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, 2001

[ ]   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 25, 2002 was approximately $234,095,000.

     As of March 25, 2002 there were 73,154,753 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 29, 2002, 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.


<PAGE>


                                     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. OUR 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. WE UNDERTAKE 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 WE FILE FROM TIME TO TIME WITH THE
SECURITIES AND EXCHANGE COMMISSION, INCLUDING OUR QUARTERLY REPORTS ON FORM
10-Q.

         DERMAGRAFT(R), NOURICEL(TM) AND ANGINERA(TM) ARE OUR TRADEMARKS.
TRANSCYTE(R) IS A REGISTERED TRADEMARK OF OUR JOINT VENTURE PARTNER, SMITH &
NEPHEW PLC. EACH OTHER TRADEMARK, TRADE NAME OR SERVICE MARK APPEARING IN THIS
FORM 10-K BELONGS TO ITS HOLDER.

     ITEM 1. BUSINESS

INTRODUCTION

     Advanced Tissue Sciences, Inc. was incorporated under the laws of the State
of Delaware in 1987. We maintain our executive offices at 10933 North Torrey
Pines Road, La Jolla, California 92037, and our telephone number at that address
is (858) 713-7300. Financial information regarding our 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.

     We are a leader in the field of tissue engineering, using our patented
technology to develop human-based tissue products for a variety of therapeutic
applications. We use principles of cell biology, bioengineering, biochemistry,
polymer science and transplant science in order to culture living human cells,
either within, "in vivo", or outside, "ex vivo", the human body, in a way that
allows the cells to develop and assemble into a functioning three-dimensional
tissue. With this human-based tissue development technology, we have
successfully replicated a number of tissues that are being developed for the
purpose of replacing, repairing or restoring diseased, damaged or aging tissue
and organs.

     Our strategy uses our core, human-based tissue development technology to
generate our currently marketed products, as well as a broad portfolio of
potential products. By building upon our base of scientific knowledge through
the continued application of this technology, we believe that we have achieved,
and will continue to achieve, synergies in the development, clinical testing and
manufacture of successive products. We also seek to increase the potential use
of our products by identifying and pursuing multiple indications for each
product.

CORE TECHNOLOGY

     Our tissue engineering core technology involves the controlled in vivo or
ex vivo growth of living tissues and organs on three-dimensional support
structures known as scaffolds. We believe that our core technology represents a
major advance in the bioengineering of human tissues for replacing or repairing
damaged or diseased tissue or organs. Recent medical advances have made possible
the ex vivo growth of many of the over 200 different types of cells found in the
human body. 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 provide attachment sites
and produce 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.

     We have developed and patented 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 onto a mesh framework in an environment that is intended to
simulate that which is found in the body. The cells attach, divide and secrete
extracellular matrix proteins and growth factors, using the mesh as a
scaffolding. This process results in a completely human stromal tissue that, in
turn, may support the growth of


                                       1

<PAGE>


organ specific cells into functional tissue. We have been issued over 100 United
States and foreign patents covering our three-dimensional cell development
technology and have a number of patent applications pending related to this
technology. In addition, we have an exclusive license in particular fields of
use, to 20 United States patents issued to Massachusetts Institute of
Technology, or MIT, covering the growth of vascularized human tissues or organs
on three-dimensional biocompatible, biodegradable and non-biodegradable polymer
scaffolds inside the body.

     We believe that the products derived from our tissue engineering technology
may offer some or all of the following benefits, depending upon the particular
application of the product:

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

Multiple Factors For Healing -- Our technology uses human cells. The human cells
produce multiple growth factors and tissue matrix proteins, all of which we
believe are important in the tissue repair process. Living, metabolically active
cells may also respond to the surrounding environment, allowing damaged or
diseased tissue to repair more rapidly.

Human Tissue -- The tissue matrix proteins naturally secreted by the cells in
our human-based tissue engineering technology consist of human collagens, human
proteins, and human matrix components such as glycosaminoglycans. This offers
advantages over animal-derived matrix proteins which may cause allergic or
immune reactions.

Ease of Application -- An objective of our product development process is to
produce products that are easy to apply. For example, surgeons can apply our
TransCyte and Dermagraft products by using routine surgical techniques. In
addition, our objective is to deliver tissue engineered cardiovascular and
cartilage products in single arthroscopic or endoscopic procedures.

Prolonged Shelf Life -- Our dermal products can be frozen for long-term storage
and allow for complete sterility testing prior to release. Similarly, it is
expected that some of the other tissues in development will be able to be
cryopreserved for a long shelf life.

Related Products and By-products -- The manufacturing process yields related
products and by-products that we can commercialize, such as human-based
collagen, extracellular matrix and a nutrient solution for cosmetic
applications.

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. Products derived from our technology
may, therefore, be used as universal, permanent replacement products in such
applications.

Safety Tested -- The human tissue materials used in the manufacture of our
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 sterility tests on each product's
growth medium.

PRODUCTS

     Depending on available resources, clinical results, regulatory approvals,
market potential and cost benefit considerations, we plan to bring to market a
number of therapeutic tissue and related products that are currently in various
stages of commercialization, clinical trials, pre-clinical studies and research.
We are aiming to produce products that will serve the patient-pay as well as the
third party-pay markets, and are currently focused on four principal therapeutic
areas:

     o Wound Care
     o Aesthetic & Reconstructive
     o Cardiovascular
     o Orthopedic

     In each of these areas we have entered or intend to enter into alliances
with leading companies in that field. These alliance agreements are designed to
give us marketing and distribution access to the appropriate market, and in some
cases a partner to share the cost of advancing the product through its
development.


                                       2

<PAGE>


WOUND CARE

     Our development efforts in this market are focused on therapeutic skin
products that primarily treat burns and cutaneous ulcers. These products are
designed as temporary or permanent skin substitutes for the patient's own
tissue, and were developed for conditions where the inner skin layer, or dermis,
has been injured or destroyed, such as in severe burns and chronic skin ulcers.

     Our two existing skin products, Dermagraft and TransCyte, are being sold in
a number of worldwide markets and are being commercialized through a joint
venture with Smith & Nephew plc, a leading wound care company. Smith & Nephew
has successfully launched several advanced wound care products worldwide.

     Further development efforts under our Dermagraft Joint Venture with Smith &
Nephew are centered around additional indications, including venous and pressure
ulcers, and in second-generation products such as extracellular matrix for use
in wound care applications.

     BURN MARKET. 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. Data published in 1999 reflects that of the approximately 600,000 annual
emergency room admissions for burns in the United States, an estimated 45,000
patients are hospitalized. Approximately 13,000 burns are full thickness, or
third degree burns, of which approximately 1,500 require temporary covering. An
estimated 40,000 patients with partial-thickness, or second degree, burns are
treated on an outpatient basis.

     Our first commercial product, TransCyte, a human fibroblast-derived
temporary skin substitute, was approved for commercial sale by the FDA in March
1997 for full-thickness burns, and in October 1997 for partial-thickness burns.
In full-thickness burns, treatment usually requires the grafting of the
patient's own skin if it is available. Temporary coverings, including cadaver
skin, are frequently used to limit infection, protect the wound and prevent the
loss of body fluids prior to availability of the patient's skin. In
partial-thickness burns, efforts are made to close the wound as quickly as
possible to reduce the incidence of infection and scarring. TransCyte consists
of a dermal tissue grown on a scaffold with an ultra-thin synthetic covering
that acts as a temporary outer skin layer and helps to retain fluids and protect
against environmental contact to the wound bed. It is an alternative to human
cadaver skin, without the potential risk of transmitted infections or
immunological rejection. In addition, clinical data indicates that TransCyte
shows a substantially reduced time to 90% healing, thus potentially affording
the opportunity for reduction in the total cost of treatment.

     TransCyte is available for sale in the United States, the United Kingdom
and other European countries, Canada, Australia, New Zealand and South Africa
through the Dermagraft Joint Venture, for the treatment of full and
partial-thickness burns, and will be introduced in additional countries subject
to regulatory approvals. Although some countries regulate TransCyte as a
pharmaceutical, this product is regulated as a medical device in the United
States and Canada. See "Government Regulation" for a more complete description
of regulatory issues facing the approval of our products that are subject to
government regulation.

     SKIN ULCER MARKET. Skin ulcers result in the skin breaking down as a result
of disruption of blood flow caused either by prolonged pressure over a localized
area or by chronic diseases, such as diabetes, that affect the circulatory or
peripheral nervous systems. Statistical data published in 1999 in the United
States shows that approximately 300,000 to 400,000 people with diabetes suffer
each year from ulcers that represent a target market for Dermagraft, our living
human fibroblast-derived dermal substitute. Diabetic foot ulcers that do not
heal leave the patients susceptible to multiple complications including
infection, which may lead to amputation of the foot or leg. Recent statistics
indicate that more than 86,000 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%.

     We have applied the experience gained with TransCyte to Dermagraft. Both
products use similar raw materials, manufacturing processes, freezing
procedures, storage methods and packaging concepts. Dermagraft, which we grow on
a bioabsorbable scaffold, contains proteins and growth factors normally found in
healthy human dermal tissue. We have designed it so that it provides a healthy,
metabolically active dermal matrix in ulcers to support wound closure,
addressing deficiencies that are likely to be present in the patient's own
dermal tissue. 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.
To date, no evidence has been seen of any safety issues that relate to use of
this product and no incidents of immunologic rejections have been observed.


                                       3

<PAGE>


     In September 2001, we received a Pre-Market Approval, or PMA, from the FDA
to market Dermagraft in the treatment of chronic foot ulcers in patients with
diabetes in the United States.

     Since October 1998, Dermagraft had been used in the treatment of diabetic
foot ulcers in the United States after the FDA approved our application for a
Treatment Investigational Device Exemption allowing us to make Dermagraft for
the treatment of diabetic foot ulcers available to selected centers in the
United States under an approved clinical protocol. We are currently also
marketing Dermagraft for the treatment of diabetic foot ulcers, through the
Dermagraft Joint Venture, in Canada, Australia, New Zealand and South Africa.
Dermagraft has been available on a limited basis in the United Kingdom and other
European countries. During 2001, we withdrew our application seeking approval of
Dermagraft in Sweden as a pharmaceutical through the Mutual Recognition process
while we assess the need for further clinical and process information requested
by the regulatory authority. 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 the product.

     In 2001, Dermagraft was also granted extended indications in both Canada
and Australia for the treatment of lower limb ulcers, partial and full-thickness
chronic wounds, the promotion of granulation tissue and the preparation of
wounds for skin grafting.

     Venous and pressure ulcers represent additional target markets for
Dermagraft. 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
fluid in the legs, known as edema, 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. Data published in 1999 and 2000 suggests that
approximately 700,000 patients seek treatment for venous ulcers in the United
States each year. Through the Dermagraft Joint Venture, in 1999 we performed a
pilot clinical trial in the treatment of venous ulcers, which evaluated several
different application regimens of Dermagraft. Based on the results of this pilot
study, the Dermagraft Joint Venture is currently conducting a pivotal clinical
trial of Dermagraft in the treatment of venous ulcers in the United Kingdom and
United States.

     Pressure ulcers are common in hospital and nursing home patients where skin
is continually compressed under the weight of a bedridden or wheelchair-bound
patient, and frequently must be closed by the use of skin grafts or major
reconstructive surgery. It is estimated in data published in 1999 that more than
1.5 million patients are affected annually by pressure ulcers in the United
States, including over 500,000 nursing home patients. Through the Dermagraft
Joint Venture, we concluded a pilot study designed to evaluate Dermagraft for
the treatment of pressure ulcers during 2001. From the evidence gathered, we are
currently evaluating the role of Dermagraft within the appropriate regimen of
treatment for this condition, and determining whether further clinical work is
justified.

     Second generation products for wound care applications, using our tissue
engineering technology, are also currently under development, such as
extracellular matrix. The extracellular matrix comprises proteins such as
collagen, tenascin, decorin, fibronectin, and glycosaminoglycans, which are
deposited by the cells in our human-based tissue engineering process and which
the human body produces naturally for use in the wound healing process. The
extracellular matrix has the potential to be used in many wound care
applications.

AESTHETIC & Reconstructive

     The technology used in developing our existing skin products and our
research into the growth of orthopedic tissues led to the development of
products for aesthetic and reconstructive applications. A large proportion of
the aesthetic and reconstructive markets are represented by customers who pay
directly for their products and treatments, as opposed to a third-party
reimbursement market.

     Products we have developed or which we have under development for aesthetic
and reconstructive applications include:

          SOFT TISSUE AUGMENTATION

     o    human-based bioengineered collagen and extracellular matrix for
          wrinkle correction and potentially as a bulking agent for the
          treatment of urinary incontinence, in conjunction with our partner,
          Inamed Corporation


                                       4

<PAGE>


          COSMECEUTICAL INGREDIENTS

     o    NouriCel, an enriched nutrient solution that is intended to provide
          many of the essential nutrients naturally produced by the human
          body that are important for healthy skin

     o    Antioxidant Complex, a cocktail of natural antioxidants intended to
          fight free radical damage caused by the sun and other environmental
          stressors

     HUMAN-BASED 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 our wound care products
such as TransCyte and Dermagraft. We have applied our existing technology,
processes and expertise to manufacture human-based bioengineered collagen. The
objective of our collagen program has been to develop a fibrous collagen product
which, after its purification, can be sterilized and easily injected or
implanted into the human body.

     Injections of collagen are already used in the marketplace to help
eliminate wrinkles and to enhance lips. Studies estimate that in 2000,
approximately 590,000 collagen injections were used in cosmetic facial, head and
neck procedures. Additionally, in 1999 it is estimated that approximately 45,000
collagen injections were used as urethral bulking agents for the treatment of
urinary incontinence. When combined with extracellular matrix, collagen
injections may also be used in breast reconstruction following lumpectomies, or
to treat deformities.

     We believe that our human-based collagen may offer important advantages
over other soft tissue augmentation products currently on the market, including
the potential elimination of reactions of some patients to foreign animal or
synthetic proteins, and increased persistence in the body. In addition,
human-based bioengineered collagen is derived from fibroblasts which have been
extensively tested for a variety of viruses and pathogens. Additional
applications of collagen and extracellular matrix may include medical device
coatings, as an additive to cosmetics, or use as a natural vehicle for drug
delivery.

     We plan to commercialize our human-based collagen for wrinkle revision,
subject to regulatory approval, through our strategic alliance with Inamed
Corporation. See "Collaborations and Strategic Alliances - Inamed Corporation"
for further details regarding this strategic alliance. We are also in the early
stages of developing human-based collagen, and potentially extracellular matrix,
for urinary incontinence,under this strategic alliance.

     NOURICEL ENRICHED NUTRIENT SOLUTION. Our NouriCel cosmeceutical ingredient
is produced from the enriched nutrient solution in which the human fibroblast
cell expansion takes place during our wound care and collagen manufacturing
processes. During the process of cell expansion and tissue growth, the cells
produce collagen, growth factors, matrix proteins, and antioxidants which
naturally occur in human skin. These proteins and growth factors remain behind
in the nutrient solution. NouriCel contains many of the essential nutrients that
the human body naturally produces and which are important for healthy skin.

     ANTIOXIDANT COMPLEX. A mixture of low molecular weight antioxidants is
created during our NouriCel manufacturing process. Antioxidants are the leading
cosmetic chemical purchased in the United States.

     We currently have marketing, license and supply agreements with Biozhem
Cosmeceuticals, Inc. and SkinMedica, Inc. Under these agreements we provide
NouriCel as an ingredient in their skin care products. SkinMedica commenced
sales of NouriCel-MD, the professional strength of NouriCel, through
dermatologists and plastic surgeons in the United States in the third quarter of
2001. Biozhem commenced direct marketing of their RevitaCel products through
television infomercials in the fourth quarter of 2001. RevitaCel is a range of
products that includes a replenishing complex containing NouriCel. Both
alliances are sale and royalty arrangements, whereby we receive income from
transfer prices on sales of NouriCel to the respective partner, as well
milestones and royalties on net sales of the partner's products. See
"Collaborations and Strategic Alliances - Biozhem Cosmeceuticals, Inc. and
SkinMedica, Inc." for further details regarding these agreements. These
agreements do not cover the use of our antioxidant complex.

CARDIOVASCULAR

     In 1999 in the United States, over 958,000 people died from cardiovascular
disease. Data published by the American Heart Association relating to the same
year suggests that 12.6 million people suffered from coronary artery disease and
that over 355,000 of these had coronary artery bypass surgery performed. We
believe that the successful development of a product that stimulates new blood
vessel growth, and therefore increased blood flow, in diseased or damaged tissue
in the epicardial surface of the heart, could improve the results of surgical
and ultimately


                                       5

<PAGE>


interventional procedures. It also may be a viable treatment for the 150,000
patients that do not have the option of currently available treatments such as
bypass grafts, angioplasty or coronary stents, in order to provide greater blood
flow to the heart muscle.

     In 1999 it was estimated that approximately 8 million people in the United
States had peripheral vascular disease, and in 1997 over 115,000 bypass
procedures for the thigh vein alone were performed. We believe an aging
population is likely to increase the incidence of these diseases and the need
for alternative treatments. While there are some effective treatments currently
available for these patients, there are also many problems such as
biocompatibility, durability and availability. The successful development of
tissue engineered veins, arteries or heart muscle could provide some of these
patients with a viable alternative treatment.

     The dermal fibroblasts that we use to manufacture our existing wound
products are closely related to cardiac fibroblasts, which form connective
tissue. As a result, we believe that fibroblasts used with our tissue
engineering technology may be useful in the growth of coronary arteries and
veins. This may be achieved through the development of a patch of tissue that
stimulates new blood vessel growth, and therefore increased blood flow to the
heart, and potentially other cardiovascular products. We also believe that our
cell culture technology may be used in the growth of smooth muscle cells, a
functional component of the human artery, which would add strength to such
tissue engineered vessels. In addition, the proteins and growth factors secreted
by the cells during our human-based tissue development process may induce
endothelial cells to migrate into tissue engineered grafts, heart muscle, or
arteries. Endothelial cells are important to avoid clotting and the build up of
plaque, or atherosclerosis.

     We are conducting early-stage research and pre-clinical work to determine
our ability to produce tissue engineered cardiac products, such as:

     o  An epicardial angiogenesis patch, a product that stimulates new
        blood vessel growth and therefore increased blood flow, known by the
        trademark Anginera
     o  Other ischemic repair devices
     o  Tissue engineered small diameter blood vessels
     o  Tissue engineered cardiac muscle

     In October 2001, we entered into a collaboration with Medtronic, Inc. to
explore the application of our technology in areas of therapeutic interest to
Medtronic. An affiliate of Medtronic invested $20 million in shares of our
common stock in return for specified rights including a right of first refusal
to participate in the further development and commercialization of Anginera, and
certain other of our programs. Net proceeds of the equity investment were
approximately $19.9 million. We retained rights in the cardiovascular area
related to development of tissue engineered vascular grafts. Both companies have
agreed to discuss potential Medtronic participation in this area as a separate
and additional collaboration.

     EPICARDIAL ANGIOGENESIS PATCH, ANGINERA, AND OTHER ISCHEMIC REPAIR DEVICES.
When oxygen fails to reach the heart muscle as a result of restricted blood
flow, the patient experiences pain, or angina pectoris. If oxygen deprivation
reaches a critical threshold, a part of the heart muscle will suffer ischemic
injury, and extreme cases result in a heart attack and irreversible damage.
Restoring blood flow to damaged heart tissue is the most effective method for
reducing angina and preventing a heart attack. In addition, adequate blood flow
to damaged, or ischemic, heart tissue is a vital part of the healing process.
Early pre-clinical work has shown that Dermagraft in the form of a patch may
have the potential for improving blood flow in the damaged tissue. For example,
our potential product, Anginera, has been shown to cause new blood vessels to
grow in damaged heart tissue in mice. Current angina sufferers are placed on
medications to manage the angina pain, but the treatment does not cause healing.
The target population for this therapy would include patients with coronary
disease that cannot be treated by stenting, angioplasty, or bypass grafting, and
as an adjunctive therapy to these mainstream procedures.

     We are currently continuing pre-clinical studies to evaluate this
therapeutic indication. We have had discussions with the FDA and have responded
to their feedback in the design of our pre-clinical trials to support human
testing. If the pre-clinical results are definitive in safety and indicate
efficacy, we will seek FDA approval to begin human studies. The FDA has
suggested to us that Anginera may be regulated as a biologic in the United
States.

     In 2000, we were awarded a $2 million grant from the National Institute of
Standards and Technology, or NIST, to be distributed over a three-year period,
subject to annual renewal and our meeting certain minimum levels of program
funding. In addition to the potential development of Anginera, this grant will
support research and


                                       6

<PAGE>


development of tissue derived from smooth muscle cells or dermal fibroblasts,
and the development of other ischemic repair devices. While the mechanisms of
action may prove to be the same as that inherent in Anginera, this research may
provide products with less invasive therapy delivery.

     TISSUE ENGINEERED SMALL DIAMETER BLOOD VESSELS. Vascular grafts are used to
repair or replace segments of arteries, valves or veins that are weakened,
damaged or obstructed due to trauma or disease such as aneurysms and
atherosclerosis. Grafts can be 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 the patient's own tissue 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.
Cryopreserved veins from cadavers are sometimes used, but availability is
limited and rejection rates are greater than with a patient's own 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 other problems such as narrowing, or stenosis.

     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 the formation of blood clots
and promote a rapid ingrowth of tissue such as different weaves and knits,
chemical coatings and gelatins, and freeze-drying. Our research has focused on
using specialized bioreactors, polymers and other techniques to bioengineer a
small diameter human vessel. Bioreactors have been developed to generate
mechanical forces similar to that encountered in the body to stimulate the cells
to align concentrically, to absorb stress and to establish a matrix similar to
that seen with native blood vessels. Imposing such forces is believed to allow
for greater structural and mechanical integrity in the tissue engineered
vascular grafts. 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.

     In 1997, we were awarded a $2 million Advanced Technology Program grant
from NIST. The grant was structured to support development of a vascular graft
over a three-year period that began in 1998 and was completed in 2001. Under
this grant, we led a multi-disciplinary effort to design, construct and evaluate
small diameter tissue engineered vascular grafts of approximately 4mm inner
diameter produced from cells grown on a scaffold, which would then be compatible
with the patient's own tissue. Such tissue is allogeneic, or derived from the
cells of a human and implanted into another human via an allograft, as opposed
to autologous tissue which is grafted from one part of the human body to another
region of the same body via an autograft. This effort was conducted in
collaboration with the Department of Bioengineering at the University of
California, San Diego and the University of Arizona. The collaboration
integrated current advances in cellular mechanics, bioreactor technology, and
blood vessel mechanics to create a unique living tissue replacement for blood
vessels.

     Studies we performed in 2001 involving the implantation of grafts into
canine carotid arteries, demonstrated that the grafts remained open for up to 12
weeks. More than 80% of the grafts remained open at week four, when the first
grafts were removed for tissue analysis. All remaining grafts remained open
until either they were removed for analysis or the 12-week endpoint was reached.
Histological evaluation of the grafts demonstrated an intact monolayer of
endothelial cells and persistence of underlying smooth muscle cells, which is
the structure normally found in native blood vessels. We are continuing
pre-clinical studies in collaboration with the University of Arizona, utilizing
the results of research under the grant.

     TISSUE ENGINEERED CARDIAC MUSCLE. In May 2000, researchers at the
University of Washington announced that they would be partnering with us and
others in a project to grow functional human heart tissue funded by a $10
million grant from the United States National Institutes of Health, or NIH. The
proportion of the grant for which we would be eligible is approximately $1.8
million, which we would receive subject to our performance of specified
activities. The grant is expected to cover the first five years of an
anticipated 10-year project, which will initially focus on culturing cardiac
muscle that could be grafted onto damaged hearts to improve their efficiency.
Eventually, the researchers hope their work will enable scientists to grow a
fully functional human heart. Our patented bioreactor technology and cell
seeding capabilities will play a key role in the project.


                                       7

<PAGE>


ORTHOPEDIC

     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. There were also
additional arthroscopic procedures performed in joints such as the shoulder,
wrist, and ankle.

     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. Cartilage and cartilage-like tissue serves diverse
functions in many parts of the body such as providing a gliding surface for
smooth joint motion, and serving to absorb both impact and load-force
transmitted to the axial skeleton. In many cases, damage to cartilage tissue
subsequently leads to further deterioration and osteoarthritis which can
eventually require a total joint replacement.

     We are developing our orthopedic cartilage products through the NeoCyte
Joint Venture with Smith & Nephew. 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 addition, we believe
that our three-dimensional tissue engineering technology and proprietary
manufacturing systems, including those developed in our Dermagraft Joint
Venture, allow the regulation of critical environmental factors including
mechanical stresses, oxygen tension, and media composition, that may provide the
necessary conditions for the production of cartilage capable of withstanding the
high shear and load forces present in human joints.

     The NeoCyte Joint Venture also has a right of first negotiation to develop
other tissue engineered products for orthopedic applications such as meniscus,
ligament, tendon and bone. However, the NeoCyte Joint Venture is currently
focusing its product development efforts on tissue engineered articular
cartilage.

