<PAGE>   1
 
   
     AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 19, 1996
    
   
                                                      REGISTRATION NO. 333-01185
    
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
   
                                AMENDMENT NO. 1
    
   
                                       TO
    
 
                                    FORM S-3
                             REGISTRATION STATEMENT
                                     UNDER
                           THE SECURITIES ACT OF 1933
                            ------------------------
 
                         ADVANCED TISSUE SCIENCES, INC.
             (Exact Name of Registrant as Specified in Its Charter)
                            ------------------------
 
<TABLE>
<S>                                                           <C>
                         DELAWARE                                                     14-1701513
              (State or Other Jurisdiction of                                      (I.R.S. Employer
              Incorporation or Organization)                                      Identification No.)
</TABLE>
 
                            ------------------------
 
                         10933 NORTH TORREY PINES ROAD
                           LA JOLLA, CALIFORNIA 92037
                                 (619) 450-5730
              (Address, Including Zip Code, and Telephone Number,
       Including Area Code, of Registrant's Principal Executive Offices)
                            ------------------------
 
                              ARTHUR J. BENVENUTO
               CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER
                         ADVANCED TISSUE SCIENCES, INC.
                         10933 NORTH TORREY PINES ROAD
                           LA JOLLA, CALIFORNIA 92037
                                 (619) 450-5730
           (Name, Address, Including Zip Code, and Telephone Number,
                   Including Area Code, of Agent For Service)
                            ------------------------
 
                                   COPIES TO:
 
<TABLE>
<S>                                                           <C>
                   RICHARD A. FINK, ESQ.                                        DOUGLAS H. COLLOM, ESQ.
                   LAURA B. HUNTER, ESQ.                                    CHRISTOPHER K. SADEGHIAN, ESQ.
              BROBECK, PHLEGER & HARRISON LLP                                  ROBERT F. KORNEGAY, ESQ.
             4675 MACARTHUR COURT, SUITE 1000                             WILSON, SONSINI, GOODRICH & ROSATI,
              NEWPORT BEACH, CALIFORNIA 92660                                  PROFESSIONAL CORPORATION
                      (714) 752-7535                                              650 PAGE MILL ROAD
                                                                           PALO ALTO, CALIFORNIA 94304-1050
                                                                                    (415) 493-9300
</TABLE>
 
                            ------------------------
 
        APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
  As soon as practicable after this Registration Statement becomes effective.
 
    If the only securities being registered on this form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. / /
    If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, please check the following box. / /
    If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
    If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
    If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. /X/
                            ------------------------
 
                        CALCULATION OF REGISTRATION FEE
--------------------------------------------------------------------------------
 
   
<TABLE>
<S>                                     <C>                  <C>                     <C>                     <C>
------------------------------------------------------------------------------------------------------------------------------
                                                                PROPOSED MAXIMUM        PROPOSED MAXIMUM
   TITLE OF EACH CLASS OF SECURITIES        AMOUNT TO BE       OFFERING PRICE PER      AGGREGATE OFFERING        AMOUNT OF
           TO BE REGISTERED                  REGISTERED             SHARE(1)                PRICE(1)         REGISTRATION FEE
------------------------------------------------------------------------------------------------------------------------------
Common Stock ($.01 par value)..........   3,450,000 Shares          $10.3125               $35,578,125           $12,269*
------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------
</TABLE>
    
 
(1) Estimated solely for the purpose of computing the registration fee pursuant
    to Rules 457(a) and 457(c) of the Securities Act of 1933, as amended, based
    on the average of the high and low sales prices per share of Common Stock of
    Advanced Tissue Sciences, Inc. on February 20, 1996 as reported on the
    Nasdaq National Market.
 
   
 *  Previously paid.
    
                            ------------------------
 
    THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>   2
 
     INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
     REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
     SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
     MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
     BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
     THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
     SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
     UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
     OF ANY SUCH STATE.
 
   
                  SUBJECT TO COMPLETION, DATED MARCH 19, 1996
    
 
                                3,000,000 SHARES
 
                                      LOGO
 
                                  COMMON STOCK
                           (PAR VALUE $.01 PER SHARE)
                             ---------------------
 
     All of the 3,000,000 shares of Common Stock offered hereby are being sold
by Advanced Tissue Sciences, Inc. (the "Company" or "Advanced Tissue Sciences").
The Company's Common Stock is quoted on the Nasdaq National Market under the
symbol "ATIS". On February 22, 1996, the last reported sale price for the Common
Stock was $10.25 per share. See "Price Range of Common Stock and Dividend
Policy".
 
     SEE "RISK FACTORS" ON PAGE 7 FOR CERTAIN CONSIDERATIONS RELEVANT TO AN
INVESTMENT IN THE COMMON STOCK.
                             ---------------------
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
   EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
     SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
       COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
       PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
        OFFENSE.
                             ---------------------
 
<TABLE>
<CAPTION>
                                                    PUBLIC
                                                   OFFERING    UNDERWRITING    PROCEEDS TO
                                                     PRICE      DISCOUNT(1)     COMPANY(2)
                                                   ---------   -------------   ------------
<S>                                                <C>           <C>           <C>
Per Share.......................................       $             $              $
Total(3)........................................   $             $             $
</TABLE>
 
---------------
(1) The Company has agreed to indemnify the Underwriters against certain
    liabilities, including liabilities under the Securities Act of 1933. See
    "Underwriting".
 
(2) Before deducting estimated expenses of $400,000 payable by the Company.
 
(3) The Company has granted the Underwriters an option for 30 days to purchase
    up to an additional 450,000 shares of Common Stock at the public offering
    price per share, less the underwriting discount, solely to cover
    over-allotments. If such option is exercised in full, the total public
    offering price, underwriting discount and proceeds to Company will be
    $          , $          and $          , respectively. See "Underwriting".
                             ---------------------
 
   
     The shares are offered severally by the Underwriters, as specified herein,
subject to receipt and acceptance by them and subject to their right to reject
any order in whole or in part. It is expected that certificates for the shares
will be ready for delivery at the offices of Goldman, Sachs & Co., New York, New
York against payment therefor in immediately available funds on or about
        , 1996.
    
 
GOLDMAN, SACHS & CO.                                 MORGAN STANLEY & CO.
                                                         INCORPORATED
                             ---------------------
 
                 The date of this Prospectus is         , 1996.
<PAGE>   3
 
                     CORE TECHNOLOGY -- TRANSPLANT PRODUCTS
 
<TABLE>
<S>                               <C>                               <C>
[Diagram]
Human Cells
            [Diagram]                         [Diagram]                         [Diagram]
Bioabsorbable scaffold            Cells seeded onto                 Cells multiply three dimensionally
                                  bioabsorbable scaffold            on bioabsorbable scaffold

[Diagram] Matrix  [Diagram] Growth                                              [Diagram]
          proteins          factors                                 Engineered tissue in cross section

            [Diagram]                         [Diagram]                         [Diagram]
Cells multiply and naturally      During the manufacturing          Over time, the scaffold dissolves,
secrete growth factors and        process, a human tissue           leaving only human tissue
human matrix proteins             forms around the scaffold
</TABLE>
 
                        LEAD TISSUE ENGINEERED PRODUCTS
 
<TABLE>
<S>                    <C>                    <C>                    <C>
        [Photo]                                       [Photo]
                               [Photo]                                       [Photo]
     Dermagraft-TC                                   Cartilage
                           Dermagraft for                                Cardiovascular
                        diabetic foot ulcers
</TABLE>
 
   TISSUE ENGINEERED PRODUCTS GROWN IN ADVANCED TISSUE SCIENCES' PROPRIETARY
                                  BIOREACTORS
 
     IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL
IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL
MARKET, IN THE OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH TRANSACTIONS, IF
COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
 
     IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET
MAKING IN THE COMPANY'S COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE
WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934. SEE "UNDERWRITING".
 
                                        2
<PAGE>   4
 
                               PROSPECTUS SUMMARY
 
   
     The following summary is qualified in its entirety by the more detailed
information and Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Prospectus or incorporated by reference herein. Except as
otherwise noted, all information in this Prospectus assumes no exercise of the
Underwriters' over-allotment option. See "Underwriting". Unless the context
otherwise requires, "Advanced Tissue Sciences" or the "Company" refers to
Advanced Tissue Sciences, Inc. and its wholly-owned subsidiaries. This
Prospectus contains forward-looking statements within the meaning of the
Securities Act of 1933 and the Securities Exchange Act of 1934. The Company's
actual results could differ materially from those projected in the
forward-looking statements as a result of the factors described under "Risk
Factors" and elsewhere in this Prospectus.
    
 
                                  THE COMPANY
 
OVERVIEW
 
     Advanced Tissue Sciences is a leading tissue engineering company engaged in
the development of living human tissue products for therapeutic applications.
The Company is primarily focusing its efforts on skin, cartilage and
cardiovascular products. Utilizing principles of cell biology, biochemistry and
polymer science, the Company has developed and is applying its patented core
technology which permits living human cells to be cultured ex vivo in a manner
that allows the cells to develop and assemble into a functioning
three-dimensional tissue. The Company has successfully replicated a variety of
human tissues and has a number of products under various stages of development.
See "Business -- Products".
 
     Advanced Tissue Sciences' objective is to redefine tissue repair and
transplantation by developing, manufacturing and marketing human tissue
replacement products produced through tissue engineering. The Company's product
strategy is to utilize its patented core technology to develop multiple products
which address unmet therapeutic needs or offer improved, cost-effective
alternatives to current treatment modalities. By building upon its base of
scientific knowledge through the continued application of its core technology,
the Company believes it will achieve significant synergies in the development,
clinical testing and manufacture of successive tissue products. In addition, the
Company is focusing its development programs on products which are currently
being or are expected to be regulated as medical devices. Medical devices are
generally subject to shorter regulatory approval processes than biologics or
pharmaceuticals. The Company is developing marketing and reimbursement
strategies, establishing a direct sales organization and pursuing strategic
alliances, to market future commercial products.
 
     Leading the Company's product development efforts are therapeutic skin
products that address the burn and diabetic foot ulcer markets. These products,
based on Dermagraft, a three-dimensional living human tissue designed by the
Company as a temporary or permanent replacement for human dermis, were developed
to treat conditions where the dermis (the inner skin layer) has been injured or
destroyed, such as in severe burns and chronic skin ulcers. The dermis is
essential to normal skin function and healing and, unlike the epidermis (the
outer layer of skin), does not regenerate into normal tissue after injury. The
Company has two lead products currently in pivotal clinical trials, a temporary
covering for severe burns ("Dermagraft-TC") and a dermal replacement product
("Dermagraft-Ulcers") for treating diabetic foot ulcers. The Company expects to
submit a premarket approval ("PMA") application to the United States Food and
Drug Administration (the "FDA") for Dermagraft-TC during the first half of 1996
and for Dermagraft-Ulcers to treat diabetic foot ulcers in late 1996. The FDA
has notified the Company that the PMA applications for both products will
receive expedited review.
 
                                        3
<PAGE>   5
 
RECENT DEVELOPMENTS
 
   
     DERMAGRAFT-TC. In December 1995, the Company reported that data from the
pivotal clinical trial of Dermagraft-TC achieved statistical significance
(p<0.01) with respect to its primary endpoint, the ability of the Company's
product to adequately prepare the wound beds for successful autografting. Based
on these results, the Company is preparing and expects to submit a PMA
application to the FDA during the first half of 1996. In addition, the FDA has
notified the Company that it intends to review the PMA application for
Dermagraft-TC on an expedited basis, potentially accelerating the regulatory
review period.
    
 
     Dermagraft-TC has been developed as an alternative to human cadaver skin to
treat severely burned patients. Dermagraft-TC, consisting of a dermal tissue
with an ultrathin synthetic covering, acts as a protective cover to help retain
fluids and reduce the risk of infection until a sufficient amount of the
patient's own skin becomes available for grafting. Of the 70,000 burn patients
hospitalized annually in the United States, approximately 13,000 are severely
burned and require skin grafts. The Company's Dermagraft-TC product is initially
intended to address the approximately 1,500 severely burned patients with burns
exceeding 20% body surface area. The Company estimates the total initial United
States market opportunity for this indication to be approximately $30 million.
See "Business -- Products -- Burn Products".
 
     DIABETIC FOOT-ULCERS. Enrollment in the pivotal clinical trial of
Dermagraft-Ulcers for diabetic foot ulcers in the United States is nearly
complete. The primary endpoint in the pivotal trial is complete wound closure. A
planned interim analysis of this data showed that the clinical trial was on
track to achieve the primary endpoint. Upon completion of the trial, all trial
data will be evaluated for statistical significance. If the results of the
completed trial are consistent with the results shown at the interim analysis,
the Company expects to submit a PMA application to the FDA in late 1996. After
the interim analysis, the FDA notified the Company that the PMA application for
Dermagraft-Ulcers in the treatment of diabetic foot ulcers will also receive
expedited review. In an earlier pilot trial, the Dermagraft-Ulcers patients
receiving one piece of Dermagraft-Ulcers per week for eight weeks showed a
statistically significant improvement in complete wound closure. In addition,
patients healed in the pilot trial treated with Dermagraft-Ulcers had no
recurrence of their ulcers after being followed for an average of 14 months. By
contrast, published reports have indicated rates of recurrence ranging from 20%
to 50% within the first year following healing. The Company is pursuing
strategic alliances with corporate partners to accelerate the commercialization
of Dermagraft-Ulcers, assuming receipt of appropriate regulatory approvals.
 
     Dermagraft-Ulcers is a dermal replacement product grown on a bioabsorbable
scaffold and is designed to provide a healthy, metabolically active dermal
matrix in the ulcer to support wound closure. Approximately 800,000 diabetic
foot ulcer patients are treated in the United States each year, 400,000 of which
represent the Company's initial target market. Based on data from outside
sources, it is estimated that the total United States market opportunity for
this targeted indication potentially exceeds $1 billion. See
"Business -- Products -- Skin Ulcers".
 
OTHER THERAPEUTIC PRODUCTS UNDER DEVELOPMENT
 
     ORTHOPEDICS. The Company has successfully replicated cartilage tissue ex
vivo using the Company's proprietary three-dimensional culture system. Through a
joint venture with Smith & Nephew plc ("Smith & Nephew"), the Company is
developing several orthopedic applications of tissue engineered cartilage. The
joint venture is currently in a pivotal preclinical trial for articular
resurfacing which, if successfully completed, is expected to lead to human
clinical trials in 1997. Pilot preclinical trials of tissue engineered meniscus
have shown successful repair of meniscus defects in subjects followed for up to
one year. There are over 1.2 million arthroscopic procedures for repair of the
knee performed annually in the United States, including procedures involving
 
                                        4
<PAGE>   6
 
articular cartilage, meniscus and ligament. See
"Business -- Products -- Orthopedic Products" and "-- Collaborations and
Strategic Alliances".
 
     CARDIOVASCULAR. Through the use of its tissue engineering technology,
Advanced Tissue Sciences is working on developing cardiovascular products that
will grow and repair normally. Over the past year, the Company has made
substantial progress in developing dynamic bioreactors for growing tissue
engineered heart valves and blood vessels. In the United States, over 900,000
Americans die each year from cardiovascular disease, and over 60,000 prosthetic
heart valves are implanted and over 430,000 vascular graft procedures are
performed in the United States. See "Business -- Products -- Cardiovascular
Products".
 
PATENTED CORE TECHNOLOGY
 
     The Company has developed a patented core technology that combines the
principles of cell biology, biochemistry and polymer science to create a
three-dimensional living support stroma ex vivo. Products engineered by the
Company based on its core technology produce a completely human stromal tissue
that, in turn, supports the growth of organ cells into functional tissue.
Advanced Tissue Sciences has been issued United States and European patents
covering its core technology and numerous patents related to applications of
such technology. See "Business -- Overview -- Patented Core Technology" and
"-- Patents and Proprietary Rights".
 
     The Company believes that its tissue engineered products may offer some or
all of the following benefits, depending upon the particular application of the
product:
 
     - Physiological Human Tissue -- The Company's patented core technology
       allows cells to grow on a scaffold and develop into a three-dimensional
       human tissue. The Company's products may then be transplanted as a
       physiological tissue, as contrasted with the transplantation of cells or
       scaffolds alone.
 
     - Multiple Factors For Healing -- The human cells produce multiple growth
       factors and tissue matrix proteins, all of which are believed to be
       important in the tissue repair process.
 
     - Completely Human Tissue -- The tissue matrix proteins naturally secreted
       by the cells consist of human collagens, glycosaminoglycans and other
       human proteins, rather than animal-derived matrix proteins which may
       cause allergic or immune reactions.
 
     - Safety Tested -- The human tissue materials used in the manufacture of
       the Company's products are extensively tested at independent laboratories
       for potential pathogens such as Hepatitis B and HIV. All final product is
       tested for sterility by performing United States Pharmacopeia (U.S.P.)
       sterility tests on each product's growth medium.
 
     - Off-the-Shelf Products -- Medical research has shown that several
       tissues, including dermal tissue and certain cartilage tissue
       applications, are not subject to rejection by a recipient's body.
       Products engineered from these tissues may, therefore, be utilized as
       universal, permanent replacement products in such applications.
 
     - Prolonged Shelf Life -- The Company's dermal products can be frozen for
       long-term storage. Similarly, it is expected that cartilage and some of
       the other tissues in development will be able to be cryopreserved for
       prolonged shelf life.
 
     - Ease of Use -- The Company's dermal products are easy for physicians to
       apply using routine medical techniques. In addition, tissue engineered
       cartilage is being developed to be delivered in a single arthroscopic
       procedure.
 
     Advanced Tissue Sciences was incorporated in Delaware in 1987. The Company
maintains its executive offices at 10933 North Torrey Pines Road, La Jolla,
California 92037, and its telephone number at that address is (619) 450-5730.
 
                                        5
<PAGE>   7
 
                                  THE OFFERING
 
<TABLE>
<S>                                             <C>
Common Stock offered by the Company..........   3,000,000 shares
Common Stock to be outstanding after the
  offering...................................   36,885,928 shares(1)
Use of proceeds..............................   To fund the scale up of manufacturing, sales
                                                and marketing, clinical trials and research
                                                and development, and for general corporate
                                                purposes. See "Use of Proceeds".
Nasdaq National Market symbol................   ATIS
</TABLE>
 
                   SUMMARY CONSOLIDATED FINANCIAL INFORMATION
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                                            ELEVEN      YEAR ENDED
                                                           YEAR ENDED DECEMBER 31,       MONTHS ENDED    JANUARY
                                                        ------------------------------   DECEMBER 31,      31,
                                                          1995       1994       1993       1992(2)         1992
                                                        --------   --------   --------   ------------   ----------
<S>                                                     <C>        <C>        <C>        <C>            <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
  Product sales(3)....................................  $  1,177   $  1,042   $  1,401     $    755      $    488
  Contracts and fees..................................     2,388        923      3,493           62            44
  Interest and other..................................     1,185      1,250        972        1,393           825
                                                        --------   --------   --------     --------       -------
        Total revenues................................     4,750      3,215      5,866        2,210         1,357
                                                        --------   --------   --------     --------       -------
Costs and expenses:
  Research and development............................    18,498     16,459     13,810        5,666         3,863
  Selling, general and administrative.................     6,115      6,445      6,224        4,778         2,904
  Professional and consulting.........................     1,897      1,718      1,864        1,121           519
  Cost of goods sold(3)...............................     1,359      1,360      1,458          997           624
  Other expenses......................................         6          8        201          238           252
  In-process technology(4)............................        --         --         --       21,400            --
                                                        --------   --------   --------     --------       -------
        Total costs and expenses......................    27,875     25,990     23,557       34,200         8,162
                                                        --------   --------   --------     --------       -------
Net loss..............................................  $(23,125)  $(22,775)  $(17,691)    $(31,990)     $ (6,805)
                                                        ========   ========   ========     ========       =======
Net loss per share....................................  $   (.72)  $   (.75)  $   (.67)    $  (1.40)     $   (.36)
                                                        ========   ========   ========     ========       =======
Weighted average shares used in the computation of net
  loss per share......................................    32,266     30,250     26,453       22,896        18,691
                                                        ========   ========   ========     ========       =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                                                         AS OF DECEMBER 31, 1995
                                                                                        --------------------------
                                                                                         ACTUAL     AS ADJUSTED(5)
                                                                                        ---------   --------------
<S>                                                                                     <C>         <C>
BALANCE SHEET DATA:
  Cash, cash equivalents and short-term investments...................................  $  18,929     $   47,357
  Working capital.....................................................................     15,747         44,175
  Total assets........................................................................     31,141         59,569
  Long-term debt......................................................................         25             25
  Deficit accumulated during development stage........................................   (116,681)      (116,681)
  Stockholders' equity................................................................     25,900         54,328
</TABLE>
 
---------------
 
(1) Based on the number of shares outstanding at December 31, 1995. Excludes (i)
    1,830,192 shares of Common Stock reserved for future grant under the
    Company's 1992 Stock Option/Stock Issuance Plan (the "1992 Plan"), (ii)
    options to purchase an aggregate of 2,317,515 shares of Common Stock
    outstanding under the 1992 Plan at a weighted average price of $6.28 per
    share, and (iii) 1,460,299 shares of Common Stock issuable upon the exercise
    of warrants outstanding at a weighted average exercise price of $6.77 per
    share, all at December 31, 1995. Also excludes 175,000 shares of Common
    Stock issuable upon the exercise of warrants at an exercise price of $10.50
    per share issued in February 1996 as a commitment fee in connection with a
    $50 million equity line. See "Capitalization", "Management's Discussion and
    Analysis of Financial Condition and Results of Operations" and Notes 9 and
    12 of Notes to the Consolidated Financial Statements.
 
(2) The Company changed from a January 31 fiscal year end to a December 31
    calendar year end in 1992 resulting in an 11-month reporting period ended
    December 31, 1992.
 
(3) Attributable to sales of the Company's Skin(2) laboratory testing kits.
 
(4) The nonrecurring charge to in-process technology of $21.4 million relates to
    the acquisition of Neomorphics, Inc. ("Neomorphics"). See Note 8 of Notes to
    the Consolidated Financial Statements.
 
(5) Adjusted to give effect to the receipt of the net proceeds from the sale of
    3,000,000 shares of Common Stock offered by the Company hereby (at an
    assumed public offering price of $10.25 per share and after deducting
    estimated underwriting discounts and commissions and offering expenses). See
    "Use of Proceeds".
 
                                        6
<PAGE>   8
 
                                  RISK FACTORS
 
   
     In addition to the other information contained in this Prospectus, the
following risk factors should be considered carefully before purchasing the
Common Stock offered hereby. This Prospectus contains forward-looking statements
within the meaning of the Securities Act of 1933 and the Securities Exchange Act
of 1934. The Company's actual results could differ materially from those
projected in the forward-looking statements as a result of the risk factors set
forth below and other factors included elsewhere in this Prospectus.
    
 
UNCERTAINTIES OF CLINICAL TRIALS
 
     The Company is required to obtain approval from the FDA prior to marketing
its therapeutic products in the United States and the approval of foreign
regulatory authorities to commercialize its products in other countries. To
obtain such approvals, the Company is required to prove the safety and efficacy
of its products through extensive preclinical studies and clinical trials. The
Company is in various stages of such testing. The Company's lead products,
Dermagraft-TC, a temporary covering for severe burns and Dermagraft-Ulcers for
diabetic foot ulcers, are in pivotal human clinical trials in the United States
and in the United States and France, respectively. Enrollment in the pivotal
clinical trial of Dermagraft-TC is complete. Enrollment is ongoing in the
pivotal clinical trial of Dermagraft-Ulcers for diabetic foot ulcers in both the
United States and France. The completion of these trials, or any other of the
Company's clinical trials, is dependent upon many factors including the rate of
patient enrollment. Delays in patient enrollment may result in increased trial
costs and delays in FDA submissions which could have a material adverse effect
on the Company.
 
     A number of companies in the biotechnology and pharmaceutical industries
have suffered significant setbacks in clinical trials, even after showing
promising results in earlier studies or trials. Although the Company has
obtained favorable results to date in preclinical studies and clinical trials of
certain of its products, such results may not be predictive of results that will
ultimately be obtained in or throughout such clinical trials. In a previously
conducted pivotal clinical trial, the Company encountered an efficacy issue for
a Dermagraft product to treat venous ulcers. An interim analysis of that trial
indicated there was no statistically significant difference in complete healing
between the control group patients and those treated with a single dose of the
Dermagraft product. Analysis of follow-up data from patients in the trial did,
however, show a statistically significant difference in the recurrence rate of
Dermagraft-treated patients versus control patients. To date, the Company has
elected not to pursue the use of Dermagraft-Ulcers as a treatment to reduce the
recurrence of venous ulcers, although it may do so in the future. There can be
no assurance that the Company will not encounter problems in its clinical trials
that will cause the Company to delay or suspend its clinical trials, that the
clinical trials of its products will be completed at all, that such testing will
ultimately demonstrate the safety or efficacy of such products or that any
products will receive regulatory approval on a timely basis, if at all. If any
such problems occur, the Company could be materially and adversely affected. See
"Business -- Products" and "-- Government Regulation".
 
ABSENCE OF PROFITABLE OPERATIONS; NEED FOR ADDITIONAL FUNDS
 
     To date, the Company has experienced significant operating losses in
funding the research, development and testing of its products and expects to
continue to incur substantial operating losses. The Company has incurred
cumulative net operating losses of $116.7 million through December 31, 1995
(including an approximately $21.4 million non-recurring charge related to the
acquisition of Neomorphics in September 1992). Losses are expected to increase
as a result of the expenses associated with scaling up and validating
manufacturing processes and equipment and establishing sales and marketing
capabilities as well as funding additional research, development and testing.
The Company's ability to achieve profitability depends in part upon its ability,
either independently or in collaboration with others, to complete the
development and obtain required regulatory approvals of, and to successfully
manufacture and market, products. There can be no
 
                                        7
<PAGE>   9
 
assurance that the Company will ever achieve a profitable level of operations or
that profitability, if achieved, can be sustained on an ongoing basis.
 
     The further development of the Company's technology and products as well as
the scale up of the Company's manufacturing capabilities and the establishment
of necessary sales, marketing and distribution capabilities will require the
commitment of substantial funds, the amount of which will depend on many
factors, such as the schedule and progress of preclinical and clinical trials
and the timing and cost of obtaining regulatory approvals. In February 1996, the
Company entered into an equity line which allows the Company to access up to $50
million through sales of its Common Stock (the "Equity Line"). While the Company
believes that its existing working capital, together with either the net
proceeds of this offering or the availability of funds under the Equity Line,
will be sufficient to meet its present operating and capital requirements for at
least the next 12 months, the Company may ultimately need to raise additional
funds to support its long-term product development and commercialization
programs. The Company could acquire such additional funding through
collaborative arrangements, the extension of existing arrangements, additional
public or private offerings of debt or equity securities or other means. There
can be no assurance that adequate funds will be available under existing or
future arrangements when such funds are needed or, if available, on terms
acceptable to the Company. Insufficient funds may require the Company to delay,
scale back or eliminate certain of its research and product development programs
or to license third parties the right to commercialize products or technologies
that the Company would otherwise commercialize itself. See "Use of Proceeds",
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and Note 12 of Notes to the
Consolidated Financial Statements.
 
