UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, ~~2006~~2007


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

Commission file number 000-51998

Restore Medical, Inc.

(Exact name of registrant as specified in its charter)


Delaware		41-1955715
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		~~41-1955715~~ ~~(I.R.S. Employer~~ Identification No.)

2800 Patton Road
St. Paul, Minnesota 55113
(651) 634-3111
(Address and zip code of principal executive offices and registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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. Yesþ Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one):

~~Large accelerated filer~~o

~~Accelerated filer~~o

Large accelerated filero Accelerated fileroNon-accelerated filerþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: ~~15,364,281~~15,720,091 shares of Common Stock as of July ~~31, 2006.~~30, 2007.

PART I: FINANCIAL INFORMATION

Item 1. Condensed Financial Statements (Unaudited)

RESTORE MEDICAL, INC.

Condensed Balance Sheets

(Unaudited, in thousands, except ~~per~~ share amounts)


	June 30,			December 31,			June 30,			December 31,
	2006			2005			2007			2006
Assets
Current assets:
Cash and cash equivalents	$	20,213		$	3,397		$	5,955		$	11,377
Short-term investments		9,850			248			9,581			12,463
Accounts receivable, net of allowance for doubtful accounts of $60		2,011			1,240
Accounts receivable, net of allowance for doubtful accounts of $103 and $86, respectively								764			1,262
Related-party receivables		18			28			52			33
Inventories		523			744			674			598
Prepaid expenses		447			116			357			237
Other current assets		36			54			65			10

Total current assets		33,098			5,827			17,448			25,980
Machinery and equipment, net		462			426			519			539
Deferred debt issuance costs, net of accumulated amortization of $66 and $21, respectively		308			81
Deferred offering costs		—			61
Deferred debt issuance costs, net of accumulated amortization of $189 and $108, respectively								185			246

Total assets	$	33,868		$	6,395		$	18,152		$	26,765


Liabilities, Convertible Participating Preferred Stock and Stockholders’ Equity (Deficit)
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	373		$	113		$	107		$	670
Accrued expenses		832			645			319			939
Accrued payroll and related expense		631			673			472			519
Current portion of long-term debt, net of debt discount of $37 and $22, respectively		2,040			338
Current portion of long-term debt, net of debt discount of $37 and $37, respectively								2,337			2,192

Total current liabilities		3,876			1,769			3,235			4,320
Long-term debt, net of debt discount of $55 and $44, respectively		3,919			1,619
Long-term debt, net of debt discount of $18 and $37, respectively								1,655			2,863
Other long-term liabilities		11			7			15			14
Preferred stock warrants subject to redemption		—			835

Total liabilities		7,806			4,230			4,905			7,197


Convertible participating preferred stock:
Series A, $0.01 par value: no shares authorized, issued and outstanding at June 30, 2006; 775,000 shares authorized and 750,000 shares issued and outstanding at December 31, 2005		—			747
Series B, $0.01 par value: no shares authorized, issued and outstanding at June 30, 2006; 4,500,000 shares authorized and 4,185,411 shares issued and outstanding at December 31, 2005		—			13,507
Series C, $0.01 par value: no shares authorized, issued and outstanding at June 30, 2006; 9,500,000 shares authorized and 7,615,675 shares issued and outstanding at December 31, 2005		—			18,723
Series C-1, $0.01 par value: no shares authorized, issued and outstanding at June 30, 2006; 2,940,000 shares authorized and 2,498,833 shares issued and outstanding at December 31, 2005		—			6,231

Total convertible participating preferred stock		—			39,208


Stockholders’ equity (deficit):
Preferred stock, $0.01 par value: 5,000,000 shares authorized, no shares issued and outstanding		—			—
Common stock $0.01 par value: 50,000,000 shares authorized; issued and outstanding 15,364,156 and 855,926 shares, respectively		154			9
Stockholders’ equity:
Common stock $0.01 par value: 50,000,000 shares authorized; issued and outstanding 15,720,091 and 15,534,244 shares, respectively								157			155
Additional paid-in capital		91,816			3,188			93,644			92,772
Deferred stock-based compensation		(1,749	)		(2,105	)		(941	)		(1,395	)
Accumulated other comprehensive loss		(14	)		—
Accumulated deficit		(64,145	)		(38,135	)		(79,613	)		(71,964	)

Total common stockholders’ equity (deficit)		26,062			(37,043	)
Total stockholders’ equity								13,247			19,568

Total liabilities, convertible participating preferred stock and stockholders’ equity (deficit)	$	33,868		$	6,395
Total liabilities and stockholders’ equity							$	18,152		$	26,765

RESTORE MEDICAL, INC.

Condensed Statements of Operations

(Unaudited, in thousands, except share and per share amounts)


	Three months ended						Six months ended						Three months ended						Six months ended
	June 30						June 30						June 30,						June 30,
	2006			2005			2006			2005			2007			2006			2007			2006
Net sales	$	1,810		$	1,162		$	3,562		$	2,065		$	1,036		$	1,810		$	2,160		$	3,562
Cost of sales (1)		465			354			1,055			794			276			465			544			1,055

Gross margin		1,345			808			2,507			1,271			760			1,345			1,616			2,507

Operating expenses:
Research and development (1)		807			416			1,420			935			807			807			1,859			1,420
General and administrative (1)		945			858			2,461			1,606			1,402			945			2,717			2,461
Sales and marketing (1)		2,415			1,236			4,292			2,345			2,091			2,415			4,825			4,292

Total operating expenses		4,167			2,510			8,173			4,886			4,300			4,167			9,401			8,173

Loss from operations		(2,822	)		(1,702	)		(5,666	)		(3,615	)		(3,540	)		(2,822	)		(7,785	)		(5,666	)

Other income (expense):
Interest income		202			36			230			77			233			202			517			230
Interest expense		(202	)		(7	)		(286	)		(10	)		(181	)		(202	)		(377	)		(286	)
Preferred stock warrant gain (loss)		663			(243	)		500			(417	)
Preferred stock warrant gain														—			663			—			500
Other, net		2			(2	)		11			—			(4	)		2			(4	)		11

Total other income (expense)		665			(216	)		455			(350	)
Total other income														48			665			136			455

Net loss		(2,157	)		(1,918	)		(5,211	)		(3,965	)	$	(3,492	)	$	(2,157	)	$	(7,649	)	$	(5,211	)


Deemed dividend from revision of preferred stock conversion price (note 9)		20,799			—			20,799			—			—			20,799			—			20,799

Net loss attributable to common stockholders	$	(22,956	)	$	(1,918	)	$	(26,010	)	$	(3,965	)	$	(3,492	)	$	(22,956	)	$	(7,649	)	$	(26,010	)


Basic and diluted net loss per common share before deemed dividend from revision of preferred stock conversion price	$	(0.26	)	$	(1.57	)	$	(1.08	)	$	(3.27	)	$	(0.22	)	$	(0.26	)	$	(0.48	)	$	(1.08	)
Effect of deemed dividend from revision of preferred stock conversion price		(2.48	)		—			(4.30	)		—			—			(2.48	)		—			(4.30	)

Basic and diluted net loss per common share	$	(2.74	)	$	(1.57	)	$	(5.38	)	$	(3.27	)	$	(0.22	)	$	(2.74	)	$	(0.48	)	$	(5.38	)


Basic and diluted weighted average common shares outstanding		8,365,137			1,218,224			4,831,015			1,212,748			16,083,264			8,365,137			16,027,914			4,831,015

(1) Includes stock-based compensation of:
Cost of sales	$	17		$	3		$	25		$	5		$	28		$	17		$	51		$	25
Research and development		32			1			55			2			54			32			76			55
General and administrative		261			193			546			270			378			261			843			546
Sales and marketing		69			8			98			14			64			69			158			98

	$	379		$	205		$	724		$	291		$	524		$	379		$	1,128		$	724

RESTORE MEDICAL, INC.

