**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

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

| **For the fiscal year ended July 1, 2006** |   | **Commission  file number 000-14742** |
|-------------------------------------------------|--------|---------------------------------------|

 

**CANDEL**A CORPORATION

(Exact name of registrantas specified in its charter)

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

 

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

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

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

**Common Stock, $.01 parvalue per share**

(Title of Class)

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x   No o

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o   No x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period than the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x   No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K. o

Indicateby check mark whether the registrant is an large accelerated filer, anaccelerated filer, or a non-accelerated filer (as defined in Rule12b-2 of the Exchange Act)

| Large accelerated filer o |   | Accelerated  filer x |   | Non-accelerated  filer o |
|--------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule12b-2 of the ExchangeAct) Yes o   No x

The aggregate market value of the registrant’s votingand non-voting stock, held by non-affiliates of the registrant as of September 11,2006, based upon the closing price of such stock on the NASDAQ Stock Market onthat date, was $10.43. As of September 11, 2006, 23,833,104 shares ofthe registrant’s common stock, $.01 par value, were issued and outstanding.

**DOCUMENTS INCORPORATED BYREFERENCE**

Part IIIincorporates by reference certain information from the 2006 definitive ProxyStatement.

 

----

**CANDELA CORPORATION2006 FORM 10-K ANNUAL REPORTTABLE OF CONTENTS**

|               | ** ** | ** **                                                                                                             | ** ** | **Begins on  Page** | ** ** |
|---------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
|          |       | PART I                                                                                                                 |       |                     |       |   |   |
| ITEM 1.       |       | BUSINESS                                                                                                               |       |                     | 3          |   |   |
| ITEM 1A.      |       | RISK FACTORS                                                                                                           |       |                     | 18         |   |   |
| ITEM 1B.      |       | UNRESOLVED STAFF COMMENTS                                                                                              |       |                     | 23         |   |   |
| ITEM 2.       |       | PROPERTIES                                                                                                             |       |                     | 23         |   |   |
| ITEM  3.      |       | LEGAL  PROCEEDINGS                                                                                                     |       |                     | 23         |   |   |
| ITEM 4.       |       | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                    |       |                     | 24         |   |   |
|          |       | PART II                                                                                                                |       |                     |       |   |   |
| ITEM 5.       |       | MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SERVICES |       |                     | 24         |   |   |
| ITEM 6.       |       | SELECTED CONSOLIDATED FINANCIAL DATA                                                                                   |       |                     | 25         |   |   |
| ITEM 7.       |       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                            |       |                     | 26         |   |   |
| ITEM 7A. |       | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                                            |       |                     | 34         |   |   |
| ITEM 8.       |       | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                            |       |                     | 36         |   |   |
| ITEM 9.       |       | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE                                  |       |                     | 63         |   |   |
| ITEM 9A.      |       | CONTROLS AND PROCEDURES                                                                                                |       |                     | 63         |   |   |
| ITEM 9B. |       | OTHER  INFORMATION                                                                                                     |       |                     | 64         |   |   |
|          |       | PART III                                                                                                               |       |                     |       |   |   |
| ITEM 10.      |       | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                                     |       |                     | 65         |   |   |
| ITEM 11.      |       | EXECUTIVE COMPENSATION                                                                                                 |       |                     | 65         |   |   |
| ITEM 12.      |       | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED SHAREHOLDER MATTERS                        |       |                     | 65         |   |   |
| ITEM 13.      |       | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                         |       |                     | 65         |   |   |
| ITEM 14.      |       | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                                 |       |                     | 65         |   |   |
|          |       | PART IV                                                                                                                |       |                     |       |   |   |
| ITEM 15.      |       | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                                             |       |                     | 67         |   |   |
| SIGNATURES    |       |                                                                                                                   | 70         |                     |       |

 

2

----

**Part I**

**Item 1.**                        Business.

**Introduction**

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

·       hairremoval

·       skinrejuvenation, skin tightening and wrinkles

·       vascularlesions such as rosacea, facial spider veins, leg veins, port wine stains andhemangiomas

·       scars,stretch marks and warts

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

·       acneand acne scars

·       psoriasis

·       othercosmetic skin treatments

Since our founding36 years ago, we have continuously developed and enhanced applications of laserand light-based technology. In the mid-1980’s we began developing lasertechnology for medical applications, and since that time have shippedapproximately 10,000 systems to over 70 countries. Since the early 1990’s wehave focused our organizational resources on developing laser technology foruse solely in the aesthetic and cosmetic laser and light-based industry.  Below is a sampling of Candela’s innovationsin the laser and light-based technologies market:

·       firstlaser system based on selective photothermolysis to treat cutaneous vascularlesions with minimal skin injury

·       firstvascular lesion treatment laser which FDA cleared for use on children

·       firstQ-switched alexandrite laser for pigmented lesions and tattoos

·       firsteffective pulsed dye laser treatment of hemangiomas, scars and warts

·       firstmulti-wavelength long-pulse dye laser for treatment of leg telangiectasia(spider veins)

·       firstlaser with a clearance for non-invasive treatment of acne and acne scars

·       firsthair removal laser with integrated Dynamic Cooling Device (DCD)

·       firstpulsed dye laser with Dynamic Cooling Device (DCD) for wrinkles

·       firstDynamic Cooling Device (DCD) for epidermal protection in vascular lesiontreatment

Candela’s currentproduct line offers comprehensive and technologically sophisticated aestheticand medical laser and light-based systems used by dermatologists, plasticsurgeons and various other medical and personal care practitioners. Candela’sproduct line includes the following innovative products:

·       TheGentleLASE® family of lasers provides speed, efficacy and ease-of-use inpermanent hair reduction, vascular lesions, wrinkle reduction and the treatmentof pigmented lesions

3

----

·       TheGentlYAG® family of lasers provides fast, effective permanent hair reductionfor every skin type including tanned or dark skin, treatment ofpseudofolliculitis barbae (PFB), leg and facial veins, and skin tightening

·       TheVbeam® pulsed dye laser for treatment of a wide variety of vascular lesions andcosmetic applications, including port wine stain birthmarks, facial redness,leg and facial veins, pigmented lesions and skin rejuvenation by wrinklereduction, scars, warts, psoriasis and hemangiomas

·       TheALEXLAZRTM Q-switched Alexandrite laser for removal of multi-colored tattoos andpigmented lesions

·       TheSmoothbeam® diode laser, for treatment of acne and acne scars and non-ablativedermal remodeling of wrinkles

·       TheEllipse Intense Pulsed Light system specifically designed for the improvementof sun-damaged skin by photo rejuvenation through removal of both vascular(redness) and dyspigmentation (brown spots)

The growth in the cosmetic and medical market usingaesthetic laser and light-based products growth is currently being driven by anincrease in discretionary income of aging baby boomers, which creates newopportunities for Candela. This market demographic places a premium on goodhealth and personal appearance, and has demonstrated a willingness to pay for healthand cosmetic products and services. In addition, the growing popularity oflaser and light-based treatments among the general population is also spurringdemand for Candela’s products. Last year, Americans spent an estimated $12.4billion on cosmetic procedures. In particular, lasers and light-based systemsare proving an attractive alternative for eliminating unwanted hair.

Candela is dedicated to developing safe and effectiveproducts. Our aesthetic laser and light-based systems are further distinguishedby being among the fastest, smallest and most affordable in their respectivemarkets. We believe that we have increasingly captured significant market sharebecause of these product attributes and we are committed to continualinnovation to meet the needs of our markets.

Candela was incorporatedin Massachusetts on October 22, 1970 and subsequently reincorporated inDelaware on July 1, 1985.

**Industry Overview**

Medical lasers andlight-based devices use the unique characteristics of light to achieve preciseand efficacious therapeutic effects, often in a non-invasive manner. Theprecise color, concentration, and controllability of different types of lightprovide for the delivery of a wide range of specialized treatments. Firstintroduced in the 1960’s, the use of lasers for medical applications grewrapidly in the 1990’s as technical advances made medical lasers more effectiveand reliable. Medical lasers and light-based devices today are used fornumerous types of procedures falling into four broad categories: ophthalmicsurgery, aesthetic and cosmetic procedures, general surgery, and dentalprocedures. Candela competes solely within the growing market for lasers andlight-based devices for performing aesthetic and cosmetic procedures including:

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

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

·       facialrejuvenation and skin tightening to reduce the appearance of fine lines and wrinkles

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

·       treatmentof acne and acne scars

4

----

·       treatmentof psoriasis

·       treatmentof Nevus of Ota and melasma

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

We believe theaesthetic and cosmetic laser industry is now in an era of broad-based growth. Themajor factors converging to drive this growth are:

·       medicalpractitioners desire to drive additional revenue into their practices due tothe increasing reduction in insurance reimbursement

·       thediscretionary income of aging baby boomers

·       theincreased general acceptance of aesthetic and cosmetic laser treatments

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

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

Managed care and reimbursement restrictions in theUnited States, and similar constraints outside the United States, such associalized medicine, are motivating practitioners to emphasize aesthetic andcosmetic procedures that are delivered on a private, fee-for-service basis. Whilecosmetic procedures were once the domain of plastic surgeons and dermatologists,reimbursement reductions coupled with the reliable revenue stream fromprivate-pay procedures have piqued the interest of other specialties, includinggeneral practitioners, family care practitioners, obstetricians andgynecologists, and general and vascular surgeons.

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

5

----

**Business Strategy**

Candela believesthat a convergence of price, performance and technology is occurring in theaesthetic and cosmetic laser industry, driving market expansion. We believe wehave the necessary infrastructure in place to capitalize on this expansion. Candela’sobjective is to continue to be the leading provider of aesthetic and cosmeticlasers and light-based devices by using its proprietary technology andexpertise in light and tissue interaction, as well as by developingmarket-oriented products that utilize related technologies. Our businessstrategy is focused on the following goals:

·       increasepenetration of our traditional customer base

·       expandbeyond our traditional customer base

·       reduceproduct costs

·       expandour direct domestic distribution channels

·       expandour international distribution channels

·       continueinvesting in research and development to develop new applications that areefficacious, cost-effective, reliable and easy to use and have a high return oninvestment for our customers

***IncreasePenetration of Our Traditional Customer Base.******  ***Our traditional customer baseconsists of dermatologists and plastic and cosmetic surgeons. We believe thatthe affordability of our products will enable us to penetrate further into thedermatologist, plastic and cosmetic surgeon markets. We believe thataffordability has been a major obstacle preventing non-traditionalpractitioners from purchasing a laser or light-based system. As competition forpatients among practitioner’s increases, those practitioners with aesthetic andcosmetic laser and light-based systems will be able to differentiatethemselves.

***Expand beyond ourtraditional customer base.******  ***Asreimbursement rates dropped over the past several years, many primary carephysicians (family and general practice, and obstetrics and gynecologyphysicians) have begun to seek new services to offer to their patients. Cosmeticlaser and light-based procedures represent an ideal new service that isappealing to their patients, and adds a new “cash-pay” revenue stream to theirpractice. Cosmetic laser and light-based procedures are safe and easy toperform. As more primary care physicians realize that these procedures are safeand easy to perform, awareness of cosmetic laser and light-based procedureswill continue to grow.

***Reduce ProductCosts.******  ***Weapply bottom-up engineering, focusing on each component to improve theperformance of each device while reducing its size, complexity, and cost. Webelieve our approach leads to devices with fewer parts and greatermanufacturing efficiency, resulting in lower production costs. This enables usto offer more reliable products at more affordable prices.

***Expand Our DirectDomestic Distribution Channels.******  ***North America presently isthe largest single geographic market for our products. We continue to upgrade ourUnited States direct and indirect sales forces to better address the needs ofour traditional core markets.

***Expand OurInternational Distribution Channels.******  ***Outside of the Unites States,we continue to strengthen our long-standing positions in Europe and Japan andare seeking to expand our markets in Asia Pacific and Latin America. Wecurrently have direct sales offices in Madrid, Lisbon, Rome, Frankfurt, Paris,Osaka, Fukuoka, Nagoya, Tokyo and direct representation in China. Over the pastyear we increased the number and improved the quality of our internationalindependent distributor channel.

***Continue Investing in Research & Development.******  ***We believe that continuedinvestment in research and development is necessary to maintain our position asleader in the aesthetic laser and light-based device market. Our research anddevelopment approach is to develop high quality, reliable, and affordableproducts that address our existing markets and also allow us to expand intolarger, growing markets. In 

6

----

support of thisapproach, our research and development staff works closely with our marketingand operations teams to identify new clinical applications that serve bothmarkets. We have numerous research and development arrangements with leadingphysicians, hospitals and academic laboratories in the United States andthroughout the world. In a parallel effort, our research and development andengineering teams continue to optimize our existing products by adding newtechnologies, increasing the speed of treatment and ease of use for ourcustomers as well as reduce the overall size of our products.

**The Market forAesthetic and Cosmetic Laser and Light-Based Systems**

Our traditional customer base for aesthetic andcosmetic devices consists of dermatologists and plastic and cosmetic surgeons. Inaddition, other practitioner groups are emerging as potential customers,including general and family practitioners, obstetricians, gynecologists, andgeneral and vascular surgeons. In the United States, according to the AmericanMedical Association and various professional societies, there are approximately10,000 dermatologists, 8,000 plastic and cosmetic surgeons and 11,000 ear, noseand throat specialists. Practitioners in other specialties that are beginningto buy aesthetic and cosmetic laser and light-based systems include 70,000general and family practitioners, 35,000 obstetricians and gynecologists, and28,000 general and vascular surgeons. In addition, the aesthetic and cosmeticlaser and light-based system market includes non-medical practitioners, notablyelectrologists, of which there are an estimated 6,000 in the United States.

The end markets for cosmetic procedures encompassbroad and growing patient groups, including aging “baby boomers” as well asyounger age groups. Baby boomers were approximately 80 million, representingapproximately 29% of the total United States population. This large populationgroup has exhibited a strong demand for aesthetic and cosmetic procedures. Webelieve that as the cost of treatments decreases and the popularity of cosmeticprocedures such as hair removal increases, the target market for theseprocedures will expand beyond the baby boomers to include a broad range ofwomen and men aged 17 to 65. Demographic factors similar to the United Statesunderlie the growth of the aesthetic and cosmetic market outside of the UnitedStates as well.

***Hair Removal.******  ***We believe that the greatmajority of the 108 million women over the age of 16 in the United Statesemploy one or more techniques for temporary hair removal from various parts ofthe body. Also, a growing number of men are removing hair by means other thantheir daily shaving routine. A number of techniques are used to pull hair fromthe follicle including waxing, depilatories, and tweezing. In the waxingprocess, a lotion, generally beeswax-based, is spread on the area to be treatedand is then rapidly peeled off, pulling out the entrapped hairs. Depilatoriesemploy rotating spring coils or slotted rubber rolls to trap and pull out thehairs. Tweezing involves removing individual hairs with a pair of tweezers. Pullinghair from the follicle produces temporary results, but is often painful and maycause skin irritation. Depilatory creams, which contain chemicals to dissolvehair, frequently leave a temporary unpleasant odor and may also cause skinirritation. Shaving is the most widely used method of hair removal, especiallyfor legs and underarms but produces the shortest-term results. Hair bleaches donot remove hair, but instead lighten the color of hair so that it is lessvisible. A principal drawback of all of these methods is that they requirefrequent treatment.

Before the advent of laser and light-based hairremoval, electrolysis was the only method available for the long-term removalof body hair. Electrolysis is a process in which an electrologist inserts aneedle directly into a hair follicle and activates an electric current in theneedle, which disables the hair follicle. The tiny blood vessels in each hairfollicle are heated and coagulated, presumably cutting off the blood supply tothe hair matrix, or are destroyed by chemical action depending upon themodality used. The success rate for electrolysis is variable depending upon theskill of the electrologist and always requires a series of treatments. Electrolysisis time-consuming, expensive and sometimes painful. There is also some risk ofskin blemishes and a rising concern relating to needle infection. Becauseelectrolysis requires that each hair follicle be treated separately and canonly treat visible hair follicles, the treatment of an area as 

7

----

small as an upper lip mayrequire numerous visits at an aggregate cost of up to $1,000. The AmericanElectrology Association estimates that approximately one million people peryear undergo electrology procedures. Although we believe the large majority ofall electrolysis treatments are for facial hair, the neck, breasts and bikiniline are also treated. Because hair follicles are disabled one at a time,electrolysis is rarely used to remove hair from large areas such as the back,chest, abdomen, and legs.  We believelaser and light-based systems enable the practitioner to address a potentiallylarger market than electrolysis by treating a larger area of the body morequickly and with improved results.

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

·       significantlylonger term cosmetic improvement

·       treatmentof larger areas in each treatment session

·       lessdiscomfort during and immediately following procedures

·       reducedprocedure time and number of treatments

·       reducedrisk of scarring and infection

·       non-invasiveprocedures

***Vascular Lesions.******  ***Benign vascular lesions areabnormal, generally enlarged and sometimes proliferating blood vessels thatappear on the surface of the skin as splotches, dots, bulges, and spider shapesin a variety of colors ranging from red to purple. Different types of benignvascular lesions include the following:

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

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

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

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

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

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

·       stretchmarks and scars

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

***Skin Rejuvenation.******  ***Skin rejuvenation is one ofthe fastest growing segments of the aesthetic laser and light-based systemmarket. A significant percentage of the population suffers from fine lines andwrinkles or older looking skin as a result of the normal aging process. This isthe primary group of candidates for non-ablative laser and skin tighteningtreatments. While the market for skin rejuvenation is greatest in the UnitedStates, significant opportunities abound in international markets where thereis an aging 

8

----

demographic, such asJapan, or a high prevalence of photo-damaged skin, such as Australia and LatinAmerica.

***Acne.***   Patientshave expressed dissatisfaction with existing therapies for acne and acnescarring. These therapies include the following: drug therapy, dermabrasion, ablation,excision, chemical peeling and injections of filler materials. These therapieshave minimal efficacy, a significant side-effect profile, require long recoveryperiods and, in most cases, do not meet patient expectations. For many of thesepatients, laser treatment can represent a better treatment alternative. Lasertherapy can effectively target the sebaceous gland which is the root cause ofacne.

The majority of acne scar patients that seek treatmentdecide not to undertake a procedure due to the side-effects and socialdown-time. A more acceptable alternative for acne scar treatment is lasertherapy. In the treatment of acne scars, the laser initiates deposition of newcollagen to raise depressions in the skin, reducing the appearance of acne scars.Over a series of treatments, new collagen can fill in and soften the appearanceof acne scars.

***Psoriasis.***   TheNational Psoriasis Foundation estimates that psoriasis afflicts more than sevenmillion Americans and that between 150,000 and 260,000 new cases are diagnosedeach year.

**Candela’s Products**

We research,develop, manufacture, market, sell and service laser and light-based systemsused to perform procedures addressing patients’ aesthetic, medical and cosmeticconcerns. We offer a comprehensive range of products based on proprietarytechnologies. Our products focus on the major aesthetic and cosmetic laser andlight-based applications including:

·       hairremoval

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

·       treatmentof rosacea

·       removalof benign pigmented lesions such as age spots and tattoos

·       treatmentof scars and stretch marks

·       wrinklereduction

·       treatmentof acne and acne scars

·       treatmentof psoriasis

·       otherskin treatments

Our objective is to remain the leading provider ofaesthetic and cosmetic lasers by continually striving to develop smaller,faster, and less expensive devices. Candela has been, and continues to be, apioneer in the laser industry. From the start, our mission has been to lead theway in the development of innovative laser products which include:

***DynamicCooling Device.***   The Dynamic Cooling Device (“DCD”)selectively cools only the top layer of the skin, while leaving the targetedunderlying hair follicle, vein or other structure at normal temperature. As aresult, higher levels of laser energy can be delivered during treatment, whileminimizing thermal injury, pain, and the inconvenience associated withanesthetics. The design of the hand-held DCD enables the practitioner toclearly see the area being treated, and the combined efficiency of the lasersand DCD reduces the risks of over treatment. The DCD delivers just the rightamount of cooling quickly and consistently. Currently, DCD is available as anoption on several Candela laser systems.

9

----

***GentleLASE®Family.***   The GentleLASE® system is ahigh-energy, long-pulse solid-state laser that generates laser light in thenear infrared wavelength range. It is used for both hair removal pigmentedlesions and large (1mm or larger) leg and facial veins. The technology incorporatedin the GentleLASE® uses intense pulsed light energy directed through anAlexandrite rod, which achieves selective heating while keeping the temperatureof the skin below its damage threshold. The longer Alexandrite laser wavelengthenables the GentleLASE® to penetrate skin surfaces deeper than traditional Rubylasers, and the large spot size (18mm) is the industry’s largest. TheGentleLASE® was recently redesigned into a smaller, more transportableconfiguration and re-introduced with new advanced features including additionalspot sizes, longer delivery systems and faster repetition rates (Hz rates).

The other system comprising the GentleLASE® family oflasers is the GentleLASE Limited EditionTM, our most affordable hair removallaser. The GentleLASE LETM features fewer options than its namesake, includingfewer spot sizes and reduced fluences, but GentleLASE® performance advantages—speed,efficacy and ease—of-use—remain the same regardless of the configuration.

***GentleYAG®Family.***   The GentleYAG® system is ahigh-energy, long-pulse solid-state laser that is used to remove unwanted hairin all skin types, eliminate leg and facial veins and provide for skinrejuvenation, including wrinkle reduction and skin tightening. The technologyincorporated in the GentleYAG® uses intense pulsed light energy directedthrough an Nd:YAG (Neodymium: Yttrium Aluminum Garnet) rod, which targetsselected chromospheres to achieve localized heating while maintaining skintemperature below its damage threshold in conjunction with DCD epidermalcooling. Like the GentleLASE® laser, the GentleYAG® also supports an 18mm spotsize, the industry’s largest.

Other members of the GentleYAG® family of lasersinclude the GentleYAG® HR (for hair removal only), the GentleYAG® VR (for leg &facial veins) and the GentleYAG® SRT (for skin rejuvenation and tightening). Allof these models are upgradeable to provide additional treatment options.

***Vbeam®Family.***   The Vbeam® system delivers thesafety and efficacy of the clinically proven pulsed dye laser (PDL) whileminimizing the problematic side effects of postoperative bruising, commonlyreferred to as purpura. Each member of the Vbeam® family features Candela’spatented Dynamic Cooling Device that increases patient comfort while providingtargeted epidermal protection.

The Vbeam® Family has recently been upgraded tofeature a smaller, more streamlined design as well as an improved userinterface designed to accommodate the wide range of users in today’s market. Thenew design also features three individual, upgradeable models designed to meetthe needs of almost any growing practice. The Aesthetica is specificallydesigned for skin rejuvenation, the Platinum for vascular lesions, and thePerfecta, which treats a wide range of vascular lesions, as well as providingcomprehensive skin rejuvenation treatments. Additional indications treated bythe Vbeam® family include: facial spider veins, leg telangiectasias, hemangiomas,poikiloderma, rosacea, scars, warts, stretch marks, vulvodynia, acne, port winestains and other vascular abnormalities present in adults to infants.

***ALEXLAZRTMsystem.***   TheALEXLAZRTM system is a short-pulse solid-state laser, which emits near-infraredlight for the non-invasive removal of epidermal pigmentation such as sun spots,tattoo pigments and dermal pigmented lesions such as Nevus of Ota, a bluish colored,non-vascular, pigmented lesion, generally found among persons of Asian descent.The ALEXLAZRTM has a fiber optic delivery system that produces an even beamdistribution without hot spots. Its wavelength maximizes beam penetration,providing gentle treatments with effective results on deeper pigments and iseffective in the removal of most tattoo pigments.