STAGE OF PRODUCT DEVELOPMENT
 
     Although two of the Company's products are in advanced stages of pivotal
clinical trials, the remainder of the Company's other products are at earlier
stages of research, development and testing. These products will require
significant additional research and development, including extensive preclinical
and clinical testing, and regulatory approvals prior to commercialization. All
of the Company's products are subject to the risks of failure inherent in the
development of products based on innovative technologies. Such risks include the
possibilities that any or all of these products are found to be unsafe or
ineffective or otherwise fail to receive necessary regulatory approvals, that
products are uneconomical to market, that third parties may hold proprietary
rights that preclude the Company from marketing its products, or that the
Company's products fail to achieve market acceptance in light of competing
technologies and products. The Company continually reviews its product
development activities in an effort to allocate its resources to those products
the Company believes have the greatest commercial potential. Factors considered
by the Company in determining the products to pursue include projected markets
and need, potential for regulatory approval and reimbursement under the existing
health care system as well as anticipated health care reforms, technical
feasibility, expected and known product attributes and estimated costs to bring
the product to market. Based on these and other factors which the Company
considers relevant, the Company may from time to time reallocate its resources
among its product development activities. Additions of products under
development or changes to products being pursued can substantially and rapidly
change the Company's funding requirements. See "Business -- Products" and
"-- Government Regulation".
 
LIMITED MANUFACTURING AND MARKETING EXPERIENCE
 
     Although the Company believes it has the manufacturing capacity to produce
sufficient quantities of Dermagraft to support its ongoing clinical trials, the
Company must develop the capability of manufacturing its products in commercial
quantities, in compliance with regulatory requirements and at acceptable costs.
While the Company has clinical scale manufacturing experience producing its
Dermagraft products, it has no commercial scale manufacturing experi-
 
                                        8
<PAGE>   10
 
ence with these specific products. The Company has constructed and is in the
process of developing and validating commercial scale manufacturing for its
Dermagraft-TC and Dermagraft-Ulcers products. The facility and processes have
and will continue to undergo rigorous validation tests and there can be no
assurance that the Company will be able to obtain the necessary regulatory
approvals for its manufacturing operations on a timely basis or at all. Although
the Company believes it unlikely, it cannot be certain that process changes
during scale up will not require the Company to undertake additional clinical
trials which would require additional expenditures and cause delays in
commercial production. In addition, the Company's manufacturing facility must be
registered with and licensed by various regulatory authorities, including the
California Department of Health and Human Services, and comply with the good
manufacturing practices ("GMPs") requirements prescribed by the FDA. Any
significant delays in the completion of validation or regulatory inspection of
the facility or manufacturing processes could have a material adverse effect on
the ability of the Company to ultimately market its products on a timely and
profitable basis, and on the Company's ability to conduct its business. See
"Business -- Manufacturing and Supply".
 
     The Company has no direct experience marketing or obtaining third-party
reimbursement for its products. The Company will have to establish an effective
internal sales and marketing organization and/or rely on corporate partners or
licensees, or on arrangements with others to market its products domestically
and internationally. There can be no assurance that the Company will be
successful in these efforts or that any of its products, if approved, will gain
market acceptance. See "-- Uncertainties Regarding Health Care Reimbursement and
Reform" and "Business -- Sales and Marketing".
 
GOVERNMENT REGULATION
 
     The Company's preclinical studies and clinical trials and the manufacturing
and marketing of its products are subject to extensive, costly and rigorous
regulation by various governmental authorities in the United States and other
countries. The process of obtaining required regulatory approvals from the FDA
and other regulatory authorities often takes many years, is expensive and can
vary significantly based on the type, complexity and novelty of the product.
There can be no assurance that any products developed by the Company,
independently or in collaboration with others, will meet applicable regulatory
criteria to receive the required approvals for manufacturing and marketing.
Delays in obtaining United States or foreign approvals could result in
substantial additional costs to the Company and adversely affect the Company's
competitive position. In addition, delays in regulatory approvals that may be
encountered by corporate collaborators or other licensees of the Company could
adversely affect the Company's ability to receive royalties. See "Business --
Government Regulation".
 
   
     The Dermagraft-TC and Dermagraft-Ulcers products are currently in pivotal
clinical trials. The Company expects to prepare and submit a PMA application to
the FDA for the Dermagraft-TC product in the first half of 1996 and for the
Dermagraft-Ulcers product in late 1996, based upon the results of the respective
trials. There can be no assurance that the Company will submit the PMA
applications in these time frames, if at all, or that FDA will conclude that the
respective trial results support a finding of safety and efficacy for either of
these products. In addition, even though the Company has been informed by the
FDA that the Company's Dermagraft-TC and Dermagraft-Ulcers products will receive
expedited PMA review from the agency, there can be no assurance that such status
will accelerate the review process, or that such status will not be rescinded by
the FDA if products of other companies that have already received FDA approval,
or which receive FDA approval prior to the Company receiving its approval, are
deemed by the FDA to perform substantially the same functions or to provide
comparable benefits. See "Business -- Competition". There can be no assurance
that the FDA will approve either the Dermagraft-TC or Dermagraft-Ulcers PMA
applications in a timely fashion, if at all. Moreover, even if such approvals
are obtained, post-approval regulation of the Company's products could result in
the withdrawal, suspension or limitation of approvals or limit the further
marketing of the Company's products.
    
 
                                        9
<PAGE>   11
 
     The Company's Dermagraft and cartilage products are subject to regulation
as medical devices. The Company's other tissue replacement products, currently
in various stages of development, could be regulated either as medical devices
or as biologic products. Even though the FDA has classified human tissue
engineered products such as those manufactured by the Company as medical
devices, application of the Federal Food, Drug, and Cosmetic Act (the "FDC Act")
to human tissue in its original form has been accomplished one tissue type at a
time. Certain of the Company's potential products are not currently regulated by
the FDA, but may ultimately be regulated either as a medical device or a
biologic. Accordingly, while regulation of the Company's additional potential
tissue replacement products as medical devices is possible, it is impossible to
determine with certainty under which regulatory scheme they will be placed by
the FDA. Legislative and regulatory initiatives concerning the regulation of
tissue and organ transplants are ongoing and could possibly affect the future
regulation of the Company's tissue engineered products. It is not possible at
the present time to predict accurately either the time frame for such action, or
the ultimate effect that such initiatives could have, if any, on the products
under development by the Company.
 
     The Company has constructed and is in the process of developing and
validating commercial scale manufacturing for its Dermagraft-TC and
Dermagraft-Ulcers products. The 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 GMP requirements. There
can be no assurance that the facility will be found to comply with GMPs and
other requirements and that necessary regulatory approvals will be obtained on a
timely basis, if at all. See "Business -- Government Regulation".
 
DEPENDENCE ON CERTAIN SUPPLIERS
 
     The mesh framework used by the Company in its Dermagraft-Ulcers and
Dermagraft-Burns products is supplied by only one FDA-approved manufacturer. The
synthetic mesh framework used by the Company in its Dermagraft-TC product is
available from a single FDA-approved manufacturing source. Although the Company
has not experienced difficulty acquiring these materials for the manufacture of
its Dermagraft products for clinical trials, no assurance can be given that
interruptions in supplies will not occur in the future or that the Company would
not have to obtain substitute vendors for these materials, which would require
additional regulatory submissions. Any significant supply interruption could
adversely affect the Company's clinical trials as well as its product
development and marketing programs. In addition, an uncorrected impurity or
supplier's variation in a raw material, either unknown to the Company or
incompatible with the Company's manufacturing process, could have a material
adverse effect on the Company's ability to manufacture its products. See
"Business -- Manufacturing and Supply".
 
TECHNOLOGICAL CHANGE AND COMPETITION
 
     The markets for the Company's products are characterized by rapid,
unpredictable and significant technological change. Competition in the Company's
industry is intense. The Company's competitors include universities, research
institutions and pharmaceutical, chemical, medical device and biotechnology
companies. Many of these companies have greater financial resources, research
and development capabilities and more experience in conducting clinical trials,
obtaining regulatory approvals, manufacturing and marketing than the Company.
Accordingly, these competitors may succeed in developing, obtaining regulatory
approval for and commercializing their products more rapidly than the Company. A
number of companies are developing and commercializing dermal replacement and
other products, including various types of wound healing treatments employing a
variety of approaches that could, if successfully developed and commercialized,
compete with the Company's Dermagraft products. The Company also knows of other
companies that are undertaking research and development of tissue engineered
products, some of which are patented. There can be no assurance that
developments by the Company's competitors or potential competitors will
 
                                       10
<PAGE>   12
 
not render the Company's technology or proposed applications of its technology
non-competitive, uneconomical or obsolete. See "Business -- Competition".
 
PATENTS AND PROTECTION OF PROPRIETARY TECHNOLOGY
        
        The Company's ability to compete effectively with other companies will
depend, in part, on its ability to maintain the proprietary nature of its
technology, products and manufacturing processes. The Company relies on
patents, trade secrets and know-how to maintain its competitive position. The
Company has been issued one United States patent and a European patent covering
its core technology and has been issued other United States and foreign patents
related to this technology. In addition, many other United States and foreign
patent applications have been filed. The issued United States patents include
patents covering the Dermagraft-Ulcers and Dermagraft-TC products. The Company
also has licenses or licensing rights to certain other United States and
foreign patents and patent applications.
 
        There can be no assurance that any existing or future patent
applications by the Company will result in issued patents or that any current
or future issued or licensed patents, trade secrets or know-how will afford
protection against competitors with similar technologies or processes, or that
any patents issued will not be infringed upon or designed around by others. In
addition, there can be no assurance that others will not independently develop
proprietary technologies and processes which are the same as or substantially
equivalent to those of the Company. The Company could also incur substantial
costs in defending itself in suits brought against it on such patents or in
bringing suits to protect the Company's patents or patents licensed by the
Company against infringement. Additionally, the Company protects its
proprietary technology and processes in part by confidentiality agreements with
its collaborative partners, employees and consultants. There can be no
assurance that these agreements will not be breached, that the Company will
have adequate remedies for any breach, or that the Company's trade secrets will
not otherwise become known or independently discovered by competitors. See
"Business -- Patents and Proprietary Rights".
 
UNCERTAINTIES REGARDING HEALTH CARE REIMBURSEMENT AND REFORM
 
        The Company's ability to commercialize products successfully may 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. Significant
uncertainty exists as to the reimbursement status of newly approved health care
products, and there can be no assurance that adequate third party coverage will
be available for the Company to maintain price levels sufficient for
realization of an appropriate return on its investment in developing new
products. Government and other third party payors are increasingly attempting
to contain health care costs by limiting both coverage and the level of
reimbursement for new products approved for marketing by the FDA, and by
refusing, in some cases, to provide any coverage for uses of approved products
for indications for which the FDA has not granted marketing approval. Recent
initiatives to reduce the federal deficit and to reform health care delivery
are increasing these cost containment efforts. As managed care organizations
continue to expand as a means of containing health care costs, the Company
believes there may be attempts by such organizations to restrict the use or
delay authorization to use new products, such as those being developed by the
Company, pending completion of cost/benefit analyses of such products by those
managed care organizations. If adequate coverage and reimbursement levels are
not provided by government and other third party payors for uses of the
Company's products, the market acceptance of these products could be adversely
affected. See "Business -- Government Regulation".
 
UNCERTAINTY OF COLLABORATIVE ARRANGEMENTS AND STRATEGIC ALLIANCES
 
        The Company's strategy for the development, clinical testing,
manufacture and commercialization of certain of its tissue replacement products
includes entering into various collaborations with corporate partners,
licensors, licensees and others. These collaborations provide access to
technol-
 
                                       11
<PAGE>   13
 
ogies, technical expertise and financial and other resources that might
otherwise be unavailable to the Company. The Company has entered into
collaborations with various institutions related to the development and
commercialization of its tissue engineered products. Although the Company
believes that its partners in these collaborations have an economic motivation
to succeed in performing their contractual responsibilities, the amount and
timing of resources to be devoted to these activities are not within the control
of the Company. Moreover, the collaboration agreements generally provide that
they may be terminated by the collaborator prior to their expiration under
circumstances that may also be outside the control of the Company. In addition,
there can be no assurance that these collaborators will pay any additional
option or license fees to the Company or that they will develop or market any
products under the agreements. For example, in early 1996 St. Jude Medical,
Inc., which had previously worked with the Company on a collaboration effort
related to heart valves, elected not to enter into a licensing agreement even
though the feasibility studies conducted by the parties were successful.
Finally, if the Company's collaboration agreements are terminated prior to their
expiration or if the other parties to such agreements fail to adequately
perform, there can be no assurance that submission of products for regulatory
approval will not be delayed or that the Company's ability to deliver products
on a timely basis will not be impaired.
 
     Furthermore, there can be no assurance that the Company will be able to
negotiate additional collaborative arrangements in the future on acceptable
terms, if at all, or that such collaborative arrangements will be successful. To
the extent that the Company chooses not to or is unable to establish such
arrangements, it would experience increased capital requirements to undertake
research, development and marketing of its proposed products at its own expense.
In addition, the Company may encounter significant delays in introducing its
proposed products into certain markets or find that the development, manufacture
or sale of its proposed products in such markets is adversely affected by the
absence of such collaborative agreements. See "Business -- Collaborations and
Strategic Alliances".
 
DEPENDENCE ON KEY PERSONNEL
 
     The Company's success will depend in large part upon its ability to attract
and retain qualified scientific, management, marketing and sales personnel as
well as the continued contributions of its existing senior management, and
scientific and technical personnel. The Company faces strong competition for
such personnel and there can be no assurance that the Company will be able to
attract or retain such individuals. In particular, the loss of the services of
either Arthur J. Benvenuto, the Company's Chairman and Chief Executive Officer,
or Dr. Gail K. Naughton, its President and Chief Operating Officer, would have a
material adverse effect on the Company. The Company has obtained key man life
insurance on the lives of each of Mr. Benvenuto and Dr. Naughton in the amount
of $3 million, $2.5 million of which is payable to the Company. See
"Business -- Management and Directors".
 
PRODUCT LIABILITY CLAIMS AND INSURANCE
 
     The use of any of the Company's products, whether for commercial
applications or during clinical trials, exposes the Company to an inherent risk
of product liability claims in the event such products cause injury, disease or
result in adverse effects. Such liability might result from claims made directly
by health care institutions, contract laboratories or others selling or using
such products. The Company currently maintains product liability insurance
coverage; however, there can be no assurance that the level or breadth of any
insurance coverage will be sufficient to fully cover potential claims. Such
insurance is becoming increasingly expensive and difficult to obtain. There can
be no assurance that adequate insurance coverage will be available in the future
at an acceptable cost, if at all, or in sufficient amounts to protect the
Company against such liability. The obligation to pay any product liability
claim in excess of whatever insurance the Company is able to acquire could have
a material adverse effect on the business, financial condition and future
prospects of the Company.
 
                                       12
<PAGE>   14
 
HAZARDOUS MATERIALS
 
     The Company's research and development activities and operations involve
the controlled use of small quantities of radioactive compounds, chemical
solvents and other hazardous materials. In addition, the Company's business
involves the growth of human tissue samples. Although the Company believes that
its safety procedures for handling and disposing of such materials comply with
the standards prescribed by federal, state and local regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held liable
for any damages that result and any liability could have a material adverse
effect on the Company. See "Business -- Government Regulation".
 
ANTI-TAKEOVER PROVISIONS
 
     The Company's Restated Certificate of Incorporation (the "Certificate")
includes provisions that may discourage or prevent certain types of transactions
involving an actual or potential change in control of the Company, including
transactions in which the stockholders might otherwise receive a premium for
their shares over then-current market prices. The Certificate, for example,
authorizes the Board of Directors to issue shares of Preferred Stock without
stockholder approval on such terms as the Board may determine. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any Preferred Stock that may be issued in the
future. Moreover, such issuance may make it more difficult for a third party to
acquire, or may discourage a third party from acquiring, a majority of the
voting stock of the Company. Further, pursuant to the terms of a stockholder
rights plan adopted in January 1995, the Company has distributed a dividend of
one right for each outstanding share of Common Stock. The rights will cause
substantial dilution of the ownership of a person or group that attempts to
acquire the Company on terms not approved by the Board of Directors and may have
the effect of deterring hostile takeover attempts.
 
POSSIBLE VOLATILITY OF STOCK PRICE
 
     The market price of the Company's Common Stock, like that of the securities
of other biotechnology companies, has fluctuated significantly in recent years
and is likely to fluctuate in the future. From time to time the market for
securities of biotechnology companies has in fact experienced significant price
and volume fluctuations that are unrelated to the operating performance of such
companies. In addition, announcements by the Company or others regarding
scientific discoveries, technological innovations, commercial products, patents
or proprietary rights, the progress of clinical trials or government regulation,
public concern as to the safety of devices or drugs, the issuance of securities
analysts' reports and general market conditions may all have a significant
effect on the market price of the Common Stock. Fluctuations in financial
performance from period to period also may have a significant impact on the
market price of the Common Stock. See "Price Range of Common Stock".
 
POTENTIAL ADVERSE EFFECTS OF SHARES ELIGIBLE FOR FUTURE SALE.
 
     The issuance of freely tradable Common Stock upon the exercise of stock
options and warrants, as well as future sales of Common Stock by existing
stockholders, or the perception that sales could occur, could adversely affect
the market price of the Common Stock. The Company and its officers and directors
have agreed not to sell or otherwise dispose of any shares of Common Stock
beneficially owned by them prior to 180 days from the date of this Prospectus
without the prior written consent of Goldman, Sachs & Co. In addition, certain
other stockholders have agreed not to sell or otherwise dispose of certain
shares of Common Stock beneficially owned by them prior to 60 days from the date
of this Prospectus without the prior written consent of Goldman, Sachs & Co. See
"Underwriting".
 
                                       13
<PAGE>   15
 
                                USE OF PROCEEDS
 
     The net proceeds to the Company from the sale of the 3,000,000 shares of
Common Stock offered by the Company hereby (at an assumed public offering price
of $10.25 per share and after deducting underwriting discounts and commissions
and offering expenses) are estimated to be approximately $28.4 million ($32.8
million if the Underwriters' over-allotment option is exercised in full).
 
     The Company anticipates that the net proceeds of this offering will be used
to fund the scale up of manufacturing, sales and marketing, clinical trials and
continued research and development, and for other general corporate purposes. A
portion of the net proceeds may also be used to invest in joint ventures or
acquire businesses, technology or products that complement the business of the
Company. From time to time, the Company evaluates such joint ventures and
acquisitions of such businesses, technology or products. However, the Company
has no present agreements with respect to any additional material joint ventures
or acquisitions of other businesses, products or technologies. Pending the uses
noted above, the Company intends to invest the net proceeds in short-term,
investment grade, interest-bearing securities. The cost, timing and amount of
funds required for the anticipated uses by the Company cannot be precisely
determined at this time and will be based in part on competitive developments,
the rate of the Company's progress in research and development, the results of
preclinical studies and clinical trials, the timing of regulatory approvals,
payments under collaborative agreements and the availability of alternate
methods of financing. The Board of Directors has broad discretion in determining
how the proceeds of this offering will be applied.
 
                PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
 
     The Company's Common Stock is traded publicly on the Nasdaq National Market
under the symbol "ATIS." The following table sets forth, for the periods
indicated, the last reported high and low closing prices for the Common Stock as
reported by the Nasdaq National Market.
 
<TABLE>
<CAPTION>
                                                                             HIGH     LOW
                                                                             ----     ---
    <S>                                                                      <C>      <C>
    1994
      1st Quarter..........................................................  $ 9 1/4  $7 3/4
      2nd Quarter..........................................................    8 1/8   4 7/16
      3rd Quarter..........................................................    7 5/8   4 5/8
      4th Quarter..........................................................    9 1/4   6 1/4
    1995
      1st Quarter..........................................................  $ 9 1/8  $7
      2nd Quarter..........................................................   10 3/8   5 9/16
      3rd Quarter..........................................................   14 5/8   9 3/4
      4th Quarter..........................................................   11 5/8   8 1/2
    1996
      1st Quarter (through February 22, 1996)..............................  $11 3/8  $9 1/4
</TABLE>
 
     On February 22, 1996, the closing sale price of the Company's Common Stock
as reported by the Nasdaq National Market was $10.25 per share. As of December
31, 1995, there were approximately 1,237 holders of record of the Common Stock.
 
     The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently intends to retain its earnings, if any, for future
growth and, therefore, does not anticipate paying any cash dividends in the
foreseeable future.
 
                                       14
<PAGE>   16
 
                                 CAPITALIZATION
 
     The following table sets forth the capitalization of the Company at
December 31, 1995, and as adjusted to give effect to the receipt by the Company
of the net proceeds from the sale of 3,000,000 shares of Common Stock offered by
the Company hereby (at an assumed public offering price of $10.25 per share and
after deducting underwriting discounts and commissions and offering expenses).
 
<TABLE>
<CAPTION>
                                                                          DECEMBER 31, 1995
                                                                       -----------------------
                                                                        ACTUAL     AS ADJUSTED
                                                                       ---------   -----------
                                                                           (IN THOUSANDS)
<S>                                                                    <C>         <C>
Current portion of capital lease obligations.........................  $      11    $       11
                                                                       =========     =========
Capital lease obligations............................................  $      25    $       25
                                                                       ---------     ---------
Stockholders' equity:
  Preferred Stock, $.01 par value; 1,000,000 shares authorized; none
     issued and outstanding..........................................         --            --
  Common Stock, $.01 par value; 50,000,000 shares authorized;
     33,885,928 shares issued and outstanding; 36,885,928 shares
     issued and outstanding as adjusted(1)...........................        339           369
  Additional paid-in capital.........................................    143,161       171,559
  Deficit accumulated during development stage.......................   (116,681)     (116,681)
                                                                       ---------     ---------
                                                                          26,819        55,247
  Less note received in connection with the sale of Common Stock.....       (919)         (919)
                                                                       ---------     ---------
     Total stockholders' equity......................................     25,900        54,328
                                                                       ---------     ---------
          Total capitalization.......................................  $  25,925    $   54,353
                                                                       =========     =========
</TABLE>
 
---------------
(1) Excludes (i) 1,830,192 shares of Common Stock reserved for future grant
    under the 1992 Plan, (ii) options to purchase an aggregate of 2,317,515
    shares of Common Stock outstanding under the 1992 Plan at a weighted average
    price of $6.28 per share, and (iii) 1,460,299 shares of Common Stock
    issuable upon the exercise of warrants outstanding at a weighted average
    exercise price of $6.77 per share, all at December 31, 1995. Also excludes
    175,000 shares of Common Stock issuable upon the exercise of warrants at an
    exercise price of $10.50 per share issued in February 1996 as a commitment
    fee in connection with the Equity Line. See "Capitalization", "Management's
    Discussion and Analysis of Financial Condition and Results of Operations"
    and Notes 9 and 12 of Notes to the Consolidated Financial Statements.
 
                                       15
<PAGE>   17
 
                                    DILUTION
 
     The net tangible book value of the Company's Common Stock as of December
31, 1995 was $24,868,000 or $0.73 per share of Common Stock. Net tangible book
value per share represents the amount of total tangible assets less total
liabilities, divided by the total number of outstanding shares of Common Stock.
After giving effect to the sale of 3,000,000 shares offered by the Company
hereby and the receipt of net proceeds therefrom (at an assumed public offering
price of $10.25 per share and after deducting underwriting discounts and
commissions and offering expenses), the pro forma net tangible book value of the
Company at December 31, 1995, would have been approximately $53,296,000 or $1.44
per share. This represents an immediate increase in such net tangible book value
of $0.71 per share to existing stockholders and an immediate dilution of $8.81
per share to new investors. The following table illustrates this per share
dilution:
 
<TABLE>
<S>                                                                         <C>       <C>
Assumed public offering price per share...................................            $10.25
  Net tangible book value per share as of December 31, 1995...............  $0.73
  Increase per share attributable to new investors........................   0.71
Pro forma net tangible book value per share after offering................              1.44
                                                                                      ------
Dilution per share to new investors(1)....................................            $ 8.81
                                                                                      ======
</TABLE>
 
     At December 31, 1995, there were options to purchase an aggregate of
2,317,515 shares of Common Stock, at a weighted average exercise price of $6.28
per share, outstanding under the 1992 Plan. In addition (i) at December 31,
1995, there were warrants to purchase an aggregate of 1,460,299 shares of Common
Stock outstanding at a weighted average exercise price of $6.77 per share and
(ii) in February 1996, as a commitment fee in connection with the Equity Line,
the Company issued warrants to purchase 175,000 shares of Common Stock at an
exercise price of $10.50 per share. The computations in the foregoing table
assume no exercise of these stock options or warrants. To the extent these
options or warrants are exercised, there will be further dilution to new
investors. See "Capitalization", "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and Notes 9 and 12 of Notes to
the Consolidated Financial Statements.
---------------
(1) Determined by subtracting the adjusted pro forma net tangible book value per
    share after the offering from the amount of cash paid by a new investor for
    one share of Common Stock.
 