Condensed Statements of Cash Flows

(~~In thousands, unaudited)~~Unaudited, in thousands)


	Six months ended June 30						Six months ended June 30,
	2006			2005			2007			2006
Cash flows from operating activities:
Net loss	$	(5,211	)	$	(3,965	)	$	(7,649	)	$	(5,211	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		92			68			115			92
Stock-based compensation		724			291			1,128			724
Preferred stock warrant (gain) loss		(500	)		417
Preferred stock warrant loss								—			(500	)
Bad debt expense		—			5			75			—
Non-cash interest expense		60			7			79			60
Change in operating assets and liabilities:
Trade receivables		(771	)		(431	)		423			(771	)
Related-party receivables		10			71			(19	)		10
Inventories		221			(300	)		(76	)		221
Prepaid expenses		(331	)		(44	)		(120	)		(331	)
Other current assets		18			2			(55	)		18
Accounts payable		260			88			(563	)		260
Accrued expenses		187			(26	)		(620	)		187
Accrued payroll and related expenses		(42	)		252			(47	)		(42	)
Other long-term liabilities		4			—			1			4

Net cash used in operating activities		(5,279	)		(3,565	)		(7,328	)		(5,279	)

Cash flows from investing activities:
Maturities of short-term investments		1,047			4,783			41,607			1,047
Purchase of short-term investments		(10,663	)		(9	)		(38,725	)		(10,663	)
Purchases of machinery and equipment		(96	)		(94	)		(95	)		(96	)

Net cash provided by (used in) investing activities		(9,712	)		4,680			2,787			(9,712	)

Cash flows from financing activities:
Proceeds from issuance of long-term debt		4,000			—			—			4,000
Decrease in deferred offering costs		61			—			—			61
Repayments on long-term debt								(1,059	)		—
Capital lease payments		(4	)		—			(20	)		(4	)
Proceeds from stock options exercised		69			22			198			69
Net proceeds from initial public offering		27,681			—			—			27,681

Net cash provided by financing activities		31,807			22
Net cash (used in) provided by financing activities								(881	)		31,807

Net increase in cash and cash equivalents		16,816			1,137
Net (decrease) increase in cash and cash equivalents								(5,422	)		16,816
Cash and cash equivalents:
Beginning of period		3,397			2,258			11,377			3,397

End of period	$	20,213		$	3,395		$	5,955		$	20,213

Supplemental disclosure:
Interest paid	$	225		$	2		$	298		$	225
Non-cash investing and financing activities:
Value of common stock warrants issued with debt	$	273		$	—			—		$	273
Capital lease financing	$	33		$	—			—		$	33
Deemed dividend from revision of preferred stock conversion price	$	20,799		$	—			—		$	20,799

RESTORE MEDICAL, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

~~(unaudited)~~(Unaudited, in thousands, except share and per share amounts)

(1)		Nature of Business

		Restore Medical, Inc. (hereinafter “we,” “us” or the “Company”) develops and markets medical devices designed to treat sleep ~~breathing disorders.~~disordered breathing. In December 2002, we received Food and Drug Administration (FDA) 510(k) clearance to market and sell the Pillarâ palatal implant system (Pillar System) in the United States for the treatment of snoring. We received 510(k) clearance from the FDA in July 2004 to market and sell our Pillar System in the United States for mild to moderate obstructive sleep apnea (OSA). We received CE Mark certification to market and sell our Pillar System in Europe for snoring in May 2003 and for mild to moderate OSA in December 2004. ~~International sales of~~We market and sell our ~~products are subject to regulatory requirements that vary widely from country to country. The Company markets and sells its~~ products domestically through a direct sales force and internationally through independent distributors.

(2)		Basis of Presentation

		In the opinion of management, the accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and reflect all adjustments, consisting solely of normal recurring adjustments, needed to fairly present the financial results for these interim periods. These condensed financial statements include some amounts that are based on management’s best estimates and judgments. These estimates may be adjusted as more information becomes available, and any adjustment could be significant. The impact of any change in estimates is included in the determination of earnings in the period in which the change in estimate is identified. The results of operations for the ~~second quarter~~three and six months ended June 30, ~~2006,~~2007, are not necessarily indicative of the results that may be expected for the entire ~~2006~~2007 fiscal year.

		According to the rules and regulations of the United States Securities and Exchange Commission, we have omitted footnote disclosures that would substantially duplicate the disclosures contained in our audited financial statements. These unaudited condensed financial statements should be read together with the financial statements for the year ended December 31, ~~2005,~~2006, and footnotes thereto included in our Annual Report on Form ~~S-1, Registration Statement No. 333-132368,~~10-K, filed ~~May 12, 2006~~February 28, 2007, with the United States Securities and Exchange Commission.

(3)		Stock Options and Accounting for Stock-Based Compensation

		The Company has adopted the Restore Medical, Inc. 1999 Omnibus Stock Plan (the Plan) that includes both incentive stock options and nonqualified stock options to be granted to employees, officers, consultants, independent contractors, directors and affiliates of the Company. Incentive stock options must be granted at an exercise price not less than the fair market value of the common stock on the grant date. The options granted to participants owning more than 10% of the Company’s outstanding voting stock must be granted at an exercise price not less than 110% of fair market value of the common stock on the grant date. Options expire ten years from the date of grant and typically vest 25% after the first year of service with the remaining vesting 1/36th each month thereafter.

RESTORE MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
~~(unaudited)~~

(Unaudited, in thousands, except share and per share amounts)

Stock option activity was as follows:

Shares Shares Weighted Average
Available for Under Exercise Price
Grant Options Per Share
Balance, December 31, 2005 426,206 1,405,612 $ 1.09
Authorized 1,387,500 — —
Granted (1,019,700 ) 1,019,700 8.00
Exercised — (65,645 ) (1.05 )
Cancelled 36,519 (36,519 ) (2.06 )

Balance, June 30, 2006 830,525 2,323,148 $ 4.11

Exercisable as of June 30, 2006 752,677 $ 1.08


									Weighted
									Average
				Shares			Weighted Average		Remaining
	Shares Available			Under			Exercise Price		Contractual Life
	for Grant			Options			Per Share		in Years
Balance, December 31, 2006		588,407			2,399,306		$	4.17		8.4
Granted		(818,270	)		818,270			3.62		9.7
Exercised		—			(178,930	)		1.10
Cancelled		556,009			(556,009	)		6.57

Balance, June 30, 2007		326,146			2,482,637		$	3.67		8.4


Exercisable as of June 30, 2007					945,669		$	3.23		7.3

The following table summarizes information ~~about~~for unvested stock options ~~outstanding, vested and exercisable at~~for the six months ended June 30, ~~2006:~~2007:

Weighted
average
remaining Number
Number contractual vested and
Exercise price outstanding life in years exercisable
$0.40 19,500 3.7 19,500
1.00 1,283,948 7.9 733,177
8.00 1,019,700 9.9 —

2,323,148 8.7 752,677


				Weighted average
				grant date fair
	Shares			value per share
Non-vested at January 1, 2007		1,690,268		$	3.85
Granted		818,270			2.37
Vested		(417,863	)		3.07
Forfeited		(553,707	)		4.52

Non-vested at June 30, 2007		1,536,968		$	3.09

On January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R),Share Based Payment(SFAS 123(R)) prospectively to new awards and to awards modified, repurchased or cancelled after December 31, 2005. Prior to the adoption of SFAS 123(R), we used the ~~minimum-value~~minimum value method of measuring equity share options for the pro forma disclosure under SFAS 123. We will continue to apply the intrinsic-value method for awards granted prior to the adoption of SFAS 123(R). ~~The Company’s financial statements as of and for the six months ended June 30, 2006 reflect the impact of SFAS 123(R).~~

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. Since we ~~are a newly public entity with no~~have limited historical data on the volatility of our stock as a public company, the expected volatility is based on volatility of similar entities (referred to as guideline companies). In evaluating similarity, we considered factors such as industry, stage of life cycle, size and financial leverage. The expected term of options granted is determined using the “shortcut” method allowed by SAB 107. Under this approach, the expected term is presumed to be the mid-point between the vesting date and the end of the contractual term. The shortcut approach is not permitted for options granted, modified or settled after December 31, 2007. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. We have never declared or paid any cash dividends and do not presently plan to pay cash dividends in the foreseeable future. We use historical termination behavior to support estimated forfeiture rates. In addition, SFAS 123(R) requires us to reflect the benefits ~~of tax~~

RESTORE MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
~~(unaudited)~~(Unaudited, in thousands, except share and per share amounts)

		unrecognized incremental fair value of $107 will be recognized as compensation expense over the weighted average remaining vesting period of 3.1 years.