***Smoothbeam®system.*****  **Introducedin March 2001, the Smoothbeam® diode laser heats collagen in the upperdermis, stimulating new collagen deposition for the improvement of wrinkles,sebaceous hyperplasia and acne scars. The system is small, easily portable andavailable in two unique colors to ideally complement the practice environment. TheSmoothbeam® laser employs laser light at 1450 nm to heat the 

10

----

dermis, sebaceous glands,and associated structures within the dermis in combination with Candela’spatented DCD cooling to cool and protect the epidermis. The thermal injuryalters the structure of the sebaceous glands, the root cause of acne lesions,resulting in more effective and longer-lasting acne clearance.

**EllipseTM Flex system.**   TheEllipseTM system is an intense pulsed light system that is designed to improvesun damage by photorejuvenation. Photorejuvenation treatment is one of the mostcommonly requested cosmetic treatments on the market today. The EllipseTM systemis designed to target both the vascular (redness) and pigmentation (brown) toimprove the overall appearance of the skin’s tone and color. The EllipseTMsystem is manufactured by Danish Dermatologic Development A/S (DDD), a Danishmanufacturer that specializes in the design and development of light basedsystems. Candela’s distribution agreement with DDD for the Ellipse system islimits Candela’s distribution territory to the United States.

**Sales andDistribution**

We market and sell our products worldwide. Separateregional executives in North America, Latin America, Japan, Asia, Europe andthe Middle East manage our marketing, selling and service activities through acombination of direct personnel and a network of independent distributors.

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

We sell products in the United States primarilythrough our direct sales force to our traditional customer base ofdermatologists and plastic and cosmetic surgeons. Candela’s products aredistributed to our non-traditional markets through an exclusive arrangementwith McKesson’s Medical Surgical Division. McKesson has 450 dedicated salesrepresentatives that showcase a wide range of products to family and generalpractice, and obstetrics and gynecology, physicians.

Outside the United States, we sell our products inEurope, Japan, Latin America, the Middle East, and Asia Pacific through directsales offices and distribution relationships. We have a total of 82 employeesin our direct sales offices in Madrid, Lisbon, Rome, Frankfurt, Paris, Tokyo,Nagoya, Fukuoka and Osaka. We also have established distribution relationshipsin China, Europe, Japan, Africa, Latin America, and the Middle East. Outsidethe United States, we are utilizing 52 distributors. Refer to Note 10 of ourConsolidated Financial Statements for additional financial information aboutsegments and geographical areas.

Thefollowing chart shows data relating to Candela’s international activitiesduring each of the last three fiscal years by geographic region. Revenuegenerated from regions other than the United States includes sales from ourGerman, Spanish, Italian, French, and Japanese subsidiaries, as well as salesshipped directly to international locations from the United States.

| ** **                | ** ** | **July 1,** | ** ** | **July 2,** | ** ** | **July 3,** | ** ** |
|---------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| **Revenues:**             | ** ** | ** **       | ** ** | **2006**         | ** ** | **2005**         | ** ** | **2004** | ** ** |
| **(in thousands)**   | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** |
| United States and  Canada |       | $                | 69,330     |             | $          | 57,517           |       | $ | 49,915 |   |
| Japan and Asia  Pacific   |       | 30,175           |       | 29,229           |       | 26,666           |       |
| Europe                    |       | 34,618           |       | 30,659           |       | 26,525           |       |
| Latin America             |       | 15,343           |       | 6,496            |       | 1,332            |       |
| Total Revenue             |       | $                | 149,466    |             | $          | 123,901          |       | $ | 104,438 |   |
|                           |            |                  |            |                  |            |                  |            |  |  |  |  |  |

 

11

----

**Service and Support**

Candela believes that quick and effective delivery ofservice is important to our customers. We strive to respond to service callswithin 24 hours and to complete a call within 48 hours to minimize practitionerdisruption. Our principal service center and parts depot is located at ourWayland, Massachusetts headquarters. Parts depots are also located at our salesoffices in Japan, Spain, Portugal, Italy, Germany and France. Independentdistributors also maintain parts depots.

We also believe a highly trained and qualified servicestaff is important to product reliability. Distributors and subsidiaries havethe primary responsibility of servicing systems within their territories. Theirservice personnel are required to attend formal training to become authorized.We provide service training in Asia, Europe and the United States. In addition,we have service and technical support staff in each of our markets worldwide.

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

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

**Manufacturing andRaw Materials**

We design,assemble, and test our branded products at our Wayland, Massachusetts facility.Ensuring adequate and flexible production capacity, applying lean manufacturingtechniques, continually reducing costs, and maintain superior product qualityare top priorities of our manufacturing organization. We achieve our goals by:

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

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

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

·       applyingthe latest cell manufacturing techniques

Our facility has ISO 13485 certification and hasestablished and is maintaining a quality system that meets the requirements ofISO 13485:2003 and CAN/CSA-ISO 13485. The ISO 13485 certification providesguidelines for the quality of company systems associated with the design,development, production, servicing and distribution of medical lasers andaccessories. ISO 13485 standards are European quality requirements andCAN/CSA-ISO 13485 is a Canadian quality requirement, all specifically relatingto the design of medical devices.

Our products are manufactured with standard componentsand subassemblies supplied by third party manufacturers to our specifications. Wepurchase certain components and subassemblies from a limited number of suppliers.

If our suppliers areunable to meet our requirements on a timely basis, our production could beinterrupted until we obtain an alternative source of supply. To date, we havenot experienced significant delays in obtaining dyes, optical and electro-opticalcomponents, electronic components, Alexandrite rods and other raw materials forour products. We believe that over time alternative component and subassemblymanufacturers and suppliers can be identified if our current third partymanufacturers and suppliers fail to fulfill our requirements.

12

----

**Research andDevelopment**

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

·       appliedlaser physics and technology

·       tissueoptics

·       photochemistry

·       light-tissueinteraction

·       clinicalresearch

·       aestheticlaser applications

·       engineeringand design of medical laser devices

·       collaborativeresearch with leading academic and medical institutions

As we discover new technologies or applications withcommercial potential, we assemble a team to develop the new product orapplication in cooperation with leading physicians and medical and researchinstitutions. In the United States in particular, we must receive United StatesFederal Drug Administration (“FDA”) clearance before marketing new products orapplications.

Our research and development team works with ouroperations group to design our products for ease of manufacturing and assemblyand with our marketing group to create and respond to market opportunities. Webelieve this interaction between functional groups facilitates the introductionof new products with the right balance of features, clinical benefits,performance, quality, and cost. To date our research and development effort hasrelied primarily on internal development building on our core technologiesrather than through acquisition.

In addition, Candela conducts joint research withphysicians affiliated with various medical and research institutions. Oneexample of technology developed through joint research is our Dynamic CoolingDevice was developed in conjunction with the Beckman Laser Institute at theUniversity of California, Irvine. We anticipate continuing joint research andlicensing arrangements with medical research institutions.

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

**Backlog**

We have not typicallymaintained a significant backlog. As a result, we do not believe that ourbacklog at any particular date is necessarily an accurate predictor of revenuefor any succeeding period.

**Customers**

Our sales are notdependent on any single customer or distributor, and we continue to expand ourdistribution channel worldwide through direct and indirect sales forces. Weexperience some seasonal reduction of our product sales in our first fiscalquarter due to the summer holiday schedule of physicians and their patients.

13

----

**Competition**

Competition in theaesthetic and cosmetic laser industry is intense and technological developmentsare expected to continue at a rapid pace. Although there are severalmanufacturers of aesthetic and cosmetic lasers, we believe Candela is one ofonly a few companies that offer a broad range of technologies and products ableto address multiple clinical applications. Unlike Candela, few of ourcompetitors focus exclusively on the cosmetic and aesthetic laser market andseveral rely on a single technology which can be limiting. We compete on thebasis of proprietary technology, product features, performance, service, price,and reputation. Some of our competitors have greater financial, marketing, andtechnical resources than we do. Moreover, some competitors have developed, andothers may attempt to develop, products with applications similar to ours. Webelieve that many factors will affect our competitive position in the future,including our ability to:

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

·       respondto competitive developments and technological changes

·       manufactureour products at lower cost

·       retaina highly qualified research and engineering staff

·       providesales and service to a worldwide customer base

·       maintain and improveproduct reliability

**Proprietary Rights**

We have numerous patents and have a number of patentapplications pending to protect our rights in certain technical aspects of ourhair removal, benign vascular lesion, pigmented lesion, and other laser systems.The expiration dates for our issued patents range from December 8, 2006 toDecember 6, 2019.

In addition to our portfolio of patents issued andpending, we license patented technology from third parties. We use our patentedDynamic Cooling Device (DCD) under a license agreement to patent rights ownedby the Regents of the University of California (“Regents”). In August 2000,we obtained exclusive license rights to the DCD (subject to certain limitedlicense rights of Cool Touch, Inc. (“Cool Touch”)) in the following fieldsof use:  procedures that involve skinresurfacing and rejuvenation, vascular skin lesions, and laser hair removal. CoolTouch obtained a license to the DCD on a co-exclusive basis with Candela, incertain narrower fields of use. Cool Touch is restricted in its ability toassign its license rights to certain existing competitors of Candela. Candelais entitled to one-half of all royalty income payable to the Regents from CoolTouch. Under the agreement, Candela no longer is required by the Regents tonegotiate sublicenses to third parties. However, Candela is entitled toone-half of all royalties due from any other entity that licenses the DCDtechnology from the Regents in other fields of use.

We rely primarily on a combination of patent,copyright, and trademark laws to establish and protect our proprietary rights. Wealso rely on trade secret laws, confidentiality procedures, and licensingarrangements to establish and protect our technology rights. In addition, weseek to protect our proprietary rights by using confidentiality agreements withemployees, consultants, advisors, and others. We cannot be certain that theseagreements will adequately protect our proprietary rights in the event of anyunauthorized use or disclosure, that our employees, consultants, advisors, orothers will maintain the confidentiality of such proprietary information, orthat our competitors will not otherwise learn about or independently developsuch proprietary information.

Despite our efforts to protect our intellectualproperty, unauthorized third parties may attempt to copy aspects of ourproducts, to violate our patents, or to obtain and use our proprietaryinformation. In addition, the laws of some foreign countries do not protect ourintellectual property to the same extent as 

14

----

do the laws of the UnitedStates  The loss of any material patent,trademark, trade name, trade secret, or copyright could hurt our business,results of operations, and financial condition.

We believe that ourproducts do not infringe the rights of third parties, although one party ispresently asserting that our products infringe their patents (see Item 3). However,we cannot be certain that third parties will not assert infringement claimsagainst us in the future or that any such assertion will not result in costlylitigation or require us to obtain a license to third party intellectualproperty. In addition, we cannot be certain that such licenses will beavailable on reasonable terms or at all, which could hurt our business, resultsof operations, and financial condition.

**GovernmentRegulation**

***FDA’s PremarketClearance and Approval (“PMA”) Requirements.******  ***Unless an exemption applies,each medical device that we wish to market in the U.S. must receive either “510(k) clearance”or PMA in advance from the FDA pursuant to the Federal Food, Drug, and CosmeticAct. The FDA’s 510(k) clearance process usually takes from three to twelvemonths, but it can last longer. The process of obtaining PMA approval is muchmore costly, lengthy, and uncertain and generally takes from one to three yearsor even longer. We cannot be sure that 510(k) clearance or PMA approvalwill ever be obtained for any product we propose to market.

The FDA decides whether a device must undergo eitherthe 510(k) clearance or PMA approval process based upon statutory criteria.These criteria include the level of risk that the agency perceives isassociated with the device and a determination whether the product is a type ofdevice that is similar to devices that are already legally marketed. Devicesdeemed to pose relatively less risk are placed in either class I or II, whichrequires the manufacturer to submit a pre-market notification requesting 510(k) clearance,unless an exemption applies. The pre-market notification must demonstrate thatthe proposed device is “substantially equivalent” in intended use and in safetyand effectiveness to a legally marketed “predicate device” that is either inclass I, class II, or is a “pre-amendment” class III device (i.e., one that wasin commercial distribution before May 28, 1976) for which the FDA has notyet decided to require PMA approval.

After a device receives 510(k) clearance, anymodification that could significantly affect its safety or effectiveness, orthat would constitute a major change in its intended use, requires a new 510(k) clearance.The FDA requires each manufacturer to make this determination in the firstinstance, but the FDA can review any such decision. If the FDA disagrees with amanufacturer’s decision not to seek a new 510(k) clearance, the agency mayretroactively require the manufacturer to submit a pre-market notificationrequiring 510(k) clearance. The FDA also can require the manufacturer tocease marketing and/or recall the modified device until 510(k) clearanceis obtained. We have modified some of our 510(k) cleared devices but havedetermined that, in our view, new 510(k) clearances are not required. Wecannot be certain that the FDA would agree with any of our decisions not toseek 510(k) clearance. If the FDA requires us to seek 510(k) clearancefor any modification, we also may be required to cease marketing and/or recallthe modified device until we obtain a new 510(k) clearance.

Devices deemed by the FDA to pose the greatest risksuch as life-sustaining, life-supporting, or implantable devices, or deemed notsubstantially equivalent to a legally marketed predicate device, are placed inclass III. Such devices are required to undergo the PMA approval process inwhich the manufacturer must prove the safety and effectiveness of the device tothe FDA’s satisfaction. A PMA application must provide extensive pre-clinicaland clinical trial data and also information about the device and itscomponents regarding, among other things, manufacturing, labeling, andpromotion. After approval of a PMA, a new PMA or PMA supplement is required inthe event of a modification to the device, it’s labeling, or its manufacturingprocess.

15

----

A clinical trial may be required in support of a 510(k) submissionor PMA application. Such trials generally require an Investigational DeviceExemption (“IDE”) application approved in advance by the FDA for a limitednumber of patients, unless the product is deemed a non-significant risk deviceeligible for more abbreviated IDE requirements. The IDE application must besupported by appropriate data, such as animal and laboratory testing results. Clinicaltrials may begin once the IDE application is approved by the FDA and theappropriate institutional review boards are at the clinical trial sites.

To date, the FDA has deemed our products to be classII devices eligible for the 510(k) clearance process. We believe that mostof our products in development will receive similar treatment. However, wecannot be certain that the FDA will not deem one or more of our future productsto be a class III device and impose the more burdensome PMA approval process.

***Pervasive andContinuing FDA Regulation.******  ***Ahost of regulatory requirements apply to marketed devices such as our laser andlight-based products, including labeling regulations, the Quality SystemRegulation (which requires manufacturers to follow design, testing, control,documentation, and other quality assurance procedures), the Medical DeviceReporting regulation (which requires that manufacturers report to the FDAcertain types of adverse events involving their products), and the FDA’sgeneral prohibition against promoting products for unapproved or “off label”uses. Our Class II devices can have special controls such as performancestandards, post-market surveillance, patient registries, and FDA guidelinesthat do not apply to class I devices. Unanticipated changes in existingregulatory requirements or adoption of new requirements could hurt ourbusiness, financial condition, and results of operations.

We are subject to inspection and market surveillanceby the FDA for compliance with regulatory requirements. If the FDA finds thatwe have failed to comply with applicable requirements, the agency can institutea wide variety of enforcement actions. The FDA sometimes issues a publicwarning letter but also may pursue more drastic remedies, such as refusing ourrequests for 510(k) clearance or PMA approval of new products, withdrawingproduct approvals already granted to us, requiring us to recall products, orasking a court to require us to pay civil penalties or criminal fines, adhereto operating restrictions, or close down our operations. Ultimately, criminalprosecution is available to the FDA as punishment for egregious offenses. AnyFDA enforcement action against us could hurt our business, financial condition,and results of operation.

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

***Foreign Regulation.******  ***International sales are subjectto foreign government regulation, the requirements of which vary substantiallyfrom country to country. The time required to obtain approval by a foreigncountry may be longer or shorter than that required for FDA approval, and therequirements may differ. Companies are now required to obtain the CE Mark priorto sale of certain medical devices within the European Union. During thisprocess, the sponsor must demonstrate compliance with ISO manufacturing andquality requirements.

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

16

----

**Product Liabilityand Warranties**

Our products are generally covered by a standardwarranty, with an option to purchase extended warranty contracts at the time ofproduct sale or service contracts after the time of sale. We maintain a reservebased on anticipated standard warranty claims. We believe such reserves to beadequate, but in the event of a major product problem or recall, such reservesmay be inadequate to cover all costs, and such an event could have a materialadverse effect on our business, financial condition, and results of operations.

Our business involves theinherent risk of product liability claims. We believe that we maintainappropriate product liability insurance with respect to our products. We cannotbe certain that with respect to our current or future products, such insurancecoverage will continue to be available on terms acceptable to us or that suchcoverage will be adequate for liabilities that may actually be incurred.

**The Skin CareCenters**

In 1996, we began aneffort to own and operate skin care centers offering cosmetic laser treatmentsutilizing our equipment along with other cosmetic services traditionallyoffered by high-end spas. We pursued this strategy by purchasing a spa inBoston, Massachusetts in 1996, and opening a new facility in Scottsdale,Arizona in 1997. We subsequently decided to discontinue our skin care centerefforts. We closed our Scottsdale facility in 1997 and the Boston facility in2003.

**Applied Optronics**

In 2003, Candela acquiredsubstantially all of the assets of Applied Optronics, the diode division ofSchwartz Electro-Optics, Inc. Applied Optronics was a leading manufacturerof high-powered, pulsed and CW diode lasers, and was a component supplier tothe OEM market that serves a variety of industries including the military,medical, industrial, research and robotics fields. Applied Optronics was thelead supplier of the diodes for our Smoothbeam**®**diode laser system. The Applied Optronics operation, located in SouthPlainfield, New Jersey, generates revenue from diode sales to third-partycustomers.

**Employees**

As of July 1, 2006,we employed 334 employees, 252 in the United States and 82 internationally.None of our employees are subject to collective bargaining agreements.

**AvailableInformation**

Access to our AnnualReport on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and amendments to these reports filedwith or furnished to the Securities and Exchange Commission may be obtainedthrough the Investor Relations section of our website atwww.candelalaser.com/ir_corp.asp as soon as reasonably practical after weelectronically file or furnish these reports. We do not charge for access toand viewing of these reports. Information on our Investor Relations page andon our website is not part of this Annual Report on Form 10-K or anyof our other securities filings unless specifically incorporated herein byreference. In addition, our filings with the Securities and Exchange Commissionmay be accessed through the Securities and Exchange Commission’s ElectronicData Gathering, Analysis and Retrieval system at www.sec.gov. All statementsmade in any of our securities filings, including all forward-looking statementsor information, are made as of the date of the document in which the statementis included, and we do not assume or undertake any obligation to update any ofthose statements or documents unless we are required to do so by law.

17

----

**Forward-lookingand Cautionary Statements**

Certain statements contained in this Annual Report mayconstitute “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995 (“Reform Act”). We may also makeforward-looking statements in other reports filed with the Securities andExchange Commission, in materials delivered to stockholders and in pressreleases. In addition, Candela’s representatives may from time to time makeoral forward-looking statements. Forward-looking statements provide currentexpectations of future events based on certain assumptions and include anystatement that does not directly relate to any historical or current fact.Words such as “anticipates,” “believes,” “expects,” “estimates,” “intends,”“plans,” “projects,” and similar expressions, may identify such forward-lookingstatements. Such forward looking statements include but are not limited to:that we have the necessary infrastructure in place to capitalize on expansion;the affordability of our products will allow for expansion; that we can lowerproduction costs; or that the market will expand beyond baby boomers. Candelaassumes no obligation to update or revise any forward-looking statements. Inaccordance with the Reform Act, set forth under Item 1A “Risk Factors”,are cautionary statements that accompany those forward-looking statements.Readers should carefully review such cautionary statements as they identifycertain important factors that could cause actual results to differ materiallyfrom those in the forward-looking statements and from historical trends. Thosecautionary statements are not exclusive and are in addition to other factorsdiscussed elsewhere in this Annual Report, in Candela’s filings with theSecurities and Exchange Commission, or in materials incorporated therein byreference.

**Item 1A.**                RiskFactors.

The following importantfactors, among others, could cause our actual operating results to differmaterially from those indicated or suggested by forward-looking statements madein this Form 10-K or presented elsewhere by management from time totime.

***Unfavorable results in our intellectual propertylitigation with Palomar Medical Technologies may result in significant declineto our stock price.***

On August 9, 2006, one of our competitors,Palomar Medical Technologies (“Palomar”), alleged that the manufacture, use andsale of our products for laser hair removal infringe a certain United Statespatent. Public announcements concerning this litigation that are unfavorable tous may result in significant declines in our stock price. An adverse ruling orjudgment in this matter could cause our stock price to decline significantly.

Litigation with Palomar will be expensive andprotracted, and our intellectual property position may be weakened as a resultof an adverse ruling or judgment. Whether or not we are successful in thepending lawsuits, litigation consumes substantial amounts of our financial resourcesand diverts management’s attention away from our core business. See Item 3—“LegalProceedings.”

***Because we derivemore than half of our revenue from international sales, including approximately20% of our revenue from Japan and the Asia-Pacific marketplace in fiscal 2006,we are susceptible to currency fluctuations, negative economic changes takingplace in Japan and the Asia-Pacific marketplace, and other risks associatedwith conducting business overseas***.

We sell more thanhalf of our products and services outside the United States. Internationalsales, consisting of sales from our subsidiaries in Germany, Spain, Italy,France and Japan, and sales shipped directly to international locations fromthe United States, accounted for 56% of our revenue for fiscal year 2006, andwe expect that they will continue to be significant. As a result, a major partof our revenues and operating results could be adversely affected by risksassociated with international sales. In particular, significant fluctuations inthe exchange rates between the United States dollar and foreign currenciescould cause us to lower our prices and thus reduce our profitability, or couldcause prospective customers to push 

18

----

outorders to later dates because of the increased relative cost of our products inthe aftermath of a currency devaluation or currency fluctuation. Other risksassociated with international sales that we currently face or have faced in thepast include:

·       longerpayment cycles common in foreign markets

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

·       difficultiesin staffing and managing our foreign operations

***The failure toobtain Alexandrite rods for the GentleLASE® system from our sole supplier wouldimpair our ability to manufacture and sell the GentleLASE® system.***

We use Alexandrite rods to manufacture the GentleLASE***®*** system, whichaccounts for a significant portion of our total revenues. We depend exclusivelyon our contract manufacturer to supply these rods, for which no alternativesupplier meeting our quality standards exists. We cannot be certain that ourcontract manufacturer will be able to meet our future requirements at currentprices or at all. To date, we have been able to obtain adequate supplies ofAlexandrite rods in a timely manner, but any extended interruption in oursupplies could hurt our results.

