<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

                                   FORM 10-K
                                        
                 Annual Report pursuant to Section 13 or 15(d)
                    of the Securities Exchange Act of 1934

For the fiscal year ended June 28, 1997       Commission file number 0-14742

                              CANDELA CORPORATION
                              -------------------
            (Exact name of registrant as 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 telephone number, including area code:         (508) 358-7400
                                                            --------------
Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to Section 12(g) of the Act:

                         Common Stock, $.01 par value
                        Common Stock Purchase Warrants
                               (Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 
of Regulation S-K is not contained herein and will not be contained in
definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K. [  ]

As of September 19, 1997, 5,431,163 shares of the registrant's Common Stock,
$.01 par value, were issued and outstanding.  The aggregate market value of the
registrant's voting stock held by non-affiliates of the registrant as of
September 18, 1997, based upon the closing price of such stock on The NASDAQ
Stock Market on that date, was approximately $13,300,000.

                      DOCUMENTS INCORPORATED BY REFERENCE

Documents                                              Form 10-K Reference
---------                                              -------------------
 
Proxy Statement for the 1997 Annual
  Meeting of Shareholders                              Part III

<PAGE>
 
                                    PART I
                                    ------
                                        
ITEM 1.  BUSINESS
------   --------

GENERAL

Candela Corporation (the "Company") develops, manufactures, and distributes
innovative clinical solutions that enable physicians and personal care
practitioners to treat selected cosmetic and medical problems using lasers,
cryosurgery, and other proven technologies. In addition, the Company is applying
its capabilities and experience with skin care and related problems to deliver
specialized personal care services through a growing network of company-owned
skin care laser centers and spas.

Since its inception in 1970, the Company has designed and marketed custom and
scientific lasers, and since 1984 has designed and marketed laser systems for
medical applications. In 1987, the Company commercially introduced its urology
laser system to treat kidney stones, and in 1988 it commercially introduced a
dermatology/plastic surgery laser system to treat vascular skin lesions.  The
Company has since received United States Food and Drug Administration ("FDA")
clearances to market these products for additional applications and has
introduced new generations of these laser systems.

In 1990, the Company commercially introduced a new dermatology/plastic surgery
laser system to treat pigmented lesions of the skin, such as age spots.  The
Company has since received FDA clearance to market this laser for the removal
of multicolored tattoos.

In 1994, the Company also received FDA clearance to market an alexandrite laser
for the treatment of tattoos, and subsequently received FDA clearance to market
this laser for the treatment of Nevus of Ota and similar pigmented lesions.

In 1995, the Company received FDA clearance to market a new dermatology/plastic
surgery laser system to treat leg veins.  In 1996, the Company introduced the
AlexLAZR(TM) and received FDA clearance to market this system for treatment of
pigmented lesions, such as age and sun spots and freckles.

In December 1996 the Company and Fotona, d.d., a company based in the Republic
of Slovenia, entered an exclusive marketing agreement whereby the Company will
have rights to distribute the Fotona Skinlight(TM) Erbium:YAG laser in the
United States and Canada as well as the Far East, South America, South Africa
and some European countries.  In January 1997 the Fotona Skinlight(TM) was
cleared for marketing by the FDA for the cutting, vaporizing and coagulation of
soft tissue in dermatology and cosmetic surgery.

Also in the Fall of 1996, the Company announced the clearance from the FDA to
market a new device that significantly reduces pain during laser surgery.  The
instrument, known as the Dynamic Cooling Device (DCD) was designed in 
conjunction with the University of California's Beckman Laser Institute and
Medical Clinic (BLIMC).  The DCD is unique from other cooling devices in that
it selectively cools the top layers of the skin during laser treatments.  The
small compact unit is available as an upgrade to the Candela ScleroPLUS laser
and other future systems.

The Company's Dynamic Cooling Device (DCD)(TM) is manufactured and sold pursuant
to a Technology License Agreement dated December 19, 1994 (the License
Agreement) with the Regents of the University of California (Regents). The
License Agreement grants the Company exclusive rights to the dynamic cooling
technology for use in conjunction with a laser that the Company has a right to
manufacture, sell, or upgrade for use in dermatology and plastic surgery
procedures that do not involve the shrinkage or removal of collagen. On or about
June 10, 1997, the Regents sent to the Company a Notice of Partial Termination,
alleging that the

                                       2
<PAGE>
 
Company had breached the due diligence requirements of the License Agreement
and purported to narrow the exclusive field of use granted to Candela.  On or
about June 13, 1997, the Company commenced litigation in the Massachusetts
Superior Court against the Regents seeking a declaration that the License
Agreement remains in full force and effect and asserting claims for breach of
the License Agreement.  The Regents removed the action to the United States
District Court for the District of Massachusetts.  On or about July 21, 1997,
the Regents filed an Answer and Counterclaims against the Company alleging that
the Company breached and remains in breach of the License Agreement and sought
a declaratory judgment that the Regents have the right to terminate the License
Agreement.  On August 5, 1997, the Regents sent to the Company another Notice
purporting to terminate the License Agreement.  Discovery in this action is
proceeding.  Although the Company is pursuing its declaratory judgment claim,
and defending against the Regents' counterclaims vigorously, there can be no
assurance that the Company will prevail in this proceeding.  In the event the
Regents were to prevail, the Company may lose its license to the dynamic
cooling technology.

In the Spring of 1997, the FDA cleared for marketing, the Candela Skinscan(TM),
a microprocessor-driven skin scanning device designed for use with the
Skinlight(TM).  The Skinscan(TM) ensures consistent, precise treatment for
facial and other soft tissue applications.

In January 1997 Candela received a patent for its Elongated Spot Handpiece,
which provides physicians with the ability to treat linear lesions and tattoos
more precisely with less purpura.

The Company has a number of different lasers under development and plans to
continue to apply its technical expertise to develop systems for providing new
clinical solutions.

The Company continues to build on its strengths in urology, dermatology/plastic
surgery and oncology.  Accordingly, the Company has entered into strategic
alliances that are aimed at acquiring new and complementary products to enhance
the Company's position in these markets.

During l994, the Company's position in the urology market was strengthened with
the addition of two FDA cleared cryogenic devices for the ablation of prostatic
tissue and liver metastases.  The LCS 3000, which has FDA clearance for
ablation of prostatic tissue and liver metastases, and the LCS 2000, which has
FDA clearance for the ablation of liver metastases, both employ the precise
application of extreme cold to destroy diseased tissue.

In 1993, the Company entered into an agreement with Cryogenic Technology
Limited ("Cryotech") that gave the Company the exclusive worldwide (except the
United Kingdom) right to distribute the LCS 3000 and LCS 2000.  Cryotech has
since been subject to liquidation proceedings in the United Kingdom and, in
1995, Spembly Medical Limited ("Spembly") entered into an agreement to purchase
the assets of Cryotech, including the rights to the LCS 3000 and LCS 2000.  The
Company and Spembly have entered into an agreement under which Spembly will
manufacture a line of cryosurgical devices essentially similar to the former
Cryotech LCS 3000 and LCS 2000 which the Company will market.  In 1996, a new
device, the CS5, was introduced.  Under the agreement, the Company will have
exclusive rights to distribute these devices in certain geographical areas.

In the dermatology/plastic surgery market, the Company has pursued opportunities
to build on its strengths in worldwide distribution as well as acquire new
technology. In 1993, the Company, through its wholly-owned Japanese subsidiary,
Candela KK, entered into an agreement with Laser Industries, Ltd. that gives
Candela KK the exclusive right to distribute Laser Industries Nd:Yag and CO2
surgical lasers, surgical ultrasound aspirators and all related accessories for
these products in Japan. Marketed under the Sharplan tradename, this agreement
leverages the Company's distribution strength in Japan. Also, in 1994, the

                                       3
<PAGE>
 
Company entered into an agreement to acquire certain assets from Derma-Lase,
Ltd.  The assets acquired are principally the rights to market FDA cleared
products which enable the Company to market a broad line of lasers to treat
tattoos and pigmented lesions.  These agreements leverage the Company's
strengths in worldwide distribution and service as well as its strong position
in the dermatology/plastic surgery market.

The Company markets and services its products in the United States through both
a direct sales force and independent distributors.  Internationally, the
Company markets and services its products through regionally managed
independent distributors, except in Japan, where Candela KK, in combination
a network of independent distributors, markets and services the products.

In August 1995, the Company incorporated a wholly-owned subsidiary, Candela Skin
Care Centers, Inc.(CSCC). CSCC is at the forefront of creating a new service
industry which integrates laser cosmetic procedures with spa, salon, health and
fitness services. The genesis for the business stems from the proven success and
growth of the day spa industry, coupled with the increasing demand and
acceptance for laser cosmetic procedures. CSCC integrates all these services
under one facility and addresses the health, beauty and wellness needs of its
clients. CSCC specializes in supporting laser cosmetic procedures for treatment
of wrinkles, leg veins, scars, age and sun spots, facial spider veins and
tattoos. All laser procedures are performed by board certified dermatologists
and plastic surgeons. The spa services include massage, shiatsu, facials, hair
styling, hair coloring, permanents, nail treatments, cardiovascular and fitness
equipment, exercise classes and personal training. In addition to the services
that CSCC provides, each facility can also generate revenue from the sale of
gift certificates and retail items such as skin care products, robes, T-shirts,
etc.

In October 1995, CSCC opened its first cosmetic laser center, occupying 2,690
square feet in a professional office building located in Framingham, MA. The
center was established principally as a pilot site to test the various
management systems and procedures and to formalize them for application at the
planned LaserSpas.(TM) In June 1996 CSCC acquired what management believed to be
the preeminent existing day spa in Boston, MA. This facility, formerly known as
Le Pli at the Heritage on the Garden, was then renovated and expanded by adding
an additional 2,200 square feet of space to house the laser clinic. Upon
completion of the renovations to the Boston location, the Framingham location
was consolidated into Boston. The new laser clinic in Boston is licensed by the
Massachusetts Department of Public Health and began treating patients in April
1997.

In February 1997 CSCC opened a full service LaserSpa(TM) at 6939 East Main
Street, Scottsdale, AZ.  This leased facility contains approximately 7,968
square feet and provides salon, health, beauty, spa and laser cosmetic
services.

In April 1997, CSCC entered into a joint venture agreement to develop and
operate a laser cosmetic center in Cairo, Egypt. The laser cosmetic center is
located in an office suite in the As-Salam International Hospital, Nile
Corniche, Maadi, Cairo, Egypt. Under the Joint Venture Agreement covering the
operation of the clinic, CSCC's share of ownership is 51%.


BACKGROUND AND TECHNOLOGY

Lasers are optical devices which produce intense and narrow beams of light. A
laser consists of an active medium, such as a crystal, gas or liquid, that
amplifies light when excited by an external energy source (usually either an
optical source, such as a flashlamp, or an electric discharge). Light emitted by
the active medium is reflected inside the laser cavity, causing the intensity of
the light to increase and form usable output. Lasers are used in an increasing
number of diverse applications.

                                       4
<PAGE>
 
Cryosurgical devices use subzero temperatures to destroy abnormal tissue. This
tissue is then left in situ to be sloughed or reabsorbed by the body.
Cryosurgical devices typically use liquid nitrogen or other refrigerants to
create a freezing environment. Cryosurgical devices are also used in an
increasing number of diverse applications, with procedures ranging from topical
dermatological treatments to the use of cryoprobes in minimally invasive
surgery.


COMMERCIALIZED MEDICAL PRODUCTS

The Company's research and development efforts, in conjunction with related
research at leading medical institutions, have resulted in the development and
commercialization of the Company's medical laser systems.  The Company has also
commercialized a number of laser systems and cryosurgical devices through
strategic alliances with other companies.  The Company's medical products
include the following:

Skinlight(TM) Erbium:YAG Laser.  The Skinlight(TM) laser is a versatile and
------------------------------                                             
advanced laser system used for skin ablation as an alternative to CO2 laser
treatments.  This laser has the ability to vaporize tissue layer-by-layer with
surgical precision while minimizing thermal injury, thus shortening the healing
and recovery time.

Skinscan(TM) Device.  The Skinscan(TM) is a microprocessor-driven skin scanning
-------------------                                                            
device designed for use with the Skinlight(TM).  The Skinscan(TM) ensures
consistent, precise treatment for facial and other soft tissue applications.
Skinscan(TM) positions the laser treatment beam over the skin for the
physician, providing the utmost precision and uniformity when treating large
areas of skin during a single session with a reduced laser procedure time.

