**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

| **For the fiscal year ended July 2, 2005** | **Commission  file number 000-14742** |
|-------------------------------------------------|---------------------------------------|

 

**CANDELA CORPORATION**

(Exact name of registrantas specified in its charter)

| **Delaware**                                     | **04-2477008**       |
|--------------------------------------------------|----------------------|
| (State or other  jurisdiction of                 | (I.R.S. Employer     |
| incorporation or  organization)                  | Identification  No.) |
| **530 Boston Post Road, Wayland, Massachusetts** | **01778**            |
| (Address of  principal executive offices)        | (Zip Code)           |

 

Registrant’s telephonenumber, including area code  **508-358-7400**

Securities registeredpursuant to Section 12(b) of the Act: **None**

Securities registeredpursuant to section 12(g) of the Act:

**Common Stock, $.01 par value per share**

(Title of Class)

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the proceeding 12months (or for such shorter period than the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x  No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule12b-2of the Exchange Act) Yes x  No o

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

The aggregate market valueof the registrant’s voting and non-voting stock, held by non-affiliates of theregistrant as of September 23, 2005, based upon the closing price of suchstock on the NASDAQ Stock Market on that date, was $9.63. As of September 23,2005, 22,678,523 shares of the registrant’s common stock, $.01 par value, wereissued and outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the registrant’sdefinitive proxy statement for the registrant’s 2005 annual meeting of stockholders,which is expected to be filed pursuant to Regulation 14A within 120 days of theregistrant’s fiscal year ended July 2, 2005, are incorporated by referenceinto Part III of this Annual Report on Form 10-K.

 

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**CANDELACORPORATION**

**2005 FORM 10-KANNUAL REPORT**

**TABLEOF CONTENTS**
|               |   |                                                                                             |   | **Begins on  Page** |
|---------------|--------|--------------------------------------------------------------------------------------------------|--------|--------------------------|
| PART I   |
| ITEM 1.       |   | BUSINESS                                                                                         |   | 3                        |   |
| ITEM 2.       |   | PROPERTIES                                                                                       |   | 18                       |   |
| ITEM 3.       |   | LEGAL  PROCEEDINGS                                                                               |   | 19                       |   |
| ITEM 4.       |   | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                             |   | 20                       |   |
| PART II  |
| ITEM 5.       |   | MARKET  FOR THE REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDERS’ MATTERS      |   | 20                       |   |
| ITEM 6.       |   | SELECTED  FINANCIAL DATA                                                                         |   | 22                       |   |
| ITEM 7.       |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      |   | 23                       |   |
| ITEM 7A. |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 |   | 34                       |   |
| ITEM 8.       |   | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                     |   | 35                       |   |
| ITEM 9.       |   | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE            |   | 35                       |   |
| ITEM 9A.      |   | CONTROLS AND PROCEDURES                                                                          |   | 35                       |   |
| ITEM 9B.      |   | OTHER INFORMATION                                                                                |   | 37                       |   |
| PART III |
| ITEM 10.      |   | DIRECTORS  AND EXECUTIVE OFFICERS OF THE REGISTRANT                                              |   | 38                       |   |
| ITEM 11.      |   | EXECUTIVE  COMPENSATION                                                                          |   | 38                       |   |
| ITEM 12.      |   | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER  MATTERS |   | 38                       |   |
| ITEM 13.      |   | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                                                  |   | 38                       |   |
| ITEM 14.      |   | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                          |   | 38                       |   |
| PART IV  |
| ITEM  15.     |   | EXHIBITS,  FINANCIAL STATEMENT SCHEDULES, AND REPORTS  ON FORM 8-K                     |   | 39                       |   |
| SIGNATURES    |   | 42                                                                                               |   |

 

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**Part I**

**Item 1.        Business.**

Candela Corporation(“Candela”, or the “Company”) is a pioneer in the development andcommercialization of advanced aesthetic laser and light-based systems thatallow physicians and personal care practitioners to treat a wide variety ofcosmetic and medical conditions including:

·       vascularlesion treatment of rosacea, facial spider veins, leg veins, scars, stretchmarks, warts, port wine stains and hemangiomas

·       hairremoval

·       removalof benign pigmented lesions such as age spots, freckles and tattoos

·       skinrejuvenation and wrinkles

·       acneand acne scars

·       psoriasis

·       otherskin treatments

Since our founding35 years ago, we have continuously developed and enhanced applications of laserand light-based technology. In the mid-1980’s we began developing lasertechnology for medical applications, and since that time have shippedapproximately 8,500 lasers to over 64 countries. Since the early 1990’s we havefocused our organizational resources on developing laser technology for usesolely in the aesthetic and cosmetic laser and light-based industry. Ourintroduction of new dermatology/plastic surgery laser systems during the mid-1990’sallowed us to expand rapidly in this area. Candela’s current product lineoffers comprehensive and technologically sophisticated aesthetic and medicallaser and light-based systems used by dermatologists, plastic surgeonsand various other medical and personal care practitioners. Candela’s productline includes the following innovative products:

·       GentleLASE®family of lasers, including the GentlYag, for the treatment of unwanted hairand the treatment of vascular lesions, pigmented lesions and wrinkles.

·       Vbeam®for the treatment of vascular lesions, wrinkles, psoriasis and otherconditions.

·       ALEXLAZRTMfor treating pigmented lesions and tattoos.

·       SmoothbeamTMdiode laser, for non-ablative dermal remodeling of wrinkles and the treatmentof acne and acne scars.

·       C-beamTMpulsed dye laser for treatment of psoriasis and surgical scars.

·       EllipseIntense Pulsed Light system specifically designed for the improvement ofsun-damaged skin by photo rejuvenation through removal of both vascular(redness) and dyspigmentation (brown spots).

The discretionary income of aging baby boomerscontinues to rise which creates new opportunities for Candela. This marketsegment places a premium on good health and personal appearance, and hasdemonstrated a willingness to pay for health and cosmetic products and services.The growing popularity of laser and light-based treatments among the generalpopulation is also spurring demand for Candela’s products. Last year, Americansspent an estimated $12.5 billion on cosmetic procedures. Increasingly, lasersand light-based systems are proving an attractive alternative for eliminatingunwanted hair. The laser hair removal market has experienced significant growthover the last several years.

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The Company is dedicated to developing safe andeffective products. Our aesthetic laser and light-based systems arefurther distinguished by being among the fastest, smallest and most affordablein their respective markets. We believe that we have increasingly capturedsignificant market share because of these product attributes and we arecommitted to continual innovation to meet the needs of our markets.

The Company wasincorporated in Massachusetts on October 22, 1970. The Companysubsequently reincorporated in Delaware on July 1, 1985.

**Industry Overview**

Medical lasers andlight-based devices use the unique characteristics of light to achieve precise andefficacious therapeutic effects, often in a non-invasive manner. The precisecolor, concentration, and controllability of different types of light providefor the delivery of a wide range of specialized treatments. First introduced inthe 1960’s, the use of lasers for medical applications grew rapidly in the 1990’sas technical advances made medical lasers more effective and reliable. Medicallasers and light-based devices today are used for numerous types of proceduresfalling into four broad categories: ophthalmic surgery, aesthetic and cosmeticprocedures, general surgery, and dental procedures. Candela competes solelywithin the growing market for lasers and light-based devices for performingaesthetic and cosmetic procedures including:

·       removalof unwanted hair from the face, legs, back, and other body areas

·       treatmentof rosacea, facial veins and leg veins, red birthmarks, scars, stretch marks,and warts

·       facialrejuvenation and reduction in the appearance of fine lines and wrinkles

·       removalof pigmented lesions such as age spots, freckles and tattoos

·       treatmentof acne and acne scars

·       treatmentof psoriasis

·       treatmentof Nevus of Ota and melasma

Lasers produce intense bursts of highly focused lightto treat skin tissues. A laser’s wavelength (color), energy level, spot sizeand pulse width (exposure time) are optimized for the specific treatment. Light-baseddevices, commonly referred to as intense pulsed light, feature a broad range ofwavelength of light designed to target vascular and pigmentary targets forfacial rejuvenation procedures. Hair removal and the treatment of various legvein malformations require the deepest laser penetration for successfultreatment while scars and red birthmarks (port wine stains and hemangiomas)require less laser penetration. Pigmented lesions such as sun spots, liverspots and tattoos are typically surface conditions that require the leastamount of penetration. Different conditions may require the use of differenttypes of lasers or light-based devices, and an active aesthetic and cosmeticpractice addressing a broad range of laser procedures may need multiple lasersand light-based devices.

In the pioneering years of the cosmetic and aestheticlaser industry from the late 1980’s to the mid 1990’s, the market for laserprocedures was focused on vascular conditions such as port wine stains andhemangiomas and the development of treatments for pigmented lesions, such astattoos. Equipment available in this period tended to be expensive, slow, andbulky. In addition, laser applications addressed the needs of relatively smallpatient populations, served by a narrow group of specialists.

The aesthetic andcosmetic laser industry is now in an era of broad-based growth. The majorfactors converging to drive this growth are:

·       theeconomics of practitioners in a difficult medical reimbursement environment

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·       therising discretionary income of aging baby boomers

·       thedevelopment of technology that allows for new, effective and economicalprocedures for conditions with large patient populations

Aesthetic and cosmetic device vendors, who are able todeliver lasers and light-based systems that are efficacious, cost effective,reliable, and easy to use, will be well positioned to take advantage of suchbroad-based industry growth.

Managed care and reimbursement restrictions in theU.S. and similar constraints outside the U.S., such as socialized medicine, aremotivating practitioners to emphasize aesthetic and cosmetic procedures thatare delivered on a private, fee-for-service basis. While cosmetic procedureswere once the domain of plastic surgeons and dermatologists, reimbursementreductions coupled with the reliable revenue stream from private-pay procedureshave piqued the interest of other specialties, including general practitioners,family care practitioners, obstetricians and gynecologists, and general andvascular surgeons.

Key technical developmentsrequired for the broader cosmetic laser and light-based treatment marketsrelate to ease-of-use, speed, lower costs, safety, and effective elimination ofundesirable side effects. These factors are critical for broader segments ofpractitioners who wish to build aesthetic and cosmetic laser and light-basedtreatment practices. These factors are also important for minimizing thedisruption of a patient’s normal routine and for building demand for proceduresaddressing very large patient populations.

**Business Strategy**

Candela continuesto believe that a convergence of price, performance and technology is occurringin the aesthetic and cosmetic laser industry, driving market expansion. Webelieve we have the necessary infrastructure in place to capitalize on thisexpansion. Candela’s objective is to continue to be the leading provider ofaesthetic and cosmetic lasers and light-based devices by using its proprietarytechnology and expertise in light and tissue interaction, as well as bydeveloping market-oriented products that utilize related technologies. Ourbusiness strategy is focused on the following goals:

·       increasepenetration of our traditional customer base

·       expandbeyond our traditional customer base

·       reduceproduct costs

·       expandour direct domestic distribution channels

·       expandour international distribution channels

·       continueinvesting in research and development to develop new applications that areefficacious, cost-effective, reliable and easy to use

***Increase Penetration of OurTraditional Customer Base.  ***Our traditional customerbase consists of dermatologists and plastic and cosmetic surgeons. We believethat the affordability of our products will enable us to penetrate further intothe dermatologist, plastic and cosmetic surgeon markets. We believe thataffordability has been a major obstacle preventing the remaining practitionersfrom purchasing a laser or light-based system. As competition for patientsamong practitioners increases, those practitioners with aesthetic and cosmeticlaser, and light-based systems will be able to differentiate themselves.

***Expand beyond our traditionalcustomer base.  ***As reimbursement rates dropped overthe past several years, many primary care physicians (family and generalpractice, OB/GYN) have begun to seek new services to offer to their patients. Cosmeticlaser and light-based procedures represent an ideal new service that isappealing to their patients, and adds a new “cash-pay” revenue stream to theirpractice. Cosmetic laser and light-based procedures are safe and easy toperform. As more primary care physicians realize that these procedures are safeand easy to perform, awareness of cosmetic laser and light-based procedureswill continue to grow.

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***Reduce Product Costs.  ***Weapply bottom-up engineering, focusing on each component to improve theperformance of each device while reducing its size, complexity, and cost. Webelieve our approach leads to lasers with fewer parts and greater manufacturingefficiency, resulting in lower production costs, which enables us to offer morereliable products at more affordable prices.

***Expand Our Direct DomesticDistribution Channels.  ***North America presentlyrepresents almost 50% of our sales and is the largest single geographic marketfor our products. We continue to upgrade our U.S. direct and indirect salesforces to better address the needs of our traditional core markets.

***Expand Our InternationalDistribution Channels.  ***Outside of the U.S., wecontinue to strengthen our long-standing positions in Europe and Japan and areseeking to expand our markets in Asia and Latin and South America. We currentlyhave direct sales offices in Madrid, Lisbon, Rome, Frankfurt, Paris, Bangkok,Osaka, Nagoya and Tokyo. Over the past year we increased the number andimproved the quality of our international independent distributor channel. Wecurrently utilize 52 independent distributors in 64 countries.

***Continue Investing in Research &Development.  ***We believe that investment in researchand development is necessary to remain a leader in the aesthetic and cosmeticlaser and light-based system market. Our research and development approach isto develop high quality, reliable, and affordable products that continue toaddress existing markets and allow us to enter and expand into larger markets,such as acne therapy. Our research and development staff works closely with ourmarketing and operations groups to ensure our goals are met. Our strategy hasbeen to drive technology that is market applicable and addresses unmet needs inthe marketplace. To that end, Candela will continue to apply technologies toreduce the size of its technology and products, increase the speed and easewith which therapeutic applications can be delivered, improve its ability tobuild and deliver laser and light-based systems at affordable prices, andaddress expanding therapeutic applications and markets. Candela has numerousresearch and development arrangements with leading hospitals and academiclaboratories in the U.S. and throughout the world.

**TheMarket for Aesthetic and Cosmetic Laser and Light-Based Systems**

Our traditional customer base for aesthetic andcosmetic devices consists of dermatologists and plastic and cosmetic surgeons. Inaddition, other practitioner groups are emerging as potential customers,including general and family practitioners, obstetricians, gynecologists, andgeneral and vascular surgeons. In the U.S., according to the American MedicalAssociation and various professional societies, there are approximately 10,000dermatologists, 8,000 plastic and cosmetic surgeons and 11,000 ear, nose andthroat specialists. Practitioners in other specialties that are beginning tobuy aesthetic and cosmetic laser and light-based systems include 70,000 generaland family practitioners, 35,000 obstetricians and gynecologists, and 28,000general and vascular surgeons. In addition, the aesthetic and cosmetic laserand light-based system market includes non-medical practitioners, notablyelectrologists, of which there are an estimated 6,000 in the U.S.

The end markets for cosmetic procedures encompassbroad and growing patient groups, including aging “baby boomers” as well asyounger age groups. According to the U.S. Census Bureau, at the end of 1998 thenumber of “baby boomers” in the 35 to 54 age range was approximately 80million, representing more than 29% of the total U.S. population. This largepopulation group has exhibited a strong demand for aesthetic and cosmetic procedures.We believe that as the cost of treatments decreases and the popularity ofcosmetic procedures such as hair removal increases, the target market for theseprocedures will expand beyond the baby boomers to include a broad range ofwomen and men aged 17 to 65. 

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Demographic factors similar to the U.S. underlie thegrowth of the aesthetic and cosmetic market outside of the U.S. as well.

***Hair Removal.  ***Webelieve that the great majority of the 108 million women over the age of 16 inthe U.S. employ one or more techniques for temporary hair removal from variousparts of the body. Also, a growing number of men are removing hair by meansother than their daily shaving routine. A number of techniques are used to pullhair from the follicle including waxing, depilatories, and tweezing. In thewaxing process, a lotion, generally beeswax-based, is spread on the area to betreated and is then rapidly peeled off, pulling out the entrapped hairs. Depilatoriesemploy rotating spring coils or slotted rubber rolls to trap and pull out thehairs. Tweezing involves removing individual hairs with a pair of tweezers. Pullinghair from the follicle produces temporary results, but is often painful and maycause skin irritation. Depilatory creams, which contain chemicals to dissolvehair, frequently leave a temporary unpleasant odor and may also cause skinirritation. Shaving is the most widely used method of hair removal, especiallyfor legs and underarms, but produces the shortest-term results. Hair bleachesdo not remove hair, but instead lighten the color of hair so that it is lessvisible. A principal drawback of all of these methods is that they requirefrequent treatment.

Before the advent of laser and light-based hairremoval, electrolysis was the only method available for the long-term removalof body hair. Electrolysis is a process in which an electrologist inserts aneedle directly into a hair follicle and activates an electric current in theneedle, which disables the hair follicle. The tiny blood vessels in each hairfollicle are heated and coagulated, presumably cutting off the blood supply tothe hair matrix, or are destroyed by chemical action depending upon themodality used. The success rate for electrolysis is variable depending upon theskill of the electrologist and always requires a series of treatments. Electrolysisis time-consuming, expensive and sometimes painful. There is also some risk ofskin blemishes and a rising concern relating to needle infection. Becauseelectrolysis requires that each hair follicle be treated separately and canonly treat visible hair follicles, the treatment of an area as small as anupper lip may require numerous visits at an aggregate cost of up to $1,000. TheAmerican Electrology Association estimates that approximately one millionpeople per year undergo electrology procedures. Although we believe the largemajority of all electrolysis treatments are for facial hair, the neck, breastsand bikini line are also treated. Because hair follicles are disabled one at atime, electrolysis is rarely used to remove hair from large areas such as theback, chest, abdomen, and legs. We believe laser and light-based systems enablethe practitioner to address a potentially larger market than electrolysis bytreating a larger area of the body more quickly and with improved results.

We believe themarket for laser and light-based hair removal is growing as the customercompares laser and light-based treatments to other hair removal methods thatare currently available. The benefits of laser and light-based system treatmentinclude:

·       significantlonger term cosmetic improvement

·       treatmentof larger areas in each treatment session

·       lessdiscomfort during and immediately following procedures

·       reducedprocedure time and number of treatments

·       reducedrisk of scarring and infection

·       non-invasiveprocedures

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***Vascular Lesions.  ***Benignvascular lesions are abnormal, generally enlarged and sometimes proliferatingblood vessels that appear on the surface of the skin as splotches, dots,bulges, and spider shapes in a variety of colors ranging from red to purple. Differenttypes of benign vascular lesions include the following:

·       rosacea,which is the dilation of capillaries in the cheeks, nose, forehead and chin

·       telangiectasias,more commonly referred to as spider veins, appearing on the face and otherparts of the body

·       varicoseveins, which are large veins greater than 1mm in diameter and often bulge abovethe skin surface

·       legtelangiectasias, which are smaller spider veins up to 1mm in diameter appearingas single strands

·       portwine stains, which are vascular birthmarks characterized by a red or purplediscoloration of the skin

·       hemangiomas,which are protuberances that consist of dilated vessels, which often appear onnewborns within one month of birth

·       stretchmarks and scars

Varicose leg veinstypically result when damaged valves cause blood to stagnate rather than bepumped back to the heart, causing the vein walls to stretch and bulge. Varicoseveins affect a significant portion of the U.S. adult population and increase inprevalence with age. To date, treatment for varicose veins has beenpredominantly performed on women. Other benign vascular lesions include portwine stains, hemangiomas, and facial and truncal telangiectasias or spiderveins.

***Pigmented Lesions/Tattoos:  ***Benignpigmented lesions can be both epidermal, on the outer layer of skin, anddermal, on the innermost layer of skin, natural or man-made (tattoos), and canconstitute a significant cosmetic problem to those who have them.

***Skin Rejuvenation:  ***Skinrejuvenation is one of the fastest growing segments of the aesthetic laser andlight-based system market. A significant percentage of the population suffersfrom fine lines and wrinkles or older looking skin as a result of the normalaging process. This is the primary group of candidates for non-ablative laser andlight-based treatment. While the market for skin rejuvenation is greatest inthe U.S., significant opportunities abound in international markets where thereis an aging demographic, such as Japan, or a high prevalence of photodamagedskin, such as Australia and Latin/South America.

***Acne:  ***Patientshave expressed dissatisfaction with existing therapies for acne and acnescarring. These therapies include the following: drug therapy, dermabrasion,ablation, excision, chemical peeling and injections of filler materials.According to a direct survey of patients, these therapies have minimalefficacy, significant side-effect profile, require long recovery periods and,in most cases, do not meet patient expectations.

The majority of acne scarpatients that seek treatment decide not to undertake a procedure. A moreeffective alternative for acne and acne scarring treatment is laser therapy.The Smoothbeam laser employs a combination of laser light at 1450 nm andcryogen spray to heat the dermis, sebaceous glands, and associated structureswithin the dermis—without damaging the epidermis. The thermal event alters thestructure of the sebaceous glands, the root cause of acne lesions, resulting ineffective and long-lasting acne clearance. In the treatment of acne scars, thelaser initiates deposition of new collagen to raise depressions in the skin,reducing the appearance of acne scars. Over a series of treatments, newcollagen can fill in and soften the appearance of acne scars.

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***Psoriasis:  ***TheNational Psoriasis Foundation estimates that psoriasis afflicts more than sevenmillion Americans and that between 150,000 and 260,000 new cases are diagnosedeach year. Candela received FDA clearance in 2001 to market a pulsed dye laserfor the treatment of psoriasis. This laser specifically treats recalcitrantpsoriatic plaque safely and effectively and began shipping during fiscal year2002.

**Candela’s Products**

Weresearch, develop, manufacture, market, sell and service laser and light-basedsystems used to perform procedures addressing patients’ aesthetic, medical andcosmetic concerns. We offer a comprehensive range of products based onproprietary technologies. Our products focus on the major aesthetic andcosmetic laser and light-based applications including:

·       hairremoval

·       non-invasivetreatment of facial and leg veins and other benign vascular lesions

·       treatmentof rosacea

·       removalof benign pigmented lesions such as age spots and tattoos

·       treatmentof scars and stretch marks

·       wrinklereduction

·       treatmentof acne and acne scars

·       treatmentof psoriasis

·       otherskin treatments

Laser technology forms the basis for most of ourproducts. Our patented technology uses thermal energy generated by an intensepulsed laser light source to selectively eliminate unwanted skin blemisheswithout damaging the surrounding healthy tissue, and to remove facial or otherunwanted hair throughout the body. Candela’s objective is to remain as theleading provider of aesthetic and cosmetic lasers by continually striving todevelop smaller, faster, and less expensive devices. Candela has been a pioneerin the laser industry. From the start, our mission has been to lead the way inthe development of innovative laser products. Significant innovations include:

**Dynamic Cooling Device**.   TheDynamic Cooling Device (“DCD”) selectively cools only the top layer of theskin, while leaving the targeted underlying hair follicle, vein or otherstructure at normal temperature. As a result, higher levels of laser energy canbe delivered during treatment, while minimizing thermal injury, pain, and theinconvenience associated with anesthetics. The design of the hand-held DCDenables the practitioner to clearly see the area being treated, and thecombined efficiency of the lasers and DCD reduces the risks of over treatment.The DCD delivers just the right amount of cooling quickly and consistently.Currently, DCD is available as an option on several Candela laser systems.

**GentleLASE Family**.   TheGentleLASE is a high-energy, long-pulse solid-state laser that generates laserlight in the near infrared wavelength range. It is used for both hair removaland the treatment of large (1mm or larger) leg veins. The technologyincorporated in the GentleLASE uses intense pulsed light energy directedthrough an Alexandrite rod, which achieves selective heating while keeping thetemperature of the skin below its damage threshold. The longer Alexandritelaser wavelength enables the GentleLASE to penetrate skin surfaces deeper thantraditional Ruby lasers, and the large spot size (18mm) is the industry’slargest. The basic GentleLASE was recently re-introduced with new advancedfeatures including a smaller, more transportable size.

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Hair removal typically requires three to fivetreatments to achieve efficacious results due to the growth cycle of hairfollicles. A typical treatment can range from approximately $200 for an upperlip and chin procedure to as much as $1,000 per treatment for the back orchest.

The other systems of the GentleLASE family are theGentleLASE Limited EditionTM, our most affordable hair removal laser, and theGentleYAGTM platform of high energy long pulse Nd:YAG lasers, designed for hairremoval, vascular removal, and skin renewal. The GentleLASE and GentleYAGlasers are currently cleared to treat unwanted hair on all skin types, vascularand pigmented lesions, and wrinkles.

**Vbeam**.   The Vbeam deliversthe safety and efficacy of the clinically proven pulsed dye laser (PDL) whileminimizing the problematic side effects of postoperative bruising, commonlyreferred to as purpura. It features Candela’s patented Dynamic Cooling Deviceto protect the epidermis. The system comes in a choice of two colors, and ispriced very competitively. The Vbeam provides treatment of facial spider veins,port wine stains, leg telangiectasias, hemangiomas, poikiloderma, rosacea,scars, warts, stretch marks, vulvodynia, acne, and other vascular abnormalitiesin adults, children and infants. The Vbeam’s user-adjustable laser pulseduration (0.45-40msec) features Candela’s ultra-long pulse duration, thelongest offered in a dye laser. Most treatments of vascular lesions cost thepatient between $300 and $800, depending on the length and the type ofprocedure. The combination of Vbeam and GentleLASE offers the capability totreat a majority of leg veins in patients. A predecessor product to Vbeam, theSPTL-1b, is currently marketed in Japan, pending Ministry of Healthapproval of the Vbeam. The Vbeam was initially cleared by the FDA for marketingin the U.S. in January 2000, and has since received additional clearancefor the treatment of wrinkles, pigmentation lesions, and acne.

**ALEXLAZR**.   The ALEXLAZR isa short-pulse solid-state laser, which emits near-infrared light for thenon-invasive removal of tattoo pigments and pigmented lesions such as frecklesand Nevus of Ota, a bluish colored, non-vascular, pigmented lesion, generallyfound among persons of Asian descent. The ALEXLAZR was cleared by the FDA formarketing for these uses in the U.S. in 1994. The ALEXLAZR has a fiber opticdelivery system that produces an even beam distribution without hot spots. Itswavelength maximizes beam penetration, providing gentle treatments witheffective results on deeper pigments and is effective in the removal of mosttattoo pigments.

