**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

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**FORM 10-Q**

**Quarterlyreport pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**

**For thequarterly period ended March 31, 2007.**

**Commissionfile number 000-14742**

**CANDELA CORPORATION**

(Exact name ofregistrant as specified in its charter)

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

 

Registrant’stelephone number, including area code:  **(508) 358-7400**

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes x  No o

Indicate by checkmark whether the registrant is an accelerated filer (as defined by Rule 12b-2of the Securities Exchange Act of 1934).
| Large Accelerated Filer o | Accelerated Filer x | Non-Accelerated Filer o |
|---------------------------|---------------------|-------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule12b-2 of theExchange Act) Yes o  No x

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.
| Class                                   | ** ** | **Outstanding at May 9, 2007** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------|------------|
| Common Stock,  $.01 par value per share |       | 23,120,484                                         |       |

                                                                                                

 

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**CANDELACORPORATION**

**Index**
|          | ** **              | **Page**                                                                                                                                                                                               |
|----------|-------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Part I.  | Financial  Information: |                                                                                                                                                                                                   |
|     |                    |                                                                                                                                                                                                   |
|     | Item 1.                 | Unaudited Financial  Statements                                                                                                                                                                        |   |
|     |                    |                                                                                                                                                                                                   |   |
|     |                    | Consolidated  Balance Sheets as of March 31, 2007 and July 1, 2006                                                                                                                                     | 3 |
|     |                    |                                                                                                                                                                                                   |   |
|     |                    | Consolidated Statements of Income and Comprehensive  Income for the three-month periods ended March 31, 2007 and April 1, 2006,  and for the nine-month periods ended March 31, 2007 and April 1, 2006 | 4 |
|     |                    |                                                                                                                                                                                                   |   |
|     |                    | Condensed Consolidated Statements of Cash Flows for  the nine-month periods ended March 31, 2007 and April 1, 2006                                                                                     | 5 |
|     |                    |                                                                                                                                                                                                   |   |
|     |                    | Notes to Consolidated Financial Statements (Unaudited)                                                                                                                                                 | 6-15 |
|     |                    |                                                                                                                                                                                                   |   |
|     | Item 2.                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                                            | 16-21 |
|     |                    |                                                                                                                                                                                                   |   |
|     | Item 3.                 | Quantitative  and Qualitative Disclosure about Market Risk                                                                                                                                             | 22 |
|     |                    |                                                                                                                                                                                                   |   |
|     | Item 4.                 | Controls and  Procedures                                                                                                                                                                               | 22 |
|     |                    |                                                                                                                                                                                                   |   |
| Part II. | Other Information:      |                                                                                                                                                                                                   |
|     |                    |                                                                                                                                                                                                   |
|     | Item 1.                 | Legal proceedings                                                                                                                                                                                      | 23-24 |
|     |                    |                                                                                                                                                                                                   |   |
|     | Item  6.                | Exhibits                                                                                                                                                                                               | 25 |
|     |                    |                                                                                                                                                                                                   |   |
|     | Signatures              | 26                                                                                                                                                                                                     |
|     |                    |                                                                                                                                                                                                   |
|     | Index  to Exhibits      | 27                                                                                                                                                                                                     |

 

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**PartI.  Financial Information**

**Item 1 -Financial Statements**

**CANDELACORPORATION**

**ConsolidatedBalance Sheets**

(in thousands,except per share data)

