UNITED
STATES




SECURITIES AND EXCHANGE
COMMISSION




Washington,
DC.  20549




FORM
10-Q





(Mark
One)




x
            Quarterly
      Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of
      1934 for the Quarterly Period endedJune
      30,2009




or




 ̈
            Transition
      Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of
      1934 for the Transition Period from  _______________ to
      ____________________





Commission
File Number 0-19437





SAFESTITCH
MEDICAL, INC.


(Exact
name of registrant as specified in its charter)








Delaware
                  
                  11-2962080(State
      or other jurisdiction of
                    incorporation
      or organization)
                  
                  (I.R.S.
      employer identification no.)4400 Biscayne Blvd., Suite A-100, Miami,
      Florida
                  
                  33137(Address
      of principal executive offices)
                  
                  (Zip
      code)




Registrant’s
telephone number, including area code: (305) 575-4145





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.




Yes x    No
 ̈





Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit
and post such
files).                       Yes
 ̈No  ̈





Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company.  See the definitions of “large
accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule
12b-2 of the Exchange Act.




Large accelerated filer  ̈      Accelerated
filer  ̈   Non-accelerated
filer  ̈Smaller reporting companyx





Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ̈No x





17,962,718 shares of the Company’s
common stock, par value $0.001 per share, were outstanding as of August 7,
2009.








SAFESTITCH
MEDICAL, INC.


(A
Developmental Stage Company)





TABLE
OF CONTENTS FOR FORM 10-Q





PART I.  FINANCIAL
      INFORMATIONITEM
      1.
                    FINANCIAL
      STATEMENTS
                    3Condensed
      Consolidated Balance Sheets as of June 30, 2009 (unaudited) and December
      31, 2008
                    3Unaudited
      Condensed Consolidated Statements of Operations for the Three and Six
      Months ended June 30, 2009 and 2008, and for the period from September 15,
      2005 (inception) to June 30, 2009
                    4Condensed
      Consolidated Statements of Stockholders’ (Deficit) Equity for the period
      from September 15, 2005 (inception) through June 30, 2009
      (unaudited)
                    5Unaudited
      Condensed Consolidated Statements of Cash Flows for the Six Months ended
      June 30, 2009 and 2008, and for the period from September 15, 2005
      (inception) to June 30, 2009
                    6Notes
      to unaudited condensed consolidated financial statements
                    7ITEM
      2.
                    MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                    18ITEM
      3.
                    QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
                    21ITEM
      4T.
                    CONTROLS
      AND PROCEDURES
                    21PART II.  OTHER
      INFORMATIONITEM
      1.
                    LEGAL
      PROCEEDINGS
                    22ITEM
      1A.
                    RISK
      FACTORS
                    22ITEM
      2.
                    UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
                    22ITEM
      3.
                    DEFAULTS
      UPON SENIOR SECURITIES
                    22ITEM
      4.
                    SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
                    23ITEM
      5.
                    OTHER
      INFORMATION
                    23ITEM
      6.
                    EXHIBITS
                    23SIGNATURES
                    24




2


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




CONDENSED
CONSOLIDATED BALANCE SHEETS




(in 000s,
except share and per share data)




June
      30,
                        
                        
                        December
      31,2009
                        
                        
                        2008(Unaudited)ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                        
                        $
                        39
                        
                        
                        $
                        561Other
      receivable – related-party
                        
                        
                        10
                        
                        
                        
                        13Prepaid
      expenses
                        
                        
                        132
                        
                        
                        
                        151Total
      Current Assets
                        
                        
                        181
                        
                        
                        
                        725FIXED
      ASSETSProperty
      and equipment, net
                        
                        
                        177
                        
                        
                        
                        168OTHER
      ASSETSSecurity
      deposits
                        
                        
                        2
                        
                        
                        
                        2Deferred
      financing costs, net
                        
                        
                        511
                        
                        
                        
                        851Total
      Other Assets
                        
                        
                        513
                        
                        
                        
                        853LONG-TERM
      INVESTMENT, net of valuation adjustment of $1,754
                        
                        
                        –
                        
                        
                        
                        –TOTAL
      ASSETS
                        
                        $
                        871
                        
                        
                        $
                        1,746LIABILITIES
      AND STOCKHOLDERS’ (DEFICIT) EQUITYCURRENT
      LIABILITIESAccounts
      payable and accrued liabilities
                        
                        $
                        409
                        
                        
                        $
                        273Stockholder
      loans
                        
                        
                        800
                        
                        
                        
                        –Total
      Current Liabilities
                        
                        
                        1,209
                        
                        
                        
                        273Commitments
      and contingencies  (Note 9)STOCKHOLDERS’
      (DEFICIT) EQUITYPreferred
      Stock, $.01 par value per share, 25,000,000 shares authorized, no shares
      issued and outstanding
                        
                        
                        –
                        
                        
                        
                        –Common
      Stock, $.001 par value per share, 225,000,000 shares authorized,
      17,962,718 shares issued and outstanding
                        
                        
                        18
                        
                        
                        
                        18Additional
      Paid-in Capital
                        
                        
                        10,905
                        
                        
                        
                        10,817Deficit
      accumulated during the development stage
                        
                        
                        (11,261
                        )
                        
                        
                        (9,362
                        )Total
      Stockholders’ (Deficit) Equity
                        
                        
                        (338
                        )
                        
                        
                        1,473TOTAL
      LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY
                        
                        $
                        871
                        
                        
                        $
                        1,746





The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.


3


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS




(in 000s,
except per share amounts)





September15,
      2005Three
      Months Ended
                                  
                                  
                                  Six
      Months Ended
                                  
                                  
                                  (Inception)June
      30,
                                  
                                  
                                  June
      30,
                                  
                                  
                                  to
      June 30,2009
                                  
                                  
                                  2008
                                  
                                  
                                  2009
                                  
                                  
                                  2008
                                  
                                  
                                  2009REVENUES
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -COSTS
      AND EXPENSESResearch
      and development
                                  
                                  
                                  449
                                  
                                  
                                  
                                  804
                                  
                                  
                                  
                                  798
                                  
                                  
                                  
                                  1,618
                                  
                                  
                                  
                                  6,385General
      and administrative
                                  
                                  
                                  417
                                  
                                  
                                  
                                  390
                                  
                                  
                                  
                                  748
                                  
                                  
                                  
                                  806
                                  
                                  
                                  
                                  3,421Total
      Costs and Expenses
                                  
                                  
                                  866
                                  
                                  
                                  
                                  1,194
                                  
                                  
                                  
                                  1,546
                                  
                                  
                                  
                                  2,424
                                  
                                  
                                  
                                  9,806LOSS
      FROM OPERATIONS
                                  
                                  
                                  (866
                                  )
                                  
                                  
                                  (1,194
                                  )
                                  
                                  
                                  (1,546
                                  )
                                  
                                  
                                  (2,424
                                  )
                                  
                                  
                                  (9,806
                                  )INTEREST
      INCOME
                                  
                                  
                                  –
                                  
                                  
                                  
                                  7
                                  
                                  
                                  
                                  –
                                  
                                  
                                  
                                  12
                                  
                                  
                                  
                                  77AMORTIZATION
      OF DEBT ISSUANCE EXPENSE
                                  
                                  
                                  (128
                                  )
                                  
                                  
                                  (212
                                  )
                                  
                                  
                                  (340
                                  )
                                  
                                  
                                  (425
                                  )
                                  
                                  
                                  (1,474
                                  )INTEREST
      EXPENSE
                                  
                                  
                                  (13
                                  )
                                  
                                  
                                  (18
                                  )
                                  
                                  
                                  (13
                                  )
                                  
                                  
                                  (24
                                  )
                                  
                                  
                                  (58
                                  )LOSS
      BEFORE INCOME TAX
                                  
                                  
                                  (1,007
                                  )
                                  
                                  
                                  (1,417
                                  )
                                  
                                  
                                  (1,899
                                  )
                                  
                                  
                                  (2,861
                                  )
                                  
                                  
                                  (11,261
                                  )PROVISION
      FOR INCOME TAX
                                  
                                  
                                  –
                                  
                                  
                                  
                                  –
                                  
                                  
                                  
                                  –
                                  
                                  
                                  
                                  –
                                  
                                  
                                  
                                  –NET
      LOSS
                                  
                                  $
                                  (1,007
                                  )
                                  
                                  $
                                  (1,417
                                  )
                                  
                                  $
                                  (1,899
                                  )
                                  
                                  $
                                  (2,861
                                  )
                                  
                                  $
                                  (11,261
                                  )WEIGHTED
      AVERAGE SHARES OUTSTANDING, BASIC AND DILUTED
                                  
                                  
                                  17,963
                                  
                                  
                                  
                                  16,843
                                  
                                  
                                  
                                  17,963
                                  
                                  
                                  
                                  16,468NET
      LOSS PER BASIC AND DILUTED SHARE
                                  
                                  $
                                  (0.06
                                  )
                                  
                                  $
                                  (0.08
                                  )
                                  
                                  $
                                  (0.11
                                  )
                                  
                                  $
                                  (0.17
                                  )




The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.