SPTL-1b(TM) Vascular Lesion Laser.  The SPTL-1b(TM) is used in the treatment of
---------------------------------                                              
benign vascular lesions of the skin.  These lesions are characterized by the
presence of abnormal blood vessels that lie beneath the surface of the skin
such as: port wine stain birthmarks, congenital lesions that appear as light
pink lesions at birth and progressively darken and roughen with age,
telangiectasia, ("spider veins"), vascular lesions that develop with age on
many people over the age of 30, and hemangiomas, benign tumors made up of blood
vessels in a slightly elevated area of the skin.

The SPTL-1b(TM) is available with a variety of handpieces, including 10mm, 7mm,
5mm, 3mm, 2mm, and 2x7mm, providing fast and effective treatment of large and
small lesions.

The Company's SPTL-1b(TM) utilizes what is known as selective photothermolysis
to treat vascular skin lesions.  Selective photothermolysis allows for the
destruction of specific abnormal blood vessels, accomplished by using a
specific wavelength, pulse duration and energy level to ensure sufficient
destruction of the abnormal blood vessels while avoiding damage to the
surrounding normal skin.  This treatment can be used on people of all ages and
has been particularly effective in treating infants and young children with
unwanted birthmarks.

ScleroLASER(TM).  The Company received FDA clearance to market its
---------------                                                   
ScleroLASER(TM) for the treatment of leg veins in April 1995. The
ScleroLASER(TM) is a tunable, flashlamp pumped dye laser which is designed to
treat leg veins up to 1mm in size and features a unique elliptical spot designed
to fit the linear configuration of the target vessels. Currently, the most
common therapy for the treatment of leg veins is sclerotherapy. This treatment
consists of a needle injection of a chemical directly into the vessels and is
often painful for the patient.

                                       5
<PAGE>
 
ScleroPLUS(TM).  This advanced laser system offers the widest array of
--------------                                                        
wavelengths available for treatment of all vascular lesions and combines the
capabilities and applications of the ScleroLaser(TM) and the SPTL-1b(TM) laser.
This laser features 585, 590, 595, and 600 nm wavelengths and is used for the
treatment of conditions such as leg and facial veins, port wine stains, stretch
marks, scars, warts, and other vascular abnormalities.  Six handpieces allow
for precise and efficient treatment of vessels, larger lesions, or more
cosmetic-oriented procedures.  This laser provides a repetition rate up to 1
pulse per second, resulting in uniform heating/coagulation.

AlexLAZR(TM) and YAGLAZR(TM). The Company introduced the YAGLAZR(TM) in July
----------------------------                                                
1994 and AlexLAZR(TM) in February 1996.  These products join the SPTL-1b(TM),
ScleroLASER(TM), PLTL, and ScleroPLUS(TM) to offer the dermatology/plastic
surgery market the widest range of laser wavelengths for the treatment of
vascular and pigmented lesions, leg veins and tattoos.

PLTL Pigmented Lesion Laser/TATULAZR(TM).  This system represents two lasers
----------------------------------------                                    
packaged and marketed as a single dermatology/plastic surgery laser system.  It
includes a pulsed dye laser, as well as a Q-switched alexandrite laser.  The
pulsed dye laser is used to treat benign pigmented skin lesions and red color
tattoos.  Benign pigmented skin lesions result from the proliferation of non-
malignant pigmented cells and include cafe au lait birthmarks, freckles and age
spots.  Similar to the Company's SPTL-1b(TM) laser described above, this laser
effectively treats benign pigmented lesions by utilizing selective
photothermolysis to injure the abnormal pigmented cells while avoiding damage
to the surrounding skin.  The Q-switched alexandrite is used to treat
multicolored tattoos, such as blue, black and green, the most common colors
used in both amateur and professional tattoos.  The Q-switched alexandrite,
using the same principle of selective photothermolysis described above,
destroys the tattoo dye while avoiding damage to surrounding skin.

Dynamic Cooling Device.  The Dynamic Cooling Device (DCD) is a device that
----------------------                                                    
selectively cools the top layers of the skin during treatment to significantly
reduce pain without decreasing the effectiveness of the laser treatments.

Elongated Spot Handpiece.  This handpiece provides physicians with the ability
------------------------                                                      
to treat linear lesions and tattoos more precisely, with reduced purpura, by
avoiding unnecessary exposure to uninvolved tissue.

MDL 3000 LaserTripter(R).  The Company's LaserTripter(R) model MDL 3000 is
------------------------                                                  
recognized as the gold standard of lasertripsy--a safe and effective system for
fragmenting urinary and biliary stones without trauma to soft tissue.

Candela/Spembly Cryosurgical System CS-5.  This system is a high-performance,
----------------------------------------                                     
cost-effective cryosurgical system for the ablation of diseased prostate tissue
and liver metastases.

LCS 3000.  The LCS 3000 is a cryosurgical system that is FDA cleared for the
--------                                                                    
ablation of prostatic tissue and treatment of liver metastases. It employs up to
five independently controlled reusable probes to destroy diseased tissue by the
precise application of extreme cold. The probes are available in a variety of
shapes and sizes and are color coded for ease of use.

LCS 2000.  The LCS 2000 is a cryosurgical system that is FDA cleared for the
--------                                                                    
treatment of liver metastases.  The LCS 2000 offers similar features to the LCS
3000, except that it operates with only two probes.

                                       6
<PAGE>
 
MEDICAL PRODUCTS UNDER DEVELOPMENT

The Company has developed, and continues to seek to develop, new medical
products and applications for its existing products. As the Company discovers
potential new medical applications of interest, it evaluates the applications
and, if appropriate, assembles a team to research and develop a new product or
application in cooperation with leading physicians and medical institutions. The
Company is currently conducting research on a number of applications of
interest. The Company believes that its advanced laser research and engineering
activities are crucial to maintain and enhance the Company's business.

Where required, the Company is conducting these clinical research efforts under
Investigational Device Exemptions (IDE's) granted by the FDA.  The Company
must, in many instances, receive FDA clearance before commercializing new
products or applications and believes that it can obtain such clearances, but
there can be no assurance that such clearances will be received.  See
"Government Regulations."


MEDICAL RESEARCH AGREEMENTS

The Company has conducted joint research with physicians at Massachusetts
General Hospital ("MGH"), the New England Medical Center, University of
California, Beth Israel/Deaconess Hospital and elsewhere under research
agreements. The Company  has also conducted joint laser research with MIT
Lincoln Labs.  Generally, when the Company enters into research agreements, the
Company has rights to acquire exclusive licenses to any jointly developed
technology and may pay a royalty to the institution.  The Company anticipates
continuing joint research and licensing arrangements with medical research
institutions.

In addition to internally funded research projects, the Company has received a
number of Small Business Innovation Research ("SBIR") grants and contracts to
explore the feasibility of extending its laser technology to new applications.
Research is being conducted with several different types of lasers, including
pulsed dye lasers and solid state lasers.

PRODUCT MARKETING AND SERVICE

North America.  The Company markets its medical systems through both a direct
-------------                                                                
sales force and independent distributors.  With the exception of the geographic
areas covered by independent distributors, the Company has direct sales
representatives with territories covering all of North America.  The
independent distributors, who have significant medical laser distribution
experience, have exclusive arrangements for their geographic areas.

The Company's focus is on optimizing patient care and physician productivity.
The Company maintains a staff of nurse clinicians to train laser system
customers.  In addition, the Company conducts and participates in regional
workshops where physicians knowledgeable in the use of the Company's systems
instruct other doctors in their use.

Promotional activities conducted by the Company include trade advertising,
direct mail, workshops, presentations at trade shows, and in-vitro
demonstrations at medical conventions.

International.  The Company sells a significant portion of its medical systems
-------------                                                                 
outside the United States.  The Company has wholly-owned Japanese and Spanish
subsidiaries that coordinate the activities of several Japanese distributors
and Spanish businesses.  In addition, the Company has a branch office in
Singapore to develop and maintain independent distributor relationships
throughout the Asia Pacific region.  The Company has a branch office in The
Netherlands to develop and maintain independent distributor relationships in
Europe, the Middle East and Africa.

                                       7
<PAGE>
 
International revenue was approximately as follows during the last three fiscal
years:
<TABLE>
<CAPTION>
 
                                     1997          1996          1995
                                 ------------  ------------  ------------
<S>                              <C>           <C>           <C>
 International revenue:
     Total                       $18,508,000   $16,068,000   $13,772,000
     As percentage of revenue             52%           53%           49%
</TABLE>
   See also Note 10 to the Company's Consolidated Financial Statements.

Service.  The Company's principal service center and depot is located at its
-------                                                                     
Wayland, Massachusetts headquarters.  In addition, the Company has direct
service representatives throughout the United States and a depot at its wholly-
owned subsidiaries in Japan and Spain.  The Company's independent distributors
maintain depot and service representatives adequate to cover their installed
systems and have primary responsibility to service such systems.  The Company's
recommended preventive maintenance, coupled with continuing technical education
for service representatives, help to ensure product reliability.

SKIN CARE CENTER SERVICE

The Company markets skin care services through its wholly-owned subsidiary,
CSCC.  These services include laser cosmetic procedures as well as spa, salon
and health and fitness services.  The Company owns two laser/cosmetic centers
in the U.S. and one laser center in Egypt operating under a joint venture
agreement.

Revenues for the Skin Care Centers for the three years ended June 28 are:

                     1997        1996          1995
                     ----        ----          ----

                  $2,243,000  $2,149,000    $1,777,000

MANUFACTURING AND SUPPLIERS

The Company's manufacturing operations consist principally of the assembly and
testing of components purchased from outside suppliers.  The Company also
manufactures certain power supplies and other subassemblies used in its
products.

The Company depends upon, and will continue to depend upon, a number of outside
suppliers for the components that it has used to assemble laser systems
produced to date, and for products it may manufacture.  In addition, the
Company relies upon a single source for its cryosurgical products, as well as
some other components.  To date, the Company has not experienced, nor does it
expect, any significant delays in obtaining dyes, optical and electro-optical
components, electronic or any other components and raw materials for its
products, most of which are available from multiple well-established sources.
There can be no assurance, however, that the Company's supplies of components,
raw materials and cryosurgical products will continue to be available in
sufficient quantities and in a timely manner in the future.

COMPETITION

Competition in the medical device industry is intense, and technological
developments are expected to continue at a rapid pace.  The Company utilizes
proprietary technology, product features, performance and price in addition to
its market reputation as competitive methods depending upon the product, market
or geographic area in which it is competing.  The Company competes against
other manufacturers, some of which may have greater financial, marketing, and
technical resources than the Company, as well as against alternative medical
technologies.  In addition, some companies have developed, and other
established companies may attempt to develop, products for the same medical
applications as the Company's systems.

                                       8
<PAGE>
 
In addition, the Company's CSCC operations face a host of competitors including
hair salons, health spas, massage therapists, aestheticians, health and fitness
clubs, personal trainers, dermatologists, plastic surgeons, cosmetic laser
centers and cosmetic retailers.  The Company also believes its CSCC operations
will face competition from laser manufacturing companies that have, or may
develop, plans to open facilities based on concepts similar to the Candela
LaserSpa(TM) concept.  Such competition could have a material adverse effect on
the Company's business, financial condition and results of operations.
Further, even if the Company is able to successfully compete, there can be no
assurance that it would be able to do so in a profitable manner.

PATENTS AND PROPRIETARY INFORMATION

The Company owns United States and foreign patents for its urology and benign
vascular and pigmented lesion dermatology/plastic surgery laser systems and
United States patents for endoscopes.  The Company also has several other
United States and foreign patents and pending patent applications for other
medical laser systems.  The Company treats its design and technical data as
confidential, and relies on  nondisclosure safeguards, such as confidentiality
agreements, laws protecting trade secrets and noncompetition agreements to
protect proprietary information.  There can be no assurance, however, that
these measures will adequately protect the Company's technology or that others
will not independently develop such technological expertise.  See "Legal
Proceedings" for information relating to a dispute involving such license
relationship.

The Company is a licensee under patent license agreements that grant the
Company rights to use certain laser technologies and applications.  Under these
license agreements, the Company has paid, and continues to pay, royalties.

Under the federal government's SBIR (Small Business Innovation Research)
program, the Company retains rights to any invention and the ownership of all
data developed.  In return, the government receives a royalty-free license on
any patent for federal government use and it reserves certain other rights,
including the right to require the Company to license others to use the
technology in certain limited circumstances.


GOVERNMENTAL REGULATION

The Company's products are subject to government regulation in the United States
and other countries. In order to manufacture, clinically test and market
products for human diagnostic and therapeutic use, the Company must comply with
mandatory regulations and safety standards established by the FDA and comparable
state and foreign regulatory agencies. Typically, products must meet regulatory
standards as safe and effective for their intended use prior to being marketed
for human applications. The clearance process is expensive and time consuming,
and no assurance can be given that any agency will grant clearance for the sale
of the Company's products or that the length of time the process will require
will not be extensive. The Company has met FDA requirements under the 510(k)
procedure for the products it is currently marketing.