     ARTICULAR CARTILAGE. Articular 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. Our tissue
engineered articular cartilage could provide a significant opportunity to treat
a proportion of what were estimated in 1999 to be approximately 1.1 million
patients who receive articular arthroscopy each year in the United States, and
others in the rest of the world, 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 NeoCyte Joint Venture submitted an Investigational Device Exemption, or
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 pre-clinical safety study using a small
animal model. In this model, through 24 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 important medical attributes expected in healthy tissue such
as 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.

     A further IDE was submitted to the FDA in 2000. The FDA raised agency
jurisdictional issues as to whether this product should be regulated as a
medical device or biologic, as well as questions about additional pre-clinical
studies. We continue to work with the FDA to address these issues.

     The NeoCyte Joint Venture has been working to further identify those
critical factors believed necessary for the clinical success of an articular
cartilage product, to develop a product design that addresses these factors, and
to demonstrate safety and effectiveness in a large animal experimental model.
The results to date show that human tissue engineered cartilage can be made, and
that an osteochondral product design has shown early safety and effectiveness in
a large animal experimental model of cartilage repair.

     In October 2001, we were awarded a $1.4 million Small Business Innovation
Research grant from NIH and the National Institute of Arthritis and
Musculoskeletal and Skin Diseases. The grant, which is payable over three


                                       8

<PAGE>


years subject to our continuing investment in the specified research, is to
develop tissue engineered articular cartilage designed to better withstand the
extreme forces experienced in the human body. As part of the grant, we are
aiming to further develop our patented bioreactor technology to grow cartilage
using stresses, including compression and fluid flow.

     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, despite the approximately 800,000
procedures performed annually in the United States. We believe that our tissue
engineering approach could offer a benefit in the repair and eventual total
replacement of the meniscus. The NeoCyte Joint Venture has conducted
collaborative pre-clinical 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 pre-clinical studies, further sponsored research performed at
Boston Children's Hospital showed that tissue engineered meniscus can be
generated and may be used for total meniscal replacement. The NeoCyte Joint
Venture has developed a prototype for a tissue engineered meniscus and
laboratory and pre-clinical studies showed the technical feasibility of growing
and implanting a tissue engineered meniscus. However, based upon available
resources and the NeoCyte Joint Venture's assessment of market potential,
resources are currently being focused on articular resurfacing rather than
tissue engineered meniscus.

OTHER THERAPEUTIC TISSUES

     We are actively investigating the use of our existing products for new
indications, such as Dermagraft in periodontal disease. Traditionally,
periodontists have repaired damaged gum tissue by harvesting palatal tissue and
grafting it onto the diseased area. In cases of extensive damage, this procedure
is repeated several times, allowing for healing of the palate between grafts. If
successfully developed, Dermagraft could obviate the need to harvest donor
tissue from the palate and thus eliminate the pain and potential complications
associated with a second surgical site. In addition, the product may allow
periodontists to treat patients with extensive gum disease without the need for
repeat surgeries. According to the American Dental Association, approximately
500,000 people undergo periodontal soft tissue grafts annually in the United
States.

     In September 2000, we were awarded a grant in excess of $800,000 from NIH
and the National Institute of Dental and Craniofacial Research to develop tissue
engineered cartilage for the treatment of temporomandibular disorders. Payments
under the grant are payable over four years.

     In addition, other organ tissues have been successfully grown using our
technology, that could potentially be developed into therapeutic products. These
products are not currently in active development, and further development and
commercialization of these or other tissues such as liver, pancreas,
gastrointestinal, blood/brain barrier tissues and other orthopedic applications,
will be dependent on our assessment of each tissue type's market potential and
the availability of sufficient resources, either internally or through
collaborations with current or future collaborators. Some of these programs are
discussed below.

     Under research that we have funded, scientists have performed pilot
pre-clinical studies with engineered cartilage and bone for reconstructive
applications and have constructed an entire joint consisting of bone, cartilage
and ligament. Through sponsored research with scientists at MIT and Boston
Children's Hospital, we have explored growth conditions that may allow us to
grow tissue engineered ligament and tendon in the future with biomechanical
properties similar to those found in the human body.

     We have demonstrated the ability to culture enzymatically active animal and
human liver cells in long-term cultures. Our system allows for the active growth
of specialized liver cells which retain their ability to manufacture a variety
of proteins and enzymes required for normal liver function. We have conducted
pilot pre-clinical trials involving the implantation of engineered liver tissue
into both small and large animal models.

     We have successfully replicated animal and human bone marrow and natural
killer cells, which are a component of the immune system, and have conducted
pilot pre-clinical trials involving the infusion of replicated bone marrow
cells. We have also grown and grafted bone marrow cultures with high percentages
of stem cells on biodegradable polymer scaffolds.


                                        9

<PAGE>


COLLABORATIONS AND STRATEGIC ALLIANCES

     Our strategy for the research, development, manufacture and
commercialization of selected proposed tissue engineering products includes
entering into various alliances with corporate collaborators, licensees and
others from time to time. We are currently involved in the following
collaborative arrangements in connection with our product development and
commercialization activities:

     SMITH & NEPHEW PLC

     The Dermagraft Joint Venture is an arrangement between us and Smith &
Nephew. Under this joint venture, Smith & Nephew provides marketing and sales
resources, while we provide development and manufacturing resources, for the
development, manufacture, and sales of wound care products. Both partners
provide research expertise and resources to the joint venture. Smith & Nephew is
a global medical device company with established sales in approximately 90
countries, that markets technically innovative products, principally in the
areas of wound management, orthopedics and endoscopy.

     The Dermagraft Joint Venture was established in 1996. In February 2000,
with a delay in the commercial introduction of Dermagraft in the United States
and a requirement for an additional clinical trial by the FDA substantially
increasing the partners' required investment, we agreed with Smith & Nephew to
restructure the Dermagraft Joint Venture. The restructuring agreement was
amended and implemented in September 2000.

     The objective of the restructuring was to defer the potential payment of
certain milestones by Smith & Nephew while providing us a royalty stream and an
opportunity to increase our 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, we 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 us royalties on joint venture
product sales. Under the restructured joint venture, we are sharing equally with
Smith & Nephew in the expenses and revenues of the Dermagraft Joint Venture,
except that we funded the first $6 million of expenses for conducting clinical
trials and regulatory support of Dermagraft and TransCyte in the treatment of
venous ulcers and pressure ulcers. In addition, we funded a proportion of
manufacturing and distribution costs, and costs related to post-market studies,
for TransCyte through 1999.

     Since 1996, in addition to Smith & Nephew's share of the ongoing
investments in the Dermagraft Joint Venture, Smith & Nephew has paid $30 million
to us in fees and milestone payments, including $5 million in 2001 on the
approval by the FDA of the PMA for Dermagraft in the treatment of diabetic foot
ulcers. Other payments of up to $131 million will be due to us from Smith &
Nephew subject to the achievement of various regulatory, sales and profitability
milestones, over the term of the agreement which terminates in the year 2046
unless extended by mutual agreement of the partners. This amount includes a
milestone payment of $5 million related to the reimbursement status of
Dermagraft and coverage by regional insurance carriers in the United States
under Medicare. In December 2001, Dermagraft received an Ambulatory Payment
Classification, or APC, pass-through code under the Hospital Outpatient
Prospective Payment System from the Centers for Medicare & Medicaid Services, or
the CMS. The pass-through payment code for Dermagraft covers Medicare patients
with diabetic foot ulcers treated in a hospital outpatient setting. The original
notice indicated that the code would become effective on January 1, 2002,
however the CMS subsequently postponed the implementation of all new outpatient
codes, pending a review by the CMS. The CMS announced on February 28, 2002 that
the new codes would become effective on April 1, 2002. Once the code becomes
effective, each Medicare local carrier or fiscal intermediary can begin
developing coverage guidelines to determine when, how often, and under what
conditions they will pay for the use of Dermagraft for patients with chronic
diabetic foot ulcers. The pass-through payment code is the first step toward
receipt of the $5 million milestone payment, subject to other conditions in our
agreements with Smith & Nephew.

     Smith & Nephew has also made equity investments in Advanced Tissue Sciences
of $35.7 million. As of March 25, 2002, Smith & Nephew owns 5,104,163 shares
of our common stock. See Note 3 to the consolidated financial statements for
more information on the financial transactions associated with the Dermagraft
Joint Venture.

     The NeoCyte Joint Venture is an arrangement we entered into with Smith &
Nephew in 1994 under which we share equally in the development, manufacturing
and sales of our cartilage products for orthopedic applications. Under this
joint venture, Smith & Nephew contributed the first $10 million in funding and
we contributed various technology licenses related to our orthopedic research.
The NeoCyte Joint Venture terminates in 2010 unless extended by the partners or
terminated prior to this date by mutual agreement.


                                       10

<PAGE>



     INAMED CORPORATION

     In May 1999, we entered into a strategic alliance with Inamed for the
potential development, manufacturing and sales of the following aesthetic and
reconstructive products:

     o  human-based collagen for wrinkle correction and potentially as a bulking
        agent for the treatment of urinary incontinence,
     o  products for use as a temporary covering after laser resurfacing,
     o  cartilage for plastic and reconstructive applications, and
     o  extracellular matrix for breast reconstruction.

     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
this alliance, we are responsible for the funding and development of the
products and the related manufacturing processes, while Inamed is responsible
for clinical, regulatory and marketing activities. We, or an affiliate, may
elect to manufacture the products developed under the agreement.

     The Inamed agreement is structured to provide us milestone payments and
royalties on Inamed sales in the marketplace, as well as a transfer price for
sales of our human-based collagen to Inamed. Under our agreement, in exchange
for worldwide licensing rights, since 1999 Inamed has made a series of payments
totaling $10 million, including $5 million to purchase our common stock. In 1999
Inamed also received five-year warrants to purchase up to 500,000 shares of
common stock at an average exercise price of $12.80 per share. Inamed has agreed
to hold any investment in our common stock until at least October 2002. In
addition to royalties on product sales, we may potentially receive up to a total
of $10 million in milestones based on product approvals in the United States,
over the life of the license agreement, which is the later of 15 years or the
life of certain associated patents. Fees for licensing rights and milestone
payments have been and will be recognized into revenues as the related financial
commitments for product development and manufacturing processes are incurred.

     MEDTRONIC, INC.

     In October 2001, we entered into a collaboration with Medtronic, Inc. to
explore the application of our technology in areas of therapeutic interest to
Medtronic. Under the terms of the collaboration, we will explore the application
of our technology in four therapeutic areas: cardiovascular, neurological,
endocrine and spinal.

     An affiliate of Medtronic invested $20 million in shares of our common
stock at $3.72 per share in return for specified rights including a right of
first refusal to participate in the further development and commercialization of
Anginera, our epicardial angiogenesis therapy, a product that stimulates new
blood vessel growth and therefore increased blood flow, a right of first
offer/first negotiation to participate in other programs within the
cardiovascular, neurological, endocrine and spinal areas where we elect not to
pursue those programs internally; and a limited non-exclusive license to our
intellectual property in the four therapeutic areas identified, to facilitate
Medtronic's exploration of cell and tissue engineered technology in combination
with Medtronic's medical devices. Net proceeds of the equity investment were
approximately approximately $19.9 million.

     Under this agreement, we retained rights in the cardiovascular area related
to development of tissue engineered vascular grafts. We have agreed to discuss
potential Medtronic participation in this area as a separate collaboration.

     As a part of the collaboration, we also agreed to nominate a representative
of Medtronic to our board of directors. Mr. Ellwein currently serves as the
Medtronic representative on our board of directors. As of March 25, 2002,
Medtronic International, Ltd., a subsidiary of Medtronic, Inc., held 5,376,344
shares of our common stock.

 BIOZHEM COSMECEUTICALS, INC. AND SKINMEDICA, INC.

     In September 2000, we signed a developmental marketing, license and supply
agreement with Biozhem. Under the agreement, we granted a license to use, and
sell NouriCel to Biozhem. NouriCel is a patent-pending by-product of our tissue
engineering processes and will be used in Biozhem's branded skin care products
sold through specified direct marketing channels. As well as a transfer price
paid to us by Biozhem for NouriCel, we are entitled to specified milestone
payments and royalties on sales of Biozhem's products in the skin care
marketplace. Additionally, we were granted warrants to purchase Biozhem common
stock at specified prices in future time periods. The agreement will remain in
effect until March 31, 2011, subject to termination by us or Biozhem in the
event of the failure of the other party to meet stated performance requirements.
In January 2002, with the launch of


                                       11

<PAGE>


Biozhem's product having been delayed from the expected date in the agreement,
we amended our agreement with Biozhem to defer the payment to us of an initial
milestone of $1 million, from December 2001 to November 2002. In addition, the
amended agreement provides for a new schedule of minimum royalty payments by
Biozhem to us in 2002, including the payment of minimum royalties originally
scheduled in 2001. Our decision to defer the milestone and minimum royalties was
based primarily upon Biozhem's inability to make the payments as a result of the
delay in Biozhem's receipt of income from sales of our product. Terms of the
original agreement with Biozhem relating to payments and other obligations after
2003 remain unchanged.

     In October 2000, we signed a developmental marketing, license and supply
agreement with SkinMedica. Under this agreement, we granted a license to use,
and sell NouriCel to SkinMedica, to be used in SkinMedica's branded skin care
products sold through a network of dermatologists and plastic surgeons. We are
entitled to a transfer price paid to us by SkinMedica for NouriCel and to
specified milestone payments and royalties on sales of SkinMedica's products in
the skin care marketplace. We were also granted warrants to purchase SkinMedica
common stock at specified prices in future time periods. The agreement will
remain in effect until 10 years after the first commercial sale, subject to
termination by us or SkinMedica in the event of the failure of the other party
to meet stated performance requirements. In May 2001, we amended our agreement
with SkinMedica to change the effective date of first commercial sale for their
NouriCel based product to November 1, 2001, and modified certain termination
clauses. The amendment extended by six months the period of exclusivity granted
to SkinMedica under the original agreement.

     MASSACHUSETTS INSTITUTE OF TECHNOLOGY/CHILDREN'S HOSPITAL IN BOSTON

     In connection with an acquisition in September 1992, we entered into a
license agreement with MIT and Children's Hospital. Under the license agreement,
we have 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, we are required to meet diligence requirements with
respect to advancing the licensed technology, which we have met to date. We also
remain responsible for associated patent costs and related maintenance fees.

     GEORGIA INSTITUTE OF TECHNOLOGY

     Georgia Institute of Technology is recognized as having a leading academic
program in biomedical engineering. In 1997, we entered into a research agreement
providing for the investigation of the effect of fluid flow on the biological
response of cartilage cells, or chondrocytes. In 1998, we entered into
additional research collaborations that ended in 2000 relating to the study of
bioreactor fluid mechanics. Georgia Institute of Technology has also
collaborated with us on our cardiovascular program, performing biomechanical
property tests of bioengineered vascular grafts as compared to native coronary
vessels. In 1999 we began a research collaboration investigating tissue
engineering for bone repair, and this project continued through 2001. We also
initiated a further collaboration on bioreactor characterization, as part of an
NIH-funded grant. Additionally, we are a participant in an internship program
for students in the Georgia Institute of Technology Bioengineering Program and
an active member of the Georgia Institute of Technology Educational Partners
Program.

     UNIVERSITY OF CALIFORNIA, SAN DIEGO

     In 1997, we were awarded an Advanced Technology Program grant from NIST to
develop tissue engineered vascular grafts for the treatment of coronary and
peripheral artery vascular diseases. Work under the grant, which was performed
in collaboration with the Department of Bioengineering at UCSD, was completed in
2001. In this collaboration, we led a multi-disciplinary effort to design,
construct and evaluate tissue engineered vascular grafts produced from cells
grown on a biocompatible scaffold. Results indicate that tissue engineered
vascular grafts can be formed in vitro using a specifically designed bioreactor,
and early phase animal studies indicate that these grafts have the potential to
function in vivo. In additional collaborations with UCSD we are
investigating the growth of tissue engineered cartilage with mechanical
properties approaching those of normal human cartilage, for orthopedic and
craniofacial applications.

     UNIVERSITY OF WASHINGTON, SEATTLE

     In 2000, the University of Washington was awarded a Bioengineering
Partnership grant by NIH, for $10 million over 5 years, with the goal to tissue
engineer cardiac muscle. We are active collaborators on this grant, with the
role of developing bioreactor technology for cardiac tissue growth, and to
develop cells appropriate for cardiac tissue engineering. The proportion of the
grant for which we would be eligible is approximately $1.8 million, which we
would receive subject to our performance of specified activities.


                                       12

<PAGE>


     UNIVERSITY OF ARIZONA

     The University of Arizona is a recognized leader in cardiovascular
research. In 2000 we received an award from NIST, for $2 million over 3 years,
to develop ischemic repair devices for cardiac and peripheral applications. This
product concept is based on research observations that tissue engineered
products secrete angiogeneic factors and are able to induce angiogenesis in
vitro and in vivo. The University of Arizona will be responsible for performing
animal studies investigating safety and effectiveness of the tissue engineered
products developed under this award.

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 our
own direct sales force in the United States, where the markets are relatively
concentrated in specialized burn centers. In October 1998, we made the decision
to discontinue the operations of our direct sales force and TransCyte is now
being marketed for burns in the United States, Canada, Australia, New Zealand,
South Africa and, subject to foreign regulatory approvals, in the rest of the
world, through the Dermagraft Joint Venture, by Smith & Nephew.

     In September 2001, Dermagraft was approved in the United States for use as
a human fibroblast-derived dermal substitute in the treatment of full-thickness
diabetic foot ulcers of greater than six weeks duration. It is being marketed in
the United States, Canada, Australia, New Zealand and South Africa, and on a
limited basis in the United Kingdom and other European countries through the
Dermagraft Joint Venture, by Smith & Nephew. Dermagraft is approved in Canada
and Australia for use in chronic wounds of varying etiologies including diabetic
foot ulcers, venous ulcers and pressure ulcers. In Europe, we have been seeking
approval of Dermagraft as a pharmaceutical through the Mutual Recognition
process. We had filed an application with the Swedish regulatory authorities as
the Reference Member State to review the initial marketing approval application
of Dermagraft in the treatment of chronic full-thickness diabetic foot ulcers.
The Swedish regulatory authority (also known as MPA), completed its initial
review of the marketing application and has determined that additional clinical
data and technical elements are required to comply with pharmaceutical approval
requirements. We have decided to withdraw the application pending the
development of a European strategy, including the appropriate use of our
financial resources, and those of our joint venture partner. The product will
continue to be marketed in certain countries in Europe based on regulatory
status of the product in the particular member states, which allows for limited
sales.

     During the year ended December 31, 2001, we recognized $12.8 million in
revenues from sales of Dermagraft and TransCyte to the Dermagraft Joint Venture
with Smith & Nephew. Such sales to the joint venture are made at cost.

     During 1999, Inamed licensed rights to several of our human-based, tissue
engineered products for aesthetic and certain reconstructive applications. In
connection with these licensed rights, Inamed is responsible for all sales and
marketing activities, subject to successful product development and regulatory
approval. Sales of our human-based collagen to Inamed in 2001 were $5.3 million.
During 2001, a subsidiary of Inamed, McGhan Medical, filed a PMA supplement with
the FDA seeking approval to add our human-based collagen to McGhan's existing
injectable collagen products for wrinkle treatments. Inamed announced in October
2001 that the FDA had requested additional pre-clinical data and had asked them
to perform skin-test studies, which are currently being conducted. During the
fourth quarter of 2001, we continued to ship our human-based collagen to Inamed
for the purposes of clinical studies, evaluation and testing, however pre-launch
sales of collagen to Inamed are expected to cease, pending receipt of FDA
approval and the subsequent launch of the product in the wrinkle treatment
market.

     In 2000, Biozhem and SkinMedica licensed rights to sell NouriCel in the
skin care marketplace. Both companies launched their formulations on a limited
scale in 2001, however full launch of their formulations is expected to occur
during the first half of 2002. These launches and their potential success in
generating subsequent sales are subject to the results of ongoing product
evaluations, and to the ability of Biozhem and SkinMedica to raise sufficient
funds for the significant investment required to market their formulations.


                                       13

<PAGE>


RESEARCH AND DEVELOPMENT

     To date, we have invested a substantial proportion of our resources in
research related to our three-dimensional tissue engineering technology,
clinical trials of potential products related to this technology, the
development of products and the development of manufacturing systems and
processes. In the years ended December 31, 2001, 2000 and 1999, we incurred the
following research and development costs (in millions):

                                                  2001      2000      1999
                                                 ------    ------    ------
         Total Research & Development Costs      $ 10.1    $ 13.1    $ 16.3
      Of which: Costs Incurred for Customer
           Sponsored Research *                     4.4       7.4      11.4

     * Research conducted for our joint ventures with Smith & Nephew or research
reimbursable under grants

     We expect to continue to incur substantial research and development costs,
clinical trials costs, product development costs, and costs for the development
of manufacturing processes and systems related to our three-dimensional tissue
engineering technology.

     To date we have performed research and development activities primarily at
our location in La Jolla, San Diego, California. In October 2001, we signed a 10
year lease, expected to commence in May 2002, on approximately 29,000 square
feet of space in a separate facility approximately three miles from our La Jolla
location. We expect to move the majority of our research activities into the new
facility in May 2002. In addition, we collaborate with academic and medical
institutions, and have entered into agreements with several other companies and
institutions to assist in developing our technology. We expect to continue to
enter into various collaborations with corporate partners, licensees and others
from time to time. In the event that we are unable to obtain or maintain these
arrangements, we may need to incur higher than expected costs for research and
development or clinical testing if we are to progress the proposed applications
of our technology and obtain necessary regulatory approvals. The failure to
obtain or maintain such arrangements on desirable terms could prevent us from
progressing our technology or maintaining operations.

EMPLOYEES

     As of March 21, 2002, we employed 226 people, of whom 58 were engaged in
research and development, 102 in operations, and 66 in marketing and
administrative functions. Our staff includes 14 employees with Ph.D. or M.D.
degrees. None of our employees are represented by a labor union, and we believe
that our employee relations are good.

DEPENDENCE ON CERTAIN SUPPLIERS

     Although most of the raw materials used in the manufacture of our products
are available from more than one supplier, for regulated products such as
Dermagraft and TransCyte, changes in certain critical components could cause the
FDA or other regulatory agencies to require us to prove that new materials are
equivalent to those originally specified, or potentially to modify or perform
additional clinical trials. This could have the effect of restricting our
ability to sell our regulated products or to commercialize our potential
regulated products.

     For example, the mesh framework used by us in the manufacture of Dermagraft
is available from only one FDA-qualified manufacturing source, Ethicon, Inc., a
subsidiary of Johnson & Johnson. Pursuant to our agreement with Ethicon, so long
as we meet agreed purchase levels, Ethicon is to use reasonable efforts to
manufacture and sell to us such quantities as we require. The synthetic mesh
framework used by us in the manufacture of TransCyte is also available from only
one FDA-qualified manufacturing source, Bertek Pharmaceuticals, Inc. Under our
agreement with Bertek, Bertek agrees to manufacture and sell to us such
quantities ordered which do not exceed certain thresholds associated with
previous forecasts which we have provided to Bertek based upon our forecasted
demand. 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 Ethicon or Bertek.
Although there may be other suppliers who have equivalent materials that would
be available to us, FDA approval of any alternate suppliers could take several
months or years.


                                       14

<PAGE>


     To date, we have not experienced difficulty in obtaining necessary raw
materials, however interruptions in supplies for the manufacture of our
Dermagraft, TransCyte and human-based collagen products, or products used in
research or clinical trials, may occur and we may have to obtain substitute
vendors for these materials. Any significant supply interruption would reduce
our product sales, or would mean that we couldn't sell a product at all, and
would delay our marketing, product development, clinical trial or research
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. These delays may
limit our revenues, or prevent us from achieving our product development,
research or clinical trial plans.

GOVERNMENT REGULATION

     Regulation by governmental authorities in the United States and foreign
countries is a significant factor in the manufacture and marketing of our
present and proposed products and in our ongoing research and product
development activities. Our pre-clinical studies and clinical trials and the
manufacturing and marketing of our products are subject to extensive, costly and
rigorous regulation by various governmental authorities in the United States and
other countries. Many of our proposed products will require regulatory approval
prior to commercialization, and will be subject to rigorous pre-clinical 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. Also, any products we develop, independently or in collaboration
with others, may not meet applicable regulatory criteria to receive the required
approvals for manufacturing and marketing. Additionally, we may be required to
withdraw from any market a product previously approved for sale.

     In the United States, the FDA regulates the clinical testing, manufacture,
distribution and promotion of medical devices, biologics and pharmaceuticals
under the Federal Food, Drug and Cosmetic Act, or the FD&C Act, and its related
regulations. TransCyte and Dermagraft are subject to regulation by the FDA as
medical devices. The FDA has informed us that Anginera will be regulated as a
biologic. Our 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 our 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. Unlike
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.

     Similar issues affect our products in foreign jurisdictions. For example,
Dermagraft has received marketing approval for the treatment of diabetic foot
ulcers in the United States, Canada, Australia, New Zealand and South Africa,
and in Canada and Australia for use in chronic wounds of other etiologies such
as venous ulcers and pressure ulcers. In Europe, we have been seeking approval
of Dermagraft as a pharmaceutical through the Mutual Recognition process. We had
filed an application with the Swedish regulatory authorities as the Reference
Member State to review the initial marketing approval application of Dermagraft
in the treatment of chronic full-thickness diabetic foot ulcers. The Swedish
regulatory authority completed its initial review of the marketing application
and has determined that additional clinical data and technical elements are
required to comply with pharmaceutical approval requirements. We have decided to
withdraw the application pending the development of a European strategy,
including the appropriate use of our financial resources, and those of our joint
venture partner. The product will continue to be marketed in certain countries
in Europe based on regulatory status of the product in the particular member
states, which allows for limited sales.