                                       16
<PAGE>   18
 
                      SELECTED CONSOLIDATED FINANCIAL DATA
 
     The statement of operations data set forth below for the years ended
December 31, 1995, 1994 and 1993 and the balance sheet data as of December 31,
1995 and 1994 are derived from, and qualified by reference to, the audited
financial statements included elsewhere and incorporated by reference herein.
The statement of operations data for the eleven months ended December 31, 1992
and the fiscal year ended January 31, 1992, and the balance sheet data as of
December 31, 1993 and 1992 and January 31, 1992 are derived from audited
financial statements not included or incorporated by reference in this
Prospectus. The information presented below should be read in conjunction with
the financial statements and notes thereto presented elsewhere and incorporated
by reference in this Prospectus and "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
 
<TABLE>
<CAPTION>
                                                                           ELEVEN
                                          YEAR ENDED DECEMBER 31,       MONTHS ENDED   YEAR ENDED
                                       ------------------------------   DECEMBER 31,   JANUARY 31,
                                         1995       1994       1993       1992 (1)        1992
                                       --------   --------   --------   ------------   -----------
                                                (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                    <C>        <C>        <C>        <C>            <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
  Product sales(2)...................  $  1,177   $  1,042   $  1,401     $    755       $   488
  Contracts and fees.................     2,388        923      3,493           62            44
  Interest and other.................     1,185      1,250        972        1,393           825
                                       --------   --------   --------     --------       -------
     Total revenues..................     4,750      3,215      5,866        2,210         1,357
                                       --------   --------   --------     --------       -------
Costs and expenses:
  Research and development...........    18,498     16,459     13,810        5,666         3,863
  Selling, general and
     administrative..................     6,115      6,445      6,224        4,778         2,904
  Professional and consulting........     1,897      1,718      1,864        1,121           519
  Cost of goods sold(2)..............     1,359      1,360      1,458          997           624
  Interest...........................         6          8          1          165           252
  Stockholder interest and other.....        --         --        200           73            --
  In-process technology(3)...........        --         --         --       21,400            --
                                       --------   --------   --------     --------       -------
     Total costs and expenses........    27,875     25,990     23,557       34,200         8,162
                                       --------   --------   --------     --------       -------
Net loss.............................  $(23,125)  $(22,775)  $(17,691)    $(31,990)      $(6,805)
                                       ========   ========   ========     ========       =======
Net loss per share...................  $   (.72)  $   (.75)  $   (.67)    $  (1.40)      $  (.36)
                                       ========   ========   ========     ========       =======
Weighted average shares used in the
  computation of net loss per
  share..............................    32,266     30,250     26,453       22,896        18,691
                                       ========   ========   ========     ========       =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                    AS OF DECEMBER 31,                  AS OF
                                        ------------------------------------------   JANUARY 31,
                                          1995        1994       1993     1992(1)        1992
                                        ---------   --------   --------   --------   ------------
                                                             (IN THOUSANDS)
<S>                                     <C>         <C>        <C>        <C>        <C>
BALANCE SHEET DATA:
Cash, cash equivalents and
  short-term investments..............  $  18,929   $ 22,033   $ 21,693   $ 34,970     $ 15,005
Working capital.......................     15,747     19,037     17,529     34,404       13,871
Total assets..........................     31,141     33,426     30,363     40,096       19,521
Long-term debt........................         25         36         46         --        1,409
Deficit accumulated during
  development stage...................   (116,681)   (93,556)   (70,781)   (53,090)     (21,100)
Stockholders' equity..................     25,900     28,350     24,863     38,089       16,204
</TABLE>
 
---------------
(1) The Company changed from a January 31 fiscal year end to a December 31
    calendar year end in 1992 resulting in an 11-month reporting period ended
    December 31, 1992.
(2) Attributable to sales of the Company's Skin(2) laboratory testing kits.
(3) The nonrecurring charge to in-process technology of $21.4 million relates to
    the acquisition of Neomorphics. See Note 8 of Notes to the Consolidated
    Financial Statements.
 
                                       17
<PAGE>   19
 
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
OVERVIEW
 
     Advanced Tissue Sciences is a development stage company engaged in the
development and manufacture of living human tissue products for therapeutic
applications. The Company has incurred, and expects to continue to incur,
substantial and increasing expenditures in support of the development and
clinical trials of its Dermagraft products for burn and skin ulcer applications,
in developing manufacturing systems and facilities for the production and
commercialization of Dermagraft, in building its sales and marketing
capabilities, and in advancing other applications of the Company's core
technology.
 
     In addition to its Dermagraft skin products, the Company is focusing its
resources on the development of tissue engineered cartilage and cardiovascular
products. These activities have been supported by a variety of strategic
relationships over the past several years. In May 1994, the Company entered into
a joint venture with Smith & Nephew plc ("Smith & Nephew") for the worldwide
development, manufacture and marketing of human tissue engineered cartilage for
orthopedic applications. Over the past two years, the Company had worked with
St. Jude Medical, Inc. ("St. Jude Medical") on the development of tissue
engineered heart valves. In early 1996, St. Jude Medical elected not to enter
into a licensing agreement and accordingly, the Company is currently funding all
of its cardiovascular research and development activities internally. Since
September 1992, the Company has sponsored early stage research programs at the
Massachusetts Institute of Technology ("MIT") and Children's Hospital in Boston
("Children's Hospital") directed toward the tissue engineering of cartilage,
liver and numerous other tissues and several polymer technologies. See Note 3 of
Notes to the Consolidated Financial Statements.
 
   
     This Prospectus contains forward-looking statements within the meaning of
the Securities Act of 1933 and the Securities Exchange Act of 1934. The
Company's actual results could differ materially from those projected in the
forward-looking statements as a result of the factors described in "Risk
Factors" and included elsewhere in this Prospectus.
    
 
RESULTS OF OPERATIONS
 
  YEARS ENDED DECEMBER 31, 1995 AND 1994
 
     Revenues increased $1,535,000 to $4,750,000, or approximately 48%, during
1995 as compared to 1994. In 1995, the Company recognized contract revenues of
$1,548,000 and $830,000, respectively, from its joint venture with Smith &
Nephew and from St. Jude Medical for research performed related to orthopedic
applications of cartilage tissue and tissue engineered heart valves as compared
to $893,000 from the Smith & Nephew joint venture in 1994. The Company
internally funded its cardiovascular research in 1994. Revenues for 1995 also
reflect a $74,000 decrease in interest income as compared to 1994 as higher
rates earned on invested funds were more than offset by lower average invested
balances.
 
     Revenues also include sales of the Company's Skin2 laboratory testing kits
which increased $135,000, or approximately 13%, in 1995 as compared to 1994.
Sales in 1994 were limited by product availability due to manufacturing issues
in the second and third quarters. Product sales fluctuate depending on the
number and timing of validation studies initiated either by the Company or third
parties. Product sales include revenues received under validation studies of
$379,000 and $259,000, respectively, in 1995 and 1994. Revenues in calendar 1994
also include approximately $51,000 in deferred sales which were recognized upon
regulatory approval of the Skin2 kits for use in classifying corrosive
materials.
 
     Research and development expenditures have increased from $16,459,000 in
1994 to $18,498,000 in 1995, approximately a 12% increase. The increase in
research and development
 
                                       18
<PAGE>   20
 
costs reflects higher costs associated with the use and validation of the
Company's commercial manufacturing facility, the production of Dermagraft
products for clinical trials and the scale up of the Dermagraft manufacturing
processes. In addition, the Company incurred higher costs in support of the
development of orthopedic cartilage and cardiovascular products for the Smith &
Nephew joint venture and St. Jude Medical research programs discussed above. The
increased costs in 1995 are principally reflected in higher costs for outside
engineering services and overhead. The increases were partially offset by lower
costs for preclinical studies of Dermagraft and of liver tissues, and for
research related to a stem cell growth factor. Research and development costs
are expected to continue to increase in 1996 in support of process scale up, the
validation of manufacturing equipment, continuing clinical trials, and cartilage
and cardiovascular product development.
 
     Selling, general and administrative costs were $6,115,000 in 1995, a
decline of $330,000, or approximately five percent, from $6,445,000 in 1994. The
decrease in selling, general and administrative expenses primarily reflects a
slightly lower number of personnel and a decrease in associated costs.
 
     Professional and consulting costs for legal, accounting and other
consulting services were $1,897,000 in 1995 as compared to $1,718,000 in 1994.
The increase of $179,000, or approximately 10%, in 1995 reflects fees for
consultants in support of corporate development activities and higher fees for
recruiting personnel partially offset by lower fees for scientific consultants.
Calendar 1994 also included higher fees for legal matters, primarily as a result
of corporate development activities.
 
     Cost of goods sold represents direct and indirect costs of manufacturing
the Company's Skin2 laboratory testing kits. Cost of goods sold is net of the
costs of products transferred to research and development for use in developing
additional applications of the Company's testing kits. The cost of such products
is included in research and development expenses based upon estimated direct and
indirect production costs assuming planned production capacity.
 
  YEARS ENDED DECEMBER 31, 1994 AND 1993
 
     Revenues declined 45% from $5,866,000 to $3,215,000 in 1994 as compared to
1993. During 1994, the Company received $893,000 in research funding related to
the joint venture with Smith & Nephew, while 1993 included a commitment fee and
research funding of $3,272,000 under an agreement with Kirin Brewery Company,
Limited ("Kirin") related to research on a stem cell growth factor. No such
funds were received in 1994 and the agreement with Kirin was terminated in 1995.
See Note 3 of Notes to the Consolidated Financial Statements. As discussed
below, revenues also reflect a 26% decline in sales of the Company's Skin2
laboratory testing kits from $1,401,000 in 1993 to $1,042,000 in 1994. These
declines were partially offset by a $314,000 increase in interest income during
1994 due to higher average invested balances and higher rates earned on such
investments as compared to 1993.
 
     The decline in Skin2 sales in 1994 primarily reflects limited product
availability due to manufacturing issues in the second and third quarters.
Product sales include revenues received under validation studies of $259,000 and
$250,000 in 1994 and 1993, respectively. Calendar year 1994 also includes
approximately $51,000 in sales deferred from 1993 which were recognized upon
regulatory approval of the Skin2 kits for use in classifying corrosive
materials.
 
     Research and development expenditures increased significantly, or
approximately 19%, from $13,810,000 to $16,459,000 in 1994 as compared to 1993.
Research and development expenditures during 1994 increased primarily due to
costs for, and associated with, the production of Dermagraft for preclinical and
clinical trials, process development expenditures for the scale up of Dermagraft
manufacturing and the clinical trials for Dermagraft products. In addition,
costs increased with respect to research and development of cartilage tissues as
a result of the joint venture with Smith & Nephew and for heart valves as a
result of the agreement with St. Jude Medical, as well as due to costs related
to the development of a growth factor and of liver and bone marrow tissues.
 
                                       19
<PAGE>   21
 
Specifically, the increased costs are principally reflected in higher costs for
personnel, material and supplies, and overhead.
 
     Selling, general and administrative costs were $6,445,000 and $6,224,000 in
1994 and 1993, respectively, an increase of approximately four percent. The
increase in selling, general and administrative expenses primarily relates to
higher costs for increased personnel and salaries, and associated overhead
costs, partially offset by lower relocation costs.
 
     Professional and consulting costs for legal, accounting and other
consulting services incurred in 1994 and 1993 were $1,718,000 and $1,864,000,
respectively. Calendar 1994 included higher fees for scientific consultants,
while 1993 included higher fees for recruiting personnel, legal fees and
marketing and regulatory consultants.
 
     Cost of goods sold decreased from $1,458,000 to $1,360,000 as the number of
kits sold declined during 1994 as compared to 1993, a decrease of approximately
seven percent. Cost of goods sold in 1993 also includes costs associated with a
move to a new manufacturing facility.
 
     In 1993, shareholder interest and other includes a $200,000 charge for
foreign taxes on the commitment fee received under the agreement with Kirin
referred to above.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     In June and July 1995, the Company sold 2,614,432 shares of Common Stock in
a series of private placements, resulting in net proceeds of $20.3 million,
$677,000 of which was received in January 1996 and, accordingly, is not
reflected in the accompanying balance sheet for the year ended December 31,
1995. The purchase prices ranged from $8.11 to $8.62 per share. See Note 8 of
Notes to the Consolidated Financial Statements.
 
     As of December 31, 1995, the Company had available working capital of
$15,747,000, a decrease of $3,290,000 from December 31, 1994. The decrease
principally reflects funds used for operations and capital expenditures
substantially offset by the net proceeds from sales of Common Stock. Capital
expenditures were $1,476,000 in 1995, a significant portion of which was related
to the validation of the Company's manufacturing facility and the acquisition of
information systems. The Company expects to continue to incur substantial
research and development expenses (including costs associated with clinical
trials and the development of manufacturing processes), growing costs in
anticipation of product commercialization, and additional expenditures for
capital equipment (including increased expenditures for manufacturing equipment)
and patents.
 
     In February 1996 the Company entered into an Investment Agreement with a
newly formed investment group for an equity line which allows the Company to
access up to $50 million through sales of its Common Stock (the "Equity Line").
The Equity Line will remain available for a period of two years. The decision to
draw any funds under the Investment Agreement and the timing of any such draw
are solely at the Company's discretion. The Investment Agreement provides that
the Company can obtain up to $15 million at any one time through the sale of its
Common Stock. Any sales against the Equity Line will be at a five percent
discount to the average low sales prices of the Company's Common Stock over a
specified period of time as determined by market volume at the time of the draw.
The Company's ability to draw under the Investment Agreement is subject to
certain conditions including, but not limited to, registration of the shares, a
minimum trading price of $2.00 per share, and certain limitations on the number
of shares of Common Stock held by the investment group. If this offering is
consummated, the Company has agreed it will not draw on the Equity Line for a
period of 180 days from the date of this Prospectus without the prior written
consent of Goldman, Sachs & Co. See "Underwriting" and Note 12 of Notes to the
Consolidated Financial Statements.
 
     The Company believes that its working capital, together with either the net
proceeds of this offering or the availability of funds under the Equity Line,
will be sufficient to meet its present
 
                                       20
<PAGE>   22
 
operating and capital requirements for at least the next 12 months. The Company
is also pursuing strategic alliances which could provide additional funding to
the Company.
 
     The Company continually reviews its product development activities in an
effort to allocate its resources to those products the Company believes have the
greatest commercial potential. Factors considered by the Company in determining
the products to pursue include projected markets and need, potential for
regulatory approval and reimbursement under the existing health care system as
well as anticipated health care reforms, technical feasibility, expected and
known product attributes and estimated costs to bring the product to market.
Based on these and other factors which the Company considers relevant, the
Company may from time to time reallocate its resources among its product
development activities. Additions to products under development or changes in
products being pursued can substantially and rapidly change the Company's
funding requirements.
 
     To the extent necessary, further sources of funds may include existing or
future strategic alliances or other joint venture arrangements which provide
funding to the Company, and additional public or private offerings of debt or
equity securities, among others. There can be no assurance, however, that any
additional funds will be available when needed or on terms favorable to the
Company, or that the Company will be successful in entering into any other
strategic alliances or joint ventures.
 
FINANCIAL CONDITION
 
     Cash, cash equivalents and short-term investments as of December 31, 1995
have decreased by $3,104,000 from December 31, 1994 as funds used in operations
were significantly offset by the net proceeds from the private placements
discussed above. Other assets increased $663,000 to $814,000 from December 31,
1994 to December 31, 1995 primarily reflecting deposits for process equipment
and molds for Dermagraft manufacturing. Accounts payable has decreased
significantly from $1,850,000 at December 31, 1994 to $1,183,000 at December 31,
1995 principally reflecting the timing of payments for clinical trials, for
sponsored research and rent. Accrued expenses have increased $842,000 over the
same period reflecting accruals for process engineering, salaries and benefits,
and clinical studies. Stockholders' equity decreased $2,450,000 from December
31, 1994 to December 31, 1995, reflecting a net loss for the year that was
substantially offset by proceeds from sales of equity, including the exercise of
options.
 
                                       21
<PAGE>   23
 
                                    BUSINESS
 
OVERVIEW
 
     Advanced Tissue Sciences, Inc. (the "Company" or "Advanced Tissue
Sciences") is a leading tissue engineering company engaged in the development of
living human tissue products for therapeutic applications. The Company is
primarily focusing its efforts on skin, cartilage and cardiovascular products.
Utilizing principles of cell biology, biochemistry and polymer science, the
Company has developed and is applying its patented core technology which permits
living human cells to be cultured ex vivo in a manner that allows the cells to
develop and assemble into a functioning three-dimensional tissue. The Company
has successfully replicated a variety of human tissues and has a number of
products under various stages of development. See "-- Products".
 
     Advanced Tissue Sciences' objective is to redefine tissue repair and
transplantation by developing, manufacturing and marketing human tissue
replacement products produced through tissue engineering. The Company's product
strategy is to utilize its patented core technology to develop multiple products
which address unmet therapeutic needs or offer improved, cost-effective
alternatives to current treatment modalities. By building upon its base of
scientific knowledge through the continued application of its core technology,
the Company believes it will achieve significant synergies in the development,
clinical testing and manufacture of successive tissue products. In addition, the
Company is focusing its development programs on products which are currently
being or are expected to be regulated as medical devices. Medical devices are
generally subject to shorter regulatory approval processes than biologics or
pharmaceuticals. The Company is developing marketing and reimbursement
strategies, establishing a direct sales organization and pursuing strategic
alliances, to market future commercial products.
 
   
     Leading the Company's product development efforts are therapeutic skin
products that address the burn and diabetic foot ulcer markets. These products,
based on Dermagraft, a three-dimensional living human tissue by the Company
designed as a temporary or permanent replacement for human dermis, were
developed to treat conditions where the dermis (the inner skin layer) has been
injured or destroyed, such as in severe burns and chronic skin ulcers. The
dermis is essential to normal skin function and healing and, unlike the
epidermis (the outer layer of skin), does not regenerate into normal tissue
after injury. The Company has two lead products currently in pivotal clinical
trials, Dermagraft-TC and Dermagraft-Ulcers. The Company expects to submit a PMA
application to the FDA for Dermagraft-TC in the first half of 1996 and for
Dermagraft-Ulcers to treat diabetic foot ulcers in late 1996. The FDA has
notified the Company that it intends to review the PMA applications for both
products on an expedited basis.
    
 
  LEADING PRODUCTS UNDER DEVELOPMENT
 
     The following table summarizes the lead products under development by the
Company.
 
<TABLE>
<CAPTION>
                                                                                   STATUS OF
        PRODUCT                        THERAPEUTIC INDICATION                    DEVELOPMENT(1)
-----------------------    ----------------------------------------------    ----------------------
<S>                        <C>                                               <C>
BURNS
  Dermagraft-TC            Temporary covering for severe burns               Pivotal clinical
SKIN ULCERS
  Dermagraft-Ulcers        Dermal replacement for diabetic foot ulcers       Pivotal clinical
ORTHOPEDICS
  Articular Cartilage      Repair of articular surfaces in joints            Pivotal preclinical
  Meniscal Cartilage       Meniscus repair and replacement                   Pilot preclinical
CARDIOVASCULAR
  Heart Valves             Heart valve replacements                          Pilot preclinical
  Blood Vessels            Blood vessel replacements                         Pilot preclinical
</TABLE>
 
------------------------
(1) A "pivotal clinical" trial denotes a human trial intended to support an
    application to the FDA for approval to market a
    product. A "pivotal preclinical" trial denotes an animal trial intended to
    support an application to the FDA for approval to commence human clinical
    trials. A "pilot preclinical" trial denotes animal trials intended to
    evaluate a product's characteristics prior to beginning pivotal preclinical
    trials.
 
                                       22
<PAGE>   24
 
     DERMAGRAFT-TC.  Dermagraft-TC has been developed as an alternative to human
cadaver skin to treat severely burned patients. Dermagraft-TC, consisting of a
dermal tissue with an ultrathin synthetic covering, acts as a protective cover
to help retain fluids and reduce the risk of infection until a sufficient amount
of the patient's own skin becomes available for grafting. Of the approximately
70,000 burn patients hospitalized annually in the United States, approximately
13,000 are severely burned and require skin grafts. The Company's Dermagraft-TC
product is initially intended to address the approximately 1,500 severely burned
patients with burns exceeding 20% body surface area. The Company estimates the
total initial United States market opportunity for this indication to be
approximately $30 million.
 
   
     In December 1995, the Company reported that data from the pivotal clinical
trial of Dermagraft-TC achieved statistical significance (p<0.01) with respect
to its primary endpoint, the ability of the Company's product to adequately
prepare the wound beds for successful autografting. Based on these results, the
Company is preparing and expects to submit a PMA application to the FDA during
the first half of 1996. In addition, the FDA has notified the Company that it
intends to review the PMA application for Dermagraft-TC on an expedited basis,
potentially accelerating the regulatory review period. See "-- Products -- Burn
Products".
    
 
     DIABETIC FOOT ULCERS.  Dermagraft-Ulcers is a dermal replacement product
grown on a bioabsorbable scaffold and is designed to provide a healthy,
metabolically active dermal matrix in the ulcer to support wound closure.
Approximately 800,000 diabetic foot ulcer patients are treated in the United
States each year, 400,000 of which represent the Company's initial target
market. Based on data from outside sources, it is estimated that the total
United States market opportunity for this targeted indication potentially
exceeds $1 billion.
 
     Enrollment in the pivotal clinical trial of Dermagraft-Ulcers for diabetic
foot ulcers in the United States is nearly complete. The primary endpoint in the
pivotal trial is complete wound closure. A planned interim analysis of this data
showed that the clinical trial was on track to achieve the primary endpoint.
Upon completion of the trial, all trial data will be evaluated for statistical
significance. If the results of the completed trial are consistent with the
results shown in the interim analysis, the Company expects to submit a PMA
application to the FDA in late 1996. After the interim analysis, the FDA
notified the Company that the PMA application for Dermagraft-Ulcers in the
treatment of diabetic foot ulcers will also receive expedited review. In an
earlier pilot trial, the Dermagraft-Ulcers patients receiving one piece of
Dermagraft-Ulcers per week for eight weeks showed a statistically significant
improvement in complete wound closure. In addition, patients healed in the pilot
trial treated with Dermagraft-Ulcers had no recurrence of their ulcers after
being followed for an average of 14 months. By contrast, published reports have
indicated rates of recurrence ranging from 20% to 50% within the first year
following healing. The Company is pursuing strategic alliances with corporate
partners to accelerate the commercialization of Dermagraft-Ulcers, assuming
receipt of appropriate regulatory approvals. See "-- Products -- Skin Ulcer
Products".
 
     ORTHOPEDICS.  The Company has successfully replicated cartilage tissue ex
vivo using the Company's proprietary three-dimensional culture system. Through a
joint venture with Smith & Nephew plc ("Smith & Nephew"), the Company is
developing several orthopedic applications of tissue engineered cartilage. The
joint venture is currently in a pivotal preclinical trial for articular
resurfacing which, if successfully completed, is expected to lead to human
clinical trials in 1997. Pilot preclinical trials of tissue engineered meniscus
have shown successful repair of meniscus defects in subjects followed for up to
one year. There are over 1.2 million arthroscopic procedures for repair of the
knee performed annually in the United States, including procedures involving
articular cartilage, meniscus and ligament. See "-- Products -- Orthopedics
Products" and "-- Collaborations and Strategic Alliances".
 
     CARDIOVASCULAR.  Through the use of its tissue engineering technology,
Advanced Tissue Sciences is working on developing cardiovascular products that
will grow and repair normally. Over the past year, the Company has made
substantial progress in developing dynamic bioreactors for
 
                                       23
<PAGE>   25
 
growing tissue engineered heart valves and blood vessels. In the United States,
over 900,000 Americans die each year from cardiovascular disease and over 60,000
prosthetic heart valves are implanted and over 430,000 vascular graft procedures
are performed in the United States. See "-- Products-- Cardiovascular Products".
 
  PATENTED CORE TECHNOLOGY
 
     The Company's tissue engineering technology involves the controlled ex vivo
growth of living human tissues and organs on three-dimensional support
structures. The Company believes that its technology represents a major advance
in medical science. Over the last several decades, technologies have been
developed that have made possible the growth of many of the over 200 different
types of cells found in the human body. When grown on two-dimensional surfaces,
the ability of cells to interact and organize themselves into functioning
tissues is limited. In contrast, a three-dimensional framework allows cells to
develop and assemble into tissues that more closely resemble their counterparts
in the body.
 
     In normal growth and development, the body uses specialized connective
tissue cells to form "stroma" or a living matrix that provides the
three-dimensional structure for each organ. Stroma also provides attachment
sites and produces growth factors that promote the development of organ cells
into functioning tissues. While the specific components and configuration of
stroma may differ from organ to organ, the basic principle of three-dimensional
stromal support applies to most organs in the body.
 
     The Company has developed a patented core technology that combines the
principles of cell biology, biochemistry and polymer science to create a
three-dimensional living support stroma ex vivo. The support stroma is made by
first seeding organ-specific stromal cells (cell biology) onto a mesh framework
(polymer science) in an environment that simulates the body. The cells attach,
divide and secrete extracellular matrix proteins and growth factors
(biochemistry), using the mesh as a scaffolding. The process results in a
completely human stromal tissue that, in turn, supports the growth of organ
cells into functional tissue. Advanced Tissue Sciences has been issued United
States and European patents covering its core technology and numerous patents
related to applications of such technology. See "-- Patents and Proprietary
Rights".
 
     The Company believes that its tissue engineered products may offer some or
all of the following benefits, depending upon the particular application of the
product:
 
     - Physiological Human Tissue -- The Company's patented core technology
       allows cells to grow on a scaffold to develop into a three-dimensional
       human tissue. The Company's products may then be transplanted as a
       physiological tissue, as contrasted with the transplantation of cells or
       scaffolds alone.
 
     - Multiple Factors For Healing -- The human cells produce multiple growth
       factors and tissue matrix proteins, all of which are believed to be
       important in the tissue repair process.
 
     - Completely Human Tissue -- The tissue matrix proteins naturally secreted
       by the cells consist of human collagens, glycosaminoglycans and other
       human proteins, rather than animal-derived matrix proteins, which may
       cause allergic or immune reactions which can occur in response to
       animal-derived matrix proteins.
 
     - Safety Tested -- The human tissue materials used in the manufacture of
       the Company's products are extensively tested at independent laboratories
       for potential pathogens such as Hepatitis B and HIV. All final product is
       tested for sterility by performing United States Pharmacopeia (U.S.P.)
       sterility tests on each product's growth medium.
 
     - Off-the-Shelf Products -- Medical research has shown that several
       tissues, including dermal tissue and certain cartilage tissue
       applications, are not subject to rejection by a recipient's
 
                                       24
<PAGE>   26
 
       body. Products engineered from these tissues may, therefore, be utilized
       as universal, permanent replacement products in such applications.
 
     - Prolonged Shelf Life -- The Company's dermal products can be frozen for
       long-term storage. Similarly, it is expected that cartilage and some of
       the other tissues in development will be able to be cryopreserved for
       prolonged shelf life.
 
     - Ease of Use -- The Company's dermal products are easy for physicians to
       apply using routine medical techniques. In addition, tissue engineered
       cartilage is being developed to be delivered in a single arthroscopic
       procedure.
 
                                       25
<PAGE>   27
 
PRODUCTS
 
     The Company has a number of therapeutic tissue products which are in
various stages of clinical trials, preclinical studies and research. Currently,
its primary product focus is directed toward skin (for burns and ulcers),
orthopedic cartilage and cardiovascular products. In addition, based on
available resources, clinical results, markets and other cost benefit
considerations, the Company intends to bring other potential products to market
in the future. The following table summarizes the potential applications and
stages of development of these therapeutic products.
--------------------------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                                                 STATUS OF
            PRODUCT                       THERAPEUTIC INDICATION             DEVELOPMENT(1)(2)
-------------------------------  -----------------------------------------  --------------------
<S>                              <C>                                        <C>
BURNS
  Dermagraft-TC                  Temporary covering for severe burns        Pivotal clinical
  Dermagraft-Burns               Dermal replacement for severe burns        Pilot clinical
  Dermagraft-Epidermis           Full thickness skin replacement for burns  Pilot preclinical
SKIN ULCERS
  Dermagraft-Ulcers              Dermal replacement for diabetic foot       Pivotal clinical
                                   ulcers
  Dermagraft-Ulcers              Dermal replacement for pressure ulcers     Pilot clinical
  Dermagraft-Ulcers              Dermal replacement for venous ulcers       Pivotal clinical
ORTHOPEDICS
  Articular Cartilage            Repair of articular surfaces in joints     Pivotal preclinical
  Meniscal Cartilage             Meniscal repair and replacement            Pilot preclinical
  Ligament                       Ligament repair or replacement             Pilot preclinical
  Tendon                         Tendon repair or replacement               Pilot preclinical
  Bone                           Bone grafting                              Pilot preclinical
CARDIOVASCULAR
  Heart Valves                   Heart valve replacements                   Pilot preclinical
  Blood Vessels                  Blood vessel replacements                  Pilot preclinical
  Stents                         Restenosis prevention                      Research
OTHER THERAPEUTIC TISSUES
  Reconstructive Applications-
     Cartilage                   Facial reconstruction                      Pilot preclinical
     Bone                        Facial reconstruction                      Pilot preclinical
     Dermagraft                  Scar revision/temporary wrinkle removal    Research
  Liver                          Bridge to transplantation or replacement   Pilot preclinical
  Bone Marrow                    Universal bone marrow replacement          Pilot preclinical
  Pancreas                       Metabolically active tissue for            Pilot preclinical
                                   transplantation
  Gastrointestinal               Replacements/patches for gastrointestinal  Pilot preclinical
                                   tract
</TABLE>
 
---------------
(1) A "pivotal clinical" trial denotes a human trial intended to support an
    application to the FDA for approval to market a product. A "pilot clinical"
    trial denotes a human trial intended to evaluate a product's safety and
    efficacy prior to beginning a pivotal clinical trial. A "pivotal
    preclinical" trial denotes an animal trial intended to support an
    application to the FDA for approval to commence human clinical trials. A
    "pilot preclinical" trial denotes animal trials intended to evaluate a
    product's characteristics prior to beginning pivotal preclinical trials.
    "Research" denotes product development prior to studies in animal models.
 