		On March 6, 2007, the Company granted a total of 23,070 options to purchase common stock to two consultants. The terms of the agreements were consistent with employee stock options, except that the vesting provision provided for immediate vesting of all options on the date of grant. The Black-Scholes option-pricing model was utilized and the assumptions were the same as stated in the table above for employees, except that an option life of ten years was utilized, which is the contractual term of the options. The total compensation expense of $64 for these two grants was recognized in March 2007.

(4)		Net Loss per Share

		Basic net loss per common share (Basic EPS) is computed by dividing net loss by the weighted average number of common shares outstanding. Diluted net loss per common share (Diluted EPS) is computed by dividing net loss by the weighted average number of common shares and dilutive potential common shares outstanding. Potential common shares consist of shares issuable upon the exercise of stock options and warrants. Diluted EPS is identical to Basic EPS since potential common shares are excluded from the calculation, as their effect is anti-dilutive. The weighted average shares outstanding for basic and diluted loss per share includes 378,122 shares of common stock underlying warrants to purchase common stock as such warrants are immediately exercisable and have an exercise price of $0.02 per share. The common stock underlying the warrants is considered outstanding in substance for EPS purposes. Historical outstanding potential common shares not included in diluted net loss per share attributable to common stockholders were ~~2,748,190 and 11,759,582~~2,810,213 for the three and six months ended June 30, 2007 and 2,748,190 for the three and six months ended June 30, 2006.

		Net loss per share for the three and six months ended June 30, 2007 and 2006 ~~and 2005, respectively.~~is based on the weighted average shares outstanding as summarized in the following table:


	Three months ended June 30						Six months ended June 30						Three months ended June 30						Six months ended June 30
	2006			2005			2006			2005
Net loss attributable to common stockholders	$	(22,956	)	$	(1,918	)	$	(26,010	)	$	(3,965	)
													2007			2006			2007			2006
Weighted average common shares and equivalents outstanding:
Common shares outstanding		7,987,015			840,102			4,452,893			834,626			15,705,142			7,987,015			15,649,792			4,452,893
Warrants issued at a nominal exercise price		378,122			378,122			378,122			378,122			378,122			378,122			378,122			378,122

Weighted average shares outstanding — basic and diluted		8,365,137			1,218,224			4,831,015			1,212,748			16,083,264			8,365,137			16,027,914			4,831,015



Net loss per share — basic and diluted	$	(2.74	)	$	(1.57	)	$	(5.38	)	$	(3.27	)	$	(0.22	)	$	(2.74	)	$	(0.48	)	$	(5.38	)

RESTORE MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
~~(unaudited)~~(Unaudited, in thousands, except share and per share amounts)

(6)		~~Comprehensive Loss~~

		~~Comprehensive loss consists solely of unrecognized losses on investments. Comprehensive loss for the three and six months ended June 30, 2006 and 2005 are as follows (in thousands):~~

Three months ended June 30 Six months ended June 30
2006 2005 2006 2005
Net loss $ (2,157 ) $ (1,918 ) $ (5,211 ) $ (3,965 )
Change in unrealized loss on investments (14 ) — (14 ) —

Comprehensive loss $ (2,171 ) $ (1,918 ) $ (5,225 ) $ (3,965 )


~~(7)~~		Inventories

		We state our inventories at the lower of cost or market, ~~computed on a standard cost basis, with market being~~using the first-in, first-out method. Market is determined as the lower of replacement cost or net realizable value. ~~Standard costs are monitored on a quarterly basis and updated as necessary to reflect changes in raw material costs and labor and overhead rates.~~ Inventory write-downs are established when conditions indicate that the selling price could be less than cost due to physical deterioration, usage, obsolescence, reductions in estimated future demand and reductions in selling prices. Costs associated with excess capacity are charged to earnings as incurred. Inventory write-downs are measured as the difference between the cost of inventory and estimated realizable value. Inventories at June 30, ~~2006~~2007 and December 31, ~~2005~~2006 were as ~~follows (in thousands):~~follows:

June 30, December 31,
2006 2005
Raw Materials $ 70 $ 113
Work In Process 268 372
Finished Goods 185 259

$ 523 $ 744

~~RESTORE MEDICAL, INC.~~
~~NOTES TO CONDENSED FINANCIAL STATEMENTS~~
~~(unaudited)~~


	June 30,		December 31,
	2007		2006
Raw Materials	$	38	$	57
Work In Process		343		320
Finished Goods		293		221

	$	674	$	598

~~(8) Long-Term Debt~~

(7)		Long-Term Debt

		Long-term debt consisted of the following as of June 30, 2007 and December 31, 2006:

~~Long-term debt consists of the following as of June 30, 2006 and December 31, 2005 (in thousands):~~


	June 30,			December 31,			June 30,			December 31,
	2006			2005			2007			2006
Term loan (interest at prime plus 3% maturing December 2008), net of $55 debt discount at June 30, 2006 and $44 at December 31, 2005	$	5,908		$	1,933
Term loan (interest at prime plus 3% maturing December 2008), net of debt discount of $55 and $74 , respectively							$	3,881		$	4,930
Capital lease for equipment (interest at 9.35%, monthly payments maturing September 2009)		21			24			15			18
Capital lease for leasehold improvements (interest at 14.33%, monthly payments maturing March 2010)		30			—			24			27
Capital lease for equipment (interest at 12.14%, monthly payments maturing July 2011)								72			80

		5,959			1,957			3,992			5,055

Less current portion, net of debt discount of $37 at June 30, 2006 and $22 at December 31, 2005		(2,040	)		(338	)
Less current portion, net of debt discount of $37 and $37, respectively								(2,337	)		(2,192	)

Total long-term debt	$	3,919		$	1,619		$	1,655		$	2,863

RESTORE MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited, in thousands, except share and per share amounts)


(8)		Significant Customers

		The following table summarizes the number of customers who individually comprise greater than 10% of total net sales and their aggregate percentage of the Company’s total net sales for the three and six months ended:


	Three months ended						Six months ended
	June 30,						June 30,
	2007			2006			2007			2006
Number of customers		1			2			1			—
Percent of total net sales		20	%		24	%		23	%		n/a

The following table summarizes the number of customers who individually comprise greater than 10% of total net accounts receivables and their aggregate percentage of the Company’s total net accounts receivables:


	Number of		Percent of total
	customers		net receivables
June 30, 2007		1		30	%
December 31, 2006		2		26	%

(9)		Stockholders’ Equity (Deficit)

		On May 12, 2006, the Board of Directors approved a one-for-two reverse split of our issued or outstanding shares of common stock and preferred stock. All issued or outstanding common stock, preferred stock and per share amounts contained in the financial statements have been retroactively adjusted to reflect this reverse stock split.

		~~On May~~ 22, 2006, we sold ~~4,000,000~~4 million shares of common stock in ~~an initial public offering (IPO)~~our IPO for aggregate gross proceeds of ~~$32.0 million.~~$32,000. After deducting the underwriters’ commissions and discounts, and offering costs, we received net proceeds of approximately ~~$27.7 million.~~$27,700.

