review time is often significantly exceeded,
as the FDA may need additional information or clarification of information
provided. The FDA may also make a determination that, based on deficiencies in
the application or its interpretation of the information provided, additional
clinical trials are required. The PMA process is lengthy and expensive and there
can be no assurance that such FDA approval will be obtained.

     If the FDA's evaluation of the PMA application is favorable, the FDA
typically issues a letter requiring the applicant's agreement to specific
conditions (e.g., changes in labeling) or specific additional information to
secure final approval of the PMA application. Once the requirements are
satisfied, the FDA will issue a PMA for the approved indications, which can be
more limited than those originally sought by the manufacturer. The PMA can
include post-approval conditions that the FDA believes necessary to ensure the
safety and effectiveness of the device, such as restrictions on labeling,
promotion, sale and distribution. Failure to comply with the conditions of
approval can result in adverse enforcement action, including the loss or
withdrawal of the approval. Even after approval of a PMA, a new PMA or PMA
supplement is required in the event of certain modifications to the device, its
labeling or its manufacturing process.

     In addition, FDA regulations obligate a manufacturer to inform the FDA
whenever there is reasonable evidence to suggest that one of its devices may
have caused or contributed to death or serious injury, or where one of its
devices malfunctions and, if the malfunction were to recur, the device would be
likely to cause or contribute to a death or serious injury.

     The Company has constructed a commercial manufacturing facility for its
TransCyte and Dermagraft products. This facility must be registered, inspected,
and licensed by various regulatory authorities, including the California
Department of Health and Human Services, and must comply with FDA's Current Good
Manufacturing Practice (cGMP) requirements which set forth a framework for
medical device design, manufacturing and other quality system requirements. With
respect to the manufacture of products subject to FDAjurisdiction, the Company
will be subject to routine inspection by the FDA and certain state agencies,
including the California Department of Health and Human Services, for compliance
with cGMP requirements, adverse event reporting requirements, and other
applicable regulations.

     In general, if as a result of FDA inspections, adverse event reports or
information derived from any other source, the FDA believes the Company is not
in compliance with laws or regulations or that the Company's products pose a
significant health risk, the FDA can refuse to approve pending PMA applications;
withdraw previously approved PMA applications; require notification to users
regarding risks; request corrective labeling, promotional or advertising
materials; issue warning letters; require the Company to temporarily suspend
marketing or undertake product recalls; impose civil penalties; or institute
legal proceedings to detain or seize products, enjoin future violations, or seek
criminal penalties against the Company, its officers or employees. Civil
penalties may not be imposed for cGMP violations unless the violations involve a
significant or knowing departure from the requirements of the FD&C Act or a risk
to public health. The FDA provides manufacturers with an opportunity to be heard
prior to the assessment of civil penalties. If civil penalties are assessed,
judicial review is available.

     In addition, Congress has approved the Food and Drug Administration
Modernization Act of 1997 (the "Modernization Act"). The Modernization Act makes
changes to the device provisions of the FD&C Act and other provisions in the
Modernization Act affect the regulation of devices. Among other things, the
changes will affect the IDE and PMA processes, and also will affect device
standards and data requirements, procedures relating to


                                       18

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humanitarian and breakthrough devices, tracking and post-market surveillance,
accredited third party review, and the dissemination of off label information.
The Company cannot predict what effect the changes will have on the regulation
of the Company's products. There can be no assurance that the Company will not
incur significant costs to comply with laws and regulations in the future or
that laws and regulations will not have a material adverse effect upon the
Company's business, financial condition or results of operations.

     In addition, although the FDA has classified TransCyte as a medical device,
the state of California and the state of New York have notified us that we must
register as a tissue bank in order to manufacture or distribute TransCyte in
those states. Although some states do not regulate tissue banks, there are
certain other states besides California and New York that do. Such states could
take a position similar to California and New York with regard to the regulatory
status of TransCyte. In June 1997, we submitted a petition to the FDA requesting
an advisory opinion that the FDA's federal regulation of this product as a
medical device preempts conflicting New York statutes (laws) from regulating the
product as banked human tissue. In January 2000, the FDA denied our petition to
pre-empt applicable New York statutes. In view of the FDA's decision, the
Company has initiated discussions at the individual state level, beginning with
the State of California in an attempt to resolve this matter. Subject to the
outcome of these discussions, we and our customers could be subjected to a
costly new layer of regulation. In addition, under the laws of some states that
regulate tissue, including New York and Florida, the sale of human tissues for
valuable consideration is prohibited. We are currently distributing TransCyte in
California and New York under a provisional tissue banking license. Due to the
similarities of our products, regulations applicable to TransCyte are also
expected to apply to our Dermagraft product and potentially to our NeoCyte
product as well.

PATENTS AND PROPRIETARY RIGHTS

     The Company's ability to compete effectively will depend, in part, on its
ability to maintain the proprietary nature of its technology and manufacturing
processes. The Company relies on patents, trademarks, trade secrets, copyrights
and know-how to maintain its competitive position. As of March 1, 2000, the
Company owns thirty-eight issued patents and one allowed patent application in
the United States. In addition, thirty-seven counterparts to some of the United
States patents have issued in several foreign countries. The United States
patents expire at various times between 2005 and 2018.

     In October 1990, the Company received a United States patent on its core
technology. This product patent covers three-dimensional living stromal tissue
produced by culturing stromal cells in vitro on a biocompatible framework. The
stromal tissue provides the growth factors and structural proteins used in the
Company's three-dimensional matrix to grow organ tissues. This patent expires in
October 2007. In September 1995, the Company was granted a corresponding patent
by the European Patent Office covering a three-dimensional stromal tissue and
methods of use to grow skin, bone marrow and liver tissue. The patent will
expire in April 2007. In November 1998, the Company was granted a corresponding
patent by the Japanese patent Office. The Japanese patent will also expire in
April 2007.

     In November 1993, the Company received a United States patent relating to
Dermagraft, covering both three-dimensional dermal tissue and full-thickness
skin tissue cultured on living stromal tissue prepared in vitro and, in August
1995, received a United States patent covering the growth and implantation of
its Dermagraft dermal skin replacement. These patents expire in November 2010
and August 2012, respectively. In October 1995, a United States patent was
issued relating to TransCyte. This product patent covers a variety of
transitional burn coverings that use a synthetic membrane with an attached
dermal component. This patent will expire in October 2012.

     In July 1998, the Company received a U.S. patent covering three-dimensional
tissue products made with genetically-modified cells for gene therapy
applications. Under the technology described in the patent, genetically-modified
tissues can be grown on a biocompatible scaffold using genetically-engineered
stromal cells, genetically-engineered parenchymal cells or both. The patent
comprises both product and method of use claims. This patent will expire in July
2015. A complementary U.S. patent covering methods for preparing
genetically-modified, three-dimensional tissues was issued in January 1999. In
December 1998, the Company received a U.S. patent covering an apparatus for the
growth and packaging of three-dimensional tissue constructs. The apparatus is
presently being used by the Company as a "bioreactor" for the automated
production of Dermagraft and TransCyte products. This patent expires in December
2015.

     Furthermore, in June 1998, three U.S. patents covering the growth of
vascularized human tissues or organs on three-dimensional biocompatible,
biodegradable and non-biodegradable polymer scaffolds inside the body (in vivo)
were issued to MIT and Children's Hospital, Boston. These patents, which have
been licensed to the Company for a


                                       19

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broad range of tissues and organs, complement Advanced Tissue Sciences' core
patents covering the growth of tissues outside the body (ex vivo). The rights to
these patents extend until October 2013.

     In October 1999, the Company received a U.S. patent covering
three-dimensional stromal tissue cultures containing mesenchymal stem cells and
methods for preparing these cultures. Human mesenchymal stem cells are a
specialized type of stem cell and are believed to be the progenitors, or parent
cells, responsible for the formation of cartilage, bone, muscle, tendon,
ligament or other connective tissues. The patent covers culturing mesenchymal
stem cells in vitro on any biodegradable or non-biodegradable three-dimensional
framework, including a mesh or sponge. This patent complements the Company's
patent issued in May 1999 which covers the growth of living cartilage from
mesenchymal stem cells, chondroprogenitor cells and umbilical cord cells as well
as mature chondrocytes and fibroblasts.  This patent expires in 2006.

     In January 1999, the Company received a U.S. patent covering the tissue
engineering of three-dimensional tubular structures including but not limited to
blood vessels, living stents, gastrointestinal structures, and tissues of the
genitourinary tract. This patent gives the Company a proprietary position for
the production of these tissue replacements for the cardiovascular market and
for products addressing digestive system disorders and reproductive and urinary
dysfunction.  This patent expires in 2007.

     The Company's other patents issued in the United States cover
tissue-engineered compositions, apparatus and methods for preparing the same,
and processes for therapeutic applications and laboratory testing. These patents
expire between 2005 and 2018. The Company has additional pending United States
and foreign patent applications relating to its tissue engineering technology.
In addition, the Company has certain licensing rights to United States and
foreign patents and patent applications filed by MIT related to cell growth and
organ regeneration and repair, and biodegradable polymers, subject to certain
limitations as to applicable tissues and fields of use, and by the University of
Florida related to a stem cell proliferation factor.

     There can be no assurance that any applications will result in issued
patents or that any current or future issued or licensed patents, trade secrets
or know-how will afford protection against competitors with similar technologies
or processes, or that any patents issued will not be infringed upon or designed
around by others. In addition, there can be no assurance that others will not
independently develop proprietary technologies or processes which are the same
as or substantially equivalent to those of the Company. The Company could also
incur substantial costs in defending itself in suits brought against it on such
patents or in bringing suits to protect the Company's patents or patents
licensed by the Company against infringement. In addition to patent protection,
the Company relies on trade secrets, proprietary know-how and technological
advances which the Company seeks to protect in part by confidentiality
agreements with its collaborative partners, employees and consultants. There can
be no assurance that these agreements will not be breached, that the Company
will have adequate remedies for any breach, or that the Company's trade secrets
will not otherwise become known or independently discovered by competitors.

TECHNOLOGICAL CHANGE AND COMPETITION

     The biomedical technology industry is subject to rapid, unpredictable and
significant technological change. Competition from universities, research
institutions and pharmaceutical, chemical and biotechnology companies is
intense. Many competitors or potential competitors have greater financial
resources, research and development capabilities and manufacturing and marketing
experience than the Company. In general, the first biomedical product to be
commercialized for a particular therapeutic indication is often at a significant
competitive advantage relative to later entrants to the market. Accordingly, the
relative speed with which the Company can develop products, complete clinical
trials, obtain regulatory approvals and develop commercial manufacturing
capability may be determinative factors in establishing the Company's
competitive position. The Company's ability to attract and retain qualified
scientific, manufacturing, marketing and other personnel, obtain and maintain
patent protection and secure funding are also expected to be key competitive
factors for the Company.

     In the field of tissue engineering and the treatment of damaged or diseased
tissue, the Company competes with several companies which are developing various
tissue replacement products, including skin substitutes and cultured cartilage.
In addition, the Company is aware of a number of biotechnology, pharmaceutical,
medical device and chemical companies that are developing other types of
products as alternatives to tissue replacement for a variety of indications,
including burns and chronic skin ulcers. These treatments employ a variety of
approaches such as growth factors, tri-peptides and completely synthetic
materials.


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     In the area of burns, the Company competes primarily with cadaver skin or
porcine tissue. The Company is also aware of several companies that have
developed technologies involving processed cadaver skin used as a dermal
replacement (LifeCell Corporation), or sheets of epidermis grown from the
patient's own skin (Genzyme Tissue Repair and Cell Culture Technology). Integra
Life Sciences ("Integra") is marketing Integra Artificial Skin, consisting of a
bovine collagen and glycosaminoglycan matrix with a synthetic polymer covering,
for the treatment of burn wounds. In addition, the Company is aware that Ortec
International, Inc. is currently in a pivotal clinical trial with its composite
cultured skin product, consisting of fibroblasts and keratinocytes on a bovine
collagen sponge, for the treatment of burn wounds and in pilot clinical trials
for the treatment of chronic dermal ulcers of Epidermolysis Bullosa patients.
Several other companies are also developing or plan to develop growth factors as
a treatment for partial-thickness or small full-thickness wounds.

     In the area of diabetic foot ulcers, Chiron Corporation and the
Ortho-McNeil division of Johnson & Johnson, have received FDA approval and are
marketing a platelet-derived growth factor ("PDGF") for the treatment of
diabetic foot ulcers. In addition, Organogenesis, Inc. ("Organogenesis") has
completed clinical trials and has submitted a PMA supplement to the FDA for the
use of Apligraf, a product using cultured human cells seeded onto a bovine
collagen matrix, for the treatment of diabetic foot ulcers. Organogenesis
received FDA approval to market Apligraf in the treatment of venous ulcers in
May 1998. Organogenesis has also entered into an alliance with Novartis Pharma
AG for the marketing of Apligraf.

     With respect to cartilage repair, Genzyme Tissue Repair is currently
selling a service to process a patient's own cartilage cells as a treatment for
articular defects in the knee. The Company is aware that Integra and Osiris
Therapeutics, Inc. are also engaged in research on cartilage regeneration
products. The Company is not aware of any competitor that is developing an
off-the-shelf, human cartilage tissue that can be arthroscopically inserted.

     For all of its products, the Company expects to compete primarily on the
uniqueness of its technology and product features, on the quality and
cost-effectiveness of its products, and on the timing of commercial
introduction. The Company believes that its tissue-engineered products may have
many attributes that differentiate it from other competitors, including the fact
that the Company's products are human-based tissue products designed to be
available "off-the-shelf" to the end-users. However, other factors such as its
ability to secure regulatory approval for its products, to implement production
and marketing plans and to secure adequate capital resources, will also impact
its competitive position. There can be no assurance that the Company will have
the resources to compete successfully with such companies or that competition
generally will not adversely affect the Company's results of operations or
ability to successfully market its products.

     Sales of products will be affected by the Company's and the Dermagraft
Joint Venture's success in obtaining product reimbursement from both national
healthcare systems and private insurers.

FACTORS THAT MAY AFFECT FUTURE RESULTS

     RISKS RELATED TO OUR BUSINESS

     WE HAVE A HISTORY OF LOSSES AND MAY NOT BECOME PROFITABLE. To date, we have
experienced significant operating losses in funding the research, development,
testing and marketing of our products and expect to continue to incur
substantial operating losses. To December 31, 1999, we had incurred cumulative
net operating losses of $239.8 million. Our ability to achieve profitability
depends in part upon our ability to successfully manufacture and market
Dermagraft and TransCyte for skin ulcers and burns. We may never achieve a
profitable level of operations or even if we achieve profitability, we may not
be able to sustain it on an ongoing basis.

     IF OUR PRODUCTS FAIL IN CLINICAL STUDIES, WE WILL BE UNABLE TO OBTAIN FDA
APPROVAL AND WILL NOT BE ABLE TO SELL THOSE PRODUCTS. In order to sell our
products that are under development, and our existing products for additional
applications, we must receive regulatory approval for our products. To obtain
those approvals, we must conduct clinical studies demonstrating that our
products are safe and effective. If we cannot obtain FDA approval for a product
or any additional application of a product, that product cannot be sold and
revenues will suffer.

     Early in 1998, an FDA Advisory Panel recommended the FDA approve Dermagraft
for marketing in the United States for the treatment of diabetic foot ulcers.
The Advisory Panel's recommendation included certain conditions we would have
needed to satisfy after the commercial introduction of Dermagraft. However, in
June 1998, the FDA


                                       21

<PAGE>


requested we complete an additional controlled clinical trial to support our
application for approval to market Dermagraft for the treatment of diabetic foot
ulcers. The clinical trial began in late 1998 and the results of a planned
interim analysis of data from this trial were announced in December 1999. These
data showed that, although statistical significance was not achieved at the
interim analysis, Dermagraft was healing more ulcers than the control treatment
in those diabetic foot ulcers having a duration of greater than six weeks. In
February 2000, the FDA approved an application for an amendment to the
Investigational Device Exemption (IDE) for the clinical trial of Dermagraft in
the treatment of diabetic foot ulcers. Based on the data presented to the FDA in
December, the IDE has been amended to revise the enrollment criteria and the
statistical plan for data analysis. We are currently still conducting this
additional pivotal clinical trial. Commercial introduction within the United
States is subject to successful completion of the additional clinical trial and
FDA approval.

     Although Dermagraft appears promising based on clinical studies to date, it
may not be successful in this additional clinical trial or other future clinical
trials. Our ongoing clinical study of Dermagraft, and clinical studies of our
other products, may be delayed or halted for various reasons, including:

     *    the product is not effective, or physicians think that it is not
          effective;
     *    patients experience severe side effects during treatment;
     *    patients do not enroll in the study at the rate we expect; or
     *    product supplies are not sufficient to treat the patients in the
          study.

     In addition, the FDA and foreign regulatory authorities have substantial
discretion in the approval process. The FDA and foreign regulatory authorities
may not agree that we have demonstrated that Dermagraft, or any of our other
products, are safe and effective after we complete clinical trials.

     WE WILL NEED ADDITIONAL FUNDS TO SUPPORT OPERATIONS. IF WE ARE UNABLE TO
OBTAIN THEM, WE WOULD BE UNABLE TO COMPLETE OUR PRODUCT DEVELOPMENT PROGRAMS AND
WOULD HAVE TO REDUCE OR CEASE OPERATIONS, OR ATTEMPT TO SELL SOME OR ALL OF
OPERATIONS OR TO MERGE WITH ANOTHER ENTITY. The further development of our
technology and products as well as any further development of manufacturing
capabilities or the establishment of additional sales, marketing and
distribution capabilities will require the commitment of substantial funds. Our
existing working capital will not be sufficient to meet our needs. Potential
sources of additional funds include payments from our alliances with Smith &
Nephew and Inamed Corporation. If, for any reason, Smith & Nephew were to
terminate the Dermagraft Joint Venture or, to a lesser extent, the NeoCyte Joint
Venture, we would experience a substantial increase in the need for and use of
our working capital to support the commercialization and manufacture of our
Dermagraft and TransCyte products or the development of our orthopedic cartilage
products. We may pursue additional public or private offerings of debt or equity
securities or other means to obtain funds. We could also acquire additional
funding through collaborative arrangements or the extension of existing
arrangements, which could require the issuance of additional equity interests in
us.

     We may not satisfy the milestones for additional funds under the joint
ventures with Smith & Nephew or the Inamed alliance. We also may not be able to
obtain adequate funds under other existing or future arrangements when such
funds are needed or, if available, on terms acceptable to us.

     Insufficient funds may require us to delay, scale back or eliminate certain
of our research and product development programs or that we license third
parties the right to commercialize products or technologies that we would
otherwise commercialize ourselves or that we attempt to merge with another
entity.

     OUR PRODUCTS MAY NOT BE ACCEPTED BY THE MARKET AND MAY NOT BE SUCCESSFULLY
COMMERCIALIZED BECAUSE PHYSICIANS AND PATIENTS MAY NOT PURCHASE OR USE THEM. Our
products are based on new and innovative technologies and the medical community
or the general population may not broadly purchase or use our products as
alternatives to existing methods of treatment. Sales of our products may be
adversely affected by:

     *    their respective cost;
     *    concerns related to efficacy;
     *    the effectiveness of alternative methods of treatment; and
     *    the insufficiency of third-party reimbursement.

     Any future negative events or other unfavorable publicity involving the use
of our products could also adversely affect acceptance of our products. Both we
and Smith & Nephew have limited direct experience marketing or obtaining
third-party reimbursement for these types of products.


                                       22

<PAGE>


     Additionally, TransCyte has only been marketed and sold in the United
States for a limited period of time and may not achieve commercial acceptance in
the United States. Similarly, Dermagraft has only been sold internationally and
may never achieve commercial acceptance in the United States even if it receives
FDA approval.

     WE RELY ON THIRD PARTIES TO MARKET, DEVELOP AND SELL OUR PRODUCTS AND THOSE
THIRD PARTIES MAY NOT PERFORM SUCCESSFULLY. OUR DEPENDENCE ON THIRD PARTIES AND
OUR LACK OF SALES AND MARKETING PERSONNEL COULD LIMIT OUR ABILITY TO DEVELOP OUR
PRODUCTS OR TO GENERATE REVENUES FROM PRODUCT SALES. We are particularly
dependent on Smith & Nephew with respect to the Dermagraft Joint Venture and
NeoCyte Joint Venture. The amount and timing of resources to be devoted by Smith
& Nephew is not within our control. In addition, the Dermagraft and NeoCyte
Joint Venture agreements provide that they may be terminated prior to their
expiration under certain circumstances that are outside our control. If Smith &
Nephew does not perform its obligations as expected or if Smith & Nephew has a
strategic shift in its business focus, it would be difficult for us to
successfully complete the development efforts of the Dermagraft Joint Venture
and NeoCyte Joint Venture. We are relying on Smith & Nephew and others to market
our products both domestically and internationally.