(2) See "-- Burn Products", "-- Skin Ulcer Products", "-- Orthopedic Products"
    and "-- Cardiovascular Products" with respect to those programs that are
    being advanced and those programs that may be advanced subject to the
    availability of additional resources and other factors.
--------------------------------------------------------------------------------
 
                                       26
<PAGE>   28
 
  BURN PRODUCTS
 
     Although there have been many advances in the care and treatment of
severely burned patients, there are limited treatment alternatives and success
is highly dependent on the skills of burn surgeons and nurses. As a result of
the need for improvements in patient care and the ability to closely monitor
product performance, the Company selected severe burns as the target for its
first therapeutic use of the Company's tissue engineering technology. In
addition, dermal tissue has several advantages over other tissues or organs in
that it is grown from fibroblast cells, which are both readily available and not
subject to rejection by the body. The Company's burn products are also regulated
as devices and, therefore, are generally subject to a shorter regulatory
approval process than biologics. See "-- Government Regulation".
 
     Currently, to treat large full thickness burns (where both the epidermis
and the dermis are destroyed), burn surgeons typically excise the damaged tissue
and cover the wound as soon as possible. Conventional treatment for large full
thickness burns usually involves the use of temporary coverings to limit
infection, reduce pain and prevent loss of body fluids, followed by grafting of
the patient's own skin ("autograft") as it becomes available. In most cases,
permanent closure of severe burn wounds is achieved with autografts obtained by
surgically harvesting areas of the patient's skin which are still intact ("donor
sites"). The dermis at the donor site is typically "split" so that the removed
graft consists of the entire epidermis and the upper portion of the dermis (a
"split-thickness" graft), leaving the bottom portion of the dermis in the donor
site to facilitate healing.
 
     BURN MARKET.  Of the approximately 70,000 burn patients hospitalized
annually in the United States, approximately 13,000 are severely burned and
require skin grafts. Initially, the Company's Dermagraft-TC and Dermagraft-Burns
products would be expected to address the approximately 1,500 severely burned
patients requiring skin grafts with burns exceeding 20% body surface area. The
Company may be able to expand beyond this initial market segment if additional
benefits, such as reduced scarring, can be realized. The Company estimates the
total initial United States market opportunity for this indication to be
approximately $30 million.
 
     DERMAGRAFT-TC.  Patients with extensive full thickness burns have only a
limited amount of undamaged skin that can be used as donor sites for autografts.
This shortage of donor sites prevents rapid closure of the burn wounds leaving
the patient susceptible to infections and fluid loss, both of which can be
life-threatening. When sufficient autograft is not available, human cadaver skin
is often used as a temporary covering for excised burns. However, cadaver skin
may be in short supply, can transmit infection and disease, and often is
immunologically rejected within several weeks of application. As a result, the
patient may require additional surgical procedures to cover the wound,
increasing the overall cost of treatment. Rejection can also give rise to
complicating infections of the burn wounds.
 
     As an alternative to human cadaver skin, the Company has developed
Dermagraft-TC. Dermagraft-TC, consisting of Dermagraft dermal tissue with an
ultrathin synthetic covering, acts as a temporary epidermis to help retain
fluids and prevent infections of the wound bed. As with cadaver skin,
Dermagraft-TC must ultimately be removed from the wound bed prior to grafting.
However, the Company believes that Dermagraft-TC may offer certain advantages
over cadaver skin, such as no immunological rejection, longer-term wound
coverage and availability in large amounts. In addition, the human tissue
materials used in the manufacture of Dermagraft products, including
Dermagraft-TC, are extensively tested for potential pathogens such as Hepatitis
B and HIV.
 
     In December 1995, the Company reported that data from the pivotal clinical
trial of Dermagraft-TC achieved statistical significance (p< 0.01) with respect
to its primary endpoint, the ability of the Company's product to adequately
prepare the wound beds for successful autografting. In the pivotal trial,
Dermagraft-TC was compared to cryopreserved (frozen) human cadaver skin in 66
patients enrolled in 12 burn centers. The objective of the trial was to show
that Dermagraft-TC is equal to or better than cadaver skin when used as a
temporary covering for severe burns prior to
 
                                       27
<PAGE>   29
 
autografting. The Company is also following as many patients as possible for up
to one year after autografting to evaluate the quality of the wound healing.
 
   
     Based on the results of the pivotal trial, the Company is preparing and
plans to submit a PMA application for Dermagraft-TC to the FDA during the first
half of 1996. In addition, the FDA has notified the Company that it intends to
review the PMA application for Dermagraft-TC on an expedited basis. Expedited
review status means the FDA will give the marketing application for
Dermagraft-TC a priority review over other pending applications. However, there
can be no assurance that such status will accelerate the review process, or that
such status will not be rescinded by the FDA if products of other companies that
have already received FDA approval, or which receive FDA approval prior to the
Company's receiving its approval, are deemed by the FDA to perform substantially
the same functions or to provide comparable benefits. As with any PMA
application, FDA approval will require valid scientific evidence obtained from
well-designed, monitored and controlled clinical trials. There can be no
assurance, however, that Dermagraft-TC will satisfy the safety and efficacy
requirements of the FDA necessary to obtain approval or that the FDA will accept
for filing or approve the Company's PMA application in a timely manner. See
"-- Competition" and "-- Government Regulation".
    
 
     The Company also has an agreement with Battelle, a contract research
laboratory, and the U.S. Army Institute of Chemical Defense to begin preclinical
feasibility testing of Dermagraft-TC in the treatment of chemical burns. The
feasibility study is expected to be completed during 1996. FDA approval will
also be required in order to make Dermagraft-TC available for use in treating
chemical burns.
 
     DERMAGRAFT-BURNS.  Dermagraft-Burns is a dermal replacement product grown
on a biodegradable scaffold to be placed beneath an autograft. The Company
believes the Dermagraft-Burns product complements Dermagraft-TC as it is
designed to be placed in the burn immediately after the removal of the temporary
covering and, also, would be marketed by a common sales force. By providing a
dermal replacement, Dermagraft-Burns may potentially offer stronger attachment
and support of the overlying autograft, reduce scarring at the burn site, and
allow for the use of thinner autografts potentially reducing the patient's
overall hospital stay.
 
     The Company performed a series of randomized, multi-center clinical trials
of Dermagraft-Burns from January 1991 to mid-1994. These trials were directed
toward a Dermagraft-Burns product that would attach and vascularize reliably on
a variety of wound beds and allow for epithelialization from meshed grafts of
the patient's own skin, while achieving a "take", or attachment and survival, of
the autograft placed over Dermagraft-Burns as high as autografts placed directly
on the burn. In order to accelerate the commercial development of a burn
product, the Company elected to focus its patient enrollment efforts and
resources on Dermagraft-TC. As a result, no patients have been enrolled in the
Dermagraft-Burns trials since mid-1994. At this time, the Company cannot predict
when or if it will continue clinical trials of its Dermagraft-Burns product.
 
     DERMAGRAFT-EPIDERMIS.  The Company has explored a variety of concepts
involving a Dermagraft product for burns providing both an epidermal and a
dermal layer that could be used as a full thickness skin replacement. The
Company has performed research using modifications of the Company's current burn
products in combination with a patient's own epidermal cells. In addition, the
Company has conducted preclinical studies with epidermal sheets grown from a
small specimen of a patient's skin. Epidermal sheets grown by other companies
are sometimes used in patients whose burns are so extensive that sufficient
autograft skin cannot be harvested. Combined with a tissue engineered dermis,
such epidermal sheets could be used as a full-thickness skin replacement that
may improve cosmetic outcome.
 
  SKIN ULCER PRODUCTS
 
     Based on its initial experience with Dermagraft-Burns, chronic skin ulcers
were also selected as one of the Company's first therapeutic targets. The
Company believes that Dermagraft-Ulcers may provide a healthy, metabolically
active dermal matrix in the ulcer bed that will support growth of the
 
                                       28
<PAGE>   30
 
patient's epidermis from the edges of the wound and promote wound closure.
Dermagraft-Ulcers may therefore reduce the time required to heal these wounds
and potentially reduce the need for skin grafting and reconstructive procedures.
Using Dermagraft, the Company is able to benefit from the experience it has
gained from the development of the Dermagraft-Burns product, including the use
of common raw materials (i.e., cell source, scaffolds, growth media),
manufacturing processes, freezing procedures, storage methods and packaging
concepts. No safety concerns or incidents of immunologic rejections have been
observed with any Dermagraft-based product. Dermagraft-Ulcers is regulated by
the FDA as a medical device.
 
     Traditionally, there have been two approaches to skin ulcer treatment. The
most common treatment for less advanced ulcers is to allow normal healing to
occur by using dressings and topical medications to protect the wound. Even when
successful, this therapy can require many months of repeated treatments to
achieve healing. The second approach utilizes conventional skin grafts and is
typically used for more advanced skin ulcers. The difficulty of healing donor
sites and the risks associated with general anesthesia in the elderly, who
suffer a majority of chronic skin ulcers, often prevent the use of skin grafts
for these patients. Both treatment approaches have a high failure rate. The
Company has developed Dermagraft-Ulcers to treat three types of skin ulcers:
diabetic foot ulcers, pressure ulcers and venous ulcers.
 
     ULCER MARKET.  Over 2,800,000 cases of chronic, slow-healing or non-healing
skin ulcers are treated in the United States each year. In these wounds, skin
breaks down as a result of disruption of blood flow to the skin caused either by
prolonged pressure over a localized area or by chronic diseases which affect the
circulatory or peripheral nervous systems. In many of these patients, skin
ulcers are open, often painful, wounds which are resistant to healing for many
months or years. In part because current therapies for skin ulcers are often
ineffective, the treatment of skin ulcers is an expensive process. Individual
patient treatment can cost thousands of dollars per year. Published sources
estimate that the United States health care system spends more than $5 billion
each year for the treatment of chronic skin ulcers.
 
     Approximately 800,000 diabetics in the United States suffer from chronic,
non-healing diabetic foot ulcers each year, 400,000 of which represent the
Company's initial target market. It is estimated that diabetic foot ulcers lead
to over 55,000 limb amputations annually in the United States. Based on data
from outside sources, it is estimated that the total United States market
opportunity for this targeted indication potentially exceeds $1 billion. In
addition, it is estimated that approximately 1,500,000 patients are affected by
pressure ulcers and approximately 500,000 patients are diagnosed with venous
ulcers in the United States each year.
 
     DIABETIC FOOT ULCERS.  Many diabetic patients experience circulatory
deficiencies and decreased nerve sensation in their legs and feet, which
prevents them from shifting their weight in response to wound-provoking
pressure. The patient may be unaware of some injuries and can leave wounds
unattended for days, resulting in an ulcer. Once the ulcer forms, it may heal
poorly due to the effects of diabetes on normal healing processes. Unhealed
diabetic ulcers can result in gangrenous infection that may lead to amputation
of the limb.
 
     The Company completed a 50-patient pilot clinical trial in 1994 evaluating
three different dosing regimens of Dermagraft-Ulcers in the treatment of
diabetic foot ulcers prior to entering into the ongoing pivotal clinical trial.
In this pilot trial, the patients in the dosing group receiving one piece of
Dermagraft-Ulcers per week for up to eight weeks showed a statistically
significant improvement (p<0.05) with 50% (six of 12) of the treatment group and
8% (one of 13) of the control patients reaching complete wound closure in 12
weeks. In addition, follow-up data from the pilot trial collected over an
average of 14 months has showed no recurrence of the foot ulcer in the
Dermagraft-treated patients. By contrast, published reports have indicated rates
of recurrence ranging from approximately 20% to 50% within the first year
following healing.
 
     The Company is currently enrolling 280 patients in 20 wound care centers in
a single blinded and randomized pivotal clinical trial of Dermagraft-Ulcers for
the treatment of diabetic foot ulcers in
 
                                       29
<PAGE>   31
 
the United States. In this pivotal clinical trial, each patient in the treatment
group is receiving a dosing regimen of one piece of Dermagraft-Ulcers per week
for up to eight weeks. The primary endpoint of the trial, complete wound
closure, is being evaluated over a period of 12 weeks. Patients in the trial are
also being followed for a total of 32 weeks to assess Dermagraft-Ulcers' effect
on recurrence. Enrollment in the pivotal clinical trial of Dermagraft-Ulcers in
the United States is nearly complete.
 
     A planned interim analysis of this data in late 1995 showed that the
clinical trial was on track to achieve the primary endpoint. Upon completion of
the trial, all trial data will be evaluated for statistical significance. If the
results of the completed trial are consistent with the results of the interim
analysis, the Company expects to submit a PMA application to the FDA in late
1996. The FDA has notified the Company that the PMA application for
Dermagraft-Ulcers in the treatment of diabetic foot ulcers will also receive
expedited review, potentially accelerating the review period. There can be no
assurance, however, that the pivotal clinical trial of Dermagraft-Ulcers will be
successful or that it will satisfy the safety and efficacy requirements of the
FDA necessary to obtain approval, or that the FDA will accept for filing or
approve the Company's PMA application in a timely manner. See "-- Government
Regulation".
 
     The Company also has an ongoing pivotal clinical trial in France for
Dermagraft-Ulcers in the treatment of diabetic foot ulcers. Enrollment in the
French trial is expected to continue through June 1996. The French government
has helped to fund the trial and has adopted a new regulatory designation which
the Company believes may facilitate the commercialization and reimbursement of
the Company's tissue engineered products. If successful, the Company plans to
use safety and efficacy data from both the French and United States trials to
support an application for marketing approval from the French government. There
can be no assurance that additional patients will not need to be enrolled to
show efficacy, that, upon the conclusion of the clinical trial,
Dermagraft-Ulcers will satisfy the safety and efficacy requirements of the
French government necessary to obtain approval or that the Company will complete
this trial.
 
     PRESSURE ULCERS.  Pressure ulcers are common in hospital and nursing home
patients. Pressure ulcers form in skin that is continually compressed under the
weight of a bedridden or wheelchair-bound patient, who does not periodically
turn or roll to relieve the compressed skin. The compressed skin does not
receive blood flow for hours at a time, ultimately forming a wound. Severe
pressure ulcers frequently must be closed by use of skin grafts or major
reconstructive surgery. During 1994, the Company completed a pilot clinical
trial of 50 patients. In the most effective dosing group, complete wound healing
was achieved in 46% of these patients as compared to 25% in the control group.
Although the Company believes the results of the pilot trial to be encouraging,
it does not currently expect to initiate a pivotal clinical trial of
Dermagraft-Ulcers in the treatment of pressure ulcers until additional resources
become available.
 
     VENOUS ULCERS.  Venous ulcers result when damage to the valves of the deep
leg veins reduces their ability to return blood to the upper body, leading to
pooling of blood in the legs and subsequent breakdown of the skin. Venous ulcers
that do not respond to medical treatment often must be closed surgically by use
of skin grafts. As noted above for diabetic foot ulcers, an important goal in
the treatment of venous ulcers is to prevent the recurrence of the wound, which
both lowers the cost of treatment and improves overall patient care.
 
     The Company commenced a pivotal clinical trial of a single application of
Dermagraft-Ulcers in February 1993. An interim analysis of the pivotal clinical
trial in April 1994 indicated there were no statistically significant
differences between the patients in the control group and those treated with a
single dose of Dermagraft-Ulcers with respect to complete wound healing.
However, analysis of the six-month follow-up data from patients in the venous
ulcer trial did show a statistically significant (p<0.05) difference in the
recurrence rate of Dermagraft-treated patients (6%) versus control patients
(20%). Although the Company has also investigated the potential application of
multiple doses of Dermagraft-Ulcers in the treatment of venous ulcers, its
evaluation of cost benefit
 
                                       30
<PAGE>   32
 
information indicates that multiple doses may not be cost effective. Although
the Company does not currently intend to pursue the use of Dermagraft-Ulcers as
a treatment to reduce the recurrence of venous ulcers, it may do so in the
future based on further cost benefit analyses and subject to the availability of
resources.
 
  ORTHOPEDIC PRODUCTS
 
     Many of the product development and manufacturing systems developed by the
Company for its existing skin products apply to the growth of orthopedic
tissues. The Company believes that its patented core technology and proprietary
manufacturing systems allow regulation of critical environmental factors,
including oxygen tension, pressure and media composition, that may provide the
necessary conditions for the production of a high tensile-strength cartilage
capable of withstanding the high shear and load forces present in human joints.
The Company believes, and scientific research supports, that tissue engineered
cartilage products, like tissue engineered skin, will be non-immunogenic. The
FDA has also recently confirmed it will regulate the Company's tissue engineered
cartilage products as medical devices. See "-- Government Regulation".
 
     Traumatic injuries often cause permanent damage to tissues in human joints
such as cartilage, ligaments, tendon and bone. The body has a limited ability to
repair these tissues on its own, and there are few treatment options available
to replace damaged tissue. The Company is focusing its initial product
development efforts on tissue engineered cartilage. Cartilage serves diverse
functions in many parts of the body such as providing a gliding surface for
smooth joint motion (articular cartilage), and serving to absorb both impact and
load-force transmitted to the axial skeleton (meniscus). In many cases, damage
to cartilage tissue subsequently leads to further deterioration and
osteoarthritis which can eventually require a total joint replacement.
 
     The Company is developing patented orthopedic cartilage products designed
to be delivered in a single arthroscopic procedure through its joint venture
with Smith & Nephew. See "-- Collaborations and Strategic Alliances". The joint
venture also has a right of first negotiation to develop other tissue engineered
products for orthopedic applications such as ligament, tendon and bone.
 
     ORTHOPEDIC MARKETS.  In the United States each year, there are over 1.2
million arthroscopic procedures of the knee performed, including procedures
involving articular cartilage, meniscus and ligaments. By intervening early in
the degenerative process, the Company hopes to delay or eliminate the need for
some of the 230,000 total knee replacement surgeries performed annually in the
United States. There are an additional 400,000 arthroscopic procedures performed
each year in the United States in joints such as the shoulder, elbow, wrist,
hip, and ankle which could also be candidates for the Company's articular
cartilage products.
 
     ARTICULAR CARTILAGE.  Articular (joint) cartilage covers the opposing
surfaces of all moving joints in the body. Even small defects in the articular
cartilage can cause pain and 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. To the Company's
knowledge, other than autologous transplants of the patient's own cells, there
are no commercially available products either synthetic or natural which can
replace damaged cartilage in the human body. Tissue engineered cartilage could
provide a significant opportunity to treat patients at an earlier stage of joint
degeneration, thereby delaying, or in some cases eliminating, the need for total
joint replacements.
 
     In pilot preclinical trials in collaboration with researchers at MIT,
Children's Hospital, and other academic institutions, tissue engineered
cartilage was shown to produce a repair that was predominately articular
cartilage and, in addition, had integrated well with the surrounding host
tissue. Six month data from preclinical studies have demonstrated that cartilage
grown by the Company can withstand the biomechanical forces that are exerted in
the knee joint. In addition,
 
                                       31
<PAGE>   33
 
long-term follow-up has shown persistence of the implanted cartilage. The joint
venture is currently performing a pivotal preclinical trial in compliance with
FDA Good Laboratory Practices ("GLP") requirements for articular resurfacing
and, if successfully completed, expects to request approval from the FDA to
begin a pilot human clinical trial in 1997. Products to repair articular
cartilage may ultimately be used in any joint in the body, such as shoulders,
elbows, wrists, hips and ankles.
 
     MENISCAL CARTILAGE.  The meniscus is a cushion that acts as a shock
absorber in the knee which is frequently damaged or destroyed by sports injury
or other trauma. Current repair procedures for avascular meniscal injuries have
limited success in producing a long-term repair. The Company believes that its
cultured cartilage could offer a benefit in the repair and eventual total
replacement of the meniscus. The joint venture has conducted collaborative
preclinical meniscus studies with scientists at North Shore University
Hospital/Cornell Medical College. Data from the study at six months and one year
showed successful healing of meniscus defects in 20 implants, while there was no
healing in the control groups at similar time points. The Smith & Nephew joint
venture intends to continue preclinical trials toward an eventual human clinical
trial. In addition to this program addressing discrete meniscal defects, the
joint venture in conjunction with scientists at Children's Hospital is also
conducting early preclinical studies focused on total meniscal replacement with
a tissue engineered meniscus.
 
     LIGAMENT/TENDON.  Frequently, sports injuries involve damage to ligaments
and tendons, particularly injury to the anterior cruciate ligament. The Company
has successfully utilized degradable polymers shaped into ligament-like
structures combined with fibroblasts to engineer a living ligament. Research
work on the optimization of this technique for replacement of ligament and
tendon is underway in collaboration with scientists at MIT and Children's
Hospital. Through sponsored research, the Company is exploring growth conditions
that may allow it to grow tissue engineered ligaments and tendons with
biomechanical properties similar to those found in the human body.
 
     BONE.  In collaboration with researchers at MIT and Children's Hospital,
the Company has successfully grown tissue engineered bone. Research has shown
that three-dimensional bone grown ex vivo secreted extracellular matrix proteins
and retained biomechanical properties analogous to those tissues in the human
body, eliminating the need for extracting bone from other areas of the patient's
body. The use of tissue engineered bone to repair large defects in long bones,
such as the femur, has been successful in preclinical studies.
 
  CARDIOVASCULAR PRODUCTS
 
     Cardiac fibroblasts are closely related to the dermal fibroblasts the
Company uses to manufacture its existing skin products; therefore, many of the
methods and systems developed by the Company for these products may be
applicable to the growth of cardiac fibroblasts as well. Although additional
research continues to be performed, the Company also believes it may be possible
to use dermal fibroblasts in place of cardiac fibroblasts in tissue engineered
products for cardiovascular applications. In addition to the cardiac
fibroblasts, the interior of blood vessels, and the valves and chambers of the
heart, are lined with endothelial cells. The Company believes that the matrix
proteins and growth factors secreted by fibroblasts may induce endothelial cell
migration which is important to avoid clotting and the build up of plaque, or
atherosclerosis. In addition, the Company believes its cardiovascular products
will be regulated as medical devices, similar to its skin and cartilage
products.
 
     CARDIOVASCULAR MARKET.  According to the American Heart Association, over
900,000 Americans die each year in the United States from cardiovascular
disease. Approximately 60 million people suffer from some form of the disease.
An aging population is likely to increase the incidence of these diseases and
the need for cost effective treatments in the future. While there are many
effective treatments for these patients, there are also many problems to be
overcome with existing cardiovascular products such as biocompatibility,
durability and availability. Tissue engineered
 
                                       32
<PAGE>   34
 
cardiovascular products, such as heart valves, blood vessels and stents, may
potentially solve some of these issues. Each year, over 60,000 prosthetic heart
valves are implanted and over 430,000 vascular graft procedures are performed in
the United States.
 
     HEART VALVES.  The valves open and close with every beat of the heart. When
a valve becomes damaged or diseased the heart must work harder to pump the same
volume of blood. As the condition worsens the valve has to be replaced.
Currently, either mechanical or porcine (pig) valves are used to replace the
native human valves; however, each has its drawbacks. With mechanical valves,
patients are required to take anticoagulant medication for the rest of their
lives to reduce the likelihood of thromboembolic events (i.e., blood clots).
Porcine valves have problems with durability and calcification, frequently
requiring additional and costly surgery to implant replacement valves.
 
     During 1994 and 1995, the Company successfully completed a series of
feasibility studies to evaluate applications of its tissue engineering
technology to create or improve heart valve replacements under a joint
development agreement with St. Jude Medical. See "-- Collaborations and
Strategic Alliances". Through Company-sponsored research at MIT and Children's
Hospital, preclinical trials have demonstrated the feasibility of utilizing
tissue engineering to create heart valves using a three-dimensional
bioabsorbable scaffold in which the heart valve continues to grow post
transplant. During 1996, the Company plans to continue preclinical studies to
optimize the colonization and growth of tissue engineered valves on synthetic
scaffolds.
 
     BLOOD VESSELS.  Vascular grafts are used to repair or replace segments of
arterial and venous blood vessels that are weakened, damaged or obstructed due
to trauma or disease such as aneurysms and atherosclerosis. Grafts are either
autografts (the patient's own veins or arteries), prosthetic grafts made of
synthetic materials such as polyesters or other composite materials, or
non-viable preserved biological tissue from cadavers or other species. The
harvesting of autografts requires extensive surgery which is time consuming,
costly and traumatic. In addition, patients requiring multiple bypass surgeries
may not have enough suitable vessels to harvest. Prosthetic vascular grafts also
often show insufficient tissue integration and endothelialization, and often
result in stenosis (or a narrowing), pseudo aneurysm formation, and acute
occlusion due to platelet aggregation. Cryopreserved allograft veins from
cadavers are sometimes used, but availability is limited and patency rates are
lower than autograft vessels.
 
     Many companies are attempting to develop small diameter vascular grafts
(3-5mm) with characteristics similar to biological grafts. These companies are
employing a variety of technologies to reduce thrombosis and promote a rapid
ingrowth of tissue such as different weaves and knits, chemical coatings and
gelatins, and freeze drying. Advanced Tissue Sciences' research has focused on
using specialized polymer constructs, bioreactor design and colonization
techniques to create a completely human vessel. In collaboration with The
Georgia Institute of Technology ("Georgia Tech"), the Company has performed
biomechanical and immunohistochemical analysis of the tissue-engineered blood
vessels which has demonstrated increased strength and the synthesis of elastin
and other human matrix proteins essential to blood vessel formation and
function. The tissue engineered blood vessels have also been easy to handle and
suture.
 
     STENTS.  The Company is also evaluating the feasibility of a biological
stent. Stents are generally synthetic materials that are inserted in a blood
vessel after angioplasty (the mechanical removal of an occlusion by the
insertion and inflation of a balloon catheter) in an attempt to prevent
restenosis or re-occlusion of the vessel. Without stent intervention,
approximately 40% of patients will experience restenosis of the vessel within
two years of plaque removal. Placing a living stent comprised of healthy human
cells may provide a more stable vascular lining, thereby preventing or reducing
thrombosis or restenosis.
 
