June 2, 1999 RECOMMENDATION: BUY

Advanced Tissue Sciences, Inc. (NASDAQ: ATIS)

Broad, Human-Based Technology Platform and Product Pipeline; Strong Corporate Partnership; Initiating Coverage with a BUY Recommendation

Summary Investment Consideration

Advanced Tissue Sciences, Inc. ("ATIS") is a leading tissue engineering company developing living human tissue products for therapeutic applications such as tissue repair and transplants. ATIS has one FDA-approved product (TransCyte™), one product in Phase III clinical trials (Dermagraft®), and is pursuing products that include tissue-engineered cartilage for orthopedic applications, engineered cardiovascular tissues such as blood vessels, stents and heart valves, and products with applications in cosmetic and reconstructive surgery. ATIS has teamed with Smith & Nephew plc, a world leader in wound care, for the commercialization of TransCyte, Dermagraft and ATIS’ cartilage products. For a discussion of ATIS’ recent alliance with INAMED Corp., see our research update on 5/13/99.

We believe ATIS is significantly undervalued given its near-term product pipeline, its long-term technology platform and its relationship with Smith & Nephew. We are initiating coverage on ATIS with a BUY rating, and recommend purchase of ATIS for investors tolerant of the risks associated with micro-cap and small-cap equity investments.

• ATIS is using a human-based approach to growing human cells into functioning human tissues and organs for transplantation. Target markets include burns, chronic wounds, orthopedic applications such as cartilage, ligaments and bone, and cardiovascular tissues such as vascular grafts, stents and heart valves.
• ATIS has a strong intellectual property portfolio, with 50 issued patents worldwide and licenses to 17 MIT patents.

• TransCyte has been FDA approved for the treatment of second and third-degree burns. TransCyte consists of a sheet of bioengineered dermal matrix with an ultra-thin synthetic covering.
• Dermagraft, a living, human dermal replacement product designed to treat chronic skin ulcers (eg. diabetic foot ulcers, venous ulcers, etc.), is currently on the market in Canada, the U.K. and several European countries, and is in pivotal Phase III trials in the US for diabetic foot ulcers and is available in the US under a clinical protocol through a Treatment IDE for that indication.
• Pipeline Products: Includes cartilage and ligaments for orthopedic applications, heart valves and vascular grafts for cardiovascular applications, and injectable collagen for cosmetic and scar revision, urinary incontinence, surgical applications, device coatings and cosmeceuticals.

• ATIS and Smith & Nephew plc entered into a 50/50 joint venture to globally commercialize Dermagraft, TransCyte and the future cartilage products. Smith & Nephew is a global healthcare company with over $1.7 billion in annual sales and a strong record of developing, manufacturing and distributing a diverse array of tissue repair products focused primarily on bone, joints, skin and other soft tissue.

• We foresee a meaningful flow of news events for ATIS based upon the generation of revenues internationally, the presentation of clinical data at leading scientific conferences, potential partnerships in its cardiovascular and other program areas, and the launching of TransCyte and Dermagraft in additional foreign markets.
• ATIS, currently near its 52-week low, is trading at an excessively large discount to its peer tissue-engineering group as well as other biotechnology companies with promising products in late Phase III clinical trials. We recommend purchase of ATIS common stock.

Company Overview

ATIS is a leading tissue engineering company focused on the development of human-based tissue products for therapeutic applications. ATIS, whose strategy is differentiated from the competition by being human-based, is currently focusing its efforts on skin, cartilage and cardiovascular products. The Company’s first commercial product, TransCyte, a temporary covering for full-thickness (or third-degree) burns and partial-thickness (or second-degree) burns was approved by the US FDA in March and October 1997, for each respective indication. The Company’s second commercially available product, Dermagraft, a living human dermal replacement, was approved for sale in Canada in August 1997 and was launched in the United Kingdom in late 1997. Dermagraft is not yet approved for commercial sale in the US, but is available through a clinical protocol under a Treatment IDE (Investigational Device Exemption) for the treatment of diabetic foot ulcers. The Treatment IDE allows ATIS to recover manufacturing and distribution costs, but does not allow for active promotion until final product approval. Both TransCyte and Dermagraft are being commercialized through a joint venture with Smith & Nephew plc, a leading global wound-healing company.