**Smoothbeam**.   Introduced in March 2001,the Smoothbeam diode laser heats collagen in the upper dermis, stimulating newcollagen deposition for the improvement of wrinkles, sebaceous hyperplasia andacne scars. The system is small, easily portable and available in two uniquecolors to ideally complement the practice environment. Candela has received FDAclearance for the marketing of the Smoothbeam for the treatment of wrinkles,acne, sebaceous hyperplasia, and acne scars. The Smoothbeam laser employs laserlight at 1450 nm to heat the dermis, sebaceous glands, and associatedstructures within the dermis in combination with cryogen spray to cool andprotect the epidermis. The thermal injury alters the structure of the sebaceousglands, the root cause of acne lesions, resulting in more effective andlonger-lasting acne clearance.

**C-beam**.   Introduced in February 2002,the C-beam is a pulsed dye laser used for the treatment of psoriasis, wrinkles,acne, and surgical scars. The system has a very low risk profile; moreover, itis small in size, affordable, and offers effective results from just a fewtreatment sessions.

**Ellipse Flex**.   TheEllipse system is an intense pulsed light system that is designed to improvesun damage by photorejuvenation. Photorejuvenation treatment is one of the mostrequested light based treatments available on the market today. The Ellipsesystem is designed to target both the vascular (redness) and dyspigmentation(brown) to improve the overall appearance of the skin’s tone and color. TheEllipse system is manufactured by Danish Dermatologic Development A/S (DDD), aDanish manufacturer that specializes in the design and development of lightbased systems. The Company’s distribution agreement with DDD for the Ellipsesystem is valid only in the United States.

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**Sales and Distribution**

We market and sell our products in more than 64countries worldwide. Separate regional executives in North America, Latin andSouth America, Japan, Asia, Europe and the Middle East manage our marketing,selling and service activities through a combination of direct personnel and anetwork of independent distributors.

The mix of direct sales and distributor sales variesby region. Generally, our distributors enter into 2-3 year exclusiveagreements during which they typically agree not to sell our competitors’products. Our sales strategy is to choose the most productive and practicabledistribution channel within each of our geographic markets.

We sell products in the U.S. primarily through ourdirect sales force to our traditional customer base of dermatologists andplastic and cosmetic surgeons. Outside the U.S., we sell our products inWestern Europe, Japan, Latin and South America, the Middle East, and thePacific Rim through direct sales offices and distribution relationships. We havea total of 88 employees in our direct sales offices in Madrid, Frankfurt,Bangkok, Paris, Tokyo, Nagoya and Osaka. We have established distributionrelationships throughout Europe, Japan, Africa, Latin and South America, andthe Middle East. Outside the U.S., we currently utilize 52 distributors in 64countries. Refer to Note 9 of our Consolidated Financial Statements foradditional financial information about segments and geographical areas.

Thefollowing chart shows data relating to Candela’s international activitiesduring each of the last three fiscal years by geographic region. Revenuegenerated from regions other than the U.S. includes sales from Candela’sGerman, Spanish, French, and Japanese subsidiaries, as well as sales shippeddirectly to international locations from the U.S.

| ** **                                | ** ** | **July 2,** | ** ** | **July 3,** | ** ** | **June 28,** | ** ** |
|-------------------------------------------|------------|------------------|------------|------------------|------------|-------------------|------------|
| **Revenues:**                             | ** ** | ** **       | ** ** | **2005**         | ** ** | **2004**          | ** ** | **2003** | ** ** |
| **(000)**                                 | ** ** | ** **       | ** ** |
| United States and  Canada                 |       | $                | 57,517     |             | $          | 49,915            |       | $ | 37,755 |   |
| Japan and the Far  East                   |       | 29,229           |       | 26,666           |       | 23,483            |       |
| Europe                                    |       | 30,659           |       | 26,525           |       | 16,685            |       |
| United States  shipments to other regions |       | 6,496            |       | 1,332            |       | 728               |       |
| Total Revenue                             |       | $                | 123,901    |             | $          | 104,438           |       | $ | 78,651 |   |
|                                           |            |                  |            |                  |            |                   |            |  |  |  |  |  |

 

**Service and Support**

We believe that quick and effective delivery ofservice is important to our customers. We strive to respond to service calls within24 hours and to complete a call within 48 hours to minimize practitionerdisruption. Our principal service center and parts depot is located at ourWayland, Massachusetts headquarters. Parts depots are also located at our salesoffices in Japan, Thailand, Spain, Germany and France. Independent distributorsalso maintain parts depots.

We also believe a highly trained and qualified servicestaff is key to product reliability. Distributors and subsidiaries have theprimary responsibility of servicing systems within their territories. Theirservice personnel are required to attend formal training to become certified.In addition, we have service and technical support staff in each of our marketsworldwide.

Post-warranty product maintenance and repair providesan additional recurring source of revenue. Customers may elect to purchase aservice contract or purchase service on a time-and-materials basis. Candela’sservice contracts offer a range of service levels and options, includingadditional clinical support. The contract terms generally run in 12 or 24-monthintervals.

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Candela emphasizeseducation and support of its customers. Periodic devicecalibration/verification, coupled with the continuous training of our serviceproviders helps to ensure product reliability. We extend prompt and courteoustechnical and clinical support to our customers when needed.

**Manufacturing**

We design,assemble, and test our branded products at our Wayland, Massachusetts facility.Ensuring adequate and flexible production capacity, applying lean manufacturingtechniques, continuous cost reduction, and superior product quality are toppriorities of our manufacturing organization. We achieve our goals by:

·       workingclosely with the research and development organization, including significantearly involvement in product design,

·       continuallyimproving our just-in-time manufacturing and inventory processes,

·       effectivelymanaging and working closely with a limited number of the most qualifiedsuppliers, and

·       applyingthe latest cell manufacturing techniques

Our facility has ISO 9001 certification and hasestablished and is maintaining a quality system that meets the requirements ofISO 13485 and CAN/CSA-ISO 13485. ISO 9001 certification provides guidelines forthe quality of company systems associated with the design, development,production, servicing and distribution of medical lasers and accessories. ISO13485 standards are European quality requirements and CAN/CSA-ISO 13485 is aCanadian quality requirement, all specifically relating to the design ofmedical devices.

Our products are manufactured with standard componentsand subassemblies supplied by subcontractors to our specifications. We purchasecertain components and subassemblies from a limited number of suppliers.

If our suppliers areunable to meet our requirements on a timely basis, our production could beinterrupted until we obtain an alternative source of supply. To date, we havenot experienced significant delays in obtaining dyes, optical andelectro-optical components, electronic components, and raw materials for ourproducts.

**Research and Development**

We believe that ouradvanced research and engineering activities are crucial to maintaining andenhancing our business, and we are currently conducting research on a number ofapplications. We believe that our in-house research and development staff hasdemonstrated its ability to develop innovative new products that meet evolvingmarket needs. Our core competencies include:

·       appliedlaser physics and technology

·       tissueoptics

·       photochemistry

·       laser-tissueinteraction

·       clinicaland regulatory research

·       aestheticlaser applications

·       engineeringand design of medical laser devices

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As we discover newtechnologies or applications with commercial potential, we assemble a team todevelop the new product or application in cooperation with leading physiciansand medical and research institutions. In the U.S. in particular, we mustreceive FDA clearance before marketing new products or applications.

Our research and developmentteam works with our operations group to design our products for ease ofmanufacturing and assembly and with our marketing group to respond to marketopportunities. We believe this interaction between functional groupsfacilitates the introduction of new products with the right balance offeatures, performance, quality, and cost. To date our research and developmenteffort has relied primarily on internal development building on our coretechnologies rather than through acquisition.

In addition, Candela conductsjoint research with physicians affiliated with various medical and researchinstitutions. One example of technology developed through joint research is ourDCD that was developed in conjunction with the Beckman Laser Institute at theUniversity of California, Irvine. We anticipate continuing joint research andlicensing arrangements with medical research institutions.

Our expenditures onresearch and development are set forth in Item 7.

**Customers**

We currently sell ourproducts primarily to physicians. The majority of our customers choose tofinance their purchases through independent leasing companies. Our sales arenot dependent on any single customer or distributor, and Candela continues toexpand its distribution channel in the U.S. through direct and indirect salesforces. Our customers are located in more than 64 countries.

**Competition**

Competition in theaesthetic and cosmetic laser industry is intense and technological developmentsare expected to continue at a rapid pace. Although there are severalmanufacturers of aesthetic and cosmetic lasers, we believe Candela is one ofonly a few companies that offer a broad range of products able to addressmultiple applications. Unlike Candela, few of our competitors focus exclusivelyon the cosmetic and aesthetic laser market. We compete on the basis ofproprietary technology, product features, performance, service, price, andreputation. Some of our competitors have greater financial, marketing, andtechnical resources than we do; moreover, some competitors have developed, andothers may attempt to develop, products with applications similar to ours.

Webelieve that many factors will affect our competitive position in the future,including our ability to:

·       developand manufacture new products that meet the needs of our markets

·       respondto competitive developments and technological changes

·       manufactureour products at lower cost

·       retaina highly qualified research and engineering staff

·       providesales and service to a worldwide customer base

·       improveproduct reliability

**Proprietary Rights**

We have numerous U.S. andforeign patents and have eight U.S.and eight foreign patent applicationspending to protect our rights in certain technical aspects of our hair removal,benign vascular lesion, pigmented lesion, and other laser systems. Theexpiration dates for our issued U.S. patents range from December 8, 2006to December 6, 2019.

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In addition to ourportfolio of patents issued and pending, we license patented technology fromthird parties. We use DCD under a license agreement to patent rights owned bythe Regents of the University of California (“Regents”). In August 2000 weentered into an agreement to amend the license agreement whereby in exchangefor an exclusivity fee of approximately $1.7 million, which was prepaid infull, Candela obtained exclusive license rights to the DCD (subject to certainlimited license rights of Cool Touch, Inc (“Cool Touch”)) in the followingfields of use: procedures that involve skin resurfacing and rejuvenation,vascular skin lesions, and laser hair removal. Cool Touch obtained a license tothe DCD on a co-exclusive basis with Candela, in certain narrower fields of use.Cool Touch is restricted in its ability to assign its license rights to certainexisting competitors of Candela. Candela is entitled to one-half of all royaltyincome payable to the Regents from Cool Touch. Under the amended agreement,Candela no longer is required by the Regents to negotiate sublicenses to thirdparties. However, Candela is entitled to one-half of all royalties due from anyother entity that licenses the DCD technology from the Regents in other fieldsof use.

We rely primarily on acombination of patent, copyright, and trademark laws to establish and protectour proprietary rights. We also rely on trade secret laws, confidentialityprocedures, and licensing arrangements to establish and protect our technologyrights. In addition, we seek to protect our proprietary rights by usingconfidentiality agreements with employees, consultants, advisors, and others. Wecannot be certain that these agreements will adequately protect our proprietaryrights in the event of any unauthorized use or disclosure, that our employees,consultants, advisors, or others will maintain the confidentiality of suchproprietary information, or that our competitors will not otherwise learn aboutor independently develop such proprietary information.

Despite our efforts toprotect our intellectual property, unauthorized third parties may attempt tocopy aspects of our products, to violate our patents, or to obtain and use ourproprietary information. In addition, the laws of some foreign countries do notprotect our intellectual property to the same extent as do the laws of the U.S.The loss of any material trademark, trade name, trade secret, or copyrightcould hurt our business, results of operations, and financial condition.

We believe that ourproducts do not infringe the rights of third parties. However, we cannot becertain that third parties will not assert infringement claims against us inthe future or that any such assertion will not result in costly litigation orrequire us to obtain a license to third party intellectual property. Inaddition, we cannot be certain that such licenses will be available onreasonable terms or at all, which could hurt our business, results ofoperations, and financial condition.

**GovernmentRegulation**

***FDA’s Premarket Clearance andApproval (“PMA”) Requirements.  ***Unless an exemptionapplies, each medical device that we wish to market in the U.S. must receiveeither “510(k) clearance” or PMA in advance from the U.S. Food and DrugAdministration pursuant to the Federal Food, Drug, and Cosmetic Act. The FDA’s510(k) clearance process usually takes from three to twelve months, but itcan last longer. The process of obtaining PMA approval is much more costly,lengthy, and uncertain and generally takes from one to three years or evenlonger. We cannot be sure that 510(k) clearance or PMA approval will everbe obtained for any product we propose to market.

The FDA decides whether adevice must undergo either the 510(k) clearance or PMA approval processbased upon statutory criteria. These criteria include the level of risk thatthe agency perceives is associated with the device and a determination whetherthe product is a type of device that is similar to devices that are alreadylegally marketed. Devices deemed to pose relatively less risk are placed ineither class I or II, which requires the manufacturer to submit a pre-marketnotification requesting 510(k) clearance, unless an exemption applies. Thepre-market notification must demonstrate that the proposed device is “substantiallyequivalent” in intended use and in safety and effectiveness to a legallymarketed “predicate device” that is either in class I, class II, or is a “pre-amendment”class III device (i.e., one that was in commercial distribution before May 28,1976) for which the FDA has not yet decided to require PMA approval.

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After a device receives510(k) clearance, any modification that could significantly affect itssafety or effectiveness, or that would constitute a major change in itsintended use, requires a new 510(k) clearance. The FDA requires eachmanufacturer to make this determination in the first instance, but the FDA canreview any such decision. If the FDA disagrees with a manufacturer’s decisionnot to seek a new 510(k) clearance, the agency may retroactively requirethe manufacturer to submit a pre-market notification requiring 510(k) clearance.The FDA also can require the manufacturer to cease marketing and/or recall themodified device until 510(k) clearance is obtained. We have modified someof our 510(k) cleared devices, but have determined that, in our view, new510(k) clearances are not required. We cannot be certain that the FDAwould agree with any of our decisions not to seek 510(k) clearance. If theFDA requires us to seek 510(k) clearance for any modification, we also maybe required to cease marketing and/or recall the modified device until weobtain a new 510(k) clearance.

Devices deemed by the FDAto pose the greatest risk such as life-sustaining, life-supporting, orimplantable devices, or deemed not substantially equivalent to a legallymarketed predicate device, are placed in class III. Such devices are requiredto undergo the PMA approval process in which the manufacturer must prove thesafety and effectiveness of the device to the FDA’s satisfaction. A PMAapplication must provide extensive pre-clinical and clinical trial data andalso information about the device and its components regarding, among otherthings, manufacturing, labeling, and promotion. After approval of a PMA, a newPMA or PMA supplement is required in the event of a modification to the device,it’s labeling, or its manufacturing process.

A clinical trial may berequired in support of a 510(k) submission or PMA application. Such trialsgenerally require an Investigational Device Exemption (“IDE”) applicationapproved in advance by the FDA for a limited number of patients, unless theproduct is deemed a nonsignificant risk device eligible for more abbreviatedIDE requirements. The IDE application must be supported by appropriate data,such as animal and laboratory testing results. Clinical trials may begin oncethe IDE application is approved by the FDA and the appropriate institutionalreview boards are at the clinical trial sites.

To date, the FDA hasdeemed our products to be class II devices eligible for the 510(k) clearanceprocess. We believe that most of our products in development will receivesimilar treatment. However, we cannot be certain that the FDA will not deem oneor more of our future products to be a class III device and impose the moreburdensome PMA approval process.

***Pervasive and Continuing FDARegulation.  ***A host of regulatory requirements applyto marketed devices such as our laser and light-based products, includinglabeling regulations, the Quality System Regulation (which requiresmanufacturers to follow design, testing, control, documentation, and otherquality assurance procedures), the Medical Device Reporting regulation (whichrequires that manufacturers report to the FDA certain types of adverse eventsinvolving their products), and the FDA’s general prohibition against promotingproducts for unapproved or “off label” uses. Class II devices such as oursalso can have special controls such as performance standards, post-marketsurveillance, patient registries, and FDA guidelines that do not apply to classI devices. Unanticipated changes in existing regulatory requirements oradoption of new requirements could hurt our business, financial condition, andresults of operations.

We are subject toinspection and market surveillance by the FDA for compliance with regulatoryrequirements. If the FDA finds that we have failed to comply with applicablerequirements, the agency can institute a wide variety of enforcement actions. TheFDA sometimes issues a public warning letter, but also may pursue more drasticremedies, such as refusing our requests for 510(k) clearance or PMA approvalof new products, withdrawing product approvals already granted to us, requiringus to recall products, or asking a court to require us to pay civil penaltiesor criminal fines, adhere to operating restrictions, or close 

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down ouroperations. Ultimately, criminal prosecution is available to the FDA aspunishment for egregious offenses. Any FDA enforcement action against us couldhurt our business, financial condition, and results of operation.

***Other U.S. Regulation.  ***Wealso must comply with numerous federal, state, and local laws relating to suchmatters as safe working conditions, manufacturing practices, environmentalprotection, fire hazard control, and hazardous substance disposal. We cannot besure that we will not be required to incur significant costs to comply withsuch laws and regulations in the future or that such laws or regulations willnot hurt our business, financial condition, and results of operations.

***Foreign Regulation.  ***Internationalsales are subject to foreign government regulation, the requirements of whichvary substantially from country to country. The time required to obtainapproval by a foreign country may be longer or shorter than that required forFDA approval, and the requirements may differ. Companies are now required toobtain the CE Mark prior to sale of certain medical devices within the EuropeanUnion (“EU”). During this process, the sponsor must demonstrate compliance withISO manufacturing and quality requirements.

Candela and its productsmay also be subject to other federal, state, local, or foreign regulationsrelating to health and safety, environmental matters, quality assurance, andthe like. To date, Candela’s compliance with laws that regulate the dischargeof materials into the environment or otherwise relate to the protection of theenvironment has not had a material effect on its ongoing operations. Candelahas not made any material expenditures for environmental control facilities.However, we cannot be certain that we will not be required to incur significantcosts to comply with such laws and regulations in the future or that such lawsor regulations will not hurt our business, financial condition, or results ofoperations.

**ProductLiability and Warranties**

Our products are generallycovered by a standard warranty, with an option to purchase extended warrantycontracts at the time of product sale or service contracts after the time ofsale. We set aside a reserve based on anticipated standard warranty claims. Webelieve such reserves to be adequate, but in the event of a major productproblem or recall, such reserves may be inadequate to cover all costs, and suchan event could have a material adverse effect on our business, financialcondition, and results of operations.

Our business involves theinherent risk of product liability claims. We maintain appropriate productliability insurance with respect to our products with a coverage limit of $13million in the aggregate. We cannot be certain that with respect to our currentor future products, such insurance coverage will continue to be available onterms acceptable to us or that such coverage will be adequate for liabilitiesthat may actually be incurred.

**The Skin CareCenters**

In 1996, we began aneffort to own and operate skin care centers offering cosmetic laser treatmentsutilizing our equipment along with other cosmetic services traditionallyoffered by high-end spas. We pursued this strategy by purchasing an operatingspa in Boston in 1996. In March 1997, we opened a new facility inScottsdale, Arizona, with no pre-existing customer base. We subsequentlydecided to reduce our focus on our skin care center efforts. We closed ourScottsdale facility in 1997. We have subleased the Scottsdale facility as ofthe third quarter of fiscal 2002. The remaining spa in Boston was closed in September of2003.

**Applied Optronics**

On January 8, 2003,the Company acquired substantially all of the assets of Applied Optronics, thediode division of Schwartz Electro-Optics, Inc. Applied Optronics was aleading manufacturer of high-powered, pulsed and CW lasers, and was a componentsupplier to the OEM market that serves a variety of industries including themilitary, medical, industrial, research and robotics fields. Applied Optronicswas the lead supplier of the diodes for the Company’s Smoothbeam diode lasersystem. The Applied Optronics operation, located in South Plainfield, NewJersey, generates revenue from diode sales to third-party customers.

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**Employees**

As of July 2,2005, we employed 312 people in the following areas of our organization:

·       36in research, development, and engineering

·       61in manufacturing and quality assurance

·       45in service positions

·       47in sales and marketing

·       87in our international sales and service subsidiaries

·       36in finance, administrative and all other positions

**Recent Accounting Pronouncements**

In November 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS Statement No. 151, *Inventory Costs, an Amendment of AccountingPrinciples Board Opinion No. 43, Chapter 4*, orSFAS 151. SFAS 151 requires that items such as idle facility expense,freight, handling costs and wasted materials be recognized as current-periodcharges rather than being included in inventory regardless of whether the costsmeet the criterion of abnormal as defined in Accounting Principles BoardOpinion No. 43. SFAS 151 is applicable for inventory costs incurredduring fiscal years beginning after June 15, 2005. We will adopt thispronouncement on July 3, 2005 and we do not expect the adoption with havea material impact on our financial condition or results of operation.

In December 2004, theFASB issued Statement No. 123R, “Share-Based Payment” (“FAS 123R”). FAS123R is a revision of FASB Statement No. 123, “Accounting for Stock-BasedCompensation” (“FAS 123”). The Company is required to adopt the provisionsof FAS123R as of the beginning of its first fiscal quarter of 2006, beginning July 3,2005. This statement establishes standards for and requires the recognition ofthe cost of employment-related services settled in share-based payment. Theadoption of the provisions of FAS 123R will have a material impact on theCompany’s consolidated financial statements.

**Available Information**

Access to our Annual Reporton Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-Kand amendments to these reports filed with or furnished to the Securities andExchange Commission may be obtained through the Investor Relations section ofour website at *www.candelalaser.com/ir_corp.asp*as soon as reasonably practical after we electronically file or furnish thesereports. We do not charge for access to and viewing of these reports.Information on our Investor Relations page and on our website is not partof this Annual Report on Form 10-K or any of our other securities filingsunless specifically incorporated herein by reference. In addition, our filingswith the Securities and Exchange Commission may be accessed through the Securitiesand Exchange Commission’s Electronic Data Gathering, Analysis and Retrievalsystem at *www.sec.gov.* All statements made in anyof our securities filings, including all forward-looking statements orinformation, are made as of the date of the document in which the statement isincluded, and we do not assume or undertake any obligation to update any ofthose statements or documents unless we are required to do so by law.

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**Item 2.**                        Properties.

We lease a facility totaling approximately 35,000square feet for our operations in Wayland, Massachusetts, which is locatedapproximately 20 miles west of Boston. The lease on this facility was amendedin April 2003 to extend the expiration date to March 2008. We alsolease a 12,000 square foot facility in South Plainfield, New Jersey for ourdiode operation. This lease ends on October 31, 2008. Candela’s managementbelieves that its current facilities are suitable and adequate for our near-termneeds.

Candela’ssubsidiaries currently lease the following facilities:

·       CandelaSkin Care Center of Scottsdale, Inc., 7,555 square feet located inScottsdale, AZ.   The lease on this facility is for a period of ten years,expiring on June 30, 2006, with a provision for two five-yearextensions. On November 1, 2001, the Scottsdale facility was subleased,although sublease payments did not begin until April 2002. As part of thesub-lease agreement, Candela will pay one month of rent in each of fiscal years2003, 2004 and 2005. Future rent payments have been accounted for in ourrestructuring reserve.

·       CandelaSkin Care Center of Boston, Inc., 20,728 square feet located in Boston, MA.   Thelease on this facility is for a period of 15 years, and commenced on June 1,1994. Future rent payments have been accounted for in our restructuringreserve.

·       CandelaKK.—Tokyooffice.   The lease on 400, and 72 square meters of space, expires on May 23,2008, and September 16, 2006, respectively.

·       CandelaKK—Osakaoffice.   The lease on this 97 square meter facility is for a period of 2years, expiring on Jan 20, 2007.

·       CandelaKK—Nagoyaoffice.   The lease on this 49 square meter facility is for a period of 1year, expiring on November 14, 2005.

·       CandelaKK—Fukuokaoffice.   The lease on this 56 square meter facility is for a period of 2years, expiring on September 30, 2005.

·       CandelaIberica, S.A..   The lease on this 368 square meter facility located inMadrid, Spain is for a period of two years and expires on December 31,2006.

·       CandelaIberica, S.A.   The lease on this 70 square meter facility located inLisboa, Portugual is for a period of five years and expires on September 29,2008.

·       CandelaDeutschland GmbH.   The lease on this 380 square meter facility in NeuIsenberg, Germany is for a period of 5 years and expires on October 31,2006.

·       CandelaFrance SARL.   The lease on this 108 square meter facility in Villebou SurYvette, France is for a period of 9 years, expiring on May 1, 2011.

·       CandelaItalia.   The lease on this 102 square meter facility in Formello, Italy isfor a period of 1 year, expiring on June 30, 2006.

·       Bangkok,Thailand.   The Manager of Pacific Rim operations resides and operates outof a leased residence in Bangkok, Thailand. The total leased area isapproximately 4,800 square feet and the lease is renewable on an annual basis.

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**Item 3.**                        LegalProceedings.

The Company has an Amended and Restated LicenseAgreement (the “License”) with the Regents of the University of California (the“Regents”) pursuant to which the Company licenses certain patent rights to itsdynamic cooling device (“DCD”) from the Regents. The Company sells its DCD as acomponent part of its Smoothbeam® laser system and as an accessory to its otherlaser systems. In April of 2004, the Regents issued a notice of defaultunder the License, asserting, among other things, that the Company was inbreach of the License for the alleged failure to make required royalty paymentsand to make required disclosures. The Regents’ April notice asserted thatthe total underpaid royalties, interest and other charges for the period from August of2000 through September 2003 are $1,128,000. The Regents issued asubsequent notice of default, dated June 30, 2004, relating to thequarterly periods ended December 27, 2003 and March 27, 2004, forwhich the Regents asserted that the Company underpaid additional royaltiesamounting to $1,350,000. The Regents issued a subsequent notice of default,dated September 10, 2004, relating to the quarterly period ended July 3,2004, for which the Regents asserted that the Company underpaid additionalroyalties amounting to $990,000.

Under the License, disputes are to be settled bybinding arbitration through a mutually acceptable single arbitrator. On June 14,2004, the Company filed a Demand for Arbitration to adjudicate the differinginterpretations of the License held by the Company and the Regents. On July 8,2004, the Regents filed their response and counterclaim for breach of contractand declaratory relief. Candela deposited approximately $1.0 million in June of2004, and an additional $1.0 and $1.4 million in August and December,respectively, of 2004, into an escrow fund to be paid in whole or in part tothe Company or the Regents as determined by the arbitrator.