4


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




CONDENSED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ (DEFICIT) EQUITY




FOR
THE PERIOD SEPTEMBER 15, 2005 (INCEPTION) THROUGH JUNE 30, 2009




(in
000s)





DeficitAccumulatedAdditional
                            
                            
                            During
      thePreferred
      Stock
                            
                            
                            Common
      Stock
                            
                            
                            Paid-in
                            
                            
                            DevelopmentShares
                            
                            
                            Amount
                            
                            
                            Shares
                            
                            
                            Amount
                            
                            
                            Capital
                            
                            
                            Stage
                            
                            
                            TotalInception
      – September 15, 2005
                            
                            
                            –
                            
                            
                            $
                            –
                            
                            
                            
                            –
                            
                            
                            $
                            –
                            
                            
                            $
                            –
                            
                            
                            $
                            –
                            
                            
                            $
                            –Capital
      contributed
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            1
                            
                            
                            
                            –
                            
                            
                            
                            1Net
      loss
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            (76
                            )
                            
                            
                            (76
                            )Balance
      at December 31, 2005
                            
                            
                            –
                            
                            
                            $
                            –
                            
                            
                            
                            –
                            
                            
                            $
                            –
                            
                            
                            $
                            1
                            
                            
                            $
                            (76
                            )
                            
                            $
                            (75
                            )Capital
      contributed
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            11,256
                            
                            
                            
                            11
                            
                            
                            
                            1,493
                            
                            
                            
                            –
                            
                            
                            
                            1,504Net
      loss
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            (1,060
                            )
                            
                            
                            (1,060
                            )Balance
      at December 31, 2006
                            
                            
                            –
                            
                            
                            $
                            –
                            
                            
                            
                            11,256
                            
                            
                            $
                            11
                            
                            
                            $
                            1,494
                            
                            
                            $
                            (1,136
                            )
                            
                            $
                            369Exercise
      of options (CTS)-September 23, 2007 at $0.79 per share
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            42
                            
                            
                            
                            –
                            
                            
                            
                            35
                            
                            
                            
                            –
                            
                            
                            
                            35Stock-based
      compensation-September 4, 2007
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            77
                            
                            
                            
                            –
                            
                            
                            
                            77Issuance
      of shares in recapitalization - September 4, 2007 at $0.64 per
      share
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            4,795
                            
                            
                            
                            5
                            
                            
                            
                            3,078
                            
                            
                            
                            –
                            
                            
                            
                            3,083SafeStitch
      expenses associated with recapitalization
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            (156
                            )
                            
                            
                            –
                            
                            
                            
                            (156
                            )Stock-based
      compensation
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            65
                            
                            
                            
                            –
                            
                            
                            
                            65Warrants
      issued in connection with credit facility-September 4, 2007 at $2.46 per
      share
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            1,985
                            
                            
                            
                            –
                            
                            
                            
                            1,985Rule
      16 payment received
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            4
                            
                            
                            
                            –
                            
                            
                            
                            4Net
      loss
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            (3,041
                            )
                            
                            
                            (3,041
                            )Balance
      at December 31, 2007
                            
                            
                            –
                            
                            
                            $
                            –
                            
                            
                            
                            16,093
                            
                            
                            $
                            16
                            
                            
                            $
                            6,582
                            
                            
                            $
                            (4,177
                            )
                            
                            $
                            2,421Issuance
      of common shares in private offering – May 2008 at $2.15 per share, net of
      offering costs
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            1,862
                            
                            
                            
                            2
                            
                            
                            
                            3,986
                            
                            
                            
                            –
                            
                            
                            
                            3,988Issuance
      of common shares as repayment of stockholder note-December 30, 2008 at
      $1.22 per share
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            8
                            
                            
                            
                            –
                            
                            
                            
                            10
                            
                            
                            
                            –
                            
                            
                            
                            10Stock-based
      compensation
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            239
                            
                            
                            
                            –
                            
                            
                            
                            239Net
      loss
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            (5,185
                            )
                            
                            
                            (5,185
                            )Balance
      at December 31, 2008
                            
                            
                            –
                            
                            
                            $
                            –
                            
                            
                            
                            17,963
                            
                            
                            $
                            18
                            
                            
                            $
                            10,817
                            
                            
                            $
                            (9,362
                            )
                            
                            $
                            1,473Stock-based
      compensation
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            88
                            
                            
                            
                            –
                            
                            
                            
                            88Net
      loss
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            –
                            
                            
                            
                            (1,899
                            )
                            
                            
                            (1,899
                            )Balance
      at June 30, 2009 - Unaudited
                            
                            
                            –
                            
                            
                            $
                            –
                            
                            
                            
                            17,963
                            
                            
                            $
                            18
                            
                            
                            $
                            10,905
                            
                            
                            $
                            (11,261
                            )
                            
                            $
                            (338
                            )





The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.


5


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS




(in
000s)




Six
      Months Ended June
                                              30,
                                            
                                            
                                            September
      15,
                                              2005
                                              (Inception)
      to2009
                                            
                                            
                                            2008
                                            
                                            
                                            June
      30, 2009OPERATING
      ACTIVITIESNet
      loss
                                            
                                            $
                                            (1,899
                                            )
                                            
                                            $
                                            (2,861
                                            )
                                            
                                            $
                                            (11,261
                                            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Amortization
      of deferred finance costs
                                            
                                            
                                            340
                                            
                                            
                                            
                                            425
                                            
                                            
                                            
                                            1,474Stock-based
      compensation expense
                                            
                                            
                                            88
                                            
                                            
                                            
                                            171
                                            
                                            
                                            
                                            392Stock-based
      compensation expense related to Share Exchange
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            77Depreciation
      and amortization
                                            
                                            
                                            27
                                            
                                            
                                            
                                            25
                                            
                                            
                                            
                                            86Changes
      in operating assets and liabilitiesOther
      current assets
                                            
                                            
                                            22
                                            
                                            
                                            
                                            (26
                                            )
                                            
                                            
                                            (122
                                            )Other
      assets
                                            
                                            
                                            –
                                            
                                            
                                            
                                            (1
                                            )
                                            
                                            
                                            (2
                                            )Accounts
      payable and accrued liabilities
                                            
                                            
                                            136
                                            
                                            
                                            
                                            72
                                            
                                            
                                            
                                            124NET
      CASH USED IN OPERATING ACTIVITIES
                                            
                                            
                                            (1,286
                                            )
                                            
                                            
                                            (2,195
                                            )
                                            
                                            
                                            (9,232
                                            )CASH
      FLOWS FROM  INVESTING ACTIVITIESPurchase
      of equipment
                                            
                                            
                                            (36
                                            )
                                            
                                            
                                            (25
                                            )
                                            
                                            
                                            (263
                                            )Payment
      received under Rule 16b
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            4NET
      CASH USED IN INVESTING ACTIVITIES
                                            
                                            
                                            (36
                                            )
                                            
                                            
                                            (25
                                            )
                                            
                                            
                                            (259
                                            )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      cash provided in connection with the acquisition of SafeStitch
      LLC
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            3,192Issuance
      of common stock, net of offering costs
                                            
                                            
                                            –
                                            
                                            
                                            
                                            3,990
                                            
                                            
                                            
                                            3,988Capital
      contributions
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            1,431Proceeds
      from stockholder loans
                                            
                                            
                                            800
                                            
                                            
                                            
                                            1,000
                                            
                                            
                                            
                                            2,760Repayment
      of stockholder loans
                                            
                                            
                                            –
                                            
                                            
                                            
                                            (1,000
                                            )
                                            
                                            
                                            (1,876
                                            )Exercise
      of options
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            35NET
      CASH PROVIDED BY FINANCING ACTIVITIES
                                            
                                            
                                            800
                                            
                                            
                                            
                                            3,990
                                            
                                            
                                            
                                            9,530NET
      (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
                                            
                                            
                                            (522
                                            )
                                            
                                            
                                            1,770
                                            
                                            
                                            
                                            39CASH
      AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
                                            
                                            
                                            561
                                            
                                            
                                            
                                            631
                                            
                                            
                                            
                                            –CASH
      AND CASH EQUIVALENTS AT END OF PERIOD
                                            
                                            $
                                            39
                                            
                                            
                                            $
                                            2,401
                                            
                                            
                                            $
                                            39Supplemental
      disclosures:Cash
      paid for interest
                                            
                                            $
                                            –
                                            
                                            
                                            $
                                            24
                                            
                                            
                                            $
                                            45Non
      cash activities:Stockholder
      loans contributed to capital
                                            
                                            $
                                            –
                                            
                                            
                                            $
                                            –
                                            
                                            
                                            $
                                            84Warrants
      issued in connection with credit facility
                                            
                                            $
                                            –
                                            
                                            
                                            $
                                            –
                                            
                                            
                                            $
                                            1,985





The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.


6


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




NOTE
1 – BASIS OF PRESENTATION AND LIQUIDITY




The
condensed consolidated balance sheet as of December 31, 2008, which has
been derived from audited financial statements, and the unaudited condensed
consolidated interim financial statements of SafeStitch Medical, Inc.
(“SafeStitch” or the “Company”) have been prepared in accordance with accounting
principles generally accepted in the United States (“GAAP”) for interim
financial information and the instructions to the quarterly report on Form 10-Q
and Rule 8-03 of Regulation S-X.  Accordingly, they do not
include all of the information and footnotes required by GAAP for complete
financial statements.  In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included.  Operating results for the three and
six months ended June 30, 2009 are not necessarily indicative of results that
may be expected for the year ending December 31, 2009.  These
condensed consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto for the year
ended December 31, 2008 included in the Company’s annual report on form 10-K,
filed with the Securities and Exchange Commission (“SEC”) on March 27,
2009.




SafeStitch
is a developmental stage medical device company focused on the development of
medical devices that manipulate tissues for obesity, gastroesophageal reflux
disease (“GERD”), Barrett’s Esophagus, esophageal obstructions, upper
gastrointestinal bleeding, hernia formation and other intraperitoneal
abnormalities through endoscopic and minimally invasive surgery.




Cellular
Technical Services Company, Inc. (“Cellular”), a non-operating public company,
was incorporated in 1988 as NCS Ventures Corp. under the laws of the State of
Delaware.  On July 25, 2007 Cellular entered into a Share Transfer,
Exchange and Contribution Agreement (the “Share Exchange”) with SafeStitch LLC,
a limited liability company formed in Virginia on September 15,
2005.  On September 4, 2007, Cellular acquired all of the members’
equity of SafeStitch LLC in exchange for 11,256,369 shares of Cellular’s common
stock, which represented a majority of Cellular’s outstanding shares immediately
following the Share Exchange.  For accounting purposes, the
acquisition has been treated as a recapitalization of SafeStitch LLC, with
SafeStitch LLC as the acquirer (reverse acquisition).  The historical
financial statements prior to September 4, 2007 are those of SafeStitch LLC,
which began operations on September 15, 2005.  The accompanying
financial statements give retroactive effect to the recapitalization as if it
had occurred on September 15, 2005 (inception).  Effective January 8,
2008, Cellular changed its name to SafeStitch Medical, Inc. and increased the
aggregate number of shares of capital stock that may be issued from 35,000,000
to 250,000,000, comprising 225,000,000 shares of common stock, par value $0.001
per share, and 25,000,000 shares of preferred stock, par value $0.01 per
share.