Strategic Overview of the Tissue Engineering/Wound-Healing Market

Over the past several years, tremendous progress has been made in the technology to engineer artificial skin and wound healing products. Advances in both tissue culturing, or the growing of cells outside the body, and molecular biology, or the study of the structure and development of biological systems, have allowed for the mass production of certain cell types and the creation of matrices of cells, cell components and other extracellular scaffolding.

As background, skin, the largest organ in the body, is made up of two layers–the epidermis, the outer layer, and the dermis, the inner layer that consists mostly of collagen and contains the majority of pain-related nerve endings. The epidermis is continually renewing and is stratified. The lower layer of the epidermis contains the basal layer of replicating epithelial cells and is the major source for new cells as the outer cells slough off. These epithelial cells also give rise to structures like hair, nails and sweat glands, but the actual hair follicles and glands are contained in the dermis.

Many patents have been issued to protect the different types of tissue engineering processes and products being developed or already on the market. As the industry is extremely competitive and somewhat difficult to segment, we thought it would be helpful to provide brief descriptions of the most competitive skin replacement/wound healing products and technologies on the market and in development.

There are several basic differentiating factors in these types of products. The first is whether or not the composite material is "acellular", without complete cells, or "cellular", containing full cells. The second is the source of the cells or components–some are derived from living tissue (neonatal foreskin or other types of cells), some are gathered from donated cadaver skin, some are dermal cells or components thereof, some are a mix of both dermal and epidermal cells or their components. The third is the source of the scaffolding–some are bovine-, or cow-based collagen, while others are human-based or synthetic, some are porous in nature and some are more dense gels. The fourth is whether or not the characteristics of the product allow for cryopreservation, or the ability to freeze the skin product, to extend the shelf life of the product and facilitate shipping, storage and handling.

Acellular Wound-Healing Products:

• The simplest of these products is Regranex®, a topical prescription gel approved since the end of 1997 in the US for the treatment of diabetic foot ulcers (see below for full descriptions of disease categories). Regranex is marketed by Ortho-McNeil Pharmaceuticals, a Johnson & Johnson company, and is a genetically engineered, platelet-derived growth factor that stimulates the migration of cells to the ulcer site encouraging the healing of the wounds.
• Another acellular wound healing product on the market is LifeCell’s AlloDerm®, approved by the FDA for the treatment of burns, periodontal use and certain plastic surgeries. AlloDerm is a cryopreserved, complex, 3-dimensional matrix of dermal cellular components derived from cadaveric skin grafts. Sales of AlloDerm were approximately $8 million in 1998 and are expected to grow in 1999. LifeCell is planning on filing a 510K on AlloDerm for use in duraplasty, or repair of the outermost membrane covering the brain, in mid-1999, and is hoping to introduce an injectable version of AlloDerm later in 1999 for cosmetic and other uses.
• Integra LifeSciences currently markets INTEGRA™ Artificial Skin, which consists of two layers, a thin, collagen-glycosaminoglycan (GAG) sponge and a silicone membrane and is designed to minimize scar formation and wound contracture in full-thickness skin defects. The collagen-GAG sponge material encourages growth of new functional dermal tissue and has a shelf life of two years. Sales of INTEGRA Artificial Skin were $6.3 million in 1998.
• See below for a discussion of ATIS’ TransCyte™ (formerly Dermagraft-TC).

Cellular Wound-Healing Products:

• Organogenesis currently markets Apligraf®, which was launched in June 1998 for treatment of venous ulcers. Apligraf is a bi-layered matrix of dermal and epidermal cells with a bovine collagen gel scaffold. Organogenesis has partnered with Novartis to market Apligraf, however, sales of the product have been generally disappointing, despite the large venous ulcer target market. Due to the density of Apligraf’s collagen gel, which would make it impervious to a cryopreservable agent, we believe the product will not be available as a commercial, cryopreserved product. Apligraf is currently available as a "fresh" product with a shelf life of 3-5 days.
• Ortec International is currently developing Composite Cultured Skin (CCS™) to aid in the healing of wounded skin. CCS is composed of a bi-layered bovine collagen sponge seeded with human neonatal foreskin cells. The resulting product, which can be supplied in a variety of shapes and sizes, has an outer epidermal layer and an inner dermal layer that is integrated into the collagen matrix. Although CCS is currently only available as a fresh preparation with a shelf life of three days, Ortec is developing a cryopreserved version of CCS. Ortec hopes to have CCS on the market by the end of 1999 for a rare disease called Epidermolysis Bullosa (EB), and then to leverage this approval into additional therapeutic indications that include burn donor site wounds, partial thickness burns, and venous, pressure and diabetic foot ulcers.
• For a full discussion of ATIS’ Dermagraft®, see below.

TransCyte-a temporary skin replacement product

ATIS’ first developed product is TransCyte, which is marketed by a joint venture between ATIS and their partner Smith & Nephew for the temporary covering of severe and partial thickness burns. The product is available in the US, Canada, the UK, Australia, New Zealand, Finland, Denmark and the Netherlands and should be introduced in additional countries when approved. TransCyte consists of an outer layer of silicone polymer and an inner nylon mesh layer on which human fibroblasts are grown and then rendered nonviable through a freezing process, leaving behind human collagen, extracellular matrix proteins and growth factors. As the mesh is not biodegradable, the product must be removed after use.

TransCyte has been developed as an alternative to standards of treatment for both second- and third-degree burns. Second-degree burns, also referred to as partial-thickness burns, can involve damage to up to two thirds of the dermal layer. Current treatment is with silver sulfadiazine (SSD), which is repeatedly applied and requires frequent and painful redressing of the wounds. TransCyte here is used almost like plastic wrap, to cover the wound and encourage accelerated reproduction of the dermal cells underneath. The outer layer eventually peels off when healing has progressed, reducing the pain associated with dressing changes. In third-degree, or full-thickness burns, both the dermal and epidermal layers of skin have been destroyed. Full-thickness burns often require autografting of skin from alternate sites on the patient and cadaveric skin is commonly used as a temporary covering of the burns prior to an autograft. TransCyte here is used to replace the cadaveric skin, pending the autograft procedure. The Company believes TransCyte offers certain advantages over cadaver skin, as there is ample supply, no risk of rejection or transmission of disease and TransCyte does not require repeat application prior to the autograft.

Dermagraft-the first all-human dermal wound-healing product

Dermagraft is ATIS’ next-generation, dermal replacement product being developed initially to treat diabetic foot ulcers. Dermagraft is a uni-layered product that uses a bioabsorbable mesh for the scaffold, seeded with human neonatal dermal cells that produce a fully human matrix with a variety of human GAGs and growth factors. The product is cryopreserved, facilitating shipping, storage and handling of the product.

Diabetic foot ulcers: Diabetic foot ulcers often result from trauma that goes undetected due to what is called diabetic neuropathy, or the loss of sensation in peripheral nerves. Uneven pressure on the foot can cause irregular blood flow to the tissue, and cause foot lesions. Neuropathy can also decrease sweating in a patient and create dry skin that can crack and thicken and lead to infection and ulceration. With proper attention and proper footwear, these lesions can be prevented, however, diabetes currently accounts for more than half of all non-traumatic amputations in the US.

Dermagraft has had an interesting developmental history, which we believe creates the buying opportunity now for ATIS stock. Following the completion of a pivotal Phase III clinical trial involving 281 patients and a 50-patient supplemental trial, the General and Plastic Surgery Devices Panel of the Medical Devices Advisory Committee to the FDA in January 1998 recommended the approval of Dermagraft in the US for the treatment of diabetic foot ulcers, with the conditions that ATIS perform a post-marketing study to confirm efficacy and provide physician training. With the primary endpoint of complete wound closure at 12 weeks, analysis of patient data revealed that 38.5% of the evaluable patients reached the primary endpoint versus 31.7% of those treated with conventional therapy. While this was not statistically significant, upon examination of a subset of the larger patient group who had received product produced to certain commercial specifications, 50.8% of the patients reached the primary endpoint.