On February 17th 2005, the arbitrator issued aninterim decision in the dispute concerning our royalty obligations under ourAmended and Restated License Agreement with the Regents. The arbitrator foundin favor of the Regents as to the primary issue in the dispute, finding that weare obligated to pay royalties on the good faith list prices of our Sclero,SPTL, GentleLASE and GentleYAG laser systems when those systems are sold withDCDs, and not just on the good faith list prices of the DCDs for sale withthose systems. The arbitrator denied the Regents’ request for the right todeclare a forfeiture of our license with the Regents. In connection with thisinterim decision we recognized charges of approximately $5.6 million during thethird fiscal quarter. These charges consisted of the settlement of prior yearroyalty claims made by the Regents against the Company of approximately $3.4million, royalty claims for our first and second fiscal quarters of 2005 ofapproximately $0.5 and $0.9 million, respectively, and $0.8 million in attorneyfees, interest, and professional costs as reimbursement of those charges to theRegents as required by the aforementioned license agreement. The royaltycharges have been listed as a separate line under cost of goods sold. All othercharges have been listed as a separate line within operating expenses.

On May 4th, 2005, the arbitratorissued his final award after review of post-arbitration submissions by theparties as to calculation of damages. The final award was consistent with ourinterim estimation and recognition of expense recorded during the thirdquarter. There will not be any material additional charges related to thismatter in future periods. As a result of the arbitrator’s ruling, Candelaincurred royalty obligations to the Regents on ongoing sales of the DCD at ahigher royalty rate than it has recognized on DCD sales over the past fewyears.

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On August 20, 2005, DVI Inc., DVI FinancialServices, Inc., and DVI Business Credit Corporation Liquidating Trust(collectively, the “DVI Entities”) filed a complaint against the Company in theUnited States Bankruptcy Court for the District of Delaware. The DVI Entitiesfiled voluntary petitions for relief under Chapter 11 of the United StatesBankruptcy Code on August 25, 2003 (the “Petition Date”). The complaintasserts, among other things, that (i) on or within 90 days before thePetition Date, one or more of the DVI Entities transferred property to or forthe benefit of the Company in an aggregate amount not less than $1,878,921.75, (ii) atthe time of the transfers the DVI Entities were insolvent, (iii) thetransfers enabled the Company to receive more than the Company was entitled tounder the United States Bankruptcy Code, and (iv) the transfersconstitute an avoidable preference. The complaint seeks avoidance and recoveryof the transfers, plus interest and costs of the proceeding. The complaint alsoseeks, among other things, to disallow the Company’s claims against the DVIEntities until the Company has paid the recovery amount to the DVI Entities. Aspreviously disclosed in the Company’s periodic reports, prior to the filing ofthe complaint, the Company had received demands for payment of therecovery amount. The Company believes that it received all transfersfrom the DVI Entities in the ordinary course of business and that theallegations in the complaint are without merit. While the Company intends tovigorously contest the allegations, the litigation process is inherentlyuncertain and unpredictable and there can be no guarantee as to the ultimateoutcome of this pending lawsuit. An adverse outcome in the litigation couldhurt our business, results of operations, and financial condition.

From time to time, theCompany is a party to various legal proceedings incidental to its business. Exceptfor the bankruptcy preference claims in the DVI matter, the Company believesthat none of the legal proceedings that are presently pending, if adverselydecided to the Company, will have a material adverse effect upon its financialposition, results of operations, or liquidity.

**Item 4.**                        Submissionof Matters to a Vote of Security Holders

No matter was submitted toa vote of our security holders during the fourth quarter of the fiscal yearcovered by this report.

**PART II**

**Item 5.**                        Marketfor the Registrant’s Common Stock and Related Stockholder Matters.

Candela’s common stock trades on The NASDAQ NationalMarket under the symbol “CLZR.”

At September 23, 2005, there were approximately 314holders of record of our common stock and the closing sale price of our commonstock was $9.81.

The following table setsforth quarterly high and low closing sales prices of the common stock for theindicated fiscal periods. These prices have been adjusted from historic levelsto reflect the effect of the Company’s two-for-one stock split implemented inthe third quarter of 2004:

| ** **       | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------|------------|----------|------------|---------|------------|
| **Fiscal 2004**  |       |     |       |    |       |
| First Quarter    |       | $        | 8.585      |    | $          | 5.745 |   |
| Second Quarter   |       | 10.975   |       | 6.335   |       |
| Third Quarter    |       | 14.200   |       | 9.035   |       |
| Fourth Quarter   |       | 17.130   |       | 8.840   |       |
| **Fiscal  2005** |       |     |       |    |       |
| First Quarter    |       | $        | 12.52      |    | $          | 7.85 |   |
| Second Quarter   |       | 12.08    |       | 7.96    |       |
| Third Quarter    |       | 12.58    |       | 8.35    |       |
| Fourth Quarter   |       | 10.99    |       | 8.56    |       |

 

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**Dividend Policy**

We have never paid a cashdividend and have no present intention to pay cash dividends in the foreseeablefuture. The Board of Directors currently intends to retain any future earningsfor use in our business.

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

See Part III, Item 12for information regarding securities authorized for issuance under equitycompensation plans.

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**Item 6.**                        SelectedConsolidated Financial Data.

The table set forth belowcontains certain consolidated financial data for each of the last five fiscalyears of Candela. This data should be read in conjunction with the detailedinformation, financial statements and related notes, as well as Management’sDiscussion and Analysis of Financial Condition and Results of Operationsincluded elsewhere herein.

| ** **                                                                                                                                                                                                      | ** ** | **For the Year Ended**                              | ** **  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|-------------|
| ** **                                                                                                                                                                                                      | ** ** | **July 2,**                                                   | ** **  | **July 3,** | ** ** | **June 28,** | ** ** | **June 29,** | ** ** | **June 30,** | ** ** |
| **Consolidated Statement of Operations Data:**                                                                                                                                              | ** ** | ** **                                                         | ** **  | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                                                                                                                                                      | ** ** | **(in thousands, except per share data)** | ** **  |
| **Revenue:**                                                                                                                                                                                                    | ** ** | ** **                                                         | ** **  | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Lasers and other  products                                                                                                                                                                                      | ** ** | **$**                                                              | **102,323** | ** ** | **$** | **87,965** | ** ** |   | **$** | **68,072** | ** ** |   |   | **$** | **45,957** | ** ** |   |   | **$** | **48,375** | ** ** |   |
| Product related  service                                                                                                                                                                                        | ** ** | **21,578**                                                         | ** **  | **16,473** | ** ** |   | **10,579** | ** ** |   |   | **12,731** | ** ** |   |   | **12,498** | ** ** |   |
| Total revenue                                                                                                                                                                                                   | ** ** | **123,901**                                                        | ** **  | **104,438** | ** ** |   | **78,651** | ** ** |   |   | **58,688** | ** ** |   |   | **60,873** | ** ** |   |
| **Cost of sales:**                                                                                                                                                                                              | ** ** | ** **                                                         | ** **  | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Lasers and other  products                                                                                                                                                                                      | ** ** | **45,235**                                                         | ** **  | **36,413** | ** ** |   | **30,641** | ** ** |   |   | **20,396** | ** ** |   |   | **21,208** | ** ** |   |
| Product related  service                                                                                                                                                                                        | ** ** | **17,918**                                                         | ** **  | **14,860** | ** ** |   | **7,992** | ** ** |   |   | **11,205** | ** ** |   |   | **7,676** | ** ** |   |
| Litigation related  charges                                                                                                                                                                                     | ** ** | **4,829**                                                          | ** **  | **—** | ** ** |   | **—** | ** ** |   |   | **—** | ** ** |   |   | **—** | ** ** |   |
| Total cost of  sales                                                                                                                                                                                            | ** ** | **67,982**                                                         | ** **  | **51,273** | ** ** |   | **38,633** | ** ** |   |   | **31,601** | ** ** |   |   | **28,884** | ** ** |   |
| **Gross  profit:**                                                                                                                                                                                              | ** ** | **55,919**                                                         | ** **  | **53,165** | ** ** |   | **40,018** | ** ** |   |   | **27,087** | ** ** |   |   | **31,989** | ** ** |   |
| **Operating expenses:**                                                                                                                                                                                         | ** ** | ** **                                                         | ** **  | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Research and  development                                                                                                                                                                                       | ** ** | **6,890**                                                          | ** **  | **5,302** | ** ** |   | **4,545** | ** ** |   |   | **4,644** | ** ** |   |   | **5,575** | ** ** |   |
| Selling, general  and administrative                                                                                                                                                                            | ** ** | **40,165**                                                         | ** **  | **33,978** | ** ** |   | **24,519** | ** ** |   |   | **24,832** | ** ** |   |   | **21,064** | ** ** |   |
| Litigation related  charges                                                                                                                                                                                     | ** ** | **773**                                                            | ** **  | **—** | ** ** |   | **—** | ** ** |   |   | **—** | ** ** |   |   | **—** | ** ** |   |
| Total operating  expenses                                                                                                                                                                                       | ** ** | **47,828**                                                         | ** **  | **39,280** | ** ** |   | **29,064** | ** ** |   |   | **29,476** | ** ** |   |   | **26,639** | ** ** |   |
| **Income  (loss) from operations:**                                                                                                                                                                             | ** ** | **8,091**                                                          | ** **  | **13,885** | ** ** |   | **10,954** | ** ** |   |   | **(2,389** | **)** |   |   | **5,350** | ** ** |   |
| **Other income (expense):**                                                                                                                                                                                     | ** ** | ** **                                                         | ** **  | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Interest income                                                                                                                                                                                                 | ** ** | **640**                                                            | ** **  | **308** | ** ** |   | **651** | ** ** |   |   | **546** | ** ** |   |   | **1,652** | ** ** |   |
| Interest expense                                                                                                                                                                                                | ** ** | **(6**                                                             | **)**       | **(19** | **)** |   | **(218** | **)** |   |   | **(476** | **)** |   |   | **(438** | **)** |   |
| Other income  (expense), net                                                                                                                                                                                    | ** ** | **(67**                                                            | **)**       | **924** | ** ** |   | **(44** | **)** |   |   | **487** | ** ** |   |   | **31** | ** ** |   |
| Total other income  (expense)                                                                                                                                                                                   | ** ** | **567**                                                            | ** **  | **1,213** | ** ** |   | **389** | ** ** |   |   | **557** | ** ** |   |   | **1,245** | ** ** |   |
| **Income  (loss) from continuing operations before income** **tax:**                                                                                                                                       | ** ** | **8,658**                                                          | ** **  | **15,098** | ** ** |   | **11,343** | ** ** |   |   | **(1,832** | **)** |   |   | **6,595** | ** ** |   |
| **Provision  for (benefit from) income taxes**                                                                                                                                                                  | ** ** | **2,194**                                                          | ** **  | **4,586** | ** ** |   | **3,516** | ** ** |   |   | **(421** | **)** |   |   | **2,387** | ** ** |   |
| **Income  (loss) from continuing operations**                                                                                                                                                                   | ** ** | **6,464**                                                          | ** **  | **10,512** | ** ** |   | **7,827** | ** ** |   |   | **(1,411** | **)** |   |   | **4,208** | ** ** |   |
| **Discontinued operations:**                                                                                                                                                                                    | ** ** | ** **                                                         | ** **  | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Loss from  discontinued skin care center operations of $473, $1468, $964, and $2635 less  income tax benefit of $175, $455, $221, and $953 respectively                                                    | ** ** | **—**                                                         | ** **  | **(298** | **)** |   | **(1,013** | **)** |   |   | **(743** | **)** |   |   | **(1,682** | **)** |   |
| Gain (loss) on  disposal of skin care center, including revision of leasehold obligations of  $1,374 and provision for operating losses of $(3,348) less income tax of  $(515) and income tax benefit of $1,253 | ** ** | **859**                                                            | ** **  | **(2,095** | **)** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **Net  income (loss)**                                                                                                                                                                                          | ** ** | **$**                                                              | **7,323**   | ** ** | **$** | **8,119** | ** ** |   | **$** | **6,814** | ** ** |   |   | **$** | **(2,154** | **)** |   |   | **$** | **2,526** | ** ** |   |
| **Net income (loss) per share of common stock**                                                                                                                                                                 | ** ** | ** **                                                         | ** **  | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **Basic:**                                                                                                                                                                                                      | ** ** | ** **                                                         | ** **  | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Income from  continuing operations                                                                                                                                                                              | ** ** | **$**                                                              | **.29**     | ** ** | **$** | **.48** | ** ** |   | **$** | **.39** | ** ** |   |   | **$** | **(.07** | **)** |   |   | **$** | **.19** | ** ** |   |
| Income (loss) from  discontinued operations                                                                                                                                                                     | ** ** | **.04**                                                            | ** **  | **(.11** | **)** |   | **(.05** | **)** |   |   | **(.04** | **)** |   |   | **(.07** | **)** |   |
| **Net  income (loss)**                                                                                                                                                                                          | ** ** | **$**                                                              | **.33**     | ** ** | **$** | **.37** | ** ** |   | **$** | **.34** | ** ** |   |   | **$** | **(.11** | **)** |   |   | **$** | **.12** | ** ** |   |
| **Diluted:**                                                                                                                                                                                                    | ** ** | ** **                                                         | ** **  | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Income from  continuing operations                                                                                                                                                                              | ** ** | **$**                                                              | **.28**     | ** ** | **$** | **.46** | ** ** |   | **$** | **.38** | ** ** |   |   | **$** | **(.07** | **)** |   |   | **$** | **.18** | ** ** |   |
| Income (loss) from  discontinued operations                                                                                                                                                                     | ** ** | **.04**                                                            | ** **  | **(.10** | **)** |   | **(.05** | **)** |   |   | **(.04** | **)** |   |   | **(.07** | **)** |   |
| **Net  income (loss)**                                                                                                                                                                                          | ** ** | **$**                                                              | **.32**     | ** ** | **$** | **.36** | ** ** |   | **$** | **.33** | ** ** |   |   | **$** | **(.11** | **)** |   |   | **$** | **.11** | ** ** |   |
| **Basic  weighted average shares outstanding**                                                                                                                                                                  | ** ** | **22,388**                                                         | ** **  | **21,902** | ** ** |   | **20,083** | ** ** |   |   | **20,106** | ** ** |   |   | **21,856** | ** ** |   |
| **Diluted  weighted average shares outstanding**                                                                                                                                                                | ** ** | **23,073**                                                         | ** **  | **22,712** | ** ** |   | **20,645** | ** ** |   |   | **20,106** | ** ** |   |   | **23,042** | ** ** |   |
|                                                                                                                                                                                                                 |            |                                                                    |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

22

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| ** **                                           | ** ** | **For the Year Ended** | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                           | ** ** | **July 2,**                      | ** ** | **July 3,** | ** ** | **June 28,** | ** ** | **June 29,** | ** ** | **June 30,** | ** ** |
| **Consolidated Balance Sheet Data:**  | ** ** | ** **                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Cash and cash equivalents**                        | ** ** | **$**                                 | **56,383** | ** ** | **$** | **37,139** | ** ** |   | **$** | **31,813** | ** ** |   |   | **$** | **19,657** | ** ** |   |   | **$** | **32,127** | ** ** |   |
| **Working capital**                                  | ** ** | **70,378**                            | ** ** | **61,387** | ** ** |   | **47,307** | ** ** |   |   | **35,642** | ** ** |   |   | **61,836** | ** ** |   |
| **Total assets**                                     | ** ** | **116,816**                           | ** ** | **100,479** | ** ** |   | **80,501** | ** ** |   |   | **67,130** | ** ** |   |   | **72,718** | ** ** |   |
| **Long-term debt**                                   | ** ** | **—**                            | ** ** | **—** | ** ** |   | **—** | ** ** |   |   | **2,115** | ** ** |   |   | **2,815** | ** ** |   |
| **Total stockholders’ equity**                  | ** ** | **74,339**                            | ** ** | **66,769** | ** ** |   | **53,348** | ** ** |   |   | **40,853** | ** ** |   |   | **46,975** | ** ** |   |
| **Total  liabilities and stockholders’ equity** | ** ** | **116,816**                           | ** ** | **100,479** | ** ** |   | **80,501** | ** ** |   |   | **67,130** | ** ** |   |   | **72,718** | ** ** |   |
|                                                      |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

*All statements, trend analysis and other informationcontained in the following discussion relative to markets for our products andtrends in revenue, gross margins and anticipated expense levels, as well asother statements including words such as “anticipate”, “believe”, “plan”, “estimate”,“expect”, and “intend” and other similar expressions, constituteforward-looking statements. These forward-looking statements are subject tobusiness and economic risks and uncertainties, and our actual results ofoperations may differ materially from those contained in the forward-lookingstatements. Factors that could cause or contribute to such differences include,but are not limited to, those discussed in “Cautionary Statements” as well asother risks and uncertainties referenced in this Annual Report on Form 10-K.*

**Overview**

We research, develop, manufacture, market, sell andservice lasers and light-based products used to perform aesthetic and cosmeticprocedures. We sell our lasers and light-based products principally to medicalpractitioners. Candela markets its products directly and through a network ofdistributors to end users. Our traditional customer base includes plastic andcosmetic surgeons and dermatologists. More recently, we have expanded our salesto a broader group of practitioners consisting of general practitioners andcertain specialists including obstetricians, gynecologists, and general andvascular surgeons. We derive our revenue from the sale of lasers, light-baseddevices, and other products, and the provision of product related services.

We sell products in the U.S. through our direct salesforce to our traditional customer base of dermatologists and cosmetic surgeons.Outside the U.S. we sell our products in Western Europe, Japan, Latin and SouthAmerica, the Middle East, and the Pacific Rim through seven direct salesoffices and more than 50 independent distributors.

We typically assemble products in our Wayland,Massachusetts, facility in the quarter in which they are shipped, and backloghas not been significant. We experience some seasonal reduction of our productsales in the quarter ending in September due to the summer holidayschedule of physicians and their patients.

Our products are generally covered by a standardwarranty, with an option to purchase extended warranty contracts at the time ofproduct sale or service contracts after the time of sale. Distributor salesgenerally include a parts warranty only. The anticipated cost associated with thestandard warranty coverage is accrued at the time of shipment as a cost ofsales charged to product related service costs. Any costs associated withproduct installation are also recognized as costs of product related service. Bothsuch anticipated and actual costs have no associated revenue and thereforereduce the gross profit from product related service revenue.

23

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Product related servicerevenue consists of revenue from maintenance and repair services and the saleof spare parts and consumables. We derive revenue from extended servicecontracts, which are typically for a 12 or 24-month period, and the revenue isinitially deferred and recognized over the life of the service contract. Inaddition, we provide on-site service worldwide on a time-and-materials basisdirectly or through our distributors.

International revenue,consisting of sales from our subsidiaries in Germany, France, Spain, and Japan,and sales shipped directly to international locations from the U.S., during thefiscal years ended July 2, 2005, July 3, 2004 and June 28, 2003represented 54%, 52% and 53% of total sales, respectively.

Our fiscal year consistsof the 52 or 53-week period ending on the Saturday closest to June 30 ofeach year. The years ended July 2, 2005, July 3, 2004 and June 28,2003 contained 52, 53 and 52 weeks, respectively.

***DiscontinuedOperations***

In June 1996, we began an effort to own andoperate skin care centers offering cosmetic laser treatments utilizing ourequipment, along with providing other cosmetic services traditionally offeredby high-end spas. We pursued this strategy by purchasing an existing spa inBoston in 1996 and by opening a new skin care center in Scottsdale, Arizona in March 1997.We subsequently decided to reduce our focus on our skin care center efforts andto renew our commitment to our core aesthetic and cosmetic laser business. Duringfiscal 1998, we closed the Scottsdale facility. During the quarters ended December 27,1997 and June 30, 2001, the Company recorded combined restructuring chargesof $3,721 related to this closure and was subsequently able to reverse asubstantial portion of this charge due to the Company’s ability to secure asublease for the Scottsdale facility. Per the sublease agreement, the sublesseewill pay all costs associated with the facility through the end of the leaseterm ending June 2006. The sublessee commenced making payments to thelandlord on behalf of the Company on April 1, 2002.

On September 27, 2003 management initiated a planto close its only remaining skin care center. The closure is accounted for as adiscontinued operation in accordance with Statement of Financial AccountingStandards (“SFAS”) 144 “*Accounting for theImpairment or Disposal of Long-Lived Assets*” and SFAS 146 “*Accounting for Costs Associated with Exit or Disposal Activities*”.As a result, in the fiscal quarter ended September 27, 2003, the Companyrecorded a $2,095 charge for the accrual of $3,000 of future occupancy costs,primarily relating to future lease payments for the Boston facility, and $348of severance obligations and other related costs of closure, net of anticipatedtax benefits of $1,253.

During the three-monthperiod ended October 2, 2004, the landlord for the Boston facility secureda sublease for that property. The Company was not able to determine the futureeconomic benefit of the sublease at that time. The sublessee commenced makingpayments to the landlord during December of 2004. As a result of these andfuture payments scheduled under the sublease, the Company revised the estimatedfuture costs associated with the Boston facility and, in the quarter ended January 1,2005, reversed approximately $859 of the restructuring reserve. This reversalrepresents the aforementioned anticipated economic benefit due to sublessee paymentsof $1,703, net of legal and other fees of approximately $329 and income taxesof approximately $515, and was recognized in the three-month period ended January 1,2005.

24

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***Critical Accounting Policies***

The discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. On an on-going basis, we evaluate ourestimates, including those related to revenue recognition, bad debts,inventories, warranty obligations, and income taxes. We base our estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying value of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions. We believe the followingcritical accounting policies and the related judgments and estimates affect thepreparation of our consolidated financial statements.

**Revenue Recognition.**   TheCompany recognizes revenue upon shipment of product to customers and thefulfillment of all contractual terms and conditions, pursuant to the guidanceprovided by SAB No. 104, *Revenue Recognition inFinancial Statements.* Credit is not extended to customers andrevenue is not recognized until collectibility is reasonably assured. Revenuefrom the sale of service contracts is deferred and recognized on astraight-line basis over the contract period. Revenue from service administeredby Candela that is not covered by a service contract is recognized as theservices are provided. In certain instances, the Company may sell productstogether with extended warranties or maintenance contracts. The revenuerecognized per element is determined by allocating the total sales price toeach element, based on the relative fair values. Separately priced extendedwarranty and maintenance products are accounted for in accordance withFinancial Technical Bulletin 90-1 which provides for recognition ofrevenue ratably over the life of the contract.

**Allowance for Doubtful Accounts.**   Ourpolicy is to maintain allowances for estimated losses resulting from theinability of our customers to make required payments. Credit limits areestablished through a process of reviewing the financial history and stabilityof each customer. Where appropriate, we obtain credit rating reports andfinancial statements of customers when determining or modifying their creditlimits. We regularly evaluate the collectibility of our trade receivablebalances based on a combination of factors. When a customer’s account balancebecomes past due, we initiate dialogue with the customer to determine thecause. If it is determined that the customer will be unable to meet itsfinancial obligation to us, such as in the case of a bankruptcy filing,deterioration in the customer’s operating results or financial position orother material events impacting their business, we record a specific allowanceto reduce the related receivable to the amount we expect to recover given allinformation presently available.

As of July 2, 2005, our accounts receivablebalance of $34.9 million is reported net of allowances for doubtful accounts of$2.1 million. We believe our reported allowances at July 2, 2005, areadequate. If the financial conditions of those customers were to deteriorate,however, resulting in their inability to make payments, we may need to recordadditional allowances that would result in additional selling, general andadministrative expenses being recorded for the period in which suchdetermination was made.

**Inventory Reserves.**   As a designer and manufacturerof high technology equipment, we are exposed to a number of economic andindustry factors that could result in portions of our inventory becoming eitherobsolete or in excess of anticipated usage. These factors include, but are notlimited to, technological changes in our markets, our ability to meet changingcustomer requirements, competitive pressures in products and prices, and theavailability of key components from our suppliers. Our policy is to establishinventory reserves when conditions exist that suggest that our inventory may bein excess of anticipated demand or is obsolete based upon our assumptions aboutfuture demand for our products and market conditions. We regularly evaluate theability to realize the value of our inventory based on a combination of factorsincluding the following: historical usage rates, forecasted sales or usage,product 

25

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end of life dates,estimated current and future market values and new product introductions.Purchasing requirements and alternative usage avenues are explored within theseprocesses to mitigate inventory exposure. When recorded, our reserves areintended to reduce the carrying value of our inventory to its net realizablevalue. As of July 2, 2005, our inventory of $12.7 million is stated net ofinventory reserves of $1.9 million. If actual demand for our productsdeteriorates, or market conditions are less favorable than those that weproject, additional inventory reserves may be required.

**Product Warranties.**   Ourproducts are sold with warranty provisions that require us to remedydeficiencies in quality or performance of our products over a specified periodof time at no cost to our customers. Our policy is to establish warrantyreserves at levels that represent our estimate of the costs that will beincurred to fulfill those warranty requirements at the time that revenue isrecognized. We believe that our recorded liability at July 2, 2005, isadequate to cover our future cost of materials, labor and overhead for theservicing of our products sold through that date. If actual product failures ormaterial or service delivery costs differ from our estimates, our warrantyliability would need to be revised accordingly.

**Contingencies.**   We are subject to proceedings,lawsuits and other claims. We assess the likelihood of any adverse judgments oroutcomes to these matters as well as potential ranges of probable losses. Adetermination of the amount of reserves required, if any, for thesecontingencies is made after careful analysis of each individual issue. Therequired reserves may change in the future due to new developments in eachmatter or changes in approach such as a change in settlement strategy indealing with these matters. We record charges for the costs we anticipate incurringin connection with litigation and claims against us when we can reasonablyestimate these costs.

**Restructuring.**   We record restructuringcharges incurred in connection with consolidation or relocation of operations,exited business lines, or shutdowns of specific sites. These restructuringcharges, which reflect our commitment to a termination or exit plan that willbegin within twelve months, are based on estimates of the expected costsassociated with site closure, legal matters, contract terminations, or othercosts directly related to the restructuring. If the actual cost incurredexceeds the estimated cost, an additional charge to earnings will result. Ifthe actual cost is less than the estimated cost, a credit to earnings will berecognized.

**Taxes.**   In accordance with SFAS No. 109,“*Accounting for Income Taxes*,” werecognize deferred income taxes based on the expected future tax consequencesof differences between the financial statement basis and the tax basis ofassets and liabilities, calculated using enacted tax rates for the year inwhich the differences are expected to be reflected in the tax return.Realization is dependent on the generation of sufficient taxable income infuture years. Management continually evaluates the need for a valuation allowancefor deferred tax assets based on the probability of realization determined byexpectations for future taxable income and other factors. Although realizationis not assured, based on available evidence, management believes it is morelikely than not that the full amount of the net deferred tax asset will berealized. However, the amount realizable could be reduced if estimates offuture taxable income are reduced.