  OTHER THERAPEUTIC TISSUES
 
     Many other organ tissues have been successfully grown using the Company's
technology that could potentially be developed into therapeutic products.
Commercialization of these or other
 
                                       33
<PAGE>   35
 
tissues, such as cartilage and bone for reconstructive applications, liver, bone
marrow, pancreas and gastrointestinal tissues, is dependent on a number of
factors, including the Company's assessment of each tissue's market potential
and the availability to the Company of sufficient resources, either alone or
through collaboration with corporate partners.
 
  SKIN2 LABORATORY TESTING KITS
 
     The Company's first commercially introduced product, Skin2 laboratory
testing kits, contains compartmentalized squares of living human skin tissue.
Skin2 is used by cosmetic, petrochemical, household product and pharmaceutical
companies to test products under development. Results of testing performed with
the Skin2 kits can be obtained within three to 24 hours, as compared to the
minimum period of several days that is required for many other in vitro or in
vivo assays. To date, the Company has developed four different Skin2 models to
address specific testing needs.
 
     Skin2 was initially launched to test products for cytotoxicity, and skin
and eye irritation. As it gained scientific validation and acceptance, the
Company expanded the applications of Skin2 to include testing for corrosivity,
phototoxicity and wound healing, and evaluating sun protection factors and
sensitization. During 1994, the U.S. Department of Transportation and Transport
Canada approved Skin2 for use as an alternative to live animal testing of
potentially corrosive materials. The approvals were the first time a government
regulatory agency has granted approval of an in vitro test method containing
human tissue.
 
COLLABORATIONS AND STRATEGIC ALLIANCES
 
     The Company's strategy for the development, clinical testing, manufacturing
and commercialization of certain of its proposed tissue replacement products
includes entering into various collaborations with corporate partners, licensees
and others. The Company has entered into a number of collaborative arrangements
in connection with its product development activities. There can be no assurance
that the Company will be able to negotiate additional collaborative arrangements
on acceptable terms, if at all, or that existing or future collaborative
arrangements will be successful.
 
     SMITH & NEPHEW PLC.  In 1994, Smith & Nephew plc and the Company entered
into a fifty-fifty joint venture for the worldwide development, manufacture and
marketing of human tissue engineered cartilage for orthopedic applications.
Smith & Nephew is a leading worldwide health care company with extensive sales
and distribution capabilities, selling arthroscopic instrumentation, trauma,
casting and support products, orthopedic implants and wound management products.
Under the agreement, Smith & Nephew is contributing the first $10 million in
joint venture funding and the Company has contributed certain technology
licenses. Joint venture revenues and further expenditures will be shared equally
by the partners. After the first $10 million of joint venture funding occurs,
the Company has the ability to borrow up to $10 million from Smith & Nephew
under pre-negotiated terms, should it so elect, to fund the Company's share of
further joint venture expenditures. The joint venture also has the right of
first negotiation to develop tissue engineered bone, tendon and ligament for
orthopedic applications. Advanced Tissue Sciences has retained all rights to
non-orthopedic cartilage applications. The joint venture's initial product
development efforts are being focused on the repair or replacement of damaged
articular and meniscus cartilage in knee joints. Since 1994, the joint venture
has performed extensive preclinical trials of three-dimensional cartilage
products for articular joint resurfacing and meniscal repair. The joint venture
is currently in a pivotal preclinical trial for articular resurfacing, which, if
successfully completed, is expected to lead to human clinical trials in 1997.
 
     ST. JUDE MEDICAL, INC.  In February 1994, the Company and St. Jude Medical
entered into an agreement to pursue the joint development of tissue engineered
heart valves. Separately, St. Jude Medical purchased 563,380 shares of Advanced
Tissues Sciences' Common Stock for $5 million. During the collaboration, the
parties conducted a series of feasibility studies to evaluate applications
 
                                       34
<PAGE>   36
 
of Advanced Tissue Sciences' tissue engineering technology to create or improve
heart valve replacements by leveraging the knowledge gained with
fibroblast-based products from Dermagraft. Although the feasibility studies were
successful, in early 1996, St. Jude Medical elected not to enter into a
licensing agreement for tissue engineered heart valves. St. Jude Medical
indicated that it was focusing its research efforts on acellular product designs
that encourage host cell ingrowth.
 
     As part of the joint development agreement, St. Jude Medical has
non-exclusive rights to certain proprietary technology developed under the
agreement to the extent it does not infringe on the Company's core tissue
engineering patents. Under certain circumstances, St. Jude Medical has a right
of first refusal to license the Company's heart valve technology. The Company
presently intends to include heart valves in discussions it is having with other
potential corporate partners for a strategic alliance with respect to its
cardiovascular products. However, the Company cannot predict with any certainty
whether it will be able to enter into any additional collaboration or license
agreements with another company on acceptable terms or that any such
collaboration will be successful.
 
     UNIVERSITY OF FLORIDA/GENENTECH, INC.  Under a license agreement entered
into in November 1992, the Company obtained exclusive worldwide rights to a stem
cell proliferation factor ("SCPF") from the University of Florida Research
Foundation, Inc., an affiliate of the University of Florida. SCPF is believed to
stimulate the growth of hematopoietic stem cells, the cells responsible for
repopulating red blood cells and cells of the immune system. Under the license
agreement, the Company is responsible for costs and maintenance fees related to
the filing of patent applications arising out of the sponsored research and will
be required to pay royalties on the sales of any SCPF-related products. Subject
to compliance with the terms of the agreement, the license extends for the life
of certain SCPF-related patents, should any such patents issue.
 
     In October 1995, the Company entered into an Evaluation and Option
Agreement granting Genentech, Inc. ("Genentech") an option to license rights to
SCPF. Under the terms of the agreement, Genentech has obtained a one year option
to exclusively license rights for in vivo applications of SCPF outside Asia. In
exchange, Genentech will conduct all further sequencing, cloning and expression
of the factor. If the option is exercised, the Company could receive future
equity and milestone payments, plus royalties on any product sales. The Company
will retain rights to all in vivo uses of SCPF in Asia, subject to a right of
first refusal by Genentech. In addition, the Company retains worldwide rights to
use SCPF in ex vivo tissue engineering applications such as for bone marrow
expansion and gene therapy, subject to certain co-exclusive rights with
Genentech outside of Asia. The Company cannot predict with any certainty whether
Genentech will exercise its license option or if the Company will receive any
equity or milestone payments, or royalties related to SCPF.
 
     MASSACHUSETTS INSTITUTE OF TECHNOLOGY/CHILDREN'S HOSPITAL IN BOSTON.  In
connection with its acquisition of Neomorphics, Inc. in September 1992, the
Company entered into sponsored research and license agreements with MIT and
Children's Hospital. Under the research agreement, the Company has agreed to
sponsor research conducted at MIT and Children's Hospital for an aggregate
minimum of $1.1 million in 1996 and $1 million in 1997. The research agreement
may be renewed annually thereafter for four additional years. The Company has
the right to terminate the agreement under certain circumstances. Under the
license agreement, the Company has rights to certain existing and future MIT and
Children's Hospital patents and technology which relate to tissue engineering,
organ transplantation and polymer science. The Company is responsible for patent
application costs and the related maintenance fees applicable to inventions
derived from the sponsored research.
 
SALES AND MARKETING
 
     The Company currently intends to market its Dermagraft-TC product directly
in the United States and Europe, where the markets are concentrated in
specialized trauma units or burn centers.
 
                                       35
<PAGE>   37
 
Eighty of the approximately 140 specialized trauma units and burn centers in the
United States treat approximately 75% of all burn patients. Due to the highly
concentrated nature of this market, the Company currently intends to market its
Dermagraft-TC products through a direct sales organization in the United States
and with a direct sales force or through individual distributors in other
foreign markets. The Company is currently working with burn experts and others
to develop reimbursement strategies and economic analyses for the use of
Dermagraft-TC. The Company intends to have data supporting the potential
cost-offsets associated with the use of Dermagraft-TC available for marketing
purposes at the time of commercial introduction of the product.
 
     The Company estimates that there are approximately 800,000 diabetic foot
ulcer patients treated each year in the United States. More than half of those
ulcer patients are treated by podiatrists, with approximately ten percent of all
podiatrists accounting for the treatment of over 60% of these patients. The
Company intends to focus its initial marketing efforts on these high volume
podiatrists either through its own direct sales force or through collaboration
with a corporate marketing partner. The Company believes that doctors and third
party payors recognize the high cost of treating diabetic foot ulcers. The
Company intends to have an economic model supporting the product's cost
effectiveness available at the time of commercial introduction. The Company is
currently in discussions regarding the formation of strategic marketing
relationships to address the worldwide markets for diabetic foot ulcers.
 
     The Company has entered into a joint venture with Smith & Nephew for the
development and commercialization of orthopedic cartilage products and may
selectively seek further strategic alliances with leading healthcare companies
to market some of its other tissue engineered products.
 
     Achieving market acceptance for the Company's products will require a
substantial commitment of the Company's resources. The Company will have to
establish an effective internal sales and marketing organization and/or rely on
corporate partners, licensees or on arrangements with others to market its
products domestically and internationally. The Company has no direct experience
marketing, or obtaining third party reimbursement for its products and there can
be no assurance that the Company will be successful in these efforts.
 
MANUFACTURING AND SUPPLY
 
     Advanced Tissue Sciences is developing proprietary manufacturing systems to
produce the Company's tissue replacement products. These systems are intended to
allow for the maintenance of sterility and result in the manufacture of highly
reproducible living tissues. The Company believes it has the manufacturing
capacity to produce sufficient quantities of Dermagraft to support its ongoing
clinical trials. In addition, the Company has constructed and is in the process
of developing and validating commercial scale manufacturing for its
Dermagraft-TC and Dermagraft-Ulcers products. The Company has also developed
manufacturing capabilities which it believes are adequate for the current and
anticipated production needs of its Skin2 laboratory testing kits.
 
     The Company has completed construction and validation of a large scale
manufacturing facility designed to comply with the good manufacturing practices
("GMPs") requirements prescribed by the FDA. The Company is currently developing
processes to manufacture commercial quantities of its Dermagraft-TC and
Dermagraft-Ulcers products. Each product is expected to be grown in a bioreactor
which is being optimized to allow for the uniform growth, freezing, shipping and
storage of the tissue. Tissues are to be automatically fed in a system which
electronically maintains a consistent growth environment. The Company has
engaged Fluor Daniel, Inc. to assist in the design, fabrication and installation
of commercial scale process systems for the manufacture of Dermagraft-TC and
Dermagraft-Ulcers. The manufacturing process is being designed to enable the
Company to grow multiple pieces of tissue at one time. The Company believes much
of the design of this manufacturing process could be useful in manufacturing
other tissue replacement products as well. Any significant delays in the
completion of validation or regulatory inspection of the new facility could have
a material adverse effect on the ability of the Company to ultimately market its
products on a timely and profitable basis, and on the Company's ability to
conduct its business.
 
                                       36
<PAGE>   38
 
     Although most of the raw materials used in the manufacture of the Company's
Dermagraft products are available from more than one supplier, changes in
certain critical components (such as the polymers used in Dermagraft) could
cause the FDA to require the Company to prove equivalency of the materials or
potentially to modify or perform additional clinical trials for the Dermagraft
products, which could have the effect of postponing the completion of clinical
trials associated with that product. To date, the Company has not experienced
difficulty in obtaining necessary raw materials.
 
     The mesh framework used by the Company in its Dermagraft-Burns and
Dermagraft-Ulcers products is available under a supply agreement with only one
FDA-approved manufacturing source. Similarly, the synthetic mesh framework used
by the Company in its Dermagraft-TC product is available under a supply
agreement with a different FDA-approved manufacturing source. Because the FDA
approval process requires manufacturers to specify their proposed suppliers of
active ingredients and certain component parts and packaging materials in their
applications, FDA approval of a new supplier would be required if these
materials become unavailable from the current supplier.
 
     Although the Company has not experienced difficulty acquiring these
materials for the manufacture of its Dermagraft products for clinical trials, no
assurance can be given that interruptions in supplies will not occur in the
future or that the Company would not have to obtain substitute vendors for these
materials. Any significant supply interruption would adversely affect the
Company's clinical trials as well as its product development and marketing
programs. In addition, an uncorrected impurity or supplier's variation in a raw
material, either unknown to the Company or incompatible with the Company's
manufacturing process, could have a material adverse effect on the Company's
ability to manufacture products.
 
PATENTS AND PROPRIETARY RIGHTS
 
     The Company's ability to compete effectively will depend, in part, on its
ability to maintain the proprietary nature of its technology and manufacturing
processes. The Company relies on patents, trade secrets and know-how to maintain
its competitive position. To date, the Company owns seven issued patents in the
United States. In addition, foreign counterparts to some of the United States
patents have issued in several foreign countries. The United States patents
expire at various times between 2005 and 2012.
 
     In October 1990, the Company received a United States patent on its core
technology. This product patent covers three-dimensional living stromal tissue
produced by culturing stromal cells in vitro on a biocompatible framework. The
stromal tissue provides the growth factors and structural proteins used in the
Company's three-dimensional matrix to grow organ tissues. This patent expires in
October 2007. In September 1995, the Company was granted a corresponding patent
by the European Patent Office covering a three-dimensional stroma tissue and its
use to grow skin, bone marrow and liver tissues. The European patent expires in
April 2007.
 
     In November 1993, the Company received a United States patent relating to
Dermagraft, covering both three-dimensional dermal tissue and full thickness
skin tissue cultured on living stromal tissue prepared in vitro and, in August
1995, the Company received a patent covering the growth and implantation of its
Dermagraft dermal skin replacement. These patents expire in November 2010 and
August 2012, respectively. In October 1995, a United States Patent was issued
relating to Dermagraft-TC. This product patent covers a variety of temporary
burn coverings which use a synthetic membrane with an attached dermal component.
This patent will expire in October 2012.
 
     Two United States patents have issued relating to the Company's laboratory
testing kits. These patents cover the use of a variety of living tissues
produced by the Company's tissue replication technology and expire in July 2008
and November 2009. The Company's other issued United States patent covers bone
marrow transplantation techniques in which marrow cells are expanded in vitro
prior to transplantation and expires in January 2005.
 
                                       37
<PAGE>   39
 
     The Company has filed additional United States and foreign patent
applications relating to its technology. In addition, the Company has certain
licensing rights to United States and foreign patents and patent applications
filed by MIT related to cell growth and organ regeneration and repair, and
biodegradable polymers, subject to certain limitations as to applicable tissues
and fields of use, and by the University of Florida related to SCPF. In
addition, there are currently 13 pending United States patent applications and
eight allowed United States applications that will issue as patents. See
"-- Collaborations and Strategic Alliances."
 
     There can be no assurance that any further applications will result in
issued patents or that any current or future issued or licensed patents, trade
secrets or know-how will afford protection against competitors with similar
technologies or processes, or that any patents issued will not be infringed upon
or designed around by others. In addition, there can be no assurance that others
will not independently develop proprietary technologies and processes which are
the same as or substantially equivalent to those of the Company. The Company
could also incur substantial costs in defending itself in suits brought against
it on such patents or in bringing suits to protect the Company's patents or
patents licensed by the Company against infringement. The Company protects its
proprietary technology and processes in part by confidentiality agreements with
its collaborative partners, employees and consultants. There can be no assurance
that these agreements will not be breached, that the Company will have adequate
remedies for any breach, or that the Company's trade secrets will not otherwise
become known or independently discovered by competitors.
 
COMPETITION
 
     The biomedical technology industry is subject to rapid, unpredictable and
significant technological change. Competition from universities, research
institutions and pharmaceutical, chemical, medical device and biotechnology
companies is intense. Many competitors or potential competitors have greater
financial resources, research and development capabilities and manufacturing and
marketing experience than the Company. In general, the first biomedical product
to be commercialized for a particular therapeutic indication is often at a
significant competitive advantage relative to later entrants to the market.
Accordingly, the relative speed with which the Company can develop products,
complete clinical trials, obtain regulatory approvals and develop commercial
manufacturing capability may be determinative factors in establishing the
Company's competitive position. The Company's ability to attract and retain
qualified scientific, manufacturing, marketing and other personnel, obtain and
maintain patent protection and secure funding are also expected to be key
competitive factors for the Company.
 
     In the field of tissue engineering and the treatment of damaged or diseased
tissue, the Company competes with several companies which are developing various
tissue replacement products, including skin substitutes and cultured cartilage.
In addition, the Company is aware of a number of biotechnology, pharmaceutical,
medical device and chemical companies that are developing other types of
products as alternatives to tissue replacement for a variety of indications,
including burns and chronic skin ulcers. These treatments employ a variety of
approaches such as growth factors, tri-peptides and completely synthetic
materials.
 
   
     The Company's Dermagraft-TC product is intended to serve as an alternative
to cadaver skin or porcine tissue, which are generally sold by tissue banks. The
Company is also aware of several companies that have developed technologies
involving processed cadaver skin used as a dermal replacement (LifeCell
Corporation), or sheets of epidermis grown from the patient's own skin (Genzyme
Tissue Repair and Cell Culture Technology). Their products have not required FDA
approval and are, therefore, currently available on the market for the treatment
of severe burns. In addition, Integra Life Sciences ("Integra") has developed a
skin replacement product consisting of a thin bovine collagen/glycosaminoglycan
sponge and a silicone membrane. The Integra skin replacement product has
received approval from the FDA, subject to the fulfillment of various
manufacturing and marketing requirements. The Integra product could be deemed by
the FDA to perform substantially the same functions as, or to provide comparable
benefits to, Dermagraft-TC in its initial target market for the most severely
burned patients. See "Risk Factors -- Government Regulation."
    
 
                                       38
<PAGE>   40
 
   
     In the area of diabetic foot ulcers, Chiron Corporation ("Chiron"), in
collaboration with a division of Johnson & Johnson, announced completion of
Phase III clinical trials of its platelet-derived growth factor ("PDGF") for the
treatment of diabetic foot ulcers in September of last year. Chiron has not yet
announced the data from its clinical trial nor is the Company aware of any
specific plans for submitting a New Drug Application for PDGF. In addition, the
Company believes that Organogenesis Inc. ("Organogenesis") plans to begin
clinical trials for the use of Graftskin, a product using cultured human cells
seeded onto a bovine collagen matrix, for the treatment of diabetic foot ulcers.
Organogenesis has already submitted a PMA application for Graftskin in the
treatment of venous leg ulcers and has been granted expedited review by the FDA
for that indication.
    
 
     In the area of cartilage repair, Genzyme Tissue Repair is currently selling
a service to process a patient's own cartilage cells as a treatment for
articular defects in the knee. The Company is aware that Integra and Osiris
Therapeutics, Inc. are also engaged in research on cultured cartilage products.
The Company is not aware of any competitor that is developing an off-the-shelf
completely human cartilage tissue that can be arthroscopically inserted.
 
     For all of its products, the Company expects to compete primarily on the
uniqueness of its technology and product features, on the quality and
cost-effectiveness of its products and the timing of commercial introduction.
The Company believes that its tissue engineered products may have many
attributes that differentiate it from other competitors including that the
Company's products are completely human and are designed to be available
"off-the-shelf" to end-users. However, other factors such as the Company's
ability to secure regulatory approval for its products, to implement production
and marketing plans and to secure adequate capital resources, will also impact
its competitive position. There can be no assurance that the Company will have
the resources to compete successfully with such companies or that competition
generally will not adversely affect the Company's results of operations or
ability to successfully market its products.
 
GOVERNMENT REGULATION
 
     Regulation by governmental authorities in the United States and foreign
countries is a significant factor in the manufacture and marketing of the
Company's proposed products and in its ongoing research and product development
activities. The Company's preclinical studies and clinical trials and the
manufacturing and marketing of its products are subject to extensive, costly and
rigorous regulation by various governmental authorities in the United States and
other countries. Many of the Company's proposed products will require regulatory
approval prior to commercialization. There can be no assurance that any products
developed by the Company, independently or in collaboration with others, will
meet applicable regulatory criteria to receive the required approvals for
manufacturing and marketing.
 
     Except for the Company's Skin2 and other proposed research and laboratory
testing products, manufacture and sale of the Company's products is subject to
extensive regulation by the FDA, as well as by other federal, state and foreign
authorities. There is currently no requirement for government premarket approval
pertaining to the marketing of research and laboratory testing products.
However, if customers intend to use the results of such tests for safety and
efficacy data in support of final product approval by the FDA or other
regulatory agencies, they must be able to demonstrate the validity of these
tests.
 
     In the United States, the FDA regulates the clinical testing, and
manufacture, distribution and promotion of medical devices and biologics
pursuant to the Federal Food, Drug, and Cosmetic Act (the "FDC Act") and
regulations promulgated thereunder. The Company's Dermagraft and cartilage
products are subject to regulation as medical devices. The Company's other
tissue replacement products, currently in various stages of development, could
be regulated either as medical devices or as biologic products. Legislative and
regulatory initiatives concerning the regulation of tissue and organ transplants
are ongoing and could possibly affect the future regulation of the Company's
tissue engineered products. It is not possible at the present time to predict
accurately
 
                                       39
<PAGE>   41
 
either the time frame for such action, or the ultimate effect that such
initiatives could have, if any, on the products under development by the
Company. Certain of the Company's potential products, such as bone marrow
replacement products, are not currently regulated by the FDA, but may ultimately
be regulated either as a medical device or a biologic. 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.
 
     To obtain FDA approval to market medical devices similar to those under
development by the Company, the FDA requires proof of safety and efficacy in
human clinical trials performed under an Investigational Device Exemption
("IDE"). An IDE application must contain preclinical test data demonstrating the
safety of the product for human investigational use, information on
manufacturing processes and procedures, and proposed clinical protocols. If the
IDE application is approved, human clinical trials may begin. The results
obtained from these trials, if satisfactory, are accumulated and submitted to
the FDA in support of a PMA application. Premarket approval from the FDA is
required before commercial distribution of devices similar to those under
development by the Company is permitted in the United States.
 
     The PMA application must be supported by extensive data, including
preclinical and human clinical trial data, to prove the safety and efficacy of
the device. 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
more protracted period and a number of devices for which a PMA application was
submitted by other companies have never been cleared for marketing. This is a
lengthy and expensive process and there can be no assurance that such FDA
approval will be obtained.
 
     The Dermagraft-TC and Dermagraft-Ulcers products are currently in pivotal
clinical trials. The Company expects to prepare and submit a PMA application for
the Dermagraft-TC product in the first half of 1996 and for the
Dermagraft-Ulcers product in late 1996, based upon the results of the respective
trials. There can be no assurance that the Company will submit the PMA
applications in these time frames, if at all, or that the FDA will conclude that
the respective trial results support a finding of safety and efficacy for either
of these products.
 
     In addition, even though the Company has been informed by the FDA that the
Company's Dermagraft-TC and Dermagraft-Ulcers products will receive expedited
PMA review from the agency, there can be no assurance that such status will
accelerate the review process or that such status will not be rescinded by the
FDA if other products performing substantially the same functions are approved
by the FDA prior to the Company receiving its approval. There can be no
assurance that the FDA will approve any Dermagraft-TC or Dermagraft-Ulcers PMA
applications in a timely manner, if at all. Moreover, even if such approvals are
obtained, post-approval regulation of the Company's products could result in the
withdrawal, suspension or limitation of approvals or limit the further marketing
of the Company's products. Delays in obtaining United States or foreign
approvals could result in substantial additional costs to the Company and
adversely affect the Company's competitive position. In addition, delays in
regulatory approvals that may be encountered by corporate collaborators or other
licensees of the Company could adversely affect the Company's ability to receive
royalties.
 
     The Company has constructed and is in the process of developing and
validating commercial scale manufacturing for its Dermagraft-TC and
Dermagraft-Ulcers products. The Company's manufacturing facility must be
registered, inspected, and licensed by various regulatory authorities, including
the California Department of Health and Human Services, and must comply with the
FDA's GMP requirements. There can be no assurance that the facility will be
found to comply with such GMP requirements and other requirements and that
necessary regulatory approvals will be obtained on a timely basis, if at all.
 
                                       40
<PAGE>   42
 
     With respect to the manufacture of products, if any, for which PMA approval
is granted, the Company will be subject to routine inspection by the FDA and
certain state agencies, including the California Department of Health and Human
Services, for compliance with GMP requirements, adverse event reporting
requirements and other applicable regulations. There can be no assurance that
the Company will not incur significant costs to comply with laws and regulations
in the future or that laws and regulations will not have a material adverse
effect upon the Company's business, financial condition or results of
operations.
 
     Whether regulated by the FDA as a medical device or biologic, or otherwise
by any state or foreign authorities, the approval process for any of the
Company's products will be expensive and time consuming and no assurance can be
given that any regulatory agency will grant its approval. The inability to
obtain, or delays in obtaining, such approval would adversely affect the
Company's ability to commence marketing therapeutic applications of its
technology. There can be no assurance that the Company will have sufficient
resources to complete the required testing and regulatory review processes.
Furthermore, the Company is unable to predict the extent of adverse governmental
regulation which might arise from future United States or foreign legislative or
administrative action.
 
     In addition, any products distributed by the Company pursuant to the above
authorizations are subject to pervasive and continuing regulation by the FDA.
Products must be manufactured in registered establishments and must be
manufactured in accordance with the GMP requirements. Labeling and promotional
activities are subject to scrutiny by the FDA and, in certain instances, by the
Federal Trade Commission. The export of devices also is subject to regulation in
certain instances.
 
     The Company is also subject to various federal, state and local laws,
regulations and recommendations relating to such matters as safe working
conditions, laboratory and manufacturing practices and the use, handling and
disposal of hazardous or potentially hazardous substances used in connection
with the Company's research and development work. Although the Company believes
it is in compliance with these laws and regulations in all material respects,
there can be no assurance that the Company will not be required to incur
significant costs to comply with environmental and other laws or regulations in
the future.
 
EMPLOYEES
 
     As of February 1, 1996, the Company employed 159 people, of whom 69 were
engaged in research and development, 51 in operations, and 39 in marketing and
administrative functions. The Company's staff includes 13 employees with Ph.D.
or M.D. degrees. None of the Company's employees are represented by a labor
union, and the Company believes that its employee relations are good. In
addition to its employees, the Company, through its strategic alliances and
academic collaborations, works with other leading physicians and scientists.
 
FACILITIES
 
     The Company leases approximately 66,000 square feet of space at its
headquarters facility in La Jolla, California of which approximately 80% is
allocated to manufacturing and research. The facility is leased through
September 12, 2000, subject to an option to renew the lease for five additional
years. The Company's other facilities are also located in La Jolla, California.
The Company's sublease for its Skin2 manufacturing facility, consisting of
approximately 6,000 square feet, expires on May 31, 1996, subject to options to
renew the sublease for an additional six months. The Company also leases
approximately 8,000 square feet of laboratory and office space under a lease
that expires on July 31, 1997.
 