There are two principal methods by which FDA regulated medical devices may be
marketed in the United States. One method is an FDA premarket notification
filing under Section 510(k) of the Food, Drug and Cosmetics Act. Applicants
under the 510(k) procedure must demonstrate that the device for which clearance
is sought is substantially equivalent to devices on the market pursuant to a
510(k) procedure or prior to the medical device legislation of 1976. The review
period for a 510(k) application is 90 days from the date of filing the
application, although such review periods have often been extended. Applications
filed pursuant to 510(k) are often subject to questions and requests for
clarification that can extend the review period beyond the initial review
period. Marketing of the product must be deferred until written clearance is
received from the FDA. In some instances, an investigative device exemption
("IDE")is required for clinical trials for a 510(k) notification.

                                       9
<PAGE>
 
The alternate method, where section 510(k) is not available, is to obtain
premarket approval ("PMA") from the FDA.  Under the PMA procedure, the
applicant must obtain an IDE before beginning the substantial clinical testing
that is required to determine safety and efficacy.  The preparation of a PMA
application is significantly more complex and time consuming than the 510(k)
application.  The review period under a PMA application is 180 days from the
date of filing, although such review times have been substantially extended
recently.  The FDA often responds with requests for additional information or
clinical reports, which can extend the review period beyond the initial review
period.

In addition, the Company is required to obtain FDA approval to conduct clinical
studies with certain of the medical laser systems it has under development.
All of these products will require filing of a 510(k) or PMA for
commercialization of the product, and some may require the filing of an IDE
with the FDA.  The Company is currently approved to conduct clinical studies
under the IDE regulations.  There can be no assurance that the appropriate
approvals from the FDA will be granted for the Company's products or that the
process to obtain such approvals will not be excessively expensive or lengthy.
The failure to receive requisite approvals for the Company's products or
processes, when and if developed, or significant delays in obtaining such
approvals would prevent the Company from commercializing new products as
anticipated and would have a materially adverse effect on the business of the
Company.

The FDA also imposes various requirements on manufacturers and sellers of
products under its jurisdiction, such as labeling, manufacturing practices,
record keeping and reporting requirements.  The FDA also may require postmarket
testing and surveillance programs to monitor a product's effects.

The Company is also subject to regulation under the Radiation Control for
Health and Safety Act administered by the Center for Devices and Radiological
Health ("CDRH") of the FDA, which requires laser manufacturers to file new
product and annual reports; to maintain quality control, product testing and
sales records; to incorporate certain design and operating features in lasers
sold to end-users and to certify and label each laser sold to an end-user as
belonging to one of four classes, based on the level of radiation from the
laser that is accessible to users.  Various warning labels must be affixed and
certain protective devices installed, depending on the class of the product.
The CDRH is empowered to seek fines and other remedies for violations of the
regulatory requirements.  The Company believes that it has complied in all
material respects with CDRH requirements.

Foreign sales of the Company's laser systems are subject in each case to the
regulatory requirements of the FDA and the recipient country.  These vary
widely among the countries and may include technical approvals, such as
electrical safety, as well as the demonstration of clinical efficacy.  The
Company is currently working to meet foreign country regulatory requirements
for certain of its products.  There can be no assurance that additional
approvals will be obtained.


RESEARCH AND DEVELOPMENT

During the past three fiscal years, the Company spent the following amounts on
Company-sponsored and federal government SBIR-sponsored research:

                                       1997        1996         1995
                                       ----        ----         ----
 
Company-sponsored research and
 development                        $2,488,000  $1,818,000   $3,733,000

SBIR-sponsored research and
 development                        $  227,000  $  367,000   $  443,000

                                       10
<PAGE>
 
Under the SBIR Program, a portion of a federal agency's research and
development budget is awarded to small businesses that have 500 or fewer
employees. There are two phases to an SBIR award:  Phase I provides funding for
determining the scientific and technical merit and feasibility of a proposed
idea; and Phase II provides funding to further develop a proposed idea, taking
into consideration the scientific and technical merit and feasibility evidenced
by Phase I results.  After completion of the two phases using government funds,
the Company is expected to commercialize the new product using funds generated
by the Company.

CUSTOMERS

The Company's customers include distributors, hospitals, medical doctors and in
the case of CSCC, consumers.  The Company is not dependent upon any single
customer.  See Note 10 to the Company's Consolidated Financial Statements for a
description of revenue generated by region.

EMPLOYEES

As of June 28, 1997, the Company had 231 employees of which 17 were in
research, development and engineering, 37 were in manufacturing and quality
assurance, 18 were in service, 23 were in sales and marketing, 20 were in
finance and administrative positions, 96 were in the clinic and health spa
subsidiaries, and 20 were in the international sales/service subsidiaries.
None of the Company's employees are represented by a union, and the Company
believes its relationship with its employees is good.

EXECUTIVE OFFICERS

The current executive officers of the Company are as follows:
<TABLE>
<CAPTION>
 
Name                    Age                        Position
----------------------  ---  -----------------------------------------------------
<S>                     <C>  <C>
 
Gerard E. Puorro        50   President, Chief Executive Officer and Director
 
F. Paul Broyer          48   Vice President, Treasurer and Chief Financial Officer
 
Jay D. Caplan           35   Vice President, Operations
 
James C. Hsia, Ph.D     51   Senior Vice President, Research
 
William B. Kelley       42   Vice President, North American Sales and Service
 
Richard J. Olsen        64   Senior Vice President and Assistant Secretary
 
Kenji Shimizu           44   Executive Vice President, International Sales
</TABLE>

Executive officers of the Company are elected by the Board of Directors on an
annual basis and serve until their successors are duly elected and qualified,
subject to earlier removal by the Board of Directors.  There are no family
relationships among any of the executive officers or directors of the Company.

                                       11
<PAGE>
 
Mr. Puorro was appointed a Director of the Company in September 1991.  Mr.
Puorro has been President and Chief Executive Officer of the Company since
April 1993.  From April 1989 until April 1993, he was Senior Vice President and
Chief Financial Officer of the Company.  He was elected Chief Operating Officer
in December 1992.  Prior to joining the Company, and since 1982, he was Vice
President and Controller at Massachusetts Computer Corporation.  Mr. Puorro
became acting Chief Executive Officer of Candela Skin Care Centers, Inc. in
June 1997.

Mr. Broyer joined the Company in October 1996 as Vice President and Chief
Financial Officer.  Prior to joining the Company, Mr. Broyer held the position
of Vice President Finance at Integrated Genetics from 1994 to 1996, and held
earlier positions with Laserdata, Inc., Avatar Technologies and Data General
Corporation.

Mr. Caplan was appointed Vice President, Operations in February 1997, after
serving as Vice President, Manufacturing since December 1995. He has been with
the Company since September 1988 and was previously Senior Director, Corporate
Planning/Business Development.  From 1988 to 1993, Mr. Caplan held the
positions of Product Director, International Controller, Manager, Financial
Planning and Analysis and Planning Associate.  Prior to joining the Company,
Mr. Caplan held positions at Xerox Corporation, Elsegundo, CA, and the U.S. Air
Force, Washington, DC.

Dr. Hsia has been Senior Vice President, Research, of the Company since July
1991.  He has been with the Company since October 1985, and was previously Vice
President, Research and Development.  Prior to joining the Company, and since
1982, he was Vice President, Research and Development at Laser Science, Inc.

Mr. Kelley has been Vice President, North American Sales and Service, since
April 1993.  From January 1993 until April 1993 he was Vice President, Domestic
Sales.  He has been with the Company since 1987 and previously held the
positions of National Sales Manager and Eastern Regional Sales Manager.  Prior
to joining the Company, Mr. Kelley held a number of sales and sales management
positions in the medical industry.

Mr. Olsen has been President of Candela Skin Care Centers, Inc. since July 1996
and has been Senior Vice President of the Company since July 1995.  He has been
with the Company since May 1985 and previously held the positions of Vice
President, Corporate Development and Chief Financial Officer.

Mr. Shimizu has been Executive Vice President of the Company since April 1993.
He has been with the Company since March 1987 and was previously Vice
President, International Sales and Marketing.  From 1977 to 1987, he was
employed by Nippon Infrared Industries, Ltd. of Tokyo.

ITEM 2.  PROPERTIES
------   ----------

The Company leases a facility totaling approximately 35,000 square feet for its
operations in Wayland, Massachusetts, which is located approximately 20 miles
west of Boston.  The lease on this facility was amended in September 1995 to
extend the expiration date to March 1998, at which time the Company has an
option to renew the lease for a period of two years at a rate equal to the
market rental rate at the time of exercise.  Management of the Company believes
that its current facilities are suitable and adequate for its near-term needs.

The Company's new subsidiary, Candela Skin Care Centers, Inc, is currently
easing 7,030 square feet of office space at 31 St. James Avenue, Boston, MA.
The term of the lease for this location is for a period of five years, expiring
on August 4, 2001.

                                       12
<PAGE>
 
Additional locations housing clinic and spa facilities are:
 
   1) Candela Skin Care Center of Scottsdale, Inc., 7,555 square feet located at
   6939 E. Main Street, Scottsdale, AZ. The lease on this facility is for a
   period of ten years, expiring on June 30, 2006, with a provision for two(2)
   five-year extensions,
 
   2) Candela Skin Care Center of Boston, Inc., 20,728 square feet located at 28
   Arlington Street, Boston, MA. The lease on this facility is for a period of
   180 months, and commenced on June 1, 1994,
 
   3) Candela Skin Care Center of Cairo, 170 square meters (approximately 1,800
   square feet) located at International Al Salaam Hospital, 9th Floor, Cairo,
   Egypt.

ITEM 3.  LEGAL PROCEEDINGS
------   -----------------

The Company's Dynamic Cooling Device (DCD)(TM) is manufactured and sold
pursuant to a Technology License Agreement dated December 19, 1994 (the License
Agreement) with the Regents of the University of California (Regents).  The
License Agreement grants the Company exclusive rights to the dynamic cooling
technology for use in conjunction with a laser that the Company has a right to
manufacture, sell, or upgrade for use in dermatology and plastic surgery
procedures that do not involve the shrinkage or removal of collagen.  On or
about June 10, 1997, the Regents sent to the Company a Notice of Partial
Termination, alleging that the Company had breached the due diligence
requirements of the License Agreement and purported to narrow the exclusive
field of use granted to Candela.  On or about June 13, 1997, the Company
commenced litigation in the Massachusetts Superior Court against the Regents
seeking a declaration that the License Agreement remains in full force and
effect and asserting claims for breach of the License Agreement.  The Regents
removed the action to the United States District Court for the District of
Massachusetts.  On or about July 21, 1997, the Regents filed an Answer and
Counterclaims against the Company alleging that the Company breached and
remains in breach of the License Agreement and sought a declaratory judgment
that the Regents have the right to terminate the License Agreement.  On August
5, 1997, the Regents sent to the Company another Notice purporting to terminate
the License Agreement.  Discovery in this action is proceeding.  Although the
Company is pursuing its declaratory judgment claim, and defending against the
Regents' counterclaims vigorously, there can be no assurance that the Company
will prevail in this proceeding.  In the event the Regents were to prevail, the
Company may lose its license to the dynamic cooling technology.

From time to time, the Company is a party to various legal proceedings
incidental to its business.  The Company believes that none of such other
presently pending legal proceedings will have a material adverse effect upon
its financial position, results of operation, or liquidity.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
------   ---------------------------------------------------

During the fourth quarter of fiscal 1997, no matters were submitted to a vote
of security holders of the Company through the solicitation of proxies or
otherwise.

                                       13
<PAGE>
 
                                    PART II
                                    -------

ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
------   -----------------------------------------------------------------
         MATTERS
         -------

The Company's common stock trades on The NASDAQ Stock Market under the symbol
"CLZR."

At September 19, 1997, there were 419 holders of record of the Company's common
stock and the last sales price of the Company's common stock was $5 3/4 on that
day.

The following table sets forth quarterly high and low prices of the common
stock for the indicated fiscal periods:
<TABLE>
<CAPTION>
 
                            1997              1996
                          --------          --------
<S>                  <C>      <C>      <C>      <C>
 
                       High      Low      High       Low
                     --------  -------  --------  ---------
 
First Quarter        $ 8 5/8   $4 5/8  $ 4 3/4    $1 15/16
Second Quarter         7 3/8    4 5/8    5 7/8     3  1/2
Third Quarter          9 1/16   5 3/4    8 1/8     4  9/16
Fourth Quarter         7 3/4    5       11 1/4     7
</TABLE>

The Company has never paid a cash dividend and has no present intention to pay
cash dividends in the foreseeable future.  The Board of Directors currently
intends to retain any future earnings for use in the Company's business.