26

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**Results ofOperations**

Thefollowing tables set forth selected financial data for the periods indicated,expressed as a percentage of total revenue.

| ** **                                                                     | ** ** | **For the Year Ended** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| **  Consolidated Statement of Operations Data:** | ** ** | ** **                            | ** ** | **July 2,  2005** | ** ** | **July 3,  2004** | ** ** | **June 28,  2003** | ** ** |
| **Revenue Mix:**                                                               |       |                                  |       |   |   |   |   |   |   |
| Lasers and other  products                                                     |       | 82.6                                  | %          | 84.2 | % |   | 86.6 | % |   |
| Product related  service                                                       |       | 17.4                                  | %          | 15.8 | % |   | 13.4 | % |   |
| Total revenue                                                                  |       | 100.0                                 | %          | 100.0 | % |   | 100.0 | % |   |
| **Operating  Ratios:**                                                         |       |                                  |       |   |   |   |   |   |   |
| **Gross profit:**                                                              |       |                                  |       |   |   |   |   |   |   |
| Lasers and other  products                                                     |       | 46.1                                  | %          | 49.4 | % |   | 47.6 | % |   |
| Product related  service                                                       |       | 2.9                                   | %          | 1.5 | % |   | 3.3 | % |   |
| Litigation  related charges                                                    |       | (3.9                                  | )%         | — |   |   | — |   |   |
| Total gross  profit                                                            |       | 45.1                                  | %          | 50.9 | % |   | 50.9 | % |   |
| **Operating  expenses:**                                                       |       |                                  |       |   |   |   |   |   |   |
| Research and  development                                                      |       | 5.6                                   | %          | 5.1 | % |   | 5.8 | % |   |
| Selling,  general & administrative                                    |       | 32.4                                  | %          | 32.5 | % |   | 31.2 | % |   |
| Litigation  related charges                                                    |       | 0.6                                   | %          | — |   |   | — |   |   |
| Total operating  expenses                                                      |       | 38.6                                  | %          | 37.6 | % |   | 37.0 | % |   |
| Income (loss) from continuing operations                                       |       | 6.5                                   | %          | 13.3 | % |   | 13.9 | % |   |
| Total other income (expense)                                                   |       | 0.5                                   | %          | 1.2 | % |   | 0.5 | % |   |
| **Income  (loss) from continuing operations before income taxes**              |       | 7.0                                   | %          | 14.5 | % |   | 14.4 | % |   |
| Provision for (benefit from) income taxes                                      |       | 1.8                                   | %          | 4.4 | % |   | 4.4 | % |   |
| **Net income (loss) from  continuing operations**                              |       | 5.2                                   | %          | 10.1 | % |   | 10.0 | % |   |
|                                                                                |            |                                       |            |  |  |  |  |  |  |  |  |

 

**FiscalYear Ended July 2, 2005 Compared to Fiscal Year Ended July 3, 2004**

***Revenue.  ***Totalrevenue increased $19.5 million, or 18.6% to $123.9 million in fiscal 2005 from$104.4 million in fiscal 2004. Increases in unit sales and the average sellingprice per unit accounted for the increase. We sold approximately 180 additionallaser systems during fiscal 2005 as compared to 2004 with an average sellingprice approximately 4% higher than that of the prior year. Internationalrevenue, consisting of sales from our subsidiaries in Germany, Spain, Franceand Japan, and sales shipped directly to international locations from the U.S.,increased $11.9 million over the prior year and accounted for 54% of totalrevenue for fiscal 2005 in comparison to 52% for fiscal 2004. Of the $11.9million increase, approximately $5.2 million was related to increases in salesto South America. This represents an almost 400% increase in that region. Salesin Europe increased approximately 15.6%, or $4.1 million and sales in Asiaincreased 9.6%, or $2.6 million over sales during fiscal 2004. Product-relatedservice revenue increased 31% to $21.6 million in fiscal 2005 from $16.5million in fiscal 2004. This increase was consistent with the increase insystems sold over the past few years and the need for general maintenance andparts on these systems.

***Gross Profit.  ***Grossprofit increased approximately $2.7 million to $55.9 million or 45% of revenuein fiscal 2005 from $53.2 million or 51% of revenue in fiscal 2004 as a directresult of the increase in sales. Excluding the Regents litigation-related charges,gross profit increased $7.6 million, or 14% to approximately $60.7 million or49% of sales during fiscal 2005. Gross profit on lasers and other productsincreased $5.5 million or 11% to $57.1 million or 46% of revenue in fiscal 2005from $51.5 million or 49% of revenue in fiscal 2004. Gross profit on productrelated services in fiscal 2005 increased $2.0 million to $3.6 million or 3% ofrevenue compared to $1.6 million or 2% of revenue for fiscal 2004. The increasein 

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gross profit onproduct related services is due primarily to efforts in the service group toincrease the profitability of that organization.

***Research and Development Expense.  ***Research and development spendingincreased slightly as a percentage of revenue for fiscal 2005 over fiscal 2004due to the increased number and cost of ongoing projects. This increaseaccounted for approximately $1.6 million in additional expense.

***Selling, General andAdministrative Expense.  ***Selling, general andadministrative expense increased to $40.2 million or 32% of revenue duringfiscal 2005 compared to $33.9 million or 33% during fiscal 2004. The increasein selling, general and administrative expenses is due primarily to theincrease in the number of marketing programs, the implementation of theSarbanes-Oxley Act internal controls and reporting requirements, and anincrease in the number of personnel on a worldwide basis.

***Other Income/Expense.  ***Totalother income decreased $0.6 million for the fiscal year ended July 3, 2005to $0.6 million, from $1.2 million for the fiscal year ended June 28, 2004.This decrease is related to the absence of one-time gains of $0.9 millionduring fiscal 2004 from an insurance reimbursement of approximately $0.5million for stolen merchandise at our German subsidiary, period gains onsubsidiary transactions of approximately $0.2 million, and the timing of aninvestment distribution, partially offset by an increase in interest income of0.3 million due to an increased rate of return, coupled with a higher cashbalance during fiscal 2005.

***Income Taxes.  ***Theprovision for income taxes results from a combination of activities of both thedomestic and foreign subsidiaries of the Company. The Company recorded a 27%effective tax rate for the year ended July 2, 2005 compared to a 30%effective tax rate for the year ended July 3, 2004. The provision forincome taxes for the year ended July 2, 2005, includes a tax provisioncalculated for taxable income generated in Japan and Spain at rates in excessof the U.S. statutory tax rate.

**FiscalYear Ended July 3, 2004 Compared to Fiscal Year Ended June 28, 2003**

***Revenue.  ***Totalrevenue increased $25.7 million, or 33% to $104.4 million in fiscal 2004 from$78.7 million in fiscal 2003. Increases in unit sales and the growth inpopularity of our YAG and GentleLase systems accounted for the increase. Wesold approximately 440 additional laser systems during fiscal 2004 as comparedto 2003 with an average selling price roughly equivalent to that of the prioryear. International revenue, consisting of sales from our subsidiaries inGermany, Spain, France and Japan, and sales shipped directly to internationallocations from the U.S., increased $14.6 million over the prior year andaccounted for 52% of total revenue for fiscal 2004 in comparison to 51% forfiscal 2003. Of the $14.6 million increase approximately $3.0 million was relatedto favorable currency fluctuations. Product-related service revenue increased56% to $16.5 million in fiscal 2004 from $10.6 million in fiscal 2003. Thisincrease was consistent with the increase in systems sold over the past fewyears and the need for general maintenance and parts on these systems.

***Gross Profit.  ***Grossprofit increased $13.2 million to $53.2 million or 51% of revenue in fiscal2004 from $40.0 million or 51% of revenue in fiscal 2003 as a direct result ofthe increase in sales. Gross profit on lasers and other products increased$14.1 million or 38% to $51.6 million or 49% of revenue in fiscal 2004 from$37.4 million or 48% of revenue in fiscal 2003. Gross profit on product relatedservices in fiscal 2004 decreased $1.0 million to $1.6 million or 2% of revenuecompared to $2.6 million or 3% of revenue for fiscal 2003. The decrease ingross profit on product related services is due primarily to an increase inproducts under warranty associated with Vbeam and GentleLase product sales anda corresponding decrease in the number of systems on service contracts.

***Research and Development Expense.  ***Researchand development spending increased slightly for fiscal 2004 over fiscal 2003due to more active projects ongoing. This increase accounted for approximately$0.8 million in additional expense, but as a percentage of total revenue thiscategory decreased almost a full percentage point from the prior year.

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***Selling, General andAdministrative Expense.  ***Selling, general andadministrative expense increased to $33.9 million or 33% of revenue duringfiscal 2004 compared to $24.5 million or 31% during fiscal 2003. The increasein selling, general and administrative expenses is due primarily to the paymentof additional bonus and commission amounts due to overachievement of plannedtargets by our sales force coupled with the implementation of Sarbanes Oxleycontrol and reporting requirements.

***Other Income/Expense.  ***Forthe fiscal year ended July 3, 2004, total other income increased $0.8million to $1.2 million, from $0.4 million for the fiscal year ended June 28,2003. Interest income decreased $0.3 million from the prior year to $0.3million primarily as a result of the absence during the current period ofinterest payments of $0.4 million received from the PSS settlement in the prioryear, partially offset by higher cash balances invested throughout the fiscalyear. Interest expense was negligible for 2004 due to the retirement of ourlong-term debt in fiscal 2003 leading to a comparative gain of $0.2 millionover the prior year. Other income increased $1.0 million in fiscal 2004 ascompared to fiscal 2003 due primarily to an insurance reimbursement ofapproximately $0.5 million for stolen merchandise at our German subsidiary,period gains on subsidiary transactions of approximately $0.2 million, and thetiming of an investment distribution.

***Income Taxes.  ***Theprovision for income taxes results from a combination of activities of both thedomestic and foreign subsidiaries of the Company. The Company recorded a 30%effective tax rate for the year ended July 3, 2004 compared to a 31%effective tax rate for the year ended June 28, 2003. The benefit fromincome taxes for the year ended June 28, 2003, includes a tax benefit fortaxable losses in the U.S. offset by a tax provision calculated for taxableincome generated in Japan and Spain at rates in excess of the U.S. statutorytax rate.

**Liquidity and Capital Resources**

Cashprovided by operating activities amounted to $19.0 million for fiscal 2005 ascompared to $1.1 million for fiscal 2004. This increase in cash providedby operating activities is reflective of the Company’s ongoing efforts todecrease days’ sales outstanding in accounts receivable and increase inventoryturns. Days’ sales outstanding in trade accounts receivable was reduced by 16days to approximately 82 days at July, 2 2005, and inventory turns increasedapproximately one full turn for fiscal 2005 as compared to fiscal 2004. Weexpect to be able to continue this trend. Cash used by investing activitiesremained relatively flat for the fiscal 2005, as the Company continued itsconservative policy towards capital outlays for property, plant and equipment. Cashprovided by financing activities amounted to $1.0 million for the year ended July 2,2005 in comparison to cash provided of $4.7 million for the prior year. Thedecrease reflects the absence of proceeds from the issuance of common stock bythe Company during fiscal 2004, primarily to employees under the existing stockoption plan.

*Off-Balance SheetArrangements*

The Company did not have any off-balance sheetarrangements that have or are reasonably likely to have a current or futureeffect on the Company’s financial condition, changes in financial condition,revenues or expenses, results of operations, liquidity, capital expenditures orcapital resources.

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Outstandingcontractual obligations of the Company are reflected in the following table:

| ** **                          | ** ** | **Total**               | ** ** | **Less than  1 year** | ** **   | **1-3 years** | ** ** | **4-5 years** | ** **   | **After  5 years** | ** ** |
|-------------------------------------|------------|-------------------------|------------|---------------------------------|--------------|--------------------|------------|--------------------|--------------|-------------------------|------------|
| ** **                          | ** ** | **(in thousands)** | ** ** |
| Royalty commitments                 |       | $                       | 9,250      |                            |         | $                  | 4,000      |               |         |                    | $          | 2,000 |   |   |   | $ | 2,000 |   |   | $ | 1,250 |   |
| Operating leases                    |       |   2,534            |       |                            |   1,018 |               |       |               |   1,166 |                    |       |   |   302 |   |   | 48 |   |
| Total contractual cash  obligations |       | $                       | 11,784     |                            |         | $                  | 5,018      |               |         |                    | $          | 3,166 |   |   |   | $ | 2,302 |   |   | $ | 1,298 |   |

 

We maintain a renewable $10,000,000 revolving creditagreement with a major bank with interest at the bank’s base rate or LIBOR plus2.25%. Any borrowings outstanding under the line of credit are due on demand oraccording to a payment schedule established at the time funds are borrowed. Theline of credit is unsecured. The agreement contains restrictive covenantslimiting the establishment of new liens, and the purchase of margin stock. Noamounts were outstanding under the line of credit as of July 2, 2005, or July 3,2004.

We believe that cashbalances will be sufficient to meet anticipated cash requirements. However, wecannot be sure that we will not require additional capital beyond the amountscurrently forecasted by us, nor that any such required additional capital willbe available on reasonable terms, if at all, as it becomes required.

**Cautionary Statements**

This Annual Report on Form 10-K containsforward-looking statements including, without limitation, statements concerningthe future of the industry, product development, business strategy (includingthe possibility of future acquisitions), anticipated operational and capitalexpenditure levels, continued acceptance and growth of our products, anddependence on significant customers and suppliers. This Annual Report on Form 10-Kcontains forward-looking statements that we have made based on our currentexpectations, estimates and projections about our industry, operations, andprospects, not historical facts. We have made these forward-looking statementspursuant to the provisions of the Private Securities Litigation Reform Act of1995. These statements can be identified by the use of forward-lookingterminology such as “may,” “will,” “believe,” “expect,” “anticipate,” “estimate,”“continue” or other similar words. These statements discuss futureexpectations, and may contain projections of results of operations or offinancial condition or state other forward-looking information. Whenconsidering forward-looking statements, you should keep in mind the cautionarystatements in this Annual Report on Form 10-K. The cautionarystatements noted below and other factors noted throughout this Annual Report onForm 10-K could cause our actual results to differ significantlyfrom those contained in any forward-looking statement. We may not update orpublicly release the results of these forward-looking statements to reflectevents or circumstances after the date hereof.

**Because we derive more thanhalf of our revenue from international sales, including approximately 24% ofour revenue from Japan and the Asia-Pacific marketplace in fiscal 2005, we aresusceptible to currency fluctuations, negative economic changes taking place inJapan and the Asia-Pacific marketplace, and other risks associated withconducting business overseas.**

We sell more thanhalf of our products and services outside the U.S. and Canada. Internationalsales, consisting of sales from our subsidiaries in Germany, Spain, France andJapan, and sales shipped directly to international locations from the U.S.,accounted for 54% of our revenue for fiscal year 2005, and we expect that theywill continue to be significant. As a result, a major part of our revenues andoperating results could be adversely affected by risks associated withinternational sales. In particular, significant fluctuations in the exchangerates between the U.S. dollar and foreign currencies could cause us to lowerour prices and thus reduce our profitability, or could cause prospectivecustomers to push out orders to later dates because of the increased relativecost of our products in the aftermath of a currency devaluation 

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orcurrency fluctuation. Other risks associated with international sales that wecurrently face or have faced in the past include:

·       longerpayment cycles common in foreign markets

·       failureto obtain or significant delays in obtaining necessary import or foreignregulatory approvals for our products

·       difficultiesin staffing and managing our foreign operations.

**The failure to obtainAlexandrite rods for the GentleLASE from our sole supplier would impair ourability to manufacture and sell GentleLASE.**

We use Alexandrite rods to manufacture the GentleLASE,which accounts for a significant portion of our total revenues. We dependexclusively on Northrup Grumman to supply these rods, for which no alternativesupplier meeting our quality standards exists. We cannot be certain thatNorthrup Grumman will be able to meet our future requirements at current pricesor at all. To date, we have been able to obtain adequate supplies ofAlexandrite rods in a timely manner, but any extended interruption in oursupplies could hurt our results.

**Disappointingquarterly revenue or operating results could cause the price of our commonstock to fall.**

Our quarterly revenue and operating results aredifficult to predict and may swing sharply from quarter to quarter. Historically,our first fiscal quarter has typically had the least amount of revenue in anyquarter of our fiscal year. The results of the first quarter are directlyimpacted by the seasonality of the purchasing cycle.

If our quarterly revenueor operating results fall below the expectations of investors or public marketanalysts, the price of our common stock could fall substantially. Our quarterlyrevenue is difficult to forecast for many reasons, some of which are outside ofour control, including the following:

*Market Supply and Demand*

·       potentialincreases in the level and intensity of price competition between ourcompetitors and us

·       potentialdecrease in demand for our products

·       possibledelays in market acceptance of our new products.

*Customer Behavior*

·       changesin or extensions of our customers’ budgeting and purchasing cycles

·       changesin the timing of product sales in anticipation of new product introductions orenhancements by us or our competitors.

*Company Operations*

·       absenceof significant product backlogs

·       oureffectiveness in our manufacturing process

·       unsatisfactoryperformance of our distribution channels, service providers, or customersupport organizations

·       timingof any acquisitions and related costs.

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**Our failure to respond to rapid changes in technologyand intense competition in the laser industry could make our lasers obsolete.**

The aesthetic and cosmeticlaser equipment industry is subject to rapid and substantial technologicaldevelopment and product innovations. To be successful, we must be responsive tonew developments in laser technology and new applications of existingtechnology. Our financial condition and operating results could be hurt if ourproducts fail to compete favorably in response to such technologicaldevelopments, or we are not agile in responding to competitors’ new productintroductions or product price reductions. In addition, we compete againstnumerous companies offering products similar to ours, some of which havegreater financial, marketing, and technical resources than we do. We cannot besure that we will be able to compete successfully with these companies and ourfailure to do so could hurt our business, financial condition, and results ofoperations.

**Like other companies in our industry, we are subjectto a regulatory review process and our failure to receive necessary governmentclearances or approvals could affect our ability to sell our products andremain competitive.**

The types of medicaldevices that we seek to market in the U.S. generally must receive either “510(k) clearance”or “PMA approval” in advance from the U.S. Food and Drug Administration (FDA)pursuant to the Federal Food, Drug, and Cosmetic Act. The FDA’s 510(k) clearanceprocess usually takes from four to twelve months, but it can last longer. Theprocess of obtaining PMA approval is much more costly and uncertain andgenerally takes from one to three years or even longer. To date, the FDA hasdeemed our products eligible for the 510(k) clearance process. We believethat most of our products in development will receive similar treatment. However,we cannot be sure that the FDA will not impose the more burdensome PMA approvalprocess upon one or more of our future products, nor can we be sure that 510(k) clearanceor PMA approval will ever be obtained for any product we propose to market.

Many foreign countries inwhich we market or may market our products have regulatory bodies andrestrictions similar to those of the FDA. Particularly, for example, we are awaitingMinistry of Health approval in Japan for the sale of the Vbeam. We cannot becertain that we will be able to obtain (or continue to obtain) any suchgovernment approvals or successfully comply with any such foreign regulationsin a timely and cost-effective manner, if at all, and our failure to do socould adversely affect our ability to sell our products.

**We havemodified some of our products without FDA clearance. The FDA couldretroactively decide the modifications were improper and require us to ceasemarketing and/or recall the modified products.**

Any modification to one of our 510(k) cleareddevices that could significantly affect its safety or effectiveness, or thatwould constitute a major change in its intended use, requires a new 510(k) clearance.The FDA requires every manufacturer to make this determination in the firstinstance, but the FDA can review any such decision. We have modified some ofour marketed devices, but we believe that new 510(k) clearances are notrequired. We cannot be certain that the FDA would agree with any of ourdecisions not to seek 510(k) clearance. If the FDA requires us to seek 510(k) clearancefor any modification, we also may be required to cease marketing and/or recallthe modified device until we obtain a new 510(k) clearance.

**Achievingcomplete compliance with FDA regulations is difficult, and if we fail tocomply, we could be subject to FDA enforcement action.**

We are subject to inspection and market surveillanceby the FDA to determine compliance with regulatory requirements. The FDA’sregulatory scheme is complex, especially the Quality System Regulation (“QSR”),which requires manufacturers to follow elaborate design, testing, control,documentation, and other quality assurance procedures. This complexity makescomplete compliance difficult to achieve. Also, the determination as to whethera QSR violation has occurred is often subjective. 

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If the FDA findsthat we have failed to comply with the QSR or other applicable requirements,the agency can institute a wide variety of enforcement actions, including apublic warning letter or other stronger remedies, such as:

·       fines,injunctions, and civil penalties against us

·       recallor seizure of our products

·       operatingrestrictions, partial suspension, or total shutdown of our production

·       refusingour requests for 510(k) clearance or PMA approval of new products

·       withdrawingproduct approvals already granted

·       criminalprosecution

**Claims by others that our products infringe theirpatents or other intellectual property rights could prevent us frommanufacturing and selling some of our products or require us to incursubstantial costs from litigation or development of non-infringing technology.**

Our industry hasbeen characterized by frequent litigation regarding patent and otherintellectual property rights. Patent applications are maintained in secrecy inthe U.S. until such patents are issued and are maintained in secrecy for aperiod of time outside the U.S. Accordingly, we can conduct only limitedsearches to determine whether our technology infringes any patents or patentapplications of others. Any claims of patent infringement would betime-consuming and could:

·       resultin costly litigation

·       divertour technical and management personnel

·       causeproduct shipment delays

·       requireus to develop non-infringing technology

·       requireus to enter into royalty or licensing agreements.

Although patent and intellectual property disputes inthe laser industry have often been settled through licensing or similararrangements, costs associated with such arrangements may be substantial andoften require the payment of ongoing royalties, which could hurt our grossmargins. In addition, we cannot be sure that the necessary licenses would beavailable to us on satisfactory terms, or that we could redesign our productsor processes to avoid infringement, if necessary. Accordingly, an adversedetermination in a judicial or administrative proceeding, or the failure toobtain necessary licenses, could prevent us from manufacturing and selling someof our products, which could hurt our business, results of operations, andfinancial condition. On the other hand, we may have to start costly and timeconsuming litigation in order to enforce our patents, to protect trade secrets,and know-how owned by us or to determine the enforceability, scope, andvalidity of the proprietary rights of others.

**We couldincur substantial costs as a result of product liability claims.**

There are various risks of physical injury to thepatient when using our lasers for aesthetic and cosmetic treatments. Injuriesoften result in product liability or other claims being brought against thepractitioner utilizing the device and us. The costs and management time wewould have to spend in defending or settling any such claims, or the payment ofany award in connection with such claims, could hurt our business, results ofoperations, and financial condition. Although we maintain product liabilityinsurance, we cannot be certain that our policy will provide sufficient coveragefor any claim or claims that may arise, or that we will be able to maintainsuch insurance coverage on favorable economic terms.

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**We may beunable to attract and retain management and other personnel we need to succeed.**

The loss of any of our senior management or other keyresearch, development, sales, and marketing personnel, particularly if lost tocompetitors, could hurt our future operating results. Our future success willdepend in large part upon our ability to attract, retain, and motivate highlyskilled employees. We cannot be certain that we will attract, retain, andmotivate sufficient numbers of such personnel.

**Our failure to manage future acquisitions andjoint ventures effectively may divert management attention from our corebusiness and cause us to incur additional debt, liabilities or costs.**

We may acquirebusinesses, products, and technologies that complement or expand our business. Wemay also consider joint ventures and other collaborative projects. We may notbe able to:

·       identifyappropriate acquisition or joint venture candidates

·       successfullynegotiate, finance, or integrate any businesses, products, or technologies thatwe acquire

·       successfullymanage any joint ventures or collaborations.

Furthermore, theintegration of any acquisition or joint venture may divert management time andresources. If we fail to manage these acquisitions or joint ventureseffectively, we may incur debts or other liabilities or costs that could harmour operating results or financial condition. While we from time to timeevaluate potential acquisitions of businesses, products, and technologies,consider joint ventures and other collaborative projects, and anticipatecontinuing to make these evaluations, we have no present understandings,commitments, or agreements with respect to any acquisitions or joint ventures.

**Item 7A.**                Quantitativeand Qualitative Disclosures About Market Risk.

Revenue from outside the US, consisting of sales fromour subsidiaries in Germany, Spain, France and Japan and sales shipped directlyfrom the US to international locations, constituted 54% of our total revenuefor fiscal 2005.

Our international subsidiaries transact business inboth local and foreign currencies and therefore we are exposed to foreigncurrency exchange risk resulting from fluctuations in foreign currencies. Thisrisk could adversely impact our results and financial condition. From time totime, we may enter into foreign currency exchange and option contracts toreduce our exposure to foreign currency exchange risk and variability inoperating results due to fluctuation in exchange rates underlying the value ofcurrent transactions and anticipated transactions denominated in foreigncurrencies. These contracts obligate us to exchange predetermined amounts ofspecified foreign currencies at specified exchange rates on specified dates. Thesecontracts are denominated in the same currency in which the underlyingtransactions are denominated and bear a contract value and maturity date thatapproximate the value and expected settlement date, respectively, of theunderlying transactions. We do not engage in foreign currency speculation.

On July 2, 2005 the Euro closed at 0.837 Euro to1.00 U.S Dollar compared to 0.812 Euro to 1.00 U.S. Dollar on July 3,2004. The Japanese Yen closed at 111.78 Yen to 1.00 U.S. Dollar on July 2,2005 compared to 108.38 Yen to 1.00 U.S. Dollar on July 3, 2004. Netlosses resulting from foreign currency translations amounted to $(123) forfiscal 2005.

At July 2, 2005 and July 3, 2004, a hypothetical10% positive change in foreign exchange rates would result in translation gainsof $474 and $18 respectively that would be recorded in the equity section ofour balance sheet.

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At July 2, 2005 and July 3,2004, a hypothetical 10% adverse change in foreign exchange rates would resultin a net transaction loss of $343 and a net transaction loss of $6,respectively that would be recorded in current earnings.

**Item 8.**                        FinancialStatements and Supplementary Data.

Financial statements andsupplementary data are included herein and are indexed under Item 15 (a) (1)-(2).