     In the United States, in order 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 IDE. An IDE application must contain pre-clinical 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 pre-clinical and human clinical trial data, to prove the safety
and efficacy of the device, and information about the device and its


                                       15

<PAGE>


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 we
may never obtain FDA approval.

     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, such as 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. For example, in 2001 a subsidiary of
Inamed, McGhan Medical, filed a PMA supplement with the FDA seeking approval to
add our human-based collagen to McGhan's existing injectable collagen products
for wrinkle treatments. Inamed announced in October 2001 that the FDA had
requested additional pre-clinical data and had asked them to perform skin-test
studies, which are currently being conducted.

     We have constructed a commercial manufacturing facility for TransCyte and
Dermagraft, where we also produce human-based collagen and NouriCel. 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, or 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 FDA jurisdiction, we 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.

     If as a result of FDA inspections, adverse event reports or information
derived from any other source, the FDA believed we were not in compliance with
laws or regulations, or that our products posed a significant health risk, the
FDA could act in a number ways. They could 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 us 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 us, our officers or our
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 approved the Food and Drug Administration
Modernization Act of 1997, or FDAMA. The FDAMA made changes to the device
provisions of the FD&C Act and other provisions in the FDAMA affecting the
regulation of devices. Among other things, the changes affect the IDE and PMA
processes, and also affect device standards and data requirements, procedures
relating to humanitarian and breakthrough devices, tracking and post-market
surveillance, accredited third party review, and the dissemination of off label
information. We may incur significant costs to comply with laws and regulations
in the future, and new and current laws and regulations may have a material
negative impact upon our business, financial condition or results of operations.

     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 pre-empts conflicting New York statutes from


                                       16

<PAGE>


regulating the product as banked human tissue. In January 2000, the FDA
responded to our request with an opinion stating that New York State tissue bank
licensing requirements were not pre-empted by the FDA's federal regulation.
Subject to individual state regulations, we and our customers could be subjected
to additional regulation, registrations and associated costs. 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 that enables us to charge a fee for services rendered at
a profit. Due to the similarities of our products and their common technology
platform, regulations applicable to TransCyte and Dermagraft are also expected
to apply to other future products, if they are successfully developed, including
NeoCyte.

PATENTS AND PROPRIETARY RIGHTS

     Our ability to compete effectively will depend, in part, on our ability to
maintain the proprietary nature of our technology and manufacturing processes.
We rely on patents, trademarks, trade secrets, copyrights and know-how to
maintain our competitive position. As of March 26, 2002, we are the assigne of
42 patents issued in the United States and, in addition, counterparts to some of
the United States patents have been issued in several foreign countries. The
United States patents expire at various times between 2005 and 2018.

     In general, our patents cover our three-dimensional tissue engineering
technology, our three-dimensional tissue products for gene therapy applications,
including TransCyte and Dermagraft, and our tissue engineered three-dimensional
tubular structures, including but not limited to blood vessels, gastrointestinal
structures, and tissues of the genitourinary tract, and our bioreactor
technology.

     Our other patents issued in the United States cover tissue engineered
compositions, apparatus and methods for preparing them, and processes for
therapeutic applications and laboratory testing. These patents expire between
2005 and 2018. We have additional pending United States and foreign patent
applications related to our tissue engineering technology. In addition, we have
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. Three United States patents covering the
growth of vascularized human tissues or organs on three-dimensional
biocompatible, biodegradable and non-biodegradable polymer scaffolds inside the
body were issued to MIT and Children's Hospital. These patents, which have been
licensed to us for a broad range of tissues and organs, complement our core
patents covering the growth of tissues outside the body. Our licensed rights to
these MIT patents extend until October 2013.

     Our patent applications may not result in issued patents, and current or
future issued or licensed patents, trade secrets or know-how may not protect us
against competitors with similar technologies or processes. Others may infringe
or design around our patents even if issued, or independently develop
proprietary technologies or processes which are the same as or substantially
equivalent to ours. We could also incur substantial costs in defending ourselves
in suits brought against us on such patents, or in bringing suits to protect our
patents or patents licensed by us against infringement. In addition to patent
protection, we rely on trade secrets, proprietary know-how and technological
advances which we seek to protect in part by confidentiality agreements with our
collaborative partners, employees and consultants. However, these agreements may
be breached and our remedies for any breach may be inadequate, or our trade
secrets may 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 to our technology is intense and
may come from universities, research institutions, tissue engineering companies,
xenotransplant companies, various divisions of major pharmaceutical companies
and other pharmaceutical, biotechnology and medical products companies. Many
competitors or potential competitors have greater financial resources, research
and development capabilities, and manufacturing and marketing experience than
us. We rely and will continue to rely on our partners and potential partners to
provide some or all of these resources in order for us to compete.

     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 are some of
the major determinative factors in establishing our competitive position. Our


                                       17

<PAGE>


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 us.

     In the field of tissue engineering and the treatment of damaged or diseased
tissue, we compete with several companies which are developing various tissue
replacement products, including skin substitutes and cultured cartilage. In
addition, we are 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.

     In the field of wound care, several companies have developed technologies
involving cadaver, human-cell or animal-derived tissues as dermal replacement
products. Products that compete with TransCyte in the burn market include
LifeCell Corporation's Alloderm, processed from cadaver skin, and Genzyme
Biosurgery's EpiCel, sheets of epidermis grown from the patient's own tissue. In
addition, we are aware that Ortec International, Inc. has received marketing
approval from the FDA for its composite cultured skin product, OrCel, consisting
of human fibroblasts and keratinocytes on a bovine collagen sponge for use in
healing donor site wounds in burn victims. Ortec has also received a
Humanitarian Device Exemption (or HDE) approval from the FDA to market its
composite cultured skin product for use in patients with Recessive Dystrophic
Epidermolysis Bullosa undergoing hand reconstruction. An HDE is an FDA clearance
that allows medical devices that provide safe treatment to be available for
patients with rare medical conditions that affect fewer that 4,000 individuals
in the United States per year.

     Burn products that contain animal-derived tissue include Integra Life
Sciences' Integra Artificial Skin, consisting of a bovine collagen and
glycosaminoglycan matrix with a synthetic polymer covering.

     Organogenesis, Inc. is marketing Apligraf, under an alliance with Novartis
Pharma AG. Apligraf is made with two types of living human skin cells, epidermal
keratinocytes and dermal fibroblasts, and is approved for the treatment of
diabetic foot ulcers and venous ulcers. We also compete with larger
pharmaceutical or biotechnology companies who have biological based products for
the treatment of wounds. One such product is Regranex, a genetically-engineered
platelet-derived growth factor used in the treatment of neuropathic diabetic
foot ulcers, produced by Chiron Corporation and marketed by the Ortho-McNeil
division of Johnson & Johnson. Several other companies are also developing or
plan to develop growth factors as a treatment for partial-thickness or small
full-thickness wounds.

     Potential competition for our human-based collagen product, to be marketed
by Inamed within the wrinkle revision market, will, we believe, come from
existing therapies such as collagen derived from bovine and cadaver sources, as
well as from new potential products. We are aware of potential competitors
capable of producing recombinant human collagen, however, to our knowledge they
have not demonstrated the ability to produce a viable commercial application.
Within the wrinkle revision market, we believe that our human-based collagen may
compete with products such as Zyderm and Zyplast, Inamed's existing bovine
collagen derived products, fat injections, gelatin or cadaver-based collagen
products, hyaluronic acid products, currently available in Europe, Canada and
Australia), and for certain limited indications, Botox, a botulinum toxin
product marketed and manufactured by Allergan, Inc. which we believe is awaiting
FDA approval for wrinkle revision indications. We are also aware of a hyaluronic
acid based product, Restylane, from Q-Med of Sweden, that is currently in
clinical trials for wrinkle revision, and another, Hylaform, licensed by Genzyme
Biosurgery to Inamed, that is expected to commence clinical trials in 2002.

     Competition in the cosmeceuticals field is very highly fragmented, with
many different distribution and marketing channels. The success of products
containing NouriCel will, we believe, be dependent upon our ability to
demonstrate NouriCel's therapeutic value, and upon the marketing efforts of our
current and future collaborators. Many of our competitors and potential
competitors have greater financial and marketing resources than us or our
current partners.

     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. We are aware that Integra and Osiris
Therapeutics, Inc. are also engaged in research on cartilage regeneration
products. We are not aware of any competitor that is developing an
off-the-shelf, human cartilage tissue that can be inserted in an arthroscopic
procedure.

     For all of our products, we expect to compete primarily on the uniqueness
of our technology and product features, on the quality and cost-effectiveness of
our products, and on the timing of commercial introduction. We


                                       18

<PAGE>


believe that our products may have many attributes that differentiate them from
other competitors, including the fact that they are human-based tissue products
designed to be readily available and stored at the customer's location. However,
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, or may not be able to secure partners with sufficient resources,
to compete successfully. This may negatively affect our results of operations.

     Sales of Dermagraft, TransCyte and any potential products in markets other
than patient pay markets will be affected by our success, or the Dermagraft
Joint Venture's success, in obtaining product reimbursement from both national
healthcare systems and private insurers.

FACTORS AFFECTING OPERATING 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. Through December 30, 2001, we
had incurred cumulative net operating losses of $292.7 million. Our ability to
achieve profitability depends in part upon our ability to successfully
manufacture Dermagraft and TransCyte for skin ulcers and burns, for our partner,
Inamed, to obtain regulatory approval for their human-based collagen product,
for us to cost-effectively manufacture collagen and our nutrient solution for
aesthetic applications, and for each of these products to be successfully
marketed by our partners. 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 OPERATING RESULTS FLUCTUATE SIGNIFICANTLY, IT COULD RESULT IN A LOWER
PRICE OF OUR STOCK, WHICH COULD NEGATIVELY AFFECT YOUR INVESTMENT AND OUR
ABILITY TO RAISE ADDITIONAL CAPITAL.

     We expect our operating results to fluctuate from period to period based
upon when we incur expenses and receive revenues from product sales, contract
fees, milestones and other fees. We believe some of these fluctuations may be
significant, and you could lose all or some of your investment.

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 OUR
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 beyond 2002. We base our forecasts of additional
funds on many uncertain variables. Such uncertainties include regulatory
approvals, the timing of events outside our direct control such as product
launches by partners, the success of such product launches, negotiations with
potential strategic partners, and other factors. Any of these uncertain events
can significantly change our cash requirements, as they determine, among other
factors, one-time events such as the receipt of major milestones and other
payments.

     Potential sources of additional funds include payments from our alliances
with Smith & Nephew and Inamed, and to a lesser extent Biozhem and SkinMedica.
If, for any reason, Smith & Nephew were to terminate the Dermagraft 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, and we would need to pursue other means to
obtain funds, such as public or private offerings of debt or equity securities,
collaborative agreements or extensions of existing arrangements. If Smith &
Nephew were to terminate the NeoCyte Joint Venture, we would experience an
increase in the need for and use of our working capital to support the
development of our orthopedic cartilage products, or we would need to reduce or
terminate our investment in such development if funding from other sources were
not available to us.

     We may not satisfy the milestones for additional funds under the joint
ventures with Smith & Nephew or the alliance with Inamed. 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.


                                       19

<PAGE>


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

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, OR
PATIENTS MAY HAVE ADVERSE REACTIONS.

     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. We may be unable to sell our
products, or unable to sell our products in quantities that meet our forecasts,
due to:

     o  their respective cost;

     o  concerns related to efficacy;

     o  the effectiveness of alternative methods of treatment;

     o  the insufficiency of third-party reimbursement; and

     o  reports of adverse reactions.

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

     Additionally, TransCyte has been marketed and sold in the United States
since 1997, however it has not achieved widespread commercial acceptance.
Similarly, Dermagraft was only recently approved for marketing in the United
States and our experience, and that of Smith & Nephew, in marketing Dermagraft
is therefore limited. TransCyte, Dermagraft or our human-based collagen, if
approved by the FDA, may never achieve commercial acceptance in the United
States or elsewhere.

     Known adverse reactions to Dermagraft and TransCyte, or any other
commercially available products that are regulated by the FDA, are detailed in
an extensive document that accompanies each product that is shipped. We work
extensively with the FDA to arrive at approved language that describes
commercially available products in detail, including a listing of adverse
reactions that may have occurred.

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 relying on Smith & Nephew, Inamed and others to market our products
both domestically and internationally. Our success in generating revenues from,
and market acceptance of, Dermagraft and TransCyte will depend on the marketing
efforts of Smith & Nephew. Market acceptance of human-based collagen will depend
in part on the regulatory and marketing efforts of Inamed. We cannot control the
amount and timing of resources that Smith & Nephew, Inamed or others may devote
to marketing and selling our products, or their ability or willingness to
continue investment in such activities. In addition, the Dermagraft and NeoCyte
Joint Venture agreements provide that they may be terminated before their
expiration if specified events occur, such as a material default, change of
control, partner's election to withdraw, the cessation of the partnership's
regular operations for implementing its business purpose, mutual agreement or a
voting deadlock on a material issue, all or some of which may be outside of 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 and marketing efforts of the
Dermagraft Joint Venture and NeoCyte Joint Venture. Our failure to achieve broad
use of Dermagraft for the treatment of diabetic foot ulcers and, to a lesser
extent, TransCyte for burn care and human-based collagen for aesthetic
applications, 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 unable to meet these expenses, we may be unable to continue our
operations.


                                       20

<PAGE>


IF WE, OR OUR PARTNERS, ARE NOT ABLE TO OBTAIN REGULATORY APPROVAL, WE WILL NOT
BE ABLE TO SELL THE AFFECTED PRODUCTS.

     To sell our products that are under development, and our existing products
for additional applications, we, or our partners, must usually receive
regulatory approvals. To obtain approvals for new products, we, or our partners,
must conduct clinical studies demonstrating that the respective products are
safe and effective, which can be expensive and time-consuming. Similar clinical
studies may also be required to obtain approval for additional applications of
our existing products. We, or our partners, may be unable to obtain regulatory
approval on a timely basis, if at all. If regulatory approval cannot be obtained
for a regulated product or any additional application of such a product, that
product cannot be sold and revenues will never materialize.

     Our products, or potential products, may not be successful in ongoing or
future clinical trials. Such trials may be delayed or halted for various
reasons, including:

     o  the product is not effective, or physicians think that it is not
        effective;

     o  patients experience severe side effects during treatment;

     o  patients do not enroll in the study at the rate we expect; or

     o  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 our products are safe and effective
after clinical trials are completed.

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 products that are similar to or 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 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, among others:

     o  applications may not result in issued patents;

     o  current or future issued or licensed patents, trade secrets or know-how
        may not afford protection against competitors with similar technologies
        or processes;

     o  any patents issued may be infringed upon or be designed around by
        others, or be challenged and invalidated; and

     o  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 or, even if successful,
may consume enormous financial and management resources. 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.


                                       21

<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 PREVENT OR LIMIT OUR POTENTIAL FUTURE PROFITABILITY.

     Although most of the raw materials used in the manufacture of Dermagraft,
TransCyte, and our human-based collagen product 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 such 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
from only one FDA-qualified manufacturing source, Ethicon, Inc., a subsidiary of
Johnson & Johnson. Pursuant to our agreement with Ethicon, so long as we meet
agreed purchase levels, Ethicon is to use reasonable efforts to manufacture and
sell to us such quantities as we require. The synthetic mesh framework used by
us in the manufacture of TransCyte is also available from only one FDA-qualified
manufacturing source, Bertek Pharmaceuticals, Inc. Under our agreement with
Bertek, Bertek agrees to manufacture and sell to us such quantities ordered
which do not exceed certain thresholds based on previous forecasts provided by
us. 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 Ethicon or Bertek.
Although there may be other suppliers who have equivalent materials that would
be available to us, FDA approval of any alternate suppliers could take several
months or years.

     Interruptions in supplies for the manufacture of our Dermagraft, TransCyte
and human-based collagen products may occur and we may have to obtain substitute
vendors for these materials. Any significant supply interruption would delay our
marketing, product development or clinical trial 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. These delays may limit our revenues.

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,
Dermagraft and TransCyte are the only regulated products of ours that are
approved for commercial sale in the United States, however Dermagraft was only
approved in September, 2001, and as with any novel medical technology, private
and public reimbursement is not automatically conveyed upon FDA approval. In
December 2001, Dermagraft received an APC pass-through code under the Hospital
Outpatient Prospective Payment System from CMS. The pass-through payment code
for Dermagraft covers Medicare patients with diabetic foot ulcers treated in a
hospital outpatient setting. The original notice from the CMS indicated that the
code would become effective on January 1, 2002, however a subsequent
communication that was made public on December 18, 2001, postponed the
implementation of all new outpatient codes, pending a review expected by the CMS
to be completed by no later than March 31, 2002. Once the code becomes
effective, each Medicare local carrier or fiscal intermediary can begin
developing coverage guidelines to determine when, how often, and under what
conditions they will pay for the use of Dermagraft for patients with chronic
diabetic foot ulcers. However, there can be no assurances that Medicare local
carriers or fiscal intermediaries will pay for the use of Dermagraft.

     Our human-based collagen product still requires further marketing approvals
from the FDA, and all of our other regulated 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 pre-clinical 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:

     o  any or all of these products will be found to be unsafe or ineffective
        or otherwise fail to receive necessary regulatory approvals;

     o  our products are uneconomical to market;

     o  third parties may hold legal rights that preclude us from marketing such
        products;

     o  our products fail to achieve market acceptance because of competing
        technologies and products; or,

     o  we may have insufficient financial resources to pursue all or any of our
        potential programs through to commercialization.

                                       22

<PAGE>



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 development and commercial partners are subject to extensive
government regulation. The FDA and other state and foreign regulatory
authorities require rigorous pre-clinical 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.

     TransCyte, Dermagraft and cartilage products are subject to regulation by
the FDA as medical devices. The FDA has informed us that Anginera will be
regulated as a biologic. In 2000, an IDE was submitted to the FDA requesting
approval to begin pilot human clinical studies using human-based cartilage
tissue for articular resurfacing of the knee joint, under the NeoCyte Joint
Venture. The FDA raised agency jurisdictional issues as to whether or not this
product should be regulated as a medical device or biologic, as well as
questions about the pre-clinical studies. Our 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 our 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. Unlike 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. In addition, we have very limited experience of biologic
applications, and neither we nor the FDA have experience of applying biologic
regulations to our technology and products.

     In Europe, we have been seeking approval of Dermagraft as a pharmaceutical
through the Mutual Recognition process. We had filed an application with the
Swedish regulatory authorities as the Reference Member State to review the
initial marketing approval application of Dermagraft in the treatment of chronic
full-thickness diabetic foot ulcers. The Swedish regulatory authority completed
its initial review of the marketing application and has determined that
additional clinical data and technical elements are required to comply with
pharmaceutical approval requirements. We have decided to withdraw the
application pending the development of a European strategy, including the
appropriate use of our financial resources, and those of our joint venture
partner.

     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 pre-empts conflicting New York statutes from regulating the product as
banked human tissue. In January 2000, the FDA responded to our request with an
opinion stating that New York State tissue bank licensing requirements were not
pre-empted by the FDA's federal regulation. Subject to individual state
regulations, we and our customers could be subjected to additional regulation,
registrations and associated costs. 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
that enables us to charge a fee for services rendered at a profit. Due to the
similarities of our products and their common technology platform, regulations
applicable to TransCyte and Dermagraft are also expected to apply to other
future products, if successfully developed, including NeoCyte.



                                       23

<PAGE>


     Additionally, in May 2001, McGhan Medical Corporation, a subsidiary of
Inamed, filed a PMA supplement with the FDA, seeking approval to add our
human-based collagen as an alternative source of McGhan Medical's injectable
collagen. Clearance of the PMA amendment filing by the FDA would permit McGhan
to market an injectable form of human-based collagen for wrinkle treatment.
However, in October 2001 Inamed announced that the FDA had requested certain
additional pre-clinical data and had asked for skin-test studies to be
conducted. These studies are currently being performed. Further purchases of our
human-based collagen are expected to be delayed until such time as McGhan
Medical receives FDA approval of their PMA supplement.

     After regulatory approval is obtained, our products, their 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 September 1998, we successfully completed a re-inspection by the FDA of our
manufacturing facility and quality systems and have passed subsequent
inspections. 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. If an accident occurs, 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 our regulated 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. 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.

     Our TransCyte and Dermagraft 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.

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 to our technology is intense and
may come from universities, research institutions, tissue engineering companies,
xenotransplant companies, various divisions of major pharmaceutical companies
and other pharmaceutical, biotechnology and medical products companies. Many
competitors or potential competitors have greater financial resources, research
and development capabilities, and manufacturing and marketing experience than
us. We rely and will continue to rely on our partners and potential partners to
provide some or all of these resources in order for us to compete.



                                       24

<PAGE>


     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 are some of
the major determinative factors in establishing our competitive position. Our
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 us.

     In the field of tissue engineering and the treatment of damaged or diseased
tissue, we compete with several companies which are developing various tissue
replacement products, including skin substitutes and cultured cartilage. In
addition, we are 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.

     In the field of wound care, several companies have developed technologies
involving cadaver, human-cell or animal-derived tissues as dermal replacement
products. Products that compete with TransCyte in the burn market include
LifeCell Corporation's Alloderm, processed from cadaver skin, and Genzyme
Biosurgery's EpiCel, sheets of epidermis grown from the patient's own tissue. In
addition, we are aware that Ortec International, Inc. has received marketing
approval from the FDA for its composite cultured skin product, OrCel, consisting
of human fibroblasts and keratinocytes on a bovine collagen sponge for use in
healing donor site wounds in burn victims. Burn products that contain
animal-derived tissue include Integra Life Sciences' Integra Artificial Skin,
consisting of a bovine collagen and glycosaminoglycan matrix with a synthetic
polymer covering.

     Organogenesis, Inc. is marketing, under an alliance with Novartis Pharma
AG, Apligraf, made with two types of living human skin cells, epidermal
keratinocytes and dermal fibroblasts, for diabetic foot ulcers and venous
ulcers. We also compete with larger pharmaceutical or biotechnology companies
who have biological based products for the treatment of wounds. One such product
is Regranex, a genetically-engineered platelet-derived growth factor used in the
treatment of neuropathic diabetic foot ulcers, produced by Chiron Corporation
and marketed by the Ortho-McNeil division of Johnson & Johnson. Several other
companies are also developing or plan to develop growth factors as a treatment
for partial-thickness or small full-thickness wounds.

     Potential competition for our human-based collagen product, to be marketed
by Inamed within the wrinkle revision market, will, we believe, come from
existing therapies such as collagen derived from bovine and cadaver sources, as
well as from new potential products. We are aware of potential competitors
capable of producing recombinant human collagen. Within the wrinkle revision
market, we believe that our human-based collagen may compete with products such
as Zyderm and Zyplast, Inamed's existing bovine collagen derived products, fat
injections, gelatin or cadaver-based collagen products, hyaluronic acid
products, currently available in Europe, Canada and Australia, and for certain
limited indications, Botox, a botulinum toxin product marketed and manufactured
by Allergan, Inc. which we believe is awaiting FDA approval for wrinkle revision
indications. We are also aware of two hyaluronic acid based products, Hylaform,
licensed by Genzyme Biosurgery to Inamed, and Restylane, from Q-Med of Sweden,
that are currently in clinical trials for wrinkle revision.

     Competition in the cosmeceuticals field is very highly fragmented. Many of
our competitors and potential competitors have greater financial and marketing
resources than us or our current partners.

     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. We are aware that Integra and Osiris
Therapeutics, Inc. are also engaged in research on cartilage regeneration
products.

     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, or may not be able to secure partners with sufficient resources, to
compete successfully. This may negatively affect our results of operations.

IF WE ARE UNABLE TO ATTRACT KEY PERSONNEL AND ADVISORS OR IF OUR CURRENT
MANAGEMENT AND TECHNICAL PERSONNEL LEAVE US, IT MAY LIMIT 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 may be
unable to attract or retain such individuals. For instance, some competitors
have begun to expand their research and


                                      25

<PAGE>


manufacturing capabilities in San Diego, resulting in significantly increased
competition for personnel. Failure to continue to attract and retain qualified
personnel will limit our ability to achieve our business objectives and could
make it difficult to raise additional funds or to attract partners. We do not
have employment agreements with any of our executive officers or other
employees, although our executive officers have change of control agreements in
place.

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 if such products cause injury, disease or result in harmful 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 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.

ADDITIONAL RISKS

OUR STOCK PRICE COULD CONTINUE TO BE VOLATILE AND ANY INVESTMENT COULD SUFFER A
DECLINE IN VALUE, WHICH MAY PREVENT OR LIMIT OUR ABILITY TO RAISE ADDITIONAL
CAPITAL. THIS COULD IN TURN DELAY COMMERCIALIZATION OF OUR PRODUCTS OR LEAD US
TO CEASE OPERATIONS.