(unaudited)
| ** **                                                                                                                          | ** ** | **March 31,** | ** ** | **July 1,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                                                                                                                          | ** ** | **2007**           | ** ** | **2006**         | ** ** |
| **Assets**                                                                                                                          |       |               |       |             |       |
| Current assets:                                                                                                                     |       |               |       |             |       |
| Cash and cash  equivalents                                                                                                          |       | $                  | 27,879     |             | $          | 40,194 |   |
| Restricted cash                                                                                                                     |       | 57                 |       | 166              |       |
| Marketable  securities                                                                                                              |       | 14,960             |       | 27,332           |       |
| Accounts  receivable, net of allowance for doubtful accounts of $1,594 and $1,831 at  March 31 and July 1, respectively             |       | 34,501             |       | 34,273           |       |
| Notes receivable                                                                                                                    |       | 840                |       | 1,611            |       |
| Inventories, net                                                                                                                    |       | 19,347             |       | 16,666           |       |
| Other current  assets                                                                                                               |       | 3,431              |       | 1,756            |       |
|                                                                                                                                |       |               |       |             |       |
| Total current  assets                                                                                                               |       | 101,015            |       | 121,998          |       |
| Property and equipment,  net                                                                                                        |       | 3,504              |       | 3,302            |       |
| Deferred tax assets                                                                                                                 |       | 8,364              |       | 8,142            |       |
| Goodwill and acquired  Intangible assets, net                                                                                       |       | 21,984             |       | 3,402            |       |
| Marketable securities,  long-term                                                                                                   |       | 13,660             |       | 11,953           |       |
| Other assets                                                                                                                        |       | 315                |       | 379              |       |
|                                                                                                                                |       |               |       |             |       |
| Total assets                                                                                                                        |       | $                  | 148,842    |             | $          | 149,176 |   |
|                                                                                                                                |       |               |       |             |       |
| **Liabilities  and Stockholders’ Equity**                                                                                      | ** ** | ** **         | ** ** | ** **       | ** ** |
| Current liabilities:                                                                                                                |       |               |       |             |       |
| Accounts payable                                                                                                                    |       | $                  | 12,430     |             | $          | 15,968 |   |
| Accrued payroll  and related expenses                                                                                               |       | 4,275              |       | 5,728            |       |
| Accrued warranty  costs, current                                                                                                    |       | 5,769              |       | 5,868            |       |
| Income taxes  payable                                                                                                               |       | —             |       | 933              |       |
| Sales tax  payable                                                                                                                  |       | 835                |       | 854              |       |
| Royalties  payable                                                                                                                  |       | 768                |       | 764              |       |
| Other accrued  liabilities                                                                                                          |       | 6,618              |       | 3,672            |       |
| Deferred  revenue, current                                                                                                          |       | 9,227              |       | 8,342            |       |
| Current  liabilities of discontinued operations                                                                                     |       | 1,286              |       | 1,287            |       |
|                                                                                                                                |       |               |       |             |       |
| Total current  liabilities                                                                                                          |       | 41,208             |       | 43,416           |       |
| Accrued warranty costs,  long-term                                                                                                  |       | 2,916              |       | 3,761            |       |
| Deferred revenue,  long-term                                                                                                        |       | 2,716              |       | 1,987            |       |
|                                                                                                                                |       |               |       |             |       |
| Total  liabilities                                                                                                                  |       | 46,840             |       | 49,164           |       |
|                                                                                                                                |       |               |       |             |       |
| Stockholders’ equity:                                                                                                          |       |               |       |             |       |
| Common stock,  $.01 par value, 60,000,000 shares authorized; 25,978,000 and 25,914,000  issued at March 31 and July 1, respectively |       | 260                |       | 259              |       |
| Treasury stock,  3,020,000 and 2,250,000 common shares at March 31 and July 1, respectively,  at cost                               |       | (21,268            | )          | (12,997          | )          |
| Additional  paid-in capital                                                                                                         |       | 67,501             |       | 64,234           |       |
| Accumulated  earnings                                                                                                               |       | 55,263             |       | 48,280           |       |
| Accumulated  other comprehensive income                                                                                             |       | 246                |       | 236              |       |
|                                                                                                                                |       |               |       |             |       |
| Total  stockholders’ equity                                                                                                    |       | 102,002            |       | 100,012          |       |
|                                                                                                                                |       |               |       |             |       |
| Total liabilities and  stockholders’ equity                                                                                    |       | $                  | 148,842    |             | $          | 149,176 |   |

 

***The accompanying notes are anintegral part of the unaudited consolidated financial statements****.*

3

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**CANDELA CORPORATION**

**Consolidated Statements of Income and Comprehensive Income**

(in thousands, except per share data)