   
     The Company believes that its property and equipment are generally well
maintained and in good operating condition. The Company will require additional
space to support growth in anticipation of commercialization of its products.
See "-- Manufacturing and Supply."
    
 
                                       41
<PAGE>   43
 
                                   MANAGEMENT
 
EXECUTIVE OFFICERS AND DIRECTORS
 
     The executive officers and directors of the Company are as follows:
 
   
<TABLE>
<CAPTION>
                  NAME                    AGE                        POSITION
----------------------------------------  ---       -------------------------------------------
<S>                                       <C>       <C>
Arthur J. Benvenuto.....................   52       Chairman of the Board of Directors, and
                                                    Chief Executive Officer
Dr. Gail K. Naughton....................   40       Director, President and Chief Operating
                                                    Officer
Terry E. Gibson.........................   55       Vice President, Operations
Frederick C. Schramm....................   53       Vice President, Project Planning and
                                                    Development
Michael V. Swanson......................   41       Vice President, Finance and Administration
Jerome E. Groopman, M.D.................   44       Director and Chairman of the Company's
                                                    Scientific Advisory Board
Jack L. Heckel(1)(2)....................   64       Director
David S. Tappan, Jr.(1).................   73       Director
William B. Walsh, M.D.(1)(2)............   75       Director
Dr. Gail R. Wilensky(2).................   52       Director
</TABLE>
    
 
---------------
(1) Member of Compensation and Stock Option Committee.
 
(2) Member of Audit Committee.
 
     ARTHUR J. BENVENUTO has been Chairman of the Board and Chief Executive
Officer since September 1995 and had been Chairman of the Board, President and
Chief Executive Officer of the Company since June 1988. Prior to joining the
Company, Mr. Benvenuto was associated with Eli Lilly & Company for more than
twenty years. Mr. Benvenuto served as President and General Manager of Eli Lilly
Canada, Inc. from October 1986 to June 1988 and was President and Chief
Executive Officer of IVAC Corporation, an Eli Lilly & Company medical device
subsidiary, from January 1982 to September 1986. Prior to January 1982, Mr.
Benvenuto was the Director and then the Vice President of Marketing and Sales at
IVAC Corporation. Mr. Benvenuto also held various positions in marketing
planning, human resources and sales management within the pharmaceutical
division of Eli Lilly & Company. He received his B.S. in Pharmacy from St.
John's University. Mr. Benvenuto currently serves as a Director of Project HOPE
and GalaGen, Inc.
 
     GAIL K. NAUGHTON, PH.D., a co-founder of the Company and a co-inventor of
its core technology, has been a Director of the Company since its inception and
has been President and Chief Operating Officer since September 1995. Prior to
September 1995, Dr. Naughton had been Executive Vice President and Chief
Operating Officer of the Company since June 1991. Dr. Naughton served as Senior
Vice President and Chief Scientific Officer of the Company from January 1989 to
June 1991, and Principal Scientist of the Company from its inception to December
1988. Dr. Naughton received her M.S. in histology in 1978 and her Ph.D. in Basic
Medical Sciences from New York University Medical Center in 1981, and completed
her post-doctoral training at New York University Medical Center in the
Department of Dermatology. Dr. Naughton was an Assistant Professor of Research
at New York University Medical Center for two years prior to joining City
University of New York in 1985. Dr. Naughton's primary fields of research
include cell and tissue culture technology, dermatology and hematology. Dr.
Naughton holds seven issued and eight allowed United States patents with 13
United States patents pending and has numerous publications in the field of
tissue engineering. Dr. Naughton is on the advisory boards of the Department of
Bioengineering at Johns Hopkins University and Georgia Tech and a member of the
industrial liaison board at the University of California, San Diego and Georgia
Tech. Dr. Naughton is a member of the Board of Directors of Scripps Bank in La
Jolla, California and the San Diego Burn Institute.
 
                                       42
<PAGE>   44
 
     TERRY E. GIBSON joined the Company as Vice President, Operations, in April
1992. From October 1990 to April 1992, Mr. Gibson provided consulting services
in areas such as strategic planning, facilities planning, and production and
operating performance to biotechnology, diagnostic and health care companies.
Mr. Gibson served as Vice President, Operations for Meridian Diagnostics, Inc.,
which develops, manufactures and markets diagnostic products, from August 1988
to October 1990. From June 1986 to August 1988, Mr. Gibson was Director of
Manufacturing for Ortho Diagnostic Systems Inc., a Johnson & Johnson Company,
which produces a full line of diagnostic and blood banking products. Prior to
June 1986, he spent over 12 years with Amersham Corporation, a diversified
medical, research and industrial products company. Mr. Gibson holds B.S. degrees
in Chemistry and Biological Sciences and Pharmacy and an M.S. in Bionucleonics
from Purdue University.
 
     FREDERICK C. SCHRAMM was appointed Vice President, Project Planning and
Development, in March 1994, having joined the Company as Executive Director,
Program Administration in January 1994. He was associated with Eli Lilly and
Company and its affiliates for twenty-nine years. Mr. Schramm was Vice President
of Operations at Hybritech Inc. from 1991 through 1993. Between 1978 and 1991,
he held various positions at IVAC Corporation including Vice President of
Operations, Vice President of Product Development and Vice President of
International Marketing and Sales. Mr. Schramm also spent five years in Lilly
International Pharmaceutical Operations in Europe and was involved initially in
the design and construction of parenteral pharmaceutical facilities in France,
followed by an assignment as Plant Manager of Lilly's pharmaceutical plant in
Giessen, West Germany. Mr. Schramm's educational background includes an M.B.A.
from Indiana University and a B.S degree in Engineering from Purdue University.
 
     MICHAEL V. SWANSON was appointed Vice President, Finance and
Administration, in September 1992, having previously served as Vice President,
Finance from June 1991 and as Director of Finance from March 1990. Mr. Swanson
served as Director of Finance of Fisher Scientific Group Inc., a health and
scientific technology holding company, from June 1987 through August 1989, and
at its parent, The Henley Group, Inc., a widely diversified holding company,
from June 1986 to June 1987. From July 1977 to June 1986, Mr. Swanson worked for
the public accounting firm of Deloitte Haskins & Sells (now Deloitte & Touche)
advancing to the position of audit manager. Mr. Swanson received an M.B.A. from
the University of Southern California and received his B.S. in Business
Administration from the California Polytechnic State University at San Luis
Obispo.
 
     JEROME E. GROOPMAN, M.D. has been a Director of the Company since May 1993.
He has been Chief, Division of Hematology/Oncology, New England Deaconess
Hospital since 1985. Dr. Groopman holds the Dina and Raphael Recanati
Professorship in Immunology at Harvard Medical School and has been a Professor
of Medicine, Harvard Medical School since 1993. Dr. Groopman's primary expertise
is in human retroviruses, specifically in the AIDS virus and human leukemia
viruses. Dr. Groopman is on the Biological Response Modifers Advisory Committee
to the Food and Drug Administration, an advisor to the National Heart Lung Blood
Institute.
 
     JACK L. HECKEL has been a Director of the Company since September 1990. Mr.
Heckel served as President and Chief Operating Officer of GenCorp Inc., a
technology-based company with strong positions in aerospace, automotive and
related polymer products from January 1987 until his retirement in November
1993. Mr. Heckel served as Chairman of the Board of Aerojet, a division of
GenCorp, from 1985 to January 1987, and as President prior to 1985. Mr. Heckel
serves as a director of the WD-40 Company and Applied Power, Incorporated.
 
     DAVID S. TAPPAN, JR. has been a Director of the Company since October 1992.
Mr. Tappan served as Chairman of the Board and Chief Executive Officer of Fluor
Corporation, an international engineering, construction and technical services
company, from 1984 until his retirement in 1990. Mr. Tappan is a director of
Beckman Instruments, Inc., Genentech, Inc. and Allianz Insurance Company. Mr.
Tappan also is a Trustee for the University of Southern California and The
Scripps Research Institute.
 
                                       43
<PAGE>   45
 
     WILLIAM B. WALSH, M.D. has been a Director of the Company since February
1989. In 1958, Dr. Walsh founded The People-to-People Health Foundation, Inc.,
parent organization for Project HOPE, and served as its President and Chief
Executive Officer until 1992. Dr. Walsh currently serves as Project HOPE's
Chairman Emeritus. In 1981, Dr. Walsh established Project HOPE's Center for
Health Affairs, which conducts national and international health policy research
and publishes "Health Affairs", a health policy journal. Dr. Walsh has served as
a health policy advisor to several Presidents and is a recipient of the
Presidential Medal of Freedom.
 
     GAIL R. WILENSKY, PH.D. has been a Director of the Company since January
1993. Since January 1993, Dr. Wilensky has been serving as a Senior Fellow at
Project HOPE. From March 1992 to January 1993, Dr. Wilensky served in the Bush
Administration as Deputy Assistant to the President for Policy Development,
responsible for advising the President on health and welfare issues. Prior to
her tenure in the White House, from January 1990 to March 1992, Dr. Wilensky
served as the Administrator of the Health Care Financing Administration (HCFA)
in the Department of Health and Human Services, where she directed the Medicare
and Medicaid programs. From April 1983 to January 1990, Dr. Wilensky was Vice
President, Division of Health Affairs at Project HOPE. Dr. Wilensky is an
elected member of the Institute of Medicine of the National Academy of Sciences.
She has also served as a member of the Physician Payment Review Commission and
the Health Advisory Committee of the General Accounting Office. Dr. Wilensky
serves as a director of Capstone Pharmacy, Coram Healthcare Corporation, St.
Jude Medical, Inc., Syncor International Corporation and United HealthCare
Corporation.
 
KEY PERSONNEL
 
     GARY D. GENTZKOW, M.D. was appointed Executive Director, Worldwide Clinical
Research, in December 1993, having joined the Company as Senior Director,
Clinical Research in September 1992. In 1990 and 1991, Dr. Gentzkow served as
Vice President, Medical Director at Staodyn, Inc. a medical device company. From
September 1987 to December 1989, Dr. Gentzkow was Vice President and Medical
Director at Synergen, Inc. Dr. Gentzkow was Director, Medical Affairs from
December 1982 to September 1987, and Associate Director of Clinical Research
from March 1982 to December 1982 for Riker Laboratories, a division of 3M
Corporation. From August 1978 to March 1982, Dr. Gentzkow was with American
Critical Care being promoted from Associate Director of Clinical Research to
Director of Medical Development and Services. Prior to 1978, Dr. Gentzkow spent
three years at Abbott Laboratories as Assistant Director of Medical Services.
Dr. Gentzkow received his A.B. from Harvard University in 1969 and earned his
Medical Degree from the University of Oregon Health Sciences Center in 1975.
 
     ELLEN G. REDDING was appointed Executive Director, Worldwide Regulatory
Affairs and Quality Assurance, in August, 1995 having served as Executive
Director, Worldwide Regulatory Affairs, Director, Regulatory Affairs, Director,
Regulatory Affairs/Quality Assurance and Senior Manager, Regulatory Affairs and
Quality Assurance from May 1994, September 1992, May 1991 and September 1990,
respectively. Ms. Redding was with Ioptex Research, Inc., a manufacturer of
implantable optical devices, from 1986 to 1990 where she served in a variety of
positions, most recently as Manager, Regulatory Affairs/Quality Assurance. From
1985 to 1986, Ms. Redding was a Clinical Research Associate at Intermedics
Intraocular, Inc., a manufacturer of implantable optical devices. At Collagen
Corporation, from 1984 to 1985, she was the Medical Monitor. Prior to 1984, Ms.
Redding spent over 13 years in the nursing field. Ms. Redding received a diploma
in nursing from Children's Hospital School of Nursing in 1971, a B.S. in nursing
from Fitchburg State College in 1978 and her M.S. degree in nursing from the
University of Pennsylvania in 1982.
 
     JULIE A. DEMEULES was appointed Executive Director, Human Resources, in
December 1992, having joined the Company as Director, Human Resources, in
February 1991. From June 1990 to February 1991, Ms. DeMeules was Director of
Human Resources at Square D. From 1984 to 1990, Ms. DeMeules served as Vice
President, Human Resources at Signet Armorlite, Inc. Prior to 1984, Ms. DeMeules
spent five years as Personnel Manager for Signet Optical and four years with San
 
                                       44
<PAGE>   46
 
Diego State University as an Employment Representative. Ms. DeMeules received
her B.A. in Business Administration from the University of San Diego in 1974 and
her M.B.A. from San Diego State University, Graduate School of Business in 1979.
 
     ALANA B. WHEELER was appointed Executive Director, Corporate Development,
in November 1993, having previously served as Director, Business Development and
Manager, Business Planning and Development from April 1993 and July 1991,
respectively. From 1987 through 1989, Ms. Wheeler served as an Associate for
Bear Sterns and Co., Inc. and Sutro & Co., Incorporated where she focused on
securities research, finance and sales specializing in the biotechnology
industry. Ms. Wheeler received her B.A. in Biological Sciences from the
University of California, Santa Barbara in 1987 and her M.B.A. from The Anderson
School at University of California, Los Angeles in 1991.
 
     JOSEPH E. ZACK joined the Company in June 1993 as Executive Director,
Marketing. Mr. Zack has 20 years of marketing experience at Ciba-Geigy, where he
held positions in sales, new product development and marketing including
Executive Director of Cardiopulmonary Product Management. Mr. Zack received his
B.A. in Biology from Colgate University in 1973 and his M.B.A. in Marketing from
St. John's University in 1978.
 
     JANE WILLOUGHBY, PH.D. was appointed General Manager of the Smith & Nephew
joint venture in October 1994. Dr. Willoughby joined the Smith & Nephew Research
Group in March 1988 as Head of Biological Sciences, where Dr. Willoughby was
responsible for managing a team of multi-disciplinary scientists. Prior to
joining Smith & Nephew, Dr. Willoughby spent three years at the Royal
Postgraduate Medical School, London University investigating Parkinson's
Disease. Dr. Willoughby received her B.Sc. in Medical Biochemistry in 1982 and
her Ph.D. in Biochemistry in 1986 from Bartholomews Medical College, London
University.
 
     JAMES H. FLATT, PH.D. joined the Company as Director, Product Development,
in December 1994. From 1990 to December 1994, Dr. Flatt worked for KELCO, a
division of Merck, first as Senior Research Engineer, then in 1992 as Project
Manager, and in 1993 as Manager, Fermentation Process Research and Development.
Dr. Flatt worked for Proctor and Gamble Company first as Products Research
Engineer from 1983 to 1985 and then as Products Research and Product Development
Group Leader from 1985 to 1986. Dr. Flatt received his B.S. in Chemical
Engineering from Massachusetts Institute of Technology in 1981, a M.S. in
Chemical Engineering from the University of California, Berkeley in 1983 and a
Ph.D. in Chemical and Biochemical Engineering from the University of Wisconsin
in 1990.
 
     TERESA M. GRILLOT joined the Company as Director, Health Economics and
Reimbursement, in September 1994. From September 1989 to September 1994, Ms.
Grillot worked at Amgen Inc. where she established and managed the Product
Economics and Health Policy department for NEUPOGEN(R). From July 1985 to
September 1989, Ms. Grillot worked at Lederle Laboratories serving in a variety
of positions including manufacturing, quality control, marketing, and sales. Ms.
Grillot received her B.S. in Microbiology and Chemistry from Iowa State
University in 1982 and her M.S. in Health Policy and Epidemiology from Cornell
University in 1985.
 
                                       45
<PAGE>   47
 
SCIENTIFIC ADVISORY BOARD
 
     Advanced Tissue Sciences' Scientific Advisory Board consists of academic
and medical experts in the fields of organ transplantation, polymer synthesis,
in vitro toxicology and other related medical specialties. The Company generally
meets with members of the Scientific Advisory Board twice a year and with
individual members on an ad hoc basis as necessary to discuss research and
development strategies and specific details of certain projects. All of the
Scientific Advisory Board members have entered into consulting agreements
specifying the terms and scope of their individual advisory relationship with
the Company. The Company does not believe that termination of any individual
consulting agreement would materially affect its business. None of the
Scientific Advisory Board members are employed by the Company and, therefore,
may have other commitments to, or consulting or advisory contracts with, other
entities which may compete with their obligations to the Company. The members of
the Scientific Advisory Board are:
 
     JEROME E. GROOPMAN, M.D. has been a Director of the Company since May 1993
and is the Chairman of the Scientific Advisory Board. See "-- Executive Officers
and Directors".
 
     KURT J. ISSELBACHER, M.D. is the Chairman Emeritus of the Scientific
Advisory Board. Dr. Isselbacher is also the Director of Massachusetts General
Hospital Cancer Center, a Professor of Medicine at Harvard Medical School and a
member of the National Academy of Sciences and serves on its council. Dr.
Isselbacher's primary research expertise is in oncology and gastroenterology.
 
     DANIEL ACOSTA, JR., PH.D. is the Director of the Toxicology Training
Program and Head of the Biomedical Toxicology program at the Drug Dynamics
Institute of the University of Texas at Austin. Dr. Acosta's research expertise
is in in vitro toxicity to the heart, liver, kidney, skin and eyes.
 
     GERARD N. BURROW, M.D. is Dean of the Yale School of Medicine and former
Dean of the University of California, San Diego School of Medicine. Dr. Burrow's
primary expertise is endocrinology and he is a member of the Institute of the
National Academy of Sciences. Dr. Burrow is a member of the Board of Directors
of Johnson & Johnson.
 
     ROBERT S. LANGER, SC.D is the Kenneth J. Germeshausen Professor of Chemical
and Biomedical Engineering at the Massachusetts Institute of Technology. Dr.
Langer's expertise is in the design and synthesis of biomaterials for use in
tissue engineering and he is a member of the National Academy of Sciences,
National Academy of Engineering and the National Institute of Medicine. Dr.
Langer directs the Company's collaborative polymer research efforts at MIT and
is a co-inventor of issued and pending patents relating to cartilage and other
tissue engineered products, which have been exclusively licensed to the Company.
 
     JEFFREY M. LIPTON, M.D. is an Associate Professor of Pediatrics and Chief,
Division of Pediatric Hematology/Oncology at Mount Sinai School of Medicine in
New York. Dr. Lipton also serves as the Chairman, Core Committee for Bone Marrow
Transplantation, Pediatric Oncology Group at Mount Sinai. Dr. Lipton's research
expertise is in human hematopoietic progenitor differentiation and his clinical
expertise is in bone marrow transplantation.
 
     VERA M. ROGIER, PH.D. is a member of the faculty of Medicine and Pharmacy,
Department of Toxicology at the Vrije Univrsiteit Brussels. Dr. Rogier's primary
expertise is in in vitro toxicology.
 
     JOSEPH P. VACANTI, M.D. is the Director, Organ Transplantation and
Director, Laboratory for Tissue Construction at Children's Hospital, an
affiliate of Harvard Medical School and an Associate Professor of Surgery at
Harvard Medical School. Dr. Vacanti is a pediatric liver transplant specialist
whose expertise is in organ transplantation techniques. Dr. Vacanti directs the
Company's collaborative tissue engineering research work at Children's Hospital
and is a co-inventor of certain issued and pending patents relating to cartilage
and other tissue engineered products, which have been exclusively licensed to
the Company.
 
                                       46
<PAGE>   48
 
                                  UNDERWRITING
 
     Subject to the terms and conditions of the Underwriting Agreement, the
Company has agreed to sell to each of the Underwriters named below, and each of
such Underwriters, for whom Goldman, Sachs & Co. and Morgan Stanley & Co.
Incorporated are acting as representatives, has severally agreed to purchase
from the Company, the respective number of shares of Common Stock set forth
opposite its name below:
 
<TABLE>
<CAPTION>
                                                                             NUMBER OF
                                                                             SHARES OF
                                 UNDERWRITER                                COMMON STOCK
    ----------------------------------------------------------------------  ------------
    <S>                                                                     <C>
    Goldman, Sachs & Co...................................................
    Morgan Stanley & Co. Incorporated.....................................
                                                                              ---------
              Total.......................................................    3,000,000
                                                                              =========
</TABLE>
 
     Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all of the shares offered hereby,
if any are taken.
 
     The Underwriters propose to offer the shares of Common Stock in part
directly to the public at the public offering price set forth on the cover page
of this Prospectus and in part to certain securities dealers at such price less
a concession of $          per share. The Underwriters may allow, and such
dealers may reallow, a concession not in excess of $          per share to
certain brokers and dealers. After the shares of Common Stock are released for
sale to the public, the offering price and other selling terms may from time to
time be varied by the representatives.
 
     The Company has granted the Underwriters an option, exercisable for 30 days
after the date of this Prospectus, to purchase up to an aggregate of 450,000
additional shares of Common Stock solely to cover over-allotments, if any. If
the Underwriters exercise their over-allotment option, the Underwriters have
severally agreed, subject to certain conditions, to purchase approximately the
same percentage thereof as the number of shares of Common Stock to be purchased
by it shown in the above table bears to the 3,000,000 shares of Common Stock
offered hereby.
 
     The Company's officers and directors, who collectively beneficially own
(including exercisable options) an aggregate of approximately 3,685,659 shares
of Common Stock (approximately 10.2% and 9.4% of the shares of Common Stock to
be outstanding immediately prior to and following the completion of this
offering, respectively) have agreed that for a period of 180 days from the date
of this Prospectus (the "Lockup Period") they will not, without the prior
written consent of Goldman, Sachs & Co., either directly or indirectly, offer to
sell, sell, contract to sell, grant any option for the sale of, acquire any
option to dispose of, or otherwise dispose of any shares of Common Stock of the
Company or any securities exchangeable for or convertible into shares of the
Company's Common Stock. Additionally, certain other stockholders have agreed not
to sell or otherwise dispose of an aggregate of 550,332 shares beneficially
owned by them for a period of 60 days from the date of this Prospectus without
the prior written consent of Goldman, Sachs & Co. The Company has agreed that
during the Lockup Period it will not, without the prior written consent of
Goldman, Sachs & Co., issue, offer, sell or otherwise dispose of any shares of
its Common Stock or securities convertible into shares of its Common Stock;
provided, that during the Lockup Period, the Company may grant options and sell
shares of its Common Stock pursuant to the 1992 Plan and issue shares of Common
Stock upon the exercise of outstanding options and warrants.
 
     The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as amended
(the "Securities Act"). Certain of the Underwriters and selling group members
(if any) or their respective affiliates that currently act as market makers for
the Common Stock may engage in "passive market making" in the Common
 
                                       47
<PAGE>   49
 
Stock on the Nasdaq National Market in accordance with Rule 10b-6A under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Rule 10b-6A
permits, upon the satisfaction of certain conditions, underwriters and selling
group members participating in a distribution that are also NASDAQ market makers
in the security being distributed to engage in limited market making
transactions during the period when Rule 10b-6 under the Exchange Act would
otherwise prohibit such activity. Rule 10b-6A prohibits underwriters and selling
group members engaged in passive market making generally from entering a bid or
effecting a purchase at a price that exceeds that highest bid for those
securities displayed on NASDAQ by a market maker that is not participating in
the distribution. Under Rule 10b-6A, each underwriter or selling group member
engaged in passive market making is subject to a daily net purchase limitation
equal to 30% of such entity's average daily trading volume during the two full
consecutive calendar months immediately preceding the date of the filing of the
registration statement under the Securities Act pertaining to the security to be
distributed.
 
                                 LEGAL MATTERS
 
     Certain legal matters with respect to the validity of the Common Stock
offered hereby are being passed upon for the Company by Brobeck, Phleger &
Harrison LLP, Newport Beach, California. Wilson, Sonsini, Goodrich & Rosati,
Professional Corporation, Palo Alto, California, is acting as counsel for the
Underwriters in connection with certain legal matters relating to the sale of
the Common Stock offered hereby. Certain members of Brobeck, Phleger & Harrison
LLP beneficially own 20,000 shares of the Company's Common Stock.
 
                                    EXPERTS
 
     The consolidated financial statements of the Company appearing in this
Prospectus and this Registration Statement and appearing in the Company's Annual
Report (Form 10-K) for the year ended December 31, 1995, have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein and in the Registration Statement and incorporated
herein by reference. Such consolidated financial statements are included and
incorporated herein by reference in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing.
 
                             AVAILABLE INFORMATION
 
     The Company is subject to the reporting requirements of the Exchange Act,
and in accordance therewith files annual and quarterly reports, proxy statements
and other information with the Securities and Exchange Commission (the
"Commission"). Such reports, proxy statements and other information may be
inspected at the Commission's Public Reference Section, Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549, as well as at the Commission's Regional
Offices at 7 World Trade Center, Suite 1300, New York, New York 10048; and at
Northwest Atrium Center, 500 West Madison Street, Room 1400, Chicago, Illinois
60661-2511. Copies of such material can also be obtained at prescribed rates
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The Common Stock of the Company is traded on the Nasdaq
National Market. Reports and other information concerning the Company may be
inspected at the National Association of Securities Dealers, Inc. at 1735 K
Street, N.W., Washington, D.C. 20006.
 
     Additional information regarding the Company and the shares offered hereby
is contained in the Registration Statement on Form S-3 and the exhibits thereto
filed with the Commission under the Securities Act. For further information
pertaining to the Company and the shares, reference is made to the Registration
Statement and the exhibits thereto, which may be inspected without charge at,
 
                                       48
<PAGE>   50
 
and copies thereof may be obtained at prescribed rates from, the office of the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     The following documents filed with the Commission are hereby incorporated
by reference in this Prospectus: (i) the Annual Report of the Company on Form
10-K dated February 23, 1996 for the year ended December 31, 1995; (ii) the
Current Report of the Company on Form 8-K dated February 16, 1996; (iii) the
Company's Registration Statement on Form 8-A dated July 28, 1992; and (iv) the
Company's Registration Statement on Form 8-A dated January 6, 1995.
 
     All reports and other documents subsequently filed by the Company pursuant
to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this
Prospectus and prior to the termination of this offering shall be deemed to be
incorporated by reference herein and to be a part hereof from the date of filing
of such reports and documents. Any statement incorporated herein shall be deemed
to be modified or superseded for purposes of this Prospectus to the extent that
a statement contained herein, or in any other subsequently filed document which
also is or is deemed to be incorporated by reference herein, modifies or
supersedes such statement. Any statement so modified or superseded shall not be
deemed, except as so modified or superseded, to constitute a part of this
Prospectus.
 
     The Company will provide without charge to each person to whom this
Prospectus is delivered, upon written or oral request of such person, a copy of
any or all of the foregoing documents incorporated herein by reference (other
than exhibits to such documents, unless such exhibits are specifically
incorporated by reference into such document). Requests for such documents
should be submitted in writing to Michael V. Swanson, Vice President, Finance
and Administration, at Advanced Tissue Sciences, Inc., 10933 North Torrey Pines
Road, La Jolla, California 92037 or by telephone at (619) 450-5730.
 
                            ------------------------
 
     Skin(2)(R), Dermagraft(R) and Dermagraft-TC(TM) are trademarks of Advanced
Tissue Sciences, Inc. All other trademarks appearing in this Prospectus are the
property of other companies.
 