		Prior to the completion of the IPO, we amended our Certificate of Incorporation to change the conversion price of the Series C and Series C-1 preferred stock from $5.24 per share to $3.48 per share (on a post-split basis). This change in conversion price was effective immediately prior to the conversion of all outstanding shares of our preferred stock upon the completion of our IPO, and was in consideration for a modification of the definition of a “qualified” offering such that our IPO ~~triggered~~trigged the mandatory conversion of our preferred stock into common stock. As a result of this change in the conversion price of Series C and Series C-1 preferred stock, the common stock outstanding upon completion of our IPO increased by 2,679,783 shares, including 122,091 common shares issuable pursuant to the Series C-1 preferred stock warrants. For purposes of calculating net loss per share in the period in which the ~~IPO~~initial public offering was completed, net income available to common stockholders ~~has been~~was reduced by ~~$20.8 million~~$20,799 for the fair value of the additional common shares as a result of the change in the Series C and Series C-1 preferred stock conversion price. Upon completion of the IPO, all outstanding Series A, B, C and C-1 preferred stock automatically converted into 10,395,288 shares of common stock at the then current conversion prices.

(10)		Adoption of New Accounting Pronouncement

		In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainties in income taxes recognized in a company’s financial statements in accordance with Statement 109 and prescribes a recognition threshold and measurement attributable for financial disclosure of tax positions taken or expected to be taken on a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted the provisions of FIN 48 as of January 1, 2007. The adoption of FIN 48 did not impact our financial position, results of operations or cash flows for the three and six months ended June 30, 2007.

RESTORE MEDICAL, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
~~AND~~ RESULTS OF OPERATIONS
~~(unaudited)~~(Unaudited)

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

Overview

We develop, manufacture and market our proprietary and patented Pillar^® palatal implant system or(“Pillar System”). The Pillar System anis a simple, innovative, ~~minimally-invasive,~~minimally invasive, implantable medical device used to treat sleep disordered breathing, which includes mild to moderate obstructive sleep apnea, or OSA, and habitual or socially disruptive snoring. During the Pillar Procedureâ^®, a physician implants three small, braided, proprietary polyester inserts into the muscle of the soft palate. These Pillar inserts, together with the body’s natural fibrotic response to the implanted Pillar inserts, add structural support and stiffen the soft palate, thereby minimizing or eliminating the palatal tissue vibration that can cause snoring and the collapse that can obstruct the upper airway and cause OSA. We ~~currently market and sell our Pillar System to otolaryngologists (ear, nose and throat physicians, or ENTs) and to a limited number of oral maxillofacial surgeons. We~~ believe the Pillar Procedure is a safe, clinically effective, long-lasting and low-risk procedure with minimal pain or complications that offers significant benefits to both patients and physicians over other available treatment ~~options for snoring and mild to moderate OSA.~~options.

Our Pillar System was cleared by the United States Food and Drug Administration, or FDA, for snoring in December 2002 and for mild to moderate OSA in July 2004. Our Pillar System received CE Mark certification for both snoring and mild to moderate OSA from the European Commission in May 2003 and December 2004, respectively.

We currently market and sell our Pillar System to otolaryngologists (ear, nose and throat physicians) and to a limited number of oral maxillofacial surgeons. We employ a direct sales force in the United States currently consisting of 16 sales representatives and 3 regional sales directors, and market our products in 30 countries outside the United States through 21 independent distributors. We expect to continue and potentially increase our investment in marketing and sales activities, as well as research and development activities, which will be primarily funded with our current available cash. With our plans to continue to expand our commercialization activities, we expect to continue to incur net losses through at least 2008.

Application of Critical Accounting Policies and Use of Estimates

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The application of GAAP requires that we make estimates that affect our 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 revenue and expenses during the reporting period. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ significantly from these estimates.

~~Revenue Recognition~~

~~We generate revenue from sales~~A description of ~~our Pillar System to physician customers~~the Company’s critical accounting policies that represent the more significant judgments and estimates used in the ~~U.S. and third-party distributors internationally. We generally have not sold our Pillar System to hospitals or healthcare institutions, although such sales may occur~~preparation of the Company’s financial statements was provided in the ~~future.~~

~~Revenue is recognized when evidence~~Management’s Discussion and Analysis of ~~an arrangement exists, delivery to the customer has occurred, the selling price is fixed or determinable,~~Financial Condition and ~~collectability is reasonably assured. For physician customers in the U.S., the evidence~~Results of an arrangement generally consists of a verbal phone order as their normal business practices do not require a purchase order. Our international distributors place orders pursuant to a distribution agreement. The price for each sale is fixed and agreed with the customer prior to shipment and is based on established list prices. Sales to our international distributors are made according to the contractual terms of each individual distribution agreement. Revenue for all domestic and international sales is recognized upon shipment of product from our facility when title passes to the customer. As noted below, we have, on a customer-by-customer basis, granted payment terms in excess of those specified in our international distribution agreements.

A provision for estimated sales returns on domestic product sales is recorded in the same period as the related revenue is recorded. The provision for estimated sales returns, if any, is based on an analysis of historical sales

~~RESTORE MEDICAL, INC.~~
~~MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION~~
~~AND RESULTS OF OPERATIONS~~
~~(unaudited)~~

returns as adjusted for specifically identified estimated changes in historical return activity. Sales terms to our international distributors do not contain a right to return product purchased from us.

In the U.S., as part of introducing our Pillar System to potential new physician customers, we offer physicians the opportunity to participate in our “practice introduction program,” or PI program, in which they can treat up to three patients using Pillar Systems that we provide at no charge to the physician. The costs associated with providing these Pillar Systems to U.S. physicians under our PI program are accounted for as a sales and marketing expense at the time of each practice introduction. During 2005, our international distributors were offered the opportunity to participate in an international PI program whereby we would provide marketing support payments for practice introductions conducted by the distributor. The support payments made to each distributor who participated in our 2005 international PI program were accounted for as a reduction of revenue to that distributor. During the first quarter of 2006, we amended substantially all of our international distribution agreements to change the structure of our international PI program. Under the modified program, we provide our international distributors with free product to undertake a PI program with physician customers in their respective territories rather than provide our international distributors with a marketing support payment for practice introductions performed. The free product that we provide is recorded as a cost of sales.

Our standard payment terms for customers are net 30 to 60 days in the United States and net 90 days internationally. If we determine the facts and circumstances surrounding a customer’s order justify alternative payment terms, we may grant extended payment terms on a customer-by-customer basis.

Collectability is evaluated prior to shipment. Our customers typically are physicians, clinics and distributors, and are generally deemed creditworthy; however, if we have collection concerns, we will require prepaymentOperations section of the ~~order.~~

~~Allowance~~Company’s Annual Report on Form 10-K for ~~Doubtful Accounts~~

~~In estimating~~ the collectability of our accounts receivable, we analyze historical bad debts, customer concentrations, customer credit-worthiness, current economic trends, and changes in customer payment terms. In the normal course of our business, many of our international distributors pay us after their scheduled payment due date. In addition, on a case-by-case basis, we have allowed certain of our international distributors to extend the time of payment beyond their scheduled payment due date, or to make periodic partial payments of past-due amounts owing to us. We make adjustments to our allowance for doubtful accounts in the period when the net revenues are recognized based on anticipated future events. If there are unanticipated future events, this allowance may need to be adjusted. On a monthly basis, we determine the amount of this reserve based on a review of slow-paying accounts, as well as accounts with changed circumstances indicating that the balances due and owing to us are unlikely to be collectible.

~~Accounting for Income Taxes~~

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a full valuation allowance on our net deferred tax assets as of June 30, 2006 andyear ended December 31, 2005, respectively, due to uncertainties related to our ability to utilize our deferred tax assets in the foreseeable future. These deferred tax assets primarily consist of certain net operating loss carry forwards and research and development tax credits.2006.

RESTORE MEDICAL, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
~~AND~~ RESULTS OF OPERATIONS
~~(unaudited)~~

~~Stock-Based Compensation~~

Prior to the adoption of SFAS No. 123(R) on January 1, 2006, we measured compensation costs for options issued or modified under our stock-based compensation plans using the intrinsic-value method of accounting. Under the intrinsic-value method, we recorded deferred compensation expense within stockholders’ deficit for stock options awarded to employees and directors to the extent that the option exercise price was less than the fair market value of common stock on the date of grant. Recorded deferred compensation was amortized to compensation expense on a straight-line basis over the vesting period of the underlying stock option grants.