ITEM 6.  SELECTED FINANCIAL DATA
------   -----------------------

The table set forth below contains certain financial data for each of the last
five fiscal years of the Company.  This data should be read in conjunction with
the detailed information, financial statements and notes thereto, as well as
Management's Discussion and Analysis of Financial Condition and Results of
Operations included elsewhere herein.

   (in thousands, except per share data)
<TABLE>
<CAPTION>
 
Statement of Operations Data:                          1997      1996      1995      1994      1993
------------------------------------                  --------  --------  --------  --------  --------
<S>                                                   <C>       <C>       <C>       <C>       <C>
 
Revenue                                               $35,505   $30,413   $28,243   $29,820   $33,158
Gross profit                                           16,855    13,580    12,376    13,765    13,434
Research and development expense                        2,488     1,818     3,733     3,810     4,562
Selling, general & administrative
 expenses                                              13,680     9,873    10,246     9,241    10,978
Income (loss) from operations                             687     1,889    (1,603)      714    (9,106)
Net income (loss)                                         238     1,245    (1,536)      655    (9,208)
Net income (loss)per share                                .04       .22      (.29)      .13     (1.78)
Weighted average number of common
 and common equivalent shares
 outstanding                                            5,673     5,563     5,288     5,218     5,180
 
                                                      June 28,  June 29,   July 1,  July 2,   July 3,
Balance Sheet Data:                                     1997      1996      1995     1994      1993
------------------------------------                  --------  --------  --------  -------   -------
 
Working capital                                       $ 7,032   $ 8,608   $ 8,033   $ 9,109   $ 8,775
Total assets                                           24,837    19,334    16,832    20,447    20,269
Current portion of long-term debt                       1,827       708       470       102       114
Long-term debt                                          1,519       557       476       223       305
Stockholders' equity                                   10,246     9,965     9,086    10,566     9,671
</TABLE>

                                       14
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
------   ---------------------------------------------------------------
         RESULTS OF OPERATIONS
         ---------------------

RESULTS OF OPERATIONS

FISCAL 1997 COMPARED TO FISCAL 1996
-----------------------------------

Total revenue for fiscal 1997 and fiscal 1996 are as follows:
<TABLE>
<CAPTION>
 
($ in 000's)                1997      1996    $ Change  % Change
                          --------  --------  --------  ---------
<S>                       <C>       <C>       <C>       <C>
 
     Laser operations      $33,262   $28,264    $4,998      17.7%
     Skin care centers       2,243     2,149        94       4.4%
                           -------   -------    ------      -----
 
     Total Revenue         $35,505   $30,413    $5,092      16.7%
                           =======   =======    ======      =====
</TABLE>

The increase in revenues for laser operations reflects significant shipments of
the Company's leg vein device, the Sclerolaser(TM), introduced in March 1996,
the AlexLAZR(TM), used for removal of tattoos and pigmented lesions, and the
Erbium YAG laser, used for skin resurfacing.  Revenues for the Skin Care
Centers reflect increases resulting from the opening of the new center in
Scottsdale, AZ, and slight increases in the Boston, MA, center.  International
revenue as a percentage of total revenue represented 52% of revenue in 1997,
compared to 53% in fiscal 1996.

Gross margin increased to 48% in fiscal 1997 from 45% in fiscal 1996,
reflecting volume increases in the Company's new dermatology products offset in
part by greater costs associated with the laser centers.

Research and development spending increased 37% to $2,488,000 in fiscal 1997
from $1,818,000 in fiscal 1996.  As a percent of revenue, research and
development spending increased to 7% in fiscal 1997 from 6% in fiscal 1996.
The Company continues to build on its strengths in the urology and dermatology
markets and internal development efforts have been refocused accordingly.  The
Company expects expenditures for research and development to be between 7% and
10% of revenue going forward.

Selling, general and administrative expenses increased 39% to $13,680,000 in
fiscal 1997 from $9,873,000 in fiscal 1996, as a result of increased spending
associated with the establishment of the skin care centers and increased
marketing expenses.  Selling, general and administrative expenses as a
percentage of total revenue increased to 38% in fiscal 1997 from 32% in fiscal
1996.

Interest income decreased to $84,000 in fiscal 1997 from $93,000 in fiscal 1996
as a result of a decrease in the average cash balances.  Interest expense
increased to $107,000 in fiscal 1997 from $49,000 in fiscal 1996 as a result of
an increased level of both debt and lease financing. Other expenses in fiscal
1997 of $26,000 and other expense in fiscal 1996 of $207,000 results primarily
from foreign currency transactions.

                                       15
<PAGE>
 
Included in the Company's consolidated net income are results of operations of
its wholly-owned subsidiary, Candela Skin Care Centers, Inc.(CSCC), consisting
of a net loss of $3,448,000 in fiscal 1997 compared to a net loss of $687,000
for fiscal 1996, its first year of operation.  This increase in net loss is
primarily due to various start-up costs associated with CSCC's existing
facilities, all of which were opened in fiscal 1997.

The provision for income taxes in fiscal 1997 results primarily from taxable
income in the Company's subsidiary in Japan.  Income taxes provided for in
fiscal 1997 reflect an effective tax rate of 63%.  This tax rate includes both
foreign taxes, which generally are higher than the U.S. statutory rate, and
state income taxes.

As a result of the foregoing factors, the Company realized net income of
$238,000, or $0.04 per share in fiscal 1997, compared to net income of
$1,245,000, or $0.22 per share in fiscal 1996.


FISCAL 1996 COMPARED TO FISCAL 1995
-----------------------------------

Revenue for fiscal 1996 was $30,413,000, an increase of 8% from revenue of
$28,243,000 in fiscal 1995.  This increase is primarily the result of an
increase in unit volume as the result of the introduction of two new
dermatology products.  International revenue as a percentage of total revenue
represented 53% of revenue in 1996, compared to 49% in fiscal 1995.

Gross margin increased to 45% in fiscal 1996 from 44% in fiscal 1995,
reflecting volume increases in the Company's dermatology products.

Research and development spending decreased 51% to $1,818,000 in fiscal 1996
from $3,733,000 in fiscal 1995.  As a percent of revenue, research and
development spending decreased to 6% in fiscal 1996 from 13% in fiscal 1995.

Selling, general and administrative expenses decreased 4% to $9,873,000 in
fiscal 1996 from $10,246,000 in fiscal 1995.  As a result of both reduced
spending and higher revenue, selling, general and administrative spending as a
percentage of revenue, decreased to 32% in fiscal 1996 from 36% in fiscal 1995.

Interest income increased to $93,000 in fiscal 1996 from $70,000 in fiscal 1995
as a result of increased average cash balances.  Other expense in fiscal 1996
of $207,000 and other income in fiscal 1995 of $544,000 results primarily from
foreign currency transactions.

Provision for income taxes in fiscal 1996 results primarily from taxable income
in the Company's subsidiary in Japan and alternative minimum tax in the U.S.
Income taxes provided for in fiscal 1996 reflect an effective tax rate of 28%.
This is lower than the U.S. statutory rate of 34%, because of the utilization
of a deferred tax asset that will be recognized when filing the U.S. taxes.
This tax rate includes both foreign taxes, which generally are higher than the
U.S. statutory rate, state income taxes, and the effect of utilizing the
deferred tax asset.

                                       16
<PAGE>
 
As a result of the foregoing factors, the Company realized a net income of
$1,245,000, or $0.22 per share in fiscal 1996, compared to a net loss of
$1,536,000, or $0.29 in fiscal 1995.  The Company's consolidated net income for
fiscal 1996 includes a net loss of $687,000 from the first year of operation of
its new wholly-owned subsidiary, CSCC.


LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents at June 28, 1997 decreased to $2,674,000 from
$3,041,000 at June 29, 1996.  This decrease resulted primarily from additional
funding required by CSCC, during its first full year of operation and while
establishing additional facilities, and an increase in accounts receivable of
$2,404,000, partially offset by an increase in accounts payable, resulting from
the negotiation of more favorable payment terms with suppliers.

During the fiscal year, the Company utilized $4,224,000 in cash in the
operations of CSCC compared to $382,000 for the prior year.  These funds were
required, in part, to open LaserSpas(TM) in Scottsdale, AZ, in February 1997
and in Boston, MA, in April 1997.  The Company expects that CSCC will continue
to require cash during its developmental stage.

In support of the continued growth of CSCC and its laser production operation,
the Company secured a $3,500,000 Line of Credit with a major bank during fiscal
1997.  The Line of Credit bears interest at 1/2% over the bank's prime lending
rate and is secured by total domestic and international accounts receivable and
inventory and a pledge of the stock of CSCC.  Also during fiscal 1997 the
Company borrowed 75,000,000 yen on a two-year 1.745% note with a foreign bank.
The current value of this liability is $655,000, converted at the year-end
exchange rate.  During fiscal 1996, the Company borrowed 60,000,000 yen on a
two-year 1.95% note with a foreign bank.  The current value of this liability
is $196,000 as converted at the year-end exchange rate. The Company's remaining
short-term and long-term debt is comprised solely of capital lease obligations,
which were $346,000 and $1,149,000, respectively, at June 28, 1997, versus
$161,000 and $352,000 at June 29, 1996.

Other private sector sources of cash are being pursued in addition to the
above, however, there is no assurance that such funding will be available on
terms acceptable to the Company, or at all.

                                       17
<PAGE>
 
CAUTIONARY STATEMENTS

In addition to the other information in this Annual Report on Form 10-K, the
following cautionary statements should be considered carefully in evaluating
the Company and its business.  Statements contained in this Form 10-K that are
not historical facts (including without limitation, statements concerning
anticipated operational and capital expense levels and such expense levels
relative to the Company's total revenues) and other information provided by the
Company and its employees from time to time may consist of "forward-looking"
information, as that term is defined by (i)the Private Securities Litigation
Reform Act of 1995 (the "Act") and (ii)in releases made by the Securities and
Exchange Commission (the "SEC").  The factors identified in the cautionary
statements below, among other factors, could cause actual results to differ
materially from those suggested in such forward-looking statements.  The
cautionary statements below are being made pursuant to the provisions of the
Act and with the intention of obtaining the benefits of the "safe harbor"
provisions of the Act.

VARIABILITY OF QUARTERLY OPERATING RESULTS. The Company's quarterly operating
results may vary significantly from quarter to quarter, depending upon factors
such as the timing of product sales, the timing of expenditures in anticipation
of future product orders, the introduction and market acceptance of new
products, effectiveness in managing manufacturing processes, changes in cost and
availability of labor and product components, order cancellations, the budgetary
cycles of its customers, the timing of regulatory approvals and the opening of
new LaserSpas(TM) CSCC. The Company's ability to accurately forecast future
revenues and income for any period is necessarily limited, and any forward-
looking information provided from time to time by the Company represents only
management's then-best current estimate of future results or trends, and actual
results may differ materially from those contained in the Company's estimates.

POTENTIAL VOLATILITY OF STOCK PRICE.  There has been significant volatility in
the market price of securities of companies in the medical device industry.
Factors such as announcements of new products by the Company or its
competitors, quarterly fluctuations in the financial results of the Company or
its competitors, shortfalls in the Company's actual financial results compared
to results previously forecast by stock market analysts, conditions in the
medical device industry and the financial markets and the economy generally
could cause the market price of the Company's securities to fluctuate
substantially and may adversely affect the price of the Company's securities.

RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS.  A significant portion of the
Company's revenues are attributable to international operations and revenues
from international operations are likely to continue to represent a significant
portion of the Company's revenues in future periods.  The Company's
international business and financial performance may be adversely affected by a
number of factors, including without limitations to fluctuations in exchange
rates, tariffs and other trade barriers, adverse tax regulation, and adverse
political and economic conditions.  Adverse effects on the Company's
international operations may have materially adverse effects on the Company's
overall financial condition and operating results.

                                       18
<PAGE>
 
NEW BUSINESS STRATEGIC DEVELOPMENT. While the Company continues to expand and
diversify its core cosmetic and surgical laser equipment business, the Company
has embarked on a new business strategy of opening combined spa and laser
cosmetic skin care centers. Currently, the Company operates combined spa/skin
care facilities in Boston, Massachusetts and Scottsdale, Arizona. The Company's
skin care treatment center previously located in Framingham, Massachusetts has
been combined with the spa in Boston to create a combination spa/skin care
facility. Additionally, the Company has entered into a joint-venture with
Egyptian investors to open a new laser cosmetic center in Cairo, Egypt. The
surgical skin care treatments performed in each location are administered by
board-certified physicians under contract with the Company's wholly-owned
subsidiary, CSCC. While the target audience for the Company's core laser
equipment tends to be medical practice groups and other health care providers,
its target audience for its spa and skin care centers are individuals who are
typically reached through entirely different marketing efforts. The cost
structures, new client accretion methods and other demands associated with the
Company's new facilities are largely untested, and the Company could incur
significant losses in connection with its spa and skin care centers.