Despite the positive recommendation of the Advisory Committee, in June 1998, the FDA indicated that the Premarket Approval (PMA) application for Dermagraft was not approvable without supporting data from an additional clinical trial. Dermagraft is currently in the second Phase III trial for diabetic foot ulcers. ATIS expects to be able to perform an interim analysis of the data from the first 180 patients involved in the trial sometime this fall. If those data show statistical significance, the Company could be in a position to file another PMA by the end of 1999. If the 180-patient pool is not large enough to see significance, the PMA will most likely be filed in the first half of 2000. This trial is to include up to 30 treatment centers and enroll a total of 330 patients examined for a 12-week period following complete closure of the wound. Unlike the initial Phase III trial, a 32-week follow-up evaluation will not be required. Most conservatively, we are estimating that Dermagraft will be approved for marketing by the end of 2000.

Although it initially denied the PMA for Dermagraft, the FDA did allow a Treatment IDE (Investigational Device Exemption), that allows companies to make available at cost with no promotional activity, products that treat a serious disease for which there is no satisfactory alternative treatment. Dermagraft received a Treatment IDE in October 1998 for the treatment of diabetic foot ulcers.

Clinician Interviews: As part of our research, we interviewed clinicians that participated in the initial Dermagraft clinical trials. The clinical experience — Dermagraft for diabetic foot ulcers — was universally positive, with most clinicians expressing dismay at the FDA’s decision not to approve the product.

According to physicians, the product is easy to use, can be cut to fit a wound and most importantly, the product is effective. Certainly the fact that an independent FDA advisory panel recommended approval of Dermagraft following the first Phase III clinical trial indicates efficacy. It is our belief that the FDA decision was more reflective of uncertainties related to variations in the viability and metabolic activity of the cells post-cryopreservation, rather than the safety or efficacy of the product. Since the company now uses product that conforms to a certain commercial specification, we do not believe this concern will reoccur. With an extremely strong marketing partner in Smith & Nephew, we believe that Dermagraft will do quite well in the diabetic foot ulcer market and future indications.

Venous Ulcers: When upright, proper blood pressure is maintained through the creation of pressure within the vascular system and through a series of pumps that return blood to the heart. When lying down for an extended period of time, or as a result of deep vein thrombosis (blood clots), vein dilation, trauma, degeneration, calf muscle weakness or valve flaws, nutrition and oxygenation of tissue is affected. Swelling, brown pigmentation, varicose veins and ulceration may then follow. Venous stasis ulcers are a condition that effects about 350,000 people in the US. Currently, there is no treatment available other than continuous cleaning of the wounds in hope that they do not get infected. An infection of the leg in severe cases could lead to amputation.

In 1994, ATIS completed a pivotal trial examining the efficacy of an earlier version of Dermagraft in treating venous ulcers. While the product did not demonstrate statistical significance in the closure of wounds over a 24-week period, upon examination of the patients after 6 months, the Company discovered a statistically significant difference in the ulcer recurrence rate. These results could indicate that Dermagraft may offer a significant cost savings in patient treatment. In March 1999, ATIS began a pilot clinical trial on Dermagraft in the treatment of venous ulcers to evaluate the quantity of Dermagraft necessary for treatment. The Company expects the pilot trials to be completed by the end of 1999 and intends on commencing pivotal trials shortly thereafter if the pilot trials prove successful.

Decubitus Ulcers (Pressure Sores): It is estimated that over 2 million people in the US every year suffer from pressure sores, also known as bed sores. From lack of activity and the pressure exerted on certain parts of the body, skin cells begin to die, creating painful and difficult to treat sores. ATIS expects to begin pilot studies examining Dermagraft’s efficacy in closing pressure sores during the second half of 1999, and, through a joint venture with Smith & Nephew, plans to begin a pivotal trial during 2000 if the pilot trials prove successful.

Conclusions on Dermagraft: Due to the positive results of the first and supplemental clinical trials on Dermagraft to treat diabetic foot ulcers, we feel it very likely that the pivotal trial now underway will be concluded successfully. We are hopeful that, upon examination of the first 180 patients in the trial, results will be positive enough to be able to refile the PMA with the FDA. We think it unlikely that another advisory panel meeting would be necessary, and would therefore estimate that upon filing, the FDA would approve the product fairly quickly.