Under GAAP, companies are permitted to use an alternative method of valuing stock options which is based on the fair value of the stock option on the date of grant. This fair value method generally results in the recording of a greater expense related to stock options. On January 1, 2006, we adopted the fair value recognition provisions of SFAS 123(R). We will apply the provisions of SFAS 123(R) to new stock option grants and to stock option grants that are modified, repurchased, or cancelled after December 31, 2005 using the prospective method of transition. We will continue to apply the intrinsic-value method to determine compensation expense for stock options granted prior to the adoption of SFAS 123(R).

Determining the appropriate fair value model and calculating the fair value of share-based payment awards requires the input of highly subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. We use the Black-Scholes model to value our stock option awards. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and management uses different assumptions, share-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected term and forfeiture rate, and only recognize expense for those shares expected to vest. If the actual forfeiture rate is materially different from the estimate, share-based compensation expense could be significantly different from what has been recorded in the current period.

As of June 30, 2006, we had outstanding stock options to acquire an aggregate of 2,323,148 shares of common stock. Of those outstanding common stock options, 752,677 shares had vested as of June 30, 2006, and 1,570,471 shares were unvested.

~~RESTORE MEDICAL, INC.~~
~~MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION~~
~~AND RESULTS OF OPERATIONS~~
~~(unaudited)~~(Unaudited)

Results of Operations (in thousands, except for average selling price)

Comparison of the Three and Six ~~-Month Periods~~Months Ended June 30, ~~2006~~2007 and ~~2005~~2006

Net Sales.Net sales ~~increased by $648,000, or 56%, to $1,810,000~~ for the ~~three months ended June 30, 2006 from $1,162,000 in the same period in 2005. Net sales increased by $1,497,000, or 72%, to $3,562,000 for the~~quarter and six months ended June 30, ~~2006~~2007 were $1,036 and $2,160, which was a decrease of $774 (43%) and $1,402 (39%), respectively, from ~~$2,065,000~~the comparable periods in the same period in 2005. The increase in net sales during the first six months of 2006 was attributable to the increased sale of our Pillar Systems, both in the United States and international markets.2006.

The following table summarizes the geographic dispersion of the Company’s ~~revenue (in thousands):~~revenue:


	Three months ended June 30				Six months ended June 30				Three months ended June 30,				Six months ended June 30,
	2006		2005		2006		2005		2007		2006		2007		2006
United States	$	1,399	$	836	$	2,552	$	1,585	$	950	$	1,399	$	1,963	$	2,552
Asia Pacific		158		236		649		384		39		158		39		649
Europe		158		20		253		26		10		158		95		253
Middle East		41		36		52		36
South America		26		—		26		—
South Africa		28		34		30		34
All other markets										37		95		63		108

	$	1,810	$	1,162	$	3,562	$	2,065	$	1,036	$	1,810	$	2,160	$	3,562

Net sales in the United States ~~increased~~for the quarter and six months ended June 30, 2007 were $950 and $1,963, which was a decrease of $449 (32%) and $589 (23%), respectively, from the comparable periods in 2006. The decrease in domestic sales from the comparable periods in 2006 is due to the disruption caused by ~~$563,000, or 67%,~~the restructuring of our sales organization and implementation of the sales and marketing strategies required to ~~$1,399,000~~support our new integrated consultative sales approach that we initiated in the ~~second~~fourth quarter of 2006 compared to $836,000 in the second quarter of 2005. Net sales in the United States increased by $967,000, or 61%, to $2,552,000 in the first six months of 2006 compared to $1,585,000 in the first six months of 2005. The growth in United States net sales during 2006 was primarily due to a larger number of physicians performing the Pillar Procedure, resulting in increased shipments of our Pillar System.2006. The United States average selling price for the three Pillar ~~Systems~~inserts used in each Pillar Procedure ~~increased from~~was approximately ~~$620 in the first six months of 2005 to~~ $690 in the first six months of each of 2006 ~~due to a price increase initiated in October 2004 that resulted in a gradual increase to the new price level for existing customers.~~and 2007.

Net sales internationally ~~increased by $85,000 to $411,000 in~~for the ~~second~~ quarter of 2006 compared to $326,000 in the second quarter of 2005. Net sales internationally increased by $530,000 to $1,010,000 in the first six months of 2006 compared to $480,000 in the first six months of 2005. We commercially introduced our Pillar System into international markets beginning in January 2005 through independent third-party distributors. The increase in sales in both the three and six month periods of 2006 compared to 2005 was due primarily to sales to new third-party distributors. In addition, we recorded a $57,000 reduction in our sales reserve in the first six months of 2006 compared to an increase in the sales reserve of $45,000 in the first six months of 2005. The reduction to the sales reserve in the first six months of 2006 was due to a change we made in the terms of our international distributor agreements related to how we provide Pillar Systems to our international distributors for new practice introductions. As a result of the market development investment and distribution costs incurred by our international third-party distributors, our international average selling price typically is approximately 50% of our domestic average selling price.

~~RESTORE MEDICAL, INC.~~
~~MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION~~
~~AND RESULTS OF OPERATIONS~~
~~(unaudited)~~

~~our distributors purchase Pillar Systems from us on a quarterly basis to minimize international freight charges and product importation fees.~~

~~Our two largest distributors accounted for 50%, or $505,000, of our international sales in the~~ six months ended June 30, 2007 were $86 and $197, respectively, compared to $411 and $1,010, respectively, for the comparable periods in 2006. ~~One of these distributors accounted for 38%, or $158,000, of our~~The decrease in international sales inwas primarily due to lower sales to our two largest distributors covering the ~~three months ended June 30, 2006. The other distributor did not order product from us, nor did we ship product~~majority of the Asia Pacific market. Due to ~~them during the three months ended June 30, 2006. Following our periodic business plan reviews with~~current inventory levels at these two distributors ~~in July 2006, we concluded the Pillar System inventory levels at each of these distributors increased in the first half of 2006 as a result of~~resulting from delays in planned market launches, execution of certain market development activities and obtaining a required government pricing approval for the Pillar System in a key market. While our agreements with these two distributors include minimum quarterly purchase requirements, based on our assessment of current inventory levels, the expected timing of each distributor’s planned market, ~~development activities and estimated sales,~~ we dodid not ~~expect to~~ receive orders from either of these two distributors in the ~~third quarter~~first half of ~~2006, and as a result, international sales are expected~~2007. The agreement with our distributor covering China expired pursuant to ~~decrease in~~ the ~~third quarter as compared to~~original term during the second quarter of ~~2006. Orders from either distributor~~2007. Due to a change in the distributor’s organizational structure and business focus, the distribution agreement has not been renewed. We are currently evaluating alternatives for the distribution of our product in China. Additionally, we made a decision in the fourth quarter ~~will depend upon~~of 2006 to focus on our higher margin U.S. business and to significantly decrease the ~~results~~near-term investment in our international business. The combination of these factors contributed to decreased net sales in the quarter and six months ended June 30, 2007 compared to the same periods in 2006. Our independent distributors purchase our Pillar System from us at a discount to our U.S. list price for resale; the end-user price of our Pillar System in each ~~distributor’s market development~~country is determined by the distributor and ~~sales activities.~~varies from country to country.

Cost of sales and gross margin.Our cost of sales consists primarily of material, labor and manufacturing overhead expenses. Cost of sales also includes warranty expenses, as well as salaries and personnel-related expenses, including stock-based compensation, for our operations management team and quality control. Cost of sales ~~increased by $111,000, or 31%~~were $276 and $544, respectively, for the quarter and six months ended June 30, 2007

RESTORE MEDICAL, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Unaudited)

which was a decrease of $189 (41%) and $511 (48%), ~~to $465,000~~respectively, from the comparable periods in ~~the second quarter of 2006 from $354,000~~2006. The decrease in ~~the second quarter of 2005. As a percentage of net sales,~~ cost of sales ~~decreased to 26% in the second quarter~~was primarily a result of ~~2006 from 30% in the second quarter of 2005.~~lower product sales. As a percentage of net sales, gross margin ~~improved~~remained relatively consistent at 73% and 75%, respectively, for the quarter and six months ended June 30, 2007, compared to 74% and 70%, respectively, for the same periods in the second quarter of 2006 from 70% in the second quarter of 2005. Cost of sales increased by $261,000, or 33%, to $1,055,000 in the first six months of 2006 from $794,000 in the comparable period in 2005. As a percentage of net sales, cost of sales decreased to 30% in the first six months of 2006 from 38% in the first six months of 2005. As a percentage of net sales, gross margin improved to 70% in the first six months of 2006 from 62% in the first six months of 2005. The increase in cost of sales in both the three and six month periods ending June 30, 2006 was due to the increase in the number of our Pillar Systems sold. The improvement in the gross margin percent in both the three and six month periods ending June 30, 2006 was the result of significant reductions in the cost of our Pillar System following our launch of a redesigned second generation delivery system in May 2005, as well as increased volume-related production efficiencies. We expect that increased production volumes will result in further gross margin improvement due to the leverage gained from economies of scale.2006.