     Our success in generating market acceptance of Dermagraft and TransCyte
will depend on the marketing efforts of Smith & Nephew. We cannot control the
amount and timing of resources that Smith & Nephew or others may devote to
marketing and selling our products. Smith & Nephew may not perform its
obligations under the Dermagraft Joint Venture as expected. Our failure to
achieve broad use of Dermagraft for the treatment of diabetic foot ulcers and,
to a lesser extent, TransCyte for burn care, would hurt our ability to generate
revenues and any future profits.

     To the extent that we choose not to or are unable to establish such
arrangements, we would experience increased capital requirements to undertake
research, development and marketing of our proposed products at our own expense.
If we are not able to meet these expenses we may be unable to continue our
operations.

     IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WE MAY BE UNABLE TO
PREVENT OTHER COMPANIES FROM USING OUR TECHNOLOGY IN COMPETITIVE PRODUCTS. IF WE
INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WE MAY BE PREVENTED FROM
DEVELOPING OR MARKETING OUR PRODUCTS. Our ability to compete effectively will
depend, in part, on our ability to maintain the proprietary nature of our
technology and manufacturing processes. Our competitors may develop similar
products that are the same as our products and market those products after our
patents expire, or may design around our existing patents. If this happens,
sales of our products would suffer and our ability to generate revenues will be
severely impacted. Furthermore, patents may be issued to others that prevent the
manufacture or sale of our products. We may have to pay significant fees or
royalties to license those patents in order to continue marketing our products.
This would cause any future profits on sales of our products to decline.

     Our dependence upon having exclusive rights to the technology covered under
our owned or licensed patents and patent applications is subject to the
following risks:

     *    applications may not result in issued patents;
     *    current or future issued or licensed patents, trade secrets or
          know-how may not afford protection against competitors with similar
          technologies or processes;
     *    any patents issued may be infringed upon or designed around by others;
          or
     *    others may independently develop technologies or processes that are
          the same as or substantially equivalent to ours.

     In addition to patent protection, we also rely on trade secrets, know-how
and technology advances. We enter into confidentiality agreements with our
employees and others, but these agreements may not be effective in protecting
our proprietary information. Others may independently develop substantially
equivalent information or obtain access to our know-how.

     Litigation, which is very expensive, may be necessary to enforce or defend
our patents or rights and may not end favorably for us. Any of our licenses,
patents or other intellectual property may be challenged, invalidated, canceled,
infringed or circumvented and may not provide any competitive advantage to us.


                                       23


<PAGE>


     IF THE THIRD-PARTY SUPPLIERS THAT SUPPLY THE MATERIALS NECESSARY TO
MANUFACTURE OUR PRODUCTS DO NOT SUPPLY QUALITY MATERIALS IN A TIMELY MANNER, IT
MAY DELAY OR IMPAIR OUR ABILITY TO DEVELOP AND COMMERCIALIZE PRODUCTS ON A
TIMELY AND COMPETITIVE BASIS OR ADVERSELY AFFECT OUR POTENTIAL FUTURE
PROFITABILITY. Although most of the raw materials used in the manufacture of our
Dermagraft and TransCyte products are available from more than one supplier,
changes in certain critical components could cause the FDA to require us to
prove equivalency of the materials or potentially to modify or perform
additional clinical trials for our Dermagraft and TransCyte products, which
could have the effect of restricting our ability to commercialize our products.

     The mesh framework used by us in the manufacture of Dermagraft is available
under a supply agreement with only one FDA-approved manufacturing source.
Similarly, the synthetic mesh framework used by us in the manufacture of
TransCyte is only available under a supply agreement with a different
FDA-approved manufacturing source. Because the FDA approval process requires
manufacturers to specify their proposed suppliers of active ingredients and
certain component parts and packaging materials in their applications, FDA
approval of a new supplier would be required if these materials become
unavailable from the current supplier.

     Interruptions in supplies for the manufacture of our Dermagraft and
TransCyte products may occur in the future and we may have to obtain substitute
vendors for these materials. Any significant supply interruption would delay our
clinical trials as well as our product development and marketing programs. In
addition, an uncorrected impurity or supplier's variation in a raw material,
either unknown to us or incompatible with our manufacturing process, could
prevent or delay our ability to manufacture products.

     IF OUR PRODUCTS THAT ARE IN AN EARLY STAGE OF DEVELOPMENT ARE NEVER
SUCCESSFULLY COMMERCIALIZED WE MAY NOT HAVE REVENUES TO CONTINUE OPERATIONS. We
have products that are in an early stage of development. To date, only TransCyte
has been approved for commercial sale and only Dermagraft has advanced to
clinical trials for the treatment of diabetic foot ulcers, in the United States.
However, Dermagraft will still require further marketing approvals from the FDA,
and all of our other products are at earlier stages of research, development and
testing. These products, including additional indications for Dermagraft and
TransCyte, will require significant additional research and development, as well
as extensive preclinical and clinical testing.

     Since our products are based on innovative technologies, there are many
reasons why our products may not advance beyond their early stage of
development. These reasons include the possibilities that

     *    any or all of these products will be found to be unsafe or ineffective
          or otherwise fail to receive necessary regulatory approvals;
     *    our products are uneconomical to market;
     *    third parties may hold legal rights that preclude us from marketing
          such products; or
     *    our products fail to achieve market acceptance in light of competing
          technologies and products.

     RISKS RELATED TO OUR INDUSTRY

     IF WE FAIL TO OBTAIN REGULATORY APPROVAL TO COMMERCIALLY MANUFACTURE OR
SELL ANY OF OUR PRODUCTS, OR IF APPROVAL IS DELAYED, IT COULD INCREASE THE COST
OF PRODUCT DEVELOPMENT, OR ULTIMATELY PREVENT OR DELAY OUR ABILITY TO SELL OUR
PRODUCTS AND GENERATE REVENUES. We and our collaborators are subject to
extensive government regulation. The FDA and other state and foreign regulatory
authorities require rigorous preclinical testing, clinical trials and other
product approval procedures for our products. Numerous regulations also govern
the manufacturing, safety, labeling, storage, record keeping, reporting and
marketing of our products. The process of obtaining these approvals and
complying with applicable government regulations is time consuming and
expensive. The FDA and other state or foreign regulatory authorities have
limited experience with our technology and products. As a result, our products
are susceptible to requests for clinical modifications or additional supportive
data, or changes in regulatory policy, which could substantially extend the test
period for our products resulting in delays or rejections. Even after
substantial time and expense, we may not be able to obtain regulatory product
approval by the FDA or any equivalent state or foreign authorities. If we obtain
regulatory product approval, the approval may limit the uses for which we may
market the product.

     For example, in June 1998, the FDA indicated that our marketing application
for Dermagraft for the treatment of diabetic foot ulcers was not approvable
without supportive data from an additional clinical trial. We are currently
conducting the additional clinical trial as requested by the FDA. If the trial
is not successful or if we do not receive FDA approval at the conclusion of the
clinical trial it will prevent or at least delay sales of Dermagraft.


                                       24

<PAGE>


     In addition, although the FDA has classified TransCyte as a medical device,
the state of California and the state of New York have notified us that we must
register as a tissue bank in order to manufacture or distribute TransCyte in
those states. Although some states do not regulate tissue banks, there are
certain other states besides California and New York that do. Such states could
take a position similar to California and New York with regard to the regulatory
status of TransCyte. In June 1997, we submitted a petition to the FDA requesting
an advisory opinion that the FDA's federal regulation of this product as a
medical device preempts conflicting New York statutes (laws) from regulating the
product as banked human tissue. In January 2000, the FDA denied our petition to
pre-empt applicable New York statutes. In view of the FDA's decision, the
Company has initiated discussions at the individual state level, beginning with
the State of California in an attempt to resolve this matter. Subject to the
outcome of these discussions, we and our customers could be subjected to a
costly new layer of regulation. In addition, under the laws of some states that
regulate tissue, including New York and Florida, the sale of human tissues for
valuable consideration is prohibited. We are currently distributing TransCyte in
California and New York under a provisional tissue banking license. Due to the
similarities of our products, regulations applicable to TransCyte are also
expected to apply to our Dermagraft product and potentially to our NeoCyte
product as well.

     After regulatory approval is obtained, our product, its manufacture and
related manufacturing facilities will be subject to continual review and
periodic inspections. Any subsequent discovery of previously unknown problems
with a product, manufacturer or facility may result in restrictions on the
product or manufacturer, including withdrawal of the product from the market.
For example, after inspecting the manufacturing facility early in 1998 in
conjunction with our application for the approval of Dermagraft for the
treatment of diabetic foot ulcers, the FDA notified us of numerous objectionable
conditions under a Form FDA 483 list of observations. These observations
concerned our manufacturing processes and systems for Dermagraft and TransCyte.
In March 1998, the FDA issued a warning letter requiring us to investigate and
correct the conditions identified by the FDA. In September 1998, we successfully
completed a reinspection by the FDA of our manufacturing facility and quality
systems. However, we must continue to pass future facility inspections by the
FDA and foreign regulatory authorities.

     Our research and development activities and operations involve the
controlled use of small quantities of radioactive compounds, chemical solvents
and other hazardous materials. In addition, our business involves the growth of
human tissues. In the event of an accident, we could be held liable for any
damages that result. In addition, these research activities and operations are
subject to continual review under the Occupational Safety and Health Act, the
Environmental Protection Act, the Toxic Substances Control Act, the Resource
Conservation and Recovery Act and other federal, state or local laws and
regulations which impact our ability to develop and market our products.

     HEALTHCARE REFORM MEASURES AND REIMBURSEMENT PROCEDURES MAY PREVENT US FROM
OBTAINING AN ADEQUATE LEVEL OF REIMBURSEMENT FOR OUR PRODUCTS THAT IN TURN WOULD
DECREASE OUR ABILITY TO GENERATE REVENUES. Our ability to commercialize products
successfully will depend in part on the extent to which reimbursement for the
costs of such products and related treatments will be available from government
health administration authorities, private health insurers and other
organizations. In the United States, government and other third-party payors are
increasingly attempting to contain healthcare costs by limiting both coverage
and the level of reimbursement for new products approved for marketing by the
FDA. In some cases, such payors may refuse to provide any coverage for uses of
approved products for indications that the FDA has not granted marketing
approval. Initiatives to reform healthcare delivery are increasing these cost
containment efforts. As managed care organizations continue to expand as a means
of containing healthcare costs, we believe there may be attempts by such
organizations to restrict the use of, delay authorization to use, or limit
coverage and the level of reimbursement for, new products, such as those being
developed and commercialized by us, pending completion of cost/benefit analyses
of such products by those managed care organizations. Internationally, where
national healthcare systems are prevalent, little if any funding may be
available for new products, and cost containment and cost reduction efforts can
be more pronounced than in the United States.

     We have supported health economics studies and research and have developed
cost offset or cost-effectiveness models with respect to our TransCyte and
Dermagraft products in an effort to help obtain appropriate and adequate third
party coverage and reimbursement for these products. However, these products are
novel and as such are subject to inherent uncertainty in the area of
reimbursement. Adequate government or private payor coverage or levels of
reimbursement may not be available for any of our products and we may not be
able to maintain price levels sufficient for the realization of an appropriate
return on our investment in such products. Failure to obtain sufficient coverage
and reimbursement levels for uses of our products could decrease the market
acceptance of such products.


                                       25

<PAGE>


     DISCOVERIES OR DEVELOPMENT OF NEW TECHNOLOGIES BY OUR COMPETITORS OR OTHERS
MAY MAKE OUR PRODUCTS LESS COMPETITIVE OR MAKE OUR PRODUCTS OBSOLETE. The
biomedical technology industry is subject to rapid, unpredictable and
significant technological change. Competition from universities, research
institutions and pharmaceutical, chemical and biotechnology companies is
intense. Many competitors or potential competitors have greater financial
resources, research and development capabilities and manufacturing and marketing
experience than we do. In general, the first biomedical product to be
commercialized for a particular therapeutic indication is often at a significant
competitive advantage relative to later entrants to the market. Accordingly, the
relative speed with which we can develop products, complete clinical trials,
obtain regulatory approvals and develop commercial manufacturing capability may
affect our competitive position.

     Other factors such as our ability to secure regulatory approval for our
products, to implement production and marketing plans, and to secure adequate
capital resources will also impact our competitive position. We may not have the
resources to compete successfully.

     IF WE ARE NOT ABLE TO ATTRACT KEY PERSONNEL AND ADVISORS OR IF OUR CURRENT
MANAGEMENT AND TECHNICAL PERSONNEL LEAVE THE COMPANY, IT MAY ADVERSELY AFFECT
OUR ABILITY TO OBTAIN FINANCING OR TO DEVELOP OUR PRODUCTS. Our success will
depend in large part upon our ability to attract and retain qualified
scientific, administrative and management personnel as well as the continued
contributions of our existing senior management and scientific and technical
personnel. We face strong competition for such personnel and we cannot give any
assurance that we will be able to attract or retain such individuals. In
particular, if we lose the services of either Arthur J. Benvenuto, our Chairman
and Chief Executive Officer, or Dr. Gail K. Naughton, our President and Chief
Operating Officer, it will limit our ability to achieve our business objectives
and could make it difficult to raise additional funds or to attract partners.

     WE MAY NOT HAVE ADEQUATE INSURANCE AND IF WE BECOME SUBJECT TO PRODUCT
LIABILITY CLAIMS, IT MAY RESULT IN REDUCED DEMAND FOR OUR PRODUCTS OR DAMAGES
THAT EXCEED OUR INSURANCE LIMITATIONS. The use of any of our products, whether
for commercial applications or during clinical trials, exposes us to an inherent
risk of product liability claims in the event such products cause injury,
disease or result in adverse effects. Such liability might result from claims
made directly by healthcare institutions, contract laboratories or others
selling or using such products. We currently maintain product liability
insurance coverage; however, such insurance coverage might not be sufficient to
fully cover any potential claims. Such insurance can be expensive and difficult
to obtain. Adequate insurance coverage may not be available in the future at an
acceptable cost, if at all, or in sufficient amounts to protect us against any
such liability. Any product liability claim in excess of insurance coverage
would have to be paid out of our cash reserves which would have a detrimental
effect on our financial condition.

     DISCOVERY OF PREVIOUSLY UNKNOWN PROBLEMS WITH A PRODUCT, MANUFACTURER, OR
FACILITY, COULD RESULT IN PRODUCT RECALLS OR WITHDRAWALS AND SIGNIFICANTLY
REDUCE OUR RESOURCES. Our tissue repair and transplantation products are complex
and must be manufactured under well-controlled and sterile conditions, in
addition to meeting strict product release criteria. Any manufacturing errors or
defects, or uncorrected impurity or variation in a raw material, either unknown
or undetected by us, could affect the quality and safety of our products. If any
of the defects were material, we could be required to undertake a market
withdrawal or recall of the affected products. The cost of a market withdrawal
or product recall could significantly reduce our resources.

     RISKS RELATED TO FINANCING

     OUR STOCK PRICE COULD CONTINUE TO BE VOLATILE AND ANY INVESTMENT COULD
SUFFER A DECLINE IN VALUE, ADVERSELY AFFECTING OUR ABILITY TO RAISE ADDITIONAL
CAPITAL WHICH COULD IN TURN DELAY COMMERCIALIZATION OF OUR PRODUCTS. The market
price of our common stock has fluctuated significantly in recent years and is
likely to fluctuate in the future. For example, from December 1997 to December
1999, our common stock has closed as high as $18.50 per share and as low as
$1.75 per share. Factors contributing to this volatility have included:

     *    the results of research or scientific discoveries by us or others; o
          progress or the results of preclinical and clinical trials;
     *    new technological innovations
     *    the approval and commercialization of products;
     *    developments concerning technology rights;
     *    litigation and related developments; and
     *    public perception regarding the safety and efficacy of our products.


                                       26

<PAGE>


Fluctuations in our financial performance from period to period, the issuance of
analysts' reports and general industry and market conditions also tend to have a
significant impact on the market price of our common stock.

     FUTURE SALES OF OUR  SECURITIES  IN THE PUBLIC MARKET COULD LOWER OUR STOCK
PRICE AND IMPAIR OUR ABILITY IN NEW STOCK  OFFERINGS  TO RAISE FUNDS TO CONTINUE
OPERATIONS.  The  market  price of our  securities  could drop due to sales of a
large number of our securities or the  perception  that these sales could occur.
Such sales also might make it more difficult for us to sell equity securities in
the future at a price that we deem appropriate.

     OUR CHARTER DOCUMENTS AND STOCKHOLDER RIGHTS PLAN MAY PREVENT US FROM
PARTICIPATING IN TRANSACTIONS THAT COULD BE BENEFICIAL TO STOCKHOLDERS. Our
stockholder rights plan and provisions in our certificate of incorporation and
bylaws may discourage transactions involving an actual or potential change in
our ownership, including transactions in which you might otherwise receive a
premium for your shares over the then-current market prices. These provisions
also may limit our stockholder's ability to approve transactions that they deem
to be in their best interest. In addition, our Board of Directors may issue
shares of preferred stock without any further action by stockholders. Such
issuances may have the effect of delaying or preventing a change in our
ownership.

ITEM 2.  PROPERTIES

     The Company leases approximately 85,000 square feet of space at its
headquarters facility, of which approximately 89% is allocated to manufacturing
and research. The leases for this facility expire in December 2005. In addition,
the Company leases approximately 6,900 square feet of manufacturing and research
space under a five-year lease that expires in 2002. The Company's facilities are
all located in San Diego, California.

     The Company believes that its property and equipment are generally well
maintained,  in good operating  condition and are sufficient to meet its current
needs.

ITEM 3.  LEGAL PROCEEDINGS

     There is no material litigation currently pending against the Company.

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

     There were no matters submitted to vote of security holders during the
quarter ended December 31, 1999.


                                       27


<PAGE>


                                     PART II

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

MARKET INFORMATION

     The Company's Common Stock is traded on the National Association of
Securities Dealers Automated Quotation ("Nasdaq") National Market under the
symbol ATIS. The last reported high and low sales prices as reported for the
Company's Common Stock by Nasdaq for the last two fiscal years are set forth
below.

                                            HIGH              LOW
                                           ------           -------
    YEAR ENDED DECEMBER 31, 1999:

       First Quarter                       $ 3.25           $ 1.78
       Second Quarter                        6.00             1.94
       Third Quarter                         3.91             2.88
       Fourth Quarter                        3.94             2.13

    YEAR ENDED DECEMBER 31, 1998:

       First Quarter                       $15.63           $ 9.13
       Second Quarter                       11.38             3.50
       Third Quarter                         5.25             1.75
       Fourth Quarter                        4.09             2.03

     From May through November 1999, the Company sold 783,039 shares of the
Company's Common Stock to Inamed Corporation at an average price of $6.39 per
share for a total purchase price of $5,000,000 in cash. In addition, Inamed
received five-year warrants to purchase up to 500,000 shares of common stock at
an average price of $12.80 per share. The transactions were exempt from
registration with the Securities and Exchange Commission under Section 4(2) of,
and Regulation D promulgated under, the Securities Act of 1933, as amended.

HOLDERS

     As of December 31, 1999, there were 1,515 holders of record of the
Company's Common Stock.

DIVIDENDS

     The Company has never paid cash dividends on its Common Stock and does not
expect to pay any cash dividends in the foreseeable future.

ITEM 6. SELECTED FINANCIAL DATA

     The selected financial data of the Company appears in a separate section of
this Annual Report on Form 10-K on page F-1.

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

     Management's discussion and analysis of financial condition and results of
operations appears in a separate section of this Annual Report on Form 10-K
beginning on page F-2.

ITEM 7A. MARKET RISK

     Information concerning market risk relating to the Company's financial
instruments is presented in management's discussion and analysis of financial
condition and results of operations beginning on page F-2 of this Annual
Report on Form 10-K.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The Company's financial statements and schedules, as listed under Item 14,
appear in a separate section of this Annual Report on Form 10-K beginning on
page F-9.

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

     During the two years prior to the date of the most recent financial
statements and the subsequent interim period, the Company has not had a change
in its independent auditors nor have there been any disagreements between the
Company and its independent auditors.