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

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

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

***Market supply and demand***

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

·       potentialdecrease in demand for our products

·       possible delays in marketacceptance of our new products

***Customer behavior***

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

·       changes in the timing ofproduct sales in anticipation of new product introductions or enhancements byus or our competitors

***Company operations***

·       absenceof significant product backlogs

·       oureffectiveness in our manufacturing process

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

·       timingof any acquisitions and related costs

19

----

***Our failure torespond to rapid changes in technology and intense competition in the laserindustry could make our lasers obsolete.***

The aesthetic and cosmetic laser equipment industry issubject to rapid and substantial technological development and productinnovations. To be successful, we must be responsive to new developments inlaser technology and new applications of existing technology. Our financialcondition and operating results could be hurt if our products fail to competefavorably in response to such technological developments, or we are not agilein responding to competitors’ new product introductions or product pricereductions. In addition, we compete against numerous companies offering productssimilar to ours, some of which have greater financial, marketing, and technicalresources than we do. We cannot be sure that we will be able to competesuccessfully with these companies and our failure to do so could hurt ourbusiness, financial condition, and results of operations.

***Like othercompanies in our industry, we are subject to a regulatory review process andour failure to receive necessary government clearances or approvals couldaffect our ability to sell our products and remain competitive.***

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

Many foreign countries in which we market or maymarket our products have regulatory bodies and restrictions similar to those ofthe FDA. We cannot be certain that we will be able to obtain (or continue toobtain) any such government approvals or successfully comply with any suchforeign regulations in a timely and cost-effective manner, if at all, and ourfailure to do so could adversely affect our ability to sell our products.

***We have modifiedsome of our products without FDA clearance. The FDA could retroactively decidethe modifications were improper and require us to cease marketing and/or recallthe modified products.***

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

***Achieving completecompliance with FDA regulations is difficult, and if we fail to comply, wecould be subject to FDA enforcement action.***

We are subject toinspection and market surveillance by the FDA to determine compliance withregulatory requirements. The FDA’s regulatory scheme is complex, especially theQuality System Regulation (“QSR”), which requires manufacturers to followelaborate design, testing, control, documentation, and other quality assuranceprocedures. This complexity makes complete compliance difficult to achieve. Also,the determination as to whether a QSR violation has occurred is oftensubjective. If the FDA finds that we have failed to comply with the QSR orother applicable requirements, the agency 

20

----

caninstitute a wide variety of enforcement actions, including a public warningletter or other stronger remedies, such as:

·       fines,injunctions, and civil penalties against us

·       recallor seizure of our products

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

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

·       withdrawingproduct approvals already granted

·       criminalprosecution

***Claims by othersthat our products infringe their patents or other intellectual property rightscould prevent us from manufacturing and selling some of our products or requireus to incur substantial costs from litigation or development of non-infringingtechnology.***

Our industry hasbeen characterized by frequent litigation regarding patent and otherintellectual property rights. Patent applications are maintained in secrecy inthe United States until such patents are issued and are maintained in secrecyfor a period of time outside the United States. Accordingly, we can conductonly limited searches to determine whether our technology infringes any patentsor patent applications of others. Any claims of patent infringement would betime-consuming and could:

·       resultin costly litigation

·       divertour technical and management personnel

·       causeproduct shipment delays

·       requireus to develop non-infringing technology

·       requireus to enter into royalty or licensing agreements

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

***We could incursubstantial costs as a result of product liability claims.***

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

21

----

***We may be unable toattract and retain management and other personnel we need to succeed.***

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

***Our failure tomanage future acquisitions and joint ventures effectively may divert managementattention from our core business and cause us to incur additional debt,liabilities or costs.***

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

·       identifyappropriate acquisition or joint venture candidates

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

·       successfullymanage any joint ventures or collaborations

Furthermore, the integration of any acquisition orjoint venture may divert management time and resources. If we fail to managethese acquisitions or joint ventures effectively, we may incur debts or otherliabilities or costs that could harm our operating results or financialcondition. While we from time to time evaluate potential acquisitions ofbusinesses, products, and technologies, consider joint ventures and othercollaborative projects, and anticipate continuing to make these evaluations, wehave no present understandings, commitments, or agreements with respect to anyacquisitions or joint ventures.

***We face risks associated with product warranties.***

We could incur substantial costs as a result ofproduct failures for which we are responsible under warranty obligations.

***The expense andpotential unavailability of insurance coverage for our customers couldadversely affect our ability to sell our products and negatively impact ourfinancial condition.***

Some of our customers and prospective customers havehad difficulty in procuring or maintaining liability insurance to cover theiroperation and use of our products. Medical malpractice carriers are withdrawingcoverage in certain states or substantially increasing premiums. If this trendcontinues or worsens, our customers may discontinue using our products and, industry-wide,potential customers may opt against purchasing laser and other light-basedproducts due to the cost of or inability to procure insurance coverage.

***Failure to maintaineffective internal control over financial reporting could have a material adverseeffect on our business, operating results and stock price.***

Section 404 of the Sarbanes-Oxley Act of 2002requires us to include a report by our management on our internal control overfinancial reporting. Such report must contain an assessment by management ofthe effectiveness of our internal control over financial reporting as of theend of our fiscal year and a statement as to whether or not such internalcontrol is effective. Such report must also contain a statement that ourindependent registered public accounting firm has issued an attestation reporton management’s assessment of such internal control.

Effective internal controls are necessary for us toprovide reasonable assurance with respect to our financial reports and toeffectively prevent fraud. If we cannot provide reasonable assurance withrespect to our financial reports and effectively prevent fraud, our brand andoperating results could be harmed. Internal control over financial reportingmay not prevent or detect misstatements because of its inherent limitations,including the possibility of human error, the circumvention or overriding ofcontrols, or fraud. 

22

----

Therefore, even effectiveinternal controls cannot provide absolute assurance with respect to thepreparation and fair presentation of financial statements. In addition,projections of any evaluation of effectiveness of internal control overfinancial reporting to future periods are subject to the risk that the controlmay become inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate. If we fail tomaintain the adequacy of its internal controls, including any failure toimplement required new or improved controls, or if we experience difficulties intheir implementation, our business and operating results could be harmed, andwe could fail to meet our reporting obligations, which could have a materialadverse effect on our business.

Our efforts to comply withSection 404 have resulted in, and are likely to continue to result in,significant costs, the commitment of time and operational resources and thediversion of management’s attention.

**Item 1B.**               UnresolvedStaff Comments.

Not applicable.

**Item 2.**                        Properties.

We lease two facilities totaling approximately 38,000square feet for our operations in Wayland, Massachusetts, which is locatedapproximately 20 miles west of Boston. The leases on these facilities expire March 2008.We also lease a 12,000 square foot facility in South Plainfield, New Jersey forour diode operation. This lease ends on October 31, 2008. Candela’smanagement believes that its current facilities are suitable and adequate forour near-term needs.

Candela’ssubsidiaries currently lease the following facilities:

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

·       CandelaKK.—We lease 4 offices in Japan in Tokyo, Osaka, Nagoya, and Fukuoka. Theseleases expire between September 16, 2006 and May 23, 2008.

·       CandelaIberica, S.A.. We lease two locations in Lisbon, Portugal and Madrid, Spain. Theseleases expire on September 29, 2008 and December 31, 2006,respectively.

·       CandelaDeutschland GmbH. The lease on this facility in Neu Isenberg, Germany expireson October 31, 2006.

·       CandelaFrance SARL. The lease on this facility in Villebou Sur Yvette, France expireson May 1, 2011.

·       Candela Italia. The leaseon this facility in Formello, Italy expires on June 30, 2007.

**Item 3.**                        LegalProceedings.

On August 9, 2006, Palomar Medical Technologies, Inc.(“Palomar”) filed suit against Candela in the United States District Court forthe District of Massachusetts, asserting infringement by Candela ofU.S. Patent No. 5,735,844. On August 10, 2006, we filed suit againstPalomar in the United States District Court for the District of Massachusetts,asserting infringement by Palomar of U.S. Patent Nos. 6,659,999,5,312,395, and 6,743,222. Palomar served its complaint and summons onCandela on August 15, 2006. Candela served its complaint and summonson Palomar on August 10, 2006. Candela believes that it hasmeritorious defenses against Palomar’s allegations in its complaint. Bothparties seek to recover compensatory and treble damages, as well as attorneys’ feesand an injunction against the other party. 

23

----

While Candela intends tovigorously contest Palomar’s allegations, and to pursue its ownclaims against Palomar, each lawsuit is inherently uncertain andunpredictable as to its ultimate outcome. An adverse outcomein Palomar’s case against could materially hurt our business,financial condition, results of operations and cash flows.

From time to time, Candelais party to various legal proceedings incidental to its business. Candelabelieves that none of the legal proceedings, other than Palomar, that arepresently pending, if adversely decided against us, will have a materialadverse effect upon its financial position, results of operations, orliquidity.

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

Not applicable.

**PART II**

**Item 5.**                        Marketfor the Registrant’s Common Stock and Related Stockholder Matters and Issuer Purchases of EquitySecurities.

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

At September 11, 2006, there were approximately314 holders of record of our common stock and the closing sale price of ourcommon stock was $10.43.

Thefollowing table sets forth quarterly high and low closing sales prices of thecommon stock for the indicated fiscal periods:

| ** **       | ** ** | **High**   | ** ** | **Low**    | ** ** |
|------------------|------------|------------|------------|------------|------------|
| **Fiscal 2005**  | ** ** | ** ** | ** ** | ** ** | ** ** |
| First Quarter    |       | $          | 12.52      |       | $          | 7.85 |   |
| Second Quarter   |       | 12.08      |       | 7.96       |       |
| Third Quarter    |       | 12.58      |       | 8.35       |       |
| Fourth Quarter   |       | 10.99      |       | 8.56       |       |
| **Fiscal  2006** | ** ** | ** ** | ** ** | ** ** | ** ** |
| First Quarter    |       | $          | 11.62      |       | $          | 9.50 |   |
| Second Quarter   |       | 15.47      |       | 8.99       |       |
| Third Quarter    |       | 22.81      |       | 14.35      |       |
| Fourth Quarter   |       | 24.08      |       | 14.10      |       |

 

**Dividend Policy**

We have never paid a cashdividend and have no present intention to pay cash dividends in the foreseeablefuture. We intend to retain any future earnings for use in our business.

**SecuritiesAuthorized for Issuance under Equity Compensation Plans**

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

24

----

**Item 6.**                        SelectedConsolidated Financial Data.

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

| ** **                                                                                                                                                                                                      | ** ** | **For the Year Ended**                              | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **Consolidated Statement of Operations Data:**                                                                                                                                              | ** ** | ** **                                                         | ** ** | **July 1,  2006** | ** ** | **July 2,  2005** | ** ** | **July 3,  2004** | ** ** | **June 28,  2003** | ** ** | **June 29,  2002** | ** ** |
| ** **                                                                                                                                                                                                      | ** ** | **(in thousands, except per share data)** | ** ** |
| **Revenue:**                                                                                                                                                                                                    | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other  products                                                                                                                                                                                      |       | $                                                                  | 121,838    |   | $ | 102,323 |   | $ | 87,965 |   | $ | 68,072 |   | $ | 45,957 |   |
| Product-related  service                                                                                                                                                                                        |       | 27,628                                                             |       | 21,578 |   | 16,473 |   | 10,579 |   | 12,731 |   |
| Total revenue                                                                                                                                                                                                   |       | 149,466                                                            |       | 123,901 |   | 104,438 |   | 78,651 |   | 58,688 |   |
| **Cost of sales:**                                                                                                                                                                                              | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other  products                                                                                                                                                                                      |       | 54,748                                                             |       | 45,235 |   | 36,413 |   | 30,641 |   | 20,396 |   |
| Product related  service                                                                                                                                                                                        |       | 20,869                                                             |       | 17,918 |   | 14,860 |   | 7,992 |   | 11,205 |   |
| Litigation related  charges                                                                                                                                                                                     |       | —                                                             |       | 4,829 |   | — |   | — |   | — |   |
| Total cost of  sales                                                                                                                                                                                            |       | 75,617                                                             |       | 67,982 |   | 51,273 |   | 38,633 |   | 31,601 |   |
| **Gross  profit:**                                                                                                                                                                                              |       | 73,849                                                             |       | 55,919 |   | 53,165 |   | 40,018 |   | 27,087 |   |
| **Operating expenses:**                                                                                                                                                                                         | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general  and administrative                                                                                                                                                                            |       | 44,297                                                             |       | 40,165 |   | 33,978 |   | 24,519 |   | 24,832 |   |
| Research and  development                                                                                                                                                                                       |       | 8,879                                                              |       | 6,890 |   | 5,302 |   | 4,545 |   | 4,644 |   |
| Litigation related  charges                                                                                                                                                                                     |       | —                                                             |       | 773 |   | — |   | — |   | — |   |
| Total operating  expenses                                                                                                                                                                                       |       | 53,176                                                             |       | 47,828 |   | 39,280 |   | 29,064 |   | 29,476 |   |
| **Income  (loss) from operations:**                                                                                                                                                                             |       | 20,673                                                             |       | 8,091 |   | 13,885 |   | 10,954 |   | (2,389 | ) |
| **Other income (expense):**                                                                                                                                                                                     | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                                                                                                                                                                                                 |       | 1,748                                                              |       | 640 |   | 308 |   | 651 |   | 546 |   |
| Other income  (expense), net                                                                                                                                                                                    |       | (19                                                                | )          | (73 | ) | 905 |   | (262 | ) | 11 |   |
| Total other income                                                                                                                                                                                              |       | 1,729                                                              |       | 567 |   | 1,213 |   | 389 |   | 557 |   |
| **Income  (loss) from continuing operations before income tax:**                                                                                                                                                |       | 22,402                                                             |       | 8,658 |   | 15,098 |   | 11,343 |   | (1,832 | ) |
| **Provision  for (benefit from) income taxes**                                                                                                                                                                  |       | 7,468                                                              |       | 2,194 |   | 4,586 |   | 3,516 |   | (421 | ) |
| **Income  (loss) from continuing operations**                                                                                                                                                                   |       | 14,934                                                             |       | 6,464 |   | 10,512 |   | 7,827 |   | (1,411 | ) |
| **Discontinued operations:**                                                                                                                                                                                    | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loss from  discontinued skin care center operations of $473, $1468, and $964, and less  income tax benefit of $175, $455, and $221, and respectively                                                            |       | —                                                             |       | — |   | (298 | ) | (1,013 | ) | (743 | ) |
| Gain (loss) on  disposal of skin care center, including revision of leasehold obligations of  $1,374 and provision for operating losses of $(3,348) less income tax of  $(515) and income tax benefit of $1,253 |       | —                                                             |       | 859 |   | (2,095 | ) | — |   | — |   |
| **Net  income (loss)**                                                                                                                                                                                          |       | $                                                                  | 14,934     |   | $ | 7,323 |   | $ | 8,119 |   | $ | 6,814 |   | $ | (2,154 | ) |
| **Net income (loss) per share of  common stock**                                                                                                                                                                | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic:**                                                                                                                                                                                                      | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income (loss) from  continuing operations                                                                                                                                                                       |       | $                                                                  | 0.65       |   | $ | 0.29 |   | $ | 0.48 |   | $ | 0.39 |   | (0.07 | ) |
| Income (loss) from  discontinued operations                                                                                                                                                                     |       | —                                                             |       | 0.04 |   | (0.11 | ) | (0.05 | ) | (0.04 | ) |
| **Net  income (loss)**                                                                                                                                                                                          |       | $                                                                  | 0.65       |   | $ | 0.33 |   | $ | 0.37 |   | $ | 0.34 |   | $ | (0.11 | ) |
| **Diluted:**                                                                                                                                                                                                    | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income (loss) from  continuing operations                                                                                                                                                                       |       | $                                                                  | 0.62       |   | $ | 0.28 |   | $ | 0.46 |   | $ | 0.38 |   | (0.07 | ) |
| Income (loss) from  discontinued operations                                                                                                                                                                     |       | —                                                             |       | 0.04 |   | (0.10 | ) | (0.05 | ) | (0.04 | ) |
| **Net  income (loss)**                                                                                                                                                                                          |       | $                                                                  | 0.62       |   | $ | 0.32 |   | $ | 0.36 |   | $ | 0.33 |   | $ | (0.11 | ) |
| **Basic  weighted average shares outstanding**                                                                                                                                                                  |       | 23,017                                                             |       | 22,388 |   | 21,902 |   | 20,083 |   | 20,106 |   |
| **Diluted  weighted average shares outstanding**                                                                                                                                                                |       | 23,948                                                             |       | 23,073 |   | 22,712 |   | 20,645 |   | 20,106 |   |
|                                                                                                                                                                                                                 |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

25

----

 

| ** **                                          | ** ** | **For the Year Ended** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------|------------|
| **Consolidated Balance Sheet Data:** | ** ** | ** **                            | ** ** | **July 1,  2006** | ** ** | **July 2,  2005** | ** ** | **July 3,  2004** | ** ** | **June 28,  2003** | ** ** | **June 29,  2002** | ** ** |
| **Cash,  restricted cash, and cash equivalents**    |       | $                                     | 40,360     |   | $ | 56,383 |   | $ | 37,139 |   | $ | 31,813 |   | $ | 19,657 |   |
| **Marketable  securities**                          |       | 27,332                                |       | — |   | — |   | — |   | — |   |
| **Marketable  securities (long-term portion)**      |       | 11,953                                |       | — |   | — |   | — |   | — |   |
| **Working  capital**                                |       | 78,582                                |       | 70,378 |   | 61,387 |   | 47,307 |   | 35,642 |   |
| **Total  assets**                                   |       | 149,176                               |       | 116,816 |   | 100,479 |   | 80,501 |   | 67,130 |   |
| **Long-term  debt**                                 |       | —                                |       | — |   | — |   | — |   | 2,115 |   |
| **Total stockholders’ equity**                 |       | 100,012                               |       | 74,339 |   | 66,769 |   | 53,348 |   | 40,853 |   |
|                                                     |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

*All statements, trend analysis and other informationcontained in the following discussion relative to markets for our products andtrends in revenue, gross margins and anticipated expense levels, as well as otherstatements including words such as “anticipate”, “believe”, “plan”, “estimate”,“expect”, and “intend” and other similar expressions, constituteforward-looking statements. These forward-looking statements are subject tobusiness and economic risks and uncertainties, and our actual results ofoperations may differ materially from those contained in the forward-lookingstatements. Factors that could cause or contribute to such differences include,but are not limited to, those discussed in Item1A. “Risk Factors” as well asother risks and uncertainties referenced in this Annual Report on Form 10-K.*

**Critical AccountingPolicies**

The discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. On an on-going basis, we evaluate ourestimates, including those related to revenue recognition, bad debts,inventories, warranty obligations, stock-based compensation and income taxes.We base our estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying value of assetsand liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions. We believe the following critical accounting policies and therelated judgments and estimates affect the preparation of our consolidatedfinancial statements.

**RevenueRecognition.**   We generally recognize revenue uponshipment of product to customers and the fulfillment of all contractual termsand conditions, pursuant to the guidance provided by SAB No. 104, *Revenue Recognition in Financial Statements*. Credit is notextended to customers and revenue is not recognized until collectibility isreasonably assured. Revenue from the sale of service contracts is deferred andrecognized on a straight-line basis over the contract period. Revenue fromservice administered by us that is not covered by a service contract isrecognized as the services are provided. In certain instances, we may sellproducts together with extended warranties or maintenance contracts. Therevenue recognized per element is determined by allocating the total sales priceto each element, based on the relative fair values in accordance with EmergingIssues Task Force (EITF) 00-21, “Revenue Arrangements with MultipleDeliverables”.  Separately pricedextended warranty and maintenance products are accounted for over the life ofthe contract. Unearned revenue is reported on the balance sheet as deferredrevenue.

**Allowancefor Doubtful Accounts.**   Our policy is to maintainallowances for estimated losses resulting from the inability of our customersto make required payments. Credit limits are established through a process ofreviewing the financial history and stability of each customer. Where appropriate,we obtain 

26

----

credit rating reports andfinancial statements of customers when determining or modifying their creditlimits. We regularly evaluate the collectibility of our trade receivablebalances based on a combination of factors. When a customer’s account balancebecomes past due, we initiate dialogue with the customer to determine thecause. If it is determined that the customer will be unable to meet itsfinancial obligation to us, such as in the case of a bankruptcy filing,deterioration in the customer’s operating results or financial position orother material events impacting their business, we record a specific allowanceto reduce the related receivable to the amount we expect to recover given allinformation presently available. We will also provide a general reserve basedon the aging of the accounts and notes receivable based on historicalexperiences of write-offs.

As of July 1, 2006, our accounts receivablebalance of $34.3 million is reported net of allowances for doubtful accounts of$1.8 million. We believe our reported allowances at July 1, 2006, areadequate. If the financial conditions of those customers were to deteriorate,however, resulting in their inability to make payments, we may need to recordadditional allowances that would result in additional selling, general andadministrative expenses being recorded for the period in which suchdetermination was made.

**InventoryReserves.**   As a designer and manufacturer of hightechnology equipment, we are exposed to a number of economic and industryfactors that could result in portions of our inventory becoming either obsoleteor in excess of anticipated usage. These factors include, but are not limitedto, technological changes in our markets, our ability to meet changing customerrequirements, competitive pressures in products and prices, and theavailability of key components from our suppliers. Our policy is to establishinventory reserves when conditions exist that suggest that our inventory may bein excess of anticipated demand or is obsolete based upon our assumptions aboutfuture demand for our products and market conditions. We regularly evaluate theability to realize the value of our inventory based on a combination of factorsincluding the following: historical usage rates, forecasted sales or usage,product end of life dates, estimated current and future market values and newproduct introductions. Purchasing requirements and alternative usage avenuesare explored within these processes to mitigate inventory exposure. Whenrecorded, our reserves are intended to reduce the carrying value of ourinventory to its net realizable value. As of July 1, 2006, our inventoryof $16.7 million is stated net of inventory reserves of $0.6 million. Ifactual demand for our products deteriorates, or market conditions are lessfavorable than those that we project, additional inventory reserves may berequired.

**FairValue of Financial Instruments.****  **Carryingamounts of the our financial instruments, including cash and cash equivalents,marketable securities, accounts receivable, accounts payable and accruedliabilities approximate their fair values due to the short term nature of theseinstruments. The fair value of marketable securities is based on quoted marketprices.

**ProductWarranties.**   Our products are sold with warrantyprovisions that require us to remedy deficiencies in quality or performance ofour products over a specified period of time at no cost to our customers. Ourpolicy is to establish warranty reserves at levels that represent our estimateof the costs that will be incurred to fulfill those warranty requirements atthe time that revenue is recognized. We believe that our recorded liability at July 1,2006, is adequate to cover our future cost of materials, labor and overhead forthe servicing of our products sold through that date. If actual productfailures or material or service delivery costs differ from our estimates, ourwarranty liability would need to be revised accordingly.

**Stockbased compensation.****  **EffectiveJuly 3, 2005, we implemented the fair value recognition provisions ofStatement of Financial Accounting Standards No. 123 revised (“SFAS No. 123R”)and Staff Accounting Bulletin 107 (“SAB 107”) for all share-based compensationthat was not vested as of July 2, 2005. We adopted SFAS No. 123Rusing a modified prospective application, as permitted under SFAS No. 123R.Accordingly, prior period amounts have not been restated. Under thisapplication, we were required to record compensation expense for all awardsgranted after the date of adoption and for the unvested portion of previouslygranted awards that remain outstanding at the date of adoption. 