ATIS has signed up Smith & Nephew, one of the world leaders in wound care, to aid in the marketing of Dermagraft worldwide. We are estimating sales of Dermagraft for the diabetic foot indication of $22 million in 2000, growing to over $250 million by the year 2004.

As with many products, we are expecting off-label use of Dermagraft for additional indications to be quite significant. We believe that, as physicians gain experience in the using the product and ongoing trials progress for other indications, Dermagraft will be used for both venous ulcers and decubitus ulcers, both large underserved markets.

Other Tissue Engineering Applications

The underlying technology and ATIS’ experience in developing both TransCyte and Dermagraft has led to the development of additional tissue-engineered products. While we believe that Dermagraft presents the near-term investment opportunity in ATIS, we feel its pipeline of additional tissue-engineered products presents a unique long-term investment opportunity as well. Although we have not included in our model any revenues as a result of these technologies, we do believe the programs will add value to ATIS over the coming years.

Orthopedic Applications: Through a joint venture with Smith & Nephew, ATIS is developing tissue-engineered cartilage initially focusing on treatment of defects in the knee. Cartilage defects can arise from injury, usually sports related, from degenerative joint diseases or other biological defects. Articular cartilage, the cartilage responsible for providing a smooth gliding surface in joints, is made up of chondrocytes within a matrix of collagen and other proteins. Since articular cartilage is avascular (without blood vessels), the body has a limited ability to repair the tissue.

Current treatment is primarily arthroscopic, reshaping the joint to relieve pain and/or restructuring the meniscus (the tissue that absorbs most of the physical impact) and ligaments and tendons to better support the knee area. It is estimated that over 1.2 million arthroscopic procedures of the knee are performed each year in the US and over 250,000 knee replacements occur annually. ATIS is also anticipating that its cartilage products could be used to treat injuries to other joints such as the shoulder, elbow, wrist, hip or ankle.

The cartilage joint venture has conducted preclinical animal studies using ATIS’ tissue-engineered cartilage. In a 24-month study using a small animal model, significant improvement was seen in the healing of damaged articular cartilage. Following examination of data from an ongoing trial involving a large animal model, ATIS expects to be able to commence human clinical trials as early as the beginning of 2000.

Cardiovascular Applications: As with the orthopedic applications, ATIS’ experience with Dermagraft, and particularly with human fibroblast cells, has led the Company to believe its technology may be applicable in the creation of cardiovascular tissue. This tissue is made up of many cell types, among them cardiac fibroblasts, which closely resemble dermal fibroblasts, smooth muscle cells and endothelial cells. ATIS has begun investigational work on both dermal fibroblasts and smooth muscle cells for cardiovascular applications.

One of the therapeutic applications being explored by ATIS is the area of tissue-engineered vascular grafts. Over 350,000 coronary artery bypass operations are performed in the US each year, while another 70,000 undergo peripheral graft vascular replacement. Current treatment includes autografting (taking veins or arteries from alternate sites in a patient), or the insertion of cadaveric or synthetic grafts. Obviously, each of these treatments creates its own problems–autografting creates a secondary wound site, cadaveric grafts can present rejection and are often in limited supply and synthetic grafts do not always integrate properly into the surrounding tissue. Tissue-engineered blood vessels could alleviate many of these concerns if successful.

In concert with MIT, the Georgia Institute of Technology and Children’s Hospital in Boston and on its own, ATIS has demonstrated in vitro the creation of blood vessels with the appropriate structural and biochemical properties to function in vivo. In large animal studies, in vivo viability was demonstrated using both small diameter and large diameter tissue-engineered blood vessels. Under a grant from the National Institute of Standards and Technology, ATIS is currently leading an effort to design, construct and evaluate tissue-engineered vascular grafts.

Other Therapeutic Applications: ATIS is currently evaluating many other potential therapeutic applications of its technology. Included in this list are: reconstructive surgical applications, cartilage for other uses than orthopedic, the creation of engineered liver tissue, bone and stem cells, and gene therapy. Again, we have not included any revenues from these applications in our financial model, but believe they add significant value to the depth of ATIS’ technology pipeline.