The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern.  For the period from September
15, 2005 (inception) through June 30, 2009, the Company has
accumulated a deficit of $11.3 million and has not generated positive cash flows
from operations.  At June 30, 2009, the Company had a working capital
deficit of $1,028,000, including $800,000 of stockholder loans, and a capital
deficit of $338,000.  The Company has been dependent upon equity
financing and loans from stockholders to meet its obligations and sustain its
operations, including the July 2009 Series A Preferred Stock transactions
described in Note 16.  The Company’s efforts have been principally
devoted to developing its technologies and commercializing its
products.  Based upon its current cash position; its budget for
business operations; the $2.0 million gross proceeds from the July 2009 sale of
Series A Preferred Stock; the commitment from private investors for an
additional $2.0 million of Series A Preferred Stock; availability under its $4.0
million credit facility with The Frost Group LLC and the Company’s President and
CEO, Jeffrey G. Spragens, and by monitoring its discretionary expenditures,
management believes that the Company will be able to fund operations without
meaningful revenues or additional financing at least through June
2010.  Management considered the June 30, 2010 expiration of the $4.0
million credit facility when it evaluated the Company’s ability to continue
funding its operations.  If adequate funds are not available, the
Company may be required to delay, reduce the scope of or eliminate its research
and development programs, reduce its planned commercialization efforts or obtain
funds through arrangements with collaborators or others that may require the
Company to relinquish rights to certain product candidates that it might
otherwise seek to develop or commercialize independently.  Although
the Company plans to secure additional funds through the issuance of equity
and/or debt, no assurance can be given that additional financing will be
available to the Company on acceptable terms, or at all.  The
Company’s ability to continue as a going concern is ultimately dependent upon
generating revenues from those products that do not require further marketing
clearance by the U.S. Food and Drug Administration (“FDA”), obtaining FDA
clearance to market its other product candidates and achieving profitable
operations and generating sufficient cash flows from operations to meet future
obligations.


7


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES




Consolidation.  The
condensed consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, Isis Tele-Communications, Inc., which has no
current operations, and SafeStitch LLC.  All inter-company accounts
and transactions have been eliminated in consolidation.




Use of
estimates.  The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions, such
as useful lives of property and equipment, that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of expenses during
the reporting period.  Actual results could differ from those
estimates.




Cash and cash
equivalents.  We consider all highly liquid investments
purchased with a maturity of three months or less when purchased to be cash
equivalents.  The Company holds cash and cash equivalent balances in
banks and other financial institutions.  Balances in excess of FDIC
limitations may not be insured.




Property and
equipment.  Property and equipment are carried at cost less
accumulated depreciation.  Major additions and improvements are
capitalized, while maintenance and repairs that do not extend the lives of
assets are expensed.  Gain or loss, if any, on the disposition of
fixed assets is recognized currently in operations.  Depreciation is
calculated primarily on a straight-line basis over estimated useful lives of the
assets.




Research and
development.  Research and development costs principally
represent salaries of the Company’s medical and biomechanical engineering
professionals, material and shop costs associated with manufacturing product
prototypes and payments to third parties for clinical trials and additional
product development and testing.  All research and development costs
are charged to expense as incurred.




Patent
costs.  Costs incurred in connection with acquiring patent
rights and the protection of proprietary technologies are charged to expense as
incurred.




Stock-based
compensation.  The Company follows Statement of Financial
Accounting Standards (“SFAS”) No. 123R, “Share Based Payment”, which
requires all share-based payments, including grants of stock options, to be
recognized in the income statement as an operating expense, based on their grant
date fair values.  Stock-based compensation is included in general and
administrative costs and expenses for all periods presented.




Fair value of
financial instruments.  The Company follows SFAS No. 157, “Fair Value Measurements”
(“SFAS 157”), which defines fair value, establishes a framework for measuring
fair value and requires additional disclosures about fair value
measurements.  The carrying amounts of cash and cash equivalents,
accounts payable, and accrued expenses approximate fair value based on their
short-term maturity.  Related party receivables and stockholder loans
are carried at cost.




Long-lived
assets.  In accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets,” the Company reviews the carrying values
of its long-lived assets, including long-term investments, for possible
impairment whenever events or changes in circumstances indicate that the
carrying amounts of the assets may not be recoverable.  Any long-lived
assets held for disposal are reported at the lower of their carrying amounts or
fair value less costs to sell.




Income
taxes.  The Company follows the liability method of accounting
for income taxes, as set forth in SFAS No. 109, “Accounting for Income Taxes”
(“SFAS 109”).  SFAS 109 prescribes an asset and liability approach,
which requires the recognition of deferred tax liabilities and assets for the
expected future tax consequences of temporary differences between the carrying
amounts and the tax bases of the assets and liabilities.  The
Company’s policy is to record a valuation allowance against deferred tax assets,
when the deferred tax asset is not recoverable.  The Company considers
estimated future taxable income or loss and other available evidence when
assessing the need for its deferred tax valuation allowance.




Comprehensive
income (loss).  SFAS No. 130, “Reporting Comprehensive Income
(Loss),” requires companies to classify items of other comprehensive
income (loss) in a financial statement.  Comprehensive income (loss)
is defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner
sources.  The Company’s comprehensive net loss is equal to its net
loss for all periods presented.


8


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




NOTE
3 – PROPERTY AND EQUIPMENT




Property
and equipment consist of the following:




Estimated Useful Lives
                    
                    June 30, 2009
                    
                    
                    December 31, 2008Machinery
      and equipment
                    
                    5
      years
                    
                    $
                    189,000
                    
                    
                    $
                    153,000Furniture
      and fixtures
                    
                    3-5
      years
                    
                    
                    37,000
                    
                    
                    
                    37,000Software
                    
                    3-5
      years
                    
                    
                    37,000
                    
                    
                    
                    37,000263,000
                    
                    
                    
                    227,000Accumulated
      depreciation and amortization
                    
                    
                    
                    
                    (86,000
                    )
                    
                    
                    (59,000
                    )Property
      and equipment, net
                    
                    
                    
                    $
                    177,000
                    
                    
                    $
                    168,000





Depreciation
of fixed assets utilized in research and development activities is included in
research and development expense.  All other depreciation is included
in general and administrative costs and expenses.  Depreciation and
amortization expense was $14,000 and $27,000, respectively, for the three and
six months ended June 30, 2009, and was $12,000 and $25,000, respectively, for
the three and six months ended June 30, 2008.




NOTE
4 – LONG-TERM INVESTMENT




In
November 1999, Cellular invested in a one-year, $1.0 million 10% convertible
note of KSI, Inc. (“KSI”) and also received warrants to purchase KSI common
stock.  In August 2000, all of the outstanding stock of KSI was
acquired by TruePosition, Inc., a majority owned subsidiary of Liberty Media
Corporation (“Liberty Media”).  Prior to such acquisition, the
convertible note was exchanged for KSI common stock, and Cellular exercised the
KSI warrants and purchased additional KSI common stock for approximately
$754,000.  Cellular’s investment in KSI common stock was exchanged for
TruePosition common stock on the date of the acquisition.  The Company
currently holds 191,118 shares of TruePosition common stock and accounts for the
investment in TruePosition using the cost method.  In December 2002,
Cellular received certain valuation information from TruePosition, indicating a
range of values for TruePosition.  Based upon its review of available
information and communications with Liberty Media, Cellular concluded there had
been an other-than-temporary decline in estimated fair value of its investment
and reduced the recorded carrying value of this investment from its cost basis
of $1,754,000 to zero, representing its best estimate of the then-current fair
value of Cellular’s investment in the net equity of
TruePosition.  TruePosition’s operations have required significant
infusions of cash by Liberty Media, and the Company’s investment in TruePosition
common stock has been diluted by these advances, which were converted to
preferred stock in late 2002.  In August 2007, the Company was
informed that Liberty TP Acquisition, Inc., which held an aggregate of no less
than 90% of TruePosition’s outstanding capital stock, was being merged into
TruePosition.  Pursuant to the terms of the merger, TruePosition’s
minority stockholders, including the Company, were entitled to receive $3.5116
in cash in exchange for each share held.  The Company has exercised
its statutory appraisal rights in respect of this merger, and is now a party to
an appraisal action and a securities fraud litigation (see Note
9).  The Company may possibly receive proceeds from the merger, the
litigation or other disposition of this investment, but no such amount can be
estimated at this time.




NOTE
5 – STOCK-BASED COMPENSATION




On
November 13, 2007, the Board of Directors and a majority of the Company’s
stockholders approved the SafeStitch Medical, Inc. 2007 Incentive Compensation
Plan (the “2007 Plan”).  Under the 2007 Plan, which is administered by
the Compensation Committee of the Board of Directors, the Company is allowed to
grant stock options, stock appreciation rights, restricted stock and/or deferred
stock to employees, officers, directors, consultants and vendors up to an
aggregate of 2,000,000 shares of the Company’s common stock, which are fully
reserved for future issuance.  The exercise price of stock options or
stock appreciation rights may not be less than the fair market value of the
Company’s shares at the date of grant and, within any 12 month period, no person
may receive stock options or stock appreciation rights for more than one million
shares.  Additionally, no stock options or stock appreciation rights
granted under the 2007 Plan may have a term exceeding ten years.




Total
stock-based compensation recorded for the three and six months ended June 30,
2009 was $52,000 and $88,000, respectively, and is included in general and
administrative costs and expenses.  Total stock-based compensation
recorded for the three and six months ended June 30, 2008 was $32,000 and
$171,000, respectively.  The fair value of the Company’s stock option
awards is expensed over the vesting life of the underlying stock options using
the graded vesting method, with each tranche of vesting options valued
separately.