**Item9.**                        Changes inand Disagreements with Accountants on Accounting and Financial Disclosure

On December 4, 2003, the Audit Committee of theBoard of Directors of the Company (the “Audit Committee”) dismissed Ernst &YoungLLP (“E&Y”) as the Company’s independent public accountants. The auditreports of E&Y on the consolidated financial statements of the Company forthe fiscal years ended June 28, 2003 and June 29, 2002 did notcontain any adverse opinion or disclaimer of opinion, nor were the reportsqualified or modified as to uncertainty, audit scope or accounting principles. OnDecember 4, 2003, the Audit Committee engaged BDO Seidman, LLP (“BDO”) toserve as the Company’s independent public accountants for the Company’s fiscalyear ending July 3, 2004. During the Company’s fiscal years ended July 3,2004 and June 28, 2003, there have been no disagreements with E&Y onany matter of accounting principles or practices, financial statement disclosureor auditing scope or procedure, which disagreements, if not resolved to thesatisfaction of E&Y, would have caused it to make reference to the subjectmatter of the disagreements in connection with its reports.We have establisheddisclosure controls and procedures (“Disclosure Controls”) to ensure thatinformation required to be disclosed in the Company’s reports filed under theSecurities Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time periods specified in the U.S. Securities andExchange Commission’s rules and forms. Disclosure Controls are also designed toensure that such information is accumulated and communicated to management,including the CEO and CFO, as appropriate to allow timely decisions regardingrequired disclosure. Our Disclosure Controls were designed to providereasonable assurance that the controls and procedures would meet theirobjectives. Our management, including the Chief Executive Officer and ChiefFinancial Officer, realizes that no control system can prevent allpossibilities of error or fraud. A control system, no matter how well designedand operated, can provide only reasonable assurance of achieving the designedcontrol objectives and management is required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.Because of the inherent limitations in all control systems, no evaluation ofcontrols can provide absolute assurance that all control issues and instancesof fraud, if any, within the Company have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty, and that breakdowns can occur because of simple error or mistake.Additionally, controls can be circumvented by the individual acts of somepersons, by collusions of two or more people, or by management override of thecontrol. Because of the inherent limitations in a cost-effective, maturingcontrol system, misstatements due to error or fraud may occur and not be detected.

As of the end ofthe period covered by this Form 10-K, management, with the participation of theChief Executive Officer and Chief Financial Officer, has performed anevaluation of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934).This evaluation included consideration of the controls, processes andprocedures that comprise our internal control over financial reporting. Basedon such evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that, as of July 2, 2005, and solely as a result of the materialweakness in internal control over financial reporting discussed below, ourdisclosure controls and procedures were not effective in ensuring thatinformation required to be disclosed by us in the reports that we file underthe Securities Exchange Act of 1934 is recorded, processed, summarized andreported within the time periods 

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specifiedin the SEC’s rules and forms and that such information is accumulated andcommunicated to our management as appropriate to allow timely decisionsregarding required disclosure.

(b) MANAGEMENT’S REPORT ON INTERNAL CONTROL OVERFINANCIAL REPORTING

Management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rules 13a-15(f). Under the supervision and with theparticipation of management, including our Chief Executive Officer and ChiefFinancial Officer, we conducted an evaluation of the effectiveness of ourinternal control over financial reporting as of July 2, 2005 based on theframework in “Internal Control—IntegratedFramework” issued by the Committee of Sponsoring Organizations of the TreadwayCommission (“COSO”).

Based on our assessment, management determined that amaterial weakness existed in the Company’s internal controls over financialreporting as of July 2, 2005 as a result of the following identified materialweakness:

*The existence of control deficiencies that adverselyimpacted the Company’s ability to accurately and timely complete the Company’syear-end close process.

The aforementioned control deficiencies led to theCompany’s failure to record certain accruals and costs and appropriatelyaccount for demonstration equipment sales during the year-end close process.The errors were detected and corrected prior to issuance of the consolidatedfinancial statements as of and for the year ended July 2, 2005 such that thesefinancial statements are free from material misstatement. In the aggregate,these deficiencies represent a material weakness in internal control overfinancial reporting on the basis that there is a more than remote likelihoodthat a material misstatement of the Company’s annual or interim financialstatements will not be prevented or detected by its internal control overfinancial reporting. Because of this material weakness in internal control overfinancial reporting, management concluded that, as of July 2, 2005 the Company’sinternal control over financial reporting was not effective based on the criteriaset forth by COSO.

The Company’sexternal auditors, BDO Seidman, LLP, an independent registered publicaccounting firm, have issued an audit report on our assessment of the Company’sinternal control over financial reporting. This report appears on page F-1.

(c) CHANGES IN INTERNAL CONTROL OVER FINANCIALREPORTING

During the third and fourth quarters of fiscal year2005, the Company was engaged in an ongoing review of its internal control overfinancial reporting as described below. Based on that review managementbelieves that, during the fourth quarter of fiscal year 2005 we made changes inthe Company’s internal control over financial reporting, as described below, thathave materially affected, or are reasonably likely to materially affect, thosecontrols.

In the fourth quarter of fiscal 2005, managementrevised its policies and procedures related to period-end accruals andestimates. Management conducted training sessions with the finance staff toreview these policies and to increase sensitivity and focus on the issuescovered by the new policies and continues to monitor their implementation.Candela also initiated a project to review and update other accounting policies,establish written policies for areas where such policies did not exist, and hasengaged third party experts in accounting and controls implementation to assistin this effort.

Subsequent to the discovery of the aforementionedcontrol deficiencies, management implemented procedures including but notlimited to additional levels of review for accruals, judgmental estimates anddemonstration sales, and the creation of additional management reports used forthe analysis of results. Management will continue to conduct training sessionsthroughout the organization to explain each of its policies and proceduresadopted and require that accounting conclusions, assumptions and estimates aredocumented and supported by such accounting policies or relevant accountingliterature in accordance 

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with GAAP. Management willassess the effectiveness of the Company’s adherence to the accounting policiesthrough ongoing monitoring activities.

Otherthan the changes outlined above, there were no changes that materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.
| /s/ GERARD PUORRO                |                      | /s/ F. PAUL  BROYER |   |
|----------------------------------|---------------------------|---------------------|--------|
| Gerard Puorro                    | F. Paul Broyer            |
| *President  and Chief Executive* | *Chief Financial Officer* |
| September 29,  2005              |                      |

 

**Item 9B.     Other Information**

None.

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**Part III**

Anything herein to thecontrary notwithstanding, in no event are the sections entitled “StockPerformance Graph”, “Compensation Committee Report on Executive Compensation”and “Audit Committee Report” to be incorporated by reference herein from theCompany’s definitive proxy statement for the Company’s 2005 annual meeting ofstockholders.

**Item 10.**                 Directorsand Executive Officers Of The Registrant

Certain information concerning the directors andexecutive officers of the Company is incorporated by reference herein from theinformation contained in the section entitled “Occupations of Directors andExecutive Officers” in our definitive proxy statement (the “Definitive ProxyStatement”) for the 2005 annual meeting of stockholders to be filed with theSecurities and Exchange Commission within 120 days after the end of Candela’s fiscal year ended July 2,2005.

The information concerningcompliance with Section 16(a) of the Exchange Act required under thisitem is incorporated herein by reference from the information contained in thesection entitled “Section 16(a) Beneficial Ownership ReportingCompliance” in the Definitive Proxy Statement.

**Item 11.**                 ExecutiveCompensation

Certain informationconcerning executive compensation is incorporated herein by reference from theinformation contained in the section entitled “Compensation and OtherInformation Concerning Directors and Officers” in the Definitive ProxyStatement.

**Item 12.**                 SecurityOwnership Of Certain Beneficial Owners and Management and Related StockholderMatters

Certain informationconcerning security ownership of certain beneficial owners and management isincorporated herein by reference from the information contained in the sectionentitled “Security Ownership of Certain Beneficial Owners and Management” inthe Definitive Proxy Statement.

**Item 13.**                 CertainRelationships and Related Transactions

Certain informationconcerning certain relationships and related transactions is incorporatedherein by reference from the information contained in the section entitled “CertainRelationships and Related Transactions” in the Definitive Proxy Statement.

**Item 14.**                 PrincipalAccountant Fees and Services

Certain information concerning principal accountantfees and services is incorporated herein by reference from the informationcontained in the section entitled “Principal Accountant Fees and Services” inthe Definitive Proxy Statement.

38

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**Part IV**

**Item 15.**                 Exhibits,Financial Statement Schedules, and Reports on Form 8-K.

(a)    Thefollowing items are filed as part of this report:

(1) *Consolidated Financial Statements*:
| Report of Registered  Independent Public Accounting Firm                                                                                  |   | F-1 |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|-----|
| Report of Registered  Independent Public Accounting Firm                                                                                  |   | F-4 |
| Consolidated Balance  Sheets—July 2, 2005 and July 3, 2004                                                                 |   | F-5 |
| Consolidated Statements of  Operations Years ended July 2, 2005, July 3, 2004, and  June 28, 2003                     |   | F-6 |
| Consolidated Statements of  Stockholders’ Equity—Years ended July 2, 2005, July 3, 2004,  and June 28, 2003 |   | F-7 |
| Consolidated Statements of  Cash Flows—Years ended July 2, 2005, July 3, 2004,  and June 28, 2003                |   | F-8 |
| Notes  to Consolidated Financial Statements                                                                                               |   | F-9 |

 

(2) *Consolidated Financial Statement Schedules*:
| Schedule II—Valuation and  Qualifying Accounts |   | F-26 |
|-----------------------------------------------------|--------|------|

 

The reports of the registrant’s Registered IndependentPublic Accounting Firm with respect to the above-listed financial statementsand financial statement schedule appears on page F-1 and F-2of this report.

All other financial statements and schedules notlisted have been omitted since the required information is included in theconsolidated financial statements or the notes thereto, or is not applicable,material, or required.

(3) *Exhibits*: Except as otherwise noted, thefollowing documents are incorporated by reference from the Company’s RegistrationStatement on Form S-1 (File Number 333-78339) or filedherewith:
| 3.1        |   | Certificate of Incorporation, as amended                                                                                                       |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2(9)     |   | By-laws of the Company, as amended and restated                                                                                                |
| 10.1(1)    |   | 1985 Incentive Stock Option Plan                                                                                                               |
| 10.2(2)    |   | 1987 Stock Option Plan                                                                                                                         |
| 10.2.1(2)  |   | 1989 Stock Plan                                                                                                                                |
| 10.2.2(3)  |   | 1990 Employee Stock Purchase Plan                                                                                                              |
| 10.2.3(3)  |   | 1990 Non-Employee Director Stock Option Plan                                                                                                   |
| 10.2.4(7)  |   | 1993 Non-Employee Director Stock Option Plan                                                                                                   |
| 10.2.5(13) |   | 1998 Amended and Restated Stock Plan                                                                                                           |
| 10.3(7)    |   | Lease for premises at 526 Boston Post Road, Wayland,  Massachusetts.                                                                           |
| 10.4(7)    |   | Lease for premises at 530 Boston Post Road, Wayland,  Massachusetts.                                                                           |
| 10.5(7)    |   | Patent License Agreement between the Company and  Patlex Corporation effective as of July 1, 1988.                                        |
| 10.6(4)    |   | License Agreement among the Company, Technomed  International, Inc. and Technomed International S.A. dated as of  December 20, 1990. |
| 10.7(5)    |   | License Agreement between the Company and Pillco  Limited Partnership effective as of October 1, 1991.                                    |

39

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| 10.8(8)      |   | Distribution Agreement between the Company and  Cryogenic Technology Limited, dated October 15, 1993.                                                                                                                |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.9(10)     |   | Asset Purchase Agreement between the Company and  Derma-Laser, Limited and Derma-Lase, Inc. dated June 23, 1994.                                                                                                |
| 10.10(13)    |   | Letter Agreement between the Company and Fleet Bank  dated February 13, 1997.                                                                                                                                        |
| 10.10.1(13)  |   | Amendment to Letter Agreement between the Company  and Fleet Bank dated December 15, 1998.                                                                                                                           |
| 10.12*(14)   |   | Amended and Restated License Agreement between  the Company and The Regents of the University of California for Dynamic  Skin Cooling Method and Apparatus effective as of August 11, 2000.                |
| 10.12.1*(15) |   | Settlement Agreement dated August 11, 2000 by  and among the Company, the Regents of the University of California, and Cool  Touch, Inc.                                                                        |
| 10.13(12)    |   | Note and Warrant Purchase Agreement, dated as of  October 15, 1998 by and among the Company, Massachusetts Capital  Resource Company, William D. Witter and Michael D.Witter.                                        |   |
| 10.13.1(12)  |   | Form of Note delivered to the Company in the  aggregate principal amount of $3,700,000 to Massachusetts Capital Resource  Company, William D. Witter and Michael D. Witter.                                          |   |
| 10.13.2(12)  |   | Form of Common Stock Purchase Warrant to  purchase an aggregate of 370,000 shares of the Company’s Common Stock  delivered to Massachusetts Capital Resource Company, William D. Witter and  Michael D. Witter. |   |
| 21.1**       |   | Subsidiaries of the Company                                                                                                                                                                                               |   |
| 23.1**       |   | Consent of BDO Seidman, LLP (Independent Registered  Public Accounting Firm)                                                                                                                                         |   |
| 23.2**       |   | Consent of Ernst & Young LLP (Independent  Registered Public Accounting Firm)                                                                                                                               |   |
| 31.1**       |   | Rule 13a-14(a)/15d-14(a) Certification  of Chief Executive Officer                                                                                                                                              |   |
| 31.2**       |   | Rule 13a-14(a)/15d-14(a) Certification  of Chief Financial Officer                                                                                                                                              |   |
| 32.1**       |   | Section 1350 Certification of Chief Executive  Officer                                                                                                                                                               |   |
| 32.2**       |   | Section 1350 Certification of Chief Financial  Officer                                                                                                                                                               |   |
| 99.1* **     |   | McKesson Medical-Surgical Inc. Distribution  Agreement                                                                                                                                                                    |   |
| 99.2**       |   | First Amendment to the Amended and Restated License  Agreement by and between The Regents of the University of California and  Candela Corporation                                                                        |   |

----

*                    Portions ofthe exhibit have been omitted and filed separately with the SEC in reliance uponthe Company’s request for confidential treatment pursuant to Rule 24b-2.

**             Filed herewith

(1)   Previouslyfiled as an exhibit to Registration Statement No. 33-54448B andincorporated herein by reference.

(2)   Previouslyfiled as an exhibit to the Company’s Amended and Restated Annual Report onForm 10-K for the fiscal year ended June 30, 1988 (Commissionfile number 000-14742), and incorporated herein by reference.

(3)   Previouslyfiled as an exhibit to the Company’s Annual Report on Form 10-K forthe fiscal year ended June 30, 1990 (Commission file number 000-14742),and incorporated herein by reference.

(4)   Previouslyfiled as an exhibit to Form 10-Q for the quarter endedDecember 29, 1990 (Commission file number 000-14742), and incorporatedherein by reference.

(5)   Previouslyfiled as an exhibit to Form 10-Q for the quarter endedSeptember 28, 1991 (Commission file number 000-14742), andincorporated herein by reference.

40

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(6)   Previouslyfiled as an exhibit to Form 8-K, dated September 8, 1992(Commission file number 000-14742), and incorporated herein byreference.

(7)   Previouslyfiled as an exhibit to the Company’s Annual Report on Form 10-K forthe fiscal year ended July 3, 1993 (Commission file number 000-14742),and incorporated herein by reference.

(8)   Previouslyfiled as an exhibit to Form 10-Q for the quarter endedJanuary 1, 1994 (Commission file number 000-14742), and incorporatedherein by reference.

(9)   Previouslyfiled as an exhibit to Form 10-Q for the quarter ended April 2,1994 (Commission file number 000-14742), and incorporated herein byreference.

(10) Previouslyfiled as an exhibit to the Company’s Annual Report on Form 10-K forthe fiscal year ended July 2, 1994 (Commission file number 000-14742),and incorporated herein by reference.

(11) Previouslyfiled as an exhibit to Form 10-Q for the quarter endedMarch 27, 1999 (Commission file number 000-14742), and incorporatedherein for reference.

(12) Previouslyfiled as an exhibit to the Company’s Amended and Restated Annual Report onForm 10-K for the fiscal year ended June 27, 1998 (Commissionfile number 000-14742), and incorporated herein by reference.

(13) Previouslyfiled as Appendix A to the Company’s Schedule 14A, filed December 28,2002, and incorporated herein by reference.

(14) Previouslyfiled as an exhibit to Form 10-Q for the quarter endedMarch 31, 2001 (Commission file number 000-14742), and incorporatedherein by reference.

(15) Previouslyfiled as an exhibit to Form 10-K for the fiscal year endedJuly 1, 2000 (Commission file number 000-14742), and incorporated byreference.

(b)   Reportson Form 8-K. On May 3, 2005, the Company filed a current reporton Form 8-K (including item 12) reporting our earnings for the thirdfiscal quarter ended April 2, 2005.

(c)    TheCompany hereby files, as part of this Form 10-K, the exhibits listedin Item 15(a)(3) above, other than exhibits 32.1 and 32.2, which the Companyhereby furnishes.

(d)   The Companyhereby files, as part of this Form 10-K, the consolidated financialStatement schedules listed in Item 15(a)(2) above.

41

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, on September 29,2005.
|        | CANDELA  CORPORATION |
|--------|----------------------|
|   | By:                  | /s/ GERARD E. PUORRO |
|   |                 | Gerard E. Puorro, |
|   | * *             | *President, Chief Executive Officer and Director* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
|                           | **Signature** | ** **                     | ** ** |                          | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|---------------------------|---------------|--------------------------------|------------|--------------------------|-----------|------------|------------|--|----------|------------|
|                      |          |                           |       |                     |
| /s/ GERARD E. PUORRO      |          | President, Chief Executive     |       | September 29,  2005 |
| Gerard E. Puorro          |          | Officer, and  Director         |       |                     |
|                      |          | (Principal  Executive Officer) |       |                     |
| /s/  F. PAUL BROYER       |          | Senior Vice President of       |       | September 29,  2005 |
| F. Paul Broyer            |          | Finance and  Administration,   |       |                     |
|                      |          | Chief Financial  Officer       |       |                     |
| /s/  KENNETH D. ROBERTS   |          | Chairman of the Board of       |       | September 29,  2005 |
| Kenneth D.  Roberts       |          | Directors                      |       |                     |
| /s/  NANCY NAGER          |          | Director                       |       | September 29,  2005 |
| Nancy Nager               |          |                           |       |                     |
| /s/  DOUGLAS W. SCOTT     |          | Director                       |       | September 29,  2005 |
| Douglas W. Scott          |          |                           |       |                     |
| /s/  BEN BAILEY, III |          | Director                       |       | September 29,  2005 |
| Ben  Bailey, III     |          |                           |       |                     |
| /s/  GEORGE ABE           |          | Director                       |       | September 29,  2005 |
| George Abe                |          |                           |       |                     |
| /s/  ERIC BERNSTEIN       |          | Director                       |       | September 29,  2005 |
| Eric Bernstein            |          |                           |       |                     |

 

42

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**Reportof Independent Registered Public Accounting Firmon Internal Control over Financial Reporting**

Shareholders and Board ofDirectorsCandela CorporationWayland, Massachusetts

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting appearing under Item 9A of Candela Corporation and subsidiaries (the “Company”)Annual Report on Form 10-K that the Company did not maintain effective internalcontrol over financial reporting as of July 2, 2005, because of the effectof the material weakness identified in management’s assessment, based oncriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (the COSOcriteria). Candela Corporation’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining an understandingof internal control over financial reporting, evaluating management’sassessment, testing and evaluating the design and operating effectiveness ofinternal control, and performing such other procedures as we considerednecessary in the circumstances. We believe that our audit provides a reasonablebasis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. The following material weaknesseswere identified and included in management’s assessment:

As indicated in the accompanying Management’s Reporton Internal Control Over Financial Reporting, the Company had control deficiencies that adverselyimpacted the Company’s ability to accurately and timely complete the year-endclose process. The aforementioned control deficiencies led to the Company’sfailure to record certain accruals and costs during the year-end close processand appropriately account for demonstration equipment sales.

F-1

----

These material weaknesses were considered indetermining the nature, timing, and extent of audit tests applied in our auditof the 2005 financial statements, and this report does not affect our reportdated September 29, 2005, on those financial statements, which expressedan unqualified opinion.

In our opinion, management’s assessment that CandelaCorporation and subsidiaries did not maintain effective internal control overfinancial reporting as of July 2, 2005, is fairly stated, in all materialrespects, based on the COSO criteria. Also in our opinion, because of theeffect of the material weakness described above on the achievement of theobjectives of the control criteria, Candela Corporation and subsidiaries hasnot maintained effective internal control over financial reporting as ofJuly 2, 2005, based on the criteria established in *InternalControl—Integrated Framework* issued by COSO.

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the accompanying consolidatedbalance sheets of Candela Corporation and subsidiaries as of July 2, 2005and July 3, 2004, and the related consolidated statements of income,shareholders’ equity and cash flows for each of the two years in the periodended July 2, 2005 and our report dated September 29, 2005 expressedan unqualified opinion.
| By:    | /s/ BDO SEIDMAN, LLP     |   |
|--------|--------------------------|--------|
|   | BDO Seidman, LLP         |
|   | Boston,  Massachusetts   |
|   | September 29,  2005 |

 

F-2

----

**Report of Independent Registered Public AccountingFirm**

Shareholdersand Board of Directors

CandelaCorporation

Wayland, Massachusetts

We have audited the accompanying consolidated balancesheets of Candela Corporation and subsidiaries as of July 2, 2005 and July 3,2004 and the related consolidated statements of income, shareholders’ equityand cash flows for each of the two years in the period ended July 2, 2005.We have also audited the schedule listed in the accompanying index for theyears ended July 2, 2005 and July 3, 2004. These financial statementsand schedule are the responsibility of the Company’s management. Our responsibilityis to express an opinion on these financial statements and schedule based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements and schedule are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements andschedule, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall presentation of thefinancial statements and schedule. We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Candela Corporation and subsidiaries at July 2, 2005 and July 3,2004 and the results of their operations and their cash flows for each of thetwo years in the period ended July 2, 2005, in conformity with accountingprinciples generally accepted in the United States of America. 

Also, in our opinion, the financial statement schedulepresents fairly, in all material respects, the information set forth therein.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of CandelaCorporation and subsidiaries internal control over financial reporting as of July 2,2005, based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganization of the Treadway Commission and have issued our report thereondated September 29, 2005 which expressed an unqualified opinion onmanagement’s assessment that Candela Corporation and subsidiaries did notmaintain effective internal control over financial reporting as of July 2,2005, and an adverse opinion on the Company’s effectiveness of internal controlover financial reporting as of July 2, 2005.
| By:    | /s/ BDO SEIDMAN, LLP    |   |
|--------|-------------------------|--------|
|   | BDO Seidman, LLP        |
|   | Boston, Massachusetts   |
|   | September 29, 2005 |

 

F-3

----

**Report of Independent Registered Public AccountingFirm**

TheBoard of Directors and Stockholders

Candela Corporation

We have audited the accompanying consolidatedstatements of operations and comprehensive income (loss), stockholders’ equity,and cash flows for the year ended June 28, 2003. Our audit also includedthe financial statement schedule listed in the Index at Item 15(a) for the yearended June 28, 2003. These financial statements and schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements and schedule based on our audits.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance as to whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated results of operations and cashflows of Candela Corporation and Subsidiaries for the year ended June 28,2003, in conformity with U.S. generally accepted accounting principles. Also,in our opinion, the related financial statement schedule for the year endedJune 28, 2003, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects theinformation set forth therein.
| /s/ ERNST &  YOUNG LLP |
|---------------------------------|
| Boston, Massachusetts           |
| September 2, 2004          |

 

F-4

----

**CANDELA CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSJuly 2, 2005 and July 3, 2004**

| ** **                                                                                                                                | ** ** | **      2005      ** | ** **  | **      2004      ** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|-------------|----------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                | ** ** | **(in thousands, except  share information)**                          | ** **  |
| ***Assets:***                                                                                                                             | ** ** |                                                                             | ** **  | ** **                                                                       |       |   | ** ** | ** ** |   |
| Current assets:                                                                                                                           |       |                                                                             | ** **  | ** **                                                                       |       |   |   | ** ** |   |
| Cash and cash equivalents                                                                                                                 | ** ** |                                                                             | **$**       | **56,383**                                                                       | ** ** |   |   | $ | 37,139 | ** ** |   |
| Restricted cash (note 6)                                                                                                                  | ** ** |                                                                             | **199**     | ** **                                                                       |       |   | 257 | ** ** |   |
| Accounts receivable (net of allowance for doubtful  accounts of $2,065 in 2005 and $1,492 in 2004)                                        | ** ** |                                                                             | **34,866**  | ** **                                                                       |       |   | 34,302 | ** ** |   |
| Notes receivable                                                                                                                          | ** ** |                                                                             | **805**     | ** **                                                                       |       |   | 1,151 | ** ** |   |
| Inventories, net                                                                                                                          | ** ** |                                                                             | **12,676**  | ** **                                                                       |       |   | 13,571 | ** ** |   |
| Other current assets                                                                                                                      | ** ** |                                                                             | **1,821**   | ** **                                                                       |       |   | 2,184 | ** ** |   |
| Total current assets                                                                                                                      | ** ** |                                                                             | **106,750** | ** **                                                                       |       |   | 88,604 | ** ** |   |
| Property and equipment, net                                                                                                               | ** ** |                                                                             | **3,240**   | ** **                                                                       |       |   | 3,406 | ** ** |   |
| Deferred tax  assets                                                                                                                      | ** ** |                                                                             | **5,743**   | ** **                                                                       |       |   | 5,914 | ** ** |   |
| Prepaid licenses                                                                                                                          | ** ** |                                                                             | **878**     | ** **                                                                       |       |   | 1,054 | ** ** |   |
| Other assets                                                                                                                              | ** ** |                                                                             | **205**     | ** **                                                                       |       |   | 1,501 | ** ** |   |
| Total assets                                                                                                                              | ** ** |                                                                             | **$**       | **116,816**                                                                      | ** ** |   |   | $ | 100,479 | ** ** |   |
| ***Liabilities  and Stockholders’ Equity***                                                                                          |       |                                                                             | ** **  | ** **                                                                       |       |   |   | ** ** |   |
| Current liabilities:                                                                                                                      |       |                                                                             | ** **  | ** **                                                                       |       |   |   | ** ** |   |
| Accounts payable                                                                                                                          | ** ** |                                                                             | **$**       | **11,674**                                                                       | ** ** |   |   | $ | 6,973 | ** ** |   |
| Accrued payroll and related expenses                                                                                                      | ** ** |                                                                             | **4,830**   | ** **                                                                       |       |   | 5,428 | ** ** |   |
| Accrued warranty costs (current portion)                                                                                                  | ** ** |                                                                             | **5,291**   | ** **                                                                       |       |   | 4,946 | ** ** |   |
| Income taxes payable                                                                                                                      | ** ** |                                                                             | **2,073**   | ** **                                                                       |       |   | 1,844 | ** ** |   |
| Sales tax payable                                                                                                                         | ** ** |                                                                             | **2,206**   | ** **                                                                       |       |   | 2,423 | ** ** |   |
| Royalties payable                                                                                                                         | ** ** |                                                                             | **1,661**   | ** **                                                                       |       |   | 757 | ** ** |   |
| Accrued other                                                                                                                             | ** ** |                                                                             | **1,298**   | ** **                                                                       |       |   | 406 | ** ** |   |
| Deferred income (current portion)                                                                                                         | ** ** |                                                                             | **6,037**   | ** **                                                                       |       |   | 3,421 | ** ** |   |
| Current liabilities of discontinued operations                                                                                            | ** ** |                                                                             | **1,302**   | ** **                                                                       |       |   | 1,019 | ** ** |   |
| Total current liabilities                                                                                                                 | ** ** |                                                                             | **36,372**  | ** **                                                                       |       |   | 27,217 | ** ** |   |
| Accrued warranty  costs (long-term portion)                                                                                               | ** ** |                                                                             | **3,355**   | ** **                                                                       |       |   | 3,311 | ** ** |   |
| Deferred income  (long-term portion)                                                                                                      | ** ** |                                                                             | **2,313**   | ** **                                                                       |       |   | 634 | ** ** |   |
| Long-term  liabilities of discontinued operations                                                                                         | ** ** |                                                                             | **437**     | ** **                                                                       |       |   | 2,548 | ** ** |   |
| Total liabilities                                                                                                                         | ** ** |                                                                             | **42,477**  | ** **                                                                       |       |   | 33,710 | ** ** |   |
| Stockholders’  equity:                                                                                                               | ** ** |                                                                             | ** **  | ** **                                                                       |       |   |   | ** ** |   |
| Common stock, $.01 par value: 60,000,000 shares  authorized, 24,764,318 and 24,567,062 shares issued in 2005 and 2004,  respectively | ** ** |                                                                             | **248**     | ** **                                                                       |       |   | 246 | ** ** |   |
| Treasury stock, 2,250,000 shares in 2005 and 2004,  at cost                                                                               | ** ** |                                                                             | **(12,997** | **)**                                                                            |       |   | (12,997 | **)** |   |
| Additional paid-in capital                                                                                                                | ** ** |                                                                             | **54,027**  | ** **                                                                       |       |   | 53,069 | ** ** |   |
| Accumulated earnings                                                                                                                      | ** ** |                                                                             | **33,346**  | ** **                                                                       |       |   | 26,023 | ** ** |   |
| Accumulated other comprehensive income (loss)                                                                                             | ** ** |                                                                             | **(285**    | **)**                                                                            |       |   | 428 | ** ** |   |
| Total stockholders’ equity                                                                                                           | ** ** |                                                                             | **74,339**  | ** **                                                                       |       |   | 66,769 | ** ** |   |
| Total liabilities and  stockholders’ equity                                                                                          | ** ** |                                                                             | **$**       | **116,816**                                                                      | ** ** |   |   | $ | 100,479 | ** ** |   |

 

The accompanying notes are an integral part of the financial statements.