Partnership with Smith & Nephew, a World Leader in Wound Healing

Dermagraft & TransCyte: In April 1996, ATIS formed a 50/50 joint venture for the worldwide commercialization of Dermagraft for the treatment of diabetic foot ulcers, which was subsequently expanded in January 1998 to include other indications such as venous ulcers, pressure sores, burns and other skin tissue defects. In August 1998, the joint venture was expanded again and granted Smith & Nephew exclusive rights to market TransCyte for burns in the US. Smith & Nephew made an initial $10 million payment to ATIS, and ATIS has subsequently received $20 million through an equity investment and received a $15 milestone payment at the beginning of 1999. Upon completion of certain milestones, ATIS would receive additional payments from Smith & Nephew. By the agreement, both companies will share equally in the revenues and costs of the products, except that ATIS is responsible for the first $6 million spent on additional clinical trials on Dermagraft and TransCyte.

Cartilage: ATIS and Smith & Nephew entered into a separate 50/50 joint venture in 1994 for the development of tissue-engineered cartilage for orthopedic applications. Smith & Nephew contributed the first $10 million in joint venture funding, but the remainder of expenses, as well as sales should any products arise from the joint venture, are shared equally between the companies. Smith & Nephew Endoscopy is separately developing arthroscopic instrumentation that could be used with certain cartilage products developed.

In both joint ventures, ATIS is responsible for the manufacturing of the products and has contributed proprietary technology to the joint ventures, while Smith & Nephew’s worldwide salesforces are being and will continue to be used to market and distribute the products.

Management Team

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.

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 of the Company 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 is on the advisory boards of the Department of Bioengineering at Johns Hopkins University and The Georgia Institute of Technology, and is a member of the industrial liaison board at the University of California, San Diego, The Georgia Institute of Technology, The Massachusetts Institute of Technology and the University of Washington. Dr. Naughton is a member of the Board of Directors of Scripps Bank in La Jolla, California, the San Diego Burn Institute and The Charles H. and Anna S. Stern Foundation.

Joseph R. Kletzel was appointed Executive Vice President of the Company in May 1998. From March 1996 to April 1998, Mr. Kletzel served as President of Fisher Scientific International and from March 1992 to February 1996 as President and Chief Operating Officer of Devon Industries, an international manufacturer of surgical products. From 1990 to 1992, Mr. Kletzel was General Manager of Toshiba America Medical Systems, a manufacturer of diagnostic imaging equipment. Mr. Kletzel also spent 13 years at Baxter Healthcare International most recently as Vice President, Sales and Operations in the Operating Room Division. Mr. Kletzel holds a B.S. in Biology from Villanova University.

David L. Horwitz, M.D., Ph.D., joined the Company as Senior Vice President, Technology, in January 1998. Prior to joining the Company, Dr. Horwitz served as Executive Vice President from March 1994 to September 1997 and Vice President of Medical and Regulatory Affairs from April 1992 to March 1994 at SciClone Pharmaceuticals. Dr. Horwitz spent ten years at Baxter Healthcare Corporation prior to 1992, most recently as Vice President, Medical & Professional Affairs in the I.V. Systems Division. From 1979 to 1992, Dr. Horwitz was on the faculty at the University of Illinois at Chicago, and from 1972 to 1979 was a faculty member at the University of Chicago. Dr. Horwitz holds an M.B.A. in general management from Lake Forest Graduate School of Management, a Ph.D. in physiology and an M.D. from the University of Chicago, and an undergraduate degree in chemistry and physics from Harvard University.

Michael V. Swanson was appointed Vice President, Finance and Administration, of the Company 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 LLP) advancing to the position of audit manager. Mr. Swanson received his B.S. in Business Administration from the California Polytechnic State University at San Luis Obispo and received an MBA from the University of Southern California.

Financial Discussion and Valuation

Based on discussions with management, and a review of the market opportunities for ATIS’s products in development, we have generated an earnings model and forecast out to the year 2004. We have provided information pertaining to the targeted indications for Dermagraft and Transcyte and believe our assumptions (as to market size, growth, penetration and pricing) are sufficiently conservative and consistent with comparable company estimates.