9


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





The
Company granted zero and 358,500 options, respectively, under the 2007 Plan
during the three and six months ended June 30, 2009.  The options
granted during the six months ended June 30, 2009 were issued at an exercise
price of $0.80 per share and had an estimated aggregate grant date fair value of
$180,000.  The Company granted zero and 148,500 options, respectively,
under the 2007 Plan during the three and six months ended June 30,
2008.  The options granted during the six months ended June 30, 2008
were issued at exercise prices between $3.00 and $3.10 per share and had an
estimated aggregate grant date fair value of $300,000.  The fair value
of options granted is estimated on the date of their grant using the
Black-Scholes option pricing model based on the assumptions included in the
table below.  Expected volatility is based on the historical
volatility of the Company’s stock.  Due to the short period of time
that the Company has been publicly traded since the Share Exchange, the
historical volatilities of similar publicly traded entities are reviewed to
validate the Company’s expected volatility assumption.  The risk-free
interest rate for periods within the contractual life of the stock option award
is based on the yield of U.S. Treasury bonds on the grant date with a maturity
equal to the expected term of the stock option.  The expected life of
stock option awards is based upon the “simplified” method for “plain vanilla”
options described in SEC Staff Accounting Bulletin No. 107, as amended by SEC
Staff Accounting Bulletin No. 110.  Forfeiture rates are based on
management’s estimates.  The fair value of each option granted during
the six months ended June 30, 2009 and 2008 was estimated using the following
assumptions.




Six months ended
                    June 30, 2009
                  
                  
                  Six months ended
                    June 30, 2008Expected
      volatility
                  
                  
                  74.59%
      - 86.43%
                  
                  
                  
                  88.31%
      - 94.46%Expected
      dividend yield
                  
                  
                  0.00%
                  
                  
                  
                  0.00%Risk-free
      interest rate
                  
                  
                  1.39%
      – 1.79%
                  
                  
                  
                  1.96%
      – 2.61%Expected
      life
                  
                  4.0 – 5.5 years
                  
                  
                  3.5 – 5.5 yearsForfeiture
      rate
                  
                  
                  2.50%
                  
                  
                  
                  0%
      - 2.50%




The
following summarizes the Company’s stock option activity for the six months
ended June 30, 2009:




Shares
                
                
                Weighted
                    Average
                    Exercise
                    Price
                
                
                Weighted
                    Average
                    Remaining
                    Contractual
                    Term (Years)
                
                
                Aggregate
                    Intrinsic
                    ValueOutstanding
      at December 31, 2008
                
                
                256,667
                
                
                $
                2.80
                
                
                
                7.12Granted
                
                
                358,500
                
                
                $
                0.80
                
                
                
                6.62Exercised
                
                
                –
                
                
                
                –
                
                
                
                –Canceled
      or expired
                
                
                –
                
                
                
                –
                
                
                
                –Outstanding
      at June 30, 2009
                
                
                615,167
                
                
                $
                1.63
                
                
                
                6.48
                
                
                $
                107,550Exercisable
      at June 30, 2009
                
                
                143,834
                
                
                $
                2.93
                
                
                
                5.88
                
                
                $
                –Vested
      and expected to vest at June 30, 2009
                
                
                592,789
                
                
                $
                1.65
                
                
                
                6.48
                
                
                $
                102,099





None of
the 358,500 options granted during the first six months of the Company’s 2009
fiscal year were vested as of June 30, 2009.  A summary of the status
of the Company’s non-vested options and changes during the six months ended June
30, 2009 is presented below.


10


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





Stock Options
                    
                    
                    Weighted Average Grant
                        Date Fair ValueNon-Vested
      at December 31, 2008
                    
                    
                    146,833
                    
                    
                    $
                    2.00Options
      Granted
                    
                    
                    358,500
                    
                    
                    
                    0.50Options
      Vested
                    
                    
                    (34,000
                    )
                    
                    
                    2.02Non-Vested
      at June 30, 2009
                    
                    
                    471,333
                    
                    
                    $
                    0.86





At June
30, 2009, there was $249,000 of total unrecognized compensation cost related to
non-vested employee and director share-based compensation
arrangements.  That cost is expected to be recognized over a
weighted-average period of 1.70 years.





No
options were exercised during the six months ended June 30, 2009 and
2008.  The $88,000 of stock-based compensation recorded for the six
months ended June 30, 2009 is net of an approximately $15,000 credit related to
the modification of stock option awards for certain former
employees.  On the modification date, the Company’s Compensation
Committee accelerated and fully vested the former employees’ options, which were
originally scheduled to vest on various dates through
2012.  Additionally the Compensation Committee extended the term of
these options to one year following the modification date.





NOTE
6 – CREDIT FACILITY




In
connection with the acquisition of SafeStitch LLC, the Company entered into a
Note and Security Agreement (the “Credit Facility”) with both The Frost Group,
LLC (“The Frost Group”) and Jeffrey G. Spragens, the Company’s Chief Executive
Officer and President and a director.  The Frost Group is a Florida
limited liability company whose members include Frost Gamma Investments Trust, a
trust controlled by Dr. Phillip Frost, the largest beneficial holder of the
issued and outstanding shares of the Company’s common stock, Dr. Jane H. Hsiao,
the Company’s Chairman of the Board, and Steven D. Rubin, a
director.  The Credit Facility provides for $4.0 million in total
available borrowings, consisting of $3.9 million from The Frost Group and
$100,000 from Mr. Spragens.  The Company has granted a security
interest in all present and subsequently acquired collateral in order to secure
prompt, full and complete payment of the amounts due under the Credit
Facility.  The collateral includes all assets of the Company,
inclusive of intellectual property (patents, patent rights, trademarks, service
marks, etc.).  Outstanding borrowings under the Credit Facility accrue
interest at a 10% annual rate.  The Credit Facility had an initial
term of 28 months, expiring in December 2009, and was amended in March 2009 to
extend the Maturity Date to June 2010.




In
connection with the Credit Facility, the Company granted warrants to purchase an
aggregate of 805,521 shares of its common stock to The Frost Group and Mr.
Spragens.  The fair value of the warrants was determined to be
$1,985,000 on the grant date based on the Black-Scholes valuation model using
the following assumptions: expected volatility of 82%, dividend yield of 0%,
risk-free interest rate of 4.88% and expected life of 10 years.  The
fair value of the warrants was recorded as deferred financing costs and will be
amortized over the life of the Credit Facility.  The Company recorded
amortization expense related to these deferred financing costs of $128,000 and
$340,000, respectively, for the three and six months ended June 30, 2009 and
$212,000 and $425,000, respectively, for the three and six months ended June 30,
2008.




The
Company borrowed $1.0 million under the Credit Facility during the six months
ended June 30, 2008 and repaid the entire outstanding balance in June 2008 using
the proceeds of the 2008 Private Placement of Common Stock described in Note
7.  The Company borrowed $800,000 under the Credit Facility during the
six months ended June 30, 2009, which amount remained outstanding as of June 30,
2009 and was repaid with the proceeds of the 2009 issuance of Series A Preferred
Stock described in Notes 7 and 16.  The Company recognized interest
expense related to the outstanding borrowings of $13,000 and $13,000,
respectively, for the three and six months ended June 30, 2009 and approximately
$18,000 and $24,000, respectively, for the three and six months ended June 30,
2008.


11


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





NOTE
7 – CAPITAL TRANSACTIONS




2008 Private Placement of Common
Stock.During the period beginning May 22, 2008 and ended May
28, 2008, the Company entered into stock purchase subscription agreements (the
“Subscription Agreements”) with certain private investors (the “Investors”),
pursuant to which the Company agreed to issue an aggregate of 1,861,505 shares
(the “Shares”) of its Common Stock at a purchase price of $2.15 per
share.  The Company’s Board of Directors established the $2.15
purchase price based on an approximately 10% discount to the average closing
price of the Common Stock on the OTCBB during the five trading days beginning
April 23, 2008 and ended April 29, 2008.  The Company closed on the
issuance of the Shares during the period beginning May 22, 2008 and ended May
28, 2008.  The Company received aggregate consideration for the Shares
of approximately $4.0 million and incurred $14,000 of costs related to the
offering, which were recorded as a reduction of
paid-in-capital.  Among the Investors acquiring a portion of the
Shares were Dr. Hsiao, Jeffrey G. Spragens and some of his relatives, Dr.
Kenneth Heithoff, a former director, Kevin Wayne, a director, and Frost Gamma
Investments Trust.  The Company issued the Shares in reliance upon the
exemption from registration under Section 4(2) of the Securities Act of 1933, as
amended (the “Securities Act”), and Rule 506 of Regulation D promulgated
thereunder.  Each Investor represented to the Company that such person
was an “accredited investor” as defined in Rule 501(a) under the Securities Act
and that the Shares were being acquired for investment purposes.  The
Shares have not been registered under the Securities Act and are “restricted
securities” as that term is defined by Rule 144 promulgated
thereunder.  The Company has not undertaken to register the Shares and
no registration rights have been granted to the Investors in respect of the
Shares.




2009 Issuance of Series A Preferred
Stock.On July 21, 2009, the Company entered into the
securities purchase agreements described in Note 16, pursuant to which the
Company issued 2,000,000 shares of Series A Preferred Stock on July 22,
2009.




NOTE
8 – BASIC AND DILUTED NET LOSS PER SHARE




Basic net
loss per common share is computed by dividing net loss by the weighted average
number of common shares outstanding for the period reported.  Diluted
net loss per common share is computed giving effect to all dilutive potential
common shares that were outstanding for the period reported.  Diluted
potential common shares consist of incremental shares issuable upon exercise of
stock options and warrants.  In computing diluted net loss per share
for the three and six months ended June 30, 2009 and 2008, no adjustment has
been made to the weighted average outstanding common shares as the assumed
exercise of outstanding options and warrants is anti-dilutive.




Potential
common shares not included in calculating diluted net loss per share are as
follows:




June 30, 2009
                    
                    
                    June 30, 2008Stock
      options
                    
                    
                    615,167
                    
                    
                    
                    237,167Stock
      warrants
                    
                    
                    805,521
                    
                    
                    
                    805,521Total
                    
                    
                    1,420,688
                    
                    
                    
                    1,042,688





NOTE
9 – COMMITMENTS AND CONTINGENCIES




The
Company is obligated under various operating lease agreements for office
space.  Generally, the lease agreements require the payment of base
rent plus escalations for increases in building operating costs and real estate
taxes.  Rental expense under operating leases amounted to $25,000 and
$53,000 for the three and six months ended June 30, 2009, respectively, and
$30,000 and $78,000 for the three and six months ended June 30, 2008,
respectively.