                                       28


<PAGE>


                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The sections titled "Directors and Nominees", "Board Meetings and
Committees" and "Executive Officers" appearing in the Company's Proxy Statement
for the 2000 Annual Meeting of Stockholders are incorporated herein by
reference.

ITEM 11. EXECUTIVE COMPENSATION

     The section titled "Executive Compensation" appearing in the Company's
Proxy Statement for the 2000 Annual Meeting of Stockholders is incorporated
herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The section titled "Principal Stockholders" appearing in the Company's
Proxy Statement for the 2000 Annual Meeting of Stockholders is incorporated
herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The section titled "Certain Transactions" appearing in the Company's Proxy
Statement for the 2000 Annual Meeting of Stockholders is incorporated herein by
reference.

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

     (a)(1) Financial Statements:
            --------------------

     The following financial statements of the Company and of the Dermagraft
Joint Venture are included in a separate section of this Annual Report on Form
10-K commencing on the pages referenced below:

<TABLE>
<CAPTION>

                                                                                                 Page
                                                                                             ------------
     <S>                                                                                     <C>
     Consolidated Financial Statements of Advanced Tissue Sciences, Inc.:
         Consolidated Balance Sheets as of December 31, 1999 and 1998...................          F-9
         Consolidated Statements of Operations for the Years Ended December 31,
          1999, 1998 and 1997...........................................................         F-10
         Consolidated Statements of Cash Flows for the Years Ended December 31,
          1999, 1998 and 1997...........................................................         F-11
         Consolidated Statements of Stockholders' Equity for the Years Ended
           December 31, 1999, 1998 and 1997.............................................         F-12
         Notes to the Consolidated Financial Statements.................................     F-13 to F-25
         Report of Ernst & Young LLP, Independent Auditors..............................         F-26
     Combined Financial Statements of the Dermagraft Joint Venture:
         Combined Balance Sheets as of December 31, 1999 and 1998.......................         F-27
         Combined Statements of Operations for the Years Ended December 31,
          1999, 1998 and 1997...........................................................         F-28
         Combined Statements of Cash Flows for the Years Ended December 31,
          1999, 1998 and 1997...........................................................         F-29
         Combined Statements of Partners' Capital for the Years Ended December 31,
          1999, 1998 and 1997...........................................................         F-30
         Notes to the Combined Financial Statements.....................................     F-31 to F-33
         Report of Ernst & Young LLP, Independent Auditors..............................         F-34
</TABLE>


     (2) Financial Statement Schedules:
         -----------------------------

     All schedules have been omitted, since they are not applicable, not
required or the information is included in the financial statements or the notes
thereto.


                                       29


<PAGE>


     (3) Exhibits:
         --------
<TABLE>
<CAPTION>


   Exhibit
     No.                         Title                                     Method of Filing
   -------                       -----                                     ----------------
    <S>            <C>                                             <C>
     3.1           Restated Certificate of Incorporation of        Incorporated by Reference to Exhibit 3.1 to
                   Advanced Tissue Sciences, Inc. as in            the Registrant's Annual Report on Form 10-K
                   effect on February 16, 1999                     for the Year Ended December 31, 1998

     3.2           Restated By-Laws of the Registrant Dated        Incorporated by Reference to Exhibit 3 to the
                   September 17, 1991                              Registrant's Form 10-Q for the Quarter Ended
                                                                   October 31, 1991

     3.3           Certificate of Designations, Preferences        Incorporated by Reference to Exhibit 3.1 to
                   and Rights of Series B Convertible              the Registrant's Current Report on Form 8-K
                   Preferred Stock of Advanced Tissue              dated July 10, 1998
                   Sciences, Inc.

     4.1           Rights Agreement, Dated as of January 6,        Incorporated by Reference to Exhibit 1 to the
                   1995, between the Company and Chemical          Registrant's Current Report on Form 8-K dated
                   Trust Company of California, including          January 5, 1995
                   the Certificate of Determination for the
                   Series A Junior Participating Preferred
                   Stock as Exhibit A, the Form of Summary
                   of Rights to Right Certificate as
                   Exhibit B and the Purchase Preferred
                   Shares as Exhibit C

     4.2           First Amendment to Rights Agreement             Incorporated by Reference to Exhibit 1 to the
                   entered into as of November 8, 1999,            Registrant's Form 8-A, as amended, dated
                   between ChaseMellon Shareholder                 November 10, 1999
                   Services, L.L.C. and Advanced Tissue
                   Sciences, Inc.

     4.3           Second Amendment to Rights Agreement            Incorporated by Reference to Exhibit 1 to the
                   entered into as of December 13, 1999,           Registrant's Form 8-A, as amended, dated
                   between ChaseMellon Shareholder                 March 28, 2000
                   Services, L.L.C. and Advanced Tissue
                   Sciences, Inc.

     4.4           Common Stock Purchase Warrant between           Incorporated by Reference to Exhibit 4.1 to
                   the State of Wisconsin Investment Board         the Registrant's Form 10-Q for the Quarter
                   as Trustee for the Fixed Retirement             Ended September 30, 1999
                   Investment Trust and Advanced Tissue
                   Sciences, Inc. Dated November 10, 1999

     4.5           Common Stock Purchase Warrant between           Incorporated by Reference to Exhibit 4.2 to
                   the State of Wisconsin Investment Board         the Registrant's Form 10-Q for the Quarter
                   as Trustee for the Variable Retirement          Ended September 30, 1999
                   Investment Trust and Advanced Tissue
                   Sciences, Inc. Dated November 10, 1999

    10.1           Form of Indemnification Agreement               Incorporated by Reference to Exhibit 10.6 to
                   Between the Company and Each of the             the Registrant's Annual Report on Form 10-K
                   Directors of the Company                        for the Year Ended January 31, 1991

    10.2+          Nonqualified Stock Option Agreement,            Incorporated by Reference to Exhibit 19.1 to
                   Dated June 3, 1991 between the Company          the Registrant's Form 10-Q for the Quarter
                   and Arthur J. Benvenuto                         Ended July 31, 1991

    10.3+          Nonqualified Stock Option Agreement,            Incorporated by Reference to Exhibit 19.2 to
                   Dated June 3, 1991 between the Company          the Registrant's Form 10-Q for the Quarter
                   and Dr. Gail K. Naughton                        Ended July 31, 1991

</TABLE>


                                       30


<PAGE>


<TABLE>
<CAPTION>


   Exhibit
     No.                         Title                                     Method of Filing
   -------                       -----                                     ----------------
    <S>            <C>                                             <C>
    10.4**+        Advanced Tissue Sciences, Inc. 1997             Incorporated by Reference to Exhibit 99.1 to
                   Stock Incentive Plan                            the Registrant's Registration Statement No.
                                                                   333-36879 on Form S-8

    10.4(a)+       Form of Stock Option Agreement                  Incorporated by Reference to Exhibit 99.2 to
                                                                   the Registrant's Registration Statement No.
                                                                   333-36879 on Form S-8

    10.4(b)+       Form of Addendum to Stock Option                Incorporated by Reference to Exhibit 99.3 to
                   Agreement re: Involuntary Termination           the Registrant's Registration Statement No.
                                                                   333-36879 on Form S-8

    10.4(c)+       Form of Stock Issuance Agreement                Incorporated by Reference to Exhibit 99.4 to
                                                                   the Registrant's Registration Statement No.
                                                                   333-36879 on Form S-8

    10.4(d)+       Form of Addendum to Stock Issuance              Incorporated by Reference to Exhibit 99.5 to
                   Agreement re: Involuntary Termination           the Registrant's Registration Statement No.
                                                                   333-36879 on Form S-8

    10.4(e)        Form of Automatic Stock Option Agreement        Incorporated by Reference to Exhibit 99.6 to
                                                                   the Registrant's Registration Statement No.
                                                                   333-36879 on Form S-8

    10.5+          Form of Special Addendum to Certain             Incorporated by Reference to Exhibit 10.1 to
                   Employee Stock Option Agreements                the Registrant's Form 10-Q for the Quarter
                                                                   Ended March 31, 1996

    10.6(a)        Licensing Agreement between the                 Incorporated by Reference to Exhibit 10.8(a)
                   Massachusetts Institute of Technology           to the Registrant's Transition Report on
                   and Advanced Tissue Sciences, Inc. Dated        Form 10-K for the Eleven Months Ended
                   July 24, 1992                                   December 31, 1992

    10.7*          Agreement between Advanced Tissue               Incorporated by Reference to Exhibit 10.1 to
                   Sciences, Inc. and Smith & Nephew plc           the Registrant's Form 10-Q for the Quarter
                   Dated May 6, 1994                               Ended March 31, 1994

    10.8           Heads of Agreement between Advanced             Incorporated by Reference to Exhibit 10.1 to
                   Tissue Sciences, Inc. and Smith & Nephew        the Registrant's Form 10-Q for the Quarter
                   plc Dated April 29, 1996                        Ended March 31, 1996

    10.9           Promissory Note Between Advanced Tissue         Incorporated by Reference to Exhibit 10.2 to
                   Sciences, Inc. and Smith & Nephew SNATS,        the Registrant's Form 10-Q for the Quarter
                   Inc. Dated June 11, 1997                        Ended June 30, 1997

    10.10(a)       U.S. $16,000,000 Loan Facility to               Incorporated by Reference to Exhibit 10.1 to
                   DermEquip, L.L.C. Provided by The Chase         the Registrant's Form 10-Q for the Quarter
                   Manhattan Bank Dated August 12, 1997            Ended September 30, 1997

    10.10(b)       Guaranty Between Advanced Tissue                Incorporated by Reference to Exhibit 10.2 to
                   Sciences, Inc. and The Chase Manhattan          the Registrant's Form 10-Q for the Quarter
                   Bank Dated August 8, 1997                       Ended September 30, 1997

    10.11(a)       Heads of Agreement Dated January 14,            Incorporated by Reference to Exhibit 10.1 to
                   1998 between Advanced Tissue Sciences,          the Registrant's Current Report on Form 8-K
                   Inc. and Smith & Nephew plc                     Dated January 14, 1998

</TABLE>


                                       31


<PAGE>


<TABLE>
<CAPTION>


   Exhibit
     No.                        Title                                     Method of Filing
   -------                      -----                                     ----------------
   <S>             <C>                                             <C>
   10.11(b)        Common Stock Purchase Agreement, Dated          Incorporated by Reference to Exhibit 10.2 to
                   January 14, 1998, between Advanced              the Registrant's Current Report on Form 8-K
                   Tissue Sciences, Inc. and Smith & Nephew        Dated January 14, 1998
                   SNATS, Inc.

   10.12           Heads of Agreement between Advanced             Incorporated by Reference to Exhibit 10.1 to
                   Tissue Sciences, Inc. and Smith & Nephew        the Registrant's Form 10-Q for the Quarter
                   plc Dated August 6, 1998                        Ended June 30, 1998

   10.13(a)        Securities Purchase Agreement by and            Incorporated by Reference to Exhibit 10.1 to
                   among Advanced Tissue Sciences, Inc. and        the Registrant's Current Report on Form 8-K
                   the Investors Dated July 10, 1998               dated July 10, 1998

   10.13(b)        Registration Rights Agreement by and            Incorporated by Reference to Exhibit 10.2 to
                   among Advanced Tissue Sciences, Inc. and        the Registrant's Current Report on Form 8-K
                   the Investors Dated July 10, 1998               dated July 10, 1998

   10.13(c)        Redemption Amendment Agreement by and           Incorporated by Reference to Exhibit 10.1 to
                   among Advanced Tissue Sciences, Inc. and        the Registrant's Current Report on Form 8-K
                   the Buyers of Series B Convertible              dated November 6, 1998
                   Preferred Stock Dated November 6, 1998

   10.14*          Heads of Agreement between Advanced             Incorporated by Reference to Exhibit 10.1 to
                   Tissue Sciences, Inc. and Inamed                the Registrant's Current Report on Form 8-K,
                   Corporation dated May 10, 1999                  as amended, dated November 2, 1999

   10.15           Securities Purchase Agreement dated as          Incorporated by Reference to Exhibit 2 to the
                   of November 5, 1999, between the State          Registrant's Form 8-A, as amended, dated
                   of Wisconsin Investment Board and               November 10, 1999
                   Advanced Tissue Sciences, Inc.

   21              Subsidiaries of the Registrant                  Filed Herewith

   23              Consent of Ernst & Young LLP,                   Filed Herewith
                   Independent Auditors

   27              Financial Data Schedule                         Filed With Electronic Copy Only

</TABLE>

-------------------
*    The Company has requested confidential treatment with respect to certain
     portions of these documents.
**   Key employees (including officers and directors), non-employee Board
     members and independent consultants are eligible to participate in the 1997
     Stock Incentive Plan.
+    Management contract or compensatory plan or arrangement.

     (b) Reports on Form 8-K
         -------------------

     On November 2, 1999, the Company filed an amendment to its Current Report
on Form 8-K dated May 10, 1999 releasing certain information regarding the Heads
of Agreement dated May 10, 1999 with Inamed Corporation from confidential
treatment.


                                       32


<PAGE>


                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.


                                                  ADVANCED TISSUE SCIENCES, INC.


Date:      March 27, 2000                         By:   /s/ Arthur J. Benvenuto
     ---------------------------                     --------------------------
                                                     Arthur J. Benvenuto
                                                     Chairman of the Board of
                                                       Directors and Chief
                                                       Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been executed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>

               Signature                                   Title                             Date
               ---------                                   -----                             ----
<S>                                         <C>                                         <C>

  /s/ Arthur J. Benvenuto                   Chairman of the Board of Directors          March 27, 2000
----------------------------------------    and Chief Executive Officer
         Arthur J. Benvenuto                (principal executive officer)

  /s/ Dr. Gail K. Naughton                  Director, President and Chief               March 27, 2000
----------------------------------------    Operating Officer
         Dr. Gail K. Naughton

  /s/ Michael V. Swanson                    Senior Vice President and Chief             March 27, 2000
----------------------------------------    Financial Officer (principal financial
         Michael V. Swanson                 and accounting officer)

  /s/ Jerome E. Groopman, M.D.              Director                                    March 27, 2000
----------------------------------------
         Jerome E. Groopman, M.D.

  /s/ Jack L. Heckel                        Director                                    March 27, 2000
----------------------------------------
         Jack L. Heckel

  /s/ Ronald L. Nelson                      Director                                    March 27, 2000
----------------------------------------
         Ronald L. Nelson

  /s/ Dayton Ogden                          Director                                    March 27, 2000
----------------------------------------
         Dayton Ogden

  /s/ David S. Tappan, Jr.                  Director                                    March 27, 2000
----------------------------------------
         David S. Tappan, Jr.

  /s/ Dr. Gail R. Wilensky                  Director                                    March 27, 2000
----------------------------------------
         Dr. Gail R. Wilensky
</TABLE>


                                       33


<PAGE>


                             SELECTED FINANCIAL DATA

     See Note 1 to the accompanying consolidated financial statements for a
discussion of the basis of presentation. This summary of selected financial data
should be read in conjunction with the consolidated financial statements and
notes presented on pages F-9 to F-25.

<TABLE>
<CAPTION>

                                                             Year Ended December 31,
                                         -----------------------------------------------------------
                                            1999         1998         1997        1996        1995
                                         ----------   ----------   ----------  ----------  ----------
                                                    (In thousands, except per share amounts)
<S>                                      <C>          <C>          <C>         <C>         <C>
Revenues:
   Product sales (1)                     $  13,717    $  11,962    $   2,166   $  1,018    $   1,177
   Contracts and fees (2) (3)               29,086        8,519       10,985     13,574        2,388
Research and development
  expenses                                  16,300       15,096       18,437     24,486       19,017
Equity in losses of joint
  ventures (3)                             (21,558)     (17,628)     (11,990)        --           --
Net loss                                   (21,306)     (43,285)     (36,089)   (22,401)     (23,125)
Net loss applicable to common
   stock                                   (21,864)     (43,863)     (36,089)   (22,401)     (23,125)

Basic and diluted loss per
   common share                          $    (.45)   $   (1.11)   $    (.96)  $   (.61)   $    (.72)

Weighted average shares used in the
   calculation of basic and diluted
   loss per common share                    48,507       39,373       37,548     36,556       33,266
</TABLE>


<TABLE>
<CAPTION>

                                                                  December 31,
                                         ------------------------------------------------------------
                                            1999         1998         1997        1996        1995
                                         ----------   ----------   ----------  ----------  ----------
                                                                 (In thousands)
<S>                                      <C>          <C>          <C>         <C>         <C>
Cash, cash equivalents and
   short-term investments (4)            $  26,079    $  23,054    $  17,086   $ 40,217    $  18,929
Working capital                             10,651       20,442       13,216     35,984       15,747
Total assets                                59,386       53,985       50,460     56,501       31,141
Long-term debt, capital lease
   obligations and redeemable
   preferred stock (5)                      24,139       34,949       28,096         84           36
Accumulated deficit                       (239,762)    (218,456)    (175,171)  (139,082)    (116,681)
Stockholders' equity                        21,423       12,527       13,966     48,380       25,900
</TABLE>

(1)  Product sales include sales of TransCyte(TM) and Dermagraft(R) at cost to a
     related party in the amounts of $13,717,000, $10,927,000 and $1,190,000 for
     the years ended December 31, 1999, 1998, and 1997, respectively. Also
     included are sales of TransCyte to unrelated customers of $1,035,000 and
     $976,000 in years ended December 31, 1998 and 1997, respectively. Product
     sales in 1996 and prior years are for sales of the Company's Skin(2)(R)
     laboratory testing kits. The Company discontinued sales of its Skin(2)
     laboratory testing kits in October 1996.

(2)  Contracts and fees include the recognition of milestone payments received
     from strategic partners, revenues for research and development, marketing
     and other activities performed under collaborative agreements and
     government grants. Milestone payments of $16.4 million and $10 million were
     recognized in the years ended December 31, 1999 and 1996, respectively.

(3)  In April 1996, the Company formed a joint venture (the "Dermagraft Joint
     Venture") with Smith & Nephew plc for the commercialization of Dermagraft
     for the treatment of diabetic foot ulcers. The Company had formed a
     separate joint venture for the commercialization of tissue-engineered
     cartilage for orthopedic applications with Smith & Nephew in April 1994.
     Contracts and fees include revenues for research and development, marketing
     and other activities performed for the joint ventures. Advanced Tissue
     Sciences and Smith & Nephew began sharing in the revenues and expenses of
     the joint ventures in January 1997.

(4)  In January 2000, the Company received $7.0 million from the State of
     Wisconsin Investment Board upon exercise of warrants to purchase an
     additional 1,750,000 shares of common stock.  Also, in March 2000, all of
     the Company's Series B Preferred Stock at December 31, 1999 were converted
     into the Company's Common Stock.  As a result of the conversion, $5
     million in cash that was reported as restricted for redemption of the
     Series B Preferred Stock as of December 31, 1999 is now available to
     support the Company's operations.

(5)  Includes both the current and long-term portions of debt.


                                      F-1

<PAGE>


                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     Advanced Tissue Sciences, Inc. (the "Company" or "Advanced Tissue
Sciences") is engaged in the development and manufacture of human-based tissue
products for tissue repair and transplantation using its proprietary tissue
engineering technology. The Company's leading therapeutic products are
tissue-engineered skin products, TransCyte(TM) for the temporary covering of
severe and partial-thickness burns and Dermagraft(R) for the treatment of severe
skin ulcers. In addition to its TransCyte and Dermagraft skin products, the
Company is also focusing its resources on the development of tissue-engineered
products for other wound care, orthopedic, aesthetic, reconstructive and
cardiovascular applications.

     In March 1997, the Company received marketing approval in the United States
from the U.S. Food and Drug Administration (the "FDA") for its first therapeutic
product, TransCyte, as a temporary covering for severe, full-thickness, or third
degree, burns. In addition, in October 1997, the Company received FDA approval
to market TransCyte for partial-thickness, or second degree, burns in the United
States. Through September 1998, TransCyte was marketed for burns by Advanced
Tissue Sciences through a direct sales force in the United States. Since October
1998, TransCyte has been or will be marketed in the United States and throughout
the rest of the world consistent with regulatory approvals for burn and wound
care applications under an expanded joint venture with Smith & Nephew plc
("Smith & Nephew").