Research and development expenses. Our research and development expenses consist of salaries and other personnel-related expenses, including stock-based compensation, for employees engaged in research, development and engineering activities and materials used and other overhead expenses incurred in connection with the design and development of our products. Research and development expenses remained relatively consistent at $807 for the quarter ended June 30, 2007 as compared to $807 for the comparable period in 2006, and increased by ~~$391,000, or 94%,~~$439 (31%) to $807,000 in the second quarter of 2006 from $416,000 in the second quarter of 2005. The increase in expenses was primarily attributable to $178,000 of expenses related to additional clinical studies, increased compensation expense of $78,000 due primarily to the hiring of our Vice President of Research and Development in the fourth quarter of 2005 and an increase in stock-based compensation of $31,000 over the same period in the prior year. Research and development expenses increased by $485,000, or 52%, to $1,420,000 in$1,859 for the six months ended June 30, ~~2006~~2007 from ~~$935,000 in~~ the comparable period in ~~2005. This~~2006. The increase in expenses for the first six months of 2007 was primarily attributable to ~~$260,000 of expenses related to additional clinical studies,~~ increased compensation expense of ~~$145,000 due primarily~~$379 related to additional hiring within both our research and clinical departments in the ~~hiring~~third and fourth quarters of ~~our Vice President of Research and Development noted above~~2006, and an increase in ~~stock-based compensation~~consulting fees of ~~$53,000~~$56 over the same period in the prior year. In future quarters, we

~~RESTORE MEDICAL, INC.~~
~~MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION~~
~~AND RESULTS OF OPERATIONS~~
~~(unaudited)~~

expect research and development expenditures will increase as ~~we initiate~~our new product development projects progress, we undertake additional post-market clinical studies of the Pillar Procedure and we begin clinical ~~studies~~trials of new products.

General and administrative expenses.Our general and administrative expenses consist primarily of salaries and other personnel-related expenses, including stock-based compensation for executive, accounting and administrative personnel, professional service fees and other general corporate expenses. General and administrative expenses ~~increased by $87,000, or 10%, to $945,000~~were $1,402 and $2,717, respectively, for the ~~three~~quarter and six months ended June 30, ~~2006~~2007, which was an increase of $457 (48%) and $256 (10%), respectively, from ~~$858,000~~the comparable periods in 2006. The increase in expenses for the ~~three months ended June 30, 2005.~~quarter was mainly due to an increase in stock-based compensation expense of $117, combined professional and investor relation fees of $153 and professional liability insurance of $32. The increase isin expenses for the six-month period was due primarily to an increase of ~~$100,000 in audit~~stock-based compensation expense of $297, combined with investor relations and professional ~~fees~~liability insurance of $198 and ~~$68,000 in stock-based compensation~~ offset by ~~a reduction~~decreases in ~~wages~~professional service fees of ~~$96,000 due to severance expenses included in the second quarter of 2005. General and administrative expenses increased by $855,000, or 53%, to $2,461,000 for the six months ended June 30, 2006~~$398 mainly from ~~$1,606,000 for the six months ended June 30, 2005. The increase is due to an increase of $604,000 in audit and professional~~ fees we incurred during ~~the first six months of~~ 2006 in connection with our initial public offering. In addition, stock-based compensation increased by $276,000 in the first six months of 2006 compared to the same period in 2005. The increase in stock-based compensation included $191,000 of expense related to the separation agreement with our former Vice President of Finance.IPO.

Sales and marketing expenses.Our sales and marketing expenses consist primarily of salaries, commissions and other personnel-related expenses, including stock-based compensation, for employees engaged in sales, marketing and support of our products, trade show, co-marketing, promotional and public relations expenses and management and administration expenses in support of sales and marketing. Sales and marketing expenses ~~increased by $1,179,000, or 95%, to $2,415,000~~were $2,091 and $4,825, respectively, for the three months ended June 30, 2006 from $1,236,000 for the comparable period in 2005. This increase was attributable to additional compensation expenses of $531,000 related to the hiring of additional salesquarter and marketing personnel including an increase in stock-based compensation of $61,000. In addition, advertising and promotional expenses increased by $459,000 in connection with the development and launch of our consumer marketing programs. Sales and marketing expenses increased by $1,947,000, or 83%, to $4,292,000 for the six months ended June 30, ~~2006~~2007, which was a decrease of $324 (13%) from ~~$2,345,000~~the comparable quarter and an increase of $533 (12%) from the comparable six-month period in 2006. The decrease for the ~~comparable period in 2005. These additional sales and marketing expenses were~~quarter was primarily attributable to ~~increased compensation~~a combined decrease of $372 in advertising and public relation expenses ~~of $844,000 related~~due to the ~~hiring~~discontinuation of ~~additional sales and marketing personnel including~~several co-marketing programs, offset by an increase of $54 in compensation expense. The increase for the six-month period was primarily due to an increase in ~~stock-based~~ compensation expense of ~~$84,000. In addition,~~$647 due to an increase in the size of our domestic sales force, with a decrease in advertising and ~~promotional~~promotion expenses ~~increased by $731,000 in connection with the development and launch~~ of ~~our consumer marketing programs.~~$123.

Interest income. Interest income ~~increased by $166,000 to $202,000~~ for the ~~three months ended June 30, 2006, from $36,000 for the three months ended June 30, 2005~~quarter and ~~by $153,000 to $230,000 for the~~ six months ended June 30, ~~2006 from $77,000~~2007 was $233 and $517 , respectively, compared to interest income of $202 and $230, respectively, for the ~~six months ended June 30, 2005. The~~comparable periods in 2006. This increase is mainly attributable to interest earned from the investment of the proceeds of our ~~initial public offering~~IPO completed in May 2006.

Interest expense. Interest expense ~~increased by $195,000 to $202,000~~ for the ~~three months ended June 30, 2006 from $7,000 for the three months ended June 30, 2005~~quarter and ~~increased by $276,000 to $286,000 for the~~ six months ended June 30, ~~2006 from $10,000~~2007 was $181 and $377, compared to $202 and $286, respectively, for the ~~six months ended June 30, 2005.~~comparable periods in 2006. The decrease in the quarter and increase in the six-month period was due to ~~interest expense resulting from draws on our loan facility with Lighthouse Capital Partners. For~~ the ~~three months ended June 30, 2005, we had not borrowed against our loan facility with Lighthouse Capital Partners.~~

~~Preferred stock warrant gain (loss)~~. In the three months ended June 30, 2006, we recognized a gain of $663,000 related to the change in estimated fair value of our preferred stock warrants subject to redemption compared to a loss of $243,000 for the change in fair value of our preferred stock warrants during the same period in 2005. In the six months ended June 30, 2006, we recognized a gain of $500,000 related to the change in estimated fair value of our preferred stockinterest

1614

RESTORE MEDICAL, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
~~AND~~ RESULTS OF OPERATIONS
~~(unaudited)~~(Unaudited)

expense resulting from draws on our loan facility with Lighthouse Capital Partners during the first quarter of 2006 prior to our IPO, and the subsequent pay down of the loan facility and the correlating decrease in expense.