The
Company is presently a plaintiff in securities fraud and appraisal actions in
respect of its ownership of 191,118 shares of common stock of TruePosition (See
Note 4).  The securities fraud action was filed November 13, 2007 in
the United States District Court for the District of Connecticut, whereby
SafeStitch and other plaintiffs seek damages and other relief totaling $80
million.  The related appraisal action was filed in the Chancery Court
of the State of Delaware on August 31, 2007.  In August 2007, the
Company was informed that Liberty TP Acquisition, Inc., which held an aggregate
of no less than 90% of TruePosition’s outstanding capital stock, was being
merged into TruePosition.  Pursuant to the terms of the merger,
TruePosition’s minority stockholders, including the Company, became entitled to
receive $3.5116 in cash in exchange for each share held, which the Company and
certain other minority stockholders considered insufficient
compensation.  The Company and other minority stockholders brought
forth the aforementioned securities fraud and appraisal action, and, on August
10, 2007, the Company entered into a joint stockholder litigation governance and
funding agreement (the “Funding Agreement”) with such other
stockholders.  Under the Funding Agreement, the Company has agreed to
fund a portion of the litigation expenses in connection with the appraisal and
securities fraud action.  Through June 30, 2009, the Company has
contributed approximately $81,000 in cash and has incurred additional
liabilities of approximately $129,000.  Management anticipates that
the Company will be called upon to fund additional amounts during the next
twelve months.  The Company may elect to terminate its participation
in the Funding Agreement, whereby the Company would no longer be required to
contribute funds; however, the Company would lose all rights under the Funding
Agreement, including access to any work-product created after the date of
termination.  Additionally, the Company’s portion of any proceeds from
a favorable disposition of the litigation may be reduced if the Company
terminates its participation.


12


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





In
February 2009, the United States District Court for the District of Connecticut
granted the defendants’ motion to dismiss the securities fraud action described
above.  In March 2009, the Company, together with the other plaintiffs
filed an appeal of the District Court’s dismissal with the United States 2nd Circuit
Court of Appeals.  The outcomes of the appeal and the appraisal action
are not now known, nor can they be reasonably predicted at this
time.




NOTE
10 – AGREEMENT WITH CREIGHTON UNIVERSITY




On May
26, 2006, our wholly-owned subsidiary, SafeStitch LLC (“LLC”) entered into an
exclusive license and development agreement (the “License Agreement”) with
Creighton University (“Creighton”) granting LLC a worldwide exclusive (even as
to Creighton) license, with rights to sublicense, to all of LLC’s product
candidates and associated know-how, including the exclusive right to
manufacture, use and sell the product candidates.  Pursuant to the
License Agreement, LLC is entitled to exercise its own business judgment and
sole and absolute discretion over the marketing, sale, distribution, promotion
and other commercial exploitation of any licensed products, provided that, if
LLC has not commercially exploited or commenced development of a licensed patent
and its associated know-how by the seventh anniversary of the later of the date
of the License Agreement or the date such technology is disclosed to and
accepted by LLC, then the licensed patent and associated know-how shall revert
back to Creighton, with no rights retained by LLC, and Creighton will have the
right to seek a third party with whom to commercialize such patent and
associated know-how, unless LLC purchases one or more one-year
extensions.




Pursuant
to the License Agreement, LLC is obligated to pay Creighton, on a quarterly
basis, a royalty of 1.5% of the revenue collected worldwide from the sale of any
product licensed under the License Agreement, less certain amounts including,
without limitation, chargebacks, credits, taxes, duties and discounts or
rebates.  The License Agreement does not provide for minimum
royalties.  Also pursuant to the License Agreement, LLC agreed to
invest, in the aggregate, at least $2.5 million over 36 months, beginning May
26, 2006, towards development of any licensed product.  This $2.5
million investment obligation excludes the first $150,000 of costs related to
the prosecution of patents, which LLC invested outside of the License
Agreement.  LLC is further obligated to pay to Creighton an amount
equal to 20 percent of certain of LLC’s research and development expenditures as
reimbursement for the use of Creighton’s facilities.  Failure to
comply with the payment obligations above will result in all rights in the
licensed patents and know-how reverting back to Creighton.  As of
December 31, 2007, LLC had satisfied the $2.5 million investment obligation
described above.  The Company recorded research and development costs
and expenses related to the 20% facility reimbursement obligation totaling
approximately $10,000 and $20,000, respectively, for the three and six months
ended June 30, 2009, and $81,000 and $147,000, respectively, for the three and
six months ended June 30, 2008.




NOTE
11 – INCOME TAXES




The
Company accounts for income taxes using the asset and liability method described
in SFAS No. 109, “Accounting
For Income Taxes,” the objective of which is to establish deferred tax
assets and liabilities for the temporary differences between the financial
reporting and the tax bases of the Company’s assets and liabilities at enacted
tax rates expected to be in effect when such amounts are realized or
settled.  A valuation allowance related to deferred tax assets is
recorded when it is more likely than not that some portion or all of the
deferred tax assets will not be realized.  All of the Company’s
deferred tax assets have been fully reserved by a valuation allowance due to
management's uncertainty regarding the future profitability of the
Company.




The
Company has adopted the provisions of FASB interpretation No. 48 “Accounting for Uncertainty in
Income Taxes, an interpretation of FASB Statement No.
109.”  The Company has recognized no adjustment for uncertain
tax provisions.  SafeStitch recognizes interest and penalties related
to uncertain tax positions in general and administrative costs and expenses;
however no such provisions for accrued interest and penalties related to
uncertain tax positions have been recorded as of June 30, 2009 and December 31,
2008.


13


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





The tax
years 2004 through 2008 remain open to examination by the major tax
jurisdictions in which the Company operates.




NOTE
12 – CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS




As more
fully described in Note 6, the Company entered into a $4.0 million Credit
Facility with both Jeffrey G. Spragens, the Company’s President, Chief Executive
Officer and director, and The Frost Group, a Florida limited liability company
whose members include Chairman of the Board Dr. Jane H. Hsiao, director Steven
D.  Rubin and Frost Gamma Investments Trust, a trust controlled by Dr.
Phillip Frost, the Company’s largest beneficial stockholder.  Advances
under the Credit Facility totaled $500,000 and $800,000 for the three and six
months ended June 30, 2009, respectively, and zero and $1.0 million for the
three and six months ended June 30, 2008, respectively.  $800,000 was
outstanding under the Credit Facility as of June 30, 2009.  The
Company recognized interest expense related to the Credit Facility of
approximately $13,000 and $13,000 for the three and six months ended June 30,
2009, respectively, and approximately $18,000 and $24,000 for the three and six
months ended June 30, 2008, respectively.




The
Company entered into a five year lease for office space in Miami, Florida with a
company controlled by Dr. Frost.  The initial rental payments under
the Miami office lease, which commenced January 1, 2008, were approximately
$8,000 per month for the first year and escalate 4.5% annually over the life of
the lease.  Pursuant to a lease amendment effective February 2009, the
Company relocated its corporate office to an alternate space within the same
building for annual rental payments of approximately $68,000.  All
other terms and conditions of the Company’s corporate office lease remain
unchanged.  The Company recorded approximately $19,000 and $40,000 of
rent expense related to the Miami lease for the three and six months ended June
30, 2009, respectively, and $24,000 and $61,000 for the three and six months
ended June 30, 2008, respectively.




Dr. Hsiao
is a director of Great Eastern Bank of Florida, a bank where the Company
maintains a bank account in the normal course of business.  As of June
30, 2009, the Company had approximately $23,000 on deposit with Great Eastern
Bank of Florida.




Dr.
Hsiao, Dr. Frost and Mr. Rubin are each significant shareholders and/or
directors of Non-Invasive Monitoring Systems, Inc. (“NIMS”), a publicly-traded
medical device company, and of Aero Pharmaceuticals, Inc. (“Aero”), a
privately-held pharmaceutical distribution company.  Director Richard
Pfenniger is also a shareholder of NIMS.  Commencing in March 2008,
the Company’s Chief Financial Officer also serves as the Chief Financial Officer
and supervises the accounting staffs of NIMS and Aero under a Board-approved
cost sharing arrangement whereby the total salaries of the accounting staffs of
the three companies are shared.  The Company has recorded reductions
to general and administrative costs and expenses for the three and six months
ended June 30, 2009 of approximately $20,000 and $39,000, respectively, and
$15,000 and $15,000 for the three and six months ended June 30, 2008,
respectively, to account for the sharing of costs under this
arrangement.  Accounts receivable from NIMS and Aero were
approximately $7,000 and $3,000, respectively, as of June 30, 2009.




Dr.
Hsiao, Dr. Frost, Mr. Rubin and Mr. Pfenniger are each significant stockholders,
officers and/or directors of OPKO Health, Inc. (“OPKO”), a publicly-traded
specialty healthcare company.  Certain of the Company’s employees from
time to time during the year ended December 31, 2008 provided consulting
services to OPKO on a cost-plus basis.  The Company recorded
reductions totaling $37,000 to general and administrative costs and expenses for
the three and six months ended June 30, 2008 to account for the provision of
these services.  No such services have been provided to OPKO in the
six months ended June 30, 2009.  The amounts charged may not be
representative of those that would have been charged in an “arms-length”
transaction.  The 2008 transactions were ratified by the Audit
Committee of the Board of Directors.


14


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





NOTE
13 – EMPLOYEE BENEFIT PLANS




Effective
May 1, 2008, the SafeStitch 401(k) Plan (the “401k Plan”) permits employees
to contribute up to 100% of qualified annual compensation up to annual statutory
limitations.  Employee contributions may be made on a pre-tax basis to
a regular 401(k) account or on an after-tax basis to a “Roth” 401(k)
account.  The Company will contribute to the 401k Plan a “safe harbor”
match of 100% of each participant’s contributions to the 401k Plan up to a
maximum of 4% of the participant’s qualified annual earnings.  The
Company recorded 401(k) Plan matching expense of approximately $5,000 and
$11,000 for the three and six months ended June 30, 2009, respectively, and
approximately $8,000 and $8,000, respectively, for the three and six months
ended June 30, 2008.