     The market price of our common stock has fluctuated significantly in recent
years and is likely to fluctuate in the future. For example, from April 1998 to
March, 2002, our common stock has closed as high as $12.13 per share and as
low as $1.97 per share. Factors contributing to this volatility have included:

     o  the timing of approval and commercialization of products;

     o  the results of research or scientific discoveries by us or others;

     o  progress or the results of pre-clinical and clinical trials;

     o  new technological innovations;

     o  developments concerning technology rights;

     o  litigation and related developments; and

     o  public perception regarding the safety and efficacy of our products.

     Fluctuations in our financial performance from period to period 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.


                                       26

<PAGE>


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 amended and restated
certificate of incorporation and by-laws 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 price. 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 share issuances may have the effect of delaying or
preventing a change in our ownership.

ITEM 2.  PROPERTIES

     We lease approximately 85,000 square feet of space at our headquarters
facility in La Jolla, San Diego, California, of which approximately 85% is
currently allocated to manufacturing and research. The leases for this facility
expire in December 2005.

     In October 2001, we signed a 10-year lease on 29,000 square feet of office
and laboratory space in a facility approximately three miles from our La Jolla
location, and expect to move the majority of our research activities into the
new facility in May 2002. The lease term will commence in May 2002. This
facility replaces a laboratory facility of approximately 7,000 square feet, on
which our lease expired in January 2002. The new facility will expand our
research capabilities and provide approximately 4,000 square feet in the La
Jolla facility for other uses.

     We believe that our property and equipment are generally well maintained,
in good operating condition and, subsequent to our move in May 2002, will be
sufficient to meet our current needs.

ITEM 3.  LEGAL PROCEEDINGS

     There is no material litigation currently pending against us. From time to
time, we may be involved in litigation relating to claims arising out of our
operations in the ordinary course of business.

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

     There were no matters submitted to a vote of security holders during the
quarter ended December 31, 2001.


                                       27

<PAGE>



                                     PART II


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

MARKET INFORMATION

     Our common stock is traded on the National Association of Securities
Dealers Automated Quotation, or NASDAQ, National Market under the symbol ATIS.
On March 25, 2002, the last reported closing price of our common stock by
Nasdaq was $3.20. The last reported high and low sales prices as reported for
our common stock by Nasdaq for the last two fiscal years are set forth below.
Such quotations represent inter-dealer prices without retail mark up, mark down
or commission and may not necessarily represent actual transactions.

                                                  HIGH           LOW
                                                 ------        -------
      YEAR ENDED DECEMBER 31, 2001:
         First Quarter                           $ 6.75        $ 2.88
         Second Quarter                            5.00          2.96
         Third Quarter                             5.70          3.01
         Fourth Quarter                            5.23          3.35

      YEAR ENDED DECEMBER 31, 2000:
         First Quarter                           $16.00        $ 2.50
         Second Quarter                            8.75          3.75
         Third Quarter                             8.63          5.00
         Fourth Quarter                            8.00          2.97

HOLDERS

     As of December 31, 2001, there were approximately 1,434 holders of record
of our common stock.

DIVIDENDS

     We have never paid cash dividends on our common stock and do not expect to
pay any cash dividends in the foreseeable future.

RECENT SALES OF UNREGISTERED SECURITIES

     In October 2001, as part of a broader strategic collaboration with
Medtronic, Inc., we sold 5,376,344 unregistered shares of our common stock to
Medtronic Asset Management, Inc., at $3.72 per share, resulting in net proceeds
of approximately $19.9 million. Medtronic Asset Management, Inc. merged with
Medtronic International, Ltd. effective as of December 31, 2001. In November
2001, we completed a private placement of approximately $14.7 million in gross
proceeds, covering the sale of 3,534,335 unregistered shares of our common stock
at $4.15 per share to a group of institutional investors led by the State of
Wisconsin Investment Board, which purchased 2,450,000 shares in this offering.
Net proceeds from this private placement were approximately $13.5 million.

     We subsequently filed a Form S-3 registration statement registering
14,014,842 shares of common stock for resale. The shares registered included the
5,376,344 shares held by Medtronic International, Ltd., the 3,534,335 shares
issued to institutional investors in November 2001, and 5,104,163 shares of our
common stock acquired by Smith & Nephew SNATS, Inc. over a period from January
1998 to September 2000. The Form S-3 was declared effective by the Securities
and Exchange Commission on February 8, 2002. Each of the transactions were
private offerings 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.

ITEM 6.  SELECTED FINANCIAL DATA

     Our selected financial data 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 37.


                                       28

<PAGE>


ITEM 7A.  MARKET RISK

     Information concerning market risk relating to our financial instruments is
presented in Management's Discussion and Analysis of Financial Condition and
Results of Operations beginning on page 37 of this annual report on Form 10-K.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Our 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-1.

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, we have not had a change in our
independent auditors nor have there been any disagreements between us and our
independent auditors.


                                       29


<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 our Proxy Statement for the
2002 Annual Meeting of Stockholders, to be filed with the SEC by April 15, 2002,
are incorporated herein by reference.

ITEM 11.  EXECUTIVE COMPENSATION

     The section titled "Executive Compensation" appearing in our Proxy
Statement for the 2002 Annual Meeting of Stockholders, to be filed with the SEC
by April 15, 2002, is incorporated herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The section titled "Principal Stockholders" appearing in our Proxy
Statement for the 2002 Annual Meeting of Stockholders, to be filed with the SEC
by April 15, 2002, is incorporated herein by reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The section titled "Certain Transactions" appearing in our Proxy Statement
for the 2002 Annual Meeting of Stockholders, to be filed with the SEC by April
15, 2002, 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 Advanced Tissue Sciences, Inc. 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.:
         Report of Ernst & Young LLP, Independent Auditors..............................                 F-1
         Consolidated Balance Sheets as of December 31, 2001 and 2000...................                 F-2
         Consolidated Statements of Operations for the Years Ended December 31, 2001,
            2000 and 1999...............................................................                 F-3
         Consolidated Statements of Cash Flows for the Years Ended December 31, 2001,
            2000 and 1999...............................................................                 F-4
         Consolidated Statements of Stockholders' Equity for the Years Ended December
            31, 2001, 2000 and 1999.....................................................                 F-5
         Notes to the Consolidated Financial Statements.................................             F-6 to F-22
      Combined Financial Statements of the Dermagraft Joint Venture:
         Report of Ernst & Young LLP, Independent Auditors..............................                 F-23
         Combined Balance Sheets as of December 31, 2001 and 2000.......................                 F-24
         Combined Statements of Operations for the Years Ended December 31, 2001,
            2000 and 1999...............................................................                 F-25
         Combined Statements of Cash Flows for the Years Ended December 31, 2001,
            2000 and 1999...............................................................                 F-26
         Combined Statements of Partners' Capital for the Years Ended December 31,
            2001, 2000 and 1999.........................................................                 F-27
         Notes to the Combined Financial Statements.....................................              F-28 to F-31

</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.


                                       30

<PAGE>



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

     Exhibit
       No.                         Title                                        Method of Filing
     -------                       -----                                        ----------------
   <S>               <C>                                               <C>
    3.1              Amended and Restated Certificate of               Incorporated by Reference to Exhibit 3.1 to the
                     Incorporation of the Company                      Company's Form 10-Q for the Quarter Ended June
                                                                       30, 2000

    3.2              Restated By-Laws of the Company                   Incorporated by Reference to Exhibit 3.2 to the
                                                                       Company's Form 10-Q for the Quarter Ended June
                                                                       30, 2000

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

    4.1              Rights Agreement, Dated as of January 6, 1995,    Incorporated by Reference to Exhibit 1 to the
                     between the Company and Chemical Trust Company    Company's Current Report on Form 8-K dated
                     of California, including the Certificate of       January 5, 1995
                     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 entered       Incorporated by Reference to Exhibit 1 to the
                     into as of November 8, 1999, between              Company's Form 8-A, as amended, dated November
                     ChaseMellon Shareholder Services, L.L.C. and      10, 1999
                     Advanced Tissue Sciences, Inc.

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

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

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

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

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

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

</TABLE>


                                       31

<PAGE>


<TABLE>
<CAPTION>

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

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

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

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

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

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

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

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

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

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

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

   10.11(b)          Common Stock Purchase Agreement, Dated January    Incorporated by Reference to Exhibit 10.2 to
                     14, 1998, between Advanced Tissue Sciences,       the Company's Current Report on Form 8-K Dated
                     Inc. and Smith & Nephew SNATS, Inc.               January 14, 1998

</TABLE>


                                       32

<PAGE>

<TABLE>
<CAPTION>


    Exhibit
       No.                         Title                                        Method of Filing
     -------                       -----                                        ----------------
   <S>               <C>                                               <C>
   10.12             Heads of Agreement between Advanced Tissue        Incorporated by Reference to Exhibit 10.1 to
                     Sciences, Inc. and Smith & Nephew plc Dated       the Company's Form 10-Q for the Quarter Ended
                     August 6, 1998                                    June 30, 1998

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

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

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

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

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

   10.16             Stock Purchase Agreement dated as of              Incorporated by Reference to Exhibit 10.1 to
                     September 19, 2000, between the State of          the Company's Form 10-Q for the Quarter Ended
                     Wisconsin Investment Board and  the Company       September 30, 2000

   10.17*            License and Supply Agreement effective as of      Incorporated by Reference to Exhibit 10.2 to
                     September 25, 2000, between the Company and       the Company's Form 10-Q for the Quarter Ended
                     Biozhem Cosmeceuticals Inc.                       September 30, 2000

   10.18*            Term Sheet restructuring certain terms of the     Incorporated by Reference to Exhibit 10.3 to
                     Dermagraft Joint Venture, as amended and          the Company's Form 10-Q for the Quarter Ended
                     effective as of September 2000 between the        September 30, 2000
                     Company and Smith & Nephew plc

   10.19(a)*         Development, License and Supply Agreement         Incorporated by Reference to Exhibit 10.20(a)
                     effective as of October 5, 2000, between the      to the Company's Form 10-K for the Year Ended
                     Company and SkinMedica Inc.                       December 31, 2000

   10.19(b)*         Investor Rights Agreement effective as of         Incorporated by Reference to Exhibit 10.20(b)
                     October 5, 2000, between the Company and          to the Company's Form 10-K for the Year Ended
                     SkinMedica Inc.                                   December 31, 2000

   10.19(c)*         Option to Purchase Common Stock of SkinMedica     Incorporated by Reference to Exhibit 10.20(c)
                     Inc. dated October 5, 2000                        to the Company's Form 10-K for the Year Ended
                                                                       December 31, 2000

   10.20(a)*         License Agreement effective as of May 10,         Incorporated by Reference to Exhibit 10.22(a)
                     1999, between the Company and Inamed              to the Company's Form 10-K for the Year Ended
                     Corporation                                       December 31, 2000

   10.20(b)*         Addendum to License Agreement effective as of     Incorporated by Reference to Exhibit 10.22(b)
                     May 10, 1999, between the Company and Inamed      to the Company's Form 10-K for the Year Ended
                     Corporation                                       December 31, 2000

</TABLE>


                                       33

<PAGE>


<TABLE>
<CAPTION>


    Exhibit
       No.                         Title                                        Method of Filing
     -------                       -----                                        ----------------
   <S>               <C>                                               <C>
   10.20(c)*         Common Stock Purchase Agreement effective as      Incorporated by Reference to Exhibit 10.22(c)
                     of November 1, 1999, between the Company and      to the Company's Form 10-K for the Year Ended
                     Inamed Corporation                                December 31, 2000

   10.21*            First Amendment to Development, License and       Incorporated by Reference to Exhibit 10.1 to
                     Supply Agreement, as of May 21, 2001, between     the Company's Form 10-Q/A for the Quarter Ended
                     the Company and SkinMedica, Inc.                  June 30, 2001

   10.22             Investment Agreement dated October 3, 2001,       Filed Herewith
                     between the Company, and Medtronic Asset
                     Management, Inc., and Medtronic, Inc.

   10.23             License Agreement dated October 3, 2001,          Filed Herewith
                     between the Company and Medtronic, Inc.

   10.24             Lease Agreement dated October 26, 2001 between    Filed Herewith
                     the Company and Wateridge Investors, LLC

   10.25             Stock Purchase Agreement dated October 31,        Filed Herewith
                     2001, by and among the Company, the State of
                     Wisconsin Investment Board and other investors

   10.26*            First Amended and Restated Investor Rights        Filed Herewith
                     Agreement dated December 28, 2001, by and
                     among the Company, SkinMedica, Inc, and other
                     parties

   21                Subsidiaries of the Registrant                    Filed Herewith

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

     We filed a report on Form 8-K dated October 3, 2001 under Item 5, and
attached a press release dated October 3, 2001 announcing a collaboration with
Medtronic, Inc. and the receipt of a $20 million equity investment by an
affiliate of Medtronic.

     We filed a report on Form 8-K dated November 5, 2001 under Item 5, and
attached a press release dated November 5, 2001 announcing the completion of a
private placement of approximately $14.7 million in gross proceeds, covering the
sale of 3,534,335 shares of unregistered common stock at $4.15 per share, to a
group of institutional investors led by the State of Wisconsin Investment Board.


                                       34

<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 28, 2002                     By:  /s/ Arthur J. Benvenuto
     -------------------                      --------------------------------
                                              Arthur J. Benvenuto
                                              Chairman of the Board of Directors
                                                and Chief Executive Officer

                                POWER OF ATTORNEY

     Know all men by these present, that each person whose signature appears
below constitutes and appoints Arthur J. Benvenuto, his or her attorney-in-fact,
with power of substitution in any and all capacities, to sign any amendments to
this annual report on Form 10-K, and to file the same with exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that the attorney-in-fact or his
or her substitute or substitutes may do or cause to be done by virtue hereof.

     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 28, 2002
--------------------------------------------   and Chief Executive Officer (principal
            Arthur J. Benvenuto                executive officer)

 /s/ Gail K. Naughton                          Director and President                           March 28, 2002
--------------------------------------------
            Dr. Gail K. Naughton

 /s/ Nikhil A. Mehta                           Senior Vice President and Chief                  March 28, 2002
--------------------------------------------   Financial Officer (principal financial
              Nikhil A. Mehta                  and accounting officer)

 /s/ Michael D. Ellwein                        Director                                         March 28, 2002
--------------------------------------------
             Michael D. Ellwein

 /s/ Jerome E. Groopman                        Director                                         March 28, 2002
--------------------------------------------
          Jerome E. Groopman, M.D.

 /s/ Jack L. Heckel                            Director                                         March 28, 2002
--------------------------------------------
               Jack L. Heckel

 /s/ Ronald L. Nelson                          Director                                         March 28, 2002
--------------------------------------------
              Ronald L. Nelson

 /s/ Dayton Ogden                              Director                                         March 28, 2002
--------------------------------------------
                Dayton Ogden

 /s/ David S. Tappan, Jr.                      Director                                         March 28, 2002
--------------------------------------------
            David S. Tappan, Jr.

 /s/ Gail R. Wilensky                          Director                                         March 28, 2002
--------------------------------------------
            Dr. Gail R. Wilensky

</TABLE>


                                       35

<PAGE>


                             SELECTED FINANCIAL DATA

     See Note 1 to the accompanying consolidated financial statements for a
discussion of the basis of presentation. The selected financial data
should be read in conjunction with the consolidated financial statements and
related notes thereto included elsewhere in this Form 10-K.  The information is
not necessarily indicative of future operating results.

<TABLE>
<CAPTION>

                                                                  Years Ended December 31,
                                        ----------------------------------------------------------------------------
                                           2001             2000            1999            1998             1997
                                        ----------       ----------      ----------      ----------       ----------
                                                          (In thousands, except per share amounts)
<S>                                     <C>              <C>             <C>             <C>              <C>

Revenues:
   Joint venture contract (1)           $   16,778       $   20,647      $   25,767      $   18,862       $   12,165
   Product sales (2)                         5,328               87              --           1,035              976
   Milestones, contracts & fees (3)          6,834            4,537          17,036             584               10
Research and development
  expenses                                   7,784            7,428           6,746          10,750           10,054
Equity in losses of joint
  ventures (1)                             (12,391)         (13,278)        (21,558)        (17,628)         (11,990)
Net loss                                   (28,373)         (24,571)        (21,306)        (43,285)         (36,089)
Net loss applicable to common
  stock                                    (28,373)         (24,619)        (21,864)        (43,863)         (36,089)

Basic and diluted loss per
  common share                          $     (.43)      $     (.41)     $     (.45)     $    (1.11)      $     (.96)

Weighted average shares used in the
  calculation of basic and diluted
  loss per common share                     66,069           60,575          48,507          39,373           37,548
</TABLE>


<TABLE>
<CAPTION>


                                                                         December 31,
                                        ----------------------------------------------------------------------------
                                           2001             2000            1999            1998             1997
                                        ----------       ----------      ----------      ----------       ----------
                                                                        (In thousands)
<S>     <C>    <C>    <C>    <C>    <C>    <C>
Cash, cash equivalents and
   short-term investments               $   29,973       $   31,051      $   26,079      $   23,054       $   17,086
Working capital                             30,508           25,082          10,651          20,442           13,216
Total assets                                61,922           59,106          59,386          53,985           50,460
Long-term debt, capital lease
  obligations and redeemable
  preferred stock (4)                       11,812           14,399          24,139          34,949           28,096
Accumulated deficit                       (292,706)        (264,333)       (239,762)       (218,456)        (175,171)
Stockholders' equity                        42,023           35,802          21,423          12,527           13,966

</TABLE>


(1)  In April 1996, we formed the Dermagraft Joint Venture with Smith &
     Nephew plc for the commercialization of Dermagraft for the treatment of
     diabetic foot ulcers, having formed a separate joint venture for the
     commercialization of tissue engineered cartilage for orthopedic
     applications with Smith & Nephew in April 1994. We and Smith & Nephew began
     sharing in the revenues and expenses of the joint ventures in January 1997.
     Joint venture contract revenues include:

          (a) Sales of TransCyte and Dermagraft to the Dermagraft Joint
              Venture at cost, of $12,767,000, $12,771,000, $13,717,000,
              $10,927,000 and $1,190,000 for the years ended December 31, 2001,
              2000, 1999, 1998 and 1997.

          (b) Revenues for research and development, marketing and other
              activities performed for the Dermagraft and NeoCyte Joint
              Ventures.

(2)  Includes sales of our products to unrelated customers, including sales of
     collagen to Inamed Corporation in the years ended December 31, 2001 and
     2000; and sales of TransCyte made by our sales force in the years ended
     December 31, 1998 and 1997.

(3)  Includes (a) recognition of milestones and license fees from strategic
     partners, (b) royalties, and (c) revenues for research, development and
     other activities performed for unrelated parties under collaborative
     agreements and government grants. Milestones and license fees of
     $5,000,000, $3,595,000 and $16,405,000 were recognized in the years ended
     December 31, 2001, 2000 and 1999 respectively.

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


                                       36

<PAGE>


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

     The following discussion and analysis should be read with "Selected
Financial Data" and our financial statements and notes thereto included
elsewhere in this annual report on Form 10-K. The discussion and analysis in
this annual report on Form 10-K may contain forward-looking statements that
involve risks and uncertainties, such as statements of our plans, objectives,
expectations and intentions. The cautionary statements made in this annual
report on Form 10-K should be read as applying to all related forward-looking
statements wherever they appear in this annual report on Form 10-K. Our actual
results could differ materially from those discussed here. Factors that could
cause or contribute to these differences include those discussed in "Factors
Affecting Operating Results" included in Part I, Item 1 - Business above as well
as those discussed elsewhere. Such risks and uncertainties could cause actual
results to differ materially from any future performance suggested below. We
undertake no obligation to release publicly the results of any revisions to
these forward-looking statements to reflect events or circumstances arising
after the date of this report.

     Advanced Tissue Sciences, Inc. is engaged in the development and
manufacture of human-based tissue products for tissue repair and transplantation
using our proprietary tissue engineering technology. Our leading products are
skin products, TransCyte for the temporary covering of severe and
partial-thickness burns, and Dermagraft for the treatment of severe skin ulcers.
In addition, we are focusing our resources on the development of tissue
engineered products for other wound care, aesthetic and reconstructive,
cardiovascular and orthopedic applications. These other applications include
collagen and our nutrient solution, NouriCel, for aesthetic and reconstructive
applications.

     Since 1996 we have participated in a joint venture, the Dermagraft Joint
Venture, with Smith & Nephew plc for the worldwide commercialization of
Dermagraft in the treatment of diabetic foot ulcers.

     In 1998, we 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 TransCyte for full and partial-thickness
burns. We received marketing approval for TransCyte in the United States from
the FDA, in 1997, as a temporary covering for severe, full-thickness, or third
degree burns and for partial-thickness, or second degree burns. Until September
1998, we marketed TransCyte for burns through a direct sales force in the United
States, however subsequent to the expansion of the Dermagraft Joint Venture in
1998, TransCyte was and will be marketed in the United States and throughout the
rest of the world for burn and other wound care applications under the
Dermagraft Joint Venture.

     Dermagraft for the treatment of diabetic foot ulcers was approved for sale
in Canada and was introduced by the Dermagraft Joint Venture in the United
Kingdom and several other European countries, on a limited basis, in 1997. In
that year we also submitted a PMA application to the FDA for approval to market
Dermagraft for the treatment of diabetic foot ulcers in the United States. In
1998 the FDA decided the PMA application was not approvable without supportive
data from an additional controlled clinical trial. The additional clinical trial
began in late 1998, and by August 2000 statistical significance was reached for
the primary endpoint and a new PMA application was submitted to the FDA. In
September 2001, we received approval from the FDA to market Dermagraft as a
human fibroblast-derived dermal substitute in the treatment of chronic foot
ulcers in patients with diabetes. We are currently also marketing Dermagraft for
the treatment of diabetic foot ulcers, through the Dermagraft Joint Venture, in
Australia, New Zealand and South Africa. We have been seeking approval of
Dermagraft in Sweden as a pharmaceutical through the Mutual Recognition process,
however in 2001 we withdrew the application while we assess the need for further
clinical and process information requested by the regulatory authority.
Pharmaceutical guidelines generally require much more extensive and rigorous
clinical and process information than is customarily provided for products that
are regulated as devices.

     In 2001, Dermagraft was granted extended indications in both Canada and
Australia for the treatment of lower limb ulcers, partial and full-thickness
chronic wounds, the promotion of granulation tissue and the preparation of
wounds for skin grafting.

     In connection with the expansion of the Dermagraft Joint Venture, in
January 1999 we received a $15,000,000 up front payment from Smith & Nephew that
was recognized in contract revenues during 1999, as related financial
commitments were met. See Note 3 to the consolidated financial statements for
more information on the financial transactions associated with the Dermagraft
Joint Venture.

     In February 2000, with a delay in the commercial introduction of Dermagraft
in the United States and a requirement for an additional clinical trial by the
FDA substantially increasing the partners' required investment, we


                                       37


<PAGE>


agreed in principle with Smith & Nephew to restructure the Dermagraft Joint
Venture. The restructuring agreement was amended and implemented in September
2000. See Note 3 to the consolidated financial statements for more information
on the financial transactions associated with the Dermagraft Joint Venture.

     The objective of the restructuring was to defer the potential payment of
certain milestones by Smith & Nephew while providing us a royalty stream and an
opportunity to increase our long-term return from the venture. Specifically,
except for $10,000,000 in regulatory approval and reimbursement milestones
related to Dermagraft in the treatment of diabetic foot ulcers, we 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 us royalties on joint venture
product sales. As part of the agreement we also sold the Dermagraft
manufacturing assets that we owned to DermEquip, but retained all raw material
inventory. DermEquip is a limited liability company owned jointly with Smith &
Nephew, and is consolidated in our financial statements. The proceeds of this
sale were used in September 2000 to pay down a portion of the outstanding
balance of the NeoCyte Loan, with the remaining outstanding principal and
interest being paid in our common stock based on a specified average market
price. Subsequent to this transaction, the Dermagraft Joint Venture in September
2000 made us a new long-term loan, with raw material inventory being pledged as
collateral security. See Notes 3, 7 and 10 to the consolidated financial
statements for a discussion of transactions under the Dermagraft Joint Venture.

     Under the restructured joint venture, we are sharing equally with Smith &
Nephew in the expenses and revenues of the Dermagraft Joint Venture, except that
we funded the first $6 million of expenses for conducting clinical trials and
regulatory support of Dermagraft and TransCyte in the treatment of venous ulcers
and pressure ulcers. In addition, we funded a proportion of manufacturing and
distribution costs and costs related to post-market studies for TransCyte
through 1999. See Note 3 to the consolidated financial statements for a
discussion of transactions under the Dermagraft Joint Venture.

     In addition to Smith & Nephew's share of the ongoing investments in the
Dermagraft Joint Venture they have paid $30 million to us in fees and milestone
payments since 1996, including $5 million in 2001 on the approval by the FDA of
the PMA for Dermagraft in the treatment of diabetic foot ulcers. Other payments
of up to $131 million will be due to us from Smith & Nephew subject to the
achievement of various regulatory, sales and profitability milestones, over the
term of the agreement which terminates in the year 2046 unless extended by
mutual agreement of the partners. This amount includes a milestone payment of $5
million related to the reimbursement status of Dermagraft and coverage by
regional insurance carriers in the United States under Medicare. In December
2001, Dermagraft received an Ambulatory Payment Classification (or APC)
pass-through code under the Hospital Outpatient Prospective Payment System from
the Centers for Medicare & Medicaid Services (or CMS). The pass-through payment
code for Dermagraft covers Medicare patients with diabetic foot ulcers treated
in a hospital outpatient setting. The original notice indicated that the code
would become effective on January 1, 2002, however the CMS subsequently
postponed the implementation of all new outpatient codes, pending a review by
the CMS. The CMS announced on February 28, 2002 that the new codes would become
effective on April 1, 2002. Once the code becomes effective, each Medicare local
carrier or fiscal intermediary can begin developing coverage guidelines to
determine when, how often, and under what conditions they will pay for the use
of Dermagraft for patients with chronic diabetic foot ulcers. The pass-through
payment code is the first step toward receipt of the $5 million milestone
payment, subject to other conditions in our agreements with Smith & Nephew.