27

----

Compensation cost will berecognized over the period that an employee provides service in exchange forthe award

The fair value of each option/SARS award is estimatedon the date of grant using the Black-Scholes-Merton option-pricing modelincorporating various assumptions. Expected volatility is determined using bothcurrent and historical implied volatilities of the underlying stock which isobtained from public data sources. The expected life of the options is based onhistorical observations adjusted for the estimated exercise dates ofunexercised options/SARS. Additionally, separate groups of employees that havesimilar historical exercise behavior are considered separately for valuationpurposes. The average risk-free interest rate is based on the U.S. treasurysecurity rate with a term to maturity that approximates the option’s expectedlife as of the grant date. The forfeiture rate is based on historicalexperience as well as future expectations. Forfeitures are required to beestimated at the time of grant and revised, if necessary, in subsequent periodsif actual forfeitures differ from from these estimates.

Prior to July 3, 2005, we followed the provisionsof SFAS No. 123, “Accounting for Stock-Based Compensation”. The provisionsof SFAS No. 123 allowed companies to either expense the estimated fairvalue of stock options or to continue to follow the intrinsic value method setforth in Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees” (“APB 25”), but disclose the pro forma effects on net income(loss) had the fair value of the options been expensed. We elected toapply APB 25 in accounting for its stock option incentive plans.

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

**Contingencies.**   Weare subject to proceedings, lawsuits and other claims. We assess the likelihoodof any adverse judgments or outcomes to these matters as well as potentialranges of probable losses. A determination of the amount of reserves required,if any, for these contingencies is made after careful analysis of eachindividual issue. The required reserves may change in the future due to newdevelopments in each matter or changes in approach such as a change insettlement strategy in dealing with these matters. We record charges for thecosts we anticipate incurring in connection with litigation and claims againstus when we can reasonably estimate these costs.

**Restructuring.**   Werecord restructuring charges incurred in connection with consolidation orrelocation of operations, exited business lines, or shutdowns of specificsites. These restructuring charges, which reflect our commitment to atermination or exit plan that will begin within twelve months, are based onestimates of the expected costs associated with site closure, legal matters,contract terminations, or other costs directly related to the restructuring. Ifthe actual cost incurred exceeds the estimated cost, an additional charge toearnings will result. If the actual cost is less than the estimated cost, acredit to earnings will be recognized.

**Taxes.**   Inaccordance with SFAS No. 109, “*Accounting for IncomeTaxes*,” we recognize deferred income taxes based on the expectedfuture tax consequences of differences between the financial statement basisand the tax basis of assets and liabilities, calculated using enacted tax ratesfor the year in which the differences are expected to be reflected in the taxreturn. Realization is dependent on the generation of sufficient taxable incomein future years. Management continually evaluates the need for a valuation allowancefor deferred tax assets based on the probability of realization determined byexpectations for future taxable income and other factors. Although realizationis not assured, based on available evidence, 

28

----

management believesit is more likely than not that the full amount of the net deferred tax assetwill be realized. However, the amount realizable could be reduced if estimatesof future taxable income are reduced.

**Overview**

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

We sell products worldwide through our direct salesforce and independent distributors.

We typically assemble products in our Wayland,Massachusetts, facility in the quarter in which they are shipped, and backloghas not been significant. We experience some seasonal reduction of our productsales in our first fiscal quarter due to the summer holiday schedule of physiciansand their patients.

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

Product-related service revenue consists of revenuefrom maintenance and repair services and the sale of spare parts andconsumables. We derive revenue from extended service contracts, which aretypically for a 12 or 24-month period, and the revenue is initiallydeferred and recognized over the life of the service contract. In addition, weprovide on-site service worldwide on a time-and-materials basis directly orthrough our distributors.

International revenue, consisting of sales from oursubsidiaries in Germany, France, Italy, Spain, and Japan, and sales consistingof products shipped from the United States directly to international locationsfrom the United States during the fiscal years ended July 1, 2006, July 2,2005, and July 3, 2004 represented 56%, 54%, and 52% of total sales,respectively.

Our fiscal year consistsof the 52 or 53-week period ending on the Saturday closest to June 30of each year. The years ended July 1, 2006, July 2, 2005, and July 3,2004 contained 52, 52, and 53 weeks, respectively.

29

----

**Results ofOperations**

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

| ** **                                                 | ** ** | **For the Year Ended** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                 | ** ** | **July 1,  2006**                | ** ** | **July 2,  2005** | ** ** | **July 3,  2004** | ** ** |
| **Revenue Mix:**                                           | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other  products                                 |       | 81.5                                  | %          | 82.6 | % | 84.2 | % |
| Product-related  service                                   |       | 18.5                                  | %          | 17.4 | % | 15.8 | % |
| Total revenue                                              |       | 100.0                                 | %          | 100.0 | % | 100.0 | % |
| **Operating  Ratios:**                                     | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Gross profit:**                                          | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other  products                                 |       | 44.9                                  | %          | 46.1 | % | 49.4 | % |
| Product-related  service                                   |       | 4.5                                   | %          | 2.9 | % | 1.5 | % |
| Litigation  related charges                                |       | —                                |       | -3.9 | % | — |   |
| Total gross  profit                                        |       | 49.4                                  | %          | 45.13 | % | 50.9 | % |
| **Operating  expenses:**                                   | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research and development                                   |       | 5.9                                   | %          | 5.6 | % | 5.1 | % |
| Selling,  general & administrative                |       | 29.7                                  | %          | 32.4 | % | 32.5 | % |
| Litigation  related charges                                |       | —                                |       | 0.6 | % | — |   |
| Total operating expenses                                   |       | 35.6                                  | %          | 38.6 | % | 37.6 | % |
| Income from operations                                     |       | 13.8                                  | %          | 6.5 | % | 13.3 | % |
| Total other income                                         |       | 1.2                                   | %          | 0.5 | % | 1.2 | % |
| **Income  from continuing operations before income taxes** |       | 15.0                                  | %          | 7.0 | % | 14.5 | % |
| Provision for income taxes                                 |       | 5.0                                   | %          | 1.8 | % | 4.4 | % |
| **Income  from continuing operations**                     |       | 10.0                                  | %          | 5.2 | % | 10.1 | % |

 

**Fiscal Year Ended July 1,2006 Compared to Fiscal Year Ended July 2, 2005**

***Revenue.******  ***Total revenue increased $25.6million or 20.6% to $149.5 million in fiscal 2006 from $123.9 million infiscal 2005. Increases in unit sales accounted for the increase. The increasewas due primarily to strong growth for the GentleLASE® systems, GentleYAG®systems and the introduction of the newer Vbeam® models. The increase is alsoattributable to the exclusive arrangement with McKesson’s Medical SurgicalDivision in 2006.

International revenue increased $13.8 million over theprior year and accounted for 56% of total revenue for fiscal 2006 in comparisonto 54% for fiscal 2005. Of the $13.8 million increase, approximately $8.8million was related to increases in sales to Latin America, which represents a136% increase in that region. Sales in Europe increased approximately 13%,representing a $4 million increase in Europe compared to 2005. The large growthinternationally resulted from our sales force expansion and distributornetworks and new product introductions.

Product-related service revenue increased 28% to $27.6million in fiscal 2006 from $21.6 million in fiscal 2005. This increase wasconsistent with the increase in systems sold over the past few years andincrease in renewal contracts.

30

----

***Gross Profit.******  ***Gross profit increasedapproximately $17.9 million to $73.8 million or 49% of revenue in fiscal 2006from $55.9 million, or 45% of revenue in fiscal 2005, as a direct result of theincrease in revenue. Excluding the Regents litigation-related charges, grossprofit would have increased $13.1 million from $60.7 million, or 49% ofrevenue compared to fiscal 2005. As a percentage of revenue, 2006 gross profitis comparable to prior year excluding the Regents litigation-related chargesincurred in 2005 which related to the proceeding against the Regents.

***Research andDevelopment Expense.******  ***Research and development spendingincreased $2 million to $8.9 million compared to $6.9 million for fiscalyear 2005.  This increase was primarily attributable to $1.3 million of higherpersonnel expense due primarily to increased headcount, stock-based compensationand $0.7 million of other research and development related costs. As apercentage of revenue, research and development expenses were approximately 6%for 2006 and 2005.

***Selling, Generaland Administrative Expense.******  ***Selling,general and administrative expense increased to $44.3 million or 30% ofrevenue during fiscal 2006 compared to $40.2 million or 32% during fiscal2005. Of the $4.1 million increase,$2.3 million was due to higher personnel expense for increased headcount,higher commission expense due to increased revenue, and stock-basedcompensation. The increase is also attributable to a $1 million increasein marketing-related expenses such as customer-related work-shops, advertising,trade shows, and an increase of $1 million due to an increase in legal andaudit fees, excluding the litigation related charges in 2005, offset by a decrease in bad debt expense ofapproximately $0.4 million.

***OtherIncome/Expense.******  ***Totalother income increased $1.2 million for the fiscal year 2006 to $1.7 million,from $0.6 million for the fiscal year 2005.  This increase is related primarily to interestearned from the increase in our cash and cash equivalents, marketablesecurities and long-term investments and an increase in interest rates.

***Income Taxes.***   Theprovision for income taxes results from a combination of activities of both thedomestic and foreign subsidiaries. The Company recorded a 33% effective taxrate for the year ended July 1, 2006 compared to a 27% effective tax ratefor the year ended July 2, 2005. The provision for income taxes for theyear ended July 1, 2006, includes a tax provision calculated for taxableincome generated at the foreign subsidiaries at rates in excess of the UnitedStates statutory tax rate. The Company has a decreasing benefit from theExtraterritorial Income Exclusion which is phasing out through 2006. During theyear ended July 2, 2005, the Company recorded a benefit for theutilization of deferred tax assets which was not applicable during the currentfiscal year.

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

***Revenue.******  ***Total revenue increased $19.5million or 18.6% to $123.9 million in fiscal 2005 as compared to $104.4 millionin fiscal 2004. Increases in unit sales and the average selling price per unitaccounted for the increase. We sold approximately 180 additional laser systemsduring fiscal 2005 as compared to 2004 with an average selling priceapproximately 4% higher than that of the prior year. International revenue,consisting of sales from our subsidiaries in Germany, Spain, France and Japan,and sales shipped directly to international locations from the U.S., increased$11.9 million over the prior year and accounted for 54% of total revenue forfiscal 2005 in comparison to 52% for fiscal 2004. Of the $11.9 millionincrease, approximately $5.2 million was related to increases in sales toSouth America. This represents an almost 400% increase in that region. Sales inEurope increased approximately 15.6%, or $4.1 million and sales in Asiaincreased 9.6% or $2.6 million over sales during fiscal 2004. Product-relatedservice revenue increased 31% to $21.6 million in fiscal 2005 from$16.5 million in fiscal 2004. This increase was consistent with theincrease in systems sold over the past few years and the need for generalmaintenance and parts on these systems.

31

----

***Gross Profit.******  ***Gross profit increasedapproximately $2.7 million to $55.9 million or 45% of revenue in fiscal 2005from $53.2 million or 51% of revenue in fiscal 2004 as a direct result of theincrease in sales. Excluding the Regents litigation-related charges, grossprofit would of increased $7.6 million, or 14%, to approximately $60.7 millionor 49% of sales during fiscal 2005. Gross profit on lasers and other productsincreased $5.5 million or 11% to $57.1 million or 46% of revenue in fiscal 2005from $51.5 million or 49% of revenue in fiscal 2004. Gross profit onproduct-related services in fiscal 2005 increased $2.0 million to $3.6 millionor 3% of revenue compared to $1.6 million or 2% of revenue for fiscal 2004. Theincrease in gross profit on product-related services is due primarily toefforts in the service group to increase the profitability of that organization.

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

***Selling, Generaland Administrative Expense.******  ***Selling,general and administrative expense increased to $40.2 million or 32% ofrevenue during fiscal 2005 compared to $33.9 million or 33% during fiscal2004. The increase in selling, general and administrative expenses is dueprimarily to the increase in the number of marketing programs, theimplementation of the Sarbanes-Oxley Act internal controls and reportingrequirements, and an increase in the number of personnel on a worldwide basis.

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

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

**DiscontinuedOperations**

On September 27, 2003 management initiated a planto close its only remaining skin care center. The closure is accounted for as adiscontinued operation in accordance with Statement of Financial AccountingStandards (“SFAS”) 144, “*Accounting for theImpairment or Disposal of Long-Lived Assets*” and SFAS 146, “*Accounting for Costs Associated with Exit or Disposal Activities*”.As a result, in fiscal year 2004, we recorded a $2,095 charge for the accrualof $3,000 of future occupancy costs, primarily relating to future leasepayments for the Boston facility, and $348 of severance obligations and otherrelated costs of closure, net of anticipated tax benefits of $1,253.

During fiscal year 2005,the landlord for the Boston facility secured a sublease for that property. Thesublessee commenced making payments to the landlord during December of2004. As a result of these and future payments scheduled under the sublease, werevised the estimated future costs associated with the Boston facility and, inthe fiscal year 2005, reversed approximately $859 of the restructuring reserve.This reversal represents the aforementioned anticipated economic benefit due tosublessee payments of $1,703, net of legal and other fees ofapproximately $329 and income taxes of approximately $515.

32

----

**Liquidity andCapital Resources**

Our cash and cash equivalents, and marketablesecurities at July 1, 2006 totaled $79.6 million compared with $56.4million at July 2, 2005. We continue to have no long-term debt.  We believe that the combination of existingcash and cash equivalents, and marketable securities on hand, along with cashto be generated by future operations and amounts available under our line ofcredit, will be sufficient to meet our ongoing operating and capitalexpenditure requirements for the foreseeable future. However, we cannot be surethat we will not require additional capital beyond the amounts currentlyforecasted by us, nor that any such required additional capital will beavailable on reasonable terms, if at all, as it becomes required.

Cash provided by operatingactivities amounted to $14.4 million for fiscal 2006 as compared to $19 millionfor fiscal 2005. This decrease in cash provided by operating activitieswas due to an increase in inventories to support the increase in revenue.

Cash used by investing activities amounted to $40million compared to $0.6 million for fiscal 2005. This increase reflects thepurchase of held-to-maturity investments.

Cash provided by financingactivities amounted to $8.9 million for the fiscal year 2006 compared to $1.0million for the prior year. The increase reflects proceeds from the issuance ofstock to employees under the existing stock option plan and resulting taxbenefits.

***Debt Instruments and Related Covenants***

We maintain a renewable$10,000,000 revolving credit agreement with a major bank with interest at thebank’s base rate of LIBOR plus 2.25%. Any borrowings outstanding under the lineof credit are due on demand or according to a payment schedule established atthe time funds are borrowed. The line of credit is unsecured. The agreementcontains restrictive covenants limiting the establishment of new liens, and thepurchase of margin stock. No amounts were outstanding under the line of creditas of July 1, 2006 or July 2, 2005.

***Off-Balance Sheet Arrangements***

Our only off-balance sheetarrangements consist of non-cancelable operating leases entered into in theordinary course of business and the license agreement with the Regents. Thetable below in the next section titled “Contractual Obligations” shows theamounts of our operating lease commitments and purchase commitments payable byyear. For liquidity purposes, we choose to lease our facilities and automobilesinstead of purchasing them.

***Contractual obligations***

In August 2000, Candela obtained exclusivelicense rights to the DCD (subject to certain limited license rights of CoolTouch, Inc. (“Cool Touch”)) in the following fields of use:  procedures that involve skin resurfacing andrejuvenation, vascular skin lesions, and laser hair removal. Cool Touch, asubsidiary of New Star Technology, Inc. obtained a license to the DCD on aco-exclusive basis with Candela, in certain narrower fields of use. Cool Touchis restricted in its ability to assign its license rights to certain existingcompetitors of Candela. Candela is entitled to one-half of all royalty incomepayable to the Regents from Cool Touch. Under the amended agreement, Candela nolonger is required by the Regents to negotiate sublicenses to third parties. However,Candela is entitled to one-half of all royalties due from any other entity thatlicenses the DCD technology from the Regents in other fields of use.

We recognized royalty expense of $9.2 million and $2.6million for fiscal 2005 and 2004, respectively, based on the license agreementwith the Regents. Included in the fiscal 2005 expense of $9.2 million is$4.8 million of expense for the third quarter charge taken related to theRegents arbitration decision. Of 

33

----

that $4.8 million, $1.3million related to fiscal 2005, $3.0 million related to fiscal 2004 and 0.5million related to prior years (see note 13).

Effective July 3, 2005, we amended certainportions of our agreement with the Regents whereby for the annual license feeof $0.3 million, our royalty obligation will be reduced to 3% from its priorlevel of 6%. The annual fee of $0.3 million was paid by a lump sum of $3.0million and is being amortized over the remaining life of the patent agreement,which as of July 1, 2006 was nine years. This reduced royalty rate and theamortization of the annual license fee payment is reflected in our financialstatements as of July 1, 2006. The unamortized portion of the license feepayment is reflected in prepaid licenses in the July 1, 2006 balancesheet. We recognized royalty expense of $3.6 million for fiscal year 2006.

Outstandingcontractual obligations are reflected in the following table:

| ** **                          | ** ** | ** **              | ** ** | **Less than** | ** ** | ** **         | ** ** | ** **         | ** ** | **After**        | ** ** |
|-------------------------------------|------------|-------------------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|------------------|------------|
| ** **                          | ** ** | **Total**               | ** ** | **1 year**    | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **5 years** | ** ** |
| ** **                          | ** ** | **(in thousands)** | ** ** |
| Royalty  commitments                |       | $                       | 5,250      |               |       | $                  | 1,000      |               |       |             | $          | 2,000 |   |   |   | $ | 1,250 |   |   | $ | 1,000 |   |
| Operating leases                    |       | $                       | 2,813      |               |       | $                  | 1,267      |               |       |             | $          | 1,406 |   |   |   | $ | 140 |   |   | $ | — |   |
| Total contractual cash  obligations |       | $                       | 8,063      |               |       | $                  | 2,267      |               |       |             | $          | 3,406 |   |   |   | $ | 1,390 |   |   | $ | 1,000 |   |

 

**Recent AccountingPronouncements**

In May 2005, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 154,“Accounting Changes and Error Corrections”. The statement replaces APB Opinion No. 20,“Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes inInterim Financial Statements.” SFAS No. 154 requires companies to applyvoluntary changes in accounting principles retrospectively wheneverpracticable. The requirements are effective for us beginning in fiscal 2007.Adoption of the Statement will have a significant impact on our consolidatedfinancial statements to the extent that we change our accounting principles inthe future.

In June 2006, FASBissued FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes—an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48requires companies to determine whether it is more likely than not that a taxposition will be sustained upon examination by the appropriate taxingauthorities before any part of the benefit can be recorded in the financialstatements. This interpretation also provides guidance on derecognition,classification, accounting in interim periods, and expanded disclosurerequirements. FIN 48 is effective for fiscal years beginning after December 15,2006. We are currently in the process of assessing the impact that FIN 48 willhave on our consolidated financial statements.

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

We have cash equivalents and marketable securitiesthat primarily consist of money market mutual funds, certificates of deposit,US government securities and fixed income corporate securities. The majority ofthese investments have maturities within one to five years. We believe that ourexposure to interest rate risk is minimal due to the term and type of ourinvestments and those fluctuations in interest rates would not have a materialadverse effect on our results of operations.

We have international subsidiaries that transactbusiness in both local and foreign currencies and therefore we are exposed toforeign currency exchange risk resulting from fluctuations in foreigncurrencies. This risk could adversely impact our results and financialcondition. From time to time, we may enter into foreign currency exchange andoption contracts to reduce our exposure to foreign currency exchange risk andvariability in operating results due to fluctuation in exchange ratesunderlying the value of current transactions and anticipated transactionsdenominated in foreign currencies. These contracts obligate us to exchangepredetermined amounts of specified foreign currencies at specified exchange rates

34

----

on specified dates. Thesecontracts are denominated in the same currency in which the underlyingtransactions are denominated and bear a contract value and maturity date thatapproximate the value and expected settlement date, respectively, of the underlyingtransactions. Unrealized gains and losses on open contracts at the end of eachaccounting period, resulting from changes in the fair value of these contracts,are recognized in earnings generally in the same period as exchange gains andlosses on the underlying foreign denominated receivables are recognized.  We do not engage in foreign currencyspeculation.

We had three forward exchange contracts outstandingserving as a hedge of our Euro and Yen denominated intercompany receivables inthe notional amount of approximately 1.7 million Euros and 196 millionYen at July 1, 2006. These contracts serve as hedges of a substantialportion of our Euro-denominated and Yen intercompany balances. The fair valueof the foreign currency derivative contract outstanding at July 1, 2006was approximately $3.8 million resulting in an unrealized gain of $47,000. Anygains and losses on the fair value of the derivative contract would be largelyoffset by losses and gains on the underlying transaction.

35

----

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

**CandelaCorporation and Subsidiaries Index to Consolidated Financial Statements**

|                                                                                                                                         | ** ** | **Page** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm on Internal Control over Financial Reporting                                   |       |     | 37         |   |   |
| Report of Independent Registered Public Accounting  Firm                                                                                |       |     | 39         |   |   |
| Financial  Statements:                                                                                                                  |       |     |       |   |   |
| Consolidated  Balance Sheets—July 1, 2006 and July 2, 2005                                                               |       |     | 40         |   |   |
| Consolidated Statements of Income and Comprehensive  Income—Years ended July 1, 2006, July 2, 2005 and July 3, 2004 |       |     | 41         |   |   |
| Consolidated Statements of Stockholders’ Equity—Years  ended July 1, 2006, July 2, 2005 and July 3, 2004       |       |     | 42         |   |   |
| Consolidated Statements of Cash Flows—Years ended  July 1, 2006, July 2, 2005 and July 3, 2004                      |       |     | 43         |   |   |
| Notes to Consolidated Financial Statements                                                                                              |       |     | 44         |   |   |
| Supporting  Financial Statement Schedule:                                                                                               |       |     |       |   |   |
| Schedule  II—Valuation and Qualifying Accounts                                                                                     |       |     | 66         |   |   |

 

36

----

**Report ofIndependent Registered Public Accounting Firmon Internal Control over Financial Reporting**

Shareholders and Board of DirectorsCandela CorporationWayland, Massachusetts

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control, that CandelaCorporation and subsidiaries (the “Company”) maintained effective internalcontrol over financial reporting as of July 1, 2006, based on the criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (COSO). The Company’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

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

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

In our opinion, management’s assessment that CandelaCorporation and subsidiaries maintained effective internal control overfinancial reporting as of July 1, 2006, is fairly stated, in all materialrespects, based on the criteria established in Internal Control—IntegratedFramework issued by COSO. Also in our opinion, the Company maintained, in allmaterial respects, effective internal control over financial reporting as of July 1,2006, based on the criteria established in Internal Control-IntegratedFramework issued by COSO.

37

----

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of Candela Corporation andsubsidiaries as of July 1, 2006 and July 2, 2005 and the relatedconsolidated statements of income and comprehensive income, stockholders’equity, and cash flows for each of the three years in the period ended July 1,2006 and our report dated September 1, 2006 which expressed an unqualifiedopinion thereon.

| By:    | /s/ BDO  SEIDMAN, LLP  |
|--------|------------------------|
|   | BDO Seidman, LLP       |
|   | Boston, Massachusetts  |
|   | September 1, 2006 |

 

38

----

 

**Report ofIndependent Registered Public Accounting Firm**

Shareholders and Board of DirectorsCandela CorporationWayland, Massachusetts

We have audited the accompanying consolidated balancesheets of Candela Corporation and subsidiaries as of July 1, 2006 and July 2,2005 and the related consolidated statements of income and comprehensiveincome, stockholders’ equity and cash flows for each of the three years in theperiod ended July 1, 2006. We have also audited the schedule listed in theaccompanying index for the years ended July 1, 2006, July 2, 2005 andJuly 3, 2004. These financial statements and schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements and schedule based on our audits.