NOTE
14 – FINANCIAL INSTRUMENTS




Effective
January 1, 2008, the Company adopted SFAS 157, which defines fair value,
establishes a framework for measuring fair value and requires additional
disclosures about fair value measurements.  In accordance with FASB
Staff Position 157-2, “Effective Date of the FASB Statement
No. 157,” the Company deferred adoption of SFAS 157 for its
nonfinancial assets and nonfinancial liabilities, except those items recognized
or disclosed at fair value on an annual or more recurring basis, until
January 1, 2009.  SFAS 157 establishes a three-tier fair value
hierarchy, which prioritizes the inputs used in measuring fair
value.  These tiers include:  Level 1, defined as observable
inputs such as quoted prices in active markets; Level 2, defined as inputs other
than quoted prices in active markets that are either directly or indirectly
observable; and Level 3, defined as unobservable inputs in which little or no
market data exists, therefore requiring an entity to develop its own
assumptions.  As of June 30, 2009, the Company did not hold any assets
or liabilities that were required to be measured at fair value on a recurring
basis and did not hold any non-financial assets or liabilities that were
required to be re-measured at fair value, and therefore the adoption of the
respective provisions of SFAS 157 did not have a material impact on the
Company’s consolidated financial statements.




NOTE
15 – RECENT ACCOUNTING PRONOUNCEMENTS




Effective
January 1, 2009, the Company adopted SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements-an amendment of
ARB No. 51”(“SFAS 160”).
 SFAS 160 establishes accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary.  It clarifies that a noncontrolling interest in a
subsidiary is an ownership interest in the consolidated entity that should be
reported as equity in the consolidated financial statements.  The
adoption of SFAS 160 has not had a material impact on the Company’s consolidated
financial statements.




Effective
January 1, 2009, the Company adopted SFAS No. 141 R “Business Combinations” (“SFAS
141R”).  SFAS 141R establishes principles and requirements for how the
acquirer of a business recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed and any noncontrolling
interest in the acquiree.  SFAS 141R also provides guidance for
recognizing and measuring the goodwill acquired in a business combination and
determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of a business
combination.  The adoption of SFAS 141R has not had a material
impact on the Company’s consolidated financial statements. In April
2009, the FASB issued FSP No. FAS 141(R)-1, “Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies”(“FSP 141(R)-1”), to amend and clarify the initial
recognition and measurement, subsequent measurement and accounting, and related
disclosures arising from contingencies in a business combination under SFAS
141R.  Under the new guidance, assets acquired and liabilities assumed
in a business combination that arise from contingencies should be recognized at
fair value on the acquisition date if fair value can be determined during the
measurement period.  If fair value cannot be determined, acquired
contingencies should be accounted for using existing guidance.  FSP
141(R)-1 is effective January 1, 2009.  As such, the adoption applies
to business combinations for which the acquisition date is on or after January
1, 2009.




Effective
January 1, 2009, the Company adopted Emerging Issues Task Force Issue No. 07-1,
“Accounting for Collaborative
Arrangements Related to the Development and Commercialization of Intellectual
Property” (“EITF 07-1”).  EITF 07-1 defines collaborative
arrangements and establishes reporting requirements for transactions between
participants in a collaborative arrangement and between participants in the
arrangement and third parties.  The adoption of EITF 07-1 has not had a
material impact on the Company’s consolidated financial
statements.


15


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




Effective
January 1, 2009, the Company adopted EITF 07-05, “Determining whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF
07-05”).  EITF 07-05 provides guidance on determining what types of
instruments or embedded features in an instrument held by a reporting entity can
be considered indexed to its own stock for the purpose of evaluating the first
criteria of the scope exception in paragraph 11(a) of SFAS 133.  The
adoption of EITF 07-05 has not had a material impact on the Company’s
consolidated financial statements.




Effective
June 30, 2009 the Company adopted FASB Staff Position FAS-157-4, “Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS
157-4”).  FSP FAS 157-4 provides guidelines for making fair value
measurements more consistent with the principles presented in SFAS
157.  FSP FAS 157-4 provides additional authoritative guidance in
determining whether a market is active or inactive and whether a transaction is
distressed.  FSP FAS 157-4 is applicable to all assets and liabilities
(i.e. financial and nonfinancial) and will require enhanced
disclosures.  The adoption of FSP FAS 157-4 has not had a material
impact on the Company’s consolidated financial statements.




Effective
June 30, 2009 the Company adopted FASB Staff Positions FAS 115-2 and FAS 124-2,
“Recognition and Presentation
of Other-Than-Temporary Impairments” (“FSP FAS 115-2”) and (“FSP FAS
124-2”).  FSP FAS 115-2 and FSP FAS 124-2 provide additional guidance
to provide greater clarity about the credit and noncredit component of an
other-than-temporary impairment event and to improve presentation and disclosure
of other than temporary impairments in the financial statements.  The
adoption of FSP FAS 115-2 and FSP FAS 124-2 has not had a material impact on the
Company’s consolidated financial statements.




Effective
June 30, 2009 the Company adopted FASB Staff Position FAS 107-1 and APB 28-1,
“Interim Disclosures about
Fair Value of Financial Instruments” (“FSP FAS 107-1”) and (“APB
28-1”).  FSP FAS 107-1 amends FASB Statement No. 107, “Disclosures about Fair Value of
Financial Instruments”, to require disclosures about fair value of
financial instruments in interim as well as in annual financial statements and
amends APB Opinion No. 28 “Interim Financial
Reporting”, to require those disclosures in interim financial
statements.  The adoption of FSP FAS 107-1 and APB 28-1 has not had a
material impact on the Company’s consolidated financial statements.




Effective
June 30, 2009 the Company adopted SFAS 165, “Subsequent Events,” which
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
available to be issued. The adoption of SFAS 165 has not had a material impact
on the Company’s consolidated financial statements.  The Company has
evaluated subsequent events through August 7, 2009, which is the date the
financial statements were available to be issued.




In June
2009, the FASB issued FAS No. 168, “The FASB Accounting Standards
CodificationTM and the Hierarchy of Generally Accepted Accounting Principles - a
replacement of FASB Statement No. 162” (“FAS No. 168”).  FAS
No. 168 replaces FAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” and establishes the FASB Accounting Standards
CodificationTM (“Codification”) as the source of authoritative accounting
principles recognized by the FASB to be applied by nongovernmental entities in
the preparation of financial statements in accordance with GAAP. All existing
accounting standard documents are superseded by the Codification and any
accounting literature not included in the Codification will not be
authoritative. However, rules and interpretive releases of the SEC issued under
the authority of federal securities laws will continue to be sources of
authoritative GAAP for SEC registrants. FAS No. 168 will be effective beginning
with the Company’s third fiscal quarter of 2009.  Therefore, all
references made by it to GAAP in its consolidated financial statements will use
the new Codification numbering system. The Codification does not change or alter
existing GAAP and, therefore, it is not expected to have any impact on the
Company’s consolidated financial statements.




NOTE
16 – SUBSEQUENT EVENTS




2009 Issuance of Series A Preferred
Stock.On July 21, 2009, the Company entered into a securities
purchase agreement (the “Current Purchase Agreement”) with a private investor
(the “Current Investor”), pursuant to which the Current Investor agreed to
purchase an aggregate of up to 2,000,000 shares (the “Current Shares”) of the
Company’s newly-designated 10.0% Series A Cumulative Convertible Preferred
Stock, par value $0.01 per share (“Series A Preferred Stock”), at a purchase
price of $1.00 per share.  On July 22, 2009, the Company closed on the
issuance of 2,000,000 Current Shares under the Current Purchase Agreement for
aggregate consideration of $2.0 million.  A portion of the proceeds
from the issuance was used to repay all principal and interest outstanding under
the Credit Facility described in Note 6.


16


SAFESTITCH MEDICAL,
INC.




(A
Developmental Stage Company)




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





The
Company issued the Current Shares in reliance upon the exemption from
registration under Section 4(2) of the Securities Act.  The Current
Investor represented to the Company that such person was an “accredited
investor” as defined in Rule 501(a) of the Securities Act and that the Current
Shares were being acquired for investment purposes.  The Current
Shares have not been registered under the Act and are “restricted securities” as
that term is defined by Rule 144 under the Securities Act.  The
Company has not undertaken to register the Current Shares, and no registration
rights have been granted to the Current Investor in respect of the Current
Shares.





Additionally,
on July 21, 2009, the Company entered into a second securities purchase
agreement (the “Future Purchase Agreement”) with certain other private investors
(the “Future Investors”), pursuant to which the Future Investors agreed to
purchase an aggregate of up to 2,000,000 shares of Series A Preferred Stock (the
“Future Shares”) at a purchase price of $1.00 per share.  The Company
is not obligated to consummate the sale of the Future Shares under the Future
Purchase Agreement, and the Company may elect, in its sole discretion, to
consummate such sale on any date on or prior to June 30, 2010, subject to
providing the Future Investors ten days written notice of such closing
date.  Among the Future Investors who have obligated themselves to
potentially acquire a portion of the Future Shares are Hsu Gamma Investment,
L.P., an entity of which Dr. Jane Hsiao, the Company’s Chairman of the Board, is
general partner, Jeffrey G. Spragens, the Company’s Chief Executive Officer,
President and a director, and Frost Gamma Investments Trust, a trust controlled
by Dr. Phillip Frost, who is the largest beneficial owner of the Company’s
outstanding common stock (collectively, the “Related Party
Investors”).  Each of the Related Party Investors is the beneficial
owner of more than 10% of the Company’s common stock.





Holders
of the Series A Preferred Stock are entitled to receive, when, as and if
declared by the Company’s Board of Directors, dividends on each share of Series
A Preferred Stock at a rate per annum equal to 10.0% of the sum of (a) $1.00,
plus (b) any and all declared and unpaid and accrued dividends thereon, subject
to adjustment for any stock split, combination, recapitalization or other
similar corporate action (the “Liquidation Amount”).  Upon the
occurrence of a Liquidation Event (as defined in the Certificate of Designation
of the Powers, Preferences and Relative, Participating, Optional and Other
Special Rights of 10.0% Series A Cumulative Convertible Preferred Stock, and
Qualifications, Limitations and Restrictions Thereof), holders of Series A
Preferred Stock are entitled to be paid, subject to applicable law, out of the
assets of the Company available for distribution to its stockholders, an amount
in cash (the “Liquidation Payment”) for each share of Series A Preferred Stock
equal to the greater of (x) the Liquidation Amount for each share of Series A
Preferred Stock outstanding, or (y) the amount for each share of Series A
Preferred Stock the holders would be entitled to receive pursuant to the
Liquidation Event if all of the shares of Series A Preferred Stock had been
converted into Common Stock as of the date immediately prior to the date fixed
for determination of stockholders entitled to receive a distribution in such
Liquidation Event.  Such Liquidation Payment will be paid before any
cash distribution will be made or any other assets distributed in respect of any
class of securities junior to the Series A Preferred Stock, including, without
limitation, the Company’s common stock, par value $0.001 per share (“Common
Stock”).