GOVERNMENTAL REGULATION. Medical devices are subject to approval before they can
be utilized for clinical studies or sold commercially. In addition, the
Company's activities in connection with its CSCC business may subject the
Company to additional regulation under state and federal laws. The process for
obtaining the necessary approvals and compliance with applicable regulations can
be costly and time-consuming. Many foreign countries in which the Company
markets or may market its products have similar regulatory bodies and
restrictions. There is no assurance that the Company will be able to obtain any
such government approvals or successfully comply with any such regulations in a
timely and cost-effective manner, if at all, and failure to do so may have an
adverse effect on the Company's financial condition and results of operations.

RISKS ASSOCIATED WITH PRODUCT LIABILITY. The administration of medical and
cosmetic treatments using laser products is subject to various risks of physical
injury to the patient which may result in product liability or other claims
against the Company. The costs and resources involved in defending or settling
any such claims, or the payment of any award in connection therewith, may
adversely affect the Company's financial condition and operating results. The
Company maintains product liability insurance, but there is no assurance that
its policy will provide sufficient coverage for any claim or claims that may
arise, or that the Company will be able to maintain such insurance coverage on
favorable economic terms.

RAPID TECHNOLOGICAL CHANGE; COMPETITION. The medical laser industry is subject
to rapid and substantial technological development and product innovations. The
Company, to be successful, must be responsive to new developments in laser
technology and applications of existing technology, and the Company's financial
condition and operating results may be adversely affected by the failure of new
or existing products to compete favorably in response to such technological
developments. In addition, the Company competes against numerous other companies
offering products similar to the Company's and/or alternative products and
technologies, some of which have greater financial, marketing and technical
resources than the Company. There can be no assurance the Company will be able
to compete successfully. In addition, the Company's CSCC operations face a host

                                       19
<PAGE>
 
of competitors including hair salons, health spas, massage therapists,
aestheticians, health and fitness clubs, personal trainers, dermatologists,
plastic surgeons, cosmetic laser centers and cosmetic retailers.  The Company
also believes its CSCC operations will face competition from laser
manufacturing companies that have, or may develop, plans to open facilities
based on concepts similar to the Candela LaserSpa(TM) concept.  Such
competition could have a material adverse effect on the Company's business,
financial condition and results of operations.  Further, even if the company is
able to successfully compete, there can be no assurance that it would be able
to do so in a profitable manner.

RELIANCE ON ATTRACTING AND RETAINING KEY EMPLOYEES.  The Company's success will
depend in large part on its ability to attract and retain highly-qualified
scientific, technical, managerial, sales and marketing, management and other
personnel.  Competition for such personnel is intense and any decline in the
Company's ability to attract and retain such personnel may have adverse effects
on its financial condition and operating results.



ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
------   -------------------------------------------

Financial statements and supplementary data are included herein and are indexed
under item 14 (a) (1)-(2).


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
------   ---------------------------------------------------------------
         Financial Disclosure
         --------------------

   None.

                                       20
<PAGE>
 
                                   PART III


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
-------   --------------------------------------------------

For information with respect to the Directors of the Company, see the section
entitled "Election of Directors" appearing in the Company's Proxy Statement in
connection with its 1997 Annual Meeting of Shareholders, which section is
incorporated herein by reference.  The current executive officers of the
Company are set forth under the caption "Executive Officers" in Item 1 of this
Form 10-K.


Item 11.  EXECUTIVE COMPENSATION
-------   ----------------------

See the section entitled "Executive Compensation and Other Information
Concerning Officers and Directors" appearing in the Company's Proxy Statement
in connection with its 1997 Annual Meeting of Shareholders, which section is
incorporated herein by reference.


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
-------   --------------------------------------------------------------

See the section entitled "Security Ownership of Certain Beneficial Owners and
Management" appearing in the Company's Proxy Statement in connection with its
1997 Annual Meeting of Shareholders, which section is incorporated herein by
reference.


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
-------   ----------------------------------------------

See the section entitled "Certain Transactions" appearing in the Company's
Proxy Statement in connection with its 1997 Annual Meeting of Shareholders,
which section is incorporated herein by reference.

                                       21
<PAGE>
 
                                    PART IV
                                    -------

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
-------   ---------------------------------------------------------------

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

(1)  Consolidated Financial Statements:
     --------------------------------- 
<TABLE>
<CAPTION>
<S>                                                                             <C>
     Report of Independent Accountants                                           F-1
     Consolidated Balance Sheets - June 28, 1997 and June 29, 1996               F-2
     Consolidated Statements of Operations - Years ended June 28,1997,
        June 29, 1996 and July 1, 1995                                           F-3
     Consolidated Statements of Stockholders' Equity - Years Ended
        June 28, 1997, June 29, 1996 and July 1, 1995                            F-4
     Consolidated Statements of Cash Flows - Years Ended June 28, 1997,
        June 29, 1996 and July 1, 1995                                           F-5
     Notes to Consolidated Financial Statements                                  F-6
 
(2)  Consolidated Financial Statement Schedules:
     ------------------------------------------ 
     Schedule II - Valuation and Qualifying Accounts                             F-17
</TABLE>

The report of the registrant's independent accountants with respect to the
above-listed financial statements and financial statement schedule appears on
page F-1 of this report.

All other financial statements and schedules not listed have been omitted since
the required information is included in the consolidated financial statements
or the notes thereto, or is not applicable, material or required.
<TABLE>
<CAPTION>
 
(3)  Exhibits:  Except as otherwise noted, the following documents are
     incorporated by reference from the Company's Registration Statement on Form
     S-3 (File Number 33-24565):
<S>      <C>                      <C>
 
 3.1                              Certificate of Incorporation, as amended
 3.2     <FN9>                    By-laws of the Company, as amended and restated
 3.3     <FN1>                    Agreement of Merger between Candela Corporation, Inc., a
                                  Massachusetts corporation, and Candela Laser Corporation, a
                                  Delaware corporation
 4.1     <FN6>                    Form of Rights Agreement dated as of September 4, 1992 between the Company and The First
                                  National Bank of Boston, as Rights Agent, which includes as Exhibit A thereto the Form of
                                  Rights Certificate
10.1     (FN1)                    1985 Incentive Stock Option Plan
10.2                              1987 Stock Option Plan
10.2.1   (FN2)                    1989 Stock Plan
10.2.2   (FN3)                    1990 Employee Stock Purchase Plan
10.2.3   (FN3)                    1990 Non-Employee Director Stock Option Plan
10.2.4   (FN7)                    1993 Non-Employee Director Stock Option Plan
10.3     (FN7)                    Lease for premises at 526 Boston Post Road, Wayland, Massachusetts
10.4     (FN7)                    Lease for premises at 530 Boston Post Road, Wayland, Massachusetts
10.5                              Patent License Agreement between the Company and Patlex Corporation effective as of July 1,
                                  1988
10.6     (FN4)                    License Agreement among the Company, Technomed International, Inc. and Technomed
                                  International S.A. dated as of December 20, 1990
10.7     (FN5)                    License Agreement between the Company and Pillco Limited Partnership effective as of October
                                  1, 1991
10.8     (FN8)                    Distribution Agreement between the Company and Cryogenic
                                  Technology Limited, dated October 15, 1993
</TABLE>

                                       22
<PAGE>
 
<TABLE> 
<CAPTION> 
<S>      <C>                      <C>
10.9     <FN10>                   Asset Purchase Agreement between the Company and Derma-Laser,
                                  Limited and Derma-Lase, Inc. dated June 23, 1994.

21                                Subsidiaries of the Company

23                                Consent of Independent Accountants (Coopers & Lybrand, L.L.P.)

27                                Financial Data Schedule

         (FN1)                    Previously filed as an exhibit to Registration Statement No.
                                  33-54448B and incorporated herein by reference.

         (FN2)                    Previously filed as an exhibit to the Company's Amended and
                                  Restated Annual Report on Form 10-K for the fiscal year ended
                                  June 30, 1988, and incorporated herein by reference.

         (FN3)                    Previously filed as an exhibit to the Company's Annual Report 
                                  on Form 10-K for the fiscal year ended June 30, 1990, and 
                                  incorporated herein by reference.

         (FN4)                    Previously filed as an exhibit to Form 10-Q for the quarter
                                  ended December 29, 1990, and incorporated herein by reference.

         (FN5)                    Previously filed as an exhibit to Form 10-Q for the quarter
                                  ended September 28, 1991, and incorporated herein by reference.

         (FN6)                    Previously filed as an exhibit to Form 8-K, dated September 8,
                                  1992, and incorporated herein by reference.

         (FN7)                    Previously filed as an exhibit to the Company's Annual Report
                                  on Form 10-K for the fiscal year ended July 3, 1993, and
                                  incorporated herein by reference.

         (FN8)                    Previously filed as an exhibit to Form 10-Q for the quarter
                                  ended January 1, 1994, and incorporated herein by reference.

         (FN9)                    Previously filed as an exhibit to Form 10-Q for the quarter
                                  ended April 2, 1994, and incorporated herein by reference.

         (FN10)                   Previously filed as an exhibit to the Company's Annual Report
                                  on Form 10-K for the fiscal year ended July 2, 1994, and
                                  incorporated herein by reference.

</TABLE>
 
(b)  Reports on Form 8-K.  No reports on Form 8-K were filed by the
     Company during the fourth quarter of the fiscal year ended June 28,
     1997.

(c)  The Company hereby files, as part of this Form 10-K, the exhibits
     listed in Item 14(a)(3) above.

                                       23
<PAGE>
 
                                    SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on September 21, 1997.

                                    CANDELA CORPORATION

                                    By:  Gerard E. Puorro
                                        ------------------------------------
                                        Gerard E. Puorro, President,
                                        Chief Executive Officer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
Signature                       Title                      Date
---------------------    -----------------------------  ------------------
 
 Gerard E. Puorro        President, Chief Executive     September 21, 1997
 --------------------    Officer, and Director
 Gerard E. Puorro        (Principal Executive Officer)
 
 F. Paul Broyer          Vice President, Treasurer      September 21, 1997
 --------------------    and Chief Financial Officer
 F. Paul Broyer
 
 Kenneth D. Roberts      Chairman of the Board          September 21, 1997
 --------------------    of Directors
 Kenneth D. Roberts
 
 Richard J. Cleveland    Director                       September 21, 1997
 ---------------------
 Richard J. Cleveland
 
 Robert E. Dornbush      Director                       September 21, 1997
 ----------------------
 Robert E. Dornbush
 
 Theodore G. Johnson     Director                       September 21, 1997
 ----------------------
 Theodore G. Johnson
 
 Douglas W. Scott        Director                       September 21, 1997
 ----------------------

 Douglas W. Scott

                                       24
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareholders and Board of Directors of Candela Corporation:

We have audited the consolidated financial statements and the financial
statement schedule of Candela Corporation listed in Item 14(a) of this Form 10-
K. These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Candela
Corporation as of June 28, 1997 and June 29, 1996, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended June 28, 1997 in conformity with generally accepted accounting principles.
In addition, in our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.



Boston, Massachusetts                            COOPERS & LYBRAND L.L.P.
August 5, 1997, except as to the
                information presented
                in Note 6, for which
                the date is September 12, 1997.