     In addition to the Dermagraft Joint Venture, since 1994, we have shared in
a separate joint venture with Smith & Nephew, the NeoCyte Joint Venture, for the
worldwide development, manufacture and marketing of human tissue engineered
cartilage for orthopedic applications. We are sharing equally with Smith &
Nephew in the expenses of the joint venture. During 2000, an IDE was submitted
to the FDA requesting approval to begin pilot human clinical studies of human
tissue engineered cartilage. The FDA raised agency jurisdictional issues as to
whether or not this product should be regulated as a medical device or biologic,
as well as questions about the pre-clinical studies. We continue to work closely
with the FDA to address these issues. The efforts of the joint venture in this
area currently center around articular cartilage, in which we commenced a
pivotal large animal pre-clinical study in 2001.

     In May 1999, we entered into a strategic alliance with Inamed Corporation
for the development and marketing of several of our human-based, tissue
engineered products for aesthetic and certain reconstructive applications. Under
the related agreements, Inamed licensed rights to further develop, manufacture
and sell certain of our tissue engineered products such as human-based collagen
for use in wrinkle correction and as a bulking agent for the treatment of
urinary incontinence, cartilage for plastic and reconstructive surgery, and
extracellular matrix for use in breast reconstruction and other soft tissue
augmentation. We are responsible for the development of the products and the
related manufacturing processes while Inamed is responsible for clinical,
regulatory and marketing activities. We, or an affiliate, have the right to
manufacture the products developed for Inamed. In total, under the agreements
between the parties, in exchange for worldwide licensing rights, Inamed has paid
us a series of payments totaling $10 million, including $5 million to purchase
our common stock. Inamed also received five-year warrants


                                       38

<PAGE>


to purchase up to 500,000 shares of common stock. In addition to a price for our
product and royalties on Inamed's sales in the market place, we may potentially
receive up to a total of $10 million in milestones based on product approvals in
the United States, subject to our success in developing products under the
aggrement and Inamed's success in obtaining such approvals.

     During 2001, a subsidiary of Inamed, McGhan Medical, filed a PMA supplement
with the FDA seeking approval to add our human-based collagen to McGhan's
existing injectable collagen products for wrinkle treatments. Inamed announced
in October 2001 that the FDA had requested additional pre-clinical data and had
asked them to perform skin-test studies, which are currently being conducted.
During 2001 we shipped our human-based collagen to Inamed for the purposes of
clinical studies, evaluation and testing, however pre-launch sales of collagen
to Inamed are expected to cease, pending receipt of FDA approval and the
subsequent launch of the product in the wrinkle treatment market. See Note 3 to
the consolidated financial statements for a discussion of transactions under our
alliance with Inamed.

     In September 2000, we signed a license and supply agreement with Biozhem
Cosmeceuticals, Inc. Under the agreement, we granted a license to use and are
selling NouriCel to Biozhem. NouriCel is a patent-pending by-product of our
tissue engineering processes, to be used in Biozhem's branded skin care
products. As well as a selling price for sales of NouriCel to Biozhem, we are
entitled to specified milestone payments and royalties on sales of Biozhem's
products in the skin care marketplace. Additionally, we were granted warrants to
purchase Biozhem common stock at specified prices in future time periods. In
January 2002, with the launch Biozhem's product having been delayed from the
expected date in the agreement, we amended our agreement with Biozhem to defer
the payment to us of an initial milestone of $1 million, from December 2001 to
November 2002. In addition, the amended agreement provides for a new schedule of
minimum royalty payments by Biozhem to us in 2002, including the payment of
minimum royalties originally scheduled in 2001. Our decision to defer the
milestone and minimum royalties was based primarily upon Biozhem's ability to
make the payments as a result of the delay in Biozhem's receipt of income from
sales of our product Terms of the original agreement with Biozhem relating to
payments and other obligations after 2003 remain unchanged. See Note 3 to the
consolidated financial statements for a discussion of transactions under our
alliance with Biozhem.

     In October 2000, we signed a license and supply agreement with SkinMedica,
Inc. Under this agreement, we granted a license to use and are selling NouriCel
to SkinMedica, to be used in SkinMedica's branded skin care products sold
through a network of dermatologists and plastic surgeons. We are entitled to a
selling price for sales of NouriCel to SkinMedica and to specified milestone
payments and royalties on sales of SkinMedica's products in the skin care
marketplace. We were also granted warrants to purchase SkinMedica common stock
at specified prices in future time periods. In May 2001, the agreement was
amended to change specified commencement and termination provisions. See Note 3
to the consolidated financial statements for a discussion of transactions under
our alliance with SkinMedica.

     In October 2001, we entered into a broad strategic collaboration with
Medtronic, Inc. to explore the application of our technology in the areas of
cardiovascular, neurological, endocrine and spinal. An affiliate of Medtronic
simultaneously purchased $20 million of our common stock at $3.72 per share, in
return for specified rights including a right of first refusal to collaborate in
the further development and commercialization of Anginera, our epicardial
angiogenesis therapy, a product that stimulates new blood vessel growth and
therefore increased blood flow, a right of first offer/first negotiation to
collaborate in other programs within the cardiovascular, neurological, endocrine
and spinal areas where we elect not to pursue those programs internally, and a
limited non-exclusive license to our intellectual property in the four
therapeutic areas identified to facilitate Medtronic's exploration of cell and
tissue engineered technology in combination with Medtronic's medical devices.
Net proceeds of the equity investment were approximately $19.9 million.

     In May 2000, researchers at the University of Washington announced that
they would be partnering with us and others in a project, funded by a $10
million grant from NIH to grow functional human heart tissue. The proportion of
the grant for which we would be eligible is approximately $1.8 million. The
grant is expected to cover the first five years of an anticipated 10 year
project.

     In September 2000, we were awarded a $2 million Advanced Technology Program
grant from NIST, for development of a tissue engineered Ischemic Repair Device
to induce vascularization of, and restore function to, tissues and organs with
reduced blood supplies, or ischemia. The grant commenced in 2000 and is payable
over three years. This grant follows a $2 million award in October 1997 from
NIST to fund collaborative cardiovascular research with the University of
California, San Diego, that was completed in the second quarter of 2001.

     Also in September 2000, we were awarded a grant in excess of $800,000 from
NIH and the National Institute of Dental and Craniofacial Research to develop
tissue engineered cartilage for the treatment of temporomandibular disorders.
Payments under the grant are payable over four years.


                                       39

<PAGE>


     In October 2001, we signed a 10-year lease on 29,000 square feet of
additional office and research laboratory space in a facility approximately
three miles from our La Jolla location, and expect to move the majority of our
research activities into the new facility in May 2002. The lease term will
commence in May 2002, subject to the completion of improvements. We have options
to extend the term of the lease for two five-year periods. As a condition of
signing the lease, we were required to purchase a standby letter of credit in
the amount of $1.7 million. This facility replaces a laboratory facility of
approximately 7,000 square feet, on which our lease expired in January 2002.

     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. Through December 30, 2001, we
had incurred cumulative net operating losses of $292.7 million. Our ability to
achieve profitability depends in part upon our ability to successfully
manufacture Dermagraft and TransCyte for skin ulcers and burns, for our partner,
Inamed, to obtain regulatory approval for their human-based collagen product,
for us to cost-effectively manufacture collagen and our nutrient solution for
aesthetic applications, and for each of these products to be successfully
marketed by our partners. 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.

     We have incurred and expect to continue to incur, either directly or
through the Dermagraft Joint Venture, substantial expenditures in support of the
commercialization, development, clinical trials and post-market studies of
TransCyte and Dermagraft for burn and skin ulcer applications, for manufacturing
systems and in advancing other applications of our core technology. We also
expect to incur additional costs for the development of products and
manufacturing processes under our strategic alliance with Inamed, additional
costs for the development and clinical trials of tissue engineered cartilage
products through the NeoCyte Joint Venture, costs for products we may develop
for cardiovascular applications, and costs which may be associated with other
products which we may undertake from time to time. Our agreements with our
current strategic alliance partners are structured to share some or all of these
costs as well as to provide us with income from milestone payments, royalties
and licensing fees for the respective products. See Note 3 to the consolidated
financial statements for details regarding financial transactions under our
strategic alliance agreements.

CRITICAL ACCOUNTING POLICIES

     Our financial statements are prepared in conformity with generally accepted
accounting principles. We believe the following accounting policies, in
particular, are critical to our results of operations and to the understanding
of our consolidated financial statements. Our consolidated financial statements
include the accounts of Advanced Tissue Sciences, its wholly owned subsidiaries,
and DermEquip L.L.C., a limited liability company owned jointly with Smith &
Nephew. DermEquip is a special purpose entity which was established to finance
an expansion of our manufacturing facility, and which holds the assets used in
the facility. All intercompany accounts and transactions are eliminated. Our
other interests in joint ventures with Smith & Nephew are accounted for under
the equity method.

     Revenues from product sales are recognized when products are shipped and
title has passed, and we have no further specified performance obligations.
Revenues from product sales to related parties, such as our joint ventures with
Smith & Nephew, are recognized at such time as ownership of the product is
transferred to the related party, generally upon the completion of
manufacturing. Such product sales to related parties are equal to our cost.

     As a result of the delay in Dermagraft approval by the FDA until September
2001, we continue to incur significant costs associated with excess production
capacity within our manufacturing facility. The Dermagraft Joint Venture
purchases Dermagraft and TransCyte from us as they are manufactured, at cost,
including period costs, and immediately writes the inventory down to estimated
market value at the date of purchase. The estimated market value is the net
realizable value at which the Joint Venture believes it will be able to sell the
products to its customers. In the year ended December 31, 2001 inventory
write-downs by the Dermagraft Joint Venture totaled $9,089,000, down from
$9,821,000 in 2000. We incur our share of the write-downs, currently 50%,
through our equity in the joint venture. To the extent that we do not sell such
products to the Dermagraft Joint Venture, we would be required to write such
inventories down to net realizable value.

     We own and have patents pending in the United States and abroad to protect
the processes and products we are developing.  Direct patent application costs
related to patents issued are amortized over the estimated useful life of the
patent, approximately 20 years from the date of application.  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.  Patent application and maintenance costs related to licensing
agreements are expensed as incurred.


                                       40

<PAGE>


RESULTS OF OPERATIONS

     The presentation of the statement of operations in the attached financial
statements has been reformatted from prior presentations to more clearly reflect
revenue and cost transactions between us and our joint ventures with Smith &
Nephew. These transactions are separately presented from transactions with other
parties.

     Year Ended December 31, 2001 as Compared to the Year Ended December 31,
2000

     Joint venture contract revenues were $16,778,000 in 2001, compared to
$20,647,000 in 2000. Joint venture contract revenues include sales of Dermagraft
and TransCyte to the Dermagraft Joint Venture at cost, and revenues for research
and development, administration, and other services performed for the Dermagraft
and NeoCyte Joint Ventures under collaborative agreements. See Notes 3 and 15 to
the consolidated financial statements for further discussion of transactions
under the Dermagraft and NeoCyte Joint Ventures. Sales of Dermagraft and
TransCyte to the Dermagraft Joint Venture were $12,767,000 in 2001, and
$12,771,000 in 2000. Growth in sales of Dermagraft and TransCyte in 2002 and
beyond will be primarily dependent on the Dermagraft Joint Venture partners'
success in obtaining product reimbursement from both national healthcare systems
and private insurers, and on the success of Smith & Nephew in marketing the
products.

     Revenue for services performed for the joint ventures was $4,011,000 in
2001, compared to $7,876,000 in 2000. The primary causes of this decrease are a
reduction of $2,077,000 in revenue for services performed for the NeoCyte Joint
Venture, and $1,647,000 due to the completion in 2000 of the clinical trial of
Dermagraft for the treatment of diabetic foot ulcers.

     Product sales to third parties were $5,328,000 in 2001, compared to $87,000
in 2000. These revenues primarily represent sales of our human-based collagen to
Inamed Corporation, which we have been shipping to Inamed for the purposes of
clinical studies, evaluation and testing. Prior to the launch of Inamed's
human-based collagen product, our sales of collagen to Inamed are expected to
cease, pending receipt of FDA approval and Inamed's subsequent launch of the
product in the wrinkle treatment market.

     Milestone revenue in 2001 was $5,000,000, compared to $3,595,000 in 2000.
In September 2001 we recognized the $5,000,000 milestone from Smith & Nephew
that resulted from the approval of the PMA for Dermagraft in the treatment of
diabetic foot ulcers in the United States. In 2000 we recognized the final
$3,595,000 of a $5,000,000 licensing payment received from Inamed Corporation in
1999.

     Other contract and fee revenue was $1,834,000 in 2001, compared to $942,000
in 2000, primarily reflecting an increase in government grant revenue.

     Joint venture contract expense was $16,564,000 in 2001, compared to
$20,420,000 in 2000. Joint venture contract expenses include (in thousands):

                                                        2001          2000
                                                      --------      --------


     Manufacturing and distribution costs -
          Dermagraft & TransCyte                      $ 12,645      $ 12,699
     Research and development costs                      2,299         5,673
     Administration and other expenses                   1,620         1,962
                                                      --------      --------
        Total joint venture contract expenses         $ 16,564      $ 20,334

     As a result of the delay in Dermagraft approval by the FDA until September
2001, we continue to incur significant costs associated with excess production
capacity within our manufacturing facility. We expect to continue to have excess
production capacity in future years. The Dermagraft Joint Venture purchases
Dermagraft and TransCyte from us as they are manufactured at cost, including
period costs, and immediately writes the inventory down to estimated market
value at the date of purchase. The estimated market value is the net realizable
value at which the Joint Venture believes it will be able to sell the products
to its customers. In the year ending December 31, 2001 inventory write-downs by
the Dermagraft Joint Venture totaled $9,089,000, down from $9,821,000 in 2000.
We incur our share of the write-downs, currently 50%, through our equity in the
joint venture. To the extent that we do not sell such products to the Dermagraft
Joint Venture, we would be required to write such inventories down to net
realizable value.

     The decrease in joint venture research and development contract expenses
resulted primarily from the reduced spending in 2001 by the NeoCyte Joint
Venture, and the completion during 2000 of the clinical trial of Dermagraft in
the treatment of diabetic foot ulcers.

     Cost of goods sold for products sold to third parties increased from
$153,000 in 2000, to $8,340,000 in 2001. This increase primarily reflects
production costs for the human-based collagen sold to Inamed in 2001, which
included costs associated with the implementation of collagen manufacturing.


                                       41

<PAGE>


     Research and development expense for projects, other than those performed
for our joint ventures with Smith & Nephew, increased by $356,000 to
$7,784,000, from $7,428,000 in 2000. Year over year, development costs related
to the development of NouriCel increased by $792,000, and research costs under
grant projects increased by $525,000. These increases were offset by a reduction
of $1,073,000 in collagen product development costs included in research and
development, as our collagen product was moved from product development into
manufacturing. Our research and development costs, under both our joint ventures
and for other projects, will continue to be significant due to continuing and
anticipated clinical trials and post-market studies during 2002 and beyond. In
addition, in 2002 we will incur increased costs related to our new research
facility. A discussion of our current research and development projects appears
below:

                        Research and Development Expenses

                          (In thousands, except dates)

      Expenditure includes overheads and support services such as quality
                      assurance and information technology
<TABLE>
<CAPTION>

                                                        2001         2000         1999         Expenditure to Date
                                                     ----------   ----------   ----------      -------------------
<S>                                                  <C>          <C>          <C>                   <C>
Projects :
Dermagraft & TransCyte R&D
(Dermagraft Joint Venture)                           $  1,932.2   $  3,351.8   $  6,986.5               **

Articular cartilage pre-clinical research
(NeoCyte Joint Venture)                                   367.2      2,321.0      2,817.6               **

NIST grant - vascular grafts
(see Cardiovascular page 6)                                34.1      1,298.8      1,718.7            4,365.5

Development of Aesthetic & Reconstructive
manufacturing processes                                 1,146.7      1,427.8           --            2,574.5

NIST grant - ischemic repair devices
(see Cardiovascular page 7)                               841.7         75.2           --              916.9

Anginera pre-clinical research                            518.2        170.9           --              689.1

Initial 5 year phase of NIH grant to grow heart
tissue (University of Washington)
see Cardiovascular page 7)                                512.1         62.3           --              574.4

NIH grant - tempromandibular disorders
(see Other Therapeutic Tissues page 10)                   243.2         48.5           --              291.7

Periodontal pre-clinical research                         272.7           --           --              272.7

Other active grants                                       423.9        226.8         120.6             463.4

Other research & development expenditure,
including management & administration                   3,791.2      4,117.4       4,656.5              **
                                                     ----------   ----------   -----------
Total Research and Development                       $ 10,083.2   $ 13,100.5   $  16,299.9

</TABLE>

** Total expenditure to date not available or estimable, due to historical
   changes in reporting methodologies or business re-organization.

     We generally do not provide forward-looking estimates of costs and time to
complete current projects, as such estimates involve a high degree of
uncertainty. Uncertainties include, but are not limited to, our ability to
predict the outcome of complex research, regulatory requirements placed upon us
by regulatory authorities such as the FDA, our ability to raise capital to
finance research activities, competition from other entities of which we may
become aware in future periods, predictions of market potential from products
that may be derived from our research projects, and our ability to recruit and
retain personnel with the necessary knowledge and skills to perform the
research. We have made certain commitments to third parties in order to receive
funds under our research grants. Such commitments involve estimates of time
needed and activities required to complete projects. However significant
uncertainty exists in our ability to accurately forecast the costs of performing
the activities, such as the cost of recruiting and retaining the necessary
personnel with the knowledge and skills to perform the research, the cost of
required materials, and the overhead required to support the specific projects.

     Selling, general and administrative expenses in 2001 increased by
$2,727,000 over 2000, to $12,515,000. Salary and benefits expense increased by
$1,163,000, including $449,000 of recruitment related costs, primarily as a
result of senior management additions made in the fourth quarter of 2000 and the
first quarter of 2001, and the


                                       42

<PAGE>


building of infrastructure to support anticipated product launches. Outside
services expense for consultants and professional services increased by $728,000
as a result of planning and business development initiatives undertaken during
2001. The increase in 2001 compared to 2000 also reflects a non-cash charge of
$677,000 in 2001 related to compensation expense for a variable stock option.
Expense related to the variable stock option was zero for the full year 2000.
See Note 10 to the consolidated financial statements for a discussion of
transactions associated with our capital stock.

     Our equity in losses of joint ventures was $12,391,000 in 2001, compared to
$13,278,000 million in 2000. These amounts represent our share of the losses of
the Dermagraft and NeoCyte Joint Ventures. Joint venture losses were reduced in
2001 primarily as a result of the NeoCyte Joint Venture's decrease in research
and development spending, and the completion of the clinical trial of Dermagraft
in the treatment of diabetic foot ulcers in 2000.

     Joint venture product sales to third parties for the year 2001 were
$4,212,000, compared to $4,280,000 in 2000. Of these sales, TransCyte accounted
for $3,792,000 in 2001 and $3,940,000 in 2000. The reduction in sales resulted
primarily from the Joint Venture's ability to meet market demand being
constrained by declines in manufacturing yields.

     Interest income and other was $525,000 in 2001, compared to $1,925,000 in
2000. Interest income in 2001 was $1,083,000 below interest income received in
2000, due to a combination of lower interest rates and lower average cash
balances. Total interest expense was $643,000 in 2001, compared to $1,513,000 in
2000. Excluding interest expense incurred on behalf of our joint ventures with
Smith & Nephew, which appears in joint venture conract expense in our statement
of operations, interest expense was $244,000 in 2001, compared to $786,000 in
2000. The decrease in interest expense reflects lower interest rates, the
repayment of a $10,000,000 loan from Smith & Nephew in September 2000, and a
declining balance in the Chase loan. These decreases were partially offset by
interest on approximately $5,412,000 in borrowings from the Dermagraft Joint
Venture associated with the restructuring of the Joint Venture in September
2000. See Notes 3 and 7 to the consolidated financial statements for a
discussion of transactions associated with our joint ventures.

     We paid dividends on preferred stock of approximately $48,000 in 2000. All
remaining shares of our Convertible Series B Preferred Stock were converted to
common stock in March 2000. See Note 11 to the consolidated financial statements
for details regarding our Convertible Series B Preferred Stock.

     Year Ended December 31,2000 as Compared to the Year Ended December 31, 1999

     Joint venture contract revenues were $20,647,000 in 2000, compared to
$25,767,000 in 1999. Joint venture contract revenues include sales of Dermagraft
and TransCyte to the Dermagraft Joint Venture at cost, and revenues for research
and development, administration, and other services performed for the Dermagraft
and NeoCyte Joint Ventures under collaborative agreements. See Notes 3 and 15 to
the consolidated financial statements for further discussion of transactions
under the Dermagraft and NeoCyte Joint Ventures. Sales of Dermagraft and
TransCyte to the Dermagraft Joint Venture were $12,771,000 in 2000, compared to
$13,717,000 in 1999. The reduction in sales reflects primarily the timing of
products moving from work in process to inventory and therefore being recorded
as sales to the Dermagraft Joint Venture, as well as reductions in manufacturing
costs arising from process improvements. Inventory held by the Dermagraft Joint
Venture was reduced by approximately $450,000 from December 31, 1999 to December
31, 2000.

     Revenue for services performed for the joint ventures was $7,876,000 in
2000, compared to $12,050,000 in 1999. This is primarily due to the completion
in 2000 of the clinical trial of Dermagraft for the treatment of diabetic foot
ulcers. The costs of the trial, which were significantly higher for the full
year of 1999 than the partial year's expense in 2000, were charged to the
Dermagraft Joint Venture under our collaborative agreement.

     Product sales of $87,000 in 2000 represent our first sales of human-based
collagen to Inamed Corporation. There were no product sales to third parties in
1999.

     Milestone revenue was $3,595,000 in 2000, compared to $16,405,000 in 1999.
Milestone revenue in 2000 relates to the recognition of $3,595,000 of a $5
million licensing payment received from Inamed Corporation in 1999, the first
$1,405,000 having been recognized into revenues in 1999. The $5 million
milestone payment from Inamed in 1999 was recognized over 18 months,
representing the performance period. Additionally, revenue in 1999 included the
recognition of a $15,000,000 up front payment from Smith & Nephew associated
with the expansion of the Dermagraft Joint Venture. See Note 3 to the
consolidated financial statements regarding these milestone and up front
payments.

     Other contract and fee revenue was $942,000 in 2000, compared to $631,000
in 1999, primarily reflecting an increase in government grant income.


                                       43

<PAGE>


     Joint venture contract expenses were $20,334,000 in 2000 compared to
$25,593,000 in 2000. Joint venture contract expenses include (in thousands):

                                                      2000          1999
                                                   ----------    ----------

     Manufacturing and distribution costs -
          Dermagraft & TransCyte                   $ 12,699      $ 13,717
     Research and development costs                   5,673         9,554
     Administration and other expenses                1,962         2,322
                                                   --------      --------
        Total joint venture contract expenses      $ 20,334      $ 25,593

     The cost to manufacture and distribute Dermagraft and TransCyte decreased
from $13,717,000 in 1999 to $12,699,000 in 2000. As a result of the delay in
Dermagraft approval by the FDA, we continued to incur significant costs
associated with excess production capacity within our manufacturing facility in
2000 and 1999. The Dermagraft Joint Venture purchases Dermagraft and TransCyte
from us as they are manufactured, at cost including period costs, and
immediately writes the inventory down to estimated market value at the date of
purchase. Period costs reflect overhead costs related to excess production
capacity and include rent, depreciation, and quality control, facilities,
supplies and other such costs to support, or related to excess production
capacity. The estimated market value is the net realizable value at which the
Joint Venture believes it will be able to sell the products to its customers. In
the year ending December 31, 2000 inventory write-downs by the Dermagraft Joint
Venture totaled $9,821,000, down from $11,982,000 in 1999. To the extent that we
do not sell such products to the Dermagraft Joint Venture, we would be required
to write such inventories down to net realizable value.

     The decrease in joint venture research and development contract expenses
primarily relates to the costs of the additional clinical trial of Dermagraft
for the treatment of diabetic foot ulcers, which begin in late 1998 and was
completed in the first half of 2000.

     Cost of goods sold for products sold to third parties was $153,000 in 2000,
reflecting production costs for human-based collagen sold to Inamed. As
shipments commenced in 2000, there was no related cost of goods sold in 1999.

     Research and development expense for projects other than those performed
for our joint ventures with Smith & Nephew increased in 2000 by $682,000 to
$7,428,000, from $6,746,000 in 1999. The increase primarily relates to our
investment in the development of human-based collagen and NouriCel.