The
Series A Preferred Stock is presently convertible by the holders into shares of
Common Stock on a one-for-one basis. The Series A Preferred Stock may be
converted by the Company at any time after September 5, 2009 at the then-current
conversion rate if the aggregate market value of the Common Stock equals or
exceeds $150 million over a specified period. The holders of Series A Preferred
Stock have the right to receive notice of any meeting of holders of Common Stock
or Series A Preferred Stock and to vote (on an as-converted into Common Stock
basis) upon any matter submitted to a vote of the holders of Common Stock or
Series A Preferred Stock.  Except as otherwise expressly set forth in
the Company’s Restated Certificate of Incorporation, as amended from time to
time, the holders of Series A Preferred Stock will vote on each matter submitted
to them with the holders of Common Stock and all other classes and series of the
Company’s capital stock entitled to vote on such matter, taken together as a
single class.  To the extent it is
lawfully able to do so, the Company may redeem all of the then outstanding
shares of Series A Preferred Stock by paying in cash an amount per share equal
to $1.00 plus all declared or accrued unpaid dividends on such shares, subject
to adjustment for any stock dividends or distributions, splits, subdivisions,
combinations, reclassifications, stock issuances or similar events with respect
to the Common Stock.


17


Item
2.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations.




This
Quarterly Report on Form 10-Q contains certain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”),
Section 27A of the Securities Act of 1933, as amended (the “Securities Act”),
and Section 21E of the Securities Exchange Act of 1934, as amended, (the
“Exchange Act”), about our expectations, beliefs or intentions regarding our
product development efforts, business, financial condition, results of
operations, strategies or prospects. You can identify forward-looking statements
by the fact that these statements do not relate strictly to historical or
current matters.  Rather, forward-looking statements relate to
anticipated or expected events, activities, trends or results as of the date
they are made.  Because forward-looking statements relate to matters
that have not yet occurred, these statements are inherently subject to risks and
uncertainties that could cause our actual results to differ materially from any
future results expressed or implied by the forward-looking
statements.  Many factors could cause our actual operations or results
to differ materially from the operations and results anticipated in
forward-looking statements.  These factors include, but are not
limited to:  our ability to obtain additional funding to continue our
operations; our ability to successfully commercialize our existing products; our
ability to successfully develop, clinically test and commercialize our product
candidates; the timing and outcome of the regulatory review process for our
product candidates; changes in the regulatory environments of the United States
and other countries in which we intend to operate; our ability to attract and
retain key management and scientific personnel; competition; our ability to
successfully prepare file, prosecute, maintain, defend and enforce patent claims
and other intellectual property rights; our ability to successfully transition
from a research and development company to a marketing, sales and distribution
concern, and our ability to identify and pursue development of additional
product candidates, as well as the factors contained in “Item 1A - Risk Factors”
of our Annual Report on Form 10-K.  We do not undertake any obligation
to update forward-looking statements, except as required by applicable
law.  We intend that all forward-looking statements be subject to the
safe harbor provisions of PSLRA.  These forward-looking statements are
only predictions and reflect our views as of the date they are made with respect
to future events and financial performance.




Overview




We are a
developmental stage medical device company focused on the development of medical
devices that manipulate tissues for obesity, GERD, hernia formation, esophageal
obstructions, Barrett’s Esophagus, upper gastrointestinal bleeding, and other
intraperitoneal abnormalities through endoscopic and minimally invasive
surgery.




We have
utilized our expertise in intraperitoneal surgery to test certain of our devices
in in vivo and ex vivo animal trials and
ex vivo human trials,
and with certain products, in limited in vivo human
trials.  Certain of our products did not or may not require clinical
trials, including our SMART DilatorTM,
standard and airway bite blocks and AMID StaplerTM.  Where
required, we intend to rapidly, efficiently and safely move into clinical trials
for certain other devices, including those utilized in surgery for the treatment
of obesity, GERD and for the treatment and diagnosis of Barrett’s
Esophagus.  Clinical trials for certain of these product candidates
are anticipated to begin in 2010.




Immediately
prior to our acquisition of SafeStitch LLC, a privately held Virginia limited
liability company, on September 4, 2007, we had no business
operations.  Under the name Cellular Technical Services Company, Inc.
(“CTSC”), we had previously developed, marketed, distributed and supported a
diversified mix of products and services for the telecommunications
industry.  In 2002, CTSC ceased its product development efforts and
adopted a plan to wind down all operations related to its historical business,
which process it completed in December 2005.  Between that time and
the 2007 consummation of our acquisition of SafeStitch LLC described below, all
of CTSC’s staff and administrative positions were eliminated.  As
such, CTSC was a company with primarily cash and cash equivalents and no
operations.




On
September 4, 2007, we completed our acquisition of SafeStitch LLC pursuant to a
Share Transfer, Exchange and Contribution Agreement, dated as of July 25, 2007,
by and among us, SafeStitch LLC and the members of SafeStitch
LLC.  The acquisition was accounted for as a recapitalization of
SafeStitch, LLC, which has been treated as the continuing reporting
entity.




In
January 2008, we changed our name from Cellular Technical Services Company, Inc.
to SafeStitch Medical, Inc., and, on February 11, 2008, our trading symbol on
the OTCBB changed from “CTSC” to “SFES”.  We intend to apply for the
listing of our Common Stock on the NYSE Amex Equities at such time as we meet
the initial listing requirements set by the exchange.


18




Products




Three of
our products may currently be marketed in the United States without further FDA
clearance.  We received FDA clearance to market our SMART DilatorTM in
February 2009, and we believe that our standard and airway bite blocks are Class
I 510(k)-exempt devices that require no preclearance from the FDA prior to
marketing.  We believe our Intraluminal Gastroplasty Device for
Obesity and GERD (the “Gastroplasty Device”), which is still in development,
will require IDE (investigational device exemption) clinical data for FDA
approval as a Class II 510k device.  We expect to commence the
necessary clinical trials for this device in 2010.  We have completed
principal development of the AMID StaplerTM, and we
expect to submit applications during the third quarter of 2009 for approval to
market the AMID StaplerTM to both
United States and European Economic Community regulatory agencies.




Critical
Accounting Policies and Estimates




The
discussion and analysis of our financial condition and results of operations set
forth below under “Results of Operations” and “Liquidity and Capital Resources”
should be read in conjunction with our financial statements and notes thereto
appearing elsewhere in this Form 10-Q.  The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities and expenses, and related disclosure of
contingent assets and liabilities.  On an on-going basis, we evaluate
our estimates, including those related to investments, including the carrying
value of our long term investments, property and equipment, contingencies and
litigation.  We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources.  A more detailed discussion on the application of these
and other accounting policies can be found in Note 2 in the Notes to the
Consolidated Financial Statements set forth in Item 8 of our Annual Report on
Form 10-K for the year ended December 31, 2008.  Actual results may
differ from these estimates.




Results
of Operations




Our
losses totaled $11.3 million for the period commencing September 15, 2005
(inception) and ended June 30, 2009.  Such losses included $1.9
million and $2.9 million for the six months ended June 30, 2009 and 2008,
respectively.  At June 30, 2009, we had an accumulated deficit of
$11.3 million.  Since we do not currently generate revenue from any of
our product candidates, including those approved for commercial marketing by the
FDA, we expect to continue to generate losses in connection with the initial
commercial launch of such FDA-approved products and the development of our other
products and technologies.  Our research and development activities
are budgeted to expand over time and will require further resources if we are to
be successful.  As a result, we believe our operating losses are
likely to be substantial over the next several years.  In January
2009, we reduced our research and development staff by five full-time employees
to reduce costs as we completed development of three products and refocused our
development efforts on our most promising product candidates.  We plan
to add to our headcount in key functional areas as required to commence
commercialization activities and further the development of our product
candidates.




Three
and Six Months ended June 30, 2009 Compared to Three and Six Months Ended June
30, 2008




Research
and development costs and expenses were $449,000 and $798,000, respectively, for
the three and six months ended June 30, 2009 as compared to $804,000 and $1.6
million, respectively, for the same periods in 2008.  These $355,000
and $820,000 respective decreases resulted primarily from the reduction in
R&D staffing discussed above and from completion of development activities
related to certain of our products.  We expect research and
development costs and expenses in 2009 to remain below 2008 levels, but such
costs and expenses should increase in 2010 and beyond as we enter into more
advanced stages of development for our Gastroplasty Device and other surgical
product candidates, including the commencement of clinical
trials.


19


General
and administrative costs and expenses were $417,000 for the three months ended
June 30, 2009, as compared to $390,000 for the three months ended June 30,
2008.  This $27,000 increase was primarily due to a $50,000 increase
in legal and professional fees, related in part to the TruePosition litigation,
partially offset by reductions in travel expenses.  General and
administrative costs and expenses were $748,000 for the six months ended June
30, 2009, as compared to $806,000 for the six months ended June 30,
2008.  This $58,000 decrease was primarily the result of $83,000 lower
stock-based compensation expense and reductions in rent and travel expense,
partially offset by increases in accounting and administrative payroll costs and
legal and professional fees.  General and administrative costs and
expenses consist primarily of salaries and other related costs, including
stock-based compensation expense.  Other general and administrative
costs and expenses include facility-related costs not otherwise included in
research and development costs and expenses, and professional fees for legal and
accounting services.  We expect that our general and administrative
costs and expenses will increase during 2009 as compared to 2008 as we commence
commercialization activities for our SMART DilatorTM and
bite block products, as well as for the AMID StaplerTM, which
we expect will be cleared for marketing before the end of
2009.  Additionally, we expect increased costs as we expand our
finance and administrative staff, add infrastructure and incur continuing costs
related to being a public company, including the costs of directors’ and
officers’ insurance, investor relations programs and increased professional
fees.