                                      F-1
<PAGE>
 
                          Consolidated Balance Sheets
                        June 28, 1997 and June 29, 1996
                            (dollars in thousands)
<TABLE>
<CAPTION>
 
Assets                                                   1997      1996
-----------------------------------------------------  --------  --------
<S>                                                    <C>       <C>
 
Current assets:
Cash and cash equivalents (Note 1)                     $ 2,674   $ 3,041
Accounts receivable (net of allowance of $197 and
  $305 in 1997 and 1996, respectively)(Notes 1 & 6)      8,848     6,444
Notes receivable                                         1,284     1,956
Inventory (Notes 3 & 6)                                  6,776     5,627
Other current assets                                       522       352
                                                       -------   -------
 
Total current assets                                    20,104    17,420
Property and equipment, net (Note 4)                     3,523     1,183
Other assets                                             1,210       731
                                                       -------   -------
 
                                                       $24,837   $19,334
                                                       =======   =======
 
Liabilities and Stockholders' Equity
------------------------------------
 
Current liabilities:
Current portion of long-term debt (Note 6)             $ 1,827   $   708
Deferred income (Note 5)                                 2,071     1,943
Accounts payable                                         5,879     3,162
Accrued payroll and related expenses                       833       748
Accrued warranty costs                                   1,338       897
Income taxes payable                                       516       350
Other accrued liabilities                                  608     1,004
                                                       -------   -------
 
Total current liabilities                               13,072     8,812
 
Long-term debt (Note 6)                                  1,519       557
Commitments (Note 6)
 
Stockholders' equity (Note 8):
 Common stock, $.01 par value: 30,000,000
 shares authorized;  5,419,913 and
 5,384,715 shares issued in 1997 and 1996,
 respectively                                               54        53
 
 Additional paid-in capital                             17,223    17,069
 Accumulated deficit                                    (6,885)   (7,123)
 Accumulated translation adjustment                       (146)      (34)
                                                       -------   -------
 
Total stockholders' equity                              10,246     9,965
                                                       -------   -------
 
                                                       $24,837   $19,334
                                                       =======   =======
</TABLE>

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


                                      F-2
<PAGE>
 
                     Consolidated Statements of Operations
      For the years ended June 28, 1997, June 29, 1996, and July 1, 1995
                     (in thousands, except per share data)
<TABLE>
<CAPTION>
 
                                            1997      1996      1995
                                          --------  --------  --------
<S>                                       <C>       <C>       <C>
 
Revenue
  Product sales                           $25,601   $20,403   $18,017
  Services and other revenue                9,904    10,010    10,226
                                          -------   -------   -------
    Total revenue                          35,505    30,413    28,243
 
Cost of sales
  Product sales                            11,195     9,159     7,952
  Services and other revenue                7,455     7,674     7,915
                                          -------   -------   -------
    Total cost of sales                    18,650    16,833    15,867
                                          -------   -------   -------
 
Gross profit                               16,855    13,580    12,376
 
Operating expenses:
  Research and development                  2,488     1,818     3,733
  Selling, general and administrative      13,680     9,873    10,246
                                          -------   -------   -------
 
    Total operating expenses               16,168    11,691    13,979
                                          -------   -------   -------
 
Income (loss) from operations                 687     1,889    (1,603)
Other income (expense):
  Interest income                              84        93        70
  Interest expense                           (107)      (49)      (47)
  Other                                       (26)     (207)      544
                                          -------   -------   -------
 
    Total other income (expense)              (49)     (163)      567
                                          -------   -------   -------
 
Income (loss) before income taxes             638     1,726    (1,036)
Provision for income taxes                    400       481       500
                                          -------   -------   -------
 
Net income (loss)                         $   238   $ 1,245   $(1,536)
                                          =======   =======   =======
 
Net income (loss) per share                 $0.04     $0.22    $(0.29)
                                          =======   =======   =======
 
Weighted average number of common and
  common equivalent shares outstanding      5,673     5,563     5,288
                                          =======   =======   =======
</TABLE>
 The accompanying notes are an integral part of the consolidated financial
 statements.

                                      F-3
<PAGE>
 
                Consolidated Statements of Stockholders' Equity
      For the years ended June 28, 1997, June 29, 1996, and July 1, 1995
                                (in thousands)
<TABLE>
<CAPTION>
                                              Additional                              Accumulated
                                               Paid-in   Accumulated   Treasury       Translation
                            Common Stock       Capital    (Deficit)      Stock         Adjustment
                           --------------     ---------  -----------   ----------     -----------
                            Shares Amount                            Shares Amount        Total
-------------------------------------------------------------------------------------------------
<S>                          <C>    <C>    <C>        <C>        <C>     <C>        <C>  <C>
Balance, July 2, 1994        5,481  $54    $ 18,326   ($6,715)   (197)   $ (1,574)  $475 $10,566
 
Sale of common stock
  under stock plans             15               23                                           23
Dividend paid by Le Pli                                   (43)                               (43)
Net loss                                               (1,536)                            (1,536)
Currency translation 
  adjustment                                                                          76      76
-------------------------------------------------------------------------------------------------
 
Balance, July 1, 1995        5,496   54      18,349    (8,294)   (197)     (1,574)   551   9,086
 
Sale of common stock
  under stock plans             86    1         244                                          245
Dividend paid by Le Pli                                   (26)                               (26)
Net income                                              1,245                              1,245
Retirement of Treasury
  Stock                       (197)  (2)     (1,572)              197       1,574              0
Conversion of
  Spa Management,Inc.
  to a C-Corporation                             48       (48)                                 0
Currency translation
  adjustment                                                                        (585)   (585)
-------------------------------------------------------------------------------------------------
 
Balance June 29, 1996        5,385  $53     $17,069   $(7,123)      0    $      0   $(34)$ 9,965
 
Sale of common stock
   under stock plans            35    1         154                                          155
Net income                                                238                                238
Currency translation
   adjustment                                                                       (112)   (112)
-------------------------------------------------------------------------------------------------
 
Balance, June 28, 1997       5,420  $54     $17,223   $(6,885)      0    $      0  $(146)$10,246
=================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.

                                      F-4
<PAGE>

                     Consolidated Statements of Cash Flows
      For the years ended June 28, 1997, June 29, 1996, and July 1, 1995 
                                (In thousands) 

<TABLE>
<CAPTION>
                                                                                           1997      1996      1995
                                                                                         --------  --------  ---------
<S>                                                                                      <C>       <C>       <C>
 
Cash flows from operating activities:
  Net income (loss)                                                                      $   238   $ 1,245    $(1,536)
  Adjustments to reconcile net income (loss)
    to net cash provided by (used for)
    operating activities:
    Depreciation and amortization                                                            666       475        640
    (Gain)Loss on disposal of equipment                                                        -        (8)        25
  Change in assets and liabilities:
      Accounts receivable                                                                 (2,592)   (1,909)     1,412
      Notes receivable                                                                       620      (545)     1,204
      Inventory                                                                           (1,216)     (590)       277
      Refundable income taxes                                                                  -         -         31
      Other current assets                                                                  (188)       74        106
      Other assets                                                                          (529)     (171)       (51)
      Accounts payable                                                                     2,945     1,552     (2,346)
      Accrued payroll and related expenses                                                    88       130       (294)
      Deferred income                                                                        145       315       (214)
      Accrued warranty costs                                                                 445       278       (166)
      Income taxes payable                                                                   181      (222)       179
      Other accrued liabilities                                                             (395)       90       (760)
                                                                                         -------   -------    -------
 
         Total adjustments                                                                   170      (531)        43
                                                                                         -------   -------    -------
 
Net cash provided by (used for) operating
  activities                                                                                 408       714     (1,493)
 
Cash flows from investing activities:
  Proceeds from sale of assets                                                                50        10          -
  Payment for additions to property and
    equipment                                                                             (1,867)     (377)      (475)
                                                                                         -------    ------    -------
 
Net cash used for investing activities                                                    (1,817)     (367)      (475)
 
Cash flows from financing activities:
  Proceeds from issuance of debt                                                           1,655       479        708
  Principal payments on debt                                                                (422)     (225)         -
  Payments of capital lease obligations                                                     (258)     (125)      (100)
  Proceeds from issuance of common stock, net                                                155       294         23
  Payment of dividends                                                                         -       (26)       (43)
                                                                                         -------   -------    -------
 
Net cash provided by financing
  activities                                                                               1,130       397        588
 
Accumulated translation adjustment                                                           (88)     (268)       155
                                                                                         -------   -------    -------
 
Net increase (decrease) in cash and equivalents                                             (367)      476     (1,225)
Cash and equivalents at beginning of period                                                3,041     2,565      3,790
                                                                                         -------   -------    -------
 
Cash and equivalents at end of period                                                    $ 2,674   $ 3,041    $ 2,565
                                                                                         =======   =======    =======
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
 

                                      F-5
<PAGE>
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of Candela
Corporation and its wholly-owned subsidiaries.  All intercompany accounts and
transactions have been eliminated.  In August 1995, the Company incorporated a
wholly-owned subsidiary, Candela Skin Care Centers, Inc. (CSCC).  CSCC offers
services to its customers, through cosmetic laser facilities, integrating laser
cosmetic procedures with spa, salon, health and fitness services.  In June
1996, the Company acquired all of the outstanding capital stock of Spa
Management, Inc. which was accounted for using the pooling of interests method
of accounting. (See Note 2)

The Company's fiscal year ends on the Saturday nearest June 30.

Certain amounts from prior years have been reclassified to conform to the
current year's presentation.


Use of Estimates

The presentation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and would impact future
results of operations and cash flows.


Cash Equivalents

The Company classifies investments purchased with a maturity of three months or
less at the date of acquisition as cash equivalents. At June 28, 1997 and June
29, 1996, substantially all cash equivalents were invested in overnight
Repurchase Agreements or U.S. Treasury Bills with a major bank.


Financial Instruments

Derivative financial instruments are used by the Company in the management of
foreign currency exposures and are accounted for on an accrual basis.  Gains
and losses resulting from effective hedges of existing assets, liabilities, or
firm commitments are deferred and recognized when the offsetting gains and
losses are recognized on the related hedged items.


                                      F-6
<PAGE>
 
Accounts Receivable and Notes Receivable

The Company's trade accounts receivables and notes receivables are primarily
from sales to end users and distributors servicing the urology and dermatology
markets and reflect a broad domestic and international customer base.  The
Company does not require collateral and has not historically experienced
significant credit losses related to receivables from individual customers or
groups of customers in any particular industry or geographic area.  One
distributor customer accounted for 6% of total receivables at June 28, 1997.


Inventory

Inventory is stated at the lower of cost (first-in, first-out method) or
market.



Pre-opening costs

The Company capitalizes pre-opening costs directly related to the Candela Skin
Care Centers through the opening date of the center.  The Company then
amortizes these costs over a 12-month period beginning in the quarter following
the opening date.


Property and Equipment

Purchased property and equipment is recorded at cost. Property and equipment
purchased under capital lease obligations is recorded at the lesser of cost or
the present value of the minimum lease payments required during the lease
period. Laser systems are capitalized at cost. Significant improvements are
capitalized; maintenance and repairs are charged to expense as incurred. Upon
sale or retirement of property and equipment, the costs and accumulated
depreciation are removed from the accounts and any gain or loss is included in
other income (expense). Depreciation and amortization are provided using the
straight-line method over estimated useful lives as follows:
<TABLE>
<CAPTION>
                                                            Number of Years
                                                            ---------------
<S>                                                         <C>
 
   Leasehold improvements and assets under capital lease        2 to 5
   Office furniture and other equipment                         3 to 5
   Laser systems                                                  3
 
</TABLE>

Revenue Recognition

Product sales - Revenue from product sales, except sales to certain
distributors, are generally recognized at the time of shipment.  Shipments made
to distributors, where payment is dependent on resale of the system, are not
recognized unless the distributor demonstrates that the system is sold.

Grants - Grants represent revenue earned through government contracts granted
under the Small Business Innovation Research program.  Government contracts
limit reimbursement to 100% of allowable direct costs and a negotiated rate for
indirect costs.  Revenue is recognized as reimbursable costs are incurred.

                                      F-7
<PAGE>
 
Service - Revenue from the sale of service contracts is deferred and recognized
on a straight-line basis over the contract period.  Revenue from service
administered through CSCC and Spa Management, Inc., is recognized as the
services are provided.  Amounts received from the sale of gift certificates by
Spa Management, Inc. are deferred and recognized as revenue when the services
are provided.


Research and Development

Research and development costs are expensed as incurred.


Foreign Currency Translation

The financial statements of the Company's foreign subsidiaries are translated
into U.S. dollars in accordance with Statement of Financial Accounting
Standards (SFAS) No. 52, "Foreign Currency Translation."  Assets and
liabilities are translated into U.S. dollars at current exchange rates, while
income and expense items are translated at average rates of exchange prevailing
during the year.  Exchange gains and losses arising from translation of the
Japanese and Spanish subsidiary balance sheets are accumulated as a separate
component of stockholders' equity.  Net exchange gains(losses) resulting from
foreign currency transactions amounted to $(60,000), $(420,000) and $514,000
for fiscal 1997, 1996 and 1995, respectively, and are included in other income
(expense).


Financial Instruments

The Company uses forward foreign exchange contracts to hedge some foreign
denominated receivables.  The related gains and losses are deferred and
recognized as the forward contracts are settled.


Product Warranty Costs

The Company's warranty policy on end user sales of medical devices is generally
one year on parts and labor.  Distributor sales generally include a parts
warranty only.  Estimated future costs for initial product warranties are
provided for at the time of sale.


Earnings (Loss) Per Share

Net income (loss) per share is computed by dividing net income (loss) by the
weighted average number of shares of common stock and, if dilutive, common
stock equivalents outstanding.  Common stock equivalents include shares
issuable upon the exercise of stock option or warrants, net of shares assumed
to have been purchased with the proceeds.