     Selling, general and administrative expenses were $9,788,000 in 2000,
compared to $9,527,000 in 1999. A decrease in facilities costs of approximately
$900,000, primarily related to the consolidation of our facilities into two
buildings in 1999, was offset by an increase in compensation, benefit and
recruitment related costs.

     Equity in losses of Joint Ventures was $13,278,000 in 2000, compared to
$21,558,000 in 1999. These amounts represent our share of the losses of the
Dermagraft and NeoCyte Joint Ventures. During 1999, we funded certain
manufacturing and distribution costs associated with the transfer of sales and
marketing of TransCyte in the United States to the Dermagraft Joint Venture, and
included such costs as a loss in equity in Joint Ventures. No such costs were
included as a loss in equity in 2000, compared to approximately $3,200,000 in
1999. Other factors affecting the reduction include the completion of the
clinical trial of Dermagraft for diabetic foot ulcers in 2000, increased sales
to third parties, and reductions in the Dermagraft Joint Venture's cost
structure.

     Interest income and other was $1,925,000 million in 2000, compared to
$362,000 in 1999. Interest income in 2000 was largely unchanged from 1999,
however we incurred other expenses of approximately $1,300,000 in 1999 related
to the consolidation of our operations into two facilities. Specifically, this
included a $417,000 fee paid in terminating a long-term facility lease, and
asset disposals and write-downs of approximately $900,000.

     Total interest expense was $1,513,000 in 2000, compared to $1,801,000 in
1999. Excluding interest expense incurred on behalf of our joint ventures with
Smith & Nephew, which appears in joint venture contract expense in our statement
of operations, interest expense was $786,000 in 2000, compared to $1,047,000 in
1999. The decrease in interest expense primarily reflects the repayment of a
$10,000,000 loan from Smith & Nephew in June 1999, partially offset in 2000 by
additional borrowing from Smith & Nephew related to the NeoCyte Joint Venture
that were repaid in September. See Notes 3 and 7 to the consolidated financial
statements for details regarding these transactions.

     We paid dividends on preferred stock of approximately $48,000 in 2000 and
$558,000 in 1999. All remaining shares of our Convertible Series B Preferred
Stock were converted to common stock in March 2000. See Note 11 to the
consolidated financial statements for details regarding our Convertible Series B
Preferred Stock.


                                       44

<PAGE>


LIQUIDITY AND CAPITAL RESOURCES

     To date, we have funded our operating and capital expenditures primarily
through the sale of equities, contract revenues, funding from strategic
partners, bank loans, government grants, product sales and lease financing
transactions.

     In addition to investments in money market funds, our cash equivalents
consist primarily of investments in commercial paper, which are unsecured
obligations, and obligations issued or guaranteed by the United States
Government with maturities of three months or less at the date of acquisition.
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, 2001 and 2000, our cash equivalents and short-term
investments were classified as available-for-sale. 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, 2001 or
2000. When making investments in commercial paper, we use ratings supplied by
recognized debt-rating agencies to assess potential risks.

     Cash and cash equivalents at December 31, 2001 increased by approximately
$5,776,000 from December 31, 2000. Major inflows included $19,943,000 in net
proceeds from the sale of common stock to an affiliate of Medtronic, Inc. in
October 2001, $13,548,000 in net proceeds from the sale of common stock to a
private group of investors led by the State of Wisconsin Investment Board in
November 2001, the receipt of $5,000,000 from Smith & Nephew on the approval of
the PMA for Dermagraft, see Note 3, and $6,854,000 in net proceeds from sales of
short-term investments. These inflows were partially offset by the use of
$22,846,000 to fund operations, a net investment of $11,148,000 to support the
Dermagraft and NeoCyte Joint Ventures, $1,700,000 in restricted cash, (see Note
9 to the consolidated financial statements), $971,000 for capital expenditures
and $2,673 for payment of debt, (see Note 7 to the consolidated financial
statements). Cash flows were as follows (in thousands):

                                                                        2001
                                                                     ----------
CASH FLOWS:
     Sale of common stock to an affiliate of Medtronic
          in October 2001                                             $ 19,943
     Sale of common stock to a private group in November 2001           13,548
     Dermagraft milestone payment received from Smith & Nephew           5,000
     Net proceeds from short-term investments                            6,854
     Cash used to support operations, excluding milestone income       (22,846)
     Investment in joint ventures with Smith & Nephew, net             (11,148)
     Debt payment                                                       (2,673)
     Restricted cash to support letter of credit                        (1,700)
     Capital expenditures                                                 (971)
     Other cash disbursements, net                                        (231)
                                                                      --------
       NET CHANGE IN CASH AND EQUIVALENTS December 31, 2001 to 2000   $  5,776
                                                                      ========

     Receivables from joint ventures from December 31, 2001 to December 31, 2000
increased by $378,000, in line with product sales. Receivables from Inamed
increased by $3,459,000 from December 31, 2000 to December 31, 2001, primarily
relating to receivables from Inamed for sales of collagen. Inventory increased
by $832,000, primarily relating to collagen. During 2001, a subsidiary of
Inamed, McGhan Medical, filed a PMA supplement with the FDA seeking approval to
add our human-based collagen to McGhan's existing injectable collagen products
for wrinkle treatments. Inamed announced in October 2001 that the FDA had
requested additional pre-clinical data and had asked them to perform skin-test
studies, which are currently being conducted. During the fourth quarter of 2001,
we continued to ship our human-based collagen to Inamed for the purposes of
clinical studies, evaluation and testing, however pre-launch sales of collagen
to Inamed are expected to cease, pending receipt of FDA approval and the
subsequent launch of the product in the wrinkle treatment market.

     Current and long-term debt at December 31, 2001 decreased by $2,413,000
from December 31, 2000, primarily reflecting the reduction in the DermEquip
Chase loan. See Note 7 to the consolidated financial statements for a discussion
of long-term debt. Accrued expenses decreased primarily as the result of a
decrease in accrued wages and benefits.

     There were no deferred revenues at December 31, 2001 or 2000.

     Maturities of long-term debt and capital lease obligations over the next
five years are approximately $7,972,000 in 2002, $2,560,000 in 2003 and
$1,280,000 in 2004. Of the $7,972,000 in 2002, $5,412,000 relates to a


                                       45

<PAGE>


loan from the Dermagraft Joint Venture currently payable on December 31, 2002.
See Note 7 to the consolidated financial statements for further detail regarding
the Dermagraft Joint Venture Loan.

     Under an agreement with Ethicon, Inc., for the supply of the mesh framework
used by us in the manufacture of Dermagraft, we are committed to purchasing
minimum quantities. Based upon current market prices the commitment is estimated
to be approximately $2.5 million in 2002, with the current agreement expiring in
January 2003.

     We expect to continue to expend cash as we incur substantial research and
development expenses, additional costs in support of clinical trials, general
and administrative costs in support of product commercialization, and
expenditures for capital equipment and patents. In addition, under the terms of
our agreements with Smith & Nephew, we have agreed to fund our share of the
costs of the Dermagraft and NeoCyte Joint Ventures. To the extent that such
costs can be forecast, they are mutually agreed by us and Smith & Nephew as
partners in the joint ventures. We have also agreed to fund specified costs to
develop products, and related manufacturing processes, which will be marketed by
Inamed under the terms of our licensing agreement. These uses of cash are
expected to be only partially offset by revenues received from the Dermagraft
and NeoCyte Joint Ventures with Smith & Nephew, from the Inamed alliance, from
sale or royalties under our alliance agreements for the marketing of
NouriCel-based products, or from other potential revenue sources. If, for any
reason, Smith & Nephew were to terminate the Dermagraft Joint Venture, we would
experience a substantial increase in the need for and use of our cash to support
the commercialization and manufacture of Dermagraft and TransCyte. If Smith &
Nephew were to terminate the NeoCyte Joint Venture, we would experience an
increase in the need for and use of our working capital to support the
development of our orthopedic cartilage products, or we would need to reduce or
terminate our investment in such development if funding from other sources were
not available to us.

     Our cash requirements are dependent upon a number of factors, including the
achievement and timing of regulatory approvals and third-party reimbursement,
sales and marketing efforts by our partners, market acceptance of our products
and potential products, the establishment of new strategic alliances, the timing
and expense of pre-clinical and clinical studies, and new technological
innovations. We currently believe we have sufficient funds to support our
planned operations into the fiscal year 2003.

     The further development of our technology and commercialization of our
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. Sources of funds
may include payments from alliances with Smith & Nephew, Inamed, Biozhem or
SkinMedica. We may also pursue additional public or private offerings of equity
or debt securities. Additional funding could potentially be obtained through new
strategic alliances or other collaborative arrangements, or through the
extension of existing strategic alliances. However, funds from the sources
outlined above may not be available when needed or on terms favorable to us,
under existing arrangements or otherwise, and we may not be successful in
entering into any other strategic alliances or collaborative arrangements.

     We continually review our product development activities in an effort to
allocate available resources to those products we believe have the greatest
commercial potential. Factors considered by us in determining the products to
pursue include projected market demand, potential for regulatory approval and
reimbursement, if required, 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 we consider relevant, we may from time to time
reallocate resources among product development activities. Additions to products
under development or changes in products being pursued can substantially and
rapidly change our funding requirements.

MARKET RISK

     We are exposed to changes in interest rates primarily from our long-term
debt arrangements and, secondarily, our investments in certain securities. Under
our current policies, we do not use interest rate derivative instruments to
manage exposure to interest rate changes. We believe 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 our interest sensitive
financial instruments at December 31, 2001.


                                       46

<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, 2001 and 2000, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2001. 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, 2001 and 2000, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 2001, in conformity with accounting principles generally
accepted in the United States.



                                                               ERNST & YOUNG LLP

San Diego, California
Janury 29, 2002


                                      F-1

<PAGE>


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

<TABLE>
<CAPTION>

                                                                 December 31,
                                                   ---------------------------------------
                                                         2001                  2000
                                                   -----------------     -----------------
<S>                                                  <C>                   <C>
ASSETS
Current assets:
   Cash and cash equivalents                         $      29,973         $      24,197
   Short-term investments                                       --                 6,854
   Receivable from joint ventures                            1,852                 1,474
   Receivables from third parties                            3,546                    87
   Inventory                                                 6,605                 5,773
   Other current assets                                      2,669                 1,727
                                                     -------------         -------------
     Total current assets                                   44,645                40,112
Property - net                                              11,067                13,681
Patent costs - net                                           2,527                 2,320
Restricted cash (Note 9)                                     1,700                    --
Other assets                                                 1,983                 2,993
                                                     -------------         -------------
     Total assets                                    $      61,922         $      59,106
                                                     =============         =============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Accounts payable                                  $       1,050         $       1,075
   Payable to joint ventures (Notes 3 and 7)                 6,039                 5,977
   Accrued expenses                                          4,314                 5,391
   Short-term debt and current portion of
     long-term debt (Note 7)                                 2,734                 2,587
                                                     -------------         -------------
     Total current liabilities                              14,137                15,030
Long-term debt                                               3,840                 6,400
Other long-term liabilities                                  1,922                 1,874
                                                     -------------         -------------
     Total liabilities                                      19,899                23,304
                                                     -------------         -------------

Commitments and contingencies (Notes 8 and 9)

Stockholders' equity:
   Common Stock, $.01 par value; 125,000,000 shares
     authorized; 73,148,553 and 64,200,941 shares
     issued and outstanding at December 31, 2001
     and 2000, respectively                                    731                   642
   Additional paid-in capital                              335,368               301,168
   Note received in connection with the sale of
     Common Stock and deferred compensation
     applicable to Common Stock                             (1,370)               (1,672)
   Accumulated deficit                                    (292,706)             (264,333)
   Accumulated other comprehensive income (loss) -
     loss on securities                                         --                    (3)
                                                     -------------         --------------
     Total stockholders' equity                             42,023                35,802
                                                     -------------         -------------
     Total liabilities and stockholders' equity      $      61,922         $      59,106
                                                     =============         =============

</TABLE>

        See accompanying notes to the consolidated financial statements.


                                       F-2

<PAGE>


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

<TABLE>
<CAPTION>


                                                                     Years Ended December 31,
                                                   ------------------------------------------------------------
                                                           2001                2000                1999
                                                   -------------------  ------------------  -------------------
<S>                                                  <C>                  <C>                 <C>
Revenues:
  Joint venture contract                             $   16,778           $   20,647          $  25,767
  Product sales to third parties                          5,328                   87                 --
  Contracts and fees -
     Milestones                                           5,000                3,595             16,405
     Others                                               1,834                  942                631
                                                     ----------           ----------          ---------
     Total revenues                                      28,940               25,271             42,803
                                                     ----------           ----------          ---------
Costs and expenses:
  Joint venture contract                                 16,564               20,334             25,593
  Cost of goods sold                                      8,340                  153                 --
  Research and development                                7,784                7,428              6,746
  Selling, general and administrative                    12,515                9,788              9,527
                                                     ----------           ----------          ---------
     Total costs and expenses                            45,203               37,703             41,866
                                                     ----------           ----------          ---------
Income (loss) from operations before equity
  in losses of joint ventures                           (16,263)             (12,432)               937

Equity in losses of joint ventures                      (12,391)             (13,278)           (21,558)
                                                     ----------           ----------          ---------
Loss from operations                                    (28,654)             (25,710)           (20,621)

Other income (expense):
  Interest income and other                                 525                1,925                362
  Interest expense                                         (244)                (786)            (1,047)
                                                     ----------           ----------          ---------
Net loss                                                (28,373)             (24,571)           (21,306)

Dividends on preferred stock                                 --                  (48)              (558)
                                                     ----------           ----------          ---------
Net loss applicable to common stock                  $  (28,373)          $  (24,619)         $ (21,864)
                                                     ==========           ==========          =========
Basic and diluted loss per common share              $     (.43)          $     (.41)         $    (.45)
                                                     ==========           ==========          =========
Weighted average number of common shares
  used in the computation of basic and
  diluted loss per common share                          66,069               60,575             48,507
                                                     ==========           ==========          =========

</TABLE>

        See accompanying notes to the consolidated financial statements.


                                       F-3

<PAGE>


                         ADVANCED TISSUE SCIENCES, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In Thousands)

<TABLE>
<CAPTION>

                                                                     Years Ended December 31,
                                                   -----------------------------------------------------------
                                                           2001                 2000              1999
                                                   -------------------  ------------------  ------------------
<S>                                                  <C>                  <C>                 <C>
Operating activities:
  Net loss                                           $  (28,373)          $  (24,571)         $  (21,306)
  Adjustments to reconcile net loss to cash
    used in operating activities:
     Depreciation and amortization                        3,660                3,903               4,772
     Compensation for services paid in stock,
       options or warrants                                1,044                  450                 344
     Equity in losses of joint ventures                  12,391               13,278              21,558
     Other adjustments to net loss                           83                  (18)              1,575
     Deferred revenue                                        --               (3,595)              3,595
     Changes in assets and liabilities:
       Receivables from joint ventures                     (378)                 711              (1,023)
       Receivable from Inamed                            (3,459)                 (87)                 --
       Inventory                                           (832)              (1,478)               (931)
       Other current assets                                (942)                 (57)               (414)
       Accounts payable                                     (25)                 320                (139)
       Payable to joint ventures                             62               (2,985)              2,234
       Accrued expenses                                  (1,077)                (157)              2,071
                                                     ----------           ----------          ----------
         Net cash provided by (used in)
           operating activities                         (17,846)             (14,286)             12,336
                                                     ----------           ----------          ----------
Investing activities:
  Purchases of short-term investments                    (3,462)              (9,778)            (15,995)
  Maturities and sales of short-term
    investments                                          10,316               12,909              12,510
  Acquisition of property                                  (971)                (873)               (972)
  Investment in joint ventures                          (12,698)             (19,635)            (24,700)
  Distributions from joint ventures                       1,550                4,343               3,440
  Patent application costs                                 (298)                (367)               (483)
  Other long-term assets                                   (361)                 496                (264)
                                                     ----------           ----------          ----------
         Net cash used in investing
           Activities                                    (5,924)             (12,905)            (26,464)
                                                     ----------           ----------          ----------
Financing activities:
  Proceeds from borrowings                                  260                7,612               1,840
  Payments of borrowings                                 (2,673)              (6,636)             (2,690)
  Net proceeds from sale of Common Stock                 33,491               20,000              19,877
  Restricted cash                                        (1,700)               5,000              (5,000)
  Repurchase of Common Stock                                 --                   --                (457)
  Options and warrants exercised                            120                7,942                  10
  Payment of note receivable and accrued
    interest from related party - common stock               --                1,265                  --
  Note receivable from related party - common
  stock                                                      --               (1,332)                 --
  Other long-term obligations                                48                1,446                  88
                                                     ----------           ----------          ----------
         Net cash provided by financing
           Activities                                    29,546               35,297              13,668
                                                     ----------           ----------          ----------
Net increase (decrease) in cash and cash
     Equivalents                                          5,776                8,106                (460)
Cash and cash equivalents at beginning of year           24,197               16,091              16,551
                                                     ----------           ----------          ----------
Cash and cash equivalents at end of year             $   29,973           $   24,197          $   16,091
                                                     ==========           ==========          ==========

</TABLE>

        See accompanying notes to the consolidated financial statements.


                                       F-4

<PAGE>



                         ADVANCED TISSUE SCIENCES, INC.
                 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                             (Dollars In Thousands)

<TABLE>
<CAPTION>

                                                         Preferred Stock           Common Stock         Additional
                                                      ---------------------   -----------------------     Paid-In
                                                        Shares     Amount       Shares       Amount       Capital
                                                      ---------- ----------   ----------   ----------   ----------
<S>                                                        <C>          <C>   <C>               <C>       <C>
Balance, December 31, 1998                                  350         --    40,353,524        403       230,963
Sale of Common Stock                                                           4,533,039         45        19,829
Issuance of Common Stock for debt and accrued
  interest                                                                     2,800,595         28        10,776
Conversion of Preferred Stock                              (309)        --     7,865,798         79         1,926
Transfer of Preferred Stock to Redeemable Preferred
  Stock                                                     (41)                                            (2,045)
Repurchase of Common Stock                                                      (463,154)        (5)        (1,762)
Preferred Stock dividends                                                        432,808          4            468
Restricted Common Stock awarded for services                                     300,000          3          1,122
Options exercised                                                                777,934          9          1,311
Interest on note receivable
Net loss and comprehensive loss
                                                      ---------   --------    ----------      -----       --------

Balance, December 31, 1999                                   --         --    56,600,544        566        262,588

Sale of Common Stock                                                           3,494,365         35         19,965
Issuance of Common Stock for debt and accrued
  interest                                                                       770,453          8          5,668
Conversion of Preferred Stock                                --         --     1,354,539         14          5,026
Preferred Stock dividends                                    --         --        37,926         --             63
Warrants and Options exercised                                                 1,943,114         19          7,923
Other                                                                                                          (65)
Comprehensive loss:
  Net loss
  Unrealized loss on securities
                                                      ---------   --------    ----------      -----       --------
Total comprehensive loss

Balance December 31, 2000                                    --         --    64,200,941        642        301,168

Sale of Common Stock                                                           8,910,679         89         33,402
Options exercised                                                                 36,933                       120
Other                                                                                                          678
Comprehensive loss:
  Net loss
  Unrealized loss on securities
                                                     ----------   --------    ----------      -----       --------
Total comprehensive loss
                                                     ----------   --------    ----------      -----       --------

Balance, December 31, 2001                                   --   $     --    73,148,553      $ 731       $335,368
                                                     ==========   ========    ==========      =====       ========


<CAPTION>

                                                                         Accumulated    Accrued Dividends/    Total
                                                                            Other        Note Receivable/     Stock
                                                       Accumulated      Comprehensive        Deferred        holders'
                                                         Deficit       Income / (Loss)     Compensation       Equity
                                                       -----------     ---------------  ------------------   --------
<S>                                                    <C>               <C>               <C>               <C>

Balance, December 31, 1998                               (218,456)                             (383)           12,527

Sale of Common Stock                                                                                            19,874
Issuance of Common Stock for debt and accrued
  interest                                                                                                      10,804
Conversion of Preferred Stock                                                                                    2,005
Transfer of Preferred Stock to Redeemable Preferred
  Stock                                                                                                         (2,045)
Repurchase of Common Stock                                                                                      (1,767)
Preferred Stock dividends                                                                      (472)                --
Restricted Common Stock awarded for services                                                   (813)               312
Options exercised                                                                                                1,320
Interest on note receivable                                                                    (301)              (301)
Net loss and comprehensive loss                           (21,306)                                             (21,306)
                                                       ----------        -----------       --------          ---------
Balance, December 31, 1999                               (239,762)                           (1,969)            21,423

Sale of Common Stock                                                                                            20,000
Issuance of Common Stock for debt and accrued
  interest                                                                                                       5,676
Conversion of Preferred Stock                                                                                    5,040
Preferred Stock dividends                                                                       (63)                --
Warrants and Options exercised                                                                                   7,942
Other                                                                                           360                295
Comprehensive loss:
  Net loss                                                (24,571)                                             (24,571)
  Unrealized loss on securities                                                   (3)                               (3)
                                                       -----------       -----------       ---------         ---------
Total comprehensive loss                                   (24,571)               (3)                          (24,574)
                                                       -----------       -----------       ---------         ---------
Balance December 31, 2000                                 (264,333)               (3)         (1,672)        $  35,802

Sale of Common Stock                                                                                            33,491
Options exercised                                                                                                  120
Other                                                                                            302               980
Comprehensive loss:
  Net loss                                                 (28,373)                                            (28,373)
  Unrealized loss on securities                                                    3                                 3
                                                       -----------       -----------       ---------         ---------
Total comprehensive loss                                   (28,373)                3                           (28,370)
                                                       -----------       -----------       ---------         ---------
Balance, December 31, 2001                             $  (292,706)      $        --       $  (1,370)        $  42,023
                                                       ===========       ===========       =========         =========

</TABLE>

        See accompanying notes to the consolidated financial statements.


                                       F-5

<PAGE>



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

NOTE 1 - BASIS OF PRESENTATION

     Organization - Advanced Tissue Sciences, Inc. is a leader in the field of
tissue engineering, using its proprietary technology to develop and manufacture
human-based products for tissue repair and transplantation. We are focusing on
the worldwide commercialization of tissue engineered products for wound care,
aesthetic and reconstructive, cardiovascular and orthopedic applications. We
currently have two leading therapeutic products, both of which are being
commercialized through a joint venture, the Dermagraft Joint Venture, with Smith
& Nephew plc. The first, TransCyte is available for sale in the United States,
the United Kingdom and other European countries, Canada, Australia, New Zealand
and South Africa, for the treatment of full and partial-thickness burns. The
second product, Dermagraft, for the treatment of foot ulcers in patients with
diabetes, is available in Canada, Australia, New Zealand and South Africa, and
on a limited basis in the United Kingdom and other European countries. In
September 2001, we received approval from the FDA to market Dermagraft in the
treatment of chronic foot ulcers in patients with diabetes in the United States.
In addition to the Dermagraft Joint Venture, we also have a strategic alliance
with Inamed Corporation for the development of tissue engineered products for
aesthetic and reconstructive markets.

     Principles of Consolidation - The consolidated financial statements include
the accounts of Advanced Tissue Sciences, its wholly owned subsidiaries, and
DermEquip, L.L.C., a limited liability company owned jointly with Smith &
Nephew. DermEquip is a special purpose entity which was established to finance
an expansion of our manufacturing facility, and which holds the assets used in
the facility. All intercompany accounts and transactions have been eliminated.
Our other interests in joint ventures with Smith & Nephew are accounted for
under the equity method. See Note 3 for more information on the financial
transactions asociated with the Dermagraft Joint Venture.

     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 we use in our therapeutic products, are sourced from single
manufacturers. Any significant supply interruption would adversely affect our
product manufacturing. In addition, an uncorrected impurity or supplier's
variation in a raw material, either unknown to us or incompatible with our
manufacturing process, could have a material adverse effect on our ability to
manufacture our products.

     Reclassification - Certain reclassifications have been made to prior year
amounts to conform to the presentation for the year ended December 31, 2001. In
particular, the presentation of the statement of operations has been reformatted
from prior presentations to more clearly reflect revenue and cost transactions
between us and our joint ventures with Smith & Nephew. These transactions are
separately presented from transactions with other parties.


                                       F-6

<PAGE>


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 $28,649,000 as of December 31, 2001 and
$24,278,000 as of December 31, 2000. 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, 2001 and 2000, our
cash equivalents and short-term investments were classified as
available-for-sale and consisted of (in thousands):

                                                      2001             2000
                                                   ----------       ----------

     Debt securities of U.S. Government agencies    $  2,000        $     --
     Commercial paper                                  3,994          26,110
     Money market funds                               22,655           5,009
                                                    --------        --------
        Total cash equivalents and short-term
          investments                               $ 28,649        $ 31,119
                                                    ========        ========

     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, 2001 or 2000.

     Our cash and cash equivalents included approximately $301,000 at December
31, 2001 and $167,000 at December 31, 2000 held by DermEquip. These amounts are
fully consolidated in our balance sheet.

     Impairment of Long-Lived Assets - We account for impairment of long-lived
assets in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to be Disposed of". SFAS 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 SFAS No. 121, we use 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 our current and past operating history could be
indicative of an impairment, we believe the future cash flows to be received
from the majority of long-lived assets will exceed the assets' carrying value.
We believe that no impairment adjustments need be made at December 31, 2001.