Interest
income was negligible for the three and six months ended June 30, 2009 as
compared to $7,000 and $12,000, respectively, for the comparable 2008 periods,
primarily due to lower invested cash balances resulting from the use of cash in
our operating activities.  Interest expense was $13,000 and $13,000,
respectively, for the three and six months ended June 30, 2009 as compared to
$18,000 and $24,000, respectively, for the comparable 2008 periods, due to lower
balances outstanding under the Credit Facility.  We expect interest
expense to decrease due to the repayment of balances outstanding under the
Credit Facility with the proceeds of the July 2009 issuance of Series A
Preferred Stock described below.




Liquidity
and Capital Resources




As a
result of our significant research and development expenditures and the lack,
until February 2009, of any products approved for sale, we have not been
profitable and have generated operating losses since
inception.  Additionally, in connection with our involvement as a
plaintiff in the TruePosition litigation, we spent approximately $81,000 during
the two years since the litigation began, which reduced our available cash and
will continue to do so for so long as we stay involved in the
litigation.  We do not expect to generate any meaningful revenues
before the beginning of 2010, and we expect to incur losses from operations for
the foreseeable future.  Beginning in 2010, we expect to incur
increasing research and development costs and expenses, including expenses
related to hiring new personnel and conducting clinical trials for our
Gastroplasty Device.  We expect that general and administrative costs
and expenses will also increase as we expand our finance and administrative
staff, add infrastructure and incur continuing costs related to being a public
company, including the costs of directors’ and officers’ insurance, investor
relations programs and increased professional fees.




To date,
we have funded our operations primarily with proceeds from the private placement
of stock and credit facilities available to us, including the July 2009 issuance
of Series A Preferred Stock described in Note 16 to the accompanying unaudited
condensed consolidated financial statements.  Our ability to sell
additional shares of our stock and/or borrow cash under existing or new credit
facilities could be materially adversely affected by the recent and continuing
economic turmoil in the world’s equity and credit markets.  There can
therefore be no assurance that we will be able to raise funds on acceptable
terms or at all, which may materially adversely affect our ability to continue
our operations.  Additionally, the current economic turmoil could also
reduce the demand for new and innovative medical devices, resulting in delayed
market acceptance of our product candidates.  Such delay could have a
material adverse impact on our expected cash flows, liquidity, results of
operations and financial position.  In order to address this
uncertainty, our management has taken steps to reduce our near-term cash
requirements by focusing our product development efforts primarily on the
significant product candidates, including the Gastroplasty Device and AMID
StaplerTM, which
are expected to have the most promising market potential and the shortest
remaining development time.




As a
result of these actions, our management has budgeted expenditures through June
2010 to fund the final development of the AMID StaplerTMand the
initial marketing of the AMID StaplerTMand
the three other product candidates already developed, as well as to continue
research and development of our Gastroplasty Device.  Our management
believes that our $39,000 cash balance as of June 30, 2009, the $2.0 million
gross proceeds from the July 2009 sale of Series A Preferred Stock, the
commitment from private investors for an additional $2.0 million of Series A
Preferred Stock, together with the $3.2 million availability remaining under our
Credit Facility, which expires in June 2010, will be sufficient to fund our cash
flow requirements through at least June 2010.  We have based this
estimate on assumptions that are subject to change and may prove to be wrong,
and we may be required to use our available capital resources sooner than we
currently expect.  Because of the numerous risks and uncertainties
associated with the development and commercialization of our product candidates,
we are unable to estimate the precise amounts of capital outlays and operating
expenditures associated with our current and anticipated clinical
trials.


20




Our
future capital requirements will depend on many factors, including the progress
and results of our clinical trials, the duration and cost of discovery and
preclinical development, and laboratory testing and clinical trials for our
product candidates, the timing and outcome of regulatory review of our product
candidates, the costs involved in preparing, filing, prosecuting, maintaining,
defending and enforcing patent claims and other intellectual property rights,
the number and development requirements of other product candidates that we
pursue and the costs and results of commercialization activities, including
product marketing, sales and distribution.




We will
need to finance our future cash needs through public or private equity
offerings, debt financings or corporate collaboration and licensing
arrangements.  Our Credit Facility expires in June 2010, and we are
continuing to evaluate longer-term financing alternatives.  Under the
second of the two securities purchase agreements we entered into in July 2009,
we obtained commitments from private investors to purchase from us an additional
$2 million of Series A Preferred Stock on a date selected by our Board of
Directors on or before June 30, 2010.  We may need to raise additional
funds more quickly if one or more of our budgeting assumptions prove to be
incorrect or if we choose to expand our product development efforts more rapidly
than we presently anticipate.  We may also decide to raise additional
funds before we need them if the conditions for raising capital are
favorable.  The sale of additional equity or debt securities will
likely result in dilution to our stockholders.  The incurrence of
indebtedness would result in increased fixed obligations, and the terms of such
indebtedness could include covenants restricting, among other things, our
operations, our ability to incur additional indebtedness, our ability to pay
dividends on our capital stock or our ability merge or otherwise enter into
business combination transactions.  Additional equity or debt
financing or corporate collaboration and licensing arrangements may not be
available on acceptable terms, if at all.  If adequate funds are not
available, we may be required to delay, reduce the scope of or eliminate our
research and development programs, reduce our planned commercialization efforts
or obtain funds through arrangements with collaborators or others that may
require us to relinquish rights to certain product candidates that we might
otherwise seek to develop or commercialize independently.




Item
3.  Quantitative and Qualitative Disclosures About Market
Risk.




Not
required for smaller reporting companies as defined in Rule 12b-2 of the
Exchange Act.




Item
4T.  Controls and Procedures.




We
maintain a system of disclosure controls and procedures (as defined in Exchange
Act Rule 13a-15(e)) that is designed to provide reasonable assurance that
information we are required to disclose in the reports we file or submit under
the Exchange Act is accumulated and communicated to management in a timely
manner.  Our Chief Executive Officer and Chief Financial Officer
evaluated this system of disclosure controls and procedures as of the end of the
period covered by this quarterly report, and have concluded that the system is
operating effectively to ensure appropriate disclosure.




There
were no significant changes in our internal control over financial reporting
identified in connection with the evaluation required by paragraph (d) of Rule
13a-15 of the Exchange Act that occurred during period covered by this report
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.


21




PART
II.  OTHER INFORMATION




Item
1.  Legal Proceedings.




See Note
9 to our unaudited condensed consolidated financial statements included in this
Quarterly Report on Form 10-Q for a discussion of recent material developments
related to our legal proceedings since the filing of our Annual Report on Form
10-K for the year ended December 31, 2008.




Item
1A.  Risk Factors.




Healthcare
policy changes, including pending proposals to reform the U.S. healthcare
system, may have a material adverse effect on us.




Healthcare
costs have risen significantly over the past decade. There have been and
continue to be proposals by legislators, regulators, and third-party payors to
keep these costs down. Certain proposals, if passed, may impose limitations on
the prices we will be able to charge for our products, or the amounts of
reimbursement available for our products from governmental agencies or
third-party payors. These limitations could have a material adverse effect on
our financial position and results of operations.




Recently,
President Obama and members of Congress have proposed significant reforms to the
U.S. healthcare system. Both the U.S. Senate and House of Representatives have
conducted hearings about U.S. healthcare reform. In the Obama administration’s
fiscal year 2010 federal budget proposal, the administration emphasized
maintaining patient choice, reducing inefficiencies and costs, increasing
prevention programs, increasing coverage portability and universality, improving
quality of care and maintaining fiscal sustainability. The Obama
administration’s fiscal year 2010 budget included proposals to limit Medicare
payments, reduce drug spending and increase taxes. In addition, members of
Congress have proposed a single-payer healthcare system, a government health
insurance option to compete with private plans and other expanded public
healthcare measures. Various healthcare reform proposals have also emerged at
the state level. We cannot predict what healthcare initiatives, if any, will be
implemented at the federal or state level, or the effect any future legislation
or regulation will have on us. However, an expansion in government’s role in the
U.S. healthcare industry may lower reimbursements for our products, reduce
medical procedure volumes and adversely affect our business, possibly
materially.




Except as
set forth above, there have been no material changes in our risk factors since
the filing of our Annual Report on Form 10-K for the year ended December 31,
2008.




Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds.




None.




Item
3.  Defaults Upon Senior Securities.




None.


22




Item
4.  Submission of Matters to a Vote of Security Holders.




At our
Annual Meeting of Stockholders held on June 10, 2009, our stockholders
voted to re-elect each of the Director nominees named in our Definitive Proxy
Statement on Schedule 14A as filed with the SEC on April 30,
2009.  The number of votes cast for or withheld, with respect to each
of the nominees, were as follows:




Nominee
                  
                  For
                  
                  
                  WithheldJane
      H. Hsiao, Ph.D., MBA
                  
                  
                  11,910,332
                  
                  
                  
                  13,857Jeffrey
      G. Spragens
                  
                  
                  11,843,732
                  
                  
                  
                  80,457Charles
      J. Filipi, M.D.
                  
                  
                  11,843,832
                  
                  
                  
                  80,357Kenneth
      Heithoff, M.D.
                  
                  
                  11,840,334
                  
                  
                  
                  83,855Richard
      C. Pfenniger, Jr.
                  
                  
                  11,840,234
                  
                  
                  
                  83,955Steven
      D. Rubin
                  
                  
                  11,840,134
                  
                  
                  
                  84,055Kevin
      Wayne, DBA
                  
                  
                  11,916,340
                  
                  
                  
                  7,849




No other
matters were submitted to a vote of our stockholders at the Annual
Meeting.




Item
5.  Other Information.




None.




Item
6.  Exhibits.




Exhibits:31.1
                
                Certification
      of Chief Executive Officer pursuant to Rule
      13a-14(a)/15d-14(a)31.2
                
                Certification
      of Chief Financial Officer pursuant to Rule
      13a-14(a)/15d-14(a)32.1
                
                Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 200232.2
                
                Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002




23




SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.





SAFESTITCH
      MEDICAL, INC.Date:
      August 7, 2009
                  By:
                  /s/
      Jeffrey G. SpragensJeffrey
      G. SpragensPresident
      and Chief Executive OfficerDate:
      August 7, 2009
                  By:
                  /s/
      Adam S. JacksonAdam
      S. JacksonChief
      Financial Officer




24