F-5

----

**CANDELA CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)For the years ended July 2, 2005, July 3, 2004 and June 28, 2003**

| ** **                                                                                                                                                                                                                | ** ** | **2005**                                                       | ** **  | **2004**    | ** ** | **2003**   | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|-------------|-------------|------------|------------|------------|
| ** **                                                                                                                                                                                                                | ** ** | **(in thousands, except  per share data)** | ** **  |
| **Revenue:**                                                                                                                                                                                                              | ** ** | ** **                                                     | ** **  | ** **  | ** ** | ** ** | ** ** |
| Lasers and other  products                                                                                                                                                                                                | ** ** | **$**                                                          | **102,323** | ** **  | **$**      | **87,965** | ** ** | **$** | **68,072** | ** ** |
| Product related  service                                                                                                                                                                                                  | ** ** | **21,578**                                                     | ** **  | **16,473**  | ** ** | **10,579** | ** ** |
| Total revenue                                                                                                                                                                                                             | ** ** | **123,901**                                                    | ** **  | **104,438** | ** ** | **78,651** | ** ** |
| **Cost of sales:**                                                                                                                                                                                                        | ** ** | ** **                                                     | ** **  | ** **  | ** ** | ** ** | ** ** |
| Lasers and other  products                                                                                                                                                                                                | ** ** | **45,235**                                                     | ** **  | **36,413**  | ** ** | **30,641** | ** ** |
| Product related  service                                                                                                                                                                                                  | ** ** | **17,918**                                                     | ** **  | **14,860**  | ** ** | **7,992**  | ** ** |
| Litigation related  charges                                                                                                                                                                                               | ** ** | **4,829**                                                      | ** **  | **—**  | ** ** | **—** | ** ** |
| Total cost of  sales                                                                                                                                                                                                      | ** ** | **67,982**                                                     | ** **  | **51,273**  | ** ** | **38,633** | ** ** |
| **Gross  profit**                                                                                                                                                                                                         | ** ** | **55,919**                                                     | ** **  | **53,165**  | ** ** | **40,018** | ** ** |
| **Operating expenses:**                                                                                                                                                                                                   | ** ** | ** **                                                     | ** **  | ** **  | ** ** | ** ** | ** ** |
| Research and  development                                                                                                                                                                                                 | ** ** | **6,890**                                                      | ** **  | **5,302**   | ** ** | **4,545**  | ** ** |
| Selling, general  and administrative                                                                                                                                                                                      | ** ** | **40,165**                                                     | ** **  | **33,978**  | ** ** | **24,519** | ** ** |
| Litigation related  charges                                                                                                                                                                                               | ** ** | **773**                                                        | ** **  | **—**  | ** ** | **—** | ** ** |
| Total operating  expenses                                                                                                                                                                                                 | ** ** | **47,828**                                                     | ** **  | **39,280**  | ** ** | **29,064** | ** ** |
| **Income  from operations**                                                                                                                                                                                               | ** ** | **8,091**                                                      | ** **  | **13,885**  | ** ** | **10,954** | ** ** |
| **Other income (expense):**                                                                                                                                                                                               | ** ** | ** **                                                     | ** **  | ** **  | ** ** | ** ** | ** ** |
| Interest income                                                                                                                                                                                                           | ** ** | **640**                                                        | ** **  | **308**     | ** ** | **651**    | ** ** |
| Interest expense                                                                                                                                                                                                          | ** ** | **(6**                                                         | **)**       | **(19**     | **)**      | **(218**   | **)**      |
| Other income  (expense), net                                                                                                                                                                                              | ** ** | **(67**                                                        | **)**       | **924**     | ** ** | **(44**    | **)**      |
| Total other income  (expense)                                                                                                                                                                                             | ** ** | **567**                                                        | ** **  | **1,213**   | ** ** | **389**    | ** ** |
| Income from  continuing operations before income tax                                                                                                                                                                      | ** ** | **8,658**                                                      | ** **  | **15,098**  | ** ** | **11,343** | ** ** |
| Provision for  income taxes                                                                                                                                                                                               | ** ** | **2,194**                                                      | ** **  | **4,586**   | ** ** | **3,516**  | ** ** |
| Income from  continuing operations                                                                                                                                                                                        | ** ** | **6,464**                                                      | ** **  | **10,512**  | ** ** | **7,827**  | ** ** |
| Discontinued operations:                                                                                                                                                                                                  | ** ** | ** **                                                     | ** **  | ** **  | ** ** | ** ** | ** ** |
| Loss from  discontinued skin care center operations of $473, and $1468 less income  tax benefit of $175, and $455 respectively                                                                                       | ** ** | **—**                                                     | ** **  | **(298**    | **)**      | **(1,013** | **)**      |
| Gain (loss) on  disposal of skin care center, including revision of leasehold obligations  of $1,374 and provision for operating losses of $(3,348) less income tax  of $(515) and income tax benefit of $1,253 | ** ** | **859**                                                        | ** **  | **(2,095**  | **)**      | ** ** | ** ** |
| **Net  income**                                                                                                                                                                                                           | ** ** | **$**                                                          | **7,323**   | ** **  | **$**      | **8,119**  | ** ** | **$** | **6,814** | ** ** |
| Net income (loss) per share of common stock                                                                                                                                                                               | ** ** | ** **                                                     | ** **  | ** **  | ** ** | ** ** | ** ** |
| Basic:                                                                                                                                                                                                                    | ** ** | ** **                                                     | ** **  | ** **  | ** ** | ** ** | ** ** |
| Income from  continuing operations                                                                                                                                                                                        | ** ** | **$**                                                          | **.29**     | ** **  | **$**      | **.48**    | ** ** | **$** | **.39** | ** ** |
| Income (loss) from  discontinued operations                                                                                                                                                                               | ** ** | **.04**                                                        | ** **  | **(.11**    | **)**      | **(.05**   | **)**      |
| Net income                                                                                                                                                                                                                | ** ** | **$**                                                          | **.33**     | ** **  | **$**      | **.37**    | ** ** | **$** | **.34** | ** ** |
| Diluted:                                                                                                                                                                                                                  | ** ** | ** **                                                     | ** **  | ** **  | ** ** | ** ** | ** ** |
| Income from continuing  operations                                                                                                                                                                                        | ** ** | **$**                                                          | **.28**     | ** **  | **$**      | **.46**    | ** ** | **$** | **.38** | ** ** |
| Income (loss) from  discontinued operations                                                                                                                                                                               | ** ** | **.04**                                                        | ** **  | **(.10**    | **)**      | **(.05**   | **)**      |
| Net income                                                                                                                                                                                                                | ** ** | **$**                                                          | **.32**     | ** **  | **$**      | **.36**    | ** ** | **$** | **.33** | ** ** |
| Basic weighted  average shares outstanding                                                                                                                                                                                | ** ** | **22,388**                                                     | ** **  | **21,902**  | ** ** | **20,083** | ** ** |
| Diluted weighted  average shares outstanding                                                                                                                                                                              | ** ** | **23,073**                                                     | ** **  | **22,712**  | ** ** | **20,645** | ** ** |
| Net income                                                                                                                                                                                                                | ** ** | **$**                                                          | **7,323**   | ** **  | **$**      | **8,119**  | ** ** | **$** | **6,814** | ** ** |
| Other comprehensive (loss) income net of tax:                                                                                                                                                                             | ** ** | ** **                                                     | ** **  | ** **  | ** ** | ** ** | ** ** |
| Foreign currency  translation adjustment                                                                                                                                                                                  | ** ** | **(713**                                                       | **)**       | **595**     | ** ** | **(732**   | **)**      |
| **Total  comprehensive income**                                                                                                                                                                                           | ** ** | **$**                                                          | **6,610**   | ** **  | **$**      | **8,714**  | ** ** | **$** | **6,082** | ** ** |

 

The accompanying notes are an integral part of the financial statements.

F-6

----

**CANDELA CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF STOCKHOLDERS’ EQUITYFor the years ended July 2, 2005, July 3, 2004 and June 28, 2003**

| ** **                                  | ** ** | ** **              | ** ** | ** **                         | ** **     | ** **              | ** ** | ** **      | ** **        | ** **        | ** ** | ** **   | ** ** | **Accumulated**        | ** **  | ** ** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------------------|----------------|-------------------------|------------|-----------------|-------------------|-------------------|------------|--------------|------------|------------------------|-------------|------------|------------|
| ** **                                  | ** ** | ** **              | ** ** | ** **                         | ** **     | **Additional**          | ** ** | ** **      | ** **        | ** **        | ** ** | ** **   | ** ** | **Other**              | ** **  | ** ** | ** ** |
| ** **                                  | ** ** | **Common Stock**   | ** ** | **Paid-in**                        | ** **     | **Treasury Stock** | ** ** | **Accumulated** | ** **        | **Comprehensive** | ** ** | ** **   | ** ** |
| ** **                                  | ** ** | **Shares**              | ** ** | **  Amount  ** | ** **     | **Capital**             | ** ** | **Shares**      | ** **        | **Amount**        | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** **  | **Total**  | ** ** |
| ** **                                  | ** ** | **(in thousands)** | ** ** |
| **Balance June 29, 2002**              | ** ** | **21,518**              | ** ** |                               | **$ 215** | ** **              |       |            | **$ 43,773** | ** **        |       | **(2,250**   | **)**      | **$**                  | **(12,997** | **)**      |       | **$ 11,090** | ** ** |   |   | **$ (1,228** | **)** |   | **$** | **40,853** | ** ** |
| Sale of common stock under stock plans |       | 1,140                   |       |                               | 11             | ** **              |       |            | 3,452             | ** **        |       |         |       |                   |        |       |       | ** ** |   |   | ** ** | ** ** |   | 3,463 |   |
| Exercise of stock warrants                  |       | 870                     |       |                               | 9              | ** **              |       |            | 1,148             | ** **        |       |         |       |                   |        |       |       | ** ** |   |   | ** ** | ** ** |   | 1,157 |   |
| Net income                                  |       |                    |       |                               |           | ** **              |       |            |              | ** **        |       |         |       |                   |        |       | 6,814      | ** ** |   |   | ** ** | ** ** |   | 6,814 |   |
| Currency translation adjustment             |       |                    |       |                               |           | ** **              |       |            |              | ** **        |       |         |       |                   |        |       |       | ** ** |   |   | 1,061 | ** ** |   | 1,061 |   |
| **Balance June 28, 2003**              | ** ** | **23,528**              | ** ** |                               | **235**        | ** **              |       |            | **48,373**        | ** **        |       | **(2,250**   | **)**      | **(12,997**            | **)**       |       | **17,904** | ** ** |   |   | **(167** | **)** |   | **53,348** | ** ** |
| Sale of common stock under stock plans |       | 979                     |       |                               | 9              | ** **              |       |            | 4,618             | ** **        |       |         |       |                   |        |       |       | ** ** |   |   | ** ** | ** ** |   | 4,627 |   |
| Exercise of stock warrants                  |       | 60                      |       |                               | 1              | ** **              |       |            | 79                | ** **        |       |         |       |                   |        |       |       | ** ** |   |   | ** ** | ** ** |   | 80 |   |
| Net income                                  |       |                    |       |                               |           | ** **              |       |            |              | ** **        |       |         |       |                   |        |       | 8,119      | ** ** |   |   | ** ** | ** ** |   | 8,119 |   |
| Currency translation adjustment             |       |                    |       |                               |           | ** **              |       |            |              | ** **        |       |         |       |                   |        |       |       | ** ** |   |   | 595 | ** ** |   | 595 |   |
| **Balance July 3, 2004**               | ** ** | **24,567**              | ** ** |                               | **246**        | ** **              |       |            | **53,069**        | ** **        |       | **(2,250**   | **)**      | **(12,997**            | **)**       |       | **26,023** | ** ** |   |   | **428** | ** ** |   | **66,769** | ** ** |
| Sale of common stock under stock plans |       | 197                     |       |                               | 2              | ** **              |       |            | 958               | ** **        |       |         |       |                   |        |       |       | ** ** |   |   | ** ** | ** ** |   | 960 |   |
| Net income                                  |       |                    |       |                               |           | ** **              |       |            |              | ** **        |       |         |       |                   |        |       | 7,323      | ** ** |   |   | ** ** | ** ** |   | 7,323 |   |
| Currency translation adjustment             |       |                    |       |                               |           | ** **              |       |            |              | ** **        |       |         |       |                   |        |       |       | ** ** |   |   | (713 | ) |   | (713 | ) |
| **Balance  July 2, 2005**              | ** ** | **24,764**              | ** ** |                               | **$ 248** | ** **              |       |            | **$ 54,027** | ** **        |       | **(2,250**   | **)**      | **$**                  | **(12,997** | **)**      |       | **$ 33,346** | ** ** |   |   | **$  (285** | **)** |   | **$** | **74,339** | ** ** |

 

The accompanying notes are an integral part of the financial statements.

F-7

----

**CANDELA CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF CASH FLOWSFor the years ended July 2, 2005, July 3, 2004 and June 28, 2003**(in thousands)

| ** **                                                                              | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Cash flows from operating  activities:                                                  |       |       | ** ** | ** ** | ** ** |       | ** ** | ** ** |   |
| Net income                                                                              |       | **$**      | **7,323**  | ** ** | **$**      | **8,119**  | ** ** |   | **$** | **6,814** | ** ** |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:      |       |       | ** ** | ** ** | ** ** |       | ** ** | ** ** |   |
| (Revision of) provision for the disposal of  discontinued operations                    |       | **(859**   | **)**      | **2,095**  | ** ** |       | **—** | ** ** |   |
| Loss from discontinued operations                                                       |       | **—** | ** ** | **298**    | ** ** |       | **1,013**  | ** ** |   |
| Depreciation                                                                            |       | **755**    | ** ** | **668**    | ** ** |       | **582**    | ** ** |   |
| Accretion of imputed interest on stock warrants                                         |       | **—** | ** ** | **—** | ** ** |       | **475**    | ** ** |   |
| Provision for bad debts                                                                 |       | **573**    | ** ** | **520**    | ** ** |       | **(13**    | **)** |   |
| Provision for deferred taxes                                                            |       | **233**    | ** ** | **955**    | ** ** |       | **(682**   | **)** |   |
| Tax benefit from exercised stock options                                                |       | **—** | ** ** | **—** | ** ** |       | **(505**   | **)** |   |
| Effect of exchange rate changes on foreign currency  denominated assets and liabilities |       | **(180**   | **)**      | **26**     | ** ** |       | **36**     | ** ** |   |
| Changes in assets  and liabilities:                                                     |       |       |       |       | ** ** |       | ** ** | ** ** |   |
| Restricted cash                                                                         |       | **58**     | ** ** | **(200**   | **)**      |       | **(57**    | **)** |   |
| Accounts receivable                                                                     |       | **(1,801** | **)**      | **(7,663** | **)**      |       | **(2,417** | **)** |   |
| Notes receivable                                                                        |       | **(19**    | **)**      | **62**     | ** ** |       | **179**    | ** ** |   |
| Inventories                                                                             |       | **719**    | ** ** | **(2,134** | **)**      |       | **1,761**  | ** ** |   |
| Other current assets                                                                    |       | **1,335**  | ** ** | **(2,550** | **)**      |       | **225**    | ** ** |   |
| Other assets                                                                            |       | **427**    | ** ** | **(236**   | **)**      |       | **157**    | ** ** |   |
| Accounts payable                                                                        |       | **4,760**  | ** ** | **(91**    | **)**      |       | **(1,409** | **)** |   |
| Accrued payroll and related expenses                                                    |       | **(567**   | **)**      | **707**    | ** ** |       | **1,622**  | ** ** |   |
| Deferred income                                                                         |       | **2,731**  | ** ** | **548**    | ** ** |       | **574**    | ** ** |   |
| Accrued warranty costs                                                                  |       | **2,091**  | ** ** | **1,776**  | ** ** |       | **(921**   | **)** |   |
| Income tax payable                                                                      |       | **(303**   | **)**      | **(2,535** | **)**      |       | **4,168**  | ** ** |   |
| Other accrued liabilities                                                               |       | **1,698**  | ** ** | **767**    | ** ** |       | **53**     | ** ** |   |
| Net cash provided  by operating activities                                              |       | **18,974** | ** ** | **1,132**  | ** ** |       | **11,655** | ** ** |   |
| Cash flows from  investing activities:                                                  |       |       | ** ** | ** ** | ** ** |       | ** ** | ** ** |   |
| Purchase of property, plant and equipment                                               |       | **(635**   | **)**      | **(685**   | **)**      |       | **(1,227** | **)** |   |
| Net cash used in  investing activities                                                  |       | **(635**   | **)**      | **(685**   | **)**      |       | **(1,227** | **)** |   |
| Cash flows from  financing activities:                                                  |       |       | ** ** | ** ** | ** ** |       | ** ** | ** ** |   |
| Proceeds from issuance of common stock                                                  |       | **960**    | ** ** | **4,707**  | ** ** |       | **4,620**  | ** ** |   |
| Principal payments of long-term debt                                                    |       | **—** | ** ** | **—** | ** ** |       | **(3,330** | **)** |   |
| Net borrowings (repayments) on line of credit                                           |       | **—** | ** ** | **—** | ** ** |       | **(1,114** | **)** |   |
| Net cash provided  by financing activities                                              |       | **960**    | ** ** | **4,707**  | ** ** |       | **176**    | ** ** |   |
| Effect of exchange rate changes on cash and cash  equivalents                           | ** ** | **(55**    | **)**      | **172**    | ** ** |       | **1,552**  | ** ** |   |
| Net increase in  cash and cash equivalents                                              | ** ** | **19,244** | ** ** | **5,326**  | ** ** |       | **12,156** | ** ** |   |
| Cash and cash equivalents, beginning of year                                            | ** ** | **37,139** | ** ** | **31,813** | ** ** |       | **19,657** | ** ** |   |
| Cash and cash equivalents, end of year                                                  | ** ** | **56,383** | ** ** | **$**      | **37,139** | ** ** |       | **$** | **31,813** | ** ** |   |
| Cash paid during  the year for:                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |       | ** ** | ** ** |   |
| Interest                                                                                |       | **—** |       | **$**      | **15**     | ** ** |       | **$** | **235** | ** ** |   |
| Income Taxes                                                                            |       | **$**      | **2,269**  |       | **$**      | **3,265**  | ** ** |   | **$** | **751** | ** ** |   |

 

F-8

----

**Notes to Consolidated Financial Statements**

**1.**   Summaryof Significant Accounting Policies

***Description ofBusiness and Basis of Presentation***

Candela Corporation is apioneer in the development and commercialization of advanced aesthetic lasersystems that allow physicians and personal care practitioners to treat a widevariety of cosmetic and medical conditions. The consolidated financialstatements include the accounts of Candela Corporation and its wholly-ownedsubsidiaries. All intercompany accounts and transactions have been eliminatedin consolidation. The notes to our consolidated financial statements pertain tocontinuing operations except where otherwise noted.

All prior period financialstatements have been restated to reflect skin care centers operations asdiscontinued (See note 11), as required under generally accepted accountingprinciples in the U.S.

All share and per-shareinformation included in the accompanying consolidated financial statements forall periods presented have been restated to retroactively reflect the effect ofa two-for-one stock split which occurred on February 16, 2004.

The Company’s fiscal yearends on the Saturday nearest June 30. The years ended July 2, 2005and June 28, 2003 each contain 52 weeks. The year ended July 3, 2004contains 53 weeks.

***Use of Estimates***

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. It is the beliefof the Company’s management that all necessary adjustments have been made foran accurate presentation of results. Actual results could differ from thoseestimates and impact future results of operations and cash flows.

In the ordinary course ofaccounting for the items discussed above, the Company makes changes inestimates as appropriate, and as we become aware of circumstances surroundingthose estimates. Such changes and refinements in estimation methodologies arereflected in reported results of operations in the period in which the changesare made and, if material, their effects are disclosed in the Notes to theConsolidated Financial Statements.

***Cash and CashEquivalents***

The Company classifiesinvestments purchased with a maturity, at the date of acquisition, of threemonths or less as cash equivalents. These are valued at cash plus accruedinterest, which approximates market value. At July 2, 2005, and July 3,2004, substantially all cash equivalents were invested in short durationCertificates of Deposit and overnight Repurchase Agreements with major financialinstitutions.

***Accounts Receivableand Notes Receivable***

The Company’s tradeaccounts receivables and notes receivables are primarily from sales to endusers, leasing companies, and distributors servicing the medical device market,and reflect a broad domestic and international customer base. The Company doesnot require collateral and has not historically experienced significant creditlosses related to receivables from individual customers or groups of customersin any particular industry or geographic area. Our policy is to maintainallowances for estimated losses resulting from the inability of our customersto make required payments. Credit limits are established through a process ofreviewing the financial history and stability of each customer. Where appropriate,we obtain credit rating reports and financial statements of customers whendetermining or modifying their credit limits. We regularly evaluate thecollectibility of our trade receivable balances based on a combination offactors. When a customer’s account balance becomes past due, we initiatedialogue with the customer to determine the cause. If it is determined that thecustomer will be unable to meet its financial obligation to us, such as in thecase of a bankruptcy filing, deterioration in the customer’s operating resultsor financial position or other material events impacting their business, werecord a specific allowance to reduce the related receivable to the amount weexpect to recover given all information presently available.

F-9

----

***Inventories***

Inventories are stated atthe lower of cost (first-in, first-out method) or market, using a standardcosting system.

***Property andEquipment***

Purchasedproperty and equipment is recorded at cost. Property and equipment purchasedunder capital lease arrangements is recorded at the lesser of cost or thepresent value of the minimum lease payments required during the lease period. Lasersystems used for testing are capitalized at cost. Repairs and maintenance costs are expensed asincurred. Depreciation is provided using the straight-line method overthe estimated useful lives as follows:

| ** **                                             | ** ** | **Number of Years** | ** ** |
|--------------------------------------------------------|------------|-------------------------------|------------|
| Leasehold  improvements and assets under capital lease |       |                          | 2 to 15    |   |   |
| Office furniture,  computer and other equipment        |       |                          | 3 to 10    |   |   |

 

***Income Taxes***

The Company accounts forincome taxes using an asset and liability approach that requires therecognition of deferred tax assets and liabilities for the expected future taxconsequences of events that have been recognized in the financial statements ortax returns. In estimating future tax consequences, all expected future eventsare considered other than enactments of changes in tax laws or rates. Valuationallowances are established as necessary to reduce deferred tax assets in theevent that realization of the assets is considered unlikely.