     Inventory - Inventories manufactured for sale are stated at cost. Such
costs are 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 respective customer.

     Property - 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. Depreciation expense for the years ended December 31, 2001, 2000 and
1999 amounted to approximately (in thousands):

                                        2001          2000           1999
                                      --------      --------       --------

     Depreciation expense             $  3,569      $  3,817       $  4,712

     Patents - We own and have patents pending in the United States and abroad
to protect the processes and products we are developing. Direct patent
application costs related to patents issued are amortized over the estimated
useful life of the patent, approximately 20 years from the date of application.
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 $496,000 at December 31, 2001 and $405,000 at December 31, 2000.
Patent application and maintenance costs related to licensing agreements are
expensed as incurred.


                                       F-7

<PAGE>


     Industry Segment and Geographic Information - We operate 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, 2001, 2000 and 1999, international sales have been through a related party.
We have no foreign operations.

     Revenue Recognition - Revenues from product sales are recognized when
products are shipped and title has passed, and we have no further specified
performance obligations. Revenues from product sales to related parties are
recognized at such time as ownership of the product is transferred to the
related party, generally upon the completion of manufacturing. Such product
sales to related parties are equal to our cost. See Notes 3 for more information
on the financial transactions associated with the Dermagraft Joint Venture. We
perform research and certain administrative functions for our joint ventures
with Smith & Nephew, for which we are reimbursed as expenditure is incurred.
Under license agreements such as the one that we have with Inamed, up front
fees, as applicable, are deferred and recognized over the exclusivity period,
term of the license or ongoing research period, in accordance with Staff
Accounting Bulletin No. 101. At December 31, 2001 and 2000 we had no such
deferred revenue. In 1999 we received a $5 million milestone payment from
Inamed, which was recognized over eighteen months, representing the performance
period. See Note 3 for more information on the financial transactions associated
with the Dermagraft Joint Venture. Deferred revenue at December 31, 1999
associated with this milestone payment was $3.6 million. Milestone payments, if
any, are recognized when earned, provided that the event is substantive, its
achieveability was not assured at the inception of the respective agreement, and
that our performance obligations have been met. If these criteria are not met,
any milestone payment would be recognized over the remaining minimum period of
the performance obligation. 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 - Research and development costs are
expensed as incurred. Such costs include proprietary research and development
activities and expenses associated with collaborative research agreements. Total
research and development expenses were $10.1 million in the year ended December
31, 2001, $13.1 million in the year ended December 31, 2000, and $16.3 million
in the year ended December 31, 1999. Of these amounts, in the year ended
December 31, 2001, we incurred $4.4 million of expense related to research
conducted for our joint ventures with Smith & Nephew, or for research
reimbursable under grants, compared to $7.4 million of such expense in the year
ended December 31, 2000, and $11.4 million in the year ended December 31, 1999.

     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 share equivalents
such as options and warrants outstanding, in periods in which they are dilutive.
Both the basic and diluted loss per common share for the years ended December
31, 2001, 2000 and 1999 are based on the weighted average number of shares of
our common stock outstanding during the periods. The net loss applicable to
common stock used in the calculation of basic and diluted loss per common share
includes dividends of $48,000 for the year ended December 31, 2000 and $558,000
for the year ended December 31, 1999 accrued on our Convertible Series B
Preferred Stock outstanding during such periods. There were no such dividends
included in the net loss applicable common stock for the year ended December 31,
2001, as all remaining shares of our Convertible Series B Preferred Stock were
converted to common stock in March 2000.

     Stock-Based Compensation - As permitted under SFAS No. 123, "Accounting for
Stock-Based Compensation", we follow 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
our 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
non-compensatory. Adoption of SFAS 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 SFAS No. 123 and EITF
96-18, stock options and warrants issued to consultants and other non-employees
as compensation for services provided to us 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. We recognize this


                                       F-8

<PAGE>


expense over the period the services are provided. See Note 12 regarding
transactions under our employee benefit plans.

     New Accounting Standards - In June 2001, the Financial Accounting Standards
Board (or FASB), issued SFAS No. 141, "Business Combinations" and SFAS No. 142,
"Goodwill and Other Intangible Assets". Under these rules, goodwill and
indefinite lived intangible assets are no longer amortized but are reviewed
annually for impairment. As we have no existing goodwill in our balance sheet,
we do not expect the adoption of SFAS No. 141 and SFAS No. 142 to have a
material impact on our financial statements.

NOTE 3 - STRATEGIC ALLIANCES

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

     In 1994, we entered into a joint venture with Smith & Nephew plc for the
development of tissue engineered cartilage for orthopedic applications, the
NeoCyte Joint Venture. Smith & Nephew is a global medical device company
employing over 7,000 people, with operations in 34 countries, that markets
technically innovative products principally in the areas of wound management,
orthopedics and endoscopy.

     Under the NeoCyte Joint Venture, Smith & Nephew contributed the first $10
million in funding and we 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, we began sharing equally
in NeoCyte Joint Venture revenues and expenditures. See Note 15 with respect to
related party transactions with the NeoCyte Joint Venture.

     In April 1996, we entered into a separate agreement with Smith & Nephew to
form the Dermagraft Joint Venture for the worldwide commercialization of
Dermagraft for the treatment of diabetic foot ulcers. In January 1998, we agreed
with Smith & Nephew to expand the Dermagraft Joint Venture to include venous
ulcers, pressure ulcers, burns and other skin tissue wounds. At that time, we
retained the exclusive right to market TransCyte, 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 1998, we agreed with Smith & Nephew to further expand the
Dermagraft Joint Venture to include exclusive rights to market TransCyte for
full and partial-thickness burns in the United States, effective in October of
that year.

     As consideration for entering into the Dermagraft Joint Venture, we
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 our common stock at approximately $13.05 per
share in January 1998 (see Note 10) and we also received an additional $15
million as consideration for expanding the joint venture in January 1999, which
was recognized into revenue in 1999 as the related financial commitments were
met. Additionally, we received a milestone payment of $5 million in 2001 on the
approval by the FDA of the PMA for Dermagraft in the treatment of diabetic foot
ulcers, and could receive, subject to the achievement of certain milestones
related to regulatory approvals, reimbursement and sales levels, further
payments of up to $131 million.

     In February 2000, we agreed in principle with Smith & Nephew 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 an additional clinical trial by the FDA substantially increased
the partners' investments, necessitating the restructuring. The restructuring
deferred the potential payment of certain milestones by Smith & Nephew, while
providing Advanced Tissue Sciences a royalty stream and an opportunity to
increase our 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 first $5 million of
which we received in 2001 on the approval by the FDA of our PMA, we 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 pays us royalties on joint venture product
sales. In addition, as a part of the agreement, as amended in September 2000, we
sold the Dermagraft manufacturing plant assets that we owned to DermEquip, see
Note 1 with regard to the DermEquip entity, but retained the raw material
inventory.

     We share equally with Smith & Nephew in the expenses and revenues of the
expanded Dermagraft Joint Venture, except that we funded the first $6 million of
expenses for conducting clinical trials and for


                                       F-9

<PAGE>


regulatory support of Dermagraft and TransCyte in the treatment of venous and
pressure ulcers. In addition, we 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 will
bereturned to us out of future gross margin or net profits, if any, from sales
of TransCyte for burns in the United States. See Note 15 with respect to related
party transactions with the Dermagraft Joint Venture. Under the expanded
Dermagraft Joint Venture, we will continue to manufacture, and Smith & Nephew
will continue to market and sell the Dermagraft Joint Venture's products.

     Per the agreement, as amended in September 2000, we and Smith & Nephew also
agreed that certain of the proceeds from the sale of the manufacturing plant
assets discussed above would be used to pay down a portion of the outstanding
balance of the loan from Smith & Nephew related to the NeoCyte Joint Venture,
the NeoCyte Loan. This transaction was completed in September 2000, at which
time the outstanding balance of principal and interest due on the loan was $10
million. The cash portion we paid down amounted to $4.3 million, the balance of
$5.7 million being paid by means of issuing 770,453 shares of our common stock
to Smith & Nephew.

     In a subsequent transaction in September 2000, the Dermagraft Joint Venture
made a new loan to us of $5.4 million, with raw material inventory being pledged
as collateral security. This loan, which is payable on December 31, 2002 unless
extended by mutual agreement of the partners, is included in "Payable to joint
ventures" on the face of the consolidated balance sheet at December 31, 2001 and
2000.

     The results of operations of the joint ventures for the years ended
December 31, 2001, 2000 and 1999 are as follows (in thousands):


                                               2001         2000         1999
                                           ------------ ------------ -----------
Dermagraft Joint Venture
------------------------
    Net sales                               $  4,212     $  4,301     $  2,571
    Contract revenue                             603           --           --
    Cost of goods sold                        13,776       13,710       13,958
    Other costs and expenses                  18,511       12,298       35,135
    Net loss                                 (27,472)     (21,707)     (46,522)

    Current assets                             8,140        7,780        4,852
    Non-current assets                           151          201          278
    Current liabilities                        5,891        3,427        4,450
    Partners' capital (deficit)                2,400        4,554          680

NeoCyte Joint Venture
---------------------
    Costs and expenses                      $  1,138     $  3,822     $  5,533
    Net loss                                  (1,138)      (3,822)      (5,533)

    Current assets                               193           94          142
    Non-current assets                            77          167          274
    Current liabilities                          146          298          832
    Partners' capital (deficit)                  124          (37)        (416)


                                      F-10

<PAGE>


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

     In May 1999, we entered into a strategic alliance with Inamed for the
development and marketing of a number of our potential 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 our extracellular matrix, including
human-based collagen, from our three-dimensional tissue engineering process, for
wrinkle correction and other soft tissue augmentation, 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 us a series of payments totaling $10
million, including $5 million to purchase our common stock. Inamed also received
five-year warrants to purchase up to 500,000 shares of our common stock. In
addition to a price for our product and royalties on Inamed's sales in the
market place, we may potentially receive up to a total of $10 million in
milestones based on product approvals in the United States, subject to our
success in developing products under the aggrement and Inamed's success in
obtaining such approvals.

     Under our agreement, we are responsible for the funding and development of
the products and the related manufacturing processes, while Inamed is
responsible for funding clinical, regulatory and marketing activities. We, or an
affiliate, may elect to manufacture the products developed under the agreement.
See Note 2 regarding revenue recognition for up front fees and milestones under
this agreement.

Medtronic Agreement
-------------------

     In October 2001, we entered into a collaboration with Medtronic, Inc. to
explore the application of our technology in areas of therapeutic interest to
Medtronic. Under the terms of the collaboration, we will explore the application
of our technology in four therapeutic areas: cardiovascular, neurological,
endocrine and spinal.

     An affiliate of Medtronic invested $20 million in shares of our common
stock at $3.72 per share in return for specified rights including a right of
first refusal to participate in the further development and commercialization of
Anginera, our epicardial angiogenesis therapy, a product that stimulates new
blood vessel growth and therefore increased blood flow; a right of first
offer/first negotiation to participate in other programs within the
cardiovascular, neurological, endocrine and spinal areas where we elect not to
pursue those programs internally; and a limited non-exclusive license to our
intellectual property in the four therapeutic areas identified, to facilitate
Medtronic's exploration of cell and tissue engineered technology in combination
with Medtronic's medical devices. Net proceeds of the equity investment were
approximately approximately $19.9 million.

NOTE 4 - INVENTORIES

     Inventories consist of the following components as of December 31, 2001 and
2000 (in thousands):

                                                 2001             2000
                                             ------------     ------------

     Raw materials and supplies                $  5,277         $  5,021
     Work-in-process                              1,221              683
     Finished goods                                 107               69
                                               --------         --------
                                               $  6,605         $  5,773
                                               ========         ========


                                      F-11

<PAGE>


NOTE 5 - PROPERTY

     The major classes of property as of December 31, 2001 and 2000 are as
follows (in thousands):

                                                           2001         2000
                                                       ------------  -----------

     Equipment                                           $ 21,257     $ 20,496
     Furniture and fixtures                                   727          746
     Leasehold improvements                                12,032       11,989
     Equipment under capital leases                           110          110
                                                         --------     --------
                                                           34,126       33,341
     Less accumulated depreciation and amortization       (23,059)     (19,660)
                                                         --------     --------
     Net property                                        $ 11,067     $ 13,681
                                                         ========     ========

NOTE 6 - ACCRUED EXPENSES

     Accrued expenses as of December 31, 2001 and 2000 consisted of (in
thousands):

                                                           2001         2000
                                                       ------------  -----------

     Salaries and benefits                               $  3,605     $  4,371
     Clinical studies                                          --          175
     Other                                                    709          845
                                                         --------     --------
                                                         $  4,314     $  5,391
                                                         ========     ========

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. 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, or LIBOR, plus 1/4 percent, which was 2.91% at
December 31, 2001. Smith & Nephew and ourselves jointly and severally guarantee
DermEquip's obligations with respect to the Chase loan. The guarantees are
secured by DermEquip's assets, having a carrying value of $9.8 million as of
December 31, 2001, and by each company's interest in DermEquip. The outstanding
balance of the Chase loan at December 31, 2001 was $6.4 million.

     In September 2000, the Dermagraft Joint Venture made a loan to us, the
Dermagraft Joint Venture Loan, of approximately $5.4 million payable on December
31, 2001 with raw material inventory being pledged as collateral security. The
loan was subsequently renewed and is payable on December 31, 2002. See Notes 3
and 7 for further information on this loan. This loan is included in "Payable to
joint ventures" on the face of the Consolidated Balance Sheet at December 31,
2001 and 2000.

     Total interest expense for the years ended December 31, 2001, 2000 and 1999
was $643,000, $1,513,000, and $1,801,000 respectively, including interest
expense incurred on behalf of our joint ventures with Smith & Newphew, which
appears in joint venture contract expense in our statement of operations.

     Debt and capital lease obligations as of December 31, 2001 and 2000 were as
follows (in thousands):

                                                           2001         2000
                                                       -----------   -----------
     Chase Loan                                          $ 6,400      $  8,960
     Dermagraft Joint Venture Loan                         5,412         5,412
     Obligations under capital leases                         --            27
     Less current portion                                 (7,972)       (7,999)
                                                         -------      --------
     Long-term debt                                      $ 3,840      $  6,400
                                                         =======      ========


                                      F-12

<PAGE>


     Maturities of long-term debt over the next five years are approximately
$7,972,000 in 2002, $2,560,000 in 2003, and $1,280,000 in 2004. Of the
$7,972,000 in 2002, $5,412,000 relates to a loan from the Dermagraft Joint
Venture payable on December 31, 2002, which may be extended by agreement of the
Joint Venture partners. As substantially all of our 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 our facilities. The leases
for our primary location, 85,000 square feet of space at our headquarters in La
Jolla, San Diego, which includes manufacturing, research and administrative
operations, expire in December 2005. These leases include the cost of a
proportion of utilities charges 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.

     In October 2001, we signed a 10-year lease on 29,000 square feet of
additional office and research laboratory space in a facility approximately
three miles from our La Jolla location, and expect to move the majority of our
research activities into the new facility in May 2002. The lease term will
commence in May 2002, subject to the completion of improvements. The lease
provides for a 3% annual rent increase. We have options to extend the term of
the lease for two five-year periods. As a condition of signing the lease, we
were required to purchase a standby letter of credit in the amount of $1.7
million. See Note 9 for a discussion of our commitments and contingencies. This
facility replaces a laboratory facility of approximately 7,000 square feet, on
which our lease expired in January 2002.

     We have also financed approximately $1.4 million of office furniture,
communications and laboratory equipment under an operating lease with a term of
four years, that expires in 2002.

     The following is a summary of the annual future minimum operating lease
commitments as of December 31, 2001, in thousands; there are no future capital
lease commitments:

                                                                  Operating
                                                                   Leases
                                                                   ------
       Year Ending December 31:
          2002                                                    $  3,410
          2003                                                       3,291
          2004                                                       3,381
          2005                                                       3,472
          2006                                                       1,030
          Thereafter                                                 5,943
                                                                  --------
       Total minimum lease payments                               $ 20,527
                                                                  ========

     Rental expense charged to operations under operating leases for facilities
and equipment for the years ended December 31, 2001, 2000 and 1999 amounted to
approximately (in thousands):

                                                 2001       2000      1999
                                               --------   --------  --------

     Rental expense under operating leases     $  2,652   $  2,347  $  4,251


NOTE 9 - COMMITMENTS AND CONTINGENCIES

     Under the terms of our agreements with Smith & Nephew, we have agreed to
fund our share of the costs of the Dermagraft and NeoCyte Joint Ventures. To the
extent that such costs can be forecast, they are mutually agreed by us and Smith
& Nephew as partners in the joint ventures. We have also agreed to fund certain
costs to develop products, and related manufacturing processes, which will be
marketed by Inamed under the terms of our licensing agreement.

     In October 2001, we purchased a $1.7 million letter of credit as security
for the lease of our new research facility. The letter of credit will expire in
May of 2010, and as security we are required to maintain $1.7 million in
restricted cash balances with the issuing institution. The amount of the letter
of credit and required restricted cash balances will decrease to $850,000 in
2007, $595,000 in 2008 and $240,000 in 2009.


                                      F-13

<PAGE>


     Under an agreement with Ethicon, Inc., for the supply of the mesh framework
used by us in the manufacture of Dermagraft, we are committed to purchasing
minimum quantities. Based upon current market prices the commitment is estimated
to be approximately $2.5 million in 2002, with the current agreement expiring in
January 2003.

     In 2000, we were awarded a $2 million grant NIST, to be distributed over a
three-year period. Also in 2000, researchers at the University of Washington
announced that they would be partnering with us and others in a project, funded
by a $10 million grant from NIH, to grow functional human heart tissue. The
proportion of the grant for which we would be eligible is approximately $1.8
million. The grant is expected to cover the first five years of an anticipated
10 year project. In the same year we were awarded a grant in excess of $800,000
from NIH and the National Institute of Dental and Craniofacial Research to
develop tissue engineered cartilage for the treatment of temporomandibular
disorders. Payments under this grant are payable over four years. In October
2001, we were awarded a $1.4 million Small Business Innovation Research grant
from NIH and the National Institute of Arthritis and Musculoskeletal and Skin
Diseases. The grant, which is payable over three years, is to develop tissue
engineered articular cartilage designed to better withstand the extreme forces
experienced in the human body. Under each of these, and other smaller grants we
have been awarded, we are committed to continuing our investment in the
specified research, and meeting specified performance requirements, in order for
us to receive the grant funding.

     We are also responsible for patent application costs and associated
maintenance fees related to inventions under certain licensing agreements. We
seek to protect our proprietary technology through the use of various aspects of
United States and foreign patent law and contractual arrangements. However, our
patents or patent applications may not protect us against competitors with
similar technology, or others may infringe upon or design around our present
patents. We could incur substantial costs to defend or protect our patents and
licensed patents against infringement.

NOTE 10 - CAPITAL STOCK

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

     As of December 31, 2001, we had 5,856,345 shares of common stock reserved
for issuance under outstanding options and warrants. In February 1999, our
common stockholders approved an amendment to our 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 October 2001, an affiliate of Medtronic, Inc. purchased 5,376,334 shares
of our common stock at $3.72 per share, equal to the average closing price for
the 12 days prior to purchase. Net proceeds from this transaction were
approximately $19,942,000. In November 2001, we completed a private placement of
3,534,335 shares of our common stock at $4.15 per share to a group of
institutional investors. Net proceeds from this transaction were approximately
$13,548,000.

     In September 2000, we completed a private placement of 3,494,365 shares of
our common stock at $5.7235 per share, resulting in net proceeds of
approximately $19.9 million. We also issued 770,453 shares of common stock to
Smith & Nephew in September 2000 as payment for the remaining balance of a loan,
the NeoCyte Loan.  The loan balance paid by means of issuing these shares was
approximately $5.7 million.

     In March 2000, 100.8 shares, representing all of our Convertible Series B
Preferred were converted into 1,354,539 shares of common stock at $3.72 per
share.

     In November 1999, we completed a public offering of 3,750,000 units at
$4.00 per unit, resulting in proceeds of $15 million. Once issued, the units
separated into 3,750,000 shares of our common stock and warrants to purchase an
additional 1,750,000 shares of common stock at $4.00 per share. In January 2000,
we received an additional $7.0 million from the exercise of warrants to purchase
all 1,750,000 shares of common stock. As part of the November 1999 public
offering, we agreed to reserve $5 million of the proceeds for the redemption of
our Series B Preferred Stock submitted for conversion, and to terminate an
equity line agreement with a separate group of investors.

     As part of our licensing agreement with Inamed, 783,039 shares of our
common stock were purchased by Inamed, during 1999, for $5 million, an average
price of approximately at $6.39 per share.


                                      F-14

<PAGE>


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 our common stock until at least October 2002.

     In June 1999, a $10 million loan and accrued interest of $804,000, payable
to Smith & Nephew and related to the formation of the Dermagraft Joint Venture,
see Note 3, was converted into 2,800,595 shares of our common stock, as allowed
under the loan agreement.  See Note 3 for more information on the financial
trasactions associated with the Dermagraft Joint Venture.

     In May 1995, our Chairman and Chief Executive Officer exercised an employee
stock option. The purchase price was paid through the issue of an
interest-bearing, full recourse promissory note. In July 1999, we extended the
repayment terms on the note. As a result of the extension, the stock options
exercised through the issuance of the note were accounted for as variable stock
options which could result in significant increases and decreases in
compensation expense subject to variability in our stock price. In September
2000, the outstanding principal and interest of $1,265,000 was repaid by our
Chairman and Chief Executive Officer and we guaranteed a personal loan obtained
by the Chairman and Chief Executive Officer from a third party, for a like
amount. The third party loan was collateralized by the shares exercised through
the stock options, and its maintenance was dependent upon our share price
maintaining a certain value. Following a decline in our share price, in October
2000, we honored our guarantee to the third party and re-established a note from
our Chairman and Chief Executive Officer. The note receivable and accrued
interest of approximately $1.4 million at December 31, 2001 and $1.3 million at
December 31, 2000, are included in stockholders' equity in the accompanying
balance sheets.

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

     In January 1995, we adopted a Shareholder Rights Plan, or the Rights Plan,
and issued one preferred share purchase right, or 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 our 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 our common stock and in
December 1999 to eliminate the continuing director provisions of the plan. In
connection with the adoption of the Rights Plan, our Board of Directors
designated and reserved 500,000 shares of our authorized Preferred Stock as
Series A Junior Participating Preferred Stock, par value $.01 per share. 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 anti-dilution adjustments. In addition, if at any time after the Rights
become exercisable, should (i) we be acquired in a merger or other business
combination transaction, or sell 50% or more of our 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 our
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 our 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.

NOTE 11 - REDEEMABLE PREFERRED STOCK

     In July 1998, we raised $25 million through a private placement of
Convertible Series B Preferred Stock to a group of investors. The Series B
Preferred Stock accrued dividends at 5% per annum, payable quarterly in common
stock or cash at our option. Twenty percent of the Series B Preferred Stock was
redeemable at the option of the holders on the occurrence of certain events.
Through December 1999, 399.2 shares of the Convertible Series B Preferred Stock
had been converted into 8,878,192 shares of common stock at an average price of
$2.25 per share.

     In conjunction with our November 1999 public offering we agreed that $5
million of the proceeds would be reserved for the redemption of any of our
Series B Preferred Stock submitted for conversion. As a result of this agreement
the remaining 100.8 shares of our Series B Preferred Stock were classified as
redeemable and $5 million of cash was restricted for redemption of the Series B
Preferred Stock as of


                                      F-15

<PAGE>


December 31, 1999. In March 2000, 100.8 shares, representing all of our
outstanding Series B Preferred Stock, were converted into 1,354,539 shares of
our common stock at $3.72 per share. As of December 31, 2001 and 2000 there were
no shares of our Series B Preferred Stock outstanding and the $5 million of
restricted cash has been used to support our operations. As of December 31,
1999, 2,624,810 shares ofcommon stock would have been required at that time for
the conversion of all outstanding Series B Preferred Stock.

NOTE 12 - EMPLOYEE BENEFIT PLANS

     Our 1997 Stock Incentive 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,
2001, a total of 4,831,345 shares were outstanding under options or available
for grant under the 1997 Plan.

     Under the 1997 Plan, we generally grant 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 our service. We also began to make
annual grants to employees in 1997. 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 our Board of Directors.