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

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Candela Corporation and subsidiaries at July 1, 2006 and July 2,2005 and the results of their operations and their cash flows for each of thethree years in the period ended July 1, 2006, in conformity withaccounting principles generally accepted in the United States of America.

Also, in our opinion, the financial statement schedulelisted on the accompanying index presents fairly, in all material respects, theinformation set forth therein.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of CandelaCorporation and subsidiaries’ internal control over financial reporting as of July 1,2006, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated September 1, 2006, which expressed an unqualifiedopinion thereon.

| By:    | /s/ BDO  SEIDMAN, LLP  |
|--------|------------------------|
|   | BDO Seidman, LLP       |
|   | Boston, Massachusetts  |
|   | September 1, 2006 |

 

39

----

**CANDELA CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSJuly 1, 2006 and July 2, 2005**

| ** **                                                                                                                    | ** ** | **2006**                | ** ** | **2005**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------|------------|
| ** **                                                                                                                    | ** ** | **(in thousands)** | ** ** |
| **Assets:**                                                                                                                   | ** ** | ** **              | ** ** | ** ** | ** ** |
| Current assets:                                                                                                               |       |                    |       |       |       |
| Cash and cash equivalents                                                                                                     |       | $                       | 40,194     |       | $          | 56,383 |   |
| Restricted cash                                                                                                               |       | 166                     |       | 199        |       |
| Marketable securities                                                                                                         |       | 27,332                  |       | —     |       |
| Accounts receivable, (net  of allowance for doubtful accounts of $1,831 and $2,065 in 2006 and 2005,  repectively)            |       | 34,273                  |       | 34,866     |       |
| Notes receivable                                                                                                              |       | 1,611                   |       | 805        |       |
| Inventories, net                                                                                                              |       | 16,666                  |       | 12,676     |       |
| Other current assets                                                                                                          |       | 1,756                   |       | 1,821      |       |
| Total current assets                                                                                                          |       | 121,998                 |       | 106,750    |       |
| Property and equipment,  net                                                                                                  |       | 3,302                   |       | 3,240      |       |
| Deferred tax assets                                                                                                           |       | 8,142                   |       | 5,743      |       |
| Prepaid licenses                                                                                                              |       | 3,402                   |       | 878        |       |
| Marketable securities  (long-term portion)                                                                                    |       | 11,953                  |       | —     |       |
| Other assets                                                                                                                  |       | 379                     |       | 205        |       |
| Total assets                                                                                                                  |       | $                       | 149,176    |       | $          | 116,816 |   |
| **Liabilities and Stockholders’ Equity:**                                                                                | ** ** | ** **              | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                          |       |                    |       |       |       |
| Accounts payable                                                                                                              |       | $                       | 15,968     |       | $          | 11,674 |   |
| Accrued payroll and  related expenses                                                                                         |       | 5,728                   |       | 4,830      |       |
| Accrued warranty costs  (current portion)                                                                                     |       | 5,868                   |       | 5,291      |       |
| Income taxes payable                                                                                                          |       | 933                     |       | 2,073      |       |
| Sales tax payable                                                                                                             |       | 854                     |       | 2,206      |       |
| Royalties payable                                                                                                             |       | 764                     |       | 1,661      |       |
| Other accrued liabilities                                                                                                     |       | 3,672                   |       | 1,298      |       |
| Deferred revenue (current  portion)                                                                                           |       | 8,342                   |       | 6,037      |       |
| Current liabilities of  discontinued operations                                                                               |       | 1,287                   |       | 1,302      |       |
| Total current liabilities                                                                                                     |       | 43,416                  |       | 36,372     |       |
| Accrued warranty costs  (long-term portion)                                                                                   |       | 3,761                   |       | 3,355      |       |
| Deferred revenue  (long-term portion)                                                                                         |       | 1,987                   |       | 2,313      |       |
| Long-term liabilities of  discontinued operations                                                                             |       | —                  |       | 437        |       |
| Total liabilities                                                                                                             |       | 49,164                  |       | 42,477     |       |
| Stockholders’ equity:                                                                                                    |       |                    |       |       |       |
| Common stock, $.01 par  value, 60,000,00 shares authorized;   25,914,000 and 24,764,000 issued in 2006 and 2005, respectively |       | 259                     |       | 248        |       |
| Treasury stock, 2,250,000  common shares in 2006 and 2005 at cost                                                             |       | (12,997                 | )          | (12,997    | )          |
| Additional paid-in  capital                                                                                                   |       | 64,234                  |       | 54,027     |       |
| Accumulated earnings                                                                                                          |       | 48,280                  |       | 33,346     |       |
| Accumulated other  comprehensive income (loss)                                                                                |       | 236                     |       | (285       | )          |
| Total stockholders’  equity                                                                                              |       | 100,012                 |       | 74,339     |       |
| Total liabilities and stockholders’ equity                                                                               |       | $                       | 149,176    |       | $          | 116,816 |   |

 

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

40

----

**CANDELA CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOMEFor the years ended July 1, 2006, July 2, 2005 and July 3, 2004**

| ** **                                                                                                                                                                                                             | ** ** | **2006**                                                           | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                                                                                                                                             | ** ** | **(in thousands, except per share data)** | ** ** |
| **Revenue**                                                                                                                                                                                                            | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other products                                                                                                                                                                                              |       | $                                                                  | 121,838    |       | $          | 102,323    |       | $ | 87,965 |   |
| Product-related  service                                                                                                                                                                                               |       | 27,628                                                             |       | 21,578     |       | 16,473     |       |
| Total revenue                                                                                                                                                                                                          |       | 149,466                                                            |       | 123,901    |       | 104,438    |       |
| **Cost of sales**                                                                                                                                                                                                      | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other  products                                                                                                                                                                                             |       | 54,748                                                             |       | 45,235     |       | 36,413     |       |
| Product-related  service                                                                                                                                                                                               |       | 20,869                                                             |       | 17,918     |       | 14,860     |       |
| Litigation related  charges                                                                                                                                                                                            |       | —                                                             |       | 4,829      |       | —     |       |
| Total cost of  sales                                                                                                                                                                                                   |       | 75,617                                                             |       | 67,982     |       | 51,273     |       |
| **Gross  profit**                                                                                                                                                                                                      |       | 73,849                                                             |       | 55,919     |       | 53,165     |       |
| **Operating expenses:**                                                                                                                                                                                                | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general  and administrative                                                                                                                                                                                   |       | 44,297                                                             |       | 40,165     |       | 33,978     |       |
| Research and  development                                                                                                                                                                                              |       | 8,879                                                              |       | 6,890      |       | 5,302      |       |
| Litigation related  charges                                                                                                                                                                                            |       | —                                                             |       | 773        |       | —     |       |
| Total operating  expenses                                                                                                                                                                                              |       | 53,176                                                             |       | 47,828     |       | 39,280     |       |
| **Income  from operations**                                                                                                                                                                                            |       | 20,673                                                             |       | 8,091      |       | 13,885     |       |
| **Other income (expense):**                                                                                                                                                                                            | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                                                                                                                                                                                                        |       | 1,748                                                              |       | 640        |       | 308        |       |
| Other income  (expense), net                                                                                                                                                                                           |       | (19                                                                | )          | (73        | )          | 905        |       |
| Total other income                                                                                                                                                                                                     |       | 1,729                                                              |       | 567        |       | 1,213      |       |
| **Income  from continuing operations before income taxes**                                                                                                                                                             |       | 22,402                                                             |       | 8,658      |       | 15,098     |       |
| **Provision  for income taxes**                                                                                                                                                                                        |       | 7,468                                                              |       | 2,194      |       | 4,586      |       |
| **Income  from continuing operations**                                                                                                                                                                                 |       | 14,934                                                             |       | 6,464      |       | 10,512     |       |
| **Discontinued operations:**                                                                                                                                                                                           | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loss from  discontinued skin care center operations of $473 less income tax benefit of  $175                                                                                                                      |       | —                                                             |       | —     |       | (298       | )          |
| Gain (loss) on  disposal of skin care center including revision of leasehold obligations of  $1,374 and operating losses of $(3,348) less income tax expense of $(515) and  income tax benefit of $1,253, repectively. |       | —                                                             |       | 859        |       | (2,095     | )          |
| **Net  income**                                                                                                                                                                                                        |       | $                                                                  | 14,934     |       | $          | 7,323      |       | $ | 8,119 |   |
| **Net income per share of common stock**                                                                                                                                                                               | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic:**                                                                                                                                                                                                             | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from  continuing operations                                                                                                                                                                                     |       | $                                                                  | 0.65       |       | $          | 0.29       |       | $ | 0.48 |   |
| Gain (loss) from  discontinued operations                                                                                                                                                                              |       | —                                                             |       | 0.04       |       | (0.11      | )          |
| Net income                                                                                                                                                                                                             |       | $                                                                  | 0.65       |       | $          | 0.33       |       | $ | 0.37 |   |
| **Diluted:**                                                                                                                                                                                                           | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from  continuing operations                                                                                                                                                                                     |       | $                                                                  | 0.62       |       | $          | 0.28       |       | $ | 0.46 |   |
| Gain (loss) from  discontinued operations                                                                                                                                                                              |       | —                                                             |       | 0.04       |       | (0.10      | )          |
| Net income                                                                                                                                                                                                             |       | $                                                                  | 0.62       |       | $          | 0.32       |       | $ | 0.36 |   |
| **Weighted average shares outstanding:**                                                                                                                                                                               | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                                                                                                                                                                                  |       | 23,017                                                             |       | 22,388     |       | 21,902     |       |
| Diluted                                                                                                                                                                                                                |       | 23,948                                                             |       | 23,073     |       | 22,712     |       |
| **Net  income**                                                                                                                                                                                                        |       | $                                                                  | 14,934     |       | $          | 7,323      |       | $ | 8,119 |   |
| **Other comprehensive income (loss), net of tax:**                                                                                                                                                                     | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Foreign currency  translation adjustment                                                                                                                                                                               |       | 521                                                                |       | (713       | )          | 595        |       |
| **Comprehensive  income**                                                                                                                                                                                              |       | $                                                                  | 15,455     |       | $          | 6,610      |       | $ | 8,714 |   |

 

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

41

----

**CANDELA CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYFor the years ended July 1, 2006, July 2, 2005, and July 3, 2004**

| ** **                              | ** ** | ** **            | ** ** | ** **  | ** ** | ** **              | ** ** | ** **      | ** ** | ** **        | ** ** | ** **   | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|-------------|------------|-------------------------|------------|-----------------|------------|-------------------|------------|--------------|------------|------------------------|------------|------------|------------|
| ** **                              | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**          | ** ** | ** **      | ** ** | ** **        | ** ** | ** **   | ** ** | **Other**              | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Treasury Stock** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **   | ** ** |
| ** **                              | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**             | ** ** | **Shares**      | ** ** | **Amount**        | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Total**  | ** ** |
| ** **                              | ** ** | **(in thousands)**    | ** ** |
| **Balance  June 28, 2003**         | ** ** |                  | **23,528** | ** **  |       |                    | **$**      | **235**         | ** ** |              |       | **$**        | **48,373** | ** **             |       |       | **(2,250** | **)** |   | **$(12,997** | **)** |   | **$** | **17,904** | ** ** |   |   | **$(167** | **)** |   | **$** | **53,348** | ** ** |
| Sale of common  stock under stock plans |       |                  | 979        | ** **  |       |                    | 9          | ** **      |       |              | 4,618      | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | ** ** | ** ** |   |   | ** ** |   |   | 4,627 |   |
| Exercise of stock  warrants             |       |                  | 60         | ** **  |       |                    | 1          | ** **      |       |              | 79         | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | ** ** | ** ** |   |   | ** ** |   |   | 80 |   |
| Net income                              |       |                  |       | ** **  |       |                    |       | ** **      |       |              |       | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | 8,119 | ** ** |   |   | ** ** |   |   | 8,119 |   |
| Currency  translation adjustment        |       |                  |       | ** **  |       |                    |       | ** **      |       |              |       | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | ** ** | ** ** |   |   | 595 |   |   | 595 |   |
| **Balance  July 3, 2004**          | ** ** |                  | **24,567** | ** **  |       |                    | **246**    | ** **      |       |              | **53,069** | ** **   |       |                   | **(2,250** | **)**      |       | **(12,997** | **)** |   | **26,023** | ** ** |   |   | **428** | ** ** |   | **66,769** | ** ** |
| Sale of common  stock under stock plans |       |                  | 197        | ** **  |       |                    | 2          | ** **      |       |              | 958        | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | ** ** | ** ** |   |   | ** ** |   |   | 960 |   |
| Net income                              |       |                  |       | ** **  |       |                    |       | ** **      |       |              |       | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | 7,323 | ** ** |   |   | ** ** |   |   | 7,323 |   |
| Currency  translation adjustment        |       |                  |       | ** **  |       |                    |       | ** **      |       |              |       | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | ** ** | ** ** |   |   | (713 | ) |   | (713 | ) |
| **Balance  July 2, 2005**          | ** ** |                  | **24,764** | ** **  |       |                    | **248**    | ** **      |       |              | **54,027** | ** **   |       |                   | **(2,250** | **)**      |       | **(12,997** | **)** |   | **33,346** | ** ** |   |   | **(285** | **)** |   | **74,339** | ** ** |
| Sale of common  stock under stock plans |       |                  | 1,150      | ** **  |       |                    | 11         | ** **      |       |              | 8,111      | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | ** ** | ** ** |   |   | ** ** |   |   | 8,122 |   |
| Net income                              |       |                  |       | ** **  |       |                    |       | ** **      |       |              |       | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | 14,934 | ** ** |   |   | ** ** |   |   | 14,934 |   |
| Stock-based  compensation expense       |       |                  |       | ** **  |       |                    |       | ** **      |       |              | 1,285      | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | ** ** | ** ** |   |   | ** ** |   |   | 1,285 |   |
| Tax beneifit of  stock exercise         |       |                  |       | ** **  |       |                    |       | ** **      |       |              | 811        | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | ** ** | ** ** |   |   | ** ** |   |   | 811 |   |
| Currency  translation adjustment        |       |                  |       | ** **  |       |                    |       | ** **      |       |              |       | ** **   |       |                   | ** ** | ** ** |       |   | ** ** |   | ** ** | ** ** |   |   | 521 |   |   | 521 |   |
| **Balance  July 1, 2006**          | ** ** |                  | **25,914** | ** **  |       |                    | **$**      | **259**         | ** ** |              |       | **$**        | **64,234** | ** **             |       |       | **(2,250** | **)** |   | **$(12,997** | **)** |   | **$** | **48,280** | ** ** |   |   | **$** | **236** | ** ** |   | **$** | **100,012** | ** ** |
|                                         |            |                       |            |             |            |                         |            |                 |            |                   |            |              |            |                        |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

42

----

**CANDELA CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSFor the years ended July 1, 2006, July 2, 2005, and July 3, 2004**

| ** **                                                                              | ** ** | **2006**                | ** ** | **2005**     | ** ** | **2004**     | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------|------------|--------------|------------|
| ** **                                                                              | ** ** | **(in thousands)** | ** ** |
| **Cash flows from operating activities:**                                               | ** ** | ** **              | ** ** | ** **   | ** ** | ** **   | ** ** |
| Net income                                                                              |       | $                       | 14,934     |         | $          | 7,323        |       | $ | 8,119 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:      |       |                    |       |         |       |         |       |
| (Gain) loss of  disposal of discontinued operations                                     |       | —                  |       | (859         | )          | 2,095        |       |
| Loss from  discontinued operations                                                      |       |  —            |       |  — |       | 298          |       |
| Amortization of  share-based compensation expense                                       |       | 1,285                   |       | —       |       | —       |       |
| Depreciation and  amortization                                                          |       | 571                     |       | 755          |       | 668          |       |
| Provision  (benefit) for bad debts                                                      |       | 1,241                   |       | 573          |       | 520          |       |
| Provision for  deferred taxes                                                           |       | (2,399                  | )          | 233          |       | 955          |       |
| Effect of exchange  rate changes on foreign currency denominated assets and liabilities |       | 95                      |       | (180         | )          | 26           |       |
| Increase (decrease) in  cash from working capital:                                      |       |                    |       |         |       |         |       |
| Accounts  receivable                                                                    |       | (681                    | )          | (1,801       | )          | (7,663       | )          |
| Notes receivable                                                                        |       | (844                    | )          | (19          | )          | 62           |       |
| Inventories                                                                             |       | (3,561                  | )          | 719          |       | (2,134       | )          |
| Other current  assets                                                                   |       | 75                      |       | 1,335        |       | (2,550       | )          |
| Other assets                                                                            |       | (2,684                  | )          | 427          |       | (236         | )          |
| Accounts payable                                                                        |       | 3,593                   |       | 4,760        |       | (91          | )          |
| Accrued payroll  and related expenses                                                   |       | 882                     |       | (567         | )          | 707          |       |
| Deferred revenue                                                                        |       | 2,243                   |       | 2,731        |       | 548          |       |
| Accrued warranty  costs                                                                 |       | 620                     |       | 2,091        |       | 1,776        |       |
| Income taxes  payable                                                                   |       | (779                    | )          | (303         | )          | (2,535       | )          |
| Other accrued  liabilities                                                              |       | (238                    | )          | 1,698        |       | 767          |       |
| Change in  restricted cash                                                              |       | 33                      |       | 58           |       | (200         | )          |
| Net cash provided  by operating activities                                              |       | 14,386                  |       | 18,974       |       | 1,132        |       |
| **Cash flows from investing activities:**                                               |       |                    |       |         |       |         |       |
| Purchases of  property and equipment                                                    |       | (715                    | )          | (635         | )          | (685         | )          |
| Maturities of  held-to-maturity marketable securities                                   |       | 4,369                   |       |  — |       |  — |       |
| Purchases of  held-to-maturity marketable securities                                    |       | (43,654                 | )          | —       |       | —       |       |
| Net cash used for  investing activities                                                 |       | (40,000                 | )          | (635         | )          | (685         | )          |
| **Cash flows from financing activities:**                                               |       |                    |       |         |       |         |       |
| Proceeds from the  issuance of common stock                                             |       | 8,122                   |       | 960          |       | 4,707        |       |
| Benefits of tax  effects from exercise of stock options                                 |       | 811                     |       |  — |       |  — |       |
| Net cash provided  by financing activities                                              |       | 8,933                   |       | 960          |       | 4,707        |       |
| Effect of exchange  rates on cash and cash equivalents                                  |       | 492                     |       | (55          | )          | 172          |       |
| **Net  increase (decrease) in cash and cash equivalents**                               |       | (16,189                 | )          | 19,244       |       | 5,326        |       |
| **Cash and  cash equivalents at beginning of period**                                   |       | 56,383                  |       | 37,139       |       | 31,813       |       |
| **Cash and  cash equivalents at end of period**                                         |       | $                       | 40,194     |         | $          | 56,383       |       | $ | 37,139 |   |
| **Cash paid during the year for:**                                                      |       |                    |       |         |       |         |       |
| Interest                                                                                |       | $                       | —     |         | $          | —       |       | $ | 15 |   |
| Income taxes                                                                            |       | 9,834                   |       | 2,269        |       | 3,265        |       |

 

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

43

----

**Notes to Consolidated Financial Statements**

**(amounts are in thousands except per share data)**

**1.**                 Summaryof Significant Accounting Policies

***Description of Business and Basis of Presentation***

Candela Corporation (“theCompany”) is a pioneer in the development and commercialization of advancedaesthetic laser systems that allow physicians and personal care practitionersto treat a wide variety of cosmetic and medical conditions.

***Principles of Consolidations***

The consolidated financialstatements include the accounts of the Company and its wholly-ownedsubsidiaries.  All intercompany accountsand transactions have been eliminated in consolidation.

***Fiscal Years***

The Company’s fiscal yearends on the Saturday nearest June 30. The years ended July 1, 2006and July 2, 2005 each contain 52 weeks. The year ended July 3, 2004contains 53 weeks.

***Use of Estimates***

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. It is the belief of the Company’s management that allnecessary adjustments have been made for an accurate presentation of results. Actualresults could differ from those estimates and impact future results ofoperations and cash flows.

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

***Cash and Cash Equivalents***

The Company considers allhighly liquid instruments with original maturities of three months or less tobe cash equivalents. Substantially all cash and cash equivalents were investedin short duration certificates of deposit and overnight repurchase agreementswith major financial institutions. These are valued at cost plus any accruedinterest, which approximates market value.

***Marketable Securities***

The Company accounts formarketable securities in accordance with Statement of Financial AccountingStandards No. 115, “Accounting for Certain Investments in Debt and EquitySecurities” (“SFAS 115”). SFAS 115 establishes the accounting and reportingrequirements for all debt securities and for investments in equity securitiesthat have readily determinable fair values. All marketable securities must beclassified as one of the following: held-to-maturity, available-for-sale, ortrading. The Company classifies its marketable securities as held-to-maturityas the Company has the intent and ability to hold them to maturity. Held-to-maturitydebt securities are reported at amortized cost which approximates fair value. Currentmarketable securities include investments that are expected to mature in morethan three months and up to twelve months.  Long-term investments have remainingmaturities of one to three years. 

44

----

Unrealizedgains and losses related to the marketable securities are not considered apermanent decline in the market value of such securities.

***Accounts Receivable and Notes Receivable***

The Company’s trade accounts receivable and notesreceivable are primarily from sales to end users, leasing companies, anddistributors servicing the medical device market, and reflect a broad domesticand international customer base. The Company does not require collateral andhas not historically experienced significant credit losses related toreceivables from individual customers or groups of customers in any particularindustry or geographic area.

The Company’s policy is tomaintain reserves for potential losses resulting from the inability of ourcustomers to make required payments. These reserves are charged to bad debtsexpense. The Company determines the adequacy of this allowance by regularlyreviewing the aging of its accounts and notes receivable and evaluating theindividual customer’s balances considering the customer’s financial condition,historical experience credit history and current economic conditions. Creditassessments are established through a process of reviewing the financialhistory and stability of each customer prior to inception of the sale. Whereappropriate, the Company will obtain credit rating reports and financialstatements of customers when determining or modifying their credit limits. Whena customer’s account balance becomes past due, the Company will initiatedialogue with the customer to determine the cause. If it is determined that thecustomer will be unable to meet its financial obligation, such as in the caseof a bankruptcy filing, deterioration in the customer’s operating results orfinancial position or other material events impacting their business, theCompany will record an allowance to reduce the related receivable to the amountthe Company expects to recover given all information presently available. TheCompany will also provide a general reserve based on the aging of the accountsand notes receivable based on historical experiences of write-offs.

***Fair value of financial instruments***

Carrying amounts of theCompany’s financial instruments, including cash and cash equivalents,marketable securities, accounts receivable, accounts payable and accruedliabilities approximate their fair values due to the short term nature of theseinstruments. The fair value of marketable securities is based on quoted marketprices.