***Research andDevelopment Costs***

Research and developmentcosts are expensed as incurred

***Impairment ofLong-Lived Assets***

We review therecoverability of our long-lived assets, including building improvements,equipment and other intangible assets, when events or changes in circumstancesoccur that indicate that the carrying value of the asset may not berecoverable. The assessment of possible impairment is based on our ability torecover the carrying value of the asset from the expected future pre-tax cashflows (undiscounted and without interest charges) of the related operations. Ifthese cash flows are less than the carrying value of such asset, an impairmentloss is recognized for the difference between estimated fair value and carryingvalue. Our primary measure of fair value is based on discounted cash flows. Themeasurement of impairment requires management to make estimates of these cashflows related to long-lived assets, as well as other fair value determinations.

***Advertising Costs***

Advertising costs areexpensed as incurred and are included as a component of selling, general andadministrative expenses in the accompanying Statements of Operations. Advertisingcosts were $916, $766 and $798 for the years ended July 2, 2005, July 3,2004 and June 28, 2003, respectively.

***Foreign CurrencyTranslation***

The activity of theCompany’s foreign subsidiaries is translated into U.S. dollars in accordancewith SFAS No. 52, “*Foreign CurrencyTranslation*”. Assets and liabilities are translated into U.S.dollars at current exchange rates, while income and expense items aretranslated at average rates of exchange prevailing during the year. Exchangegains and losses arising from translation of the Japanese, Spanish, German, andFrench subsidiary balance sheets are accumulated as a separate component ofstockholders’ equity. Net exchange (losses) gains resulting from foreigncurrency transactions amounted to $(123), $339 and $(56) for fiscal 2005, 2004and 2003, respectively, and are included in other income (expense).

F-10

----

***Derivative Instruments and Hedging Activity***

Candela enters into financial instruments to reduceits exposure to fluctuations in foreign exchange rates by creating offsettingpositions through the use of foreign currency forward contracts. The Companyrecognizes all derivative instruments as either assets or liabilities in thestatements of financial position and measures those instruments at fair value.Changes to the fair value of derivative contracts that do not qualify for hedgeaccounting are reported in earnings in the period of the change. Forderivatives that qualify for hedge accounting, changes in the fair value of thederivatives are either recorded in shareholders’ equity as a component of othercomprehensive income or are recognized currently in earnings, along with anoffsetting adjustment against the basis of the item being hedged. Cumulativegains and losses on derivatives that have hedged our foreign operations andthat have been recorded in other comprehensive income as of July 2, 2005and July 3, 2004 did not amount to a significant gain or loss.

The Company’s foreigncurrency forward contracts may involve elements of credit and market risk inexcess of the amounts recognized in the financial statements. The Companymonitors its positions and the credit quality of counter-parties, consistingprimarily of major financial institutions, and does not anticipatenonperformance by any counter-party. The Company does not use derivativefinancial instruments for trading or speculative purposes, nor is the Company aparty to leveraged derivatives.

***Revenue Recognition***

*Productsales*—The Company recognizes revenue upon shipment ofproduct to customers and the fulfillment of all contractual terms andconditions, pursuant to the guidance provided by SAB No. 104, *Revenue Recognition in Financial Statements*. Credit is notextended to customers and revenue is not recognized until collectibility isreasonably assured.

*Service**—*Revenue from the sale of service contracts is deferred andrecognized on a straight-line basis over the contract period. Revenue fromservice administered by Candela that is not covered by a service contract isrecognized as the services are provided.

*Multiple-elementarrangements*—In certain instances, the Company maysell products together with extended warranties or maintenance contracts.   Therevenue recognized per element is determined by allocating the total salesprice to each element, based on the relative fair values. Separately pricedextended warranty and maintenance products are accounted for in accordance withFinancial Technical Bulletin 90-1 which provides for recognition ofrevenue ratably over the life of the contract.

***Product Warranty Costs***

Our products are generallycovered by a standard warranty, with an option to purchase extended warrantycontracts at the time of product sale or service contracts after the time ofsale. Distributor sales generally include a parts warranty only. Estimatedfuture costs for initial product warranties are provided for at the time ofsale.

***Comprehensive Income (Loss)***

Comprehensive income(loss) is comprised of two components, net income (loss) and othercomprehensive income (loss). Other comprehensive income (loss) consists oftranslation adjustments, which represent the effect of translating assets andliabilities of the Company’s foreign subsidiaries. Translation adjustments areshown net of tax (benefit) expense of $(199), $167 and $329 for fiscal years2005, 2004 and 2003, respectively.

F-11

----

***Earnings (Loss) Per Share***

Thefollowing table provides share information used in the calculation of the Company’sbasic and diluted earnings per share:

| ** **                                                                        | ** ** | **For the years ended:**                            | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **July 2,  2005**                                             | ** ** | **July 3,  2004** | ** ** | **June 28,  2003** | ** ** |
| ** **                                                                        | ** ** | **(in thousands, except per share data)** | ** ** |
| **Basic  shares used in the calculation of earnings per share**                   | ** ** | **22,388**                                                         |       | 21,902 |   |   | 20,083 |   |   |
| **Effect  of dilutive securities:**                                               | ** ** | ** **                                                         | ** ** | ** ** | ** ** |   |   |   |   |
| **Stock  options**                                                                | ** ** | **685**                                                            |       | 810 |   |   | 297 |   |   |
| **Stock  warrants**                                                               | ** ** | **—**                                                         |       | — |   |   | 265 |   |   |
| **Diluted shares used in the calculation of  earnings per share**                 | ** ** | **23,073**                                                         |       | 22,712 |   |   | 20,645 |   |   |
| **Per share effect of dilutive securities on  income from continuing operations** | ** ** | **$**                                                              | **.01**    |   | $ | .02 |   |   | $ | .01 |   |   |
| **Per  share effect of dilutive securities on net income**                        | ** ** | **$**                                                              | **.01**    |   | $ | .01 |   |   | $ | .01 |   |   |

 

During the years ended July 2,2005, July 3, 2004, and June 28, 2003, options and warrants topurchase 1,392, 497 and 615 shares of common stock, respectively, were notincluded in the computation of diluted earnings (loss) per share because theywould have had an anti-dilutive effect.

***Dividends***

The Company currently intendsto retain future earnings for use in its business and, therefore, does notexpect to pay dividends in the foreseeable future.

***Accounting for Stock-Based Compensation***

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement No. 123R, “Share-Based Payment”(“FAS 123R”). FAS 123R is a revision of FASB Statement No. 123, “Accountingfor Stock-Based Compensation” (“FAS 123”). The Company is required to adopt theprovisions of FAS123R as of the beginning of its first fiscal quarter of 2006,beginning July 3, 2005. This statement establishes standards for andrequires the recognition of the cost of employment-related services settled inshare-based payment. The adoption of the provisions of FAS 123R will have amaterial impact on the Company’s consolidated financial statements.

Currently and until the adoption of FAS 123R, theCompany follows the provisions of FAS 123. The provisions of FAS 123 allowcompanies to either expense the estimated fair value of its employee stockoptions or to continue to follow the intrinsic value method set forth inAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (“APB 25”), but disclose the pro forma effects on net income(loss) had the fair value of its employee stock options been expensed.Candela has elected to continue to apply APB 25 in accounting for its employee stockoption incentive plans.

In accordance with APB 25 and related interpretations,compensation expense for stock options is recognized in income based on theexcess, if any, of the quoted market price of the stock at the grant date ofthe award or other measurement date over the amount an employee must pay toacquire the stock. Generally, the exercise price for stock options granted toemployees equals or exceeds the fair market value of Candela common stock atthe date of grant, thereby resulting in no recognition of compensation expenseby Candela. For awards that generate compensation expense as defined under APB25, the Company calculates the amount of compensation expense and recognizesthe expense over the vesting period of the award.

F-12

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On May 2,2005, Candela Corporation’s Board of Directors approved accelerating thevesting of unvested, “out-of-the-money” options to purchase approximately 535,000shares of the Company’s common stock awarded to employees, officers andnon-employee directors under its stock option plans. The accelerated optionshave exercise prices ranging from $9.50 to $12.33 and a weighted averageexercise price of $11.52. The acceleration was unconditional to the employees,officers and non-employee directors and was applied to all outstanding,unvested options priced above the closing price of Candela’s common stock onMonday, May 2, 2005. Approximately $6,393 of the FY 2005 proforma expenselisted below relates to options included in this acceleration pool.

The primary purpose of the accelerated vesting is toenable the Company to avoid recognizing future compensation expense associatedwith the accelerated stock options upon the planned adoption of FAS 123R,by Candela in fiscal 2006.

Hadcompensation cost for Candela’s stock option plans been determined based on thefair value method set forth in FAS 123, Candela’s net income (loss) andbasic and diluted net income(loss) per common share would have been changed tothe pro forma amounts indicated below:

| ** **                                                                                                                                | ** ** | **For the year ended**                              | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                                | ** ** | **   July 2,     2005**         | ** ** | **July 3,  2004** | ** ** | **June 28,  2003** | ** ** |
| ** **                                                                                                                                | ** ** | **(in thousands, except per share data)** | ** ** |
| **Net  Income (loss), as reported**                                                                                                       | ** ** |                                                               | **$**      | **7,323** | ** ** |   | **$** | **8,119** | ** ** |   | **$** | **6,814** | ** ** |   |
| **Deduct:  Total stock-based employee compensation expense determined under fair value  based method for all awards, net of tax effects** | ** ** |                                                               | **(6,609** | **)** |   | **(780** | **)** |   | **(833** | **)** |   |
| **Pro forma net income (loss)**                                                                                                           | ** ** |                                                               | **$**      | **714** | ** ** |   | **$** | **7,339** | ** ** |   | **$** | **5,981** | ** ** |   |
| **Earnings (loss) per share**                                                                                                             | ** ** |                                                               | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| **Basic—as  reported**                                                                                                               | ** ** |                                                               | **$**      | **0.33** | ** ** |   | **$** | **0.37** | ** ** |   | **$** | **0.34** | ** ** |   |
| **Basic—pro  forma**                                                                                                                 | ** ** |                                                               | **$**      | **0.03** | ** ** |   | **$** | **0.34** | ** ** |   | **$** | **0.30** | ** ** |   |
| **Diluted—as  reported**                                                                                                             | ** ** |                                                               | **$**      | **0.32** | ** ** |   | **$** | **0.36** | ** ** |   | **$** | **0.33** | ** ** |   |
| **Diluted—pro forma**                                                                                                                | ** ** |                                                               | **$**      | **0.03** | ** ** |   | **$** | **0.32** | ** ** |   | **$** | **0.29** | ** ** |   |

 

Incomputing this pro-forma amount, the Company has used the Black-Scholes pricingmodel using the following assumptions for options granted in fiscal years 2005,2004, and 2003:

| ** **                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| risk-free  interest rate                     |       | 4.25     | %          | 1.25     | %          | 4.25     | %          |
| estimated  volatility                        |       | 76       | %          | 80       | %          | 76       | %          |
| expected life for  stock options (yrs)       |       | 2.87     |       | 2.92     |       | 2.99     |       |
| expected life for  stock purchase plan (yrs) |       | 0.5      |       | 0.5      |       | 0.5      |       |
| expected dividends                           |       | none     |       | none     |       | none     |       |

 

The weighted average grant-date fair value per shareof options granted, calculated using the Black-Scholes option-pricing model,was $7.77 in 2005, $5.86 in 2004 and $2.18 in 2003.

F-13

----

***Recent Accounting Pronouncements***

In November 2004, the Financial AccountingStandards Board issued SFAS Statement No. 151, *Inventory Costs, an Amendment of AccountingPrinciples Board Opinion No. 43, Chapter 4*, orSFAS 151. SFAS 151 requires that items such as idle facility expense,freight, handling costs and wasted materials be recognized as current-periodcharges rather than being included in inventory regardless of whether the costsmeet the criterion of abnormal as defined in Accounting Principles BoardOpinion No. 43. SFAS 151 is applicable for inventory costs incurredduring fiscal years beginning after June 15, 2005. We will adopt thispronouncement on July 3, 2005 and we do not expect the adoption with havea material impact on our financial condition or results of operation.

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued Statement No. 123R, “Share-BasedPayment” (“FAS 123R”). FAS 123R is a revision of FASB Statement No. 123, “Accountingfor Stock-Based Compensation” (“FAS 123”). The Company is required to adopt theprovisions of FAS123R as of the beginning of its first fiscal quarter of 2006,beginning July 3, 2005. This statement establishes standards for andrequires the recognition of the cost of employment-related services settled inshare-based payment. The adoption of the provisions of FAS 123R will have amaterial impact on the Company’s consolidated financial statements.

***Uncertainties***

The Company is subject to risks common to companies inthe aesthetic laser industry, including (i) the Company’s ability tosuccessfully complete preclinical and clinical development and obtain timelyregulatory approval and adequate patent and other proprietary rights protectionof its products and services, (ii) the content and timing of decisionsmade by the Food & Drug Administration and other agencies regardingthe procedures for which the Company’s products may be approved, (iii) theability of the Company to manufacture adequate supplies of its products fordevelopment and commercialization activities, (iv) the accuracy of theCompany’s estimates of the size and characteristics of markets to be addressedby the Company’s products and services, (v) market acceptance of theCompany’s products and services, (vi) the Company’s ability to obtainreimbursement for its products from third-party payers, where appropriate, and (vii) theaccuracy of the Company’s information concerning the products and resources ofcompetitors and potential competitors.

The Company depends on asingle vendor for Alexandrite rods used to manufacture the GentleLASE. Thisproduct accounts for a significant portion of total revenues.

F-14

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**2.   Inventories**

Inventoriesconsist of the following:

| ** **              | ** ** | **July 2,  2005**  | ** ** | **July 3,  2004** | ** ** |
|-------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **              | ** ** | **(in thousands)** | ** ** |
| Raw materials           |       | $                       | 3,968      |                   | $          | 4,833 |   |
| Work in process         |       | 166                     |       | 556                    |       |
| Finished goods          |       | 8,542                   |       | 8,182                  |       |
| Total  inventories, net |       | $                       | 12,676     |                   | $          | 13,571 |   |

 

**3.   Property and Equipment**

Propertyand equipment consist of the following:

| ** **                              | ** ** | **July 2,  2005**  | ** ** | **July 3,  2004** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **(in thousands)** | ** ** |
| Leasehold  improvements                 |       | $                       | 743        |                   | $          | 740 |   |
| Office furniture                        |       | 567                     |       | 479                    |       |
| Computers, software and other equipment |       | 8,698                   |       | 8,172                  |       |
|                                    |       | 10,008                  |       | 9,391                  |       |
| Less accumulated depreciation           |       | 6,768                   |       | 5,985                  |       |
| Property and  equipment, net            |       | $                       | 3,240      |                   | $          | 3,406 |   |

 

**4.   Guarantees**

The Company’s products generally carry a standardwarranty. The Company sets aside a reserve based on anticipated warranty claimsat the time product revenue is recognized. In anticipation of actual warrantyclaims, the Company amortizes the reserve ratably over the life of the warrantythereby offsetting actual warranty claims incurred. Actual warranty claimsincurred and charged to product costs of sales during an interim period may bemore or less than the amount of amortized warranty reserve allocated againstthem. Factors that affect the Company’s product warranty liability include thenumber of installed units, the anticipated cost of warranty repairs andhistorical and anticipated rates of warranty claims.

Thefollowing table reflects changes in the Company’s accrued warranty accountduring the fiscal year ended July 2, 2005:

| ** **                                     | ** ** | **(in thousands)** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|
| **Beginning  balance on July 3, 2004**    | ** ** |                    | **$**      | **8,257** | ** ** |   |
| **Plus accruals related to new sales**         | ** ** |                    | **8,864**  | ** ** |   |
| **Less amortization of prior period accruals** | ** ** |                    | **8,476**  | ** ** |   |
| **Ending  balance on July 2, 2005**       | ** ** |                    | **$**      | **8,645** | ** ** |   |

 

The Company also offers extended service contractsthat may be purchased after a standard warranty has expired. Service contractsmay be purchased for periods from one to five years. The Company recognizes servicecontract revenue ratably over the life of the contract. Actual service contractexpenses incurred and charged to service costs of sales during an interimperiod may be more or less than the amount of amortized service contractrevenue recognized in that period.

F-15

----

Thefollowing table reflects changes in the Company’s deferred service contractrevenue account during the fiscal year ended July 2, 2005:

| ** **                                      | ** ** | **(in thousands)** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
| **Beginning  balance on July 3, 2004**     | ** ** |                    | **$**      | **4,055** | ** ** |   |
| **Plus deferral of new service contract sales** | ** ** |                    | **9,672**  | ** ** |   |
| **Less recognition of deferred revenue**        | ** ** |                    | **5,377**  | ** ** |   |
| **Ending  balance on July 2, 2005**        | ** ** |                    | **$**      | **8,350** | ** ** |   |

 

**5.   Deferred Income**

Deferredincome consists solely of service contract revenue:

| ** **                                | ** ** | **July 2,  2005**  | ** ** | **July 3,  2004** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| **Service  contract revenue**             | ** ** | **$**                   | **8,350**  |                   | **$**      | **4,055** | ** ** |
| **Less current portion**                  | ** ** | **6,037**               |       | **3,421**              | ** ** |
| **Long  term portion of deferred income** | ** ** | **$**                   | **2,313**  |                   | **$**      | **634** | ** ** |

 

**6.   Debt, Lease and Other Obligations**

***Line of Credit***

The Company has arenewable $10,000,000 revolving credit agreement with a major bank withinterest at the bank’s base rate or LIBOR plus 2.25 percent. Any borrowingsoutstanding under the line of credit are due on demand or according to apayment schedule established at the time funds are borrowed. The line of creditis unsecured. The agreement contains restrictive covenants limiting theestablishment of new liens, and the purchase of margin stock. No amounts wereoutstanding under the line of credit as of July 2, 2005 or July 3,2004.

***Restricted Cash***

A financing company usedby Candela’s customers has limited recourse with Candela on a small number ofproduct leases. As such, Candela has placed approximately $0.2 and $0.3 millionin restricted funds at this institution as collateral as of July 2, 2005and July 3, 2004, respectively. This restricted cash represents Candela’sentire exposure under these agreements.

***Operating Lease Commitments***

The Company leases several facilities and automobilesunder non-cancelable lease arrangements. The facility leases may be adjustedfor increases in maintenance and insurance costs above specified levels. Inaddition, certain facility leases contain escalation provisions based oncertain specified criteria, and one lease calls for the payment of additionalrent based on a percentage of gross revenues above a base gross sales level forthat particular location. These operating leases expire in various yearsthrough 2011. These leases may be renewed for periods ranging from one to fiveyears.

F-16

----

Ouroutstanding leases payableare reflected in the following table as of July 2, 2005:

| ** **                    | ** ** | **(in thousands)** | ** ** |
|-------------------------------|------------|-------------------------|------------|
| 2006                          |       |                    | $          | 1,018 |   |   |
| 2007                          |       |                    | 788        |   |   |
| 2008                          |       |                    | 378        |   |   |
| 2009                          |       |                    | 205        |   |   |
| 2010                          |       |                    | 92         |   |   |
| Thereafter                    |       |                    | 48         |   |   |
| Total minimum  lease payments |       |                    | $          | 2,534 |   |   |

 

Total rent expense wasapproximately $1,376, $884 and $1,100 in fiscal 2005, 2004 and 2003,respectively.

Ouroutstanding contractual obligations relating to future minimum royalties payable to the Regents are reflectedin the following table as of July 2, 2005:

| ** **                      | ** ** | **(in thousands)** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| 2006                            |       |                    | $          | 4,000 |   |   |
| 2007                            |       |                    | 1,000      |   |   |
| 2008                            |       |                    | 1,000      |   |   |
| 2009                            |       |                    | 1,000      |   |   |
| 2010                            |       |                    | 1,000      |   |   |
| Thereafter                      |       |                    | 1,250      |   |   |
| Total minimum royalty  payments |       |                    | $          | 9,250 |   |   |

 

***Royalty***

In August 2000, the Company entered into anagreement to amend the license agreement with The Regents of the University ofCalifornia (the “Regents”) whereby in exchange for an exclusivity fee of approximately$1.7 million, which was prepaid in full, Candela obtained exclusive licenserights to the DCD (subject to certain limited license rights of Cool Touch, Inc.(“Cool Touch”)) in the following fields of use: procedures that involve skinresurfacing and rejuvenation, vascular skin lesions, and laser hair removal. CoolTouch, a subsidiary of New Star Technology, Inc. obtained a license to theDCD on a co-exclusive basis with Candela, in certain narrower fields ofuse. Cool Touch is restricted in its ability to assign its license rights tocertain existing competitors of Candela. Candela is entitled to one-half of allroyalty income payable to the Regents from Cool Touch. Under the amendedagreement, Candela no longer is required by the Regents to negotiatesublicenses to third parties. However, Candela is entitled to one-half of allroyalties due from any other entity that licenses the DCD technology from theRegents in other fields of use. The Company recognized royalty expense of $9.2,$2.6, and 3.4 million for fiscal 2005, 2004, and 2003, respectively basedon the license agreement with the Regents. Included in the fiscal 2005 expenseof $9.2 mllion is $4.8 of expense for the third quarter charge taken related tothe Regents arbitration decision (see note 12). Of that $4.8 million, $1.3million related to fiscal 2005, $3.0 million related to fiscal 2004 and 0.5million related to fiscal 2003. In fiscal 2003, the Company recognized royaltyincome of approximately $0.3 million which related to royalties earned sincethe August 11, 2000 settlement agreement with the Regents of theUniversity of California and New Star Technology, Inc. No royalty incomewas recognized in fiscal 2005 or fiscal 2004.

Effective July 3,2005, the Company amended certain portions of their agreement with the Regentswhereby for the annual license fee of $0.3 million, the Company’s royaltyobligation will be reduced to 3% 

F-17

----

from itsprior level of 6%. The annual fee of $0.3 million is payable by a lump sum of$3.0 million and will be amortized over the remaining life of the patentagreement, which as of July 3, 2005 was 10 years. No portion of thisreduced royalty rate or annual license fee payment is reflected in the Company’sfinancial statements as of July 2, 2005.

**7.   Stockholders’ Equity**

**Stock Plans**

***1990 Candela Corporation Employee Stock Purchase Plan***

The 1990 Employee Stock Purchase Plan (the “PurchasePlan”) provides for the sale of up to 1,500,000 shares of common stock toeligible employees. The shares are issued at the lesser of 85% of the averagemarket price on the first or last day of semi-annual periods. Substantially allfull-time employees are eligible to participate in the Purchase Plan. At July 2,2005 there were 720,227 shares available for sale.

Thefollowing is a summary of shares issued under the Purchase Plan:

| ** ** | ** ** | ** ** | ** ** | **Range of**             | ** ** |
|------------|------------|------------|------------|-------------------------------|------------|
| ** ** | ** ** | **Shares** | ** ** | **Price per share** | ** ** |
| 2003       |       | 49,724     |       |                          | $          | 2.35-$2.65 |   |   |
| 2004       |       | 37,956     |       |                          | $          | 5.00-$8.00 |   |   |
| 2005       |       | 35,059     |       |                          | $          | 8.50-$9.00 |   |   |

 

***1985, 1987, 1989 and 1998 Candela Corporation Stock OptionPlans***

The 1985, 1987, 1989 and 1998 Stock Option Plans (the “StockOption Plans”) provide for the granting of incentive stock options to employeesfor the purchase of common stock at an exercise price not less than the fairmarket value of the stock on the date of grant. The Stock Option Plans alsoprovide for the granting of non-qualified stock options.

The Board of Directors hasterminated the granting of options under the 1985, 1987 and 1989 Stock OptionPlans. Options granted under the 1998 Stock Option Plan become exercisable onthe date of grant or in installments, as specified by a Committee establishedby the Board of Directors, and expire ten years from the date of the grant. Themaximum number of shares for which options may be granted under the 1998 StockOption Plan was increased from 2,500,000 to 3,300,000 in fiscal 2003, and from3,300,000 to 5,300,000 in fiscal 2004.

***1990 and 1993 Candela Corporation Non-EmployeeDirector Stock Option Plans***

The 1990 and 1993 Non-Employee Director Stock OptionPlans (the “Non-Employee Director Plans,” collectively with the Stock OptionPlans, the “Plans”) provide for the issuance of options for the purchase of upto 180,000 and 240,000 shares of common stock, respectively. Under theNon-Employee Director Plans, each director who is neither an employee nor anofficer receives a one-time grant of an option to purchase 20,000 shares ofcommon stock at an exercise price equal to the fair market value of the commonstock on the date of grant. Under the 1990 and 1993 Non-Employee DirectorPlans, options become exercisable in equal amounts over a period of four andtwo years, respectively. Shares under the Non-Employee Director Plansexpire four and ten years, respectively, after the date of grant and arenontransferable.