     Dermagraft for the treatment of diabetic foot ulcers was approved for sale
in Canada in August 1997, and was introduced in the United Kingdom and several
other European countries late in 1997 through the joint venture with Smith &
Nephew. The Company also submitted a Premarket Approval (PMA) application to the
FDA for approval to market Dermagraft for the treatment of diabetic foot ulcers
in the United States. In January 1998, an FDA advisory panel recommended
approval of Dermagraft with the condition that the Company perform a
post-marketing study to confirm efficacy and provide physician training.
However, in June 1998, the FDA decided the PMA application was not approvable
without supportive data from an additional controlled clinical trial. The
clinical trial began in late 1998 and the results of a planned interim analysis
of data from this trial were announced in December 1999. These data showed that,
although statistical significance was not achieved at the interim analysis,
Dermagraft was healing more ulcers than the control treatment in those diabetic
foot ulcers having a duration of greater than six weeks.

     In February 2000, the FDA approved an application for an amendment to the
Investigational Device Exemption (IDE) for the ongoing clinical trial of
Dermagraft in the treatment of diabetic foot ulcers. Based on the data from the
interim analysis, the IDE was amended to revise the enrollment criteria and the
statistical plan for data analysis. The amended IDE allows for the modification
of the study inclusion criteria to limit future enrollment to patients with
ulcers of greater than six weeks duration. In addition, the amended statistical
plan allows the Company to integrate the interim analysis data with additional
data generated since that time from patients with ulcer duration of greater than
six weeks. If these additional data confirm the treatment benefit that was seen
in the interim analysis for patients with ulcer duration of greater than six
weeks, the Company believes it could submit an amendment to the PMA application
for approval of Dermagraft for the treatment of diabetic foot ulcers to the FDA
as early as mid-year.

     In October 1998, the FDA approved the Company's application for a Treatment
Investigational Device Exemption (the "Treatment IDE") for Dermagraft, allowing
the Company to make Dermagraft for the treatment of diabetic foot ulcers
available to selected centers in the United States under an approved clinical
protocol. The Treatment IDE is a regulatory provision that (1) permits companies
to make available promising new products to patients with serious diseases for
which there is no satisfactory alternative, and (2) allows companies to recover
the costs of manufacturing and distributing the product. The Treatment IDE is
being conducted concurrently with the ongoing clinical trial of Dermagraft in
the treatment of diabetic foot ulcers in the United States.

     In May 1999, the Company and Inamed Corporation ("Inamed") entered into a
strategic alliance for the development and marketing of several of the Company's
human-based, tissue-engineered products for aesthetic and certain reconstructive
applications. Specifically, Inamed licensed rights to further develop,
manufacture and sell certain of the Company's tissue-engineered products for use
in cosmetic surgery, cartilage for plastic and reconstructive surgery,
extracellular matrix for use in breast reconstruction, and extracellular matrix,
including


                                      F-2


<PAGE>


human collagen, for soft tissue augmentation (wrinkle and cosmetic correction)
and as a bulking agent for the treatment of urinary incontinence. As part of
this alliance, the Company received certain payments in 1999 and will be
entitled to royalties on the future sales of the Company's tissue-engineered
products by Inamed. In addition, the Company may also potentially receive
certain milestone payments from Inamed. Under the related agreements, Advanced
Tissue Sciences will be responsible for the development of the products and
related manufacturing processes while Inamed will be responsible for clinical
and regulatory activities. Advanced Tissue Sciences or an affiliate has the
right to manufacture the products developed for Inamed. See Note 3 to the
consolidated financial statements.

     In April 1996, the Company entered into an agreement with Smith & Nephew to
form a joint venture (the "Dermagraft Joint Venture") for the worldwide
commercialization of Dermagraft in the treatment of diabetic foot ulcers. Under
the joint venture agreement, the joint venture partners began sharing equally in
all expenses and revenues associated with the development and commercialization
of Dermagraft for diabetic foot ulcers from January 1997. In January 1998,
Advanced Tissue Sciences and Smith & Nephew expanded the Dermagraft Joint
Venture to include additional technology for the treatment of skin tissue wounds
and applications such as venous ulcers, pressure ulcers and burns. In August
1998, the Company and Smith & Nephew expanded the Dermagraft Joint Venture
further to include exclusive rights to TransCyte for full and partial-thickness
burns in the United States effective October 1998. Under the expanded joint
venture, Advanced Tissue Sciences and Smith & Nephew are sharing equally in the
expenses and revenues of the Dermagraft Joint Venture, except the Company is
funding the first $6 million in expense for conducting clinical trials and
regulatory support of Dermagraft and TransCyte in the treatment of venous ulcers
and pressure ulcers. In addition, the Company funded certain manufacturing and
distribution costs and certain costs related to post-market studies of TransCyte
through December 1999. See Note 3 to the consolidated financial statements.

     In February 2000, the Company and Smith & Nephew agreed in principle to
restructure certain milestone payments associated with the Dermagraft Joint
Venture. The objective of the restructuring is to defer the potential payment of
certain milestones by Smith & Nephew while providing the Company a royalty
stream and an opportunity for an increase in its long-term return from the
venture. As part of the agreement, the Company will sell the Dermagraft
manufacturing assets that it currently owns to a company jointly owned with
Smith & Nephew, and also will sell its raw material inventories to the
Dermagraft Joint Venture. The proceeds of these sales will be used to pay down a
portion of the outstanding balance of the loan from Smith & Nephew, with the
remaining outstanding principal and interest due at the June 30, 2000 maturity
to be paid in the Company's Common Stock at the then current market price. See
Note 17 to the consolidated financial statements.

     In May 1994, the Company and Smith & Nephew entered into a separate joint
venture (the "NeoCyte Joint Venture") for the worldwide development, manufacture
and marketing of human tissue-engineered cartilage for orthopedic applications.
In January 1997, the joint venture partners began sharing equally in the NeoCyte
Joint Venture's expenses. See Note 3 to the consolidated financial statements.

     In October 1997, the Company was awarded a $2 million Advanced Technology
Program grant from the National Institute of Standards and Technology to fund
collaborative cardiovascular research with the University of California, San
Diego over a three-year period. Funding under the grant began in 1998. From 1993
through 1997, the Company sponsored at least $1 million annually in early stage
research programs at the Massachusetts Institute of Technology and Children's
Hospital in Boston directed toward the tissue engineering of cartilage, liver
and numerous other tissues and several polymer technologies. The Company has
subsequently reduced its commitments to these institutions; however, certain
research has been sponsored at several other academic institutions during 1998
and 1999.

     The Company has incurred, and expects to continue to incur, substantial
expenditures in support of the commercialization, development and clinical
trials of its TransCyte and Dermagraft products for burns and skin ulcer
applications, for manufacturing systems and in advancing other applications of
the Company's core technology. In particular, the Company will incur, either
directly or through the Dermagraft Joint Venture, substantial costs for the
additional clinical trial of Dermagraft in the treatment of diabetic foot ulcers
and in support of clinical trials and post-market studies of Dermagraft and
TransCyte in the treatment of venous, pressure and diabetic ulcers and for full
and partial thickness burns. The Company also expects to incur additional costs
for the development of products and manufacturing processes under its strategic
alliance with Inamed and, through the


                                      F-3


<PAGE>


NeoCyte Joint Venture, for the development and clinical trials of
tissue-engineered cartilage products; however, such costs are expected to be
partially offset by the recognition of licensing fees and milestone payments
from Inamed and by sharing such costs with partners.

RESULTS OF OPERATIONS

Year Ended December 31, 1999 as Compared to the Year Ended December 31, 1998

     Product sales totaled $13,717,000 in 1999, as compared to $11,962,000 in
1998. During these periods all product sales were to related parties, except
$1,035,000 of TransCyte sales in 1998 made through the Company's direct sales
force to third party customers in the United States. As discussed above,
domestic TransCyte sales and marketing activities were transferred from the
Company to the Dermagraft Joint Venture effective October 1998.

     Product sales to related parties reflect sales of Dermagraft and TransCyte
to the Dermagraft Joint Venture at cost (see Notes 3 and 16 to the consolidated
financial statements). Since October 1998, the Company has manufactured
Dermagraft and TransCyte to meet the Dermagraft Joint Venture's forecasted
requirements. As a result, sales to related parties in 1999 and the fourth
quarter of 1998 reflect costs to manufacture Dermagraft and TransCyte including
period costs, while sales to related parties through September 1998 include
costs to manufacture Dermagraft and TransCyte but do not include period costs
for TransCyte. As the Company sold TransCyte to third parties through September
1998, TransCyte sales to the joint venture were at a price negotiated between
the Company and the Dermagraft Joint Venture rather than total product costs,
including period costs. Growth in sales of existing products in 2000 and beyond
will continue to be sensitive to the Dermagraft Joint Venture partners' success
in obtaining regulatory approvals and product reimbursement from both national
healthcare systems and private insurers.

     Revenues from contracts and fees were $29,086,000 in 1999, compared to
$8,519,000 in 1998. The increase in 1999 over the prior year mainly reflects the
recognition of $15 million in revenue related to the January 1999 milestone
payment associated with the expansion of the Dermagraft Joint Venture. In
addition, $1,405,000 of the $5,000,000 in payments received for the licensing of
certain product applications to Inamed have been recognized as revenue in 1999
with the balance of payments expected to be recognized in fiscal 2000, as
related financial commitments have been met. Other contract and fee revenues are
principally for research and development activities performed for the Dermagraft
and NeoCyte Joint Ventures. Fiscal 1999 includes higher revenues of $3,513,000
in contracts and fees for conducting clinical trials of Dermagraft and
TransCyte. Clinical trial activities are expected to continue in 2000 as the
Company pursues additional indications for existing products, and develops
further products. See Notes 2 and 3 to the consolidated financial statements.

     Cost of goods sold decreased from $15,135,000 in 1998 to $13,717,000 in
1999. Cost of goods sold represents the cost of TransCyte and Dermagraft sold to
the Dermagraft Joint Venture and, in 1998, the cost of TransCyte sold
domestically to third parties through September 1998. The decrease in the 1999
cost of goods sold reflects both a decrease in manufacturing salaries and
benefits of $440,000 and a $780,000 increase in the cost of product used in
clinical trials and development activities. As a result of the FDA's decision to
require additional clinical data for Dermagraft in the treatment of diabetic
foot ulcers, the Company expects to continue to incur significant costs
associated with excess production capacity within its manufacturing facility in
2000. Due to costs related to excess production capacity, the Dermagraft Joint
Venture immediately writes inventory down to estimated market value at the date
of purchase, which is the net realizable value at which the joint venture
believes it will be able to sell the products to its customers. In the years
ending December 31, 1999 and 1998, such write-downs totaled $11,982,000 and
$8,267,000, respectively. To the extent the Company does not sell such products
to the Dermagraft Joint Venture, it will be required to write such inventories
down to net realizable value.

     Research and development expenditures increased by $1,204,000 to
$16,300,000 in 1999 from $15,096,000 in 1998. The increase in research and
development costs reflects higher expenditures for clinical trials of $3,513,000
in 1999. This increase includes costs for clinical trials of Dermagraft in
venous and diabetic foot ulcers as well as post-market studies of TransCyte for
full and partial-thickness burns. The increase in clinical trial expenditures
was partially offset by declines of $1,486,000 in product development costs and
$458,000 in regulatory costs for 1999. Research and development costs will
continue to be significant due to continuing and anticipated clinical trials
during 2000.


                                      F-4


<PAGE>


     Selling, general and administrative costs were $11,095,000 in 1999
reflecting a 25% decrease as compared to $14,884,000 in 1998. The lower costs
primarily reflect a decrease of $3,878,000 in selling and marketing costs as a
result of the transfer of the TransCyte sales and marketing activities in the
United States to the Dermagraft Joint Venture in October 1998. In addition,
recruiting costs declined from the prior year by $665,000. The impact of these
decreases was partially offset by higher facility costs of $555,000 in 1999.
Selling, general and administrative costs also includes $309,000 in 1999 in
compensation expense related to a restricted stock award and the stock options
exercised through the issuance of a loan are accounted for as variable stock
options. As a result of the variable accounting treatment, variability in the
market price of the Company's common stock may result in significant increases
and decreases in compensation expense from period to period.

     Equity in losses of joint ventures was $21,558,000 in 1999, as compared to
$17,628,000 in 1998. These amounts represent the Company's share of the losses
of the Dermagraft and NeoCyte Joint Ventures. The equity in losses of joint
ventures includes costs incurred by the Company and charged to the Dermagraft
and NeoCyte Joint Ventures totaling $15,934,000 and $9,547,000 in the years
ended December 31, 1999 and 1998, respectively (see Note 16 to the consolidated
financial statements). The increase in 1999 losses principally reflects
manufacturing and distribution costs associated with the transfer of sales and
marketing of TransCyte in the United States to the Dermagraft Joint Venture, as
well as support for clinical trials for Dermagraft in the treatment of diabetic
and venous ulcers and for TransCyte in full and partial-thickness burns, as
discussed above.

     Interest income and other was $362,000 in 1999, which compared to
$1,320,000 in 1998. This principally reflects an increase in other expenses,
including a $416,000 fee paid in terminating a long-term facility lease (see
Note 8 to the consolidated financial statements) and asset disposals and
write-downs of $893,000 in 1999 offset by the amortization of commitment fees
associated with an equity line of $430,000 in 1998. Interest expense was
$1,801,000 in 1999, compared to $2,343,000 in 1998. The decrease in 1999
reflects the repayment of a $10 million loan from Smith & Nephew in June 1999
(see Note 7 to the consolidated financial statements).

Year Ended December 31, 1998 as Compared to the Year Ended December 31, 1997

     Product sales totaled $11,962,000 in 1998, as compared to $2,166,000 in
1997. Product sales included sales to related parties of $10,927,000 and
$1,190,000 and to others of $1,035,000 and $976,000 in 1998 and 1997,
respectively. Product sales to related parties reflect sales of Dermagraft and
TransCyte to the Dermagraft Joint Venture at cost. See Notes 3 and 16 to the
consolidated financial statements. Increased product sales to the Dermagraft
Joint Venture in 1998 reflect increased manufacturing costs as discussed with
respect to cost of goods sold below and the fact that commercial sales to the
Dermagraft Joint Venture did not begin until the second quarter of 1997. As
discussed above, TransCyte sales and marketing were transferred from the Company
to the Dermagraft Joint Venture effective October 1998. As a result, product
sales to others include sales of TransCyte in the United States from January
through September 1998. Product sales in 1997 reflect sales for the period April
through December 1997. There were no sales to outside customers in the first
quarter of 1997, as TransCyte was first introduced in April 1997 for
full-thickness burns and in October 1997 for partial-thickness burns.

     Revenues from contracts and fees were $8,519,000 for 1998, compared to
$10,985,000 in 1997. Contract revenues decreased $2,466,000 for 1998 reflecting
lower contract revenues recognized for research and development and clinical
activities performed for the Dermagraft and the NeoCyte Joint Ventures and for
associated administrative costs. See Notes 3 and 16 to the consolidated
financial statements.

     Cost of goods sold for 1998 represents the cost of the Company's TransCyte
product sold domestically and the cost of TransCyte and Dermagraft sold to the
Dermagraft Joint Venture. Cost of goods sold in 1997 represents costs to
manufacture TransCyte since its introduction in April 1997 and sales to the
Dermagraft Joint Venture beginning in the second quarter of 1997. Products were
sold to the Dermagraft Joint Venture at cost to manufacture including period
costs (except for the period from January 1, 1997 to September 30, 1998 when the
Company also sold TransCyte in the United States and therefore, absorbed period
costs related to TransCyte). The Company initiated production of Dermagraft in
its commercial facility in January 1998 and, accordingly, cost of goods sold has
reflected costs associated with this manufacturing facility such as depreciation
and overhead since that date. The Company did not receive FDA approval to sell
Dermagraft in the United States during 1998 resulting in excess production
capacity within the facility. As a result of the costs of this excess production
capacity, the Dermagraft


                                      F-5


<PAGE>


Joint Venture immediately writes the inventory down to estimated market value at
the date of purchase, which is the net realizable value at which the joint
venture believes it will be able to sell the products to its customers. During
the years ended December 31, 1998 and 1997, such write-downs by the Dermagraft
Joint Venture totaled $8,267,000 and $491,000, respectively.

     Research and development expenditures decreased 18% to $15,096,000 for
1998, compared to $18,437,000 in 1997. The cost of sponsored research programs,
the clinical studies expenses of TransCyte and Dermagraft clinical trials and
the development of commercial manufacturing processes decreased by $1,677,000,
$536,000 and $1,126,000, respectively in 1998.

     Selling, general and administrative costs were $14,884,000 in 1998, a
decrease of $1,651,000 from $16,535,000 in 1997. The decrease primarily reflects
lower expenditures for selling and marketing costs and professional and
consulting services related to the commercialization of products, partially
offset by higher administrative compensation costs. Selling and marketing costs
decreased during the fourth quarter of 1998 due to the transfer of sales and
marketing of TransCyte to the Dermagraft Joint Venture effective October 1998.
In 1998 selling and marketing costs were $1,242,000 less than in the prior year.
Professional and consulting fees decreased $535,000 in 1998 while compensation
costs increased by $475,000 from 1997.

     Equity in losses of joint ventures was $17,628,000 in 1998, as compared to
$11,990,000 in 1997. These amounts represent the Company's share of the losses
of the Dermagraft and NeoCyte Joint Ventures. The equity in losses of joint
ventures includes costs incurred by the Company and charged to the Dermagraft
and NeoCyte Joint Ventures totaling $9,547,000 and $5,899,000 in the years ended
December 31, 1998 and 1997, respectively (see Note 16 to the consolidated
financial statements). The increase in 1998 primarily reflects increased
manufacturing costs and selling, general and administrative expenses in the
Dermagraft Joint Venture. As the Company sells products to the Dermagraft Joint
Venture at its cost to manufacture, costs of the commercial facility began to be
recognized in cost of goods sold for the Dermagraft Joint Venture in January
1998. Selling, general and administrative expenses in the Dermagraft Joint
Venture have increased to support the commercial introduction of Dermagraft and
TransCyte in certain markets.

     Interest income and other was $1,320,000 in 1998, which compared to
$1,252,000 in 1997. Interest income in 1998 increased by $95,000 as higher cash
balances in the second half of 1998 from a $25 million private placement of
Convertible Series B Preferred Stock offset lower cash balances in the first
half of the year as compared to 1997. Interest expense was $2,343,000 in 1998,
compared to $877,000 in 1997. The increase in 1998 principally reflects interest
on notes payable to Smith & Nephew and The Chase Manhattan Bank (see Note 7 to
the consolidated financial statements).

LIQUIDITY AND CAPITAL RESOURCES

     The Company has funded its operating and capital expenditures to date
primarily through the sale of equities, contract revenues, funding from
strategic partners, government grants, product sales and lease financing
transactions. As of December 31, 1999, the Company had available working capital
of $10,651,000, a decrease of $9,791,000 from December 31, 1998. The decrease in
working capital in 1999 reflects the use of working capital to support
operations of $14,317,000 including the Company's net investment in its joint
ventures with Smith & Nephew of $21,260,000, the transfer of a loan from Smith &
Nephew from long-term to current in June 1999 (see Note 7 to the consolidated
financial statements) and capital expenditures and patent application costs of
$1,455,000. Working capital at December 31, 1999 also reflects approximately $20
million received from sales of common stock and warrants during 1999, net of $5
million which has been reserved for the redemption of the Company's Series B
Preferred Stock (see Note 11 to the consolidated financial statements).

     The Company's working capital and capital requirements are dependent upon a
number of factors, including the timing and expense of the Company's preclinical
and clinical studies, the achievement and timing of regulatory approvals and
third-party reimbursement, sales and marketing efforts by the Company's
strategic partners, new technological innovations, market acceptance of the
Company's products and the establishment of new strategic alliances. The Company
currently believes it has sufficient funds, including those received from the
exercise of warrants in January 2000 (as discussed below) and to be received
from the sale of certain manufacturing assets in January 2000 (see Note 17 to
the consolidated financial statements) to support its operations to
approximately the end of fiscal 2000.


                                      F-6


<PAGE>


     The further development of the Company's technology and commercialization
of its products, as well as any further development of manufacturing
capabilities or the establishment of any additional sales, marketing and
distribution capabilities, will require the commitment of substantial funds. In
addition to existing working capital, other sources of funds may include
payments from alliances with Smith & Nephew and Inamed, and up to $2.5 million
of borrowing capacity under the NeoCyte Joint Venture with Smith & Nephew. The
Company may also pursue additional public or private offerings of debt or equity
securities. Additional funding could potentially be obtained through new
strategic alliances or other collaborative arrangements, or through the
extension of existing strategic alliances. However, there can be no assurance
that funds from the sources outlined above will be available when needed or on
terms favorable to the Company, under existing arrangements or otherwise, or
that the Company will be successful in entering into any other strategic
alliances or collaborative arrangements.