(unaudited)
| ** **                                                    | ** ** | **For the three-months ended:** | ** ** | **For the nine-months ended:** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                    | ** ** | **March 31,**                             | ** ** | **April 1,**                             | ** ** | **March 31,** | ** ** | **April 1,** | ** ** |
| ** **                                                    | ** ** | **2007**                                       | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Revenue**                                                   | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other products                                     |       | $                                              | 29,017     |                                          | $          | 34,795 |   | $ | 84,014 |   | $ | 88,677 |   |
| Product-related service                                       |       | 9,673                                          |       | 7,519                                         |       | 25,556 |   | 19,444 |   |
|                                                          |       |                                           |       |                                          |       |   |   |   |   |
| Total revenue                                                 |       | 38,690                                         |       | 42,314                                        |       | 109,570 |   | 108,121 |   |
| **Cost of  sales**                                            | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other products                                     |       | 12,411                                         |       | 15,688                                        |       | 37,007 |   | 39,235 |   |
| Product-related service                                       |       | 6,539                                          |       | 5,228                                         |       | 17,620 |   | 13,960 |   |
|                                                          |       |                                           |       |                                          |       |   |   |   |   |
| Total cost of sales                                           |       | 18,950                                         |       | 20,916                                        |       | 54,627 |   | 53,195 |   |
|                                                          |       |                                           |       |                                          |       |   |   |   |   |
| **Gross  profit**                                             |       | 19,740                                         |       | 21,398                                        |       | 54,943 |   | 54,926 |   |
| **Operating  expenses**                                       | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general and administrative                           |       | 13,208                                         |       | 11,602                                        |       | 36,856 |   | 30,858 |   |
| Research and development                                      |       | 4,873                                          |       | 2,432                                         |       | 13,059 |   | 5,873 |   |
|                                                          |       |                                           |       |                                          |       |   |   |   |   |
| Total operating expenses                                      |       | 18,081                                         |       | 14,034                                        |       | 49,915 |   | 36,731 |   |
| **Income  from operations**                                   |       | 1,659                                          |       | 7,364                                         |       | 5,028 |   | 18,195 |   |
| **Other  income (expense)**                                   | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                                               |       | 716                                            |       | 546                                           |       | 2,231 |   | 1,057 |   |
| Other income (expense), net                                   |       | 85                                             |       | (15                                           | )          | 3,727 |   | (18 | ) |
|                                                          |       |                                           |       |                                          |       |   |   |   |   |
| Total other income                                            |       | 801                                            |       | 531                                           |       | 5,958 |   | 1,039 |   |
|                                                          |       |                                           |       |                                          |       |   |   |   |   |
| **Income  before income taxes**                               |       | 2,460                                          |       | 7,895                                         |       | 10,986 |   | 19,234 |   |
| Provision for income taxes                                    |       | 920                                            |       | 2,892                                         |       | 4,003 |   | 6,703 |   |
| **Net  income**                                               |       | $                                              | 1,540      |                                          | $          | 5,003 |   | $ | 6,983 |   | $ | 12,531 |   |
| ** **                                                    | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  income per share of common stock**                     | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                         |       | $                                              | 0.07       |                                          | $          | 0.22 |   | $ | 0.30 |   | $ | 0.55 |   |
| Diluted                                                       |       | $                                              | 0.07       |                                          | $          | 0.21 |   | $ | 0.30 |   | $ | 0.53 |   |
| ** **                                                    | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Weighted  average shares outstanding**                      | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                         |       | 22,937                                         |       | 23,255                                        |       | 23,128 |   | 22,817 |   |
|                                                          |       |                                           |       |                                          |       |   |   |   |   |
| Diluted                                                       |       | 23,320                                         |       | 24,204                                        |       | 23,592 |   | 23,762 |   |
|                                                          |       |                                           |       |                                          |       |   |   |   |   |
| **Net  income**                                               |       | $                                              | 1,540      |                                          | $          | 5,003 |   | $ | 6,983 |   | $ | 12,531 |   |
| **Other  comprehensive income (loss), net of tax**            | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Foreign currency translation adjustment                       |       | 20                                             |       | 367                                           |       | 135 |   | (7 | ) |
| Unrealized loss on available-for-sale securities, net  of tax |       | (63                                            | )          | —                                        |       | (395 | ) | — |   |
|                                                          |       |                                           |       |                                          |       |   |   |   |   |
| **Comprehensive Income**                                      |       | $                                              | 1,497      |                                          | $          | 5,370 |   | $ | 6,723 |   | $ | 12,524 |   |

 

***The accompanying notes are anintegral part of the unaudited consolidated financial statements****.*

4

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**CANDELA CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

(in thousands)