Preferred stock warrant gain. In the quarter and six months ended June 30, 2006, we recognized a gain of $663 and $500, respectively, due to a decrease in the estimated fair value of our preferred stock warrants subject to ~~redemption compared~~redemption. Following our IPO in May 2006, all preferred stock and preferred stock warrants were converted to common stock and common stock warrants.

Deemed dividend from revision of preferred stock conversion price.In 2006, we recognized a non-cash dividend of $20.8 million due to a ~~loss of $417,000 in 2005 for the~~ change in ~~fair value during~~ the ~~same period in 2005.~~conversion price of our Series C and C-1 preferred stock prior to the completion of our IPO. All outstanding Series A, B, C and C-1 preferred stock automatically converted into shares of common stock at the then current conversion prices.

Liquidity and Capital Resources

Since our inception and prior to May 2006, we ~~have~~ funded our operations primarily through issuances of convertible preferred stock and related warrants, which provided us with aggregate gross proceeds of $39.9 million. On May 22, 2006, we sold 4,000,000 shares of common stock in an ~~initial public offering (IPO)~~IPO for aggregate gross proceeds of $32.0 million to finance current operations and provide for general corporate purposes, including expanding domestic and international marketing and sales organizations and programs, increasing product development efforts and increasing our clinical study initiatives. After deducting the underwriters’ commissions and discounts, we received net proceeds of approximately $27.7 million.

As of June 30, ~~2006,~~2007, we had total cash, cash equivalents and marketable securities of ~~$30.1~~$15.5 million. ~~We believe that our current cash and cash equivalents and cash generated from operations will be sufficient to fund our working capital and capital resource needs for at least the next 24 months.~~

Net cash used in operating activities was ~~$5.3~~$7.3 million during the first six months of ~~2006~~2007 compared to ~~$3.6~~$5.3 million in the first six months of ~~2005.~~2006. Cash used in operating activities ~~has historically resulted~~increased by $2.0 million resulting from operating losses ~~reduced by~~and changes in working capital, net of non-cash ~~interest expenses,~~ stock-based ~~compensation and depreciation and increased by net increases in accounts receivable and inventories resulting from the growth of our business.~~compensation.

Net cash ~~used in~~provided by investing activities was ~~$9.7~~$2.8 million during the first six months of ~~2006~~2007 compared to ~~$4.7~~$9.7 million ~~provided by~~used in investing activities in the first six months of ~~2005.~~2006. During 2007 and 2006, cash used in investing activities ~~was~~ primarily related to the purchase and maturities of marketable ~~securities with a portion~~securities.

Net cash used in financing activities was $881,000 during the first six months of 2007 primarily consisting of the repayment of long-term debt, offset by proceeds from the ~~proceeds~~issuance of ~~our IPO. During 2005, cash provided by investing activities was primarily related to the sale of marketable securities offset by the purchase of $94,000 of capital equipment.~~

common stock. Net cash provided by financing activities was $31.8 million during the first six months of 2006 ~~primarily~~ consisting of ~~$27.7 million~~proceeds from the issuance of ~~net proceeds from~~common stock in relation to our IPO and ~~$4.0 million from debt financing. Net cash provided by financing activities was $22,000 during~~ the ~~first six months~~issuance of ~~2005 consisting of net proceeds from the exercise of stock options.~~long-term debt.

As of June 30, ~~2006,~~2007, we had outstanding long-term debt of ~~$6.0~~$4.0 million pursuant to a term loan, which accrues interest at a rate equal to prime plus 3%. The term loan ~~will be~~is being repaid over 30 consecutive monthly payments of principal and interest ~~beginning~~which began on July 1, 2006, with an additional final payment in an amount equal to 5% of the original loan due on December 31, 2008. The term loan is collateralized by substantially all of our assets excluding our intellectual property. As of June 30, 2007, we were in compliance with all of the covenants contained in the term loan agreement.

We believe that our current cash, cash equivalents, marketable securities and cash generated from operations will be sufficient to fund our working capital and capital resource needs for the next 12 months. Funding of operations beyond 12 months will require additional capital investments in our Company. Our future capital requirements will depend upon a number of factors, including, but not limited to, the amount of cash generated by operations, ~~competitive and technological developments and~~ the rate of growth of our ~~business. Although~~business, the level of investment in our domestic and international marketing and sales organizations and programs, new product development efforts and clinical study initiatives. Any sale of additional equity or issuance of debt securities will result in dilution to our stockholders, and we ~~have been successful~~cannot be certain that additional public or private financing will be available in ~~raising funds in the past, there is no assurance that any such financings~~amounts or ~~borrowings can be obtained in the future~~ on terms acceptable to ~~us.~~us, or at all. If we are unable to obtain this additional financing when needed, we may be required to delay, reduce the scope of, or eliminate programs and initiatives, which could harm the growth of our business.

RESTORE MEDICAL, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Unaudited)

expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including, but not limited to the following factors:

• ~~the continued increase in the number of patients seeking treatment for snoring and mild to moderate OSA, both domestically and internationally;~~

• ~~the demand for and acceptance of our Pillar System to treat snoring and mild to moderate OSA by both physicians and patients;~~

• the success of alternative therapies and surgical procedures to treat individuals suffering from sleep disordered breathing, and the possible future introduction of new products and treatments for sleep disordered breathing;

• ~~our ability to continue current pricing for our Pillar System;~~

• ~~the expansion and rate of success of our direct sales force in the United States and our independent distributors internationally;~~

• the successful completion of current and future clinical studies, the presentation and publication of positive outcomes data from these clinical studies, and the increased adoption of the Pillar Procedure by these physicians as a result of this clinical study data;

• ~~actions relating to ongoing FDA and European Union compliance;~~

• ~~the size and timing of orders from physician customers and independent distributors;~~

• ~~our ability to obtain reimbursement for the Pillar Procedure for the treatment of mild to moderate OSA in the future from third-party healthcare insurers;~~

~~RESTORE MEDICAL, INC.~~
~~MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION~~
~~AND RESULTS OF OPERATIONS~~
~~(unaudited)~~

• the willingness of patients to pay out-of-pocket for the Pillar Procedure for the treatment of snoring and, in the absence of reimbursement from third-party healthcare insurers, for the treatment of mild to moderate OSA;

• ~~unanticipated delays in the development and introduction of our future products and/or an inability to control costs;~~

• ~~seasonal fluctuations in revenue due to the elective nature of all sleep-disordered breathing treatments, including the Pillar Procedure;~~

• ~~general economic conditions as well as those specific to our customers and markets; and~~

• ~~other risks and factors identified from time to time in our reports and prospectuses filed with the Securities and Exchange Commission.~~

	•		the demand for and acceptance of our Pillar System to treat mild to moderate OSA and snoring by both physicians and patients;

	•		the success of alternative therapies and surgical procedures to treat individuals suffering from sleep disordered breathing, and the possible future introduction of new products and treatments for sleep disordered breathing;

	•		our ability to maintain current pricing for our Pillar System;

	•		the expansion and rate of success of our direct sales force in the United States and our independent distributors internationally;

	•		the successful completion of current and future clinical studies, the presentation and publication of positive outcomes data from these clinical studies and the increased adoption of the Pillar Procedure by physicians as a result of the data from these clinical studies;

	•		actions relating to ongoing FDA and European Union compliance;

	•		the size and timing of orders from physicians and independent distributors;

	•		our ability to obtain reimbursement for the Pillar Procedure for the treatment of mild to moderate OSA in the future from third-party healthcare insurers;

	•		the willingness of patients to pay out-of-pocket for the Pillar Procedure to treat snoring and, in the absence of reimbursement from third-party healthcare insurers, mild to moderate OSA;

	•		unanticipated delays in the development and introduction of our future products and/or our inability to control costs;

	•		seasonal fluctuations in revenue due to the elective nature of sleep-disordered breathing procedures and treatments, including the Pillar Procedure;

	•		general economic conditions, as well as those specific to our customers and markets; and

	•		other risks and factors identified from time to time in our reports and prospectuses filed with the Securities and Exchange Commission, including, without limitation, the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2006.

All forward-looking statements and reasons why results may differ included in this report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.