     In January 2000, the Company received $7.0 million from the exercise of
warrants to purchase 1,750,000 shares of Common Stock at $4.00 per share. These
warrants were a component of the 3,750,000 units sold pursuant to a public
offering in November 1999. See Notes 11 and 17 to the consolidated financial
statements. In conjunction with the public offering in November 1999, the
Company notified the holders of its Convertible Series B Preferred Stock that it
would redeem for cash at 105% of liquidation value any preferred share submitted
for conversion at a conversion price at or below $3.58 per share (see Note 12 to
the consolidated financial statements). However, in March 2000, 100.8 shares,
representing all of the Company's Series B Preferred Stock as December 31, 1999,
were converted into 1,354,539 shares of the Company's Common Stock at $3.72 per
share. As a result of the conversion, $5 million in cash that was reported as
restricted for redemption of the Series B Preferred Stock in the accompanying
balance sheet as of December 31, 1999 is now available to support the Company's
operations. See Note 17 to the consolidated financial statements.

     The Company continually reviews its product development activities in an
effort to allocate its resources to those products the Company believes have the
greatest commercial potential. Factors considered by the Company in determining
the products to pursue include projected markets and need, potential for
regulatory approval and reimbursement under the existing healthcare system as
well as anticipated healthcare reforms, technical feasibility, expected and
known product attributes and estimated costs to bring the product to market.
Based on these and other factors that the Company considers relevant, the
Company may from time to time reallocate its resources among its product
development activities. Additions to products under development or changes in
products being pursued can substantially and rapidly change the Company's
funding requirements. In addition, if, for any reason, Smith & Nephew were to
terminate the Dermagraft Joint Venture or, to a lesser extent, the NeoCyte Joint
Venture, the Company would experience a substantial increase in the need for and
the use of its working capital to support the commercialization and manufacture
of its Dermagraft and TransCyte products or the development of its orthopedic
cartilage products.

FINANCIAL CONDITION

     Cash, cash equivalents and short-term investments as of December 31, 1999
increased by $3 million from December 31, 1998 reflecting principally the effect
of the $15 million payment received in January 1999 associated with the
expansion of the Dermagraft Joint Venture, payments of $10 million received from
Inamed (see Note 3 to the consolidated financial statements) and $10 million in
unrestricted funds from a public offering completed in November 1999 (see Note
11 to the consolidated financial statements), partially offset by $7.7 million
of cash used to fund operations and $21.3 million to support the Dermagraft and
NeoCyte Joint Ventures. Restricted cash at December 31, 1999 represents cash
reserved for the redemption of any of the Company's Series B Preferred Stock
submitted for conversion at or below $3.58 per share (see Note 12 to the
consolidated financial statements). Increases in receivables from and payables
to joint ventures are a function of the timing of payments made to and from the
Company's joint ventures with Smith & Nephew.

     Accrued expenses at December 31, 1999 increased $2.1 million from year-end
1998 primarily due to increases in amounts accrued for payroll costs and
clinical studies (see Note 6 to the consolidated financial statements). Deferred
revenue of $3.6 million as of December 31, 1999 reflects the portion of the $5
million in payments related to the Inamed licensing agreement yet to be
recognized (see Notes 2 and 3 to the consolidated financial statements). The
current portion of long-term debt at December 31, 1999 has increased by $7.4
million from December 31, 1998 reflecting the fact the Cartilage loan from Smith
& Nephew is due and payable in June 2000 (see Note 7 to the consolidated
financial statements). Long-term debt has decreased by $18.3 million in 1999
primarily as the $10 million Dermagraft loan from Smith & Nephew was converted
to equity and the Cartilage loan discussed above has been transferred to current
liabilities (see Note 7 to the consolidated financial statements).


                                      F-7


<PAGE>


Redeemable preferred stock at December 31, 1999 reflects the remaining shares
outstanding from the private placement of the Convertible Series B Preferred
Stock in July 1998 (see Note 12 to the consolidated financial statements).

MARKET RISK

     The Company is exposed to changes in interest rates primarily from its
long-term debt arrangements and, secondarily, its investments in certain
securities. Under its current policies, the Company does not use interest rate
derivative instruments to manage exposure to interest rate changes. The Company
believes that a hypothetical 100 basis point adverse move in interest rates
along the entire interest rate yield curve would not materially affect the fair
value of the Company's interest sensitive financial instruments at December 31,
1999.

OTHER INFORMATION

     THE DISCUSSIONS IN THIS ANNUAL REPORT ON FORM 10-K, PARTICULARLY THOSE
RELATING TO STRATEGIC ALLIANCES (INCLUDING POTENTIAL REVENUES FROM EXISTING
JOINT VENTURES), THE USE OF WORKING CAPITAL, THE SUFFICIENCY AND AVAILABILITY OF
FUNDS TO SUPPORT OPERATIONS, ADDITIONAL CLINICAL TRIALS AND COMMERCIALIZATION OF
THE COMPANY'S PRODUCTS, MAY BE FORWARD-LOOKING STATEMENTS INVOLVING RISKS AND
UNCERTAINTIES WITHIN THE MEANING OF THE SECURITIES ACT OF 1933 AND THE
SECURITIES EXCHANGE ACT OF 1934. NO ASSURANCE CAN BE GIVEN THAT THE COMPANY WILL
SUCCESSFULLY COMPLETE CLINICAL TRIALS, OBTAIN U.S. FOOD AND DRUG ADMINISTRATION
APPROVAL, SCALE UP MANUFACTURING PROCESSES, SUCCESSFULLY MARKET ITS PRODUCTS,
ACHIEVE MILESTONES REQUIRED TO RECEIVE ADDITIONAL FUNDING, OR ENTER INTO NEW
STRATEGIC ALLIANCES. THESE AND OTHER RISKS ARE DETAILED IN THE COMPANY'S
PUBLICLY AVAILABLE FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION,
INCLUDING ITS ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999.
THE FORWARD-LOOKING STATEMENTS ARE QUALIFIED IN THEIR ENTIRETY BY REFERENCE TO
SUCH RISKS AND RISK FACTORS.


                                      F-8


<PAGE>


                         ADVANCED TISSUE SCIENCES, INC.
                           CONSOLIDATED BALANCE SHEETS
                (Dollars In Thousands, Except Per Share Amounts)

                                                             December 31,
                                                     --------------------------
                                                        1999            1998
                                                     ----------      ----------
         ASSETS
Current assets:
   Cash and cash equivalents                         $   16,091      $  16,551
   Short-term investments                                 9,988          6,503
   Receivable from joint ventures                         2,185          1,162
   Inventory                                              4,295          3,364
   Other current assets                                   1,664          1,250
                                                     ----------      ---------
     Total current assets                                34,223         28,830
Property - net                                           16,627         20,624
Patent costs - net                                        2,075          1,846
Restricted cash                                           5,000             --
Other assets                                              1,461          2,685
                                                     ----------      ---------
     Total assets                                    $   59,386      $  53,985
                                                     ==========      ==========

        LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable                                  $      755      $     894
   Payable to joint ventures                              3,550          1,316
   Accrued expenses                                       5,560          3,489
   Deferred revenue                                       3,595             --
   Current portion of long-term debt and
    capital lease obligations                            10,112          2,689
                                                     ----------      ---------
     Total current liabilities                           23,572          8,388
Long-term debt and capital lease obligations              8,987         27,260
Other long-term liabilities                                 364            810
                                                     ----------      ---------
     Total liabilities                                   32,923         36,458
                                                     ----------      ---------
Redeemable  Convertible  Series B Preferred
  Stock, $.01 par value; 1,000 shares authorized,
  100.8 shares issued and outstanding at December
  31, 1999 and 100 at December 31, 1998 (aggregate
  redemption and liquidation value of $5,104
  and $5,119 at December 31, 1999 and December
  31, 1998)                                               5,040          5,000
                                                     ----------      ---------
Commitments and contingencies (Notes 8, 9 and 10)

Stockholders' equity:
   Convertible Series B Preferred Stock, $.01
     par value; no shares issued and outstanding
     at December 31, 1999 and 350 at December 31,
     1998 (aggregate liquidation value of $17,917
     at December 31, 1998)                                   --             --
   Accrued cumulative preferred stock dividends              64            536
   Common Stock, $.01 par value; 125,000,000 and
     100,000,000 shares authorized at December 31,
     1999 and 1998, respectively; issued and
     outstanding, 56,600,544 shares at December
     31, 1999 and 40,353,524 shares at December
     31, 1998                                               566            403
   Additional paid-in capital                           262,588        230,963
   Note received in connection with the sale
     of Common Stock and deferred compensation
     applicable to Common Stock                          (2,033)          (919)
   Accumulated deficit                                 (239,762)      (218,456)
                                                     ----------      ---------
     Total stockholders' equity                          21,423         12,527
                                                     ----------      ---------
     Total liabilities and stockholders' equity      $   59,386      $  53,985
                                                     ==========      =========


        See accompanying notes to the consolidated financial statements.


                                      F-9


<PAGE>


                         ADVANCED TISSUE SCIENCES, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                    (In Thousands, Except Per Share Amounts)

                                                Year Ended December 31,
                                      ------------------------------------------
                                         1999           1998            1997
                                      ----------     ----------      -----------
Revenues:
  Product sales -
     Related parties                  $   13,717     $   10,927      $   1,190
     Others                                   --          1,035            976
  Contracts and fees -
     Related parties                      27,050          7,935         10,975
     Others                                2,036            584             10
                                      ----------     ----------      ---------
     Total revenues                       42,803         20,481         13,151
                                      ----------     ----------      ---------
Costs and expenses:
  Research and development                16,300         15,096         18,437
  Selling, general and administrative     11,095         14,884         16,535
  Cost of goods sold                      13,717         15,135          2,653
                                      ----------     ----------      ---------
     Total costs and expenses             41,112         45,115         37,625
                                      ----------     ----------      ---------
Income (loss) from operations
  before equity in losses of
  joint ventures                           1,691        (24,634)       (24,474)

Equity in losses of joint ventures       (21,558)       (17,628)       (11,990)
                                      ----------     ----------      ---------
Loss from operations                     (19,867)       (42,262)       (36,464)

Other income (expense):
  Interest income and other                  362          1,320          1,252
  Interest expense                        (1,801)        (2,343)          (877)
                                      ----------     ----------      ---------
Net loss                                 (21,306)       (43,285)       (36,089)

Dividends on preferred stock                (558)          (578)            --
                                      ----------     ----------      ---------
Net loss applicable to common stock   $  (21,864)    $  (43,863)     $ (36,089)
                                      ==========     ==========      =========
Basic and diluted loss per
  common share                        $     (.45)    $    (1.11)     $    (.96)
                                      ==========     ==========      =========
Weighted average number of common
  shares used in the computation
  of basic and diluted loss per
  common share                            48,507         39,373         37,548
                                      ==========     ==========      =========


        See accompanying notes to the consolidated financial statements.


                                      F-10


<PAGE>


                         ADVANCED TISSUE SCIENCES, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In Thousands)
<TABLE>
<CAPTION>

                                                                      Year Ended December 31,
                                                   ---------------------------------------------------
                                                          1999              1998             1997
                                                     --------------    --------------   --------------
<S>                                                  <C>               <C>              <C>
Operating activities:
  Net loss                                           $    (21,306)     $    (43,285)    $    (36,089)
  Adjustments to reconcile net loss to cash
    used in operating activities:
     Depreciation and amortization                          4,772             4,756            2,120
     Compensation for services paid in stock,
       options or warrants                                    344             1,092              438
     Equity in losses of joint ventures                    21,558            17,628           11,990
     Other adjustments to net loss                          1,575               162              366
     Deferred revenue                                       3,595                --               --
     Changes in assets and liabilities:
       Receivables from joint ventures                     (1,023)             (830)             496
       Inventory                                             (931)            1,279           (3,364)
       Other current assets                                  (414)             (187)             657
       Accounts payable                                      (139)              (64)          (1,274)
       Payable to joint ventures                            2,234               634              682
       Accrued expenses                                     2,071            (2,840)             524
                                                     ------------      ------------     ------------
         Net cash provided by (used in)
           operating activities                            12,336           (21,655)         (23,454)
                                                     ------------      ------------     ------------
Investing activities:
  Purchases of short-term investments                     (15,995)          (17,449)          (6,234)
  Maturities and sales of short-term
    investments                                            12,510            12,946           16,544
  Acquisition of property                                    (972)           (3,740)         (15,567)
  Proceeds from sale of furniture
    and equipment                                              --             1,502               --
  Investment in joint ventures                            (24,700)          (23,436)         (11,040)
  Distributions from joint ventures                         3,440             3,909              605
  Patent application costs                                   (483)             (284)            (439)
  Other long-term assets                                     (264)            1,739           (3,118)
                                                     ------------      ------------     ------------
         Net cash used in investing
           activities                                     (26,464)          (24,813)         (19,249)
                                                     ------------      ------------     ------------
Financing activities:
  Proceeds from borrowings                                  1,840             3,993           28,000
  Payments of borrowings                                   (2,690)           (2,140)             (38)
  Net proceeds from sale of Preferred Stock                    --            24,915               --
  Net proceeds from sale of Common Stock                   19,877            20,000               --
  Restricted cash                                          (5,000)               --               --
  Repurchase of Common Stock                                 (457)               --               --
  Options and warrants exercised                               10               852            1,675
  Other long-term obligations                                  88               313              245
                                                     ------------      ------------     ------------
         Net cash provided by financing
           activities                                      13,668            47,933           29,882
                                                     ------------      ------------     ------------
Net increase (decrease) in cash and cash
     equivalents                                             (460)            1,465          (12,821)
Cash and cash equivalents at beginning of year             16,551            15,086           27,907
                                                     ------------      ------------     ------------
Cash and cash equivalents at end of year             $     16,091      $     16,551     $     15,086
                                                     ============      ============     ============
</TABLE>


         See accompanying notes to the consolidatedfinancial statements.


                                      F-11


<PAGE>



                         Advanced Tissue Sciences, Inc.
                 Consolidated Statement of Stockholders' Equity
                             (Dollars In Thousands)

                                          Preferred Stock       Common Stock
                                         -----------------  --------------------
                                          Shares   Amount     Shares     Amount
                                         -------- --------  ----------  --------
Balance, December 31, 1996                                  37,474,677   $  375

Options exercised                                              199,306        2
Net loss
                                                            ----------   ------
Balance, December 31, 1997                                  37,673,983     377

Sale of Common Stock                                         1,533,115      15
Sale of Preferred Stock                     400   $    --
Conversion of Preferred Stock               (50)       --    1,012,394      10
Preferred Stock dividends                                       16,957      --
Warrants granted for services
Options exercised                                              117,075       1
Net loss                                  -----   -------   ----------   -----

Balance, December 31, 1998                  350        --   40,353,524     403

Sale of Common Stock                                         4,533,039      45
Issuance of Common Stock for
  debt and accrued interest                                  2,800,595      28
Conversion of Preferred Stock              (309)       --    7,865,798      79
Transfer of Preferred Stock to
  Redeemable Preferred Stock                (41)       --
Repurchase of Common Stock                                    (463,154)     (5)
Preferred Stock dividends                                      432,808       4
Restricted Common Stock
  awarded for services                                         300,000       3
Options exercised                                              777,934       9
Interest on note receivable
Net loss
                                          -----   -------   ----------   -----
Balance, December 31, 1999                  --    $    --   56,600,544   $ 566
                                          ====    =======   ==========   =====

<TABLE>
<CAPTION>

                                                                             Accrued
                                                                           Dividends/
                                                                              Note             Total
                                        Additional                         Receivable/         Stock-
                                         Paid-In        Accumulated         Deferred          holders'
                                         Capital          Deficit         Compensation         Equity
                                        ----------      -----------       ------------       ----------
<S>                                     <C>             <C>                 <C>              <C>
Balance, December 31, 1996              $  188,006      $  (139,082)        $   (919)        $  48,380

Options exercised                            1,673                                               1,675
Net loss                                                    (36,089)                           (36,089)
                                        ----------      -----------         --------         ---------
Balance, December 31, 1997                 189,679         (175,171)            (919)           13,966

Sale of Common Stock                        19,985                                              20,000
Sale of Preferred Stock                     19,915                                              19,915
Conversion of Preferred Stock                  (10)                                                 --
Preferred Stock dividends                     (536)                              536                --
Warrants granted for services                1,079                                               1,079
Options exercised                              851                                                 852
Net loss                                                    (43,285)                           (43,285)
                                        ----------      -----------         --------         ---------
Balance, December 31, 1998                 230,963         (218,456)            (383)           12,527

Sale of Common Stock                        19,829                                              19,874
Issuance of Common Stock for
  debt and accrued interest                 10,776                                              10,804
Conversion of Preferred Stock                1,926                                               2,005
Transfer of Preferred Stock to
  Redeemable Preferred Stock                (2,045)                                             (2,045)
Repurchase of Common Stock                  (1,762)                                             (1,767)
Preferred Stock dividends                      468                              (472)               --
Restricted Common Stock
  awarded for services                       1,122                              (813)              312
Options exercised                            1,311                                               1,320
Interest on note receivable                                                     (301)             (301)
Net loss                                                    (21,306)                           (21,306)
                                        ----------      -----------         --------         ---------
Balance, December 31, 1999              $  262,588      $  (239,762)        $ (1,969)        $  21,423
                                        ==========      ===========         ========         =========
</TABLE>

        See accompanying notes to the consolidated financial statements.


                                      F-12

<PAGE>



                         ADVANCED TISSUE SCIENCES, INC.
                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

Organization - Advanced Tissue Sciences, Inc. (the "Company") is a leading
tissue engineering company utilizing its proprietary technology to develop and
manufacture human-based tissue products for tissue repair and transplantation.
The Company is focusing on the worldwide commercialization of tissue engineered
products for wound care, orthopedics, aesthetic, reconstructive and
cardiovascular applications. The Company's leading therapeutic products are
tissue engineered skin products for the temporary covering of severe and
partial-thickness burns, which is on the market in the United States, and for
the treatment of diabetic foot ulcers, which is in clinical trials in the United
States and on the market in Canada, the United Kingdom and several other
European countries. Both products are being commercialized through a joint
venture with Smith & Nephew plc ("Smith & Nephew"). The Company also has a
strategic alliance with Inamed Corporation ("Inamed") for the development of
tissue-engineered products for the aesthetic and reconstructive markets.

Principles of Consolidation - The consolidated financial statements include the
accounts of the Company, its wholly owned subsidiaries and DermEquip, L.L.C.
("DermEquip"), a limited liability company owned jointly with Smith & Nephew.
DermEquip is a special purpose entity established to finance an expansion of the
Company's manufacturing facility. All intercompany accounts and transactions
have been eliminated. The Company's other interests in joint ventures with Smith
& Nephew are accounted for under the equity method (see Notes 3 and 16).

Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
related disclosures at the date of the financial statements, and the amounts of
revenues and expenses reported during the period. Actual results could differ
from those estimates.

Dependence on Certain Suppliers - Certain materials, such as the mesh frameworks
used by the Company in its therapeutic products, are sourced from single
manufacturers. Any significant supply interruption would adversely affect the
Company's product manufacturing. In addition, an uncorrected impurity or
supplier's variation in a raw material, either unknown to the Company or
incompatible with the Company's manufacturing process, could have a material
adverse effect on the Company's ability to manufacture its products.

Reclassification - Certain reclassifications have been made to prior year
amounts to conform to the presentation for the year ended December 31, 1999.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash Equivalents and Short-term Investments - In addition to investments in
money market funds, cash equivalents consist primarily of investments in
commercial paper and obligations issued or guaranteed by the United States
Government with maturities of three months or less at the date of acquisition.
Cash equivalents were approximately $14,942,000 and $14,509,000 as of December
31, 1999 and 1998, respectively. Short-term investments are valued on the basis
of quoted market value and consist primarily of investments in commercial paper
and obligations issued or guaranteed by the United States Government with
maturities of one year or less but more than three months at the date

of acquisition. Cash equivalents and short-term investments are stated at
amortized cost, which approximates market value. As of December 31, 1999 and
1998, the Company's cash equivalents and short-term investments were classified
as available-for-sale and consisted of (in thousands):

                                                        1999          1998
                                                     ----------    ----------

    Debt securities of U.S. Government agencies      $  7,986      $  6,503
    Commercial paper                                   10,828         5,578
    Money market funds                                  6,115         8,931
                                                     --------      --------
      Total cash equivalents and short-term
        investments                                  $ 24,929      $ 21,012
                                                     ========      ========

These investments all mature in less than one year. There were no significant
unrealized or realized gains or losses related to such securities during the
years ended December 31, 1999 or 1998. Cash and cash equivalents include


                                      F-13


<PAGE>


$1,713,000 and $2,145,000, respectively, as of December 31, 1999 and 1998 held
by DermEquip. Such funds are only available to support the operations of
DermEquip.