                                      F-8
<PAGE>
 
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 128-Earnings per Share.
SFAS No. 128 establishes standards for computing and presenting earnings per
share (EPS) and requires a dual presentation of basic and dilutive EPS.  SFAS
No. 128 is effective for financial statements issued for periods ending after
December 15, 1997, and earlier adoption is not permitted.  Neither basic nor
diluted EPS computed in accordance with FAS 128 would be materially different
from the Company's primary EPS presented in the financial statements.


Accounting for Stock-Based Compensation

In October 1995, the Financial Accounting Standards Board issued Statement No.
123 (SFAS 123), "Accounting for Stock-Based Compensation," which is effective
for fiscal 1997. SFAS encourages, but does not require, companies to recognize
compensation costs for employee and director stock-based compensation
arrangements using a fair value method of accounting. The Company has determined
that it will elect the disclosure only alternative and, accordingly, will
continue to account for employee and director stock-based compensation in
accordance with Accounting Principles Board Opinion No. 25. The Company is
required to disclose the pro forma net income or loss and per share amounts in
the notes to the consolidated financial statements using the fair value based
method beginning in fiscal 1997. The adoption of SFAS 123 will have no cash flow
impact on the Company.


2. Pooling of Interests

On June 27, 1996, the Company acquired all of the outstanding shares of capital
stock of Spa Management, Inc. The acquisition was accomplished through an
exchange of 60,317 shares of the Company's common stock for all of the
outstanding shares of capital stock of Spa Management, Inc. This transaction has
been accounted for using the pooling of interests method of accounting. Spa
Management, Inc., d/b/a Le Pli at the Heritage(Le Pli) was formed in May 1994,
and is a Boston-based health spa with approximately 60 employees at the time of
acquisition and specializes in personal care and health and beauty services. Le
Pli (currently operating as Candela Skin Care Center of Boston, Inc.) operates
as a wholly-owned subsidiary of CSCC.

The following information presents certain income statement data of Candela
Corporation and Spa Management, Inc. for the periods prior to the acquisition.
The acquisition was substantially coincident with the fiscal year end close.
<TABLE>
<CAPTION>
 
                             Candela           Spa
                           Corporation   Management, Inc.   Total
                           ------------  ----------------  --------
<S>                        <C>           <C>               <C>
Revenue for:
Year ending
  June 29, 1996                $28,434             $1,979  $30,413
  July  1, 1995                 26,466              1,777   28,243
 
Net Income (Loss) for:
Year ending
  June 29, 1996                $ 1,210             $   35  $ 1,245
  July  1, 1995                 (1,577)                41   (1,536)
</TABLE>
                                      F-9
<PAGE>
 
The accompanying consolidated financial statements of the Company have been
prepared to give retroactive effect to the acquisition of Le Pli.  All prior
period historical consolidated financial statements presented herein have been
restated to include the financial position, results of operations, and cash
flows of Le Pli.


3.  Inventory

Inventory consists of the following at June 28, 1997 and June 29, 1996 (in
thousands):
<TABLE>
<CAPTION>
                                                                          1997    1996
                                                                         ------  ------
<S>                                                                      <C>     <C>
 
  Raw Materials                                                          $2,429  $3,534
  Work in process                                                         1,023     531
  Finished goods                                                          3,324   1,562
                                                                         ------  ------
                                                                         $6,776  $5,627
                                                                         ======  ======
 
4.  Property and Equipment
 
Property and equipment consists of the following at June 28, 1997 and
June 29, 1996 (in thousands):
                                                                          1997    1996
                                                                         ------  ------
  Leasehold improvements                                                 $2,014  $  361
  Office furniture                                                        1,064     724
  Laser systems                                                             483     543
  Computers and other equipment                                           4,271   3,296
                                                                         ------  ------
                                                                          7,832   4,924
  Less accumulated depreciation and amortization                          4,309   3,741
                                                                         ------  ------
  Property and equipment, net                                            $3,523  $1,183
                                                                         ======  ======
</TABLE>

Depreciation expense was approximately $ 616,000, $552,000, and $507,000 for
fiscal 1997, 1996 and 1995, respectively.

Assets under capital lease obligations of $1,747,000 and $1,007,000 are
included in property and equipment at June 28, 1997 and June 29, 1996,
respectively.  Accumulated depreciation on these assets was $ 769,000 and
$547,000 at June 28, 1997 and June 29, 1996, respectively.


5.  Deferred Income

Deferred income consists of the following at June 28, 1997 and June 29, 1996
(in thousands):
<TABLE>
<CAPTION>
                                       1997    1996
                                      ------  ------
<S>                                   <C>     <C>
 
Service contract revenue              $1,243  $1,086
Customer deposits                          0      74
Gift certificate revenue                 362     352
Other                                    466     431
                                      ------  ------
                                      $2,071  $1,943
                                      ======  ======
</TABLE>
                                      F-10
<PAGE>
 
6.  Debt and Lease Obligations

Line of Credit

In February 1997 the Company obtained a renewable $3,500,000 revolving credit
agreement with a bank with interest at the bank's corporate base rate plus one-
half of one percent (9% at June 28, 1997). This line of credit is secured by all
of the Company's accounts receivable, inventory and the pledge of stock of CSCC.
The agreement contains restrictive covenants establishing maximum leverage,
certain minimum ratios and minimum levels of net income. At June 28, and during
the year, the Company was in violation of certain of the covenants related to
the level of net income, capital expenditure levels and other ratio covenants.
On September 12, 1997, the lender waived its rights under the agreement for
violations occurring during fiscal 1997 and effective September 30, 1997, has
amended the loan covenants for fiscal 1998 and thereafter. As of June 28, 1997,
the Company had utilized $1,000,000 of the line of credit.


Long-term Debt

The Company's long-term debt consists of the following at June 28, 1997 and
June 29, 1996 (in thousands):
<TABLE>
<CAPTION>
                                                             1997   1996
                                                            ------  -----
<S>                                                         <C>     <C>
 
  Unsecured term bank loan denominated in 60,000,000
   Japanese yen; interest at 1.95%; quarterly
   payments of principal and interest through March 1998    $  196  $ 479
 
  Unsecured term bank loan denominated in 60,000,000
   Japanese yen; interest at 1.90%; quarterly
   payments of principal and interest through June 1997          0    273
 
  Unsecured term bank loan denominated in 75,000,000
   Japanese yen; interest at 1.745%; quarterly payments
   of principal and interest through September 1999            655      0
 
  Obligations under capital leases with options to
   purchase equipment; interest from 5.8% to 12.31%;
   payments of principal and interest through March 2001     1,495    513
                                                            ------  -----
 
                                                             2,346  1,265
   Less current portion                                        827    708
                                                            ------  -----
                                                            $1,519 $  557
                                                            ====== ======
</TABLE>


Lease Commitments

The Company leases several facilities and automobiles under noncancellable lease
arrangements. The facility leases may be adjusted for increases in maintenance
and insurance costs above specified levels. In addition, certain of the facility
leases bear escalation provisions based on certain specified criteria and one
lease calls for the payment of additional rent based on a percentage of Gross

                                      F-11
<PAGE>
 
Revenues above a Base Gross Sales level for that particular operation. These
operating leases expire in various years through 2009.  These leases may be
renewed for periods ranging from one to five years.

Future minimum lease payments under noncancellable operating leases with
initial terms of one year or more consisted of the following at June 28, 1997:
<TABLE>
<CAPTION>
 
<S>                                                 <C>
                     1998                            $  665,432
                     1999                               483,358
                     2000                               368,490
                     2001                               368,490
                     2002                               220,274
                     Thereafter                       1,110,116
                                                     ----------
                     Total minimum lease payments    $3,216,160
                                                     ========== 
</TABLE>


Total rent expense was approximately $772,000, $607,000 and $665,000 for fiscal
1997, 1996 and 1995, respectively.

The Company had additions to capital lease obligations of approximately
$1,240,000, $400,000, and $33,000 for fiscal 1997, 1996, and 1995 respectively,
for the acquisition of certain equipment.  These obligations are collateralized
against the respective equipment.

Cash paid for interest, including interest on capital lease obligations,
totaled approximately $107,000, $50,000 and $49,000 for fiscal 1997, 1996, and
1995 respectively.

As of June 28, 1997, the Company's approximate minimum payment requirements
under debt and capital lease obligations are as follows (in thousands):
<TABLE>
<CAPTION>
 
                   Fiscal
                   ------
<S>                                                    <C>
                    1998                                 $1,963
                    1999                                    722
                    2000                                    508
                    2001                                    337
                    2002                                    125
                                                         ------
                    Total minimum payments                3,655
                    Less interest                           309
                                                         ------
 
                    Present value of minimum payments     3,346
                    Less current portion                  1,827
                                                         ------
                    Long-term obligations                $1,519
                                                         ======
</TABLE>

7.   Financial Instruments

The Company operates internationally, with sales offices, customers, and vendors
in several countries outside of the United States. The Company may reduce its
exposure to fluctuations in foreign exchange rates by creating offsetting
positions through the use of foreign currency forward contracts, a type of
derivative financial instrument. The Company does not use derivative financial
instruments for trading or speculative purposes, nor is the Company a party to
leveraged derivatives.

                                      F-12
<PAGE>
 
At June 28, 1997 the Company held foreign currency forward contracts with
notional value totaling approximately $500,000 (58,625,000 Japanese Yen).
These contracts have maturities prior to August 15, 1997.  The carrying and net
fair value of these contracts at June 28, 1997 was $0 and $12,000,
respectively.
 
                                        
8.  Stockholders' Equity

Stock Plans

1985, 1987 and 1989 Stock Option Plans

The 1985, 1987 and 1989 Stock Option Plans (the "Plans") provide for the
granting of incentive stock options to employees to purchase common stock at an
exercise price not less than the fair market value of the stock on the date of
grant. The 1987 and 1989 Stock Option Plans also provide for the granting of 
non-qualified stock options. The options generally become exercisable ratably
over two or four years from the date of grant and expire ten years from the date
of the grant. The maximum number of shares to which options may be granted under
the 1989 Plan is 1,000,000 shares. The Board of Directors has terminated the
granting of options under the 1985 and 1987 plans. On July 21, 1995, the Board
of Directors approved the repricing of certain previously outstanding stock
options. Options outstanding at prices ranging from $5.50 to $14.00 were amended
to $3.1875, the fair market value of the stock on that date. In November 1995,
the shareholders approved an increase in the number of shares under the 1989
Plan of 250,000 shares, changing the maximum number of shares that may be
granted to 1,000,000.

1996 Candela Skin Care Center Inc. Stock Option Plan

During fiscal year 1996, Candela Skin Care Centers, Inc. adopted the 1996
Incentive and Non-Statutory Stock Option Plan under which options may be granted
enabling the purchase, at a price not less than the fair market value, of the
common stock on the date of grant for incentive stock options and at a price of
not less than the par value of the common stock for non-qualified stock options.
Options granted under this plan become exercisable at different rates over one
to four years from the date of grant and expire ten years from the date of
grant. As of June 28, 1997, 188,000 options to purchase shares of the
subsidiary's common stock were outstanding, representing 16% of the common
shares outstanding plus the stock options. All such options were issued with an
exercise price equal to the fair market value of the subsidiary's common stock
on the date of grant.

1990 and 1993 Non-Employee Director Stock Option Plans

The 1990 and 1993 Non-Employee Director Stock Option Plans provide for the
issuance of options for the purchase of up to 60,000 and 80,000 shares of common
stock, respectively. Under these plans, each director who is neither an employee
nor an officer receives a one-time grant of an option to purchase 10,000 shares
of common stock at an exercise price equal to the fair market value of the
common stock on the date of grant. Under the 1990 and 1993 Plans options become
exercisable in equal amounts over a period of four and two years, respectively.
Shares under these Plans expire four and ten years, respectively, after the date
of grant and are nontransferable.