(unaudited)
| ** **                                                                                   | ** ** | **For the nine-months ended:** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                   | ** ** | **March 31,**                            | ** ** | **April 1,** | ** ** |
| ** **                                                                                   | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| **Cash  flows from operating activities:**                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net income                                                                                   |       | $                                             | 6,983      |   | $ | 12,531 |   |
| Adjustments to reconcile net income to net cash  (used by) provided by operating activities: |       |                                          |       |   |   |
| Gain on exchange of stock (Note 17)                                                          |       | (3,540                                        | )          | — |   |
| Share-based compensation expense                                                             |       | 2,887                                         |       | 642 |   |
| Depreciation and amortization                                                                |       | 972                                           |       | 354 |   |
| Provision for bad debts                                                                      |       | 900                                           |       | 700 |   |
| Other non-cash items                                                                         |       | (89                                           | )          | 3 |   |
| Increase (decrease) in cash from working capital                                             | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Accounts receivable                                                                          |       | (968                                          | )          | (1,561 | ) |
| Notes receivable                                                                             |       | 703                                           |       | (348 | ) |
| Inventories                                                                                  |       | (2,234                                        | )          | (2,473 | ) |
| Other current assets                                                                         |       | (2,751                                        | )          | (1,922 | ) |
| Other assets                                                                                 |       | (3,202                                        | )          | (2,777 | ) |
| Accounts payable                                                                             |       | (4,166                                        | )          | 1,542 |   |
| Accrued payroll and related expenses                                                         |       | (1,505                                        | )          | (551 | ) |
| Deferred revenue                                                                             |       | 938                                           |       | 1,062 |   |
| Accrued warranty costs                                                                       |       | (214                                          | )          | 7 |   |
| Income taxes payable                                                                         |       | (1,478                                        | )          | (1,011 | ) |
| Other accrued liabilities                                                                    |       | 2,748                                         |       | (170 | ) |
| Change in restricted cash                                                                    |       | 1                                             |       | 32 |   |
| ** **                                                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net cash (used  by) provided by operating activities                                         |       | (4,015                                        | )          | 6,060 |   |
| ** **                                                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Cash  flows from investing activities:**                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                          |       | (267                                          | )          | (323 | ) |
| Maturities of held-to-maturity marketable securities                                         |       | 32,746                                        |       | — |   |
| Cash proceeds from exchange of stock (Note 17)                                               |       | 994                                           |       | — |   |
| Purchases of held-to-maturity marketable securities                                          |       | (17,278                                       | )          | (34,588 | ) |
| Acquisition of business, net of cash acquired                                                |       | (15,686                                       | )          | — |   |
| Acquisition of intangible assets                                                             |       | (1,380                                        | )          | — |   |
|                                                                                         |       |                                          |       |   |   |
| Net cash used by  investing activities                                                       |       | (871                                          | )          | (34,911 | ) |
| ** **                                                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Cash  flows from financing activities:**                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Proceeds from the issuance of common stock                                                   |       | 378                                           |       | 7,321 |   |
| Purchase of treasury stock                                                                   |       | (8,271                                        | )          | — |   |
| ** **                                                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net cash (used  by) provided by financing activities                                         |       | (7,893                                        | )          | 7,321 |   |
| ** **                                                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Effect of  exchange rates on cash and cash equivalents                                       |       | 521                                           |       | 343 |   |
| ** **                                                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Net  decrease in cash and cash equivalents**                                               |       | (12,258                                       | )          | (21,187 | ) |
| ** **                                                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Cash  and cash equivalents at beginning of period**                                        |       | 40,194                                        |       | 56,383 |   |
| ** **                                                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Cash and cash equivalents at  end of period**                                              |       | $                                             | 27,936     |   | $ | 35,196 |   |

 

***The accompanying notes are anintegral part of the unaudited consolidated financial statements****.*

5

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**Candela Corporation**

**Notes to Consolidated FinancialStatements (unaudited)**

(amounts are in thousandsexcept per share data)

 

**1.****       Basis of Presentation andConsolidation**

 

*Basis of Presentation*

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States for interimfinancial information and with the instructions to Form 10-Q and Article 10 ofRegulation S-X. The year-end consolidated balance sheet is derived from ouraudited financial statements, but does not include all disclosures required byaccounting principles generally accepted in the United States of America. Inthe opinion of management, the accompanying unaudited consolidated financialstatements contain all adjustments, consisting only of those of a normalrecurring nature, considered necessary for a fair presentation of our financialposition, results of operations and cash flows at the dates and for the periodsindicated. Actual results may differ from these estimates.