Impairment of Long-Lived Assets - The Company accounts for impairment of
long-lived assets in accordance with Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to
be Disposed of" ("FAS No. 121"). FAS No. 121 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances suggest that
the carrying amount of the asset may not be recoverable. In accordance with FAS
No. 121, the Company uses an estimate of the future undiscounted net cash flows
of the related asset or asset grouping over the remaining life in measuring
whether the asset's carrying amount is recoverable. Assets are grouped at the
lowest level for which there are identifiable cash flows. While the Company's
current and past operating history could be indicative of an impairment, the
Company believes the future cash flows to be received from the majority of
long-lived assets will exceed the assets' carrying value. The Company believes
that no impairment adjustments need to be made at December 31, 1999.

Inventory - Inventories manufactured for sale to related parties are stated at
cost, principally standard costs which approximate actual costs on a first-in,
first-out basis reflecting the price at which such goods will be sold to the
related parties (see Notes 3 and 16).

Property is recorded at cost and is depreciated using estimated useful lives
ranging from 2 to 11 years. For financial statement purposes, depreciation is
generally computed using the straight-line method. For tax purposes,
depreciation is generally computed by accelerated methods on allowable useful
lives. Amortization of capitalized leases is included with depreciation expense.
Costs related to the validation of new manufacturing facilities and equipment
are capitalized prior to the assets being placed in service. In addition,
interest is capitalized related to the construction of such assets. Such costs
and capitalized interest are amortized over the estimated useful lives of the
related assets. During 1997, $444,000 of interest expense was capitalized. No
interest was capitalized in 1999 or 1998. Depreciation expense for the years
ended December 31, 1999, 1998 and 1997 amounted to approximately $4,712,000,
$4,710,000, and $2,077,000, respectively.

Patents - The Company owns and has patents pending in the United States and
abroad to protect the processes and products being developed by the Company.
Direct patent application costs related to patents issued are amortized over the
estimated useful life of the patent, approximately 17 years. Such costs related
to pending applications are deferred until the patent is issued or charged to
operations at the time a determination is made not to pursue an application.
Patents are presented net of accumulated amortization of approximately $319,000
and $259,000 as of December 31, 1999 and 1998, respectively. Patent application
and maintenance costs related to licensing agreements are expensed as incurred.
See Note 9.

Industry Segment and Geographic Information - The Company operates in a single
industry segment - the development and commercialization of human-based tissue
products for tissue repair and transplantation. During the years ended December
31, 1999, 1998 and 1997, international sales have been through a related party
(see Note 3). The Company has no foreign operations.

Revenue Recognition - Revenues from product sales to third parties are
recognized when products are shipped, the risk of ownership has passed to the
purchaser, and the Company has no further specified performance obligations.
Revenues from product sales to related parties are recognized at such time as
the related party is contractually obligated to purchase the product, generally
upon the completion of manufacture. Such product sales to related parties are
equal to the Company's cost (see Notes 3 and 16). Revenues under collaborative
research and licensing agreements, including nonrefundable up-front fees and
milestone payments where the Company has continuing financial commitments, are
recognized as costs are incurred over the related period of the agreement.
Revenues from government grants are recognized based on the performance
requirements of the grant or as the grant expenditures are incurred.

Research and Development Costs are expensed as incurred. Such costs include
proprietary research and develop-ment activities and expenses associated with
collaborative research agreements.

Basic and Diluted Loss Per Common Share - Basic earnings per share are
determined based on the weighted average number of shares outstanding during the
period. Diluted earnings per share include the weighted average number of
shares outstanding and give effect to potentially dilutive common shares such as
options and warrants outstanding. Both the basic and diluted loss per common
share for the years ended December 31, 1999, 1998 and 1997 are based on the
weighted average number of shares of Common Stock outstanding during the
periods. Potentially dilutive securities include options and warrants
outstanding (see Note 13) and debt and convertible preferred stock (see


                                      F-14

<PAGE>


Notes 7, 11 and 12); however, such securities have not been included in the
calculation of the diluted loss per share as their effect is antidilutive. Since
such securities are antidilutive, there is no difference between basic and
diluted loss per share for any of the periods presented. The net loss applicable
to common shares used in the calculation of basic and diluted loss per common
share for the years ended December 31, 1999 and 1998 includes dividends of
$558,000 and $578,000, respectively, accrued on the Company's Convertible Series
B Preferred Stock outstanding during such periods.

Stock-Based Compensation - As permitted under Financial Accounting Standards
Board Statement No. 123, "Accounting for Stock-Based Compensation" ("FAS No.
123"), the Company follows Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," in accounting for outstanding stock
options and warrants issued to employees. Under APB Opinion No. 25, compensation
expense relating to employee stock options is determined based on the excess of
the market price of the Company's stock over the exercise price on the date of
grant and does not require the recognition of compensation expense for stock
issued under plans defined as noncompensatory. Adoption of FAS No. 123 for
options issued to employees would require recognition of employee compensation
expense based on their computed "fair value" on the date of grant. In accordance
with FAS No. 123, stock options and warrants issued to consultants and other
non-employees as compensation for services provided to the Company are accounted
for based upon the fair value of the services provided or the estimated fair
market value of the option or warrant, whichever can be more clearly determined.
The Company recognizes this expense over the period the services are provided.
See Note 13.

NOTE 3 - STRATEGIC ALLIANCES

Smith & Nephew Joint Ventures
-----------------------------

In April 1996, the Company entered into an agreement with Smith & Nephew to form
a joint venture for the worldwide commercialization of Dermagraft(R), the
Company's tissue-engineered dermal skin replacement, for the treatment of
diabetic foot ulcers (the "Dermagraft Joint Venture"). In January 1998, the
Company and Smith & Nephew expanded the Dermagraft Joint Venture to include
venous ulcers, pressure ulcers, burns and other skin tissue wounds. At that
time, the Company retained the exclusive right to market TransCyte(TM), a
temporary covering for full and partial-thickness burns, in the United States,
while the Dermagraft Joint Venture was granted the right to market TransCyte for
other skin wounds in the United States. In August 1998, the Company and Smith &
Nephew further expanded the Dermagraft Joint Venture to include exclusive rights
to TransCyte for full and partial-thickness burns in the United States effective
October 1998. Smith & Nephew is a global medical device company with established
sales in 90 countries. Smith & Nephew markets technically innovative products
principally in the areas of wound management, orthopedics and endoscopy to
deliver cost effective solutions, significant physician advantages and real
patient benefits.

As consideration for entering into the Dermagraft Joint Venture, Advanced Tissue
Sciences received a $10 million up front fee in 1996. In addition, as a part of
the agreement to expand the joint venture, Smith & Nephew purchased $20 million,
or 1,533,115 newly-issued shares, of the Company's Common Stock at approximately
$13.05 per share in January 1998 (see Note 11). The Company also received an
additional $15 million as consideration for expanding the joint venture in
January 1999, and could receive, subject to the achievement of certain
milestones related to regulatory approvals, reimbursement and sales levels,
further payments of up to $136 million. The $15 million has been recognized into
revenue in 1999 as the related financial commitments were met. In February 2000,
the Company and Smith & Nephew agreed in principle to restructure certain
payments associated with the Dermagraft Joint Venture. See Note 17.

In the expanded joint venture, the Company and Smith & Nephew share equally in
the expenses and revenues of the Dermagraft Joint Venture, except the Company
will fund the first $6 million of expenses for conducting clinical trials and
for regulatory support of Dermagraft and TransCyte in the treatment of venous
and pressure ulcers. In addition, the Company funded certain manufacturing and
distribution costs and certain costs related to post-market studies of TransCyte
through December 1999. However, such manufacturing and distribution costs are to
be returned to the Company out of future gross margin or net profits, if any,
from sales of TransCyte for burns in the United States. During 1997, the Company
and Smith & Nephew shared equally in the expenses and revenues of the joint
venture. See Note 16 with respect to related party transactions with the
Dermagraft Joint Venture. Under the expanded joint venture, the Company will
continue to manufacture and Smith & Nephew will continue to market and sell the
joint venture's products.


                                      F-15

<PAGE>


In 1994, Smith & Nephew and the Company entered into a separate joint venture
for the development of tissue-engineered cartilage for orthopedic applications
(the "NeoCyte Joint Venture"). Under the NeoCyte Joint Venture, Smith & Nephew
contributed the first $10 million in funding and the Company contributed certain
technology licenses. The NeoCyte Joint Venture's total funding since inception
reached $10 million in January 1997 and, as provided in the joint venture
agreement, the Company and Smith & Nephew began sharing equally in NeoCyte Joint
Venture revenues and expenditures. See Note 16 with respect to related party
transactions with the NeoCyte Joint Venture.

The results of operations of the joint ventures for the years ended December 31,
1999, 1998 and 1997 are as follows (in thousands):

                                       1999            1998           1997
                                   -------------   ------------   --------------
Dermagraft Joint Venture

    Net sales*                      $  2,571       $    632        $      36
    Cost of goods sold                13,453         10,054              824
    Other costs and expenses          35,640         20,874           17,052
    Net loss                         (46,522)       (30,296)         (17,840)

    Current assets                     4,852          3,296              373
    Non-current assets                   278            237              304
    Current liabilities                4,450          2,767            3,737
    Partners' capital (deficit)          680            766           (3,060)

NeoCyte Joint Venture

    Costs and expenses              $  5,533       $  4,468        $   7,150
    Net loss                          (5,533)        (4,468)          (7,150)

    Current assets                       142             55               79
    Non-current assets                   274            400              591
    Current liabilities                  832            338              535
    Partners' capital (deficit)         (416)           117              135
---------------
* Includes sales of TransCyte in the United States for burns beginning in
  October 1998.

Inamed Agreements
-----------------

In May 1999, the Company and Inamed entered into a strategic alliance for the
development and marketing of several of the Company's human-based,
tissue-engineered products for certain aesthetic and reconstructive
applications. Specifically, Inamed licensed rights to further develop,
manufacture and sell tissue engineered products for use in cosmetic surgery as a
temporary covering after laser resurfacing or chemical peels, cartilage for
plastic and reconstructive surgery, and extracellular matrix for use in breast
reconstruction. In addition, in September 1999, Inamed also received license
rights to use extracellular matrix, including human collagen, from the Company's
three-dimensional culture system for soft tissue augmentation (wrinkles and
cosmetic correction) and as a bulking agent for the treatment of urinary
incontinence. Inamed is a global surgical and medical device company engaged in
the development, manufacturing and marketing of medical products for aesthetic
medicine, plastic and reconstructive surgery and the treatment of obesity.

In total, under the agreements between the parties, in exchange for worldwide
licensing rights, Inamed has paid the Company a series of payments totaling $10
million, including $5 million to purchase Advanced Tissue Sciences' common
stock. Inamed also received five-year warrants to purchase up to 500,000 shares
of common stock. See Note 11. In addition to royalties on product sales, the
Company may potentially receive up to a total of $10 million in milestones based
on product approvals in the United States.

The Company will be responsible for the funding and development of the products
and the related manufacturing processes while Inamed will be responsible for the
funding of clinical and regulatory activities. Advanced Tissue Sciences, or an
affiliate, may elect to manufacture the products developed under the agreement.
Fees for licensing rights and milestone payments will be recognized into
revenues as the related financial commitments for product development and
manufacturing processes are incurred.


                                      F-16

<PAGE>


NOTE 4 - INVENTORIES

Inventories consist of the following components as of December 31, 1999 and 1998
(in thousands):

                                               1999              1998
                                           ------------      ------------
    Raw materials and supplies              $   3,618         $   2,965
    Work-in-process                               677               399
                                            ---------         ---------
                                            $   4,295         $   3,364
                                           ===========        =========

NOTE 5 - PROPERTY

The major classes of property as of December 31, 1999 and 1998 are as follows
(in thousands):

                                               1999              1998
                                           ------------      ------------

    Equipment                               $  20,898         $  20,992
    Furniture and fixtures                        723               622
    Leasehold improvements                     10,835            10,754
    Equipment under capital leases                110               110
    Construction in progress                       --                87
                                            ---------         ---------
                                               32,566            32,565
    Less accumulated depreciation
      and amortization                        (15,939)          (11,941)
                                            ---------         ---------
    Net property                            $  16,627         $  20,624
                                            =========         =========

NOTE 6 - ACCRUED EXPENSES

Accrued expenses as of December 31, 1999 and 1998 consisted of (in thousands):

                                                1999             1998
                                           ------------      ------------

    Salaries and benefits                   $   3,418         $   2,083
    Clinical studies                              928                57
    Sponsored research                            510               401
    Other                                         704               948
                                            ---------         ---------
                                            $   5,560         $   3,489
                                            =========         =========

NOTE 7 - LONG-TERM DEBT

In August 1997, DermEquip entered into a term loan agreement with The Chase
Manhattan Bank to borrow up to $16 million (the "Chase Loan") through June 1998.
During the first half of 1998, DermEquip completed drawdowns under the loan
agreement to a total of $16 million. Principal is payable in equal quarterly
installments from June 1998 through June 2004. The Chase Loan bears interest
payable quarterly at the 90-day London Interbank Offered Rate ("LIBOR") plus 1/4
percent (6.25% at December 31, 1999). DermEquip's obligations with respect to
the Chase Loan are jointly and severally guaranteed by Smith & Nephew and the
Company. The guaranties are secured by DermEquip's assets, having a carrying
value of $11,757,000 as of December 31, 1999, and by each company's interest in
DermEquip.

In March 1997, the Company borrowed $10 million from Smith & Nephew pursuant to
a commitment as a part of the agreement to form the Dermagraft Joint Venture
(see Note 3). In June 1999, the loan and accrued interest payable to Smith &
Nephew were converted into 2,800,595 shares of the Company's common stock, as
allowed under the loan agreement. The loan had an interest rate equal to the
90-day LIBOR plus 4%.

Through December 1999, the Company has borrowed $7.5 million from Smith & Nephew
pursuant to a commitment as a part of the agreement to form the NeoCyte Joint
Venture (see Note 3). Under the terms of that joint venture agreement, the
Company may borrow up to a total of $10 million. The loan is unsecured and bears
interest at 90-day LIBOR plus 4% (10.00% at December 31, 1999) and is due on the
earlier of (i) June 2000 or (ii) the date on which the Company no longer has an
ownership interest in the NeoCyte Joint Venture. In February 2000, the Company
and Smith & Nephew agreed that the proceeds from the sale of the Company's
manufacturing plant assets and raw material inventory would be used to pay a
portion of this note with the remaining outstanding principal and interest due
at the June 30, 2000 maturity paid in the Company's Common Stock at the then
current market price for the common stock (see Note 17).


                                      F-17

<PAGE>


Debt and capital lease obligations as of December 31, 1999 and 1998 were as
follows (in thousands):

                                                1999             1998
                                           --------------   --------------

    Chase Loan                              $  11,520         $  14,080
    Smith & Nephew notes:
       Dermagraft Joint Venture                    --            10,000
       NeoCyte Joint Venture                    7,525             5,685
    Obligations under capital leases
      and other                                    54               184
    Less current portion                      (10,112)           (2,689)
                                            ---------         ---------
                                            $   8,987         $  27,260
                                            =========         =========

Maturities of long-term debt and capital lease obligations over the next five
years are $10,112,000 in 2000, $2,587,000 in 2001, $2,560,000 in 2002,
$2,560,000 in 2003, and $1,280,000 in 2004. As substantially all of the
Company's debt carries interest at variable rates, the fair market value of such
instruments is estimated to approximate their carrying value.

NOTE 8 - LEASE COMMITMENTS

Operating lease commitments relate primarily to the Company's manufacturing,
research and administrative facilities. In May 1999, the Company terminated a
15-year lease agreement for additional research and administrative space and
consolidated its activities into two existing facilities substantially reducing
its lease commitments for facilities. The leases for the Company's primary
facility, which include manufacturing, research and administrative facilities,
expire in September 2000; however, subsequent to year end, the Company exercised
its option to extend the term of these leases through December 2005. These
leases include the cost of some of the utilities and certain services, and
provide for annual rental increases ranging from a minimum of 3% to a maximum of
7% based on changes in the Consumer Price Index. The lease on the Company's
second facility has a five-year term and expires in January 2002. The lease
provides that the Company will pay rent, which increases 4% annually, as well as
the operating costs of the leased facility. The Company has also financed $1.5
million of office furniture and laboratory equipment under three operating
leases with terms ranging from three to four years and expiring in 2001 and
2002.

The following is a summary of the annual future minimum lease commitments as of
December 31, 1999 (in thousands):

                                                        Capital        Operating
                                                        Leases          Leases

     Year Ending December 31:
       2000                                             $    36         $ 2,534
       2001                                                  30             885
       2002                                                  --             500
                                                        -------         -------
     Total minimum lease payments                            66         $ 3,919
                                                                        =======
     Less amount representing interest                      (12)
                                                        -------
     Present value of net minimum lease payments        $    54
                                                        =======

Rental expense charged to operations under operating leases for facilities and
equipment for the years ended December 31, 1999, 1998 and 1997 amounted to
approximately $4,251,000, $4,219,000 and $3,412,000, respectively.

NOTE 9 - COMMITMENTS AND CONTINGENCIES

In 1997, the Company was awarded a $2 million grant by the National Institute of
Standards and Technology under their Advanced Technology program to support the
development of tissue-engineered vascular grafts over a three-year period
beginning in 1998. The grant requires the Company to meet certain minimum levels
of program funding in order to receive the grant funding. In addition, under
agreements with several universities, the Company has entered into commitments
to sponsor research for a minimum of $540,000 in 2000.

The Company is also responsible for patent application costs and associated
maintenance fees related to inventions under certain licensing agreements. The
Company seeks to protect its proprietary technology through the use of various
aspects of United States and foreign patent law and contractual arrangements.
However, there can be no assurance that the Company's patents or patent
applications will afford protection against competitors with similar technology,
nor can there be any assurance that the Company's present patents will not be
infringed upon or


                                      F-18

<PAGE>


designed around by others. Substantial costs could be incurred to protect
against infringement or defend the Company's patents and licensed patents.

Under the terms of its joint venture agreements, the Company has agreed to fund
its share of the costs of the Dermagraft and NeoCyte Joint Ventures. The Company
has also agreed to fund certain costs to develop products, and the related
manufacturing processes, which will be marketed by Inamed under the terms a
licensing agreement. See Note 3.

NOTE 10 - LEGAL PROCEEDINGS

During 1998, several lawsuits were filed in the United States District Court for
the Southern District of California against the Company and two of its officers.
The lawsuits alleged violations of federal securities laws arising out of
alleged misstatements and alleged failures to disclose certain material facts
concerning the clinical trials and obtaining United States Food and Drug
Administration approval of Dermagraft for the treatment of diabetic foot ulcers.
The lawsuits purported to seek damages on behalf of a class of shareholders who
purchased Advanced Tissue Sciences, Inc. Common Stock during the period
generally from January 13, 1997 through June 11, 1998. On May 3, 1999, the class
action was voluntarily dismissed by lead plaintiffs' counsel. No payment was
made by the Company and the voluntary dismissal terminates the action.

NOTE 11 - CAPITAL STOCK

Common Stock
------------

As of December 31, 1999, the Company had 11,424,467 shares of Common Stock
reserved for issuance under options and warrants, and for the conversion of and
the payment of dividends on the Company's Convertible Series B Preferred Stock.
In February 1999, the common stockholders of the Company approved an amendment
to the Company's Restated Certificate of Incorporation to increase the number of
authorized shares of common stock from 100,000,000 shares to 125,000,000 shares.

In November 1999, the Company completed a public offering of 3,750,000 units at
$4.00 per unit, resulting in proceeds to the Company of $15 million. In
conjunction with the offering, the Company agreed that $5 million of the
proceeds would be reserved for the redemption of any of its Series B Preferred
Stock submitted for conversion at or below $3.58 per share. Upon issuance, the
units separated into 3,750,000 shares of the Company's common stock and warrants
to purchase an additional 1,750,000 shares of common stock at $4.00 per share
over a three-year period (see Note 17). As part of the investment agreement, the
Company terminated its equity line agreement with a separate group of investors
prior to its February 2000 expiration date.