                                       49
<PAGE>   51
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                 INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                                       PAGE
                                                                                       ----
<S>                                                                                    <C>
Consolidated Balance Sheet as of December 31, 1995 and 1994..........................   F-2
Consolidated Statement of Operations for the Years Ended December 31, 1995, 1994 and
  1993, and the Cumulative Period January 21, 1986 (inception) to December 31,
  1995...............................................................................   F-3
Consolidated Statement of Cash Flows for the Years Ended December 31, 1995, 1994 and
  1993, and the Cumulative Period January 21, 1986 (inception) to December 31,
  1995...............................................................................   F-4
Consolidated Statement of Stockholders' Equity (Deficit) for the Period January 21,
  1986 (inception) to December 31, 1995..............................................   F-5
Notes to the Consolidated Financial Statements.......................................   F-7
Report of Ernst & Young LLP, Independent Auditors....................................  F-17
</TABLE>
 
                                       F-1
<PAGE>   52
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                           CONSOLIDATED BALANCE SHEET
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                           DECEMBER 31,
                                                                      ----------------------
                                                                        1995          1994
                                                                      ---------     --------
<S>                                                                   <C>           <C>
                                           ASSETS
Current assets:
  Cash and cash equivalents.........................................  $  18,929     $ 12,417
  Short-term investments............................................         --        9,616
  Prepaid expenses..................................................        820          861
  Other current assets..............................................      1,214        1,183
                                                                      ---------      -------
     Total current assets...........................................     20,963       24,077
Property -- net.....................................................      8,332        8,374
Patent costs -- net.................................................      1,032          824
Other assets........................................................        814          151
                                                                      ---------      -------
          Total assets..............................................  $  31,141     $ 33,426
                                                                      =========      =======
                             LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
  Current portion of obligations under capital leases...............  $      11     $     10
  Accounts payable..................................................      1,183        1,850
  Accrued expenses..................................................      4,022        3,180
                                                                      ---------      -------
     Total current liabilities......................................      5,216        5,040
                                                                      ---------      -------
Obligations under capital leases....................................         25           36
                                                                      ---------      -------
Commitments and contingencies (Notes 6 and 7)
Stockholders' equity:
  Preferred Stock, $.01 par value, 1,000,000 shares authorized; none
     issued.........................................................         --           --
  Common Stock, $.01 par value; 50,000,000 shares authorized; issued
     and outstanding, 33,885,928 shares at December 31, 1995 and
     30,568,713 shares at December 31, 1994.........................        339          306
  Additional paid-in capital........................................    143,161      121,600
  Deficit accumulated during development stage......................   (116,681)     (93,556)
                                                                      ---------      -------
                                                                         26,819       28,350
  Less note received in connection with the sale of Common Stock
     (Note 8).......................................................       (919)          --
                                                                      ---------      -------
          Total stockholders' equity................................     25,900       28,350
                                                                      ---------      -------
          Total liabilities and stockholders' equity................  $  31,141     $ 33,426
                                                                      =========      =======
</TABLE>
 
      See the accompanying notes to the consolidated financial statements.
 
                                       F-2
<PAGE>   53
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                      CONSOLIDATED STATEMENT OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                                    CUMULATIVE
                                                                                   JANUARY 21,
                                                                                       1986
                                                                                   (INCEPTION)
                                                 YEAR ENDED DECEMBER 31,                TO
                                            ----------------------------------     DECEMBER 31,
                                              1995         1994         1993           1995
                                            --------     --------     --------     ------------
<S>                                         <C>          <C>          <C>          <C>
Revenues:
  Product sales...........................  $  1,177     $  1,042     $  1,401      $    4,876
  Contracts and fees......................     2,388          923        3,493           7,010
  Interest and other......................     1,185        1,250          972           6,783
                                            --------     --------     --------       ---------
          Total revenues..................     4,750        3,215        5,866          18,669
                                            --------     --------     --------       ---------
Costs and expenses:
  Research and development................    18,498       16,459       13,810          64,960
  Selling, general and administrative.....     6,115        6,445        6,224          31,778
  Professional and consulting.............     1,897        1,718        1,864          10,274
  Cost of goods sold......................     1,359        1,360        1,458           5,963
  Interest................................         6            8            1             549
  Stockholder interest and other..........        --           --          200             426
  In-process technology...................        --           --           --          21,400
                                            --------     --------     --------       ---------
          Total costs and expenses........    27,875       25,990       23,557         135,350
                                            --------     --------     --------       ---------
Net loss..................................  $(23,125)    $(22,775)    $(17,691)     $ (116,681)
                                            ========     ========     ========       =========
Net loss per share........................  $   (.72)    $   (.75)    $   (.67)
                                            ========     ========     ========
Weighted average number of common shares
  used in the computation of net loss per
  share...................................    32,266       30,250       26,453
                                            ========     ========     ========
</TABLE>
 
      See the accompanying notes to the consolidated financial statements.
 
                                       F-3
<PAGE>   54
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                                     CUMULATIVE
                                                                                    JANUARY 21,
                                                                                        1986
                                                     YEAR ENDED DECEMBER 31,       (INCEPTION) TO
                                                  ------------------------------    DECEMBER 31,
                                                    1995       1994       1993          1995
                                                  --------   --------   --------   --------------
<S>                                               <C>        <C>        <C>        <C>
Operating activities:
  Net loss......................................  $(23,125)  $(22,775)  $(17,691)    $ (116,681)
  Adjustments to reconcile net loss to cash used
     in operating activities:
     Depreciation and amortization..............     1,421      1,102        905          4,941
     Write-off of acquired in-process
       technology...............................        --         --         --         21,000
     Compensation for services paid in stock or
       stock options............................        55         --         43          1,548
     Other adjustments to net loss..............       212         38         61            496
  Change in assets and liabilities:
     Prepaid expenses and other current
       assets...................................        10       (754)       151         (2,034)
     Other assets...............................      (663)       200       (237)          (627)
     Accounts payable...........................      (667)       512        765          1,183
     Accrued expenses...........................       842       (928)     2,674          4,022
                                                  --------   --------   --------   --------------
          Net cash used in operating
            activities..........................   (21,915)   (22,605)   (13,329)       (86,152)
                                                  --------   --------   --------   --------------
Investing activities:
  Purchases of short-term investments...........    (5,363)   (35,196)   (25,728)      (124,404)
  Sales of short-term investments...............    14,979     28,965     37,622        124,404
  Acquisition of property.......................    (1,476)    (3,145)    (4,283)       (11,179)
  Patent application costs......................      (323)      (164)       (86)        (1,314)
                                                  --------   --------   --------   --------------
          Net cash provided by (used in)
            investing activities................     7,817     (9,540)     7,525        (12,493)
                                                  --------   --------   --------   --------------
Financing activities:
  Proceeds from borrowings......................        --         --         --            529
  Payments of borrowings........................       (10)        (8)        (1)        (2,907)
  Loans received from officers..................        --         --         --          1,132
  Payment of loan to shareholders...............        --         --         --            (50)
  Net proceeds from sale of equity..............    19,515     26,197         --        110,709
  Options exercised.............................     1,105         65      4,422          8,432
  Purchase of options and other.................        --         --         --           (271)
                                                  --------   --------   --------   --------------
          Net cash provided by financing
            activities..........................    20,610     26,254      4,421        117,574
                                                  --------   --------   --------   --------------
Net increase (decrease) in cash and cash
  equivalents...................................     6,512     (5,891)    (1,383)        18,929
Cash and cash equivalents at the beginning of
  period........................................    12,417     18,308     19,691             --
                                                  --------   --------   --------   --------------
Cash and cash equivalents at the end of
  period........................................  $ 18,929   $ 12,417   $ 18,308     $   18,929
                                                  =========  =========  =========   ===========
</TABLE>
 
      See the accompanying notes to the consolidated financial statements.
 
                                       F-4
<PAGE>   55
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                     COMMON STOCK
                                           ---------------------------------                  DEFICIT        NOTE         TOTAL
                                                                                            ACCUMULATED   RECEIVABLE/    STOCK-
                                              CLASS A*           CLASS B       ADDITIONAL     DURING       DEFERRED     HOLDERS'
                                           ---------------   ---------------    PAID-IN     DEVELOPMENT     COMPEN-      EQUITY
                                           SHARES   AMOUNT   SHARES   AMOUNT    CAPITAL        STAGE        SATION      (DEFICIT)
                                           ------   ------   ------   ------   ----------   -----------   -----------   ---------
<S>                                        <C>      <C>      <C>      <C>      <C>          <C>           <C>           <C>
January 21, 1986 (inception) to January
 31, 1988 Shares issued by predecessor
 company converted on merger (at $26.67
 per share):
    For cash.............................       1    $ 20                                                                $    20
    For patent rights....................       1      17                                                                     17
    For services.........................              16                                                                     16
  Par value adjustment on merger.........      (2)    (53)       2              $     53                                      --
  Split of Class B Common................                    7,708     $  8           (8)                                     --
  Sale of stock for cash, less expenses
    of $25 (at $1.11 per share)..........                      377                   393                                     393
  Issuance in payment of liabilities
    (at $1.11 per share).................                      863        1          958                                     959
  Other..................................                                            235                                     235
  Net loss...............................                                                    $  (1,863)                   (1,863)
                                           ======    ====   ======      ===      =======      ========                   =======
Balance, January 31, 1988................      --      --    8,950        9        1,631        (1,863)                     (223)
Sale of Units for Class A Common, less
  expenses of $1,533 (at $1.67 per
  share).................................   4,140      41                          5,326                                   5,367
Sale of Class A Common for cash and a
  note receivable (at $1.67 per share)...     550       5                            913                    $  (913)           5
Options exercised ($.01 to $.20 per
  share).................................     211       2                             29                                      31
Conversion of Class B to Class A
  Common.................................      67       1      (67)                   (1)                                     --
Surrender and cancellation...............                     (150)                                                           --
Options granted for services and other...                                            174                       (147)          27
Net loss.................................                                                       (2,716)                   (2,716)
                                           ------    ----   ------      ---      -------      --------      -------      -------
Balance, January 31, 1989................   4,968      49    8,733        9        8,072        (4,579)      (1,060)       2,491
Sale of stock for cash, less expenses of
  $104
  (at $1.25 per share)...................   1,600      16                          1,880                                   1,896
Exercise of Class A Warrants, less
  expenses of $592 (at $2.55 per
  share).................................   4,114      41                          9,856                                   9,897
Options exercised (at $.01 to $1.81 per
  share).................................      25       1                             18                                      19
Conversion of Class B to Class A
  Common.................................     926       9     (926)      (1)          (8)                                     --
Options granted for services and other...                                            375                         11          386
Net loss.................................                                                       (4,228)                   (4,228)
                                           ------    ----   ------      ---      -------      --------      -------      -------
Balance, January 31, 1990................  11,633     116    7,807        8       20,193        (8,807)      (1,049)      10,461
Options exercised (at $1.25 to $1.69 per
  share).................................      51                                     80                                      80
Repurchase of Class A Common.............    (550)     (5)                          (913)                       913           (5)
Conversion of Class B to Class A
  Common.................................   3,790      38   (3,790)      (4)         (34)                                     --
Options granted for services and other...     (29)                                   850                       (438)         412
Surrender of Class B Common..............                   (4,000)      (4)           4                                      --
Net loss.................................                                                       (5,488)                   (5,488)
                                           ------    ----   ------      ---      -------      --------      -------      -------
Balance, January 31, 1991................  14,895     149       17       --       20,180       (14,295)        (574)       5,460
Options exercised (at $1.63 to $5.31 per
  share).................................     356       4                            771                                     775
Exercise of Class B Warrants, less
  expenses of $746 (at $3.82 per
  share).................................   4,513      45                         16,449                                  16,494
Conversion of Class B to Class A
  Common.................................      17              (17)                                                           --
Options granted for services.............                                                                       377          377
Other....................................     (13)                                   (97)                                    (97)
Net loss.................................                                                       (6,805)                   (6,805)
                                           ------    ----   ------      ---      -------      --------      -------      -------
Balance, January 31, 1992................  19,768    $198       --     $ --     $ 37,303     $ (21,100)     $  (197)     $16,204
                                           ------    ----   ======      ===      -------      --------      -------      -------
</TABLE>
 
---------------
        * Represents Common Stock prior to the designation of classes in October
  1987.                                                              (Continued)
 
                                       F-5
<PAGE>   56
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
    CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) -- (CONTINUED)
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                                            DEFICIT         NOTE          TOTAL
                                                                                          ACCUMULATED    RECEIVABLE/     STOCK-
                                            COMMON STOCK*       COMMON      ADDITIONAL      DURING        DEFERRED      HOLDERS'
                                           ----------------    STOCK TO      PAID-IN      DEVELOPMENT      COMPEN-       EQUITY
                                           SHARES    AMOUNT    BE ISSUED     CAPITAL         STAGE         SATION       (DEFICIT)
                                           ------    ------    ---------    ----------    -----------    -----------    ---------
<S>                                        <C>       <C>       <C>          <C>           <C>            <C>            <C>
Balance, January 31, 1992................  19,768     $198                   $  37,303     $ (21,100)       $(197)      $  16,204
Sale of Common Stock for cash, less
  expenses of $2,514
  (at $14.50 per share)..................   2,300       23                      30,813                                     30,836
Issuance of stock and stock to be issued
  to Neomorphics' stockholders (Note
  8).....................................     682        7      $15,000          5,993                                     21,000
Options exercised (at $1.69 to $8.13 per
  share).................................   1,103       11                       2,007                                      2,018
Options granted for services.............                                                                     154             154
Other....................................     (15)      (1)                       (132)                                      (133)
Net loss.................................                                                    (31,990)                     (31,990)
                                           ------     ----     --------       --------     ---------        -----        --------
Balance, December 31, 1992...............  23,838      238       15,000         75,984       (53,090)         (43)         38,089
Options and warrants exercised, less
  expenses of $40
  (at $1.69 to $8.13 per share)..........   1,812       18                       4,784                                      4,802
Stock issued to Neomorphics' stockholders
  (Note 8)...............................   1,486       15      (15,000)        14,985                                         --
Options granted for services.............                                                                      43              43
Other....................................     (29)                                (380)                                      (380)
Net loss.................................                                                    (17,691)                     (17,691)
                                           ------     ----     --------       --------     ---------        -----        --------
Balance, December 31, 1993...............  27,107      271           --         95,373       (70,781)          --          24,863
Sale of Common Stock for cash, less
  expenses of $1,803
  (at $8.00 per share) (Note 8)..........   2,875       29                      21,168                                     21,197
Sale of Common Stock to St. Jude Medical,
  Inc. (at $8.875 per share) (Note 8)....     563        6                       4,994                                      5,000
Options exercised (at $1.69 to $8.13 per
  share).................................      24                                   65                                         65
Net loss.................................                                                    (22,775)                     (22,775)
                                           ------     ----     --------       --------     ---------        -----        --------
Balance, December 31, 1994...............  30,569      306           --        121,600       (93,556)          --          28,350
Sale of Common Stock for cash, less
  expenses of $1,744
  (at $6.86 to $8.47 per share) (Note
  8).....................................   2,614       26                      19,489                                     19,515
Options exercised (at $1.67 to $12.13 per
  share).................................     703        7                       2,017                       (919)          1,105
Options granted for services.............                                           55                                         55
Net loss.................................                                                    (23,125)                     (23,125)
                                           ------     ----     --------       --------     ---------        -----        --------
Balance, December 31, 1995...............  33,886     $339      $    --      $ 143,161     $(116,681)       $(919)      $  25,900
                                           ======     ====     ========       ========     =========        =====        ========
</TABLE>
 
---------------
* Represents Class A Common Stock prior to the elimination of classes in June
  1992.
 
      See the accompanying notes to the consolidated financial statements.
 
                                       F-6
<PAGE>   57
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1 -- BASIS OF PRESENTATION
 
     Organization -- Advanced Tissue Sciences, Inc. is a development stage,
tissue engineering company utilizing its proprietary technology to develop and
manufacture completely human tissue products for transplantation. The Company is
focusing on the worldwide commercialization of skin, cartilage and
cardiovascular products. The Company's first therapeutic products, tissue
engineered skin products for the treatment of severe burns and chronic skin
ulcers, are in multi-site human clinical trials.
 
     Liquidity and Capital Resources -- As of December 31, 1995, the Company had
available working capital of $15.7 million. In addition to available working
capital, in February 1996 the Company filed to register 3,000,000 shares of
Common Stock in an underwritten public offering and obtained an equity line
which could provide up to $50 million in funding. The Company believes it will
have sufficient funds to support its operations for at least the next twelve
months, based on funds from the public offering, if successful, or availability
under the equity line. The Company is also pursuing strategic alliances which
could provide additional funding to the Company. See Note 12.
 
     Principles of Consolidation -- The consolidated financial statements
include the accounts of the Company's wholly owned subsidiaries. The Company's
fifty percent interest in the Advanced Tissue Sciences-Smith & Nephew joint
venture is accounted for under the equity method (see Note 3). All intercompany
accounts and transactions have been eliminated.
 
     Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and related disclosures at the date of the financial statements,
and the amounts of revenues and expenses reported during the period. Actual     
results could differ from those estimates.                                   
 
     Dependence on Certain Suppliers -- The mesh frameworks used by the Company
in its therapeutic products are sourced from single manufacturers. Any
significant supply interruption would adversely affect the Company's clinical
trials. In addition, an uncorrected impurity or supplier's variation in raw
material, either unknown to the Company or incompatible with the Company's
manufacturing process, could have a material adverse effect on the Company's
ability to manufacture its products.
 
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
     Cash Equivalents and Short-term Investments -- 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 $18,622,000
and $12,421,000 as of December 31, 1995 and 1994, respectively. Short-term
investments 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, 1995 and 1994, the
 
                                       F-7
<PAGE>   58
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Company's cash equivalents and short-term investments were classified as
available-for-sale and consisted of (in thousands):
 
<TABLE>
<CAPTION>
                                                                  1995        1994
                                                                 -------     -------
        <S>                                                      <C>         <C>
        Debt securities of U.S. government agencies............  $13,051     $11,739
        United States treasury bills...........................    2,682       6,767
        Commercial paper.......................................    2,889         697
                                                                 -------     -------
        Total cash equivalents and short-term investments......  $18,622     $19,203
                                                                 =======     =======
</TABLE>
 
     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, 1995 or 1994.
 
     Property is recorded at cost and is depreciated using estimated useful
lives which range from 5 to 10 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.
 
     Patents -- The Company owns and has patents pending in the United States
and abroad to protect the processes and products being developed by the Company.
Direct patent application and maintenance costs related to patents issued are
amortized over the estimated useful life of the patent, generally 17 years. Such
costs related to pending applications are deferred until the patent is issued or
charged to operations at the time a determination is made not to pursue an
application. Patents are presented net of accumulated amortization of
approximately $134,000 and $109,000 as of December 31, 1995 and 1994,
respectively. Patent application and maintenance costs related to licensing
agreements are expensed as incurred.
 
     Revenue Recognition -- Revenues from product sales are recognized when
products are shipped. Revenues under collaborative research agreements are
recognized over the period specified in the related agreement. Revenues from
government grants are recognized based on the performance requirements of the
grant or as the grant expenditures are incurred. Expenses related to such
agreements and grants are classified as research and development expenses.
 
     Export Sales; Major Customers -- Export sales of the Company's laboratory
testing kits, principally to Europe and Asia, totaled approximately $622,000,
$435,000 and $486,000 in the years ended December 31, 1995, 1994 and 1993,
respectively, 37%, 54% and 15% of which were sold to the Company's Asian
distributor, Oriental Yeast Company. The Company has no foreign operations.
 
     Research and Development Costs are expensed as incurred. Such costs include
proprietary research and development activities and expenses associated with
collaborative research agreements.
 
     Cost of Goods Sold includes the direct and indirect costs of manufacturing
the Company's laboratory testing kits. Cost of goods sold is net of the cost of
products transferred to research and development for use in developing
additional applications of the Company's laboratory testing kits. The cost of
such products is included in research and development expenses based upon the
estimated direct and indirect production costs assuming planned production
during the period.
 
     Net Loss Per Share is based on the weighted average number of the shares of
Common Stock issued and outstanding and, for the year ended December 31, 1993,
1,486,079 shares of Common
 
                                       F-8
<PAGE>   59
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Stock which were distributed on March 31, 1993 as part of the purchase price of
Neomorphics, Inc. as if such shares had been issued and outstanding on January
1, 1993 (see Note 8). Shares to be issued under options and warrants have not
been included in the calculation of the net loss per share in any period as
their effect is antidilutive.
 
     New Accounting Standard -- In March 1995, the Financial Accounting
Standards Board issued Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed of" ("FAS 121"),
effective for fiscal years beginning December 15, 1995. FAS 121 requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amount. FAS
121 also addresses the accounting for long-lived assets that are expected to be
disposed. The Company does not believe, based on current circumstances, the
effect of the adoption of FAS 121 will have a material impact on its financial
statements.
 
NOTE 3 -- STRATEGIC ALLIANCES
 
     In October 1995, the Company entered into an Evaluation and Option
Agreement granting Genentech, Inc. ("Genentech") an option to license rights to
a Stem Cell Proliferation Factor ("SCPF"). Under the terms of the agreement,
Genentech has obtained a one year option to exclusively license rights for in
vivo applications of SCPF outside Asia. In exchange, Genentech will conduct all
further sequencing, cloning and expression of the factor. If the option is
exercised, the Company could receive future equity and milestone payments, and
royalties on any product sales. The Company will retain rights to all in vivo
uses of SCPF in Asia, subject to a right of first refusal by Genentech. In
addition, the Company retains worldwide rights to use SCPF in ex vivo tissue
engineering applications such as for bone marrow expansion and gene therapy,
subject to certain co-exclusive rights with Genentech outside of Asia. The
Company cannot predict with any certainty whether Genentech will exercise its
license option or if the Company will receive any equity or milestone payments,
or royalties related to SCPF.
 
     In conjunction with entering into the agreement with Genentech, the Company
terminated a license option with Kirin Brewery Company, Limited for the
development and commercialization of SCPF in certain Asian countries. The
Company licensed exclusive rights to SCPF from the University of Florida
Research Foundation, Inc. in December 1992.
 
     In May 1994, Smith & Nephew plc ("Smith & Nephew") and the Company signed
an agreement to, and subsequently entered into, a joint venture for the
worldwide development, manufacture and marketing of human tissue engineered
cartilage for orthopedic applications. Smith & Nephew is a leading worldwide
health care company with extensive sales and distribution capabilities selling
arthroscopic instrumentation, trauma, casting and support products, orthopedic
implants and wound management products.
 
     Under the joint venture agreement, Smith & Nephew is contributing the first
$10 million in joint venture funding and the Company has contributed certain
technology licenses. From inception to December 31, 1995, joint venture
expenditures totaling $3,352,000 have been funded by Smith & Nephew.
Expenditures in excess of $10 million and joint venture revenues will be shared
equally by the partners. The joint venture also has a right of first negotiation
to develop tissue engineered bone, tendon and ligament for orthopedic
applications. The Company has retained all non-orthopedic cartilage tissue
rights. During the years ended December 31, 1995 and 1994, respec-
 
                                       F-9
<PAGE>   60
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 3 -- STRATEGIC ALLIANCES -- (CONTINUED)
tively, the Company recognized $1,548,000 and $893,000 in contract revenue for
research and development activities performed for the joint venture.
 
     In February 1994, St. Jude Medical, Inc. ("St. Jude Medical") and the
Company entered into a joint development agreement under which the parties have
conducted a series of feasibility studies to evaluate applications of the
Company's tissue engineering technology to create or improve heart valve
replacements. As part of the agreement, St. Jude Medical obtained exclusive
rights to license technology resulting from such feasibility studies.
Separately, St. Jude Medical and the Company entered into a Common Stock
Purchase Agreement (see Note 8). In January 1995, the agreement was extended to
December 31, 1995 and the Company received $830,000 in funding in 1995 for
research on tissue engineered heart valves. As provided in the joint development
agreement, in early 1996, St. Jude Medical elected not to enter into a licensing
agreement with the Company for tissue engineered heart valves.
 
     The Company has also entered into sponsored research and license agreements
with the Massachusetts Institute of Technology ("MIT") and Children's Hospital
in Boston ("Children's Hospital") effective September 1992. Under the license
agreement, the Company has rights to certain existing and future MIT patents and
technology arising from the sponsored research which relate to tissue
engineering, organ transplantation and polymer science. Under the research
agreement, the Company has agreed to sponsor research until December 31, 1997
(see Note 7). The research agreement may be renewed annually thereafter for four
additional years.
 
NOTE 4 -- PROPERTY
 
     The major classes of property as of December 31, 1995 and 1994 are as
follows (in thousands):
 
<TABLE>
<CAPTION>
                                                                    1995      1994
                                                                   -------   -------
        <S>                                                        <C>       <C>
        Equipment................................................  $ 6,772   $ 6,064
        Furniture and fixtures...................................      413       400
        Leasehold improvements...................................    5,696     5,039
        Equipment under capital leases...........................       55        55
        Construction in progress.................................       --       126
                                                                   -------   -------
                                                                    12,936    11,684
        Less accumulated depreciation and amortization...........   (4,604)   (3,310)
                                                                   -------   -------
        Property -- net..........................................  $ 8,332   $ 8,374
                                                                   =======   =======
</TABLE>
 
                                      F-10
<PAGE>   61
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 5 -- ACCRUED EXPENSES
 
     Accrued expenses as of December 31, 1995 and 1994 consist of (in
thousands):
 
<TABLE>
<CAPTION>
                                                                      1995     1994
                                                                     ------   ------
        <S>                                                          <C>      <C>
        Salaries and benefits......................................  $1,144   $1,014
        Sponsored research.........................................     946    1,035
        Clinical studies...........................................     865      638
        Product and process engineering............................     243       --
        Deferred sales.............................................     118       61
        Professional fees..........................................      94       89
        Other......................................................     612      343
                                                                     ------   ------
                                                                     $4,022   $3,180
                                                                     ======   ======
</TABLE>
 
NOTE 6 -- LEASE COMMITMENTS
 
     Operating lease commitments are primarily for the Company's research and
manufacturing facilities. The leases for the Company's primary facility include
the cost of utilities and certain services, and provide for an annual rental
increase of 3% to 7% based on the Consumer Price Index. These facility leases
expire in September 2000; however, the leases include options to extend the
terms for an additional five years. Other facility leases expire in May 1996 and
July 1997 and provide for increases based on the Consumer Price Index. The
leases include an option to extend the term of the lease for up to six months
and one year, respectively. Capital leases are for equipment.
 
     The following is a summary of the annual future minimum capital and
operating lease commitments as of December 31, 1995 (in thousands):
 
<TABLE>
<CAPTION>
                                                                       CAPITAL     OPERATING
                                                                       LEASES       LEASES
                                                                       -------     ---------
    <S>                                                                <C>         <C>
    Year Ending December 31:
      1996...........................................................    $16        $ 1,756
      1997...........................................................     16          1,712
      1998...........................................................     13          1,621
      1999...........................................................     --          1,686
      2000...........................................................     --          1,302
    Thereafter.......................................................     --             --
                                                                         ---         ------
    Total minimum lease payments.....................................     45        $ 8,077
                                                                                     ======
    Less amount representing interest................................     (9)
                                                                         ---
    Present value of net minimum lease payments......................    $36
                                                                         ===
</TABLE>
 
     Rental expense charged to operations under operating leases for facilities
and equipment for the year ended December 31, 1995, 1994 and 1993 amounted to
approximately $1,982,000, $1,812,000 and $1,202,000, respectively.
 