***Derivative Instruments and Hedging Activity***

The Company will enter into financial instruments toreduce its exposure to fluctuations in foreign exchange rates by creatingoffsetting positions through the use of foreign currency forward contracts. TheCompany recognizes all derivative instruments as either assets or liabilitiesin the statements of financial position and measures those instruments at fairvalue. Changes to the fair value of derivative contracts that do not qualifyfor hedge accounting are reported in earnings in the period of the change. Forderivatives that qualify for hedge accounting, changes in the fair value of thederivatives are either recorded in shareholders’ equity as a component of othercomprehensive income or are recognized currently in earnings, along with anoffsetting adjustment against the basis of the item being hedged. Cumulativegains and losses on derivatives that have hedged our foreign operations andthat have been recorded in other comprehensive income for the years ended July 1,2006, July 2, 2005 and July 3, 2004 did not amount to a significantgain or loss.

The Company’s foreigncurrency forward contracts may involve elements of credit and market risk inexcess of the amounts recognized in the financial statements. The Companymonitors its positions and the credit quality of counter-parties, consistingprimarily of major financial institutions, and does not anticipate 

45

----

nonperformanceby any counter-party. The Company does not use derivative financial instrumentsfor trading or speculative purposes, nor is the Company a party to leveragedderivatives.

***Inventories***

Inventories are stated at the lower of cost (first-in,first-out method) or market, using a standard costing system which includesmaterial, labor and manufacturing overhead Standard costs are monitored and updated as necessary, to reflect thechanges in raw material costs and labor and overhead rates.

As a designer andmanufacturer of high technology equipment, the Company is exposed to a numberof economic and industry factors that could result in portions of inventorybecoming either obsolete or in excess of anticipated usage. These factorsinclude, but are not limited to, technological changes in markets, the Company’sability to meet changing customer requirements, competitive pressures inproducts and prices, and the availability of key components from suppliers. TheCompany’s policy is to establish inventory reserves when conditions exist thatsuggest inventory may be in excess of anticipated demand or is obsolete basedupon assumptions about future demand for the Company’s products and marketconditions. The Company regularly evaluates the ability to realize the value ofinventory based on a combination of factors including the following: historicalusage rates, forecasted sales or usage, product end of life dates, estimatedcurrent and future market values and new product introductions. Purchasingrequirements and alternative usage avenues are explored within these processesto mitigate inventory exposure. When recorded, the reserves are intended toreduce the carrying value of inventory to its net realizable value. Inventoryof $16.7 million as of July 1, 2006 and $12.7 million as of July 2,2005 is stated net of inventory reserves of $0.6 million and $0.5 million,respectively. If actual demand for the Company’s products deteriorates, ormarket conditions are less favorable than those projected, additional inventoryreserves may be required.

***Property and Equipment***

Purchasedproperty and equipment is recorded at cost. Laser systems used for testing arecapitalized at cost. Repairs and maintenance costs are expensed as incurred. Leaseholdimprovements are amortized over the shorter of the useful life or the life ofthe related lease. Depreciation is provided using the straight-line method overthe estimated useful lives as follows:

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

 

***Prepaid license fees***

Prepaid license fees areamortized over the term of the related contract (see note 7).

***Impairment of Long-Lived Assets***

The Company reviews therecoverability of long-lived assets, including building improvements, equipmentand other intangible assets, when events or changes in circumstances occur thatindicate that the carrying value of the asset may not be recoverable. Theassessment of possible impairment is based on the ability to recover thecarrying value of the asset from the expected future pre-tax cash flows(undiscounted and without interest charges) of the related operations. If thesecash flows are less than the carrying value of such asset, an impairment lossis recognized for the difference between estimated fair value and carryingvalue. The Company’s primary measure of fair value is based on discounted cashflows. The measurement of impairment requires management to make estimates ofthese cash flows related to long-lived assets, as well as other fair valuedeterminations.

46

----

***Revenue Recognition***

*Product sales*—The Companygenerally recognizes revenue upon shipment of product to customers and thefulfillment of all contractual terms and conditions, pursuant to the guidanceprovided by Securities and Exchange Commission (“SEC”) Staff AccountingBulletin No. 104, “Revenue Recognition in Financial Statements” (“SAB 104”).SAB 104 requires that at the time revenue is recognized persuasive evidence ofan arrangement exists; delivery has occurred or services rendered; the fee isfixed and determinable; and collectibility is reasonably assured. Circumstanceswhich generally preclude the immediate recognition of revenue include shippingterms of FOB destination.  In theseinstances, revenue is deferred until adequate documentation is obtained toensure that the delivery criteria have been fulfilled. The Company provides forthe estimated cost to repair or replace products under warranty at the time ofsale. Unearned revenue is reported on the balance sheet as deferred income.

*Service*—Revenue from the sale ofservice contracts is deferred and recognized on a straight-line basis over thecontract period. Revenue from service administered by the Company that is notcovered by a service contract is recognized as the services are provided.

*Multiple-elementarrangements*—In certain instances, the Company may sellproducts together with extended warranties or maintenance contracts. The revenuerecognized per element is determined by allocating the total sales price toeach element, based on the relative fair values in accordance with EmergingIssues Task Force (EITF) 00-21, “Revenue Arrangements with MultipleDeliverables”.  Revenue for extendedwarranty and maintenance contracts are recognized on a straight line basis overthe life of the contract. Unearned revenues are reported on the balance sheetas deferred revenue.

***Product Warranty Costs***

The Company’s productsgenerally carry a standard warranty. The Company maintains a reserve based onanticipated warranty claims at the time product revenue is recognized. Factorsthat affect the Company’s product warranty liability include the number ofinstalled units, the anticipated cost of warranty repairs and historical andanticipated rates of warranty claims.

***Research and Development Costs***

Research and developmentcosts are expensed as incurred.

***Advertising Costs***

Advertising costs areexpensed as incurred and are included as a component of selling, general andadministrative expenses in the accompanying Consolidated Statements of Incomeand Comprehensive Income. Advertising costs were $888, $916, and $766 for theyears ended July 1, 2006, July 2, 2005, and July 3, 2004,respectively.

***Stock-based compensation***

Effective July 3, 2005, the Company implementedthe fair value recognition provisions of SFAS No. 123 revised (“SFAS No. 123R”)and Staff Accounting Bulletin 107 (“SAB 107”) for all share-based compensationthat was not vested as of July 2, 2005. The Company adopted SFAS No. 123Rusing a modified prospective application, as permitted under SFAS No. 123R.Accordingly, prior period amounts have not been restated. Under thisapplication, the Company is required to record compensation expense for allawards granted after the date of adoption and for the unvested portion ofpreviously granted awards that remain outstanding at the date of adoption.Compensation cost will be recognized over the period that an employee providesservice in exchange for the award.

47

----

The application of SFAS No. 123R and SAB 107during the year ended July 1, 2006 resulted in the recognition ofshare-based compensation expense of $1,229 attributable to stock options/Stockappreciation rights (“SARS”) and $56 attributable to the employee stockpurchase plan. This expense was divided between operating expense cost centersbased upon the functional responsibilities of the individual holding therespective options.

The fair value of each option/SARS award is estimatedon the date of grant using the Black-Scholes-Merton option-pricing modelincorporating the assumptions noted in the following table. Expected volatilityis determined using both current and historical implied volatilities of theunderlying stock which is obtained from public data sources. The expected termof the options is based on historical observations adjusted for the estimatedexercise dates of unexercised options/SARS. Additionally, separate groups ofemployees that have similar historical exercise behavior are consideredseparately for valuation purposes. The average risk-free interest rate is basedon the U.S. treasury security rate with a term to maturity that approximatesthe option’s expected life as of the grant date. The forfeiture rate is basedon historical experience as well as future expectations. Forfeitures arerequired to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates.

As of July 1, 2006, there was approximately$3,408 of total unrecognized compensation cost related to non-vested stockoptions/SARS granted under the Company’s incentive plans. This cost is expectedto be recognized over a weighted-average period of 1.5 years.

Theamount of cash received from the exercise of stock options for the fiscal yearended July 1, 2006, was $7,801 for stock options and $321 for the employeestock purchase plan. The actual tax benefit realized from the tax deductions resultingfrom option exercises totaled $811.

| ** **                                   | ** ** | **For the year ended  July 1, 2006** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------|------------|
| Risk-free  interest rate                     |       |                                                     | 5.125      | % |   |
| Estimated  volatility                        |       |                                                     | 72         | % |   |
| Expected life for  stock options (yrs)       |       |                                                     | 3.39       |   |   |
| Expected life for  stock purchase plan (yrs) |       |                                                     | 0.50       |   |   |
| Expected dividends                           |       |                                                     | —     |   |   |

 

Prior to July 3, 2005, the Company followed theprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation”. Theprovisions of SFAS No. 123 allowed companies to either expense theestimated fair value of stock options or to continue to follow the intrinsicvalue method set forth in Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”), but disclose the pro forma effectson net income (loss) had the fair value of the options been expensed. TheCompany elected to apply APB 25 in accounting for its stock option incentiveplans.

In accordance with APB 25 and related interpretations,compensation expense for stock options is recognized in income based on theexcess, if any, of the quoted market price of the stock at the grant date ofthe award or other measurement date over the amount an employee must pay toacquire the stock. Generally, the exercise price for stock options granted toemployees equals or exceeds the fair market value of the Company’s common stockat the date of grant, thereby resulting in no recognition of compensationexpense for fixed term grants. For awards that generate compensation expense asdefined under APB 25, the Company calculates the amount of compensation expenseand recognizes the expense over the vesting period of the award.

On May 2,2005, the Company’s Board of Directors approved accelerating the vestingof unvested, “out-of-the-money” options to purchase approximately 535,000 sharesof the Company’s common stock awarded to employees, officers and non-employeedirectors under its stock option plans. The accelerated options have exerciseprices ranging from $9.50 to $12.33 and a weighted average exercise price of$11.52. 

48

----

The acceleration wasunconditional to the employees, officers and non-employee directors and wasapplied to all outstanding, unvested options priced above the closing price ofthe Company’s common stock on Monday, May 2, 2005. Approximately $6,393 ofthe FY 2005 proforma expense listed below relates to options included in thisacceleration pool.

The primary purpose of the accelerated vesting was toenable the Company to avoid recognizing future compensation expense associatedwith the accelerated stock options upon the adoption of SFAS 123R by theCompany in fiscal 2006.

Hadcompensation cost for the Company’s stock option plans been determined based onthe fair value method set forth in SFAS 123, Candela’s net income andbasic and diluted net income per common share would have been changed to thepro forma amounts indicated below:

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

 

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

| ** **                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Risk-free  interest rate                     |       | 4.25     | %          | 1.25     | %          |
| Estimated  volatility                        |       | 76       | %          | 80       | %          |
| Expected life for  stock options (yrs)       |       | 2.87     |       | 2.92     |       |
| Expected life for  stock purchase plan (yrs) |       | 0.5      |       | 0.5      |       |
| Expected dividends                           |       | none     |       | none     |       |

 

The weighted averagegrant-date fair value per share of options granted, calculated using theBlack-Scholes option-pricing model, and was $7.77 in 2005 and $5.86 in 2004.

***Income Taxes***

The Company accounts for income taxes using an assetand liability approach that requires the recognition of deferred tax assets andliabilities for the expected future tax consequences of events that have beenrecognized in the financial statements or tax returns. In estimating future taxconsequences, all expected future events are considered other than enactmentsof changes in tax laws or rates. Valuation allowances are established asnecessary to reduce deferred tax assets in the event that realization of theassets is considered unlikely.

49

----

***Foreign Currency Translation***

The local currency is thefunctional currency of the Company’s subsidiaries. The activity of the Company’sforeign subsidiaries is translated into United States dollars in accordancewith SFAS No. 52, “*Foreign Currency Translation*”.Monetary assets and liabilities are translated into United States dollars atcurrent exchange rates, while income and expense items are translated ataverage rates of exchange prevailing during the year. Exchange gains and lossesarising from translation of the subsidiary balance sheets are accumulated as aseparate component of stockholders’ equity. Net exchange (losses) gainsresulting from foreign currency transactions amounted to $95, $(180), and $26for the years ended July 1, 2006, July 2, 2005, and July 3,2004, respectively, and are included in other income (expense).

***Earnings Per Share***

Basic earnings per share is computed by dividing netincome by the weighted average number of shares of common stock outstanding forthe period and, if there are dilutive securities, diluted earnings per share iscomputed by including common stock equivalents outstanding for the period inthe denominator.

Common stock equivalents include shares issuable uponthe exercise of stock options, warrants and SARS, net of shares assumed to havebeen purchased with the proceeds, using the treasury stock method.

Thefollowing table provides share information used in the calculation of theCompany’s basic and diluted earnings per share:

| ** **                                                                    | ** ** | **For the years ended:**                            | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                    | ** ** | **July 1,  2006**                                             | ** ** | **July 2,  2005** | ** ** | **July 3,  2004** | ** ** |
| ** **                                                                    | ** ** | **(in thousands, except per share data)** | ** ** |
| Basic shares used  in the calculation of earnings per share                   |       | 23,017                                                             |       | 22,388 |   | 21,902 |   |
| Effect of dilutive  securities:                                               | * *   | * *                                                           | * *   | * * | * * | * * | * * |
| Stock options                                                                 |       | 931                                                                |       | 685 |   | 810 |   |
| Diluted shares  used in the calculation of earnings per share                 |       | 23,948                                                             |       | 23,073 |   | 22,712 |   |
| Per share effect  of dilutive securities on income from continuing operations |       | $.03                                                               |       | $.01 |   | $.02 |   |
| Per share effect of  dilutive securities on net income                        |       | $.03                                                               |       | $.01 |   | $.01 |   |

 

During the years ended July 1,2006, July 2, 2005, and July 3, 2004, options/SARS to purchase 107,1,392, and 497 shares of common stock, respectively, were not included in thecomputation of diluted earnings (loss) per share because they would have had ananti-dilutive effect.

***Comprehensive Income (Loss)***

The Company computescomprehensive income in accordance SFAS No. 130. SFAS 130, “ReportingComprehensive Income” establishes standards for the reporting and display ofcomprehensive income and its components in the financial statements. Othercomprehensive income (loss), as defined, includes all changes in equity duringa period from non-owner sources. For all periods presented, other comprehensiveincome (loss) includes the effect of foreign currency translation.

***Concentration of Risk***

Financial instruments that are subject to credit riskprimarily consist of cash and cash equivalents, marketable securities,commercial paper and accounts receivable. The Company places its cash and cashequivalents and marketable securities in established financial institutions. Depositsin the financial 

50

----

institutions may exceedthe amount of insurance provided on such deposits. The Company believes thefinancial institutions are financially sound and, accordingly, minimal creditrisk exists. The Company invests in high quality debt securities to minimizeany adverse changes in interest rates.

The Company’s sales are to end users, leasingcompanies, and distributors servicing the medical device market, and reflect abroad domestic and international customer base. The Company does not requirecollateral and has not historically experienced significant credit lossesrelated to receivables from individual customers or groups of customers in anyparticular industry or geographic area. The Company maintains an allowance forpotential losses. No single customer accounted for 10% of the Company’s totalnet sales or accounts and notes receivable.

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

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

***Recent Accounting Pronouncements***

In May 2005, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 154, “Accounting Changes and Error Corrections.”The Statement replaces APB Opinion No. 20, “Accounting Changes” and SFAS No. 3,“Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154requires companies to apply voluntary changes in accounting principlesretrospectively whenever practicable. The requirements are effective for theCompany beginning in fiscal 2007. Adoption of the Statement will have asignificant impact on the Company’s consolidated financial statements to theextent that the Company changes its accounting principles in the future.

In June 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). FIN48 requires companies to determine whether it is more likely than not that atax position will be sustained upon examination by the appropriate taxingauthorities before any part of the benefit can be recorded in the financialstatements. This interpretation also provides guidance on derecognition,classification, accounting in interim periods, and expanded disclosurerequirements. FIN 48 is effective for fiscal years beginning after December 15,2006. The Company is currently in the process of assessing the impact that FIN48 will have on the consolidated financial statements.

51

----

**2.**                 MarketableSecurities

Marketablesecurities consist of the following:

|                         | ** ** | **Carrying  value**     | ** ** | **Fair  value** | ** ** | **Unrealized   losses** | ** ** |
|-------------------------|------------|-------------------------|------------|-----------------|------------|------------------------------|------------|
| ** **              | ** ** | **(in thousands)** | ** ** |
| Short-term              | ** ** | ** **              | ** ** | ** **      | ** ** |                         | ** ** | ** ** |   |
| Held-to-maturity:       | ** ** | ** **              | ** ** | ** **      | ** ** |                         | ** ** | ** ** |   |
| Commercial paper        |       | $                       | 3,962      |            | $          | 3,960                        |       |   | $ | (2 | ) |   |
| Corporate bonds         |       | 3,005                   |       | 2,996           |       |                         | (9         | ) |   |
| Government securities   |       | 17,997                  |       | 17,946          |       |                         | (51        | ) |   |
| Certificates of deposit |       | 2,368                   |       | 2,356           |       |                         | (12        | ) |   |
|                    |       | $                       | 27,332     |            | $          | 27,258                       |       |   | (74 | ) |   |
|                         |            |                         |            |                 |            |                              |            |  |  |  |  |  |

 

| ** **              | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** | **Unrealized  Gains/loss** | ** ** |
|-------------------------|------------|---------------------|------------|-----------------|------------|----------------------------|------------|
| Long-term               |       |                |       |            |       |                       |       |   |   |
| Held-to-maturity:       |       |                |       |            |       |                       |       |   |   |
| Government securities   |       | $                   | 8,998      |            | $          | 8,917                      |       |   | $ | (81 | ) |   |
| Certificates of deposit |       | 2,955               |       | 2,903           |       |                       | (52        | ) |   |
|                    |       | $                   | 11,953     |            | $          | 11,820                     |       |   | (133 | ) |   |
| Total unrealized loss   |       |                |       |            |       |                       | $          | (207 | ) |   |

 

**3.**                 Inventories

Inventories consist of the following:

| ** **             | ** ** | **2006**                | ** ** | **2005** | ** ** |
|------------------------|------------|-------------------------|------------|----------|------------|
| ** **             | ** ** | **(in thousands)** | ** ** |
| Raw materials          |       | $                       | 5,936      |     | $          | 3,968 |   |
| Work in process        |       | 1,151                   |       | 166      |       |
| Finished goods         |       | 9,579                   |       | 8,542    |       |
| Total inventories, net |       | $                       | 16,666     |     | $          | 12,676 |   |

 

**4.**                 Propertyand Equipment

Propertyand equipment consist of the following:

| ** **                               | ** ** | **2006**                | ** ** | **2005** | ** ** |
|------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                               | ** ** | **(in thousands)** | ** ** |
| Leasehold  improvements                  |       | $                       | 920        |     | $          | 743 |   |
| Office furniture                         |       | 603                     |       | 567      |       |
| Computers,  software and other equipment |       | 9,236                   |       | 8,698    |       |
|                                     |       | 10,759                  |       | 10,008   |       |
| Less accumulated  depreciation           |       | 7,457                   |       | 6,768    |       |
| Property and equipment,  net             |       | $                       | 3,302      |     | $          | 3,240 |   |

 

Depreciation expense was $571 and $755 for the yearsended July 1, 2006 and July 2, 2005, respectively.

52

----

**5.**                 WarrantyReserve

Thefollowing table reflects changes in the Company’s accrued warranty accountduring the fiscal years ended July 1, 2006 and July 2, 2005:

| ** **                                  | ** ** | **2006**                | ** ** | **2005** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                  | ** ** | **(in thousands)** | ** ** |
| Beginning balance                           |       | $                       | 8,645      |     | $          | 8,257 |   |
| Plus accruals  related to new sales         |       | 8,323                   |       | 8,864    |       |
| Less amortization  of prior period accruals |       | 7,339                   |       | 8,476    |       |
| Ending balance                              |       | $                       | 9,629      |     | $          | 8,645 |   |

 

**6.**                 DeferredRevenue

The Company offers extended service contracts that maybe purchased after a standard warranty has expired. Service contracts may bepurchased for periods from one to five years. The Company recognizes servicecontract revenue ratably over the life of the contract. Actual service contractexpenses incurred and charged to costs of sales during an interim period may bemore or less than the amount of amortized service contract revenue recognizedin that period.

Thefollowing table reflects changes in the Company’s deferred revenue during thefiscal year ended July 1, 2006 and July 2, 2005:

| ** **                                   | ** ** | **2006**                | ** ** | **2005** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                   | ** ** | **(in thousands)** | ** ** |
| Beginning balance                            |       | $                       | 8,350      |     | $          | 4,055 |   |
| Plus deferral of  new service contract sales |       | 11,892                  |       | 9,672    |       |
| Less recognition  of deferred revenue        |       | 9,913                   |       | 5,377    |       |
| Ending balance                               |       | $                       | 10,329     |     | $          | 8,350 |   |

 

Thefollowing table reflects the Company’s current and long-term portions ofdeferred revenues for the fiscal year ended July 1, 2006 and July 2,2005:

| ** **                            | ** ** | **2006**                | ** ** | **2005** | ** ** |
|---------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Total service  contract revenue       |       | $                       | 10,329     |     | $          | 8,350 |   |
| Less current  portion                 |       | 8,342                   |       | 6,037    |       |
| Long-term portion of  deferred income |       | $                       | 1,987      |     | $          | 2,313 |   |

 

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

***Line of Credit***

The Company has arenewable $10,000,000 revolving credit agreement with a major bank withinterest at the bank’s base rate or LIBOR plus 2.25 percent. Any borrowingsoutstanding under the line of credit are due on demand or according to apayment schedule established at the time funds are borrowed. The line of creditis unsecured. The agreement contains restrictive covenants limiting theestablishment of new liens, and the purchase of margin stock. No amounts wereoutstanding under the line of credit as of July 1, 2006 or July 2,2005.

***Restricted Cash***

A financing company usedby customers has limited recourse with the Company on a small number of productleases. As such, the Company has placed approximately $0.2 million inrestricted funds at this 

53

----

institutionas collateral as of July 1, 2006 and July 2, 2005, respectively. Thisrestricted cash represents the entire exposure under these agreements.

***Operating Lease Commitments***

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

Outstandinglease commitments arereflected in the following table as of July 1, 2006:

| ** **                    | ** ** | **(in Thousands)** | ** ** |
|-------------------------------|------------|-------------------------|------------|
| 2007                          |       |                    | $          | 1,267 |   |   |
| 2008                          |       |                    | 982        |   |   |
| 2009                          |       |                    | 423        |   |   |
| 2010                          |       |                    | 96         |   |   |
| 2011                          |       |                    | 45         |   |   |
| Total minimum lease  payments |       |                    | $          | 2,813 |   |   |

 

Total rent expense wasapproximately $863, $1,376, and $884 in fiscal 2006, 2005 and 2004,respectively.

***Royalty***

In August 2000, the Company obtained through anamended license agreement the with Regents of the University of California (“Regents”),the exclusive license rights to the Dynamic Cooling Device (“DCD”) (subject tocertain limited license rights of Cool Touch, Inc. (“Cool Touch”)) in thefollowing fields of use: procedures that involve skin resurfacing andrejuvenation, vascular skin lesions, and laser hair removal. Cool Touch, asubsidiary of New Star Technology, Inc. obtained a license to the DCD on aco-exclusive basis with the Company in certain narrower fields of use. CoolTouch is restricted in its ability to assign its license rights to certainexisting competitors of the Company. The Company is entitled to one-half of allroyalty income payable to the Regents from Cool Touch. Under the amendedagreement, the Company no longer is required by the Regents to negotiatesublicenses to third parties. However, the Company is entitled to one-half ofall royalties due from any other entity that licenses the DCD technology fromthe Regents in other fields of use.