During 1999, as part of a licensing agreement signed in May 1999 between Inamed
and the Company, Inamed purchased 783,039 shares of the Company's common stock
for $5 million, an average price of approximately $6.39 per share. Inamed also
received five-year warrants to purchase a total of 500,000 shares of common
stock at an average exercise price of $12.80 per share. Inamed has agreed to
hold any investment in Advanced Tissue Sciences' common stock until at least
October 2002. See Note 3.

In June 1999, certain officers of the Company exercised employee stock options
for 775,000 shares of common stock. The purchase price of $1.3 million and
withholding taxes of $457,000 was paid by the delivery of 463,154 shares of the
Company's common stock which were held by the officers for over six months. See
Note 13 regarding stock options, warrants and restricted stock awards.

In connection with an expansion of the Dermagraft Joint Venture, Smith & Nephew
purchased $20 million, or 1,533,115 newly-issued shares, of the Company's Common
Stock in January 1998 at approximately $13.05 per share. Smith & Nephew has the
right to request registration of the shares.

In May 1995, the Company's Chairman and Chief Executive Officer exercised an
employee stock option. The purchase price was paid with an interest-bearing,
full recourse promissory note. In July 1999, the Company extended the repayment
terms on the note. As a result of the extension, the stock options exercised
through the issuance of the note are being accounted for as variable stock
options which may result in significant increases and decreases in compensation
expense subject to variability in the Company's stock price. The note receivable
and accrued interest of $1,219,665 and the note receivable of $918,500 as of
December 31, 1999 and 1998, respectively, are included in stockholders' equity
in the accompanying balance sheets.


                                      F-19

<PAGE>


Stockholders Rights Agreements
------------------------------

The Company adopted a Shareholder Rights Plan (the "Rights Plan") in January
1995 and pursuant thereto issued one preferred share purchase right ("Right") on
each outstanding share of Common Stock. The Rights are exercisable only if a
person or group acquires, or makes a tender offer to acquire, 15% or more of the
Company's Common Stock. The Rights Plan was amended in November 1999 to permit
the State of Wisconsin Investment Board to beneficially own up to 19.99% of the
Company's common stock and in December 1999 to eliminate the continuing director
provisions of the plan. In connection with the adoption of the Rights Plan, the
Company's Board of Directors designated and reserved 500,000 shares of the
Company's authorized Preferred Stock as Series A Junior Participating Preferred
Stock, par value $.01 per share (the "Series A Preferred Stock"). The Rights
have no voting privileges and expire on January 6, 2005.

When exercisable, each Right entitles its holder to buy one-hundredth of a share
of the Series A Preferred Stock at an exercise price of $55, subject to certain
antidilution adjustments. In addition, if at any time after the Rights become
exercisable, should (i) the Company be acquired in a merger or other business
combination transaction, or sell 50% or more of its consolidated assets or
earnings power, each Right will entitle its holder to purchase a number of the
acquiring company's common shares having a market value at the time of twice the
Right's exercise price or (ii) a person or group acquire 15% or more of the
Company's outstanding Common Stock (except as noted above), each Right will
entitle its holder, other than the acquirer, to purchase, at the Right's
then-current exercise price, a number of shares of the Company's Common Stock
having a market value of twice the Right's exercise price. The rights are
redeemable for one cent per Right at any time up to and including ten days after
the acquisition of 15% of the then outstanding Common Stock.

Preferred Stock
---------------

In July 1998, the Company raised $25 million through a private placement of
Convertible Series B Preferred Stock (the "Series B Preferred Stock") to a group
of investors (the "Investors"). Subject to adjustment in certain events, the
Series B Preferred Stock is convertible into Common Stock of the Company at
$4.77 per share (the "Conversion Price"). The Conversion Price will be increased
by one-half the amount by which the market price of the Common Stock on the date
of conversion exceeds $7.96 per share, if any. Conversely, should the average
daily trading price (as defined in the agreements) prior to a conversion be
equal to or below $3.58 per share, the Conversion Price will be equal to such
average daily trading price. The Series B Preferred Stock accrues dividends at
5% per annum. Dividends are payable quarterly in Common Stock or cash at the
option of the Company. To the extent not previously converted, the Series B
Preferred Stock is, at the election of the Company, redeemable at $50,000 per
share plus accrued dividends or convertible into Common Stock three years from
the date of issuance subject to extension in certain circumstances. Twenty
percent of the Series B Preferred Stock was redeemable at the option of the
holders on the occurrence of certain events (see Note 12). Through December
1999, 359.1 shares of the Company's Convertible Series B Preferred Stock and
40.1 shares of the Company's Redeemable Convertible Series B Preferred Stock
have been converted into 8,878,192 shares of common stock at an average price of
$2.25 per share.

NOTE 12 - REDEEMABLE PREFERRED STOCK

As of December 31, 1999, all 100.8 shares of the Company's outstanding Series B
Preferred Stock are classified as redeemable. In conjunction with its offering
in November 1999, the Company agreed that $5 million of the proceeds would be
reserved for the redemption of any of its Series B Preferred Stock submitted for
conversion at or below $3.58 per share. In addition, to the extent allowable,
the Company agreed to maintain an election to redeem for cash at 105% of
liquidation value any Series B Preferred Stock submitted for conversion at a
conversion price equal to or below $3.58 per share. As a result, all of the
Company's Convertible Series B Preferred Stock is reflected as redeemable and $5
million is presented as restricted cash in the consolidated balance sheet as of
December 31, 1999. In addition, as of December 31, 1999, 59.9 shares of the
Series B Preferred Stock are redeemable at 125% of liquidation value at the
option of the holders upon the occurrence of certain events such as a change in
control or suspension or delisting from the Nasdaq National Market, or at the
Conversion Price plus accrued dividends on a failure to have adequate shares
authorized, registered and available for conversion of such preferred stock. See
Note 17 regarding the conversion of all of the outstanding Series B Preferred
Stock in March 2000.


                                  F-20

<PAGE>


NOTE 13 - EMPLOYEE BENEFIT PLANS

The Company's Stock Incentive Plan (the "1997 Plan") provides for the grant of
incentive stock options, non-qualified stock options and stock issuances to
employees and consultants and automatic 50,000-share grants to non-employee
directors, currently to a maximum of 6,800,790 shares of Common Stock. At
December 31, 1999, a total of 5,014,892 shares were outstanding under options or
available for grant under the 1997 Plan. The Company has elected to continue to
account for its employee stock option plans under APB Opinion No. 25 rather than
adopt FAS No. 123 (see Note 2).

Under the 1997 Plan, the Company generally grants all employees stock options on
their date of employment and on promotion. The number of shares granted is based
on the employee's position and responsibilities. The options granted generally
become exercisable in equal annual amounts over five years and have a term of
ten years as long as the employee remains in the service of the Company. The
Company also began to make annual grants to employees in 1997. No such grants
were made in 1999. Non-employee directors receive an automatic grant of 50,000
shares upon joining the Board and generally every third year thereafter. These
options generally are immediately exercisable, become vested in equal annual
amounts over three years and have a term of ten years assuming continued service
on the Company's Board of Directors.

In August 1998, the Board of Directors approved a plan whereby each employee
option holder under the 1997 Plan, excluding officers and directors of the
Company, could exchange all of their current vested and unvested options with an
exercise price in excess of $7.00 per share for new options priced at market
value as of August 6, 1998. Specifically, existing options with exercise prices
between $7.01 and $11.00 per share were exchangeable three shares for two and
existing options priced above $11.00 were exchangeable two shares for one. A
total of 649,210 existing option shares at an average price of $12.68 were
exchanged for 360,534 replacement option shares with an exercise price of $3.34.
These replacement options vest on the same basis as the replaced options but
required that the employee continue their employment with the Company for a
minimum of one year from the date of grant in order for any of the shares to
vest. The replacement options are included as both grants and cancellations in
the stock option activity table shown below. The cancelled option shares are no
longer available for grants under the 1997 plan.

In addition to the 1997 Plan, the Company has issued options and warrants to
directors, consultants, employees and others as compensation for services. These
options and warrants vest and are exercisable over a variety of periods as
determined by the Company's Board of Directors.

The  following  table  summarizes  activity  under  the 1997  Plan and for other
options and warrants for Common Stock for the years ended December 31, 1999,
1998 and 1997:

<TABLE>
<CAPTION>

                                                       1997 Plan                    Other Options and Warrants
                                            -----------------------------          ----------------------------
                                                              Weighted                              Weighted
                                                Number      Average Price           Number        Average Price
                                               of Shares      Per Share            of Shares        Per Share
                                            --------------  -------------          ----------    ------------
   <S>                                        <C>              <C>                <C>                <C>
   Outstanding, December 31, 1996              3,773,701        $9.58              1,469,640          $7.18
     Granted                                     691,885       $13.82                     --             --
     Exercised                                  (189,306)       $8.75                (10,000)         $1.69
     Canceled                                   (161,130)      $11.48                     --             --
                                             -----------                          ----------
   Outstanding, December 31, 1997              4,115,150       $10.26              1,459,640          $7.21
     Granted                                   1,075,529        $6.23                 50,000         $14.00
     Exercised                                  (117,075)       $7.28                     --             --
     Canceled                                 (1,175,882)      $12.31                     --             --
                                             -----------                          ----------
   Outstanding, December 31, 1998              3,897,722        $8.62              1,509,640          $7.44
     Granted                                   1,151,150        $3.65              2,250,000          $5.95
     Exercised                                  (777,934)       $1.70                     --             --
     Canceled                                   (226,298)       $6.65                     --             --
                                             -----------                          ----------
   Outstanding, December 31, 1999              4,044,640        $8.64              3,759,640          $6.55
                                             ===========                           =========
</TABLE>

The weighted average fair value of options granted was $2.46, $4.47, and $10.09
under the 1997 Plan in 1999, 1998, and 1997, respectively, and $1.87 and $9.71
for other options and warrants in 1999 and 1998, respectively. The number of
shares exercisable under the 1997 Plan at December 31, 1999, 1998 and 1997 were
2,080,372, 2,104,429,


                                      F-21

<PAGE>


and 2,083,170, respectively, with a weighted average price per share of $10.22,
$7.81, and $7.09, respectively. All of the shares reflected as outstanding under
other options and warrants granted were exercisable as of December 31, 1998 and
1997 at the weighted average price per share shown above. As of December 31,
1999, 3,259,640 shares were exercisable at a weighted average price of $5.59.

In May 1999, the Company's Chairman and Chief Executive Officer was awarded
300,000 shares of restricted common stock under the 1997 Plan. The value at
grant date was $3.75, as determined by the market price of the stock upon that
date. Subject to meeting certain requirements including continued service,
50,000 shares will vest annually and the remaining 150,000 shares will vest at
the end of five years or, if earlier, upon approval of Dermagraft for the
treatment of diabetic foot ulcers in the United States. The difference between
the market price at the grant date and the purchase price of $.01 per share is
being recognized as compensation expense by the Company ratably over the
restricted periods.

Other options and warrants granted includes warrants issued to an investment
group which are exercisable for a total of 225,000 shares of Common Stock at
exercise prices ranging from $10.50 to $14.00 per share. These warrants were
issued as commitment fees on an equity line. During the years ended December 31,
1999, 1998 and 1997, $35,000, $430,000 and $438,000, respectively, were charged
to expense reflecting the amortization of the fair market value of these
warrants over the commitment period. In addition, the Company charged $309,000
and $588,000 to expense in 1999 and 1998, respectively, in connection with
options or warrants and restricted stock awards granted to employees.

The following table summarizes by price ranges the number of shares, weighted
average exercise price and weighted average remaining life (in years) of options
and warrants exercisable and outstanding as of December 31, 1999.

<TABLE>
<CAPTION>

                                               Exercisable                            Total Outstanding
                                   ----------------------------------  ---------------------------------------------
                                                                                             Weighted Average
                                     Number of      Weighted Average      Number of   ------------------------------
     Price Range                       Shares       Exercise Price         Shares       Exercise Price        Life
----------------------             ------------  --------------------  ------------   ------------------    --------
<S>                                 <C>                 <C>              <C>                 <C>              <C>
1997 Plan:
    $1.96 - 3.93                      471,122              $3.51         1,667,850            $3.53           8.4
    $3.94 - 5.89                       91,760              $5.60           102,485            $5.52           4.8
    $5.90 - 7.85                       49,600              $7.22           118,400            $6.91           6.3
    $7.86 - 9.81                      252,740              $8.69           337,375            $8.69           4.5
    $9.82 - 11.78                     226,818             $10.91           242,800           $10.92           4.7
    $11.79 - 13.74                    734,192             $13.38         1,254,405           $13.38           6.1
    $13.75 - 15.70                     64,910             $14.75            74,275           $14.71           6.2
    $15.71 - 17.66                    189,230             $17.30           247,050           $17.12           6.0
                                    ---------                            ---------
         Total 1997 Plan            2,080,372             $10.22         4,044,640            $8.64           6.8
                                    =========                            =========

Other Options and Warrants:
    $1.47 - 1.67                      300,000              $1.57           300,000            $1.57           3.5
    $3.93 - 5.89                    1,760,000              $4.00         1,760,000            $4.00           2.8
    $7.85 - 9.81                      874,640              $8.15           874,640            $8.15           1.4
    $9.82 - 11.78                     275,000             $10.50           275,000           $10.50           2.4
    $11.79 - $13.74                        --                 --           500,000           $12.79           4.6
    $14.00                             50,000             $14.00            50,000           $14.00           5.1
                                    ---------                            ---------
         Total Other                3,259,640              $5.59         3,759,640            $6.55           2.8
                                    =========                            =========
</TABLE>


                                      F-22

<PAGE>


The following table reflects the Company's pro forma net loss applicable to
common stock and basic and diluted loss per common share for the years ended
December 31, 1999, 1998 and 1997 had the expense provisions of FAS No. 123 been
implemented (in thousands except per share amounts):

<TABLE>
<CAPTION>

                                                             1999               1998             1997
                                                       ---------------    ---------------   -------------
    <S>                                                <C>                <C>               <C>
      Net loss applicable to common stock:
      As reported                                      $    (21,864)      $     (43,863)    $   (36,089)
      Pro forma                                             (27,640)            (51,040)        (43,224)

    Basic and diluted loss per share:
      As reported                                      $       (.45)      $      (1.11)     $     (.96)
      Pro forma                                                (.57)             (1.30)          (1.15)
</TABLE>

Because the Statement 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the above pro forma information may not be
representative of that to be expected in future years.

The fair value of each option grant has been estimated on the date of grant
using the Black-Scholes option pricing model. The following weighted average
assumptions were used for grants made under the 1997 Plan in 1999, 1998 and
1997: (i) risk-free interest rates of 4.5% to 6.2% for 1999, 4.0% to 5.6% for
1998, and 6.1% to 6.7% for 1997; (ii) expected lives of five years for 1999, one
year to eight years for 1998, and four to nine years for 1997, and (iii)
volatility of 79% for 1999, 69% to 100% for 1998, and 63% to 64% for 1997. It is
assumed that no dividends are paid on the stock in all the Black-Scholes option
pricing model estimates. The estimated value of warrants issued in 1998 and 1996
for services were based on the value of the services rendered.

The Company has a 401(k) Plan (the "401(k) Plan") under which employees meeting
certain eligibility requirements may elect to participate and contribute to the
401(k) Plan. Under the 401(k) Plan, the Company may elect to match a
discretionary percentage of contributions. No such matching contributions have
been made to the 401(k) Plan since its inception.

NOTE 14 - INCOME TAXES

The Company has federal and California net operating loss carryforwards of
approximately $219 million and $18 million, respectively, as of December 31,
1999. The difference between the federal and California operating tax loss
carryforwards principally results from a fifty percent limitation on California
loss carryforwards, the Company not having operations in California until late
1989 and the capitalization of certain research and development expenses for
California purposes. As of December 31, 1999, the Company also has federal and
California research and development tax credit carryforwards of approximately
$5 million and $2 million, respectively, and has California manufacturer's
investment tax credit carryforwards of approximately $480,000. The federal net
operating loss and research and development tax credit carryforwards will begin
expiring in 2000 and 2001, respectively, and the California research and
development tax credit carryforwards and the California manufacturer's
investment tax credit carryforwards will begin expiring in 2004, unless
previously utilized. California net operating loss carryforwards of
approximately $5 million expired in 1999, and $4 million and $500,000 will
expire in 2000 and 2001, respectively, if not previously utilized.

Utilization of future net operating loss carryforwards could be limited if
certain cumulative changes in the Company's ownership were to occur. Included in
the federal net operating loss carryforwards, and subject to an annual
limitation, are approximately $5 million of losses related to an acquisition.

Net deferred tax assets have been completely offset by a valuation allowance, as
realization of the deferred tax assets is uncertain. During the year ended
December 31, 1999, the valuation allowance increased by $9,603,000.


                                      F-23

<PAGE>


Significant components of the Company's net deferred tax assets as of December
31, 1999 and 1998 are as follows (in thousands):

                                                      1999              1998
                                                 --------------    -------------
    Deferred tax assets:
     Net operating loss carryforwards             $  77,557         $  72,085
     Tax credit carryforwards                         6,959             7,156
     Capitalized research and development             5,647             4,905
     Depreciation                                     2,185               490
     Deferred revenue                                 1,465                --
     Other                                            1,482             1,039
                                                   --------         ---------
       Total deferred tax assets                     95,295            85,675
                                                   --------         ---------
    Deferred tax liabilities:
     Patent expense                                    (847)             (830)
                                                   --------         ---------
       Total deferred tax liability                    (847)             (830)
                                                   --------         ---------
    Net deferred tax assets before
     valuation allowance                             94,448            84,845
    Valuation allowance                             (94,448)          (84,845)
                                                   --------         ---------
    Net deferred tax assets                        $     --         $      --
                                                   ========         =========

Approximately $7 million of the valuation allowance for deferred tax assets
relates to benefits of stock option deductions which, when and if recognized,
will be allocated directly to additional paid-in capital.

NOTE 15 - SUPPLEMENTAL CASH FLOW INFORMATION

The following summarizes the significant non-cash investing and financing
activities of the Company and provides other supplemental cash flow information.

During 1999, non-cash financing activities included the repayment of a $10
million loan and accrued interest payable through the issuance of common stock
(see Note 7) and the exercise of stock options by the delivery of common stock
in payment of the exercise price (see Note 11). The Company also issued a
restricted stock award under the 1997 Plan (see Note 13). During 1998, non-cash
financing activities included the issuance of warrants exercisable for Common
Stock as a commitment fee with a value of $418,000 representing the amount of
the fee as negotiated between the parties. Non-cash financing and investing
activities during the year ended December 31, 1997 included the financing of
$50,000 of equipment through capital leases. Other non-cash activities have
involved the issuance of compensatory stock options to employees (see Note 13).

Net cash from operating activities reflects cash payments for interest expense
of approximately $1,509,602, $1,368,000, and $868,000 for the years ended
December 31, 1999, 1998 and 1997, respectively.

NOTE 16 - RELATED PARTY TRANSACTIONS

During the years ended December 31, 1999, 1998 and 1997, the Company has
performed services for its Dermagraft and NeoCyte Joint Ventures and has
manufactured products for the Dermagraft Joint Venture to sell to customers or
for use in clinical trials as described below (see Note 3). The Company has a
fifty percent interest in each of the Dermagraft and NeoCyte Joint Ventures.

Dermagraft Joint Venture
------------------------

During the years ended December 31, 1999, 1998 and 1997, the Company recognized
$9,165,000, $5,598,000 and $7,041,000, respectively, in contract revenues for
research and development, marketing and other activities performed for the
Dermagraft Joint Venture. In addition, during the years ended December 31, 1999,
1998 and 1997, product sales to related parties include products sold to the
Dermagraft Joint Venture of $13,717,000, $10,927,000 and $1,190,000,
respectively.

As a purpose of the Dermagraft Joint Venture is to share the costs of
manufacturing and commercializing the Company's Dermagraft and TransCyte
products between the joint venture's partners, product sales to the Dermagraft
Joint Venture are equal to the Company's cost of goods sold for such products
including period costs (except for the period from January 1, 1997 to September
30, 1998 when the Company also sold TransCyte in the United States and,
therefore, absorbed period costs related to TransCyte).
Period costs reflect overhead costs related to excess production capacity and
include rent, depreciation, and quality control, facilities, supplies and other
such


                                      F-24

<PAGE>


costs to support, or related to, the excess production capacity. Due to costs
related to excess production capacity, the Dermagraft Joint Venture immediately
writes the inventory down to estimated market value at the date of purchase,
which is the net realizable value at which the joint venture believes it will be
able to sell the products to its customers. During the years ended December 31,
1999, 1998 and 1997, such write downs by the Dermagraft Joint Venture totaled
$11,982,000, $8,267,000 and $491,000, respectively.