With respect to revenues from collaborative agreements, we have included in our model only assumptions for ATIS’ joint venture with Smith & Nephew. Of particular interest is the accounting treatment for the joint venture, which warranted its own summary income statement, as well as the "Contract fees" in the consolidated income statement which consists primarily of R&D funding and milestone payments (per the ATIS and Smith & Nephew agreements, the details of which are available in the public filings for ATIS).

Note on INAMED: In this model, we have not included potential revenues and planned upfront payments and milestones for the recently announced INAMED alliance. We believe this is a very positive transaction for ATIS (refer to our research update of May 13, 1999, available at our website at www.SmallCapsOnline.com), and represents significant value to ATIS shareholders. We will be updating our model in the near future, to incorporate plans for ATIS products and technology in the cosmetic and reconstructive surgery markets.

Valuation: From our assumption pages, we developed a six-year income statement forecast. From these data, we generated valuation analyses using a discounted cash flow method, a terminal P/E multiple method and a terminal EBITDA multiple method. We believe we have been sufficiently punitive in our discount rates (particularly given the advanced-stage nature of the Dermagraft product and the validation attributed by the corporate partnerships), and are comfortable with the range of multiples being used. Regardless of the valuation methodology, ATIS’s share price appears to be significantly undervalued at its current level. We believe current fair value for ATIS to be in the range of $10 to $12 per share. We are initiating coverage of ATIS with a BUY rating, and recommend purchase of ATIS by investors tolerant of the risks associated with small-cap equity investments.

Earnings Model and Valuation Analyses: See Below

Risk Considerations

This section of the document is provided to remind potential investors to undertake a prudent level of due diligence prior to making an investment in the securities of ATIS. For a complete description of risks and uncertainties to ATIS’s business, see the "Risk Factors" section in ATIS’s SEC filings, which can be accessed directly from the SEC Edgar filings at www.SEC.gov on the Internet. Other potential risks include:

• Market risk: Like many small-cap and micro-cap stocks, ATIS shares are trading near their 52-week low. Investors should consider technical risks common to many small-cap or micro-cap stock investments, including liquidity levels, small float, risk of dilution, dependence upon key personnel, dependence upon single products or technologies, and the strength of competitors that may be larger, better capitalized and hold dominant market positions.
• Business risk: ATIS has limited experience in the manufacturing, marketing, and the distribution of engineered tissue. Many of its products are in the early stages of development. Additionally, ATIS intends to license rights to its products to other companies. There can be no assurance that these licensing agreements will be completed, or that the market will accept any products under development.
• Regulatory risk: There is no guarantee that future ATIS products will be approved by the US FDA or international regulatory bodies for marketing in the US or abroad.
• Competitive risk: The tissue engineering industry is extremely competitive, in particular because of its large market potential. Many companies are developing products for wound care and other therapeutic indications targeted by ATIS.

Sources for Additional Information

The following are website addresses offering related information, and links to other sources of information.

www.advancedtissue.com ATIS’s corporate website

www.SmithNephew.com Smith & Nephew’s corporate website

www.inamedcorp.com INAMED Corp.’s corporate website

www.SmallCapsOnline.com SmallCaps Online’s site for company information and research

www.FDA.gov US Food and Drug Administration homepage

www.sec.gov US Securities and Exchange Commission, with links to EDGAR filings

The information in this report has been obtained from sources that we believe to be reliable, but we do not guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation by SmallCaps Online LLC for the purchase or sale of any securities. SmallCaps Online LLC and/or any of its affiliates has performed investment banking, consulting or other services for ATIS and may solicit investment banking, consulting or other business from, any company mentioned in this report. SmallCaps Online LLC, any of its affiliates, or persons associated with SmallCaps Online LLC may at anytime be long or short any of the securities referred to herein and may make purchases or sales thereof while this report is in circulation or posted on the SmallCaps Online LLC website at www.SmallCapsOnline.com. This material or any portion thereof, may not be reproduced without prior permission from SmallCaps Online LLC. SmallCaps Online LLC is not responsible for the contents of this document that is intended for electronic transmission and could be thus subjected to tampering or alteration. Copyright © 1999 by SmallCaps Online LLC. All rights reserved.