The Company recognized royalty expense of $9.2 millionand $2.6 million for fiscal 2005 and 2004, respectively, based on the licenseagreement with the Regents. Included in the fiscal 2005 expense of $9.2 millionis $4.8 million of expense related to the Regents arbitration decision issuedin 2005. Of that $4.8 million, $1.3 million related to fiscal 2005, $3.0million related to fiscal 2004 and 0.5 million related to prior years (seenote 13).

Effective July 3, 2005, the Company amendedcertain portions of their agreement with the Regents whereby for the annuallicense fee of $0.3 million, the Company’s royalty obligation was reduced to 3%from its prior level of 6%. The annual fee of $0.3 million was paid by a lumpsum of $3.0 million and is being amortized over the remaining life of thepatent agreement, which as of July 1, 2006 was nine years. This reducedroyalty rate and the amortization of the annual license fee payment isreflected in the Company’s financial statements as of July 1, 2006. Theunamortized portion of the license feepayment is 

54

----

reflectedin prepaid licenses in the July 1, 2006 balance sheet. The Companyrecognized royalty expense of $3.6 million for fiscal year 2006

The outstanding contractual obligations relating tofuture minimum royalties payable to the Regents are reflected in the followingtable as of July 1, 2006:

 

| ** **                      | ** ** | **(in Thousands)** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| 2007                            |       |                    | $          | 1,000 |   |   |
| 2008                            |       |                    | 1,000      |   |   |
| 2009                            |       |                    | 1,000      |   |   |
| 2010                            |       |                    | 1,000      |   |   |
| 2011                            |       |                    | 250        |   |   |
| Thereafter                      |       |                    | 1,000      |   |   |
| Total minimum royalty  payments |       |                    | $          | 5,250 |   |   |

 

**8.**                 Stockholders’Equity

**Stock Plans**

**1990 CandelaCorporation Employee Stock Purchase Plan**

The 1990 Employee Stock Purchase Plan (the “PurchasePlan”) provides for the sale of up to 1,500,000 shares of common stock toeligible employees. The shares are issued at 85% of the market price on thelast day of semi-annual periods. Substantially all full-time employees areeligible to participate in the Purchase Plan. At July 1, 2006 there were695,226 shares available for sale.

The following is a summary of shares issued under thePurchase Plan:

| ** ** | ** ** | **Shares** | ** ** | **Range of  Price per share** | ** **   |
|------------|------------|------------|------------|----------------------------------------------|--------------|
| 2004       |       | 37,956     |       | $                                            | 5.00-$8.00   |   |
| 2005       |       | 35,059     |       | $                                            | 8.50-$9.00   |   |
| 2006       |       | 25,001     |       | $                                            | 12.50-$13.25 |   |

 

***1985, 1987, 1989 and 1998 Candela Corporation StockOption Plans***

The 1985, 1987, 1989 and 1998 Stock Option Plans (the“Stock Option Plans”) provide for the granting of incentive stock options toemployees for the purchase of common stock at an exercise price not less thanthe fair market value of the stock on the date of grant. The Stock Option Plansalso provide for the granting of non-qualified stock options.

Effective October 5, 2005, the 1998 Stock OptionPlan (the “Stock Option Plan”) was amended for granting of incentive stockoptions, non-qualified stock options, SARS. The stock options provide theholder the right to purchase common stock at an exercise price not less thanthe fair market value of the stock on the date of grant. SARS provide the holderthe right to receive an amount, payable in stock, cash or in any combination ofthese, as specified by a Committee established by the Board of Directors, equalto the excess of the market value of our common shares on the date of exerciseover the base price at the time of the grant. The base price may not be lessthan the market price of our common shares on the date of the grant.

The Board of Directors has terminated the granting ofoptions under the 1985, 1987 and 1989 Stock Option Plans. Options granted underthe 1998 Stock Option Plan become exercisable on the date of grant or ininstallments, as specified by a Committee established by the Board ofDirectors, and expire ten years from the date of the grant.   The maximum number of shares for whichoptions may be granted under the 1998 Stock Option Plan is 5,300,000.

55

----

Where payment uponexercise of SARS is made in shares of the Company’s common stock, only the netnumber of shares of common stock issued in connection with such exercise shallbe deemed “issued” for this purpose. The Company may satisfy the awards upon exerciseunder both plans with either newly issued or treasury shares.

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

The 1990 and 1993 Non-Employee Director Stock OptionPlans (the “Non-Employee Director Plans,” collectively with the Stock OptionPlans, the “Plans”) provide for the issuance of options for the purchase of upto 180,000 and 240,000 shares of common stock, respectively. Under theNon-Employee Director Plans, each new director who is neither an employee noran officer upon becoming a director receives a one-time grant of an option topurchase 20,000 shares of common stock at an exercise price equal to the fairmarket value of the common stock on the date of grant. Under the 1990 and 1993Non-Employee Director Plans, options become exercisable in equal amounts over aperiod of four and two years, respectively. Shares under the Non-EmployeeDirector Plans expire four and ten years, respectively, after the date of grantand are nontransferable.

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

| ** **                                            | ** ** | ** **         | ** ** | ** **             | ** **                | **Weighted**            | ** ** | **Aggregate** | ** ** | **Weighted Average** | ** ** |
|-------------------------------------------------------|------------|--------------------|------------|------------------------|---------------------------|-------------------------|------------|---------------|------------|---------------------------|------------|
| ** **                                            | ** ** | **Number of** | ** ** | ** **             | ** **                | **Exercise Price** | ** ** | **Intrinsic** | ** ** | **Contractual**           | ** ** |
| ** **                                            | ** ** | **Shares**         | ** ** | **Option Prices** | ** **                | **per Share**      | ** ** | **Value**     | ** ** | **Term**                  | ** ** |
| Balance  outstanding at June 28, 2003            |       | 2,057,922          |       |                   |                      |                    |       |          |       |                      |       |   |   |   |   |
| Granted                                               |       | 1,038,560          |       | $                      | 5.59 - $11.98             |                    |       | $             | 9.82       |                      |       |   |   |   |   |   |   |
| Exercised                                             |       | (928,730           | )          | $                      | 1.06 - $ 6.02        |                    |       | $             | 3.44       |                      |       |   |   |   |   |   |   |
| Forfeited                                             |       | (58,410            | )          | $                      | 2.75 - $11.96             |                    |       | $             | 9.23       |                      |       |   |   |   |   |   |   |
| Balance  outstanding at July 3, 2004             |       | 2,109,342          |       |                   |                      |                    | $          | 6.58          |       |                      |       |   |   |   |   |   |
| Granted                                               |       | 572,898            |       | $                      | 8.00 - $12.33             |                    |       | $             | 10.04      |                      |       |   |   |   |   |   |   |
| Exercised                                             |       | (156,527           | )          | $                      | 1.08 -  $  9.90 |                    |       | $             | 4.01       |                      |       |   |   |   |   |   |   |
| Forfeited                                             |       | (41,153            | )          | $                      | 2.57 - $10.93             |                    |       | $             | 9.15       |                      |       |   |   |   |   |   |   |
| Balance  outstanding at July 2, 2005             |       | 2,484,560          |       |                   |                      |                    | $          | 7.48          |       |                      |       |   |   |   |   |   |
| Granted                                               |       | 550,000            |       | $                      | 15.33 - $22.00            |                    |       | $             | 15.69      |                      |       |   |   |   |   |   |   |
| Exercised                                             |       | (1,061,557         | )          | $                      | 1.95 - $11.98             |                    |       | $             | 6.97       |                      |       |   |   |   |   |   |   |
| Forfeited                                             |       | (8,015             | )          | $                      | 5.59 - $10.93             |                    |       | $             | 10.33      |                      |       |   |   |   |   |   |   |
| Balance  outstanding at July 1, 2006             |       | 1,964,988          |       |                   |                      |                    |       |          |       | $                         | 11,250,560 |   |   | 7.79 |   |   |
| Options/SARS  exercisable at July 1, 2006        |       | 1,236,238          |       |                   |                      |                    | $          | 8.42          |       |                      | $          | 9,199,675 |   |   | 7.08 |   |   |
| Options/SARS available  to grant at July 1, 2006 |       | 553,393            |       |                   |                      |                    |       |          |       |                      |       |   |   |   |   |

 

56

----

Thefollowing table summarizes information about stock options/SARS outstandingunder the Plans as of July 1, 2006:

| **OPTIONS/SARS OUTSTANDING**           | ** ** | **OPTIONS/SARS** | ** **    |
|---------------------------------------------|------------|------------------|---------------|
| ** **                                  | ** ** | ** **       | ** **    | **Weighted** | ** ** | ** ** | ** ** | **EXERCISABLE** | ** ** |
| ** **                                  | ** ** | ** **       | ** **    | **Average** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                  | ** ** | ** **       | ** **    | **Remaining** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | **Number**       | ** **    | **Contractual** | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Range of Exercise Prices** | ** ** | ** **       | ** **    | **Outstanding** | ** ** | **Life (yrs)** | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $  1.21 - $  3.25       |       |             | 207,384       |   |   |   | 4.02 |   |   |   | $ | 2.43 |   |   | 207,384 |   |   | $ | 2.43 |   |   |
| $  3.31 - $  4.67       |       |             | 250,942       |   |   |   | 6.21 |   |   |   | $ | 4.29 |   |   | 158,442 |   |   | $ | 4.07 |   |   |
| $  5.59 - $  9.50       |       |             | 336,446       |   |   |   | 7.99 |   |   |   | $ | 8.26 |   |   | 250,196 |   |   | $ | 8.62 |   |   |
| $  9.90 - $11.40                  |       |             | 219,104       |   |   |   | 8.29 |   |   |   | $ | 10.53 |   |   | 219,104 |   |   | $ | 10.53 |   |   |
| $11.48 - $11.96                             |       |             | 175,000       |   |   |   | 7.81 |   |   |   | $ | 11.90 |   |   | 175,000 |   |   | $ | 11.90 |   |   |
| $11.98 - $11.98                             |       |             | 181,112       |   |   |   | 7.85 |   |   |   | $ | 11.98 |   |   | 181,112 |   |   | $ | 11.98 |   |   |
| $12.15 - $12.15                             |       |             | 30,000        |   |   |   | 7.80 |   |   |   | $ | 12.15 |   |   | 30,000 |   |   | $ | 12.15 |   |   |
| $12.33 - $12.33                             |       |             | 15,000        |   |   |   | 7.80 |   |   |   | $ | 12.33 |   |   | 15,000 |   |   | $ | 12.33 |   |   |
| $15.33 - $15.33                             |       |             | 520,000       |   |   |   | 9.58 |   |   |   | $ | 15.33 |   |   | — |   |   | $ | — |   |   |
| $22.00 - $22.00                             |       |             | 30,000        |   |   |   | 9.78 |   |   |   | $ | 22.00 |   |   | — |   |   | $ | — |   |   |
| $  1.21 - $22.00                  |       | ** **       | **1,964,988** |   |   |   | 7.79 |   |   |   | $ | 10.23 |   | ** ** | **1,236,238** | ** ** |   | $ | 8.42 |   |   |
|                                             |            |                  |               |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

There were 550,000 stockbased SARS granted during the fiscal year ended July 1, 2006. The SARSgranted to employees become exercisable ratably over four years, while the SARSgranted to directors become exercisable over two years. All SARS issued infiscal 2006 are payable in stock. The total intrinsic value of optionsexercised during the fiscal ended July 1, 2006 was $17 million.

57

----

**9.   IncomeTaxes**

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

| ** **                                                       | ** ** | **For Year Ended** | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                       | ** ** | **July 1,**             | ** ** | **July 2,** | ** ** | **July 3,** | ** ** |
| ** **                                                       | ** ** | **2006**                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income from continuing  operations before income taxes:          |       |                         |       |   |   |   |   |
| Domestic                                                         |       | $                            | 20,645     |   | $ | 7,075 |   | $ | 12,880 |   |
| Foreign                                                          |       | 1,757                        |       | 1,583 |   | 2,218 |   |
|                                                             |       | $                            | 22,402     |   | $ | 8,658 |   | $ | 15,098 |   |
| Income (loss)  from discontinued operations before income taxes: |       |                         |       |   |   |   |   |
| Domestic                                                         |       | $                            | —     |   | $ | 1,374 |   | $ | (3,821 | ) |
| Provision for  (benefit from) income taxes:                      |       |                         |       |   |   |   |   |
| Current  provision:                                              |       |                         |       |   |   |   |   |
| Federal                                                          |       | $                            | 8,173      |   | $ | 2,101 |   | $ | 2,911 |   |
| State                                                            |       | 735                          |       | 193 |   | 238 |   |
| Foreign                                                          |       | 952                          |       | 375 |   | 552 |   |
| Total current  provision or (benefit from) income taxes          |       | 9,860                        |       | 2,669 |   | 3,701 |   |
| Deferred provision  (benefit)                                    |       |                         |       |   |   |   |   |
| Federal                                                          |       | (1,409                       | )          | 40 |   | (543 | ) |
| State                                                            |       | (173                         | )          | — |   | — |   |
| Foreign                                                          |       | (810                         | )          | — |   | — |   |
| Total deferred  provision or (benefit from) income taxes         |       | (2,392                       | )          | 40 |   | (543 | ) |
| Total provision for  income taxes                                |       | $                            | 7,468      |   | $ | 2,709 |   | $ | 3,158 |   |

 

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

| ** **                                  | ** ** | **July 1,** | ** ** | **July 2,** | ** ** |
|---------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                  | ** ** | **2006**         | ** ** | **2005**         | ** ** |
| Accrued warranty  reserve                   |       | $                | 3,569      |             | $          | 1,959 |   |
| Inventory  valuation reserves               |       | 1,186            |       | 817              |       |
| Restructuring  reserve                      |       | 337              |       | 455              |       |
| Deferred revenue                            |       | 1,657            |       | 1,544            |       |
| Federal and state  tax credit carryforwards |       | 615              |       | 321              |       |
| Bad debt reserve                            |       | 485              |       | 681              |       |
| Other                                       |       | 292              |       | (34              | )          |
| Deferred tax assets                         |       | $                | 8,142      |             | $          | 5,743 |   |

 

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

| ** **                                   | ** ** | **July 1,** | ** ** | **July 2,** | ** ** | **July 3,** | ** ** |
|----------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                   | ** ** | **2006**         | ** ** | **2005**         | ** ** | **2004**         | ** ** |
| Statutory rate                               |       |             | 35         | %                |       |             | 35         | % |   |   | 35 | % |   |
| State income taxes                           |       |             | 2          | %                |       |             | 1          | % |   |   | 1 | % |   |
| Difference between  foreign and US tax rates |       |             | (2         | )%               |       |             | (2         | )% |   |   | (3 | )% |   |
| Benefit from foreign  sales credits          |       |             | (2         | )%               |       |             | (3         | )% |   |   | (3 | )% |   |
| Utilization of deferred  tax assets          |       |             | —     |             |       |             | (6         | )% |   |   | — |   |   |
| Other                                        |       |             | 1          | %                |       |             | —     |   |   |   | — |   |   |
| Effective tax rate                           |       |             | 33         | %                |       |             | 25         | % |   |   | 30 | % |   |

 

58

----

As of July 1, 2006, the Company has no valuationallowance against the deferred tax asset in the United States. A valuationallowance of approximately $136 has been established in France. In accountingfor the deferred tax asset, the Company has relied on historical data todetermine the necessity of providing a valuation allowance. Under therequirements of SFAS No. 109, “Accounting for Income Taxes”, the Companybelieves it is more likely than not that the deferred tax asset, unlessotherwise noted, will be fully utilized against future income taxes. At July 1,2006, the Company had available research and development tax credits ofapproximately $947 for state income tax purposes that will begin expiring infiscal year 2006.

As of July 2, 2005, the Company has no valuationallowance against the deferred tax asset. In accounting for the deferred taxasset, the Company has relied on historical data to determine the necessity ofproviding a valuation allowance for this asset. The Company believed it is morelikely than not that the deferred tax asset would be fully utilized againstfuture income taxes. At July 2, 2005, the Company had available researchand development tax credits of approximately $321 for state income tax purposesthat began expiring in fiscal year 2006.

No amount for U.S. incometax has been provided on undistributed earnings of the Company’s foreign subsidiariesbecause the Company considers such earnings to be indefinitely reinvested. Inthe event of distribution of those earnings in the form of dividends orotherwise, the Company would be subject to both U.S. income taxes, subject toan adjustment, if any, for foreign tax credits, and foreign withholding taxespayable to certain foreign tax authorities. Determination of the amount of U.S.income tax liability that would be incurred is not practicable because of thecomplexities associated with this hypothetical calculation; however,unrecognized foreign tax credit carryforwards may be available to reduce someportion of the U.S. tax liability, if any.

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

The Company operates principally in one industry segment:the design, manufacture, sale, and service of medical devices and relatedequipment. The results in this segment have been presented in the ConsolidatedStatements of Operations for the appropriate periods. The Company has no singlecustomer that represents a significant portion of revenue and accountsreceivable during the periods presented.

59

----

***Geographic data***

Geographicinformation for fiscal 2006, 2005 and 2004 is as follows (in thousands):

| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenue:                                         |       |     |       |     |       |     |       |
| United States                                    |       | $        | 105,273    |     | $          | 85,243   |       | $ | 69,626 |   |
| Intercompany                                     |       | 21,612   |       | 20,460   |       | 17,705   |       |
|                                             |       | 126,885  |       | 105,703  |       | 87,331   |       |
| Japan                                            |       | 20,586   |       | 19,550   |       | 16,947   |       |
| Spain                                            |       | 15,913   |       | 12,242   |       | 10,780   |       |
| Germany                                          |       | 3,088    |       | 3,540    |       | 3,550    |       |
| France                                           |       | 3,404    |       | 3,326    |       | 3,535    |       |
| Italy                                            |       | 1,202    |       | —   |       | —   |       |
|                                             |       | 171,078  |       | 144,361  |       | 122,143  |       |
| Elimination                                      |       | (21,612  | )          | (20,460  | )          | (17,705  | )          |
| Consolidated total                               |       | 149,466  |       | $        | 123,901    |     | $          | 104,438 |   |
| Income (loss)  from operations:                  |       |     |       |     |       |     |       |
| United States                                    |       | $        | 20,057     |     | $          | 7,390    |       | $ | 11,158 |   |
| Europe                                           |       | 861      |       | 763      |       | 663      |       |
| Japan                                            |       | 906      |       | 626      |       | 763      |       |
| Elimination                                      |       | (1,151   | )          | (688     | )          | 1,301    |       |
| Consolidated total                               |       | $        | 20,673     |     | $          | 8,091    |       | $ | 13,885 |   |
| Geographic  identification of long-lived assets: |       |     |       |     |       |     |       |
| United States                                    |       | $        | 2,979      |     | $          | 3,028    |       | $ | 3,223 |   |
| Europe                                           |       | 323      |       | 212      |       | 183      |       |
| Consolidated  total                              |       | $        | 3,302      |     | $          | 3,240    |       | $ | 3,406 |   |

 

United States revenueincludes export sales to unaffiliated companies located principally in Europe,the Asia-Pacific region and Latin America, which approximated $35.9, $27.7, and$19.7 million in fiscal 2006, 2005, and 2004, respectively.

**11.   EmployeeBenefit Plans**

The Company offers a 401(k) Planwhich allows eligible United States employees to make tax-deferredcontributions, a portion of which are matched by the Company. The Company maymake discretionary matching contributions to the Plan in an amount determinedby its Board of Directors. Company contributions vest ratably with three yearsof employment and amounted to $362, $320, and $224 in fiscal 2006, 2005 and2004, respectively.

**12.   DiscontinuedOperations**

On September 27, 2003, the Company permanentlyclosed its remaining skin care center, which was located in Boston. The closureof the Boston skin care center, together with the earlier closing of ourScottsdale, Arizona spa, and the associated cessation of this line of businesswas accounted for as a discontinued operation in accordance with SFAS No. 144,“*Accounting for the Impairment or Disposal ofLong-Lived Assets*” and SFAS No. 146, “*Accountingfor Costs Associated with Exit or Disposal Activities*”. As a result,during the fiscal year ended 2004, the Company recorded a $2,095 charge for theaccrual of $3,000 of future occupancy costs, primarily relating to future leasepayments for the Boston facility, and $348 of severance obligations and otherrelated costs of closure, net of anticipated tax benefits of $1,253.

60

----

During the fiscal year 2005, the landlord for theBoston facility secured a sublease for that property. The sublessee commencedmaking payments to the landlord during December of 2004. As a result ofthese and future payments scheduled under the sublease, the Company revised theestimated future costs associated with the Boston facility and, in the fiscalyear 2005, reversed approximately $859 of the restructuring reserve. This reversal represents theaforementioned anticipated economic benefit due to sublessee payments of$1,703, net of legal and other fees of approximately $329 and income taxes ofapproximately $515.

At July 1, 2006, thediscontinued segment had a net liability of approximately $1,287 consistingprimarily of the aforementioned reserve of $447 and deferred gift certificaterevenue of $840. Revenues for discontinued operations were $400 for the fiscalyear 2004. There were no revenues in fiscal 2006 and 2005.

**13.   LegalProceedings**

On August 9, 2006, Palomar Medical Technologies, Inc.(“Palomar”) filed suit against the Company in the United States District Courtfor the District of Massachusetts, asserting infringement by theCompany of U.S. Patent No. 5,735,844. On August 10, 2006, theCompany filed suit against Palomar in the United States District Court for theDistrict of Massachusetts, asserting infringement by Palomar of U.S.Patent Nos. 6,659,999, 5,312,395, and 6,743,222. Palomar served its complaintand summons on the Company on August 15, 2006. The Company served itscomplaint and summons on Palomar on August 10, 2006. The Companybelieves that it has meritorious defenses against Palomar’s allegationsin its complaint. Both parties seek to recover compensatory andtreble damages, as well as attorneys’ fees and an injunction againstthe other party. While the Company intends to vigorously contest Palomar’s allegations,and to pursue its own claims against Palomar,each lawsuit is inherently uncertain and unpredictable asto its ultimate outcome. An adverse outcome in Palomar’s caseagainst us could materially hurt our business, financial condition,results of operations and cash flows.

On August 20, 2005, DVI Inc., DVI FinancialServices, Inc., and DVI Business Credit Corporation Liquidating Trust(collectively, the “DVI Entities”) filed a complaint against the Company in theUnited States Bankruptcy Court for the District of Delaware. The DVI Entitiesfiled voluntary petitions for relief under Chapter 11 of the United StatesBankruptcy Code on August 25, 2003 (the “Petition Date”). The complaintasserts, among other things, that (i) on or within 90 days before thePetition Date, one or more of the DVI Entities transferred property to or forthe benefit of the Company in an aggregate amount not less than $1,8 million, (ii) atthe time of the transfers the DVI Entities were insolvent, (iii) thetransfers enabled the Company to receive more than the Company was entitled tounder the United States Bankruptcy Code, and (iv) the transfersconstitute an avoidable preference. The complaint looked for avoidance andrecovery of the transfers, plus interest and costs of the proceeding. Thecomplaint also looked for, among other things, to disallow the Company’s claimsagainst the DVI Entities until the Company has paid the recovery amount to theDVI Entities. As previously disclosed in the Company’s periodic reports, priorto the filing of the complaint, the Company had received demands for paymentof the recovery amount. The Company believed that it received alltransfers from the DVI Entities in the ordinary course of businessand that the allegations in the complaint are without merit. On March 31,2006, the Company settled the dispute for a one-time payment of $150.