F-18

----

Thefollowing is a summary of stock option activity under the Plans:

| ** **                                        | ** ** | ** **         | ** ** | ** **            | ** **                         | **Weighted Avg.**  | ** ** |
|---------------------------------------------------|------------|--------------------|------------|-----------------------|------------------------------------|-------------------------|------------|
| ** **                                        | ** ** | **Number of** | ** ** | ** **            | ** **                         | **Exercise Price** | ** ** |
| ** **                                        | ** ** | **Shares**         | ** ** | **Option Price** | ** **                         | **per Share**      | ** ** |
| Balance at  June 29, 2002                    |       | 2,317,224          |       |                  |                               |                    |       |   |   |
| Granted                                           |       | 972,032            |       | $                     | 2.75 - $  4.67 |                    |       | $ | 3.60 |   |   |
| Exercised                                         |       | (1,082,064         | )          | $                     | 1.04 - $  4.63 |                    |       | $ | 2.61 |   |   |
| Forfeited                                         |       | (149,270           | )          | $                     | 1.07 - $  4.63 |                    |       | $ | 3.11 |   |   |
| Balance at  June 28, 2003                    |       | 2,057,922          |       |                  |                               |                    | $          | 3.71 |   |   |
| Granted                                           |       | 1,038,560          |       | $                     | 5.59 - $11.98            |                    |       | $ | 9.82 |   |   |
| Exercised                                         |       | (928,730           | )          | $                     | 1.06 - $  6.02 |                    |       | $ | 3.44 |   |   |
| Forfeited                                         |       | (58,410            | )          | $                     | 2.75 - $11.96            |                    |       | $ | 9.23 |   |   |
| Balance at  July 3, 2004                     |       | 2,109,342          |       |                  |                               |                    | $          | 6.58 |   |   |
| Granted                                           |       | 572,898            |       | $                     | 8.00 - $12.33            |                    |       | $ | 10.04 |   |   |
| Exercised                                         |       | (156,527           | )          | $                     | 1.08 - $  9.90 |                    |       | $ | 4.01 |   |   |
| Forfeited                                         |       | (41,153            | )          | $                     | 2.57 - $10.93            |                    |       | $ | 9.15 |   |   |
| Balance at  July 2, 2005                     |       | 2,484,560          |       |                  |                               |                    | $          | 7.48 |   |   |
| Options available  for grant at July 2, 2005 |       | 1,091,104          |       |                  |                               |                    |       |   |   |

 

Thefollowing table summarizes information about stock options outstanding underthe Plans as of July 2, 2005:

| OPTIONS OUTSTANDING                    | ** ** | ** **      | ** **    | ** **          | ** ** |
|---------------------------------------------|------------|-----------------|---------------|---------------------|------------|
| ** **                                  | ** ** | ** **      | ** **    | **Weighted**        | ** ** | ** ** | ** ** | **OPTIONS EXERCISABLE** | ** ** |
| ** **                                  | ** ** | ** **      | ** **    | **Average**         | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                  | ** ** | ** **      | ** **    | **Remaining**       | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | **Number**      | ** **    | **Contractual**     | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Range of Exercise Prices** | ** ** | **Outstanding** | ** **    | **Life (yrs)** | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $  1.21 -  $  3.68      |       |            | 489,034       |                |       |   | 5.54 |   |   |   | $ | 2.68 |   |   | 464,034 |   |   | $ | 2.69 |   |   |
| $  4.08  - $  5.59      |       |            | 529,194       |                |       |   | 7.62 |   |   |   | $ | 4.80 |   |   | 344,194 |   |   | $ | 4.88 |   |   |
| $  6.02 - $10.35                  |       |            | 816,089       |                |       |   | 8.09 |   |   |   | $ | 8.41 |   |   | 693,589 |   |   | $ | 8.62 |   |   |
| $10.93 - $12.33                             |       |            | 700,042       |                |       |   | 9.07 |   |   |   | $ | 11.78 |   |   | 700,042 |   |   | $ | 11.78 |   |   |
| $  1.21 - $12.33                  | ** ** |            | **2,484,560** |                |       |   | 7.77 |   |   |   | $ | 7.48 |   | ** ** | **2,201,859** |   |   | $ | 7.79 |   |   |

 

***Reserved Shares***

The Company has reserved3,102,024 shares of common stock for issuance under its Purchase, Stock Option,and Non-Employee Director Plans.

F-19

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**8.**   Income Taxes

Thecomponents of income (loss) before income taxes and the related provision for(benefit from) income taxes consist of the following (in thousands):

| ** **                                                       | ** ** | **For Years Ended** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                       | ** ** | **July 2,**              | ** ** | **July 3,** | ** ** | **June 28,** | ** ** |
| ** **                                                       | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Income (loss) from  continuing operations before income taxes:   |       |                          |       |   |   |   |   |
| Domestic                                                         |       | $                             | 7,075      |   | $ | 12,880 |   | $ | 9,701 |   |
| Foreign                                                          |       | 1,583                         |       | 2,218 |   | 1,642 |   |
|                                                             |       | $                             | 8,658      |   | $ | 15,098 |   | $ | 11,343 |   |
| Income (loss)  from discontinued operations before income taxes: |       |                          |       |   |   |   |   |
| Domestic                                                         |       | $                             | 1,374      |   | $ | (3,821 | ) | $ | (1,468 | ) |
| Provision for  (benefit from) income taxes:                      |       |                          |       |   |   |   |   |
| Current  provision:                                              |       |                          |       |   |   |   |   |
| Federal                                                          |       | $                             | 2,101      |   | $ | 2,911 |   | $ | 1,841 |   |
| State                                                            |       | 193                           |       | 238 |   | 99 |   |
| Foreign                                                          |       | 375                           |       | 552 |   | 439 |   |
| Total current provision for (benefit from) income  taxes         |       | 2,669                         |       | 3,701 |   | 2,379 |   |
| Deferred  provision (benefit)                                    |       |                          |       |   |   |   |   |
| Federal                                                          |       | 41                            |       | (543 | ) | 682 |   |
| Total provision  for (benefit from) income taxes                 |       | $                             | 2,710      |   | $ | 3,158 |   | $ | 3,061 |   |

 

Thecomponents of the Company’s deferred tax assets consist of the following (inthousands):

| ** **                                  | ** ** | **July 2,** | ** ** | **July 3,** | ** ** |
|---------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                  | ** ** | **2005**         | ** ** | **2004**         | ** ** |
| Warranty reserve                            |       | $                | 1,959      |             | $          | 1,931 |   |
| Inventory  valuation reserves               |       | 817              |       | 509              |       |
| Restructuring  reserve                      |       | 455              |       | 1,193            |       |
| Deferred Revenue                            |       | 1,544            |       | 1,593            |       |
| Federal and state  tax credit carryforwards |       | 321              |       | 321              |       |
| Bad debt reserve                            |       | 681              |       | 479              |       |
| Other                                       |       | (34              | )          | (112             | )          |
| Deferred tax assets                         |       | $                | 5,743      |             | $          | 5,914 |   |

 

Areconciliation from the federal statutory tax rate to the effective tax rate isas follows:

| ** **                                   | ** ** | **July 2,** | ** ** | **July 3,** | ** ** | **June 28,** | ** ** |
|----------------------------------------------|------------|------------------|------------|------------------|------------|-------------------|------------|
| ** **                                   | ** ** | **2005**         | ** ** | **2004**         | ** ** | **2003**          | ** ** |
| Statutory rate                               |       |             | 35         | %                |       |              | 35         | % |   |   | 34 | % |   |
| State income  taxes                          |       |             | 1          | %                |       |              | 1          | % |   |   | 1 | % |   |
| Difference  between foreign and US tax rates |       |             | (2         | )%               |       |              | (3         | )% |   |   | (1 | )% |   |
| Benefit from  foreign sales credits          |       |             | (3         | )%               |       |              | (3         | )% |   |   | (2 | )% |   |
| Utilization of  deferred tax assets          |       |             | (6         | )%               |       |              | —     |   |   |   | — |   |   |
| Other                                        |       |             | —     |             |       |              | —     |   |   |   | (1 | )% |   |
| Effective tax rate                           |       |             | 25         | %                |       |              | 30         | % |   |   | 31 | % |   |

 

F-20

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As of July 2, 2005,the Company has no valuation allowance against the deferred tax asset. Inaccounting for the deferred tax asset, the Company has relied on historicaldata to determine the necessity of providing a valuation allowance for thisasset. Under the requirements of SFAS No. 109, “*Accountingfor Income Taxes*”, Candela believed it is more likely than not thatthe deferred tax asset would be fully utilized against future income taxes. At July 2,2005, the Company had available research and development tax credits ofapproximately $321,000 for state income tax purposes that will begin expiringin fiscal year 2006.

**9.   Segment,Geographic and Major Customer Information**

The Company operatesprincipally in one industry segment: the design, manufacture, sale, and serviceof medical devices and related equipment. The results in this segment have beenpresented in the Consolidated Statements of Operations for the appropriateperiods. Candela Corporation has no single customer that represents asignificant portion of revenue during the periods presented.

***Geographic data***

Geographicinformation for fiscal 2005, 2004 and 2003 is as follows (in thousands):

| ** **                                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenue:                                         |       |     |       |     |       |     |       |
| United States                                    |       | $        | 85,243     |     | $          | 69,626   |       | $ | 50,663 |   |
| Intercompany                                     |       | 20,460   |       | 17,705   |       | 15,865   |       |
|                                             |       | 105,703  |       | 87,331   |       | 66,528   |       |
| Japan                                            |       | 19,550   |       | 16,947   |       | 16,630   |       |
| Spain                                            |       | 12,242   |       | 10,780   |       | 6,636    |       |
| Germany                                          |       | 3,540    |       | 3,550    |       | 2,824    |       |
| France                                           |       | 3,326    |       | 3,535    |       | 1,898    |       |
|                                             |       | 144,361  |       | 122,143  |       | 94,516   |       |
| Elimination                                      |       | (20,460  | )          | (17,705  | )          | (15,865  | )          |
| Consolidated total                               |       | $        | 123,901    |     | $          | 104,438  |       | $ | 78,651 |   |
| Income (loss)  from operations:                  |       |     |       |     |       |     |       |
| United States                                    |       | $        | 7,390      |     | $          | 11,158   |       | $ | 9,828 |   |
| Europe                                           |       | 763      |       | 663      |       | 995      |       |
| Japan                                            |       | 626      |       | 763      |       | 556      |       |
| Elimination                                      |       | (688     | )          | 1,301    |       | (425     | )          |
| Consolidated total                               |       | $        | 8,091      |     | $          | 13,885   |       | $ | 10,954 |   |
| Geographic  identification of long-lived assets: |       |     |       |     |       |     |       |
| United States                                    |       | $        | 3,028      |     | $          | 3,223    |       | $ | 3,196 |   |
| Europe                                           |       | 212      |       | 183      |       | 131      |       |
| Consolidated  total                              |       | $        | 3,240      |     | $          | 3,406    |       | $ | 3,327 |   |

 

United States revenueincludes export sales to unaffiliated companies located principally in Europe,the Asia-Pacific region and South America, which approximated $27.7, $19.7 and$12.9 million in fiscal 2005, 2004 and 2003, respectively.

**10.**   Employee BenefitPlans

The Company offers asavings plan which allows eligible U.S. employees to make tax-deferredcontributions, a portion of which are matched by the Company. Companycontributions vest ratably with three years of employment and amounted to $320,$224 and $167 thousand in fiscal 2005, 2004 and 2003, respectively.

F-21

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**11.   Discontinued Operations**

On September 27, 2003 management initiated a planto close its only remaining skin care center. The closure is accounted for as adiscontinued operation in accordance with Statement of Financial AccountingStandards (“SFAS”) 144 “*Accounting for theImpairment or Disposal of Long-Lived Assets*” and SFAS 146 “*Accounting for Costs Associated with Exit or Disposal Activities*”.As a result, in the fiscal quarter ended September 27, 2003, the Companyrecorded a $2,095 charge for the accrual of $3,000 of future occupancy costs,primarily relating to future lease payments for the Boston facility, and $348of severance obligations and other related costs of closure, net of anticipatedtax benefits of $1,253. Approximately 45 positions were eliminated as a resultof this restructuring plan, all 45 employees have been terminated.

During the three-month period ended October 2,2004, the landlord for the Boston facility secured a sublease for that property.The Company was not able to determine the future economic benefit of thesublease at that time. The sublessee commenced making payments to the landlordduring December of 2004. As a result of these and future paymentsscheduled under the sublease, the Company revised the estimated future costsassociated with the Boston facility and, in the quarter ended January 1,2005, reversed approximately $859 of the restructuring reserve. This reversalrepresents the aforementioned anticipated economic benefit due to sublesseepayments of $1,703, net of legal and other fees of approximately $329 andincome taxes of approximately $515, and was recognized in the three-monthperiod ended January 1, 2005.

Thefollowing table reflects the restructuring charges incurred during fiscal years2002, 2003 and 2004:

| ** **                                                       | ** ** | ** **              | ** **                    | **Leasehold  Improvements** | ** ** | ** **   | ** **                                  | ** ** | ** ** |
|------------------------------------------------------------------|------------|-------------------------|-------------------------------|-----------------------------|------------|--------------|---------------------------------------------|------------|------------|
| ** **                                                       | ** ** | **Payroll &**  | ** **                    | **and Fixed**          | ** ** | **Facility** | ** **                                  | ** ** | ** ** |
| ** **                                                       | ** ** | **Severance**           | ** **                    | **Assets**                  | ** ** | **Costs**    | ** **                                  | **Total**  | ** ** |
| ** **                                                       | ** ** | **(in thousands)** | ** **                    |
| **Balance  at June 29, 2002**                               | ** ** |                    | **$ 112**                | ** **                  |       |         | **$    410**            | ** ** |       | **$** | **37** | ** ** | **$** | **559** | ** ** |
| Reduction of  reserve due to cash payments                       |       |                    | (62                           | **)**                       |       |         | —                                      | ** ** |       | (12 | ) | (74 | ) |
| Non-cash  amortization                                           |       |                    | —                        | ** **                  |       |         | (106                                        | **)**      |       | — |   | (106 | ) |
| **Balance  at June 28, 2003**                               | ** ** |                    | **50**                        | ** **                  |       |         | **304**                                     | ** ** |       | **25** | ** ** | **379** | ** ** |
| Reduction of  reserve due to cash payments                       |       |                    | (171                          | **)**                       |       |         | (152                                        | **)**      |       | (301 | ) |   |   |
| Non-cash amortization                                            |       |                    | (18                           | **)**                       |       |         | (79                                         | **)**      |       | — |   | (97 | ) |
| Additions to  reserve due to closure of the Boston facility |       |                    | 139                           | ** **                  |       |         | 124                                         | ** ** |       | 3,085 |   | 3,348 |   |
| **Balance  at July 3, 2004**                                | ** ** |                    | **—**                    | ** **                  |       |         | **197**                                     | ** ** |       | **2,809** | ** ** | **3,006** | ** ** |
| Reduction of  reserve due to cash payments                       |       |                    | —                        | ** **                  |       |         | (537                                        | **)**      |       | (537 | ) |   |   |
| Non-cash  amortization                                           |       |                    | (100                          | **)**                       |       |         | —                                      | ** ** |       |   |   |   |   |
| Reduction of  reserve due to revision of leasehold obligation    |       |                    | —                        | ** **                  |       |         | (1,374                                      | **)**      |       | (1,374 | ) |   |   |
| **Balance at July 2, 2005**                                 | ** ** |                    | **$   —** | ** **                  |       |         | **$      97** | ** ** |       | **$** | **898** | ** ** | **$** | **995** | ** ** |

 

At July 2, 2005, thediscontinued segment had a net liability of approximately $1.7 millionconsisting primarily of the aforementioned reserve of $1.0 million and deferredgift certificate revenue of $.7 million. Revenues for discontinued operationswere, $0.4 million and $2.1 million for the fiscal years 2004 and 2003, respectively.. There were no revenues in fiscal 2005.

**12.   Legal Proceedings**

The Company has an Amended and Restated LicenseAgreement (the “License”) with the Regents of the University of California (the“Regents”) pursuant to which the Company licenses certain patent rights to itsdynamic cooling device (“DCD”) from the Regents. The Company sells its DCD as acomponent part of its Smoothbeam® laser system and as an accessory to its otherlaser systems. In April of 2004, the 

F-22

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Regents issued a notice ofdefault under the License, asserting, among other things, that the Company wasin breach of the License for the alleged failure to make required royaltypayments and to make required disclosures. The Regents’ April noticeasserted that the total underpaid royalties, interest and other charges for theperiod from August of 2000 through September 2003 are $1,128,000. TheRegents issued a subsequent notice of default, dated June 30, 2004,relating to the quarterly periods ended December 27, 2003 and March 27,2004, for which the Regents asserted that the Company underpaid additionalroyalties amounting to $1,350,000. The Regents issued a subsequent notice ofdefault, dated September 10, 2004, relating to the quarterly period ended July 3,2004, for which the Regents asserted that the Company underpaid additionalroyalties amounting to $990,000.

Under the License, disputes are to be settled bybinding arbitration through a mutually acceptable single arbitrator. On June 14,2004, the Company filed a Demand for Arbitration to adjudicate the differinginterpretations of the License held by the Company and the Regents. On July 8,2004, the Regents filed their response and counterclaim for breach of contractand declaratory relief. Candela deposited approximately $1.0 million in June of2004, and an additional $1.0 and $1.4 million in August and December,respectively, of 2004, into an escrow fund to be paid in whole or in part tothe Company or the Regents as determined by the arbitrator.

On February 17th 2005, the arbitrator issued aninterim decision in the dispute concerning our royalty obligations under ourAmended and Restated License Agreement with the Regents. The arbitrator foundin favor of the Regents as to the primary issue in the dispute, finding that weare obligated to pay royalties on the good faith list prices of our Sclero,SPTL, GentleLASE and GentleYAG laser systems when those systems are sold withDCDs, and not just on the good faith list prices of the DCDs for sale withthose systems. The arbitrator denied the Regents’ request for the right todeclare a forfeiture of our license with the Regents. In connection with thisinterim decision we recognized charges of approximately $5.6 million during thethird fiscal quarter. These charges consisted of the settlement of prior yearroyalty claims made by the Regents against the Company of approximately $3.4million, royalty claims for our first and second fiscal quarters of 2005 ofapproximately $0.5 and $0.9 million, respectively, and $0.8 million in attorneyfees, interest, and professional costs as reimbursement of those charges to theRegents as required by the aforementioned license agreement. The royaltycharges have been listed as a separate line under cost of goods sold. All othercharges have been listed as a separate line within operating expenses.

On May 4th, 2005, the arbitratorissued his final award after review of post-arbitration submissions by theparties as to calculation of damages. The final award was consistent with ourinterim estimation and recognition of expense recorded during the thirdquarter. There will not be any material additional charges related to thismatter in future periods. As a result of the arbitrator’s ruling, Candelaincurred royalty obligations to the Regents on ongoing sales of the DCD at ahigher royalty rate than it has recognized on DCD sales over the past fewyears.

On August 20,2005, DVI Inc., DVI Financial Services, Inc., and DVI Business CreditCorporation Liquidating Trust (collectively, the “DVI Entities”) filed acomplaint against the Company in the United States Bankruptcy Court for theDistrict of Delaware. The DVI Entities filed voluntary petitions for reliefunder Chapter 11 of the United States Bankruptcy Code on August 25, 2003(the “Petition Date”). The complaint asserts, among other things, that (i) onor within 90 days before the Petition Date, one or more of the DVI Entitiestransferred property to or for the benefit of the Company in an aggregateamount not less than $1,878,921.75, (ii) at the time of the transfers theDVI Entities were insolvent, (iii) the transfers 

F-23

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enabled the Company toreceive more than the Company was entitled to under the United StatesBankruptcy Code, and (iv) the transfers constitute an avoidablepreference. The complaint seeks avoidance and recovery of the transfers, plusinterest and costs of the proceeding. The complaint also seeks, among otherthings, to disallow the Company’s claims against the DVI Entities until theCompany has paid the recovery amount to the DVI Entities. As previouslydisclosed in the Company’s periodic reports, prior to the filing of thecomplaint, the Company had received demands for payment of the recoveryamount. The Company believes that it received all transfers from theDVI Entities in the ordinary course of business and that the allegationsin the complaint are without merit. While the Company intends to vigorouslycontest the allegations, the litigation process is inherently uncertain andunpredictable and there can be no guarantee as to the ultimate outcome of thispending lawsuit. An adverse outcome in the litigation could hurt our business,results of operations, and financial condition.

From time to time, theCompany is a party to various legal proceedings incidental to its business.Except for the bankruptcy preference claims in the DVI matter, the Companybelieves that none of the legal proceedings that are presently pending, ifadversely decided to the Company, will have a material adverse effect upon itsfinancial position, results of operations, or liquidity.

**13.   Asset Acquisition**

On January 8, 2003, the Company acquiredsubstantially all of the assets of Applied Optronics, the diode division ofSchwartz Electro-Optics, Inc., for approximately $1,200,000 in cash.Applied Optronics was a leading manufacturer of high-powered, pulsed and CWlasers, and was a component supplier to the OEM market that serves a variety ofindustries including the military, medical, industrial, research and roboticsfields. Applied Optronics was the lead supplier of the diodes for the Company’sSmoothbeam diode laser system. In accordance with SFAS No. 141 “Business *Combinations*,” the Company records acquisitions under thepurchase method of accounting. Accordingly, the purchase price is allocated tothe tangible assets and liabilities and intangible assets acquired, based ontheir estimated fair values.

The asset acquisitionconsisted primarily of fixed assets, including production and office equipment,and inventory located at the division’s facility in New Jersey. The acquisitionincreased the Company’s net Property and Equipment by approximately $800,000and Inventory by approximately $400,000. For the period from January 8,2003 to June 28, 2003, the Applied Optronics operation generatedapproximately $1,196,000 in revenue from diode sales to third-party customers.During fiscal 2005 and 2004, the Applied Optronics operation generatedapproximately $1,179, and $466, respectively in sales to third-party customers.

F-24

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**14.**   Quarterly Results of Operations (unaudited)

| ** **                                          | ** ** | **Quarter** | ** ** |
|-----------------------------------------------------|------------|-------------|------------|
| **2004**                                            | ** ** | ** **  | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenues                                            |       | $           | 18,686     |   | $ | 23,898 |   | $ | 27,650 |   | $ | 34,204 |   |
| Gross profit                                        |       | 9,312       |       | 12,247 |   | 13,978 |   | 17,628 |   |
| Net Income from  continuing operations              |       | 1,790       |       | 2,441 |   | 1,960 |   | 4,321 |   |
| Loss from  discontinued Skin Care Center operations |       | (298        | )          | — |   | — |   | — |   |
| Loss on closure  of the Skin Care Center            |       | (2,095      | )          | — |   | — |   | — |   |
| Net (loss) income                                   |       | (603        | )          | 2,441 |   | 1,960 |   | 4,321 |   |
| Earnings (loss) per  common share                   |       |        |       |   |   |   |   |   |   |
| Basic:                                              |       |        |       |   |   |   |   |   |   |
| Income from  continuing operations                  |       | $           | 0.08       |   | $ | 0.11 |   | $ | 0.09 |   | $ | 0.20 |   |
| Loss from  discontinued operations                  |       | (0.11       | )          | — |   | — |   | — |   |
| Net (loss) income                                   |       | $           | (0.03      | ) | $ | 0.11 |   | $ | 0.09 |   | $ | 0.20 |   |
| Diluted:                                            |       |        |       |   |   |   |   |   |   |
| Income from  continuing operations                  |       | $           | 0.07       |   | $ | 0.11 |   | $ | 0.09 |   | $ | 0.19 |   |
| Loss from  discontinued operations                  |       | (0.10       | )          | — |   | — |   | — |   |
| Net (loss) income                                   |       | $           | (0.03      | ) | $ | 0.11 |   | $ | 0.09 |   | $ | 0.19 |   |
|                                                     |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                  | ** ** | **Quarter** | ** ** |
|-------------------------------------------------------------|------------|-------------|------------|
| **2005**                                                    | ** ** | ** **  | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenues                                                    |       | $           | 22,391     |   | $ | 28,204 |   | $ | 34,682 |   | $ | 38,624 |   |
| Gross profit                                                |       | 12,041      |       | 13,976 |   | 11,901 |   | 18,001 |   |
| Net Income (loss) from  continuing operations               |       | 2,846       |       | 1,750 |   | (1,356 | ) | 3,224 |   |
| Gain on revision of Skin  Care Center leasehold obligations |       | —      |       | 859 |   | — |   | — |   |
| Net income (loss)                                           |       | 2,846       |       | 2,609 |   | (1,356 | ) | 3,224 |   |
| Earnings (loss) per common share                            |       |        |       |   |   |   |   |   |   |
| Basic:                                                      |       |        |       |   |   |   |   |   |   |
| Income (loss) from  continuing operations                   |       | $           | 0.13       |   | $ | 0.08 |   | $ | (0.06 | ) | $ | 0.14 |   |
| Gain from discontinued  operations                          |       | —      |       | 0.04 |   | — |   | — |   |
| Net income (loss)                                           |       | $           | 0.13       |   | $ | 0.12 |   | $ | (0.06 | ) | $ | 0.14 |   |
| Diluted:                                                    |       |        |       |   |   |   |   |   |   |
| Income (loss) from  continuing operations                   |       | $           | 0.12       |   | $ | 0.07 |   | $ | (0.06 | ) | $ | 0.14 |   |
| Gain from discontinued  operations                          |       | —      |       | 0.04 |   | — |   | — |   |
| Net income (loss)                                           |       | $           | 0.12       |   | $ | 0.11 |   | $ | (0.06 | ) | $ | 0.14 |   |
|                                                             |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-25

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**SCHEDULE II**

**CANDELA CORPORATIONVALUATION AND QUALIFYING ACCOUNTSFor the years ended July 2, 2005, July 3, 2004 and June 28, 2003**

| ** **                                                              | ** ** | **COLUMN A**   | ** ** | **COLUMN B**   | ** ** | **COLUMN C** | ** ** | **COLUMN D**   | ** ** |
|-------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|-------------------|------------|---------------------|------------|
| ** **                                                              | ** ** | **Balance at** | ** ** | **Additions**       | ** ** | **Deductions**    | ** ** | **Balance at** | ** ** |
| ** **                                                              | ** ** | **Beginning**       | ** ** | **Charged to** | ** ** | **from**          | ** ** | **End of**     | ** ** |
| **Description**                                                         | ** ** | ** **          | ** ** | **of Period**  | ** ** | **Income**        | ** ** | **Reserves**        | ** ** | **Period** | ** ** |
| Reserves deducted from  assets to which they apply (in thousands): |       |                |       |                |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Allowance for  doubtful accounts:                                       |       |                |       |                |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Year ended July 2, 2005                                            |       |                | $          | 1,492               |       |              |       | $                   | 2,806      |   |   |   | $ | 2,233 |   |   |   | $ | 2,065 |   |   |
| Year ended July 3, 2004                                            |       |                | $          | 970                 |       |              |       | $                   | 852        |   |   |   | $ | 330 |   |   |   | $ | 1,492 |   |   |
| Year ended  June 28, 2003                                          |       |                | $          | 981                 |       |              |       | $                   | 620        |   |   |   | $ | 631 |   |   |   | $ | 970 |   |   |
|                                                                         |            |                     |            |                     |            |                   |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-26

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**EXHIBIT INDEX**
| 21.1 |   | Subsidiaries of the Company                                                                                                                        |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|
| 23.1 |   | Consent of BDO Seidman,  LLP, Independent Registered Public Accounting Firm                                                                        |
| 23.2 |   | Consent of  Ernst & Young LLP, Independent Registered Public Accounting Firm                                                              |
| 31.1 |   | Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002                                                                      |
| 31.2 |   | Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002                                                                      |
| 32.1 |   | Certification pursuant  to 18 U.S.C. Section 1350                                                                                             |
| 32.2 |   | Certification pursuant  to 18 U.S.C. Section 1350                                                                                             |
| 99.1 |   | McKesson  Medical-Surgical Inc. Distribution Agreement                                                                                             |
| 99.2 |   | First Amendment to the  Amended and Restated License Agreement by and between The Regents of the  University of California and Candela Corporation |

 

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