NOTE 7 -- COMMITMENTS AND CONTINGENCIES
 
     Under the research and licensing agreements with MIT and Children's
Hospital, the Company has agreed to sponsor research for a minimum of $1,130,000
in calendar year 1996 and $1 million in calendar year 1997. The Company is also
responsible for patent application costs and associated
 
                                      F-11
<PAGE>   62
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 7 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
maintenance fees related to inventions under these and other licensing
agreements. In addition, the Company has consulting agreements with the two
principal scientists at MIT and Children's Hospital, whereby the Company has
agreed to pay each such scientist a consulting fee of $100,000, which fee will
increase ten percent per annum (currently $133,000), through September 1997. The
parties have the right to terminate these agreements under certain
circumstances.
 
     The Company seeks to protect its proprietary technology through the use of
various aspects of United States and foreign patent law and contractual
arrangements. The Company owns seven United States patents and has numerous
patent applications pending and allowed both in the United States and
internationally. However, there can be no assurance that the Company's patents
or patent applications will afford protection against competitors with similar
technology, nor can there be any assurance that the Company's present patents
will not be infringed upon or designed around by others.
 
NOTE 8 -- CAPITAL STOCK
 
     The Company is authorized to issue 50,000,000 shares of Common Stock, of
which 33,885,928 shares were outstanding as of December 31, 1995, and 1,000,000
shares of Preferred Stock, of which there are no shares outstanding. The Board
of Directors of the Company is authorized to designate the rights, preferences
and limitations for any issuance of Preferred Stock. As of December 31, 1995,
the Company had 5,608,006 shares of Common Stock reserved for issuance under
options and warrants.
 
     In January 1995, the Company adopted a Shareholder Rights Plan and pursuant
thereto issued one preferred share purchase right ("Right") on each outstanding
share of Common Stock. The Rights are exercisable only if a person or group
acquires, or makes a tender offer to acquire, 15% or more of the Company's
Common Stock. In connection with the adoption of the Shareholder Rights Plan,
the Company's Board of Directors designated and reserved 500,000 shares of the
Company's authorized preferred stock as Series A Junior Participating Preferred
Stock, par value $.01 per share (the "Series A Preferred Stock"). The Rights
have no voting privileges and expire on January 6, 2005.
 
     When exercisable, each Right entitles its holder to buy one-hundredth of a
share of the Series A Preferred Stock at an exercise price of $55, subject to
certain antidilution adjustments. In addition, if at any time after the Rights
become exercisable, should (i) the Company be acquired in a merger or other
business combination transaction, or sell 50% or more of its consolidated assets
or earnings power, each Right will entitle its holder to purchase a number of
the acquiring company's common shares having a market value at the time of twice
the Right's exercise price or (ii) a person or group acquire 15% or more of the
Company's outstanding Common Stock, each Right will entitle its holder, other
than the acquirer, to purchase, at the Right's then-current exercise price, a
number of the Company's Common Stock having a market value of twice the Right's
exercise price. The rights are redeemable for one cent per Right at any time up
to and including ten days after the acquisition of 15% of the then outstanding
Common Stock.
 
     In June and July 1995, the Company completed a series of private placements
issuing a total of 2,614,432 shares of its Common Stock. The initial purchase
price for the shares was $6.86 per share, representing an 11.5% discount to the
closing bid price of the Company's Common Stock on June 7, 1995. However, as
provided in the placements, the initial purchase price was adjusted to result in
a purchase price per share to the investors equal to 88.5% of the average
closing price of
 
                                      F-12
<PAGE>   63
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 8 -- CAPITAL STOCK -- (CONTINUED)
the Common Stock over agreed-upon valuation periods. In total, the Company
received net proceeds of $20.3 million, $677,000 of which was received in
January 1996 and, accordingly, is not reflected in the accompanying balance
sheet for the year ended December 31, 1995. In connection with the placements,
the Company also issued warrants to purchase 235,299 shares of Common Stock. The
final purchase prices of the shares issued in the private placements and the
exercise prices for the warrants range from $8.11 to $8.62.
 
     In May 1995, the Company's Chairman of the Board and Chief Executive
Officer exercised an employee stock option for 550,000 shares of Common Stock at
an exercise price of $1.67 per share. The purchase price of $918,500 was paid
with a promissory note bearing interest at 6.75% per annum with principal and
interest due in May 1998. The note receivable is deducted from stockholders'
equity in the accompanying balance sheet.
 
     In January 1994, the Company sold 2,500,000 shares of its Common Stock at
$8.00 per share through a public offering. In February 1994, the underwriters
exercised an over-allotment option to purchase an additional 375,000 shares of
Common Stock at $8.00 per share. In total, the Company received net proceeds of
approximately $21.5 million from the offering. Also in February 1994, St. Jude
Medical, Inc. and the Company entered into a Common Stock Purchase Agreement
whereby St. Jude Medical purchased 563,380 shares of the Company's Common Stock
for $5 million or $8.875 per share.
 
     During 1993, an option to purchase 143,382 Units was exercised. The option
had been granted in connection with the underwriting of the Company's initial
public offering in 1988. Each Unit was exercisable at $5.44 and consisted of
three shares of Common Stock and three Class A Warrants. Each Class A Warrant
entitled the holder to purchase one share of Common Stock and one Class B
Warrant at a price of $2.55 per share. Each Class B Warrant entitled the holder
to purchase 1.1 shares of Common Stock at $3.82 per share. In total, the Company
received proceeds of approximately $3.7 million from the exercise of the option
and the related warrants.
 
     In September 1992, the Company acquired Neomorphics, Inc., a privately-held
development stage company engaged in the research and development of new methods
for engineering human tissue and organ replacements. Pursuant to the Agreement
and Plan of Merger, the acquisition was accomplished by an exchange of all of
Neomorphics outstanding stock for shares of the Company's Common Stock having a
value of $21 million. The purchase price was paid in two installments. In the
first installment, $6 million or 682,314 shares of the Company's Common Stock,
was distributed to Neomorphics' shareholders in September 1992. The balance of
the purchase price, $15 million or 1,486,079 shares of Common Stock, was
distributed in March 1993. The number of shares issued was based on the average
of the closing sales prices of the Company's Common Stock on the Nasdaq National
Market during the twenty consecutive trading days ending on and including the
third trading day prior to the respective distributions.
 
NOTE 9 -- EMPLOYEE BENEFIT PLANS
 
     In June 1992, the stockholders approved the Company's 1992 Stock
Option/Stock Issuance Plan (the "1992 Plan"). On the August 1, 1992 effective
date of the 1992 Plan, the Company's 1987 Incentive Stock Option and
Appreciation Plan and the 1990 Stock Option Plan for Non-Employee Directors, and
stock options outstanding under these two predecessor plans, were incorporated
into the 1992 Plan. The 1992 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
 
                                      F-13
<PAGE>   64
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 9 -- EMPLOYEE BENEFIT PLANS -- (CONTINUED)
option grants to non-employee directors on a periodic basis, currently to a
maximum of 4,450,000 shares of Common Stock.
 
     In addition to the 1992 Plan, the Company has issued options to directors,
consultants, employees and others as compensation for services. These options
vest and are exercisable over a variety of periods as determined by the
Company's Board of Directors. The following table summarizes activity under the
1992 Plan and for other options and warrants for Common Stock for the years
ended December 31, 1995 and 1994:
 
<TABLE>
<CAPTION>
                                            1992 PLAN                   OTHER OPTIONS
                                    -------------------------     -------------------------
                                     NUMBER        PRICE PER       NUMBER        PRICE PER
                                    OF SHARES        SHARE        OF SHARES        SHARE
                                    ---------     -----------     ---------     -----------
    <S>                             <C>           <C>             <C>           <C>
    Outstanding,
      December 31, 1993...........  2,432,513     $1.69-16.88     1,825,000     $1.47-10.13
    Granted.......................    256,950     $4.63- 9.13        83,334           $6.00
    Exercised.....................    (12,950)    $3.13- 8.13       (10,000)          $1.69
    Canceled......................   (380,165)    $3.13-14.75            --
                                    ---------                     ---------
    Outstanding,
      December 31, 1994...........  2,296,348     $1.69-16.88     1,898,334     $1.47-10.13
    Granted.......................    304,925     $5.56-12.88       235,299     $6.86- 8.47
    Exercised.....................   (112,783)    $3.38-12.13      (590,000)    $1.67- 8.13
    Canceled......................   (170,975)    $3.38-15.38       (83,334)          $6.00
                                    ---------                     ---------
    Outstanding,
      December 31, 1995...........  2,317,515     $1.69-16.88     1,460,299     $1.47-10.13
                                    =========                     =========
</TABLE>
 
     At December 31, 1995, options and warrants for 2,802,345 shares of Common
Stock are exercisable at a weighted average price of $5.81 per share, 1,536,747
shares of which are exercisable under the 1992 Plan at a weighted average price
of $5.16 per share.
 
     During the years ended December 31, 1995 and 1993, $55,000 and $37,000,
respectively, was charged to expense in connection with options granted to
employees reflecting amortization of the difference between the fair market
value of the shares at the date of grant and the grant price over the vesting
period. In addition, $6,000 was charged to expense reflecting the estimated fair
value of options issued for services during the year ended December 31, 1993.
 
     Effective January 1, 1993, the Company adopted the Advanced Tissue
Sciences, Inc. 401(k) Plan (the "401(k) Plan"). Employees meeting certain
eligibility requirements may elect to participate and contribute to the 401(k)
Plan. Under the 401(k) Plan, the Company may elect to match a discretionary
percentage of contributions. No such matching contributions have been made to
the 401(k) Plan since its inception.
 
NOTE 10 -- INCOME TAXES
 
     The Company has federal and California net operating loss carryforwards of
$112 million and $32 million, respectively, as of December 31, 1995. The
difference between the federal and California net tax loss carryforwards
principally result from the Company not having operations in California until
late 1989, a fifty percent limitation on California loss carryforwards and the
capitalization of certain research and development expenses for California
purposes. As of December 31, 1995, the Company also has federal and California
research and development tax
 
                                      F-14
<PAGE>   65
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 10 -- INCOME TAXES -- (CONTINUED)
credit carryforwards of $3,399,000 and $990,000, respectively. The federal tax
operating loss and research and development tax credit carryforwards will begin
expiring in 2001, while the California tax operating loss and research and
development tax credit carryforwards will begin expiring in 1997, unless
previously utilized.
 
     Utilization of future net operating loss carryforwards could be limited if
certain cumulative changes in the Company's ownership were to occur. Included in
the federal loss carryforwards, and subject to an annual limitation, are
approximately $5 million of losses acquired with the acquisition of Neomorphics.
 
     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, 1995, the valuation allowance increased by $9,791,000.
Significant components of the Company's net deferred tax assets as of December
31, 1995 and 1994 are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                                     1995         1994
                                                                   --------     --------
    <S>                                                            <C>          <C>
    Deferred tax assets:
      Net operating loss carryforwards...........................  $ 39,913     $ 31,921
      Research and development credits...........................     4,389        3,379
      Capitalized research and development.......................     2,166        1,417
      Other......................................................       791          676
                                                                   --------     --------
         Total deferred tax assets...............................    47,259       37,393
                                                                   --------     --------
    Deferred tax liabilities:
      Patent expense.............................................      (414)        (339)
                                                                   --------     --------
         Total deferred tax liability............................      (414)        (339)
                                                                   --------     --------
    Net deferred tax assets before valuation allowance...........    46,845       37,054
    Valuation allowance..........................................   (46,845)     (37,054)
                                                                   --------     --------
    Net deferred tax assets......................................  $     --     $     --
                                                                   ========     ========
</TABLE>
 
     Approximately $6.2 million of the valuation allowance for deferred tax
assets relates to benefits of stock option deductions which, when and if
recognized, will be allocated directly to additional paid-in capital.
 
NOTE 11 -- SUPPLEMENTAL CASH FLOW INFORMATION
 
     The following summarizes the significant non-cash investing and financing
activities of the Company and provides other supplemental cash flow information.
 
     Non-cash financing and investing activities have included (i) the delivery
of a promissory note as payment for the exercise of a stock option (see Note 8)
in the year ended December 31, 1995 and (ii) the acquisition of Neomorphics,
Inc. through the issuance of Common Stock (see Note 8), the exercise of stock
options by the delivery of Common Stock having a fair market value of $380,000
and the financing of $55,000 of equipment through a capital lease during the
year ended December 31, 1993. The fair market value of Common Stock delivered to
exercise stock options was based on the closing price of the Company's Common
Stock as reported on the Nasdaq National Market on the applicable date. Other
non-cash investing and financing activities included
 
                                      F-15
<PAGE>   66
 
                         ADVANCED TISSUE SCIENCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 11 -- SUPPLEMENTAL CASH FLOW INFORMATION -- (CONTINUED)
the issuance of compensatory stock options to employees and stock options to
directors, consultants and others for services (see Note 9).
 
     Net cash from operating activities reflects cash payments for interest
expense of approximately $6,000, $8,000 and $1,000 for the years ended December
31, 1995, 1994 and 1993, respectively, and $600,000 for the cumulative period
January 21, 1986 to December 31, 1995.
 
NOTE 12 -- SUBSEQUENT EVENTS
 
     Equity Line -- Effective February 9, 1996, the Company entered into an
investment agreement (the "Investment Agreement") with a newly formed investment
group for an equity line which allows the Company to access up to $50 million
through sales of its Common Stock. The equity line will remain available for a
period of two years. The decision to draw any funds under the Investment
Agreement and the timing of any such draw are solely at the Company's
discretion.
 
     The Investment Agreement provides that the Company can obtain up to $15
million at any one time through the sale of its Common Stock. Any sales against
the equity line will be at a five percent discount to the average low sales
prices of the Company's Common Stock over a specified period of time as
determined by market volume at the time of the draw. The Company's ability to
draw under the Investment Agreement is subject to certain conditions including,
but not limited to, registration of the shares, a minimum trading price of $2.00
per share, and certain limitations on the number of shares of Common Stock held
by the investment group at any point in time.
 
     As a commitment fee for keeping the equity line available for the two-year
period, the Company issued a warrant to the investment group exercisable for
175,000 shares of Common Stock at an exercise price of $10.50 per share. Under
the Investment Agreement and the warrant, a registration statement pertaining to
the warrant shares is to be filed by the earlier of 180 days from the date of
the warrant or before any funds are drawn under the Investment Agreement.
 
     Public Offering -- In February 1996, the Company filed to register
3,000,000 shares of Common Stock for sale in an underwritten public offering
(the "Offering"). In addition, the Company has granted the underwriters an
option for 30 days following the close of such Offering to purchase an
additional 450,000 shares of Common Stock. All of the shares offered are to be
sold by the Company. If successful, the Offering is expected to be completed in
the first half of 1996; however, the Company cannot predict with any certainty
whether the Offering will be completed and, if completed, the number of shares
that will be sold or the amount of proceeds that it will receive.
 
                                      F-16
<PAGE>   67
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
Advanced Tissue Sciences, Inc.
 
     We have audited the accompanying consolidated balance sheet of Advanced
Tissue Sciences, Inc. (a development stage company) as of December 31, 1995 and
1994, and the related consolidated statements of operations, cash flows and
stockholders' equity for each of the three years in the period ended December
31, 1995 and for the cumulative period from January 21, 1986 (inception) to
December 31, 1995. 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 generally accepted auditing
standards. 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, 1995 and 1994, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1995 and for the cumulative period from January 21, 1986
(inception) to December 31, 1995, in conformity with generally accepted
accounting principles.
 
                                                               ERNST & YOUNG LLP
 
San Diego, California
February 22, 1996
 
                                      F-17
<PAGE>   68
<TABLE>
<S>                     <C>               <C>                     <C>                   <C>
                            [Photo]                                   [Photo]
       [Photo]          RECONSTRUCTIVE                                  EAR
                            SURGERY
    HEART VALVES                                                                           [Photo]
       [Photo]                                                                              BURNS
        LIVER                                                                              [Photo]
       [Photo]                                                        [Photo]           BLOOD VESSELS
  GASTROINTESTINAL          [Photo]                               BONE/CARTILAGE
        TRACT
                             BONE
       [Photo]                                                        [Photo]
     BONE MARROW            [Photo]                               TENDON/LIGAMENT          [Photo]
                           CARTILAGE                                                     SKIN ULCERS
                                          [HUMAN BODY DIAGRAM]
</TABLE>
 
     Advanced Tissue Science's objective is to redefine tissue repair and
transplantation by developing, manufacturing and marketing human tissue
replacement products produced through tissue engineering.
 
     The Company believes its core technology will allow the development of
multiple tissue products to address a wide variety of medical needs. The
Company's products are in various stages of development and clinical testing.
<PAGE>   69
 
------------------------------------------------------
------------------------------------------------------
 
     NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THE PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AT ANY TIME SUBSEQUENT TO ITS DATE.
 
                               ------------------
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                        PAGE
                                        ----
<S>                                     <C>
Prospectus Summary....................    3
Risk Factors..........................    7
Use of Proceeds.......................   14
Price Range of Common Stock and
  Dividend Policy.....................   14
Capitalization........................   15
Dilution..............................   16
Selected Consolidated Financial
  Data................................   17
Management Discussion and Analysis of
  Financial Condition and Results of
  Operations..........................   18
Business..............................   22
Management............................   42
Underwriting..........................   47
Legal Matters.........................   48
Experts...............................   48
Available Information.................   48
Documents Incorporated by Reference...   49
Index to the Consolidated Financial
  Statements..........................  F-1
</TABLE>
 
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
 
                                3,000,000 SHARES
 
                                      LOGO
 
                                  COMMON STOCK
                           (PAR VALUE $.01 PER SHARE)
 
                              --------------------
 
                                   PROSPECTUS
                              --------------------
 
                              GOLDMAN, SACHS & CO.
                              MORGAN STANLEY & CO.
                      INCORPORATED
 
                      REPRESENTATIVES OF THE UNDERWRITERS
 
------------------------------------------------------
------------------------------------------------------
<PAGE>   70
 
                                    PART II
 
                     INFORMATION NOT REQUIRED IN PROSPECTUS
 
ITEM 14.  OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
 
     The following table sets forth the various costs and expenses, other than
underwriting discounts, of the sale and distribution of the securities being
registered. All of the amounts shown are estimates except the Securities and
Exchange Commission registration fee and the NASD filing fee.
 
<TABLE>
<CAPTION>
                                      ITEM
    -------------------------------------------------------------------------
    <S>                                                                        <C>
    SEC Registration Fee.....................................................  $ 12,269
    NASD Filing Fee..........................................................    21,558
    Blue Sky Fees and Expenses...............................................     5,000
    Legal Fees and Expenses..................................................   150,000
    Accounting Fees and Expenses.............................................    40,000
    Printing and Engraving Expenses..........................................   120,000
    Transfer Agent and Registrar Fees........................................    10,000
    Miscellaneous............................................................    41,173
                                                                               ----------
              Total..........................................................  $400,000
                                                                               ==========
</TABLE>
 
ITEM 15.  INDEMNIFICATION OF DIRECTORS AND OFFICERS
 
     Section 145 of the Delaware General Corporation Law provides for
indemnification of a corporation's officers and directors under certain
circumstances. Section 145 of the Delaware General Corporation Law also provides
that a corporation has the power to purchase and maintain insurance on behalf of
its officers and directors against any liability asserted against such person
and incurred by him or her in such capacity, or arising out of his or her status
as such, whether or not the corporation would have the power to indemnify him or
her against such liability under the provisions of Section 145 of the Delaware
General Corporation Law. Article VIII of the Restated Bylaws of the Company also
provides for indemnification of officers and directors, as authorized by Section
145.
 
     Section 102(b)(7) of the Delaware General Corporation Law enables a
corporation in its certificate of incorporation to limit the personal liability
of members of its board of directors for violations of a director's fiduciary
duty of care. The Section does not, however, limit the liability of a director
for breaching his or her duty of loyalty, failing to act in good faith, engaging
in intentional misconduct or knowingly violating a law, or from any transaction
in which the director derived an improper personal benefit. Section 102(b)(7)
also will have no effect on claims arising under the federal securities laws.
Article Eighth of the Restated Certificate of Incorporation of the Company
limits the liability of its directors as authorized by Section 102(b)(7) of the
Delaware General Corporation Law.
 
     The Company has entered into indemnification agreements with each of its
directors and officers which provide the directors and officers with
indemnification rights. One significant difference between the indemnification
rights provided under the Company's Bylaws and those provided under the
indemnification agreements is that, under the Bylaws, as construed in accordance
with Delaware law, amounts may be paid as indemnity only if independent
determinations are made in each specific case that under the circumstances the
individual claiming indemnity meets certain specified standards of conduct.
Under the indemnification agreements, a determination that a director or officer
has met these standards is not required for such indemnity, although the
agreements exclude indemnity for conduct which is adjudged to be knowingly
fraudulent, deliberately dishonest or to constitute willful misconduct. The
Company also currently maintains policies of
 
                                      II-1
<PAGE>   71
 
insurance under which its directors and officers are insured, within the limits
and subject to the limitations of the policies, against certain expenses in
connection with the defense of actions, suits or proceedings, and certain
liabilities which might be imposed as a result of such actions, suits or
proceedings, to which they are parties by reason of being or having been such
directors or officers.
 
     Section 8 of the Underwriting Agreement, which is filed as Exhibit 1.1
hereto, contains certain undertakings on the part of the underwriter to
indemnify the Company, its directors and officers, and each person who controls
the Company within the meaning of the Securities Act of 1933, as amended (the
"Act") against civil liabilities, including certain liabilities under the Act.
 
ITEM 16.  EXHIBITS
 
   
<TABLE>
<CAPTION>
EXHIBIT
  NO.                                 DESCRIPTION OF DOCUMENT
-------      --------------------------------------------------------------------------
<C>          <S>
   1.1       Form of Underwriting Agreement.
   4.1*      Restated Certificate of Incorporation of Advanced Tissue Sciences, Inc. as
             in effect on July 2, 1992.
   4.2**     Form of Certificate of Designations of Series A Junior Participating
             Preferred Stock of Advanced Tissue Sciences, Inc.
   5.1***    Opinion of Brobeck, Phleger & Harrison LLP.
  23.1       Consent of Ernst & Young LLP, independent auditors.
  23.2***    Consent of Brobeck, Phleger & Harrison LLP (included in Exhibit 5.1).
  24.1***    Power of Attorney (see page II-4).
</TABLE>
    
 
---------------
  * Incorporated by reference to Exhibit 4.1 to the Registrant's Registration
    Statement No. 33-50156 on Form S-8.
 
 ** Incorporated by reference to Exhibit 1 to the Registrant's Current Report on
    Form 8-K dated January 17, 1995.
 
   
*** Previously filed.
    
 
ITEM 17.  UNDERTAKINGS
 
     The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
Registrant's annual report pursuant to Section 13(a) or Section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
Registration Statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
 
     Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, Delaware Corporation Law, the
Underwriting Agreement or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefor, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid by a director,
officer, or controlling person of the Registrant in the successful defense of
any action, suit, or proceeding) is asserted by such director, officer, or
controlling person in connection with the securities being registered hereunder,
the Registrant will, unless in the opinion of its counsel the question has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question of whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
 
                                      II-2
<PAGE>   72
 
     The undersigned Registrant hereby undertakes that:
 
     (1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Act shall be deemed to be part of this Registration Statement as of
the time it was declared effective.
 
     (2) For the purpose of determining any liability under the Act, each
post-effective amendment that contains a form of Prospectus shall be deemed to
be a new Registration Statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
 
                                      II-3
<PAGE>   73
 
                                   SIGNATURES
 
   
     Pursuant to the requirements of the Securities Act of 1933, the Company has
duly caused this Amendment to the Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of La Jolla,
State of California, on March 19, 1996.
    
 
                                          ADVANCED TISSUE SCIENCES, INC.
 
   
                                          By:     /s/ MICHAEL V. SWANSON
                                              ---------------------------------
    
   
                                                    Michael V. Swanson
    
   
                                               Vice President, Finance and
                                                      Administration
    
 
   
     Pursuant to the requirements of the Securities Act of 1933, this Amendment
to the Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
    
 
   
<TABLE>
<CAPTION>
              SIGNATURE                                TITLE                        DATE
-------------------------------------  -------------------------------------   ---------------
<S>                                    <C>                                     <C>
*                                      Chairman of the Board of Directors      March 19, 1996
-------------------------------------  and Chief Executive Officer
Arthur J. Benvenuto                    (Principal Executive Officer)

*                                      Director, President and Chief           March 19, 1996
-------------------------------------  Operating Officer
Dr. Gail K. Naughton

/s/  MICHAEL V. SWANSON                Vice President, Finance and             March 19, 1996
-------------------------------------  Administration (Principal Financial
Michael V. Swanson                     and Accounting Officer)

*                                      Director                                March 19, 1996
-------------------------------------
Jerome E. Groopman, M.D.

*                                      Director                                March 19, 1996
-------------------------------------
Jack L. Heckel

*                                      Director                                March 19, 1996
-------------------------------------
David S. Tappan, Jr.

*                                      Director                                March 19, 1996
-------------------------------------
William B. Walsh, M.D.

*                                      Director                                March 19, 1996
-------------------------------------
Dr. Gail R. Wilensky

*By: /s/  MICHAEL V. SWANSON
     --------------------------------
     Michael V. Swanson
     Attorney-in-Fact
</TABLE>
    
 
                                      II-4
<PAGE>   74
 
                               INDEX TO EXHIBITS
 
   
<TABLE>
<CAPTION>
                                                                             SEQUENTIALLY
EXHIBIT                                                                        NUMBERED
  NO.                           DESCRIPTION OF DOCUMENT                          PAGE
-------      --------------------------------------------------------------  ------------
<C>          <S>                                                             <C>
   1.1       Form of Underwriting Agreement.
   4.1*      Restated Certificate of Incorporation of Advanced Tissue
             Sciences, Inc. as in effect on July 2, 1992.
   4.2**     Form of Certificate of Designations of Series A Junior
             Participating Preferred Stock of Advanced Tissue Sciences,
             Inc.
   5.1***    Opinion of Brobeck, Phleger & Harrison LLP.
  23.1       Consent of Ernst & Young LLP, independent auditors.
  23.2***    Consent of Brobeck, Phleger & Harrison LLP (included in
             Exhibit 5.1).
  24.1***    Power of Attorney (see page II-4).
</TABLE>
    
 
---------------
  * Incorporated by reference to Exhibit 4.1 to the Registrant's Registration
    Statement No. 33-50156 on Form S-8.
 
 ** Incorporated by reference to Exhibit 1 to the Registrant's Current Report on
    Form 8-K dated January 17, 1995.
 
   
*** Previously filed.