The Company has an Amended and Restated LicenseAgreement (the “License”) with the Regents of the University of California (the“Regents”) pursuant to which the Company licenses certain patent rights to itsdynamic cooling device (“DCD”) from the Regents. The Company sells its DCD as acomponent part of its Smoothbeam® laser system and as an accessory to its otherlaser systems. In April of 2004, the Regents issued a notice of default underthe License, asserting, among other things, that the Company was in breach ofthe License for the alleged failure to make required royalty payments and tomake required disclosures. The Regents’ April notice asserted that the totalunderpaid royalties, interest and other 

61

----

charges for the periodfrom August of 2000 through September 2003 are $1,128,000. The Regents issued asubsequent notice of default, dated June 30, 2004, relating to thequarterly periods ended December 27, 2003 and March 27, 2004, forwhich the Regents asserted that the Company underpaid additional royaltiesamounting to $1.4 million. The Regents issued a subsequent notice ofdefault, dated September 10, 2004, relating to the quarterly period endedJuly 3, 2004, for which the Regents asserted that the Company underpaidadditional royalties amounting to $1 million.

Under the License, disputes are to be settled bybinding arbitration through a mutually acceptable single arbitrator. OnJune 14, 2004, the Company filed a Demand for Arbitration to adjudicatethe differing interpretations of the License held by the Company and theRegents. On July 8, 2004, the Regents filed their response andcounterclaim for breach of contract and declaratory relief. The Companydeposited approximately $1.0 million in June of 2004, and an additional $1.0million and $1.4 million in August and December, respectively, of 2004, into anescrow fund to be paid in whole or in part to the Company or the Regents asdetermined by the arbitrator.

On February 17th 2005, the arbitrator issued aninterim decision in the dispute concerning our royalty obligations under ourAmended and Restated License Agreement with the Regents. The arbitrator foundin favor of the Regents as to the primary issue in the dispute, finding that weare obligated to pay royalties on the good faith list prices of our Sclero,SPTL, GentleLASE and GentleYAG laser systems when those systems are sold withDCDs, and not just on the good faith list prices of the DCDs for sale withthose systems. The arbitrator denied the Regents’ request for the right to declarea forfeiture of our license with the Regents. In connection with this interimdecision we recognized charges of approximately $5.6 million during fiscalyear 2005. These charges consisted of the settlement of prior year royaltyclaims made by the Regents against the Company of approximately$3.4 million, royalty claims made by the Regents against the Company ofapproximately $3.4 million, royalty claims for our first and second fiscalquarters of 2005 of approximately $0.5 and $0.9 million, respectively, and$0.8 million in attorney fees, interest, and professional costs asreimbursement of those charges to the Regents as required by the aforementionedlicense agreement. The royalty charges have been listed as a separate lineunder cost of goods sold. All other charges have been listed as a separate linewithin operating expenses.

On May 4th, 2005, the arbitrator issued his finalaward after review of post-arbitration submissions by the parties as tocalculation of damages. The final award was consistent with our interimestimation and recognition of expense recorded during the third quarter. Therewill not be any material additional charges related to this matter in futureperiods. As a result of the arbitrator’s ruling, the Company incurred royaltyobligations to the Regents on ongoing sales of the DCD at a higher royalty ratethan it has recognized on DCD sales over the past few years.

From time to time, the Company is a party to variouslegal proceedings incidental to its business. The Company believes that none ofthe legal proceedings, other than Palomar, that are presently pending, ifadversely decided against the Company, will have a material adverse effect uponits financial position, results of operations, or liquidity.

62

----

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

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

 

| ** **                         | ** ** | **Quarter Ended:** | ** ** |
|------------------------------------|------------|-------------------------|------------|
| **2006**                           | ** ** | ** **              | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenues                           |       | $                       | 28,087     |   | $37,720 |   | $ | 42,314 |   | $ | 41,345 |   |
| Gross profit                       |       | 14,552                  |       | 18,975 |   | 21,398 |   | 18,923 |   |
| Income from  continuing operations |       | 3,017                   |       | 4,510 |   | 5,003 |   | 2,404 |   |
| Net income                         |       | 3,017                   |       | 4,510 |   | 5,003 |   | 2,404 |   |
| Earnings per common  share         |       |                    |       |   |   |   |   |   |   |
| Basic:                             |       | $                       | 0.13       |   | $ | 0.20 |   | $ | 0.22 |   | $ | 0.10 |   |
| Diluted:                           |       | $                       | 0.13       |   | $ | 0.19 |   | $ | 0.21 |   | $ | 0.10 |   |
|                                    |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 9.**                        Changes inand Disagreements with Accountants on Accounting and Financial Disclosure.

Not Applicable

**Item 9A.**                Controlsand Procedures

(a)  EVALUATIONOF DISCLOSURE CONTROLS AND PROCEDURES

We have established disclosure controls and procedures(“Disclosure Controls”) to ensure that information required to be disclosed inthe Company’s reports filed under the Securities Exchange Act of 1934, asamended, is recorded, processed, summarized and reported within the timeperiods specified in the U.S. Securities and Exchange Commission’s rules andforms. Disclosure Controls are also designed to ensure that such information isaccumulated and communicated to management, including the CEO and CFO, asappropriate to allow timely decisions regarding required disclosure. OurDisclosure Controls were designed to provide reasonable assurance that thecontrols and procedures would meet their objectives. Our management, includingthe Chief Executive Officer and Chief Financial Officer, realizes that nocontrol system can prevent all possibilities of error or fraud. A controlsystem, no matter how well designed and operated, can provide only reasonableassurance of achieving the designed control objectives and management isrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures. Because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatall control issues and instances of fraud, if any, within the 

63

----

Company have beendetected. These inherent limitations include the realities that judgments indecision-making can be faulty, and that breakdowns can occur because of simpleerror or mistake. Additionally, controls can be circumvented by the individualacts of some persons, by collusions of two or more people, or by managementoverride of the control. Because of the inherent limitations in acost-effective, maturing control system, misstatements due to error or fraudmay occur and not be detected.

As of the end of the period covered by this Form 10-K,management, with the participation of the Chief Executive Officer and ChiefFinancial Officer, has performed an evaluation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) ofthe Securities Exchange Act of 1934). This evaluation included consideration ofthe controls, processes and procedures that comprise our internal control overfinancial reporting. Based on such evaluation, our Chief Executive Officer andChief Financial Officer concluded that, as of July 1, 2006, our disclosurecontrols and procedures were effective to provide reasonable assurance  that information required to be disclosed byus in the reports that we file under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms and that such information is accumulated andcommunicated to our management as appropriate to allow timely decisionsregarding required disclosure.

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

Management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rules 13a-15(f). Under the supervision andwith the participation of management, including our Chief Executive Officer andChief Financial Officer, we conducted an evaluation of the effectiveness of ourinternal control over financial reporting as of July 1, 2006, based on theframework in “Internal Control—Integrated Framework” issued by the Committee ofSponsoring Organizations of the Treadway Commission (“COSO”).

Based on our assessment, management determined that nomaterial weakness existed in the Company’s internal controls over financialreporting as of July 1, 2006. In addition, based on such assessment, our Chief Executive Officer and ChiefFinancial Officer concluded that, as of July 1, 2006, our disclosurecontrols and procedures were effective to provide reasonable assurance  that information required to be disclosed byus in the reports that we file under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms and that such information is accumulated andcommunicated to our management as appropriate to allow timely decisionsregarding required disclosure.

The Company’s external auditors, BDO Seidman, LLP, anindependent registered public accounting firm, have issued an audit report onour assessment of the Company’s internal control over financial reporting. Thisreport appears on page 37.

(c) CHANGES IN INTERNAL CONTROL OVER FINANCIALREPORTING

Therewas no change in our internal control over financial reporting (as definedunder Rule 13a-15(f) under the Exchange Act) during our fourthquarter that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

| /s/ GERARD PUORRO                |     | /s/ F. PAUL  BROYER       |
|----------------------------------|----------|---------------------------|
| Gerard Puorro                    |     | F. Paul Broyer            |
| *President  and Chief Executive* | * * | *Chief Financial Officer* |
| September 1,  2006          |     |                      |

 

**Item 9B.**               OtherInformation

**None.**

64

----

**Part III**

Anything herein to thecontrary notwithstanding, in no event are the sections entitled “StockPerformance Graph”, “Compensation Committee Report on Executive Compensation”and “Audit Committee Report” to be incorporated by reference herein from theCompany’s definitive proxy statement for the Company’s 2006 annual meeting ofstockholders.

**Item 10:**                Directorsand Executive Officers of the Registrant

The information required by this item concerning thedirectors and executive officers of the Company is incorporated by referenceherein from the information contained in the section entitled “Occupations ofDirectors and Executive Officers” in our definitive proxy statement (the “DefinitiveProxy Statement”) for the 2006 annual meeting of stockholders to be filed withthe Securities and Exchange Commission within 120 days after the end of Candela’s fiscal year ended July 1,2006.

The information requiredby this item concerning compliance with Section 16(a) of the ExchangeAct required under this item is incorporated herein by reference from theinformation contained in the section entitled “Section 16(a) BeneficialOwnership Reporting Compliance” in the Definitive Proxy Statement.

**Item 11:**                ExecutiveCompensation

The information requiredby this item concerning executive compensation is incorporated herein byreference from the information contained in the section entitled “Compensationand Other Information Concerning Directors and Officers” in the DefinitiveProxy Statement.

**Item 12:**                SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters

The information requiredby this item concerning security ownership of certain beneficial owners andmanagement is incorporated herein by reference from the information containedin the section entitled “Security Ownership of Certain Beneficial Owners andManagement” in the Definitive Proxy Statement.

**Item 13:**                CertainRelationships and Related Transactions

The information requiredby this item concerning certain relationships and related transactions isincorporated herein by reference from the information contained in the sectionentitled “Certain Relationships and Related Transactions” in the DefinitiveProxy Statement.

**Item 14:**                PrincipalAccountant Fees and Services

The information requiredby this item concerning principal accountant fees and services isincorporated herein by reference from the information contained in the sectionentitled “Principal Accountant Fees and Services” in the Definitive ProxyStatement.

65

----

**SCHEDULE II**

**CANDELA CORPORATION**

**VALUATION ANDQUALIFYING ACCOUNTS**

**Forthe years ended July 1, 2006, July 2, 2005 and July 3, 2004**

| ** **                                         | ** ** | **COLUMN A**       | ** ** | **COLUMN B**   | ** ** | **COLUMN C** | ** ** | **COLUMN D**   | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|---------------------|------------|-------------------|------------|---------------------|------------|
| ** **                                         | ** ** | **Balance at**     | ** ** | **Additions**       | ** ** | **Deductions**    | ** ** | **Balance at** | ** ** |
| ** **                                         | ** ** | **Beginning**           | ** ** | **Charged to** | ** ** | **from**          | ** ** | **End of**     | ** ** |
| **Description**                                    | ** ** | ** **              | ** ** | **of Period**  | ** ** | **Income**        | ** ** | **Reserves**        | ** ** | **Period** | ** ** |
| ** **                                         | ** ** | **(in thousands)** | ** ** |
| Reserves deducted  from assets to which they apply |       |                    |       |                |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Allowance for  doubtful accounts:                  |       |                    |       |                |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Year ended July 1, 2006                       |       |                    | $          | 2,065               |       |              |       | $                   | 1,241      |   |   |   | $ | 1,475 |   |   |   | $ | 1,831 |   |   |
| Year ended July 2, 2005                       |       |                    | 1,492      |                |       |              | 2,806      |                |       |   | 2,233 |   |   |   | 2,065 |   |   |
| Year ended July 3, 2004                       |       |                    | 970        |                |       |              | 852        |                |       |   | 330 |   |   |   | 1,492 |   |   |
| Reserve for inventory                              |       |                    |       |                |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Year ended July 1, 2006                       |       |                    | $          | 520                 |       |              |       | $                   | 536        |   |   |   | $ | 432 |   |   |   | $ | 624 |   |   |
| Year ended July 2, 2005                       |       |                    | 490        |                |       |              | 525        |                |       |   | 495 |   |   |   | 520 |   |   |
| Year ended July 3, 2004                       |       |                    | 996        |                |       |              | 178        |                |       |   | 684 |   |   |   | 490 |   |   |
| Reserve for discontinued  operations               |       |                    |       |                |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Year ended July 1, 2006                       |       |                    | $          | 995                 |       |              |       | $                   | —     |   |   |   | $ | 548 |   |   |   | $ | 447 |   |   |
| Year ended July 2, 2005                       |       |                    | 3,006      |                |       |              | —     |                |       |   | 2,011 |   |   |   | 995 |   |   |
| Year ended  July 3, 2004                      |       |                    | 379        |                |       |              | 3,348      |                |       |   | 721 |   |   |   | 3,006 |   |   |
|                                                    |            |                         |            |                     |            |                   |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

66

----

**Part IV**

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

(a)           The followingConsolidated Financial Statements, Notes thereto and Report of IndependentRegistered Public Accounting Firm are set forth under Item 8:

(1)         ConsolidatedFinancial Statements:

| Report of Registered  Independent Public Accounting Firm                                                                             |   | 37 |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|----|--------|
| Consolidated  Balance Sheets—July 1, 2006 and July 2, 2005                                                            |   | 40 |   |
| Consolidated Statements  of Income and Comprehensive Income Years ended July 1, 2006,  July 2, 2005, and July 3, 2004 |   | 41 |   |
| Consolidated  Statements of Stockholders’ Equity—Years ended July 1, 2006,  July 2, 2005, and July 3, 2004  |   | 42 |   |
| Consolidated  Statements of Cash Flows—Years ended July 1, 2006, July 2, 2005,  and July 3, 2004                 |   | 43 |   |
| Notes to Consolidated  Financial Statements                                                                                          |   | 44 |   |

 

(2)         ConsolidatedFinancial Statement Schedules:

| Schedule II—Valuation and  Qualifying Accounts |   | 66 |   |
|-----------------------------------------------------|--------|----|--------|

 

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

(3)   *Exhibits*:  Except asotherwise noted, the following documents are incorporated by reference from theCompany’s Registration Statement on Form S-1 (File Number 333-78339)or filed herewith:

| 3.1        |   | Certificate of Incorporation, as amended                                                                                                       |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2(9)     |   | By-laws of the Company, as amended and restated                                                                                                |
| 10.1(1)    |   | 1985 Incentive Stock Option Plan                                                                                                               |
| 10.2(2)    |   | 1987 Stock Option Plan                                                                                                                         |
| 10.2.1(2)  |   | 1989 Stock Plan                                                                                                                                |
| 10.2.2(3)  |   | 1990 Employee Stock Purchase Plan                                                                                                              |
| 10.2.3(3)  |   | 1990 Non-Employee Director Stock Option Plan                                                                                                   |
| 10.2.4(7)  |   | 1993 Non-Employee Director Stock Option Plan                                                                                                   |
| 10.2.5(13) |   | 1998 Amended and Restated Stock Plan                                                                                                           |
| 10.2.6(18) |   | 1998 Second Amended and Restated Stock Plan                                                                                                    |
| 10.3(7)    |   | Lease for premises at 526 Boston Post Road, Wayland,  Massachusetts.                                                                           |
| 10.4(7)    |   | Lease for premises at 530 Boston Post Road, Wayland,  Massachusetts.                                                                           |
| 10.5(7)    |   | Patent License Agreement between the Company and  Patlex Corporation effective as of July 1, 1988.                                        |
| 10.6(4)    |   | License Agreement among the Company, Technomed  International, Inc. and Technomed International S.A. dated as of  December 20, 1990. |
| 10.7(5)    |   | License Agreement between the Company and Pillco  Limited Partnership effective as of October 1, 1991.                                    |
| 10.8(8)    |   | Distribution Agreement between the Company and  Cryogenic Technology Limited, dated October 15, 1993.                                     |
| 10.9(10)   |   | Asset Purchase Agreement between the Company and  Derma-Laser, Limited and Derma-Lase, Inc. dated June 23, 1994.                     |

67

----

 

| 10.10(11)    |   | Letter Agreement between the Company and Fleet Bank  dated February 13, 1997.                                                                                                                                        |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.10.1(11)  |   | Amendment to Letter Agreement between the Company  and Fleet Bank dated December 15, 1998.                                                                                                                           |
| 10.12*(14)   |   | Amended and Restated License Agreement between  the Company and The Regents of the University of California for Dynamic  Skin Cooling Method and Apparatus effective as of August 11, 2000.                |
| 10.12.1*(15) |   | Settlement Agreement dated August 11, 2000 by  and among the Company, the Regents of the University of California, and Cool  Touch, Inc.                                                                        |
| 10.13(12)    |   | Note and Warrant Purchase Agreement, dated as of  October 15, 1998 by and among the Company, Massachusetts Capital  Resource Company, William D. Witter and Michael D.Witter.                                        |
| 10.13.1(12)  |   | Form of Note delivered to the Company in the  aggregate principal amount of $3,700,000 to Massachusetts Capital Resource  Company, William D. Witter and Michael D. Witter.                                          |
| 10.13.2(12)  |   | Form of Common Stock Purchase Warrant to  purchase an aggregate of 370,000 shares of the Company’s Common Stock  delivered to Massachusetts Capital Resource Company, William D. Witter and  Michael D. Witter. |
| 21.1**       |   | Subsidiaries of the Company                                                                                                                                                                                               |
| 23.1**       |   | Consent of BDO Seidman, LLP (Independent Registered  Public Accounting Firm)                                                                                                                                              |
| 31.1**       |   | Rule 13a-14(a)/15d-14(a) Certification  of Chief Executive Officer                                                                                                                                              |
| 31.2**       |   | Rule 13a-14(a)/15d-14(a) Certification  of Chief Financial Officer                                                                                                                                              |
| 32.1**       |   | Section 1350 Certification of Chief Executive  Officer                                                                                                                                                               |
| 32.2**       |   | Section 1350 Certification of Chief Financial  Officer                                                                                                                                                               |
| 99.1(16)     |   | McKesson Medical-Surgical Inc. Distribution  Agreement                                                                                                                                                                    |
| 99.2(17)     |   | First Amendment to the Amended and Restated License  Agreement by and between The Regents of the University of California and  Candela Corporation                                                                        |

----

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

**             Filed herewith

(1)          Previously filed as anexhibit to Registration Statement No. 33-54448B and incorporatedherein by reference.

(2)          Previously filed as anexhibit to the Company’s Amended and Restated Annual Report on Form 10-Kfor the fiscal year ended June 30, 1988 (Commission file number 000-14742),and incorporated herein by reference.

(3)          Previously filed as anexhibit to the Company’s Annual Report on Form 10-K for the fiscalyear ended June 30, 1990 (Commission file number 000-14742), andincorporated herein by reference.

(4)          Previously filed as anexhibit to Form 10-Q for the quarter ended December 29, 1990(Commission file number 000-14742), and incorporated herein by reference.

(5)          Previously filed as anexhibit to Form 10-Q for the quarter ended September 28, 1991(Commission file number 000-14742), and incorporated herein by reference.

(6)          Previously filed as anexhibit to Form 8-K, dated September 8, 1992 (Commission filenumber 000-14742), and incorporated herein by reference.

(7)          Previously filed as anexhibit to the Company’s Annual Report on Form 10-K for the fiscalyear ended July 3, 1993 (Commission file number 000-14742), andincorporated herein by reference.

68

----

(8)          Previously filed as anexhibit to Form 10-Q for the quarter ended January 1, 1994(Commission file number 000-14742), and incorporated herein by reference.

(9)          Previously filed as anexhibit to Form 10-Q for the quarter ended April 2, 1994(Commission file number 000-14742), and incorporated herein by reference.

(10)   Previously filed as an exhibitto the Company’s Annual Report on Form 10-K for the fiscal yearended July 2, 1994 (Commission file number 000-14742), andincorporated herein by reference.

(11)   Previously filed as an S1 filedon May 12, 1999 (Commission file number 333-78339), and incorporatedherein for reference.

(12)   Previously filed as an exhibitto the Company’s Amended and Restated Annual Report on Form 10-K forthe fiscal year ended June 27, 1998 (Commission file number 000-14742),and incorporated herein by reference.

(13)   Previously filed as Appendix Ato the Company’s Schedule 14A, filed December 28, 2002, and incorporatedherein by reference.

(14)   Previously filed as an exhibitto Form 10-Q for the quarter ended March 31, 2001 (Commissionfile number 000-14742), and incorporated herein by reference.

(15)   Previously filed as an exhibitto Form 10-K for the fiscal year ended July 1, 2000 (Commissionfile number 000-14742), and incorporated by reference.

(16)   Previously filed as an exhibitto Form 10-K for the fiscal year ended July 2, 2005 andincorporated by reference

(17)   Previously filed as an exhibitto Form 10-Q for the fiscal quarter ended December 31, 2005 andincorporated by reference

(c)           The Company herebyfiles, as part of this Form 10-K, the exhibits listed in Item 15(a)(3) above,other than exhibits 32.1 and 32.2, which the Company hereby furnishes.

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

69

----

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized, on September 11,2006.

|        | CANDELA CORPORATION |
|--------|---------------------|
|   | By:                 | /s/ GERARD E. PUORRO |
|   |                | Gerard E. Puorro, |
|   |                | *President, Chief Executive Officer and Director* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

|                          | **Signature** | ** **                    | ** ** | ** **               | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------------------------|---------------|-------------------------------|------------|--------------------------|-----------|------------|------------|------------|----------|------------|
|                     |          |                          |       |                     |
| /s/ GERARD E. PUORRO     |          | President, Chief  Executive   |       | September 11,  2006 |
| Gerard E. Puorro         |          | Officer, and Director         |       |                     |
|                     |          | (Principal Executive Officer) |       |                     |
| /s/ F. PAUL BROYER       |          | Senior Vice  President of     |       | September 11, 2006  |
| F. Paul Broyer           |          | Finance and Administration,   |       |                     |
|                     |          | Chief Financial Officer       |       |                     |
| /s/ KENNETH D. ROBERTS   |          | Chairman of the  Board of     |       | September 11, 2006  |
| Kenneth D. Roberts       |          | Directors                     |       |                     |
| /s/ NANCY NAGER          |          | Director                      |       | September 11, 2006  |
| Nancy Nager              |          |                          |       |                     |
| /s/ DOUGLAS W. SCOTT     |          | Director                      |       | September 11, 2006  |
| Douglas W. Scott         |          |                          |       |                     |
| /s/ BEN BAILEY, III |          | Director                      |       | September 11, 2006  |
| Ben Bailey, III     |          |                          |       |                     |
| /s/ GEORGE ABE           |          | Director                      |       | September 11, 2006  |
| George Abe               |          |                          |       |                     |

 

70

----

**EXHIBITINDEX**

| 21.1 |   | Subsidiaries of the  Company                                                  |
|------|--------|-------------------------------------------------------------------------------|
| 23.1 |   | Consent of BDO Seidman,  LLP, Independent Registered Public Accounting Firm   |
| 31.1 |   | Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2 |   | Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.1 |   | Certification pursuant  to 18 U.S.C. Section 1350                        |
| 32.2 |   | Certification pursuant  to 18 U.S.C. Section 1350                        |

 

----