                                      F-13
<PAGE>
 
The following is a summary of stock option activity under these Plans:

<TABLE>
<CAPTION>
 
                                                                 Weighted Average
                                  Number of                       Exercise Price
                                    Shares        Option Price      Per Share
                                --------------  ---------------- ----------------
<S>                             <C>             <C>               <C>
 
Balance at July 2, 1994               616,369                           $5.8400
Granted                               250,000    $1.50  -$ 2.75         $2.5650
Canceled                             (114,098)   $1.865 -$15.00         $5.4953
                                     --------                            
                                                                         
Balance at July 1, 1995               752,271                           $4.8100
Granted                               211,693    $3.1875-$ 9.875        $4.2092
Exercised                             (72,896)   $6.50  -$ 9.625        $3.2015
Canceled                             (232,965)   $2.00  -$15.50         $6.6946
                                     --------                             
                                                                         
Balance at June 29, 1996              658,103                           $4.1300
Granted                               296,500    $4.88  -$8.63          $6.9343
Exercised                             (22,591)   $2.00  -$7.25          $3.0484
Canceled                              (70,755)   $2.00  -$9.875         $6.8645
                                     --------                            
                                                                         
Balance at June 28, 1997              861,257                           $4.8800
                                     ========                           ========
Options available for grant at June 28,1997                         156,048
                                                                   ========
 
</TABLE>

The following table summarizes information about stock options under the Option
Plans outstanding at June 28, 1997:
<TABLE>
<CAPTION>

          Options Outstanding                           Options Exercisable
----------------------------------------------    -----------------------------------
                                       Weighted
                                       Average     Weighted                  Weighted
Range of                Options        Remaining   Average       Number      Average
Exercise             Outstanding at   Contractual  Exercise  Exercisable at  Exercise
Price                June 28, 1997       Life       Price    June 28, 1997    Price
<S>                 <C>               <C>          <C>       <C>             <C>
 
 $1.50  -$ 3.1875            292,706  5.77 Years      $2.87         206,456     $2.93
 $3.25  -$ 5.75              287,841  6.88 Years      $4.09         210,091     $3.49
 $6.1875-$ 8.125             234,700  8.09 Years      $7.44          57,200     $7.52
 $8.625 -$14.50               46,500  6.74 Years      $9.53          26,250     $9.34
 
 $1.50  -$14.50              861,747  6.83 Years      $4.88         499,997     $4.03
</TABLE>

The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
option plans. Accordingly, no compensation expense has been recognized for
options granted to employees and directors of the Company. Had compensation
expense for the Company's stock option plans and employee stock purchase plan
been determined based on the fair value at the grant date for awards under these
plans consistent with the methodology prescribed under Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," the Company's net income and net income per share would have been
reduced by $461,000, or $.08 per share in 1997 and $250,000 or $.04 per share in
1996. The weighted average fair value of the options granted under the stock
option plans and the shares issued under the employee stock purchase plan for
1997 and 1996, calculated using the Black Scholes pricing model, was $4.93 and
$2.77 per share, respectively. The following assumptions were used in the Black
Scholes pricing
                                      F-14

<PAGE>
 
model for options granted in 1997 and 1996: risk-free interest rate ranging
from 5.11% to 6.74%, estimated volatility of 85%, and an expected life of six
years for stock options and six months for shares purchased under the employee
stock purchase plans.

The effects of applying SFAS No. 123 in this pro-forma disclosure are not
indicative of the pro-forma effect on net income in future years because SFAS
No. 123 does not take into consideration pro-forma expenses related to options
granted prior to 1996.

1990 Employee Stock Purchase Plan:  The 1990 Employee Stock Purchase Plan
provides for the sale of up to 500,000 shares of common stock to eligible
employees.  The shares are issuable at the lesser of 85% of the average market
price on the first or last day of semiannual periods.  Substantially all full-
time employees are eligible to participate in the plan.

     The following is a summary of shares issued under this plan:
<TABLE>
<CAPTION>
 
           Shares  Price per share
           ------  ---------------
<S>        <C>     <C>
 
   1995    14,969    $   1.50
   1996    12,594    $1.75 - $4.50
   1997    11,483    $   5.00
 
</TABLE>
Reserved Shares

The Company has reserved 1,425,186 shares of common stock for issuance under
its stock plans.


Common Stock Warrants

In connection with a litigation settlement in January 1991, the Company issued
warrants to purchase 300,000 shares of common stock in March 1992.  The
exercise price for the warrants is $6.875 per share, the fair market value of
the Company's common stock on the date of the settlement.  These warrants will
expire in November 2000.  During fiscal 1993, 1,305 warrants were exercised and
during 1997, 199 warrants were exercised.  No warrants were exercised during
fiscal 1996 or 1995.


Stockholder Rights Plan

On September 4, 1992, the Company adopted a Stockholder Rights Plan under which
it declared a dividend of one common stock purchase Right for each share of the
Company's common stock outstanding on September 22, 1992.  The Rights are not
currently exercisable, but would become exercisable if certain triggering
events occur, such as the initiation of certain tender offers for the Company's
common stock.  If such an event occurs, each Right would initially entitle
shareholders to purchase one share of the Company's common stock at an exercise
price of $48 per share, subject to adjustment. In the event that the Rights are
exercised after  further  triggering  events, each Right would entitle holders
to purchase,

                                      F-15
<PAGE>
 
for the exercise price then in effect, shares of the Company's common stock (or
other property, under certain circumstances) having a value of twice the
exercise price.  Such Rights do not extend to any shareholders whose action
triggered the Rights.  The Company can in certain circumstances redeem the
Rights at $.005 per Right.  The Rights expire on September 22, 2002, unless
redeemed earlier by the Company.


Authorized Shares

At the annual meeting held in November, 1995, the shareholders approved an
increase in the number of authorized shares of 15,000,000 to a total of
30,000,000 shares.


Dividends

Dividend distributions made by Le Pli prior to the acquisition, were
principally for reimbursement of income tax liabilities of its former
stockholders due to Le Pli's S-Corporation tax status.  The Company currently
intends to retain future earnings for use in its business and, therefore, does
not expect to pay dividends in the foreseeable future.


9.  Income Taxes

The components of income before income taxes and the related provision for
income taxes consists of the following for fiscal 1997, 1996 and 1995 (in
thousands):
<TABLE>
<CAPTION>
 
                                                                         1997      1996      1995  
                                                                       --------  --------  ---------
<S>                                                                    <C>       <C>       <C>
Income (loss) before income taxes:
  Domestic                                                             $  (46)   $   698    $(2,291)
  Foreign                                                                 684      1,028      1,255
                                                                       --------  --------  ---------
                                                                       $  638    $ 1,726    $(1,036)
                                                                       ========  ========  =========
Provision for income taxes:
  Current provision:
    Federal                                                            $    -    $    75    $     -
    State                                                                  19         10          7
    Foreign                                                               381        396        493
                                                                       --------  --------  ---------
          Total provision for income taxes                             $  400    $   481    $   500
                                                                       ========  ========  =========
 
</TABLE>

                                      F-16
<PAGE>
 
The components of the Company's deferred tax assets consist of the following at
June 28, 1997 and June 29, 1996 (in thousands):
<TABLE>
<CAPTION>
 
                                                                                                          1997      1996
                                                                                                        -------   -------
<S>                                                                                                      <C>     <C>
Federal and state net operating loss carryforwards                                                      $   660   $ 1,029
Federal and state tax credit carryforwards                                                                1,630     1,632
Inventory valuation reserves                                                                                736       908
Warranty reserve                                                                                            498       314
Deferred revenue                                                                                            174       107
Intercompany profit                                                                                         335       330
Insurance reserve                                                                                             -        30
Other                                                                                                        80       217
                                                                                                         -------   -------
 
Net deferred tax assets before valuation allowance                                                        4,113     4,567
Valuation allowance against net deferred tax assets                                                      (4,113)   (4,567)
                                                                                                         -------   -------
 
Net deferred tax assets                                                                                  $    0    $    0
                                                                                                         =======   =======
 
A reconciliation from the federal statutory tax rate to the effective tax rate is as follows:
 
                                                                                                  1997     1996    1995
                                                                                                ------   ------  ------
 Statutory rate                                                                                     34%      34%    (34)%   
 State taxes                                                                                         3        1       -     
 Differences between foreign and                                                                                            
  U.S. tax rates                                                                                    21        5      31     
 Utilization of deferred tax assets                                                                  -      (15)    (26)    
 Unbenefitted losses                                                                                (2)       -      75     
 Other                                                                                               7        3       2     
                                                                                                ------   ------  ------
 Effective tax rate                                                                                 63%      28%     48%     
                                                                                                ======   ======  ======
</TABLE>
Actual income taxes paid were $492,000, $807,000 and $364,000 in fiscal 1997,
1996 and 1995, respectively.

At June 28, 1997, the Company had net operating loss carryforwards available
for federal income tax purposes of approximately $1,950,000 which expire from
2008 to 2011.  In addition, the Company has approximately $1,400,000 of credit
carryforwards for federal income tax purposes expiring at various dates through
2011.

Prior to its acquisition on June 27, 1996, Le Pli had elected to be treated as
an S-Corporation for income tax reporting purposes.  Under this election the
individual stockholders are deemed to have received a pro rata distribution of
taxable income whether or not such distribution was made.  Accordingly, Le Pli
did not provide for income taxes.  Le Pli's S-Corporation status was terminated
on the date of acquisition and therefore, the undistributed, previously taxed
earnings of $48,000 as of the date of acquisition has been reclassified to
additional paid-in capital.

                                      F-17
<PAGE>
 
10.  Segment, Geographic and Major Customer Information

The Company operates principally in two industry segments; the design,
manufacture sale and service of medical devices and related equipment, and the
performance of services in the skin care/health spa industry.

Geographic data

Geographic information for fiscal 1997, 1996 and 1995 is as follows (in
thousands):
<TABLE>
<CAPTION>
                                         1997       1996      1995
                                       ---------  --------  --------
<S>                                    <C>        <C>       <C>
Revenue:
   United States                        $25,185   $20,886   $20,376
   Intercompany                           6,303     6,043     4,537
                                        -------   -------   -------
                                         31,488    26,929    24,913
   Europe                                   818       296         -
   Japan                                  9,502     9,527     7,867
                                        -------   -------   -------
                                         41,808    36,456    32,780
   Elimination                           (6,303)   (6,043)   (4,537)
                                        -------   -------   -------
                                        $35,505   $30,413   $28,243
                                        =======   =======   =======
 
 Operating income(loss):
   United States                        $   (12)  $   833   $(2,472)
   Europe                                    86       (67)       (7)
   Japan                                    616     1,006       781
   Elimination                               (3)      117        95
                                        -------   -------   -------
                                          $ 687   $ 1,889   $(1,603)
                                        =======   =======   =======
Line of Business Data
 
Revenue
  Product sales and service             $33,262   $28,264   $26,466
  Skin care/health spa services           2,243     2,149     1,777
                                        -------   -------   -------
  Total Revenue                         $35,505   $30,413   $28,243
                                        =======   =======   =======
 
Operating income(loss)
  Product sales and service             $ 4,073   $ 2,583   $(1,638)
  Skin care/health spa services          (3,386)     (694)       35
                                        -------   -------   -------
  Total operating income(loss)          $   687   $ 1,889   $(1,603)
                                        =======   =======   =======
 
Geographic identification of assets
 United States                          $27,139   $17,135   $14,270
 Europe                                     852       532       468
 Japan                                    5,901     5,401     5,744
 Elimination                             (9,055)   (3,734)   (3,650)
                                        -------   -------   -------
                                        $24,837   $19,334   $16,832
                                        =======   =======   =======
</TABLE>

United States revenue includes export sales to unaffiliated companies located
principally in Western Europe, the Middle East, and in the Asia-Pacific region,
which approximated $ 8,188,000, $6,245,000 and $5,905,000 for fiscal 1997, 1996
and 1995, respectively.

                                      F-18
<PAGE>
 
11.  Employee Benefit Plans

The Company offers a savings plan which allows eligible U.S. employees to make
tax-deferred contributions, a portion of which are matched by the Company.
Company contributions vest ratably with three years of employment and amounted
to $84,000, $57,000 and $68,000 in fiscal 1997, 1996 and 1995, respectively.


                                      F-19
<PAGE>
 
                                  SCHEDULE II

                              CANDELA CORPORATION
                       VALUATION AND QUALIFYING ACCOUNTS
       For the years ended June 28, 1997, June 29, 1996 and July 1, 1995
<TABLE>
<CAPTION>
 
 
COLUMN A                                                                 COLUMN B   COLUMN C    COLUMN D    COLUMN E
                                                                        Balance at Additions  Deductions  Balance at
                                                                        Beginning  Charged to    from        End of
Description                                                             of Period    Income     Reserves     Period
                                                                        ----------  ---------  ----------  ----------
<S>                                                                     <C>         <C>        <C>         <C>
 
   Reserves deducted from assets to which they apply (in thousands):
 
   Allowance for doubtful accounts:
 
     Year ended June 28, 1997                                                 $305        $42        $150        $197
                                                                        ==========  =========  ==========  ==========
 
     Year ended June 29, 1996                                                 $361        $36        $ 92        $305
                                                                        ==========  =========  ==========  ==========
 
     Year ended July 1, 1995                                                  $445        $ -        $ 84        $361
                                                                        ==========  =========  ==========  ==========
 
</TABLE>



                                      F-20
<PAGE>
 
<TABLE>
<CAPTION>
EXHIBIT INDEX
<S>                                                                 <C>
 
Page
 
21    Subsidiaries of the Company                                       26
 
23    Consent of Independent Accountants
          (Coopers & Lybrand L.L.P.)                                    27
 
27    Financial Data Schedule                                           28
 
</TABLE>