~~RESTORE MEDICAL, INC.~~

Item 3. Quantitative and Qualitative Disclosures about Market Risk

~~We invest our excess~~Our cash is invested in bank deposits and money market funds ~~investment grade commercial paper and debt instruments~~denominated in United States dollars. The carrying value of the U.S. government and its agencies, and, by policy, restrict our exposure to any single corporate issuer by imposing concentration limits. We do not utilize derivative financial instruments, derivative commodity instruments or otherthese cash equivalents approximates fair market ~~risk-sensitive instruments, positions or transactions to any material extent. Accordingly, we believe that, while the instruments we hold~~value. Our investments in marketable securities are subject to ~~changes in the~~interest rate risk and our financial ~~standing~~condition and results of ~~the issuer of such securities, we are not subject~~operations could be adversely affected due to ~~any material risks arising from changes~~movements in interest ~~rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments.~~rates. Due to the short-term nature of these investments, a 1% change in market interest rates would have an impact of approximately ~~$300,000~~$140,000 on an annual basis. We do not utilize

RESTORE MEDICAL, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Unaudited)

derivative financial instruments, derivative commodity instruments or other market risk-sensitive instruments, positions or transactions to any material extent.

Although substantially all of our sales and purchases are denominated in U.S. dollars, in future ~~fluctuations in the value of the U.S. dollar may affect the price competitiveness~~periods, we believe a greater portion of our ~~products outside~~revenues could be denominated in currencies other than the United ~~States.~~States dollar, thereby increasing our exposure to exchange rate gains and losses on non-United States currency transactions. Historically, our only foreign denominated payments were for clinical expenditures. Foreign currency gains and losses associated with these expenditures have not been significant. We do not ~~believe, however, that we~~ currently ~~have significant direct foreign currency~~enter into forward exchange ~~rate risk and have not hedged exposures~~contracts to hedge exposure denominated in foreign ~~currencies.~~currencies or any other derivative financial instruments for trading or speculative purposes. In the future, if we believe an increase in our currency exposure merits further review, we may consider entering into transactions to help mitigate that risk.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report (the “Evaluation Date”), we ~~conducted~~carried out an evaluation, under the supervision and with the participation of ~~our~~ management, including our Chief Executive Officer and Chief Financial Officer, ~~regarding~~of the effectiveness of the design and operation of our disclosure controls and procedures ~~pursuant to~~(as defined in Rule ~~13a-15(b) under~~13a-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the ~~end of the period covered by this report,~~Evaluation Date, our disclosure controls and procedures ~~are~~were effective to ensure that information ~~that is~~ required to be disclosed ~~by us~~ in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time ~~period~~periods specified in the applicable rules ~~of the Securities~~ and ~~Exchange Commission.~~forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Changes in Internal Controls

During the most recent fiscal quarter, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is ~~reasonable~~reasonably likely to materially affect, our internal control over financial reporting.

2018

RESTORE MEDICAL, INC.

Part II. OTHER INFORMATION

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

On May 22, 2006, we completed our IPO of 4,000,000 shares of common stock (the IPO Shares). We sold the IPO Shares to the public at a price of $8.00 per share. Our sale of IPO Shares was registered under the Securities Act of 1933, as amended, onpursuant to a registration statement on Form S-1 (Registration Stmt. No. 333-132368), which was declared effective by the Securities and Exchange Commission on May 16, 2006. ~~The~~We received net proceeds ~~to us~~ from the sale of the IPO Shares, after deducting the underwriting discount and offering expenses, ~~were~~of approximately $27.7 million. The net proceeds have been invested in money market funds, investment grade commercial paper and debt instruments of the U.S. government and its agencies. During the ~~quarter~~six months ended June 30, ~~2006,~~2007, we ~~did not use any~~used approximately $12.1 million of the net proceeds from the ~~IPO.~~IPO for general corporate purposes, including expanding domestic marketing and sales organizations and programs, increasing product development efforts and increasing our clinical study initiatives.

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

Our annual meeting of shareholders was held on May 15, 2007, at which time seven nominees were elected to the Board of Directors for terms expiring at the annual meeting in 2008. We solicited proxies pursuant to Section 14(a) of the Exchange Act, and there was no solicitation in opposition to management’s solicitations. All nominees for directors as listed in the proxy statement were elected.

The voting results were as follows:


	For		Withheld
Election of Directors:
Luke Evnin, Ph.D.		10,900,773		476,174
Mark B. Knudson, Ph.D		9,601,491		1,775,456
Stephen Kraus		10,900,773		476,174
Howard Liszt		10,900,673		476,274
Richard Nigon		10,900,773		476,174
J. Robert Paulson, Jr		10,900,773		476,174
John Schulte		10,900,673		476,274

Item 6. Exhibits

The exhibits listed on the accompanying index to exhibits are filed or incorporated by reference (as stated therein) as part of this Quarterly Report on Form 10-Q.

2119


	Page
PART I. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements (Unaudited)
• Condensed Balance Sheets		2
• Condensed ~~Statement~~Statements of Operations		3
• Condensed ~~Statement~~Statements of Cash Flows		4
• Notes to Condensed Financial Statements		5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		1112
Item 3. Quantitative and Qualitative Disclosures About Market Risk		2017
Item 4. Controls and Procedures		2018
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		2119
Item 4. Submission of Matters to a Vote of Security Holders		19
Item 6. Exhibits		2119
Signatures
Exhibits
~~Rule 13a-14(a)/15d-14(a)~~302 Certification
~~Rule 13a-14(a)/15d-14(a)~~302 Certification
Section 1350 ~~Certification~~Certifications


	Granted to	Granted to	Granted to			Granted to
	Employees	Directors	Employees			Directors
Volatility	65%	65%		65	%		65	%
Risk-free interest rates	5.0%	5.0%		5.0	%		5.0	%
Expected option life	6.25 years	5.5 years	6.4		years	5.5		years
Stock dividend yield	0%	0%		0	%		0	%
Forfeiture rate				8	%		2	%


	2006
Volatility		67.5	%
Risk-free interest rates		4.6	%
Expected option life	90 Days
Stock dividend yield		0	%


	Cost		Unrealized			Fair
	Basis		Losses			Value
Held-to-maturity:
Corporate debt securities	$	4,964	$	—		$	4,964
Mortgage-backed securities		4,900		(14	)		4,886

Total	$	9,864	$	(14	)	$	9,850


		RESTORE MEDICAL, INC.

		by:		/s/ Christopher R. Geyen

				Christopher R. Geyen
				Senior Vice President and Chief Financial Officer
				~~(on behalf of the registrant~~(Principal Financial and ~~as chief financial and accounting officer)~~Accounting Officer)

(5)		~~Short-Term~~Short–term Investments in Debt Securities

		Short-term investments inconsisted solely of corporate debt securities ~~consisted of the following~~ as of June 30, ~~2006 (in thousands):~~2007. The Company classifies these investments as held-to-maturity due to the intent and ability to hold them until they mature. The carrying value of these instruments approximates fair market value. Declines in value of marketable securities classified as held-to-maturity are considered to be temporary.


			Payments Due by Period
			2006
			(remaining 6												(remaining 6 months in
Contractual Obligations	Total		months)		2007		2008		2009		2010		Total		2007)		2008		2009		2010		2011
Term-debt facility	$	6,000	$	996	$	2,202	$	2,802	$	—	$	—	$	3,936	$	1,134	$	2,802	$	—	$	—	$	—
Capital lease obligations		51		6		13		15		14		3		112		14		30		32		22		14
Operating leases		1,406		141		284		310		383		289		1,073		119		281		384		289		—
Deposit payable		5		—		5		—		—		—		5		—		5		—		—		—

Total contractual cash obligations	$	7,462	$	1,143	$	2,504	$	3,127	$	397	$	292	$	5,126	$	1,267	$	3,118	$	416	$	311	$	14


Exhibit No		Description

31.1		Rule 13a-14(a)/15d-14(a) Certification

31.2		Rule 13a-14(a)/15d-14(a) Certification

32		Section 1350 Certifications