     In addition to the 1997 Plan, we have 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 our 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, 2001,
2000 and 1999:

<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, 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
     Granted                                   1,284,860        $7.26                     --             --
     Exercised                                  (148,114)       $3.78             (1,795,000)         $4.11
     Canceled                                   (695,792)       $8.52                (29,640)         $7.09
                                             -----------                          ----------
   Outstanding, December 31, 2000              4,485,594        $8.43              1,935,000          $8.80
     Granted                                     609,460        $4.05                     --             --
     Exercised                                   (36,933)       $3.25                     --             --
     Cancelled                                  (266,813)       $9.30               (910,000)         $8.39
                                             -----------                          ----------
   Outstanding, December 31, 2001              4,791,308        $7.86              1,025,000          $9.18
                                             ===========                          ==========
</TABLE>


                                      F-16

<PAGE>


     At December 31 of 2001, 2000 and 1999, information related to the 1997 plan
and to other options and warrants was as follows:

<TABLE>
<CAPTION>

                                                                2001             2000              1999
                                                            ------------     ------------      ------------
<S>                                                         <C>              <C>               <C>
Weighted average fair value of options granted
  under the 1997 plan                                       $       4.05     $       5.55      $       2.46
Weighted average fair value of other
  options & warrants granted                                $         --     $         --      $       1.87

Number of shares exercisable under the 1997 plan               3,029,989        2,429,024         2,080,372
Weighted average price per share                            $       9.12     $       9.80      $      10.20

Number of other options and warrants exercisable                 775,000        1,560,000         3,259,640
Weighted average price per share                            $       8.01     $      7.85       $       5.59

</TABLE>

     In May 1999, our 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. Under
the award, subject to meeting certain requirements including continued service,
50,000 shares would vest annually at the completion of each of the first three
years of the award, and the remaining 150,000 shares would 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 first 50,000 shares vested in May
2000 and another 50,000 vested in May 2001. In September 2001, 150,000 shares
vested when the FDA approved a PMA application for Dermagraft in the treatment
of diabetic foot ulcers in the United States. At December 3, 2001, 50,000 shares
remain unvested under the award. The difference between the market price at the
grant date and the purchase price of $.01 per share has been, and will be,
recognized as compensation expense evenly over the restricted periods.

     Other options and warrants granted include 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 no longer in place. During the year
ended December 31, 1999, $35,000 was charged to expense, reflecting the
amortization of the fair market value of these warrants over the commitment
period. In addition, we charged $366,000 to expense in 2001, $472,000 in 2000,
and $309,000 in 1999, in connection with options or warrants and restricted
stock awards granted to employees.


                                      F-17

<PAGE>


     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, 2001:

<TABLE>
<CAPTION>

                                               Exercisable                        Total Outstanding
                                   ----------------------------------  -----------------------------------------
                                    Number of      Weighted Average      Number of    Weighted Average
     Price Range                       Shares       Exercise Price         Shares       Exercise Price    Life
----------------------             ------------  --------------------  ------------   ----------------    ----
<S>                                 <C>                   <C>            <C>                 <C>          <C>
1997 Plan:
    $1.96 - 3.93                      944,843              $3.60         1,559,503            $3.55       7.2
    $3.94 - 5.89                      172,525              $4.90           469,135            $4.70       8.4
    $5.90 - 7.85                      211,788              $7.12           842,408            $7.13       8.1
    $7.86 - 9.81                      257,051              $8.63           384,355            $8.47       4.7
    $9.82 - 11.78                     147,020             $10.67           231,200           $10.61       6.5
    $11.79 - 13.74                  1,085,372             $13.42         1,089,982           $13.42       4.0
    $13.75 - 15.70                     59,340             $14.74            62,675           $14.72       4.9
    $15.71 - 17.66                    152,050             $17.49           152,050           $17.49       4.4
                                    ---------                            ---------
         Total 1997 Plan            3,029,989              $9.12         4,791,308            $7.86       6.4
                                   ==========                            =========
Other Options and Warrants:
    $1.47 - 1.67                      300,000              $1.57           300,000            $1.57       1.5
    $9.82 - 11.78                     175,000             $10.50           175,000           $10.50       1.1
    $11.79 - $13.74                   250,000             $12.79           500,000           $12.79       2.6
    $14.00                             50,000             $14.00            50,000           $14.00       3.1
                                   ----------                            ---------
         Total other                  775,000              $8.01         1,025,000            $9.18       2.0
                                   ==========                            =========

</TABLE>

     The following table reflects our pro forma net loss applicable to common
stock and basic and diluted loss per common share for the years ended December
31, 2001, 2000 and 1999 had the expense provisions of FAS No. 123 been
implemented (in thousands except per share amounts):

<TABLE>
<CAPTION>

                                                             2001               2000              1999
                                                       ---------------    ---------------   ----------------
    <S>                                                <C>                <C>               <C>
    Net loss applicable to common stock:
      As reported                                      $    (28,373)      $    (24,619)     $    (21,864)
      Pro forma                                             (32,247)           (29,705)          (27,640)

    Basic and diluted loss per share:
      As reported                                      $       (.43)      $       (.41)     $       (.45)
      Pro forma                                                (.49)              (.49)             (.57)

</TABLE>

     Because the FAS 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 2001, 2000 and
1999: (i) risk-free interest rates of 3.5% to 5.0% for 2001, 5.1% to 6.8% for
2000 and 4.5% to 6.2% for 1999; (ii) expected lives of six years for 2001 and
five years for 2000 and 1999, and (iii) volatility of 109% for 2001, 96% for
2000 and 79% for 1999. 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 for services were based on the value of the services
rendered.

     We have a 401(k) Plan under which employees meeting certain eligibility
requirements may elect to participate and contribute. Under the 401(k) Plan, we
may elect to match a discretionary percentage of contributions. At December 31,
2001, no such matching contributions had been made to the 401(k) Plan since its
inception.


                                      F-18

<PAGE>


NOTE 13 - INCOME TAXEs

     At December 31, 2001, we had federal net operating loss carryforwards of
approximately $297.8 million and California net operating loss carryforwards of
$34.9 million. The difference between the federal and California operating tax
loss carryforwards principally results from a fifty-five percent limitation on
California loss carryforwards, as we did not have operations in California until
late 1989, and the capitalization of certain research and development expenses
for California purposes. As of December 31, 2001, we have federal and California
research and development tax credit carryforwards of approximately $7.3 million
and $3.6 million, respectively, and have California manufacturer's investment
tax credit carryforwards of approximately $507,000. Federal net operating loss
carryforwards of approximately $1.1 million expired in 2001. Approximately
$400,000 will expire in 2002, and $3.6 million in 2003, if not previously
utilized. California net operating loss carryforwards of approximately $533,000
expired in 2001. Approximately $6.8 million will expire in 2002 and $6.2 million
in 2003, if not previously utilized. Federal research and development tax credit
carryforwards of approximately $24,000 expired in 2001. Approximately $2,000
will expire in 2002 and $131,000 in 2003, if not previously utilized. The
California research and development tax credit carryforwards and California
manufacturer's investment tax credit carryforwards will begin expiring in 2004,
unless previously utilized.

     Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use
of our net operating loss carryforwards could be limited if a cumulative change
in our ownership of more than 50% were to occur within a three-year period.
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, 2001, a valuation allowance of $121,412,000 has been
established. Significant components of our net deferred tax assets as of
December 31, 2001 and 2000 are as follows (in thousands):

                                                       2001            2000
                                                       ----            ----
     Deferred tax assets:
       Net operating loss carryforwards             $ 106,257       $ 86,248
       Tax credit carryforwards                         9,966          7,578
       Capitalized research and development             4,039          4,360
       Depreciation                                       322          4,171
       Other                                            1,858          1,982
                                                    ---------       --------
          Total deferred tax assets                   122,442        104,339
                                                    ---------       --------
     Deferred tax liabilities:
       Patent expense                                  (1,030)          (947)
                                                    ---------       --------
          Total deferred tax liabilities               (1,030)          (947)
                                                    ---------       --------
     Net deferred tax assets before valuation
      allowance                                       121,412        103,392
     Valuation allowance                             (121,412)      (103,392)
                                                    ---------       --------
     Net deferred tax assets                        $      --       $     --
                                                    =========       ========

NOTE 14 - SUPPLEMENTAL CASH FLOW INFORMATION

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

     During the year ended December 31, 2001, there were no significant non-cash
investing and financing activities.

     During the year ended December 31, 2000, non-cash financing activities
included (i) the repayment of approximately $5.7 million of principal and
interest on a loan by issuing 770,453 shares of common stock to Smith & Nephew,
based on a specified average market price and (ii) the conversion of $5 million
of our Series B Preferred Stock into 1,354,539 shares of common stock. See Notes
3 and 10 for more information on these transactions.


                                      F-19

<PAGE>


     During the year ended December 31, 1999, non-cash financing activities
included (i) the repayment of a $10 million loan and accrued interest payable by
issuing 2,800,595 shares of common stock and (ii) the exercise of stock options
for 775,000 shares of common stock wherein the purchase price and withholding
taxes of approximately $1.8 million were paid by the delivery of 463,154 shares
of common stock.

     In addition, compensation expense of $1,004,000 in 2001, $450,000 in 2000
and $344,000 in 1999 was recognized related to compensatory and variable stock
options and a restricted stock award under the 1997 Plan. Other non-cash
activities have involved the issuance of compensatory stock options to
employees. See Note 12 for details of transactions under our employee benefit
plans.

     Net cash from operating activities reflects cash payments for interest
expense for the years ended December 31, 2001, 2000 and 1999 of approximately
(in thousands):

                                                2001       2000       1999
                                               ------    -------    -------

     Cash payments for interest expense        $  701    $ 1,132    $ 1,510

NOTE 15 - RELATED PARTY TRANSACTIONS

     In the years 2001, 2000 and 1999, we performed services for the Dermagraft
and NeoCyte Joint Ventures and manufactured products for the Dermagraft Joint
Venture to sell to customers or for use in clinical trials as described below.
We have a 50% interest in each of the Dermagraft and NeoCyte Joint Ventures and
share equally with Smith & Nephew in the expenses and revenues, except we funded
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.

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

     Product sales to related parties includes products sold to the Dermagraft
Joint Venture. In addition, we recognize amounts in contract revenues for
research and development, marketing and other activities performed for the Joint
Venture. During the years ended December 31, 2001, 2000 and 1999 such amounts
were (in thousands):

                                                    2001      2000      1999
                                                  --------  --------  --------

Products sold to the Dermagraft Joint Venture     $12,767   $12,771   $13,717
Contract revenues for activities performed          3,510     5,298     9,165

     As a purpose of the Dermagraft Joint Venture is to share the costs of
manufacturing Dermagraft and TransCyte, product sales to the Dermagraft Joint
Venture are equal to our cost of goods sold for such products including period
costs, except for the period from January 1, 1997 to September 30, 1998 when we
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 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. We incur our share of the write-downs, currently 50%, through our
equity in the joint venture.During the years ended December 31, 2001, 2000 and
1999, such write-downs by the Dermagraft Joint Venture totaled (in thousands):

                                                    2001      2000      1999
                                                  --------  --------  --------

Dermagraft Joint Venture inventory write-downs    $ 9,089   $ 9,821   $11,982

     As a result of restructuring the Dermagraft Joint Venture Agreement with
Smith & Nephew, we will also receive certain royalty payments from the joint
venture on product sales made by the joint venture.


                                      F-20

<PAGE>


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

     We recognized amounts in contract revenues for research and development
activities performed for the NeoCyte Joint Venture. During the years ended
December 31, 2000, 1999 and 1998, such amounts were (in thousands):

                                                    2001      2000      1999
                                                  --------  --------  --------

     Contract revenues for activities performed
     for NeoCyte Joint Venture                    $   501   $ 2,578   $ 2,885

     Our share of the costs incurred by us 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. For the years ended December 31,
2001, 2000 and 1999, such costs charged were (in thousands):

                                                    2001      2000      1999
                                                  --------  --------  --------

Charged to Dermagraft and NeoCyte Joint Ventures  $ 9,134   $10,603   $15,934

     In addition, in 2001, we paid management fees to the Dermagraft Joint
Venture for services provided in relation to the manufacture of human-based
collagen. Such fees in 2001 amounted to $603,000, and are recorded as related
party revenue in the accounts of the Dermagraft Joint Venture. No such fees were
paid in years prior to 2001. Future fees are dependent upon levels of production
of collagen and, potentially, other products.


                                      F-21

<PAGE>


NOTE 16 - SELECTED QUARTERLY DATA (UNAUDITED)

     The following tables present unaudited quarterly financial information for
each of the four quarters of the fiscal years ended December 31, 2001 and
December 31, 2000. We believe this information reflects a fair presentation of
such information in accordance with generally accepted accounting principles.
The results are not necessarily indicative of results for any future period.
More detailed information can be found in our quarterly statements on Form 10-Q
for the respective periods. Due to the nature of our business and the
presentation of our financial statements, we are not able to segregate gross
margin information in our statement of operations. Selected unaudited quarterly
results were as follows (in thousands except per share amounts):

<TABLE>
<CAPTION>

                                                                Year Ended December 31, 2001
                                                  ---------------------------------------------------------
                                                  1st Quarter    2nd Quarter     3rd Quarter    4th Quarter
                                                  -----------    -----------     -----------     ----------
<S>                                               <C>            <C>             <C>            <C>
Joint venture contract revenue (1)                $    4,320     $     4,642     $     4,174    $     3,642

Total revenues                                         4,981           5,384          10,385          8,190

Joint venture contract expenses (1)                    4,280           4,413           3,525          4,346

Compensation charge / (gain) related to
   variable stock option (see Note 10)                   444             584            (797)           446

Income (loss) from operations before
   equity in losses in joint ventures                 (5,590)         (6,028)          1,230         (5,875)

Equity in losses in joint ventures                    (2,959)         (3,370)         (2,883)        (3,179)

Loss from operations                                  (8,549)         (9,398)         (1,653)        (9,054)

Net loss                                              (8,261)         (9,349)         (1,688)        (9,075)

Basic and diluted loss per common share (2)       $     (.13)    $      (.15)    $      (.03)   $      (.13)

</TABLE>


<TABLE>
<CAPTION>

                                                                Year Ended December 31, 2000
                                                  ---------------------------------------------------------
                                                  1st Quarter    2nd Quarter     3rd Quarter    4th Quarter
                                                  -----------    -----------     -----------    -----------
<S>                                               <C>            <C>             <C>            <C>
Joint venture contract revenue (1)                $    6,376     $    5,130      $    4,583     $   4,558

Total revenues                                         7,410          6,263           5,780         5,818

Joint venture contract expenses (1)                    6,358          5,171           3,825         5,066

Compensation charge / (gain) related to
   variable stock option (See Note 10)                 1,991            704            (138)       (2,557)

Income (loss) from operations before
   equity in losses in joint ventures                 (5,045)        (3,987)         (2,379)       (1,021)

Equity in losses in joint ventures                    (3,713)        (3,542)         (3,137)       (2,886)

Loss from operations                                  (8,758)        (7,529)         (5,516)       (3,907)

Net loss                                              (8,299)        (7,428)         (5,513)       (3,331)

Basic and diluted loss per common share (2)       $     (.14)    $     (.12)     $     (.09)    $    (.05)

</TABLE>

(1) This presentation has been reformatted from prior presentations to more
    clearly reflect revenue and cost transactions between us and our joint
    ventures with Smith & Nephew. These transactions are separately presented
    from transactions with other parties.

(2) Net loss per share is computed independently for each of the quarters
    presented. Therefore, the sum of the quarterly net loss per share will not
    necessarily equal the total for the year.


                                      F-22

<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, 2001 and 2000, and the related combined
statements of operations, partners' capital and cash flows for each of the three
years in the period ended December 31, 2001. 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, 2001 and 2000, and the combined results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.


                                                               ERNST & YOUNG LLP


San Diego, California
January 18, 2002


                                      F-23

<PAGE>


                            DERMAGRAFT JOINT VENTURE
                        COMBINED BALANCE SHEETS (NOTE 1)
                                 (In thousands)


                                                               December 31,
                                                            2001          2000
                                                          ----------------------
Assets
Current assets:
   Cash                                                    $   361      $   769
   Accounts receivable from partners and affiliates          2,056        1,267
   Note receivable from partners and affiliates              5,412        5,412
   Inventory                                                   311          332
   Other current assets                                         --           --
                                                           --------------------
Total current assets                                         8,140        7,780

Property, net                                                  151          201
                                                           --------------------
Total assets                                               $ 8,291      $ 7,981
                                                           ====================

Liabilities and partners' capital
Current liabilities:
   Payable to partners and affiliates                      $ 5,431      $ 2,881
   Accounts payable                                            460          546
                                                           --------------------
Total current liabilities                                    5,891        3,427

Partners' capital                                            2,400        4,554
                                                           --------------------
Total liabilities and partners' capital                    $ 8,291      $ 7,981
                                                           ====================


          See accompanying notes to the combined financial statements.


                                      F-24


<PAGE>


                            DERMAGRAFT JOINT VENTURE
                   COMBINED STATEMENTS OF OPERATIONS (NOTE 1)
                                 (In thousands)

<TABLE>
<CAPTION>

                                                               Years ended December 31,
                                                       2001               2000              1999
                                                 ------------------ ------------------ ---------------
<S>                                                  <C>                <C>              <C>
Revenues
   Product sales                                     $     4,211        $     4,301      $    2,571
   Contract revenue                                          603                  -               -
                                                 -----------------------------------------------------
Total revenue                                              4,814              4,301           2,571

Operating expenses:
  Research and development                                 4,124              4,937           8,634
  Selling, general and administrative                      9,287              6,989          11,146
  Cost of goods sold                                      13,776             13,710          13,958
                                                 -----------------------------------------------------
Total operating expenses                                  27,187             25,636          33,738
                                                 -----------------------------------------------------
Loss from operations                                     (22,373)           (21,335)        (31,167)

Other income (expense):
  Interest income                                             17                 43             115
  Interest charges from related parties                      (49)              (318)           (479)
  License fee to related party                            (5,000)                 -         (15,000)
  Other income (expense)                                     (67)               (97)              9
                                                 -----------------------------------------------------
Net loss                                             $   (27,472)          $(21,707)       $(46,522)
                                                 ======================================================

</TABLE>


          See accompanying notes to the combined financial statements.


                                      F-25

<PAGE>


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

<TABLE>
<CAPTION>

                                                                      Years ended December 31,
                                                               2001              2000            1999
                                                         ---------------------------------------------------
<S>                                                       <C>               <C>             <C>
Operating activities:
Net loss                                                  $   (27,472)      $   (21,707)    $   (46,522)
Adjustments to reconcile net loss to cash used in
   operating activities:
     Loss on disposal of property                                   2                 6              --
     Depreciation                                                  80                77              62
     Other adjustments to net loss                                 --                --              --
     Changes in assets and liabilities:
       Accounts receivable from partners and affiliates          (789)            2,700          (2,429)

       Note receivable from partners and affiliates                --            (5,412)             --

       Inventory                                                   21               454             676
       Other current assets                                        --                 8             216
       Accounts payable                                           (86)             (342)            888
       Payable to partners and affiliates                       2,550              (681)            795
       Accrued expenses                                            --                --              --
                                                         ---------------------------------------------------
Net cash used in operating activities                         (25,694)          (24,897)        (46,314)

Investing activities:
Acquisition of property                                           (32)               (6)           (103)
                                                         ---------------------------------------------------
Net cash used in investing activities                             (32)               (6)           (103)

Financing activities:
Contributions from partners                                    28,561            30,999          51,536
Distributions to partners                                      (3,243)           (5,418)         (5,100)
                                                         ---------------------------------------------------
Net cash provided by financing activities                      25,318            25,581          46,436
                                                         ---------------------------------------------------

Net increase in cash                                             (408)              678              19
Cash at beginning of period                                       769                91              72
                                                         ---------------------------------------------------
Cash at end of period                                     $       361       $       769     $        91
                                                         ===================================================

</TABLE>

          See accompanying notes to the combined financial statements.


                                      F-26

<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, 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
     Capital contributions                                 16,448            14,890               31,338
     Capital distributions                                 (2,801)           (2,956)              (5,757)
     Net loss                                             (11,710)           (9,997)             (21,707)
                                                  ---------------------------------------------------------
Balance, December 31, 2000                                  2,277             2,277                4,554
     Capital contributions                                 12,902            15,708               28,610
     Capital distributions                                 (1,814)           (1,478)              (3,292)
     Net loss                                             (12,165)          (15,307)             (27,472)
                                                  --------------------- -----------------------------------
Balance, December 31, 2001                           $      1,200        $    1,200           $    2,400
                                                  =========================================================

</TABLE>


          See accompanying notes to the combined financial statements.


                                      F-27

<PAGE>


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. Under this joint venture, Smith & Nephew
provides marketing and sales resources, while Advanced Tissue Sciences provides
development and manufacturing resources, for the development, manufacture, and
sales of wound care products. 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(R), 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 being marketed in the
United States, Canada, Australia, New Zealand, and several 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 or net profits,
if any, from sales of TransCyte for burns in the United States.

RESTRUCTURING

     In February 2000, Advanced Tissue Sciences and Smith & Nephew agreed in
principle to restructure specified milestone payments associated with the
Dermagraft Joint Venture as a result of delays in the commercial introduction of
Dermagraft in the United States. The requirement of an additional clinical trial
by the FDA substantially increased the partners' investments necessitating the
restructuring. The objective of the restructuring is to defer the potential
payment of certain milestones by Smith & Nephew while providing Advanced Tissue
Sciences a royalty stream and an opportunity to increase its long-term return
from the Dermagraft 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. In addition, as a part of the agreement, as amended in
September 2000, the Dermagraft Joint Venture made a loan to Advanced Tissue
Sciences payable on December 31, 2001 with raw material inventory being pledged
as collateral security. At the end of 2001, this loan was renewed and is payable
December 2002.

PRINCIPLES OF COMBINATION

     The combined financial statements for 2001 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. All
intercompany accounts and transactions have been eliminated.


                                      F-28

<PAGE>


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.

RECLASSIFICATION

     Certain reclassifications have been made to prior year amounts to conform
to the presentation for the year ended December 31, 2000.

ECONOMIC DEPENDENCE

     Under the Dermagraft Joint Venture, Smith & Nephew provides marketing and
sales resources, while Advanced Tissue Sciences provides development and
manufacturing resources. Both entities have committed to funding the 2002
operations of the Dermagraft Joint Venture.

     Certain materials, purchased by Advanced Tissue Sciences on behalf of the
Dermagraft Joint Venture, 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.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

INVENTORIES

     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, 2001, 2000
and 1999, such write-downs totaled (in thousands):

                                         2001          2000           1999
                                      ----------    ----------     ----------

     Inventory Write-downs             $ 9,089       $ 9,821         $11,982

PROPERTY AND EQUIPMENT

     Property and equipment are 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
Dermagraft 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.


                                      F-29

<PAGE>


3.  INVENTORIES

     Inventories consist of the following components as of December 31, 2001 and
2000 (in thousands):

                                       2001             2000
                                    ---------------------------

     Work-in-process                  $   74           $   17
     Finished goods                      237              315
                                    ---------------------------
                                      $  311           $  332
                                    ===========================

     Inventories are net of reserves of $753,000 at December 31, 2001 and
$232,000 at December 31, 2000. See Note 2 with respect to the carrying value of
the joint venture's inventory.

4.  PROPERTY

     The following is a summary of property and accumulated depreciation as of
December 31, 2001 and 2000 (in thousands):

                                           2001             2000
                                       -----------------------------

     Equipment, at cost                  $  406           $  378
     Less accumulated depreciation         (255)            (177)
                                       -----------------------------
                  Net property           $  151           $  201
                                       =============================

     Depreciation expense charged to operations was (in thousands):

                                                    2001      2000      1999
                                                 ------------------------------

     Depreciation Expense Charged to Operations     $ 80      $ 77      $ 62

5.  RELATED PARTY TRANSACTIONS

     Under the Dermagraft Joint Venture agreement, Advanced Tissue Sciences is
responsible for manufacturing and Smith & Nephew is responsible for selling and
marketing Dermagraft and TransCyte for the Dermagraft Joint Venture (see Note
1). In addition, Advanced Tissue Sciences and Smith & Nephew provide 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 compensates the partners for
interest on the use of their working capital in support of the Dermagraft Joint
Venture's operations. The following table summarizes related party revenues and
expenses for the years ended December 31, 2001, 2000 and 1999 (in thousands):

<TABLE>
<CAPTION>


                                           Advanced Tissue Sciences                    Smith & Nephew
                                     -----------------------------------    ----------------------------------
                                         2001        2000        1999            2001        2000        1999
                                     ----------- -----------------------    -----------------------------------
<S>                                   <C>          <C>         <C>              <C>         <C>          <C>
Sales                                 $    --      $    --     $    --          $4,211      $4,301       $2,571
Contract revenue                          603           --          --              --          --           --
Cost of goods sold                     13,559       13,538      13,794             164         172          126
Research and development                1,781        3,398       7,119           1,474         993          943
Selling, general and administrative       951          749       1,145           7,479       5,572        8,481

</TABLE>


                                      F-30

<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 its 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. This $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. In 2001,
Smith & Nephew paid $5 million as the milestone payment related to product
approval. This has been allocated to Smith & Nephew's capital account. Smith &
Nephew has also agreed to pay up to an additional $131 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 1 regarding
an agreement in February 2000 to restructure certain payments associated with
the Dermagraft Joint Venture. As described in Note 1, in September 2000, the
Dermagraft Joint Venture made a loan to Advanced Tissue Sciences payable on
December 31, 2001. This loan was extended to December 31, 2002 as agreed by both
parties. At December 31, 2001, the principal balance of this note receivable was
$5.4 million. In addition related interest receivable of $35,000 is included in
accounts receivable from partners and affiliates. This interest receivable is
offset by an equal contribution to the partner's capital account of Advanced
Tissue Sciences.

6.  SUPPLEMENTAL CASH FLOW AND PARTNERS' CAPITAL INFORMATION

     The joint venture's non cash investing and financing activities for the
years ended December 31, 2001, 2000 and 1999 included the following amounts in
interest charges contributed as capital by the partners (in thousands):

                                                     2001       2000      1999
                                                  ------------------------------

     Interest Charges Contributed as Capital         $ 49       $318      $242


                                      F-31