As a result of restructuring the Dermagraft Joint Venture Agreement with Smith &
Nephew in February 2000, the Company will also receive certain royalty payments
from the joint venture on product sales made by the joint venture. See Note 17.

NeoCyte Joint Venture
---------------------

During the years ended December 31, 1999, 1998 and 1997, the Company recognized
$2,885,000, $2,337,000 and $3,934,000, respectively, in contract revenues for
research and development activities performed for the NeoCyte Joint Venture.

The Company's share of the above costs incurred by the Company and charged to
the Dermagraft and NeoCyte Joint Ventures are reflected in the equity in losses
of joint ventures in the accompanying statement of operations and totaled
$15,934,000, $9,547,000 and $5,899,000 in the years ended December 31, 1999,
1998 and 1997, respectively.

NOTE 17 - SUBSEQUENT EVENTS

Payment Received Upon Exercise of Warrants
------------------------------------------

In January 2000, the Company received an additional $7.0 million from the
exercise of warrants to purchase all 1,750,000 shares of common stock at $4.00
per share. These warrants were a component of the 3,750,000 units sold in the
November 1999 public offering (see Note 11).

Agreement to Restructure Dermagraft Joint Venture (Unaudited)
-------------------------------------------------------------

In February 2000, the Company and Smith & Nephew agreed in principle to
restructure certain payments associated with their Dermagraft Joint Venture as a
result of delays in the commercial introduction of Dermagraft in the United
States. The requirement for the ongoing clinical trial by the U.S. Food and Drug
Administration has substantially increased the partners' investments
necessitating the restructuring. The objective of the restructuring is to defer
the potential payments of certain milestones by Smith & Nephew while providing
the Company a royalty stream and an opportunity to increase its long-term return
from the venture.

Specifically, except for $10 million in regulatory approval and reimbursement
milestones related to Dermagraft in the treatment of diabetic foot ulcers, the
Company agreed to make all other approval, reimbursement and sales milestones
subject to, and payable from, joint venture earnings exceeding certain minimum
levels. In return, the Dermagraft Joint Venture will pay the Company royalties
on joint venture product sales. Other than these changes, revenues and expenses
of the Dermagraft Joint Venture will continue to be shared. In addition, as a
part of the agreement, the Company will sell the Dermagraft manufacturing assets
that it currently owns to DermEquip (see Note 1), and will also sell its raw
material inventories to the Dermagraft Joint Venture.

The Company and Smith & Nephew also agreed that certain of the proceeds from the
sale of the Company's manufacturing plant assets and raw material inventory
discussed above will be used to pay down a portion of the outstanding balance of
the loan from Smith & Nephew related to the NeoCyte Joint Venture. The remaining
outstanding principal and interest due at the June 30, 2000 maturity will be
paid in the Company's Common Stock at the then current market price for the
common stock. See Note 7.

Conversion of Convertible Series B Preferred Stock (Unaudited)
--------------------------------------------------------------

In March 2000, 100.8 shares, representing all of the Company's Series B
Preferred Stock as December 31, 1999, were converted into 1,354,539 shares of
the Common Stock at $3.72 per share. As a result of the conversion, $5 million
in cash that was reported as restricted for redemption of the Series B Preferred
Stock in the accompanying balance sheet as of December 31, 1999 is now available
to support the Company's operations. See Notes 11 and 12.


                                      F-25

<PAGE>


                Report of Ernst & Young LLP, Independent Auditors

The Board of Directors and Stockholders
Advanced Tissue Sciences, Inc.

We have audited the accompanying consolidated balance sheets of Advanced Tissue
Sciences, Inc. as of December 31, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1999. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Advanced Tissue
Sciences, Inc. at December 31, 1999 and 1998, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States.





                                                      ERNST & YOUNG LLP

San Diego, California
February 1, 2000


                                      F-26

<PAGE>



                            DERMAGRAFT JOINT VENTURE
                             COMBINED BALANCE SHEETS

                                 (In Thousands)

                                                        December 31,
                                               ------------------------------
                                                   1999              1998
                                               ------------      ------------
          ASSETS
Current assets:
   Cash                                          $    91           $    72
   Accounts receivable from partners
     and affiliates                                3,967             1,538
   Inventory                                         786             1,462
   Other current assets                                8               224
                                                 -------           -------
     Total current assets                          4,852             3,296
Property - net                                       278               237
                                                 -------           -------
     Total assets                                $ 5,130           $ 3,533
                                                 =======           =======


         LIABILITIES AND PARTNERS' CAPITAL

Current liabilities:
   Payable to partners and affiliates            $ 3,562           $  2,767
   Accounts payable                                  888                 --
                                                 -------           --------
     Total current liabilities                     4,450              2,767

Partners' capital                                    680                766
                                                 -------           --------

     Total liabilities and partners' capital     $ 5,130           $  3,533
                                                 =======           ========


          See accompanying notes to the combined financial statements.


                                      F-27

<PAGE>


                            DERMAGRAFT JOINT VENTURE
                        COMBINED STATEMENTS OF OPERATIONS
                                 (In Thousands)

<TABLE>
<CAPTION>

                                                                   Year Ended December 31,
                                                     --------------------------------------------------
                                                          1999               1998             1997
                                                     --------------     --------------   --------------
<S>                                                   <C>                <C>              <C>
Product sales                                         $    2,571         $      632       $       36
                                                      ----------         ----------       ----------

Operating expenses:
  Research and development                                 8,634              2,907            5,118
  Selling, general and administrative                     11,651             17,779           11,204
  Cost of goods sold                                      13,453             10,054              824
                                                      ----------         ----------       ----------
     Total operating expenses                             33,738             30,740           17,146
                                                      ----------         ----------       ----------
Loss from operations                                     (31,167)           (30,108)         (17,110)

Other income (expense):
  Interest income                                            115                 93              108
  Interest charges from related parties                     (479)              (622)            (454)
  License fee to related party                           (15,000)                --               --
  Other income (expense)                                       9                341             (384)
                                                      ----------         ----------       ----------

Net loss                                              $  (46,522)        $  (30,296)      $  (17,840)
                                                      ==========         ==========       ==========
</TABLE>



           See accompanying notes to the combined financial statements.


                                      F-28

<PAGE>


                            DERMAGRAFT JOINT VENTURE
                        COMBINED STATEMENTS OF CASH FLOWS
                                 (In Thousands)

<TABLE>
<CAPTION>

                                                                   Year Ended December 31,
                                                     --------------------------------------------------
                                                          1999               1998             1997
                                                     --------------     --------------   --------------
<S>                                                   <C>                <C>              <C>
Operating activities:
  Net loss                                            $  (46,522)        $  (30,296)      $  (17,840)
  Adjustments to reconcile net loss to cash
    used in operating activities:
     Depreciation                                             63                 40                3
     Other adjustments to net loss                            --                144                6
     Changes in assets and liabilities:
       Accounts receivable from partners
         and affiliates                                   (2,429)            (1,538)              --
       Inventory                                             676             (1,101)            (361)
       Other current assets                                  216               (224)              --
       Accounts payable                                      888                (35)              35
       Payable to partners and affiliates                    795               (842)           3,609
       Accrued expenses                                       --                (93)              93
                                                      ----------         ----------       ----------
         Net cash used in operating activities           (46,313)           (33,945)         (14,455)
                                                      ----------         ----------       ----------
Investing activities:
  Acquisition of property                                   (104)              (117)            (163)
                                                      ----------         ----------       ----------
Financing activities:
  Contributions from partners                             51,536             39,175           15,284
  Distributions to partners                               (5,100)            (5,053)            (654)
                                                      ----------         ----------       ----------
         Net cash provided by financing activities        46,436             34,122           14,630
                                                      ----------         ----------       ----------
Net increase in cash                                          19                 60               12
Cash at beginning of period                                   72                 12               --
                                                      ----------         ----------       ----------
Cash at end of period                                 $       91         $       72       $       12
                                                      ==========         ==========       ==========
</TABLE>



          See accompanying notes to the combined financial statements.


                                      F-29

<PAGE>


                            DERMAGRAFT JOINT VENTURE
                    COMBINED STATEMENTS OF PARTNERS' CAPITAL
                                 (In Thousands)

<TABLE>
<CAPTION>

                                                       Advanced
                                                        Tissue            Smith &
                                                    Sciences, Inc.       Nephew plc          Total
                                                   ----------------    --------------    ------------
<S>                                                   <C>                <C>              <C>
Balance, December 31, 1996                            $       --         $       --       $       --
     Capital contributions                                 7,780              7,746           15,526
     Capital distributions                                  (390)              (356)            (746)
     Net loss                                             (8,920)            (8,920)         (17,840)
                                                      ----------         ----------       ----------
Balance, December 31, 1997                                (1,530)            (1,530)          (3,060)
     Capital contributions                                20,111             19,336           39,447
     Capital distributions                                (2,504)            (2,821)          (5,325)
     Net loss                                            (15,694)           (14,602)         (30,296)
                                                      ----------         ----------       ----------
Balance, December 31, 1998                                   383                383              766
     Capital contributions                                21,888             29,890           51,778
     Capital distributions                                (2,839)            (2,503)          (5,342)
     Net loss                                            (19,092)           (27,430)         (46,522)
                                                      ----------         ----------       ----------
Balance, December 31, 1999                            $      340         $      340       $      680
                                                      ==========         ==========       ==========
</TABLE>




          See accompanying notes to the combined financial statements.


                                      F-30

<PAGE>


                            DERMAGRAFT JOINT VENTURE
                   NOTES TO THE COMBINED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

Organization - Advanced Tissue Sciences, Inc. ("Advanced Tissue Sciences") and
Smith & Nephew plc ("Smith & Nephew") entered into a fifty-fifty joint venture
(the "Dermagraft Joint Venture") for the worldwide commercialization of
Dermagraft(R), a tissue-engineered dermal replacement, for the treatment of
diabetic foot ulcers in April 1996. Advanced Tissue Sciences is a tissue
engineering company utilizing its proprietary core technology to develop and
manufacture living human tissue products for tissue repair and transplantation.
Smith & Nephew is a global medical device company which markets technically
innovative products principally in the areas of wound management, orthopedics,
and endoscopy. References herein to Advanced Tissue Sciences and Smith & Nephew
include their subsidiaries and certain affiliates.

The Dermagraft Joint Venture became responsible for the further development and
commercialization of Dermagraft for diabetic foot ulcers effective January 1997.
In January 1998, the Dermagraft Joint Venture was expanded to include venous
ulcers, pressure ulcers, burns and other skin tissue wounds. At that time,
Advanced Tissue Sciences retained the exclusive right to market TransCyte(TM), a
temporary covering for full and partial-thickness burns, in the United States,
while the Dermagraft Joint Venture was granted the right to market TransCyte for
other skin wounds in the United States. In August 1998, the joint venture was
further expanded to include exclusive rights to TransCyte for full and
partial-thickness burns in the United States effective October 1998. TransCyte
is currently being marketed in the United States for burns, and Dermagraft for
the treatment of diabetic foot ulcers is in clinical trials in the United States
and on the market in Canada, Australia, New Zealand and several other European
countries, including the United Kingdom.

In the expanded joint venture, Advanced Tissue Sciences and Smith & Nephew will
continue to share equally in the expenses and revenues of the Dermagraft Joint
Venture, except Advanced Tissue Sciences has agreed to fund the first $6 million
of expenses for conducting clinical trials and for regulatory support of
Dermagraft and TransCyte in the treatment of venous ulcers and pressure sores.
In addition, Advanced Tissue Sciences funded certain manufacturing and
distribution costs and certain costs related to post-market studies of TransCyte
through December 1999. Such manufacturing and distribution costs are to be
returned to Advanced Tissue Sciences out of future gross margin on net profits,
if any, from sales of TransCyte for burns in the United States. See Note 7
regarding an agreement in principle in February 2000 to restructure certain
payments associated with the Dermagraft Joint Venture.

Principles of Combination - The combined financial statements for 1999 include
the accounts of the Dermagraft Joint Venture, a Delaware general partnership
formed between subsidiaries of Advanced Tissue Sciences and Smith & Nephew, and
the revenues and expenses of Advanced Tissue Sciences, Smith & Nephew and their
affiliates associated with the worldwide commercialization of Dermagraft and
TransCyte. Prior to January 1, 1999, the combined financial statements included
the accounts of the Dermagraft Joint Venture (formerly Dermagraft U.S.) and
Dermagraft International, a Delaware general partnership owned by Advanced
Tissue Sciences and Smith & Nephew. The Dermagraft Joint Venture and Dermagraft
International were merged into the Dermagraft Joint Venture effective January 1,
1999. All intercompany accounts and transactions have been eliminated.

Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
related disclosures at the date of the financial statements, and the amounts of
revenues and expenses reported during the period. Actual results could differ
from those estimates.

Dependence on Certain Suppliers - Certain materials, such as the mesh frameworks
used in the manufacture of Dermagraft and TransCyte are sourced from single
manufacturers. Any significant supply interruption would adversely affect
product manufacturing. In addition, an uncorrected impurity or supplier's
variation in raw material, either unknown or incompatible with the manufacturing
process, could have a material adverse effect on the manufacture of the product.


                                      F-31

<PAGE>


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Inventories are valued at the lower of cost or market using the first-in,
first-out method. The Dermagraft Joint Venture, under contractual obligation,
purchases product at cost, which includes period costs, from Advanced Tissue
Sciences at the completion of manufacture. Period costs reflect overhead costs
related to excess production capacity and include rent, depreciation, quality
control, facilities, supplies and other such costs to support or related to the
excess production capacity. As cost currently exceeds market value due to excess
production capacity, the Dermagraft Joint Venture immediately writes the
inventory down to estimated market value at the date of purchase, which is the
net realizable value at which the joint venture believes it will be able to sell
the products to its customers. During the years ended December 31, 1999, 1998
and 1997, such write-downs totaled $11,982,000, $8,267,000 and $491,000,
respectively.

Property and Equipment is recorded at cost and depreciation is calculated on a
straight-line basis using an estimated useful life of five years.

Revenue/Expense Recognition - Revenues from product sales are recognized when
products are shipped to the customer. Research and development costs are
expensed as incurred. The joint venture does not recognize sales on consignment
shipments to third party customers until the product is used by the customer. No
sales are subject to a resale obligation. Product returns are estimated based on
past experience.

NOTE 3 - INVENTORIES

Inventories consist of the following components as of December 31, 1999 and 1998
(in thousands):

                                     1999             1998
                                 -----------       ----------

        Work-in-process           $     171         $    461
        Finished goods                  615            1,001
                                  ---------         --------
                                  $     786         $  1,462
                                  =========         ========

Inventories are net of reserves of $383,000 and $213,000 as of December 31, 1999
and 1998, respectively. See Note 2 with respect to the carrying value of the
joint venture's inventory.

NOTE 4 - PROPERTY

The following is a summary of property and accumulated depreciation as of
December 31, 1999 and 1998 (in thousands):

                                                    1999            1998
                                                -----------      ----------

        Equipment, at cost                       $    383         $   280
        Less accumulated depreciation                (105)            (43)
                                                 --------         -------
        Net property                             $    278         $   237
                                                 ========         =======

Depreciation expense charged to operations was $62,000, $40,000, and $3,000 in
1999, 1998 and 1997, respectively.

NOTE 5 - RELATED PARTY TRANSACTIONS

Under the joint venture agreements, Advanced Tissue Sciences is manufacturing
and Smith & Nephew is selling and marketing Dermagraft and TransCyte for the
Dermagraft Joint Venture (see Note 1). In addition, Advanced Tissue Sciences and
Smith & Nephew are providing research, development and administrative services
to the Dermagraft Joint Venture. All such expenses are reflected in the combined
financial statements at their estimated cost. The Dermagraft Joint Venture also
pays the partners interest on the use of their working capital in support of the
joint venture's operations. The following table summarizes related party
revenues and expenses for the years ended December 31, 1999, 1998 and 1997 (in
thousands):

<TABLE>
<CAPTION>

                                                   Advanced Tissue Sciences                Smith & Nephew
                                              ---------------------------------   --------------------------------
                                                 1999        1998        1997        1999       1998       1997
                                              ---------   ---------   ---------   ---------   --------   ---------
     <S>                                      <C>         <C>         <C>         <C>         <C>        <C>
     Sales                                    $     --    $     --    $     --    $  2,571    $   632    $    36
     Cost of goods sold                         13,453      10,054         824          --         --         --
     Research and development                    7,119       2,260       4,476         943        465        642
     Selling, general and administrative         1,486       2,979       2,750       8,607     14,161      7,101
</TABLE>


                                      F-32

<PAGE>


Upon entering into the Dermagraft Joint Venture in April 1996, Smith & Nephew
agreed to pay Advanced Tissue Sciences an up front fee of $10 million. This fee
was funded through a capital contribution to the Dermagraft Joint Venture by
Smith & Nephew and paid by the joint venture to Advanced Tissue Sciences. Under
the joint venture agreements, the $10 million expense is allocated to Smith &
Nephew's capital account. As the Dermagraft Joint Venture did not begin
operations until January 1, 1997, the $10 million fee represents the only
activity in the Dermagraft Joint Venture from April 29, 1996 (inception) to
December 31, 1996 (see Note 1). Similarly, in January 1999, Advanced Tissue
Sciences received a $15 million payment in connection with the 1998 expansion of
the Dermagraft Joint Venture to include venous ulcers, pressure ulcers, burns
and other skin wounds. The $15 million payment was a capital contribution to the
Dermagraft Joint Venture by Smith & Nephew and the related expense has been
allocated to Smith & Nephew's capital account. Smith & Nephew has also agreed to
pay up to an additional $136 million on the achievement of certain milestones
related to product approval, gaining product reimbursement and on attaining
specific sales milestones. These milestones, if achieved, are to be funded and
paid to Advanced Tissue Sciences either directly by Smith & Nephew or through
the Dermagraft Joint Venture. See Note 7 regarding an agreement in February 2000
to restructure certain payments associated with the Dermagraft Joint Venture.

NOTE 6 - SUPPLEMENTAL CASH FLOW INFORMATION

The joint venture's non-cash investing and financing activities for the years
ended December 31, 1999, 1998 and 1997 included $242,000, $325,000 and $98,000,
respectively in interest charges contributed as capital by the partners.

NOTE 7 - SUBSEQUENT EVENT (UNAUDITED)

In February 2000, Advanced Tissue Sciences and Smith & Nephew agreed in
principle to restructure certain payments associated with the Dermagraft Joint
Venture as a result of delays in the commercial introduction of Dermagraft in
the United States. The requirement for the ongoing clinical trial by the U.S.
Food and Drug Administration has substantially increased the partners'
investments necessitating the restructuring. The objective of the restructuring
is to defer the potential payments of certain milestones by Smith & Nephew while
providing Advanced Tissue Sciences a royalty stream and an opportunity for an
increase in its long-term return from the joint venture.

Specifically, except for $10 million in regulatory approval and reimbursement
milestones related to Dermagraft in the treatment of diabetic foot ulcers,
Advanced Tissue Sciences agreed to make all other approval, reimbursement and
sales milestones subject to, and payable from, joint venture earnings exceeding
certain minimum levels. In return, the Dermagraft Joint Venture will pay
Advanced Tissue Sciences royalties on joint venture product sales. Other than
these changes, revenues and expenses of the Dermagraft Joint Venture will
continue to be shared. See Note 1. In addition, as a part of the agreement,
Advanced Tissue Sciences will sell the Dermagraft manufacturing assets that it
currently owns to a company jointly owned with Smith & Nephew, and will also
sell its raw material inventories to the Dermagraft Joint Venture.


                                      F-33

<PAGE>



                REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS


The Board of Directors
ATS Dermagraft, Inc. and Smith & Nephew SNATS, Inc.


We have audited the accompanying combined balance sheets of the Dermagraft Joint
Venture as of December 31, 1999 and 1998, and the related combined statements of
operations, partners' capital and cash flows for each of the three years in the
period ended December 31, 1999. These financial statements are the
responsibility of the joint venture's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the combined financial position of the Dermagraft Joint
Venture at December 31, 1999 and 1998, and the combined results of its
operations and its cash flows for each of the three years ended December 31,
1999 in conformity with accounting principles generally accepted in the United
States.




                                                        ERNST & YOUNG LLP


San Diego, California
January 19, 2000