 

The results for the threeand nine months ended March 31, 2007 are not necessarily indicative of resultsto be expected for the remainder of the fiscal year. The information containedin the interim financial statements should be read in conjunction withManagement’s Discussion and Analysis and the financial statements and notesthereto included in the Candela Corporation 2006 Form 10-K filed with theSecurities and Exchange Commission (“SEC”). Certain prior period amounts havebeen reclassified to conform to the current period presentation. There was noimpact on operating income.

 

*Basis of Consolidation*

The financial statementsinclude the accounts of Candela Corporation and its subsidiaries. Intercompanytransactions and balances have been eliminated. Investments in which we are notable to exercise significant influence over the investee are accounted forunder the cost method.

 

*Segment Information*

SFAS No. 131, *Disclosures about Segments of an Enterprise andRelated Information*, defines operating segments as components of anenterprise about which separate financial information is available that isevaluated regularly by the chief operating decision maker, or decision-makinggroup, in deciding how to allocate resources and in assessing performance. Ourchief operating decision-making group consists of our executive officers. TheCompany operates principally in one industry segment: the design, manufacture,sale, and service of medical devices and related equipment. The results in thissegment have been presented in the Consolidated Statements of Income for theappropriate periods.

 

**2.****       Recent AccountingPronouncements**

 

In September 2006, the Securitiesand Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108, *Considering the Effects of Prior Year Misstatementswhen Quantifying Current Year Misstatements.* SAB No. 108requires analysis of misstatements using both an income statement (rollover)approach and a balance sheet (iron curtain) approach in assessing materialityand provides for a one-time cumulative effect transition adjustment. SABNo. 108 is effective for our fiscal year 2007 annual financial statements.We are currently assessing the potential impact that the adoption of SABNo. 108 will have on our financial statements; the impact is not expectedto be material.

 

In September 2006, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 157, *FairValue Measurements,*which defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. SFAS No. 157 doesnot require any new fair value measurements, but provides guidance on how tomeasure fair value by providing a fair value hierarchy used to classify thesource of the information. This statement is effective for our fiscal year2008. We are currently assessing the potential impact that the adoption of SFASNo. 157 will have on our financial statements; the impact is not expectedto be material.

6

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In July 2006, theFASB issued Interpretation No. 48,*Accounting for Uncertainty in Income Taxes—an interpretation of FASB StatementNo. 109* (FIN No. 48). FIN No. 48 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB Statement No. 109,*Accounting for Income Taxes.*  FIN No. 48 prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.FIN No. 48 also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods and disclosure relativeto uncertain tax positions. FIN No. 48 is effective for fiscal yearsbeginning after December 15, 2006, with early adoption encouraged. We arecurrently assessing the potential impact that the adoption of FIN No. 48will have on our consolidated financial statements.

In February 2006, the FASB issued StatementNo. 155,*Accounting for Certain HybridFinancial Instruments—an amendment of FASB Statements No. 133 and 140*(SFAS No. 155). This standard permits fair value remeasurement for anyhybrid financial instrument that contains an embedded derivative that otherwisewould require bifurcation; clarifies which interest-only strips andprincipal-only strips are not subject to the requirements of SFAS No. 133;requires evaluation of interests in securitized financial assets; clarifiesthat concentrations of credit risk in the form of subordination are notembedded derivatives; and eliminates the prohibition on a qualifyingspecial-purpose entity from holding a derivative financial instrument thatpertains to a beneficial interest other than another derivative financialinstrument. This standard is effective for all financial instruments acquiredor issued for fiscal years beginning after September 15, 2006. We do notbelieve that adoption of SFAS No. 155 will have a material effect on ourfinancial position or results of operations.

**3.****      Discontinued Operations**

On September 27, 2003 management initiated a plan toclose its only remaining skin care center. The closure was accounted for as adiscontinued operation in accordance with SFAS 144 “*Accountingfor the Impairment or Disposal of Long-Lived Assets*” and SFAS 146 “*Accounting for Costs Associated with Exit or Disposal Activities*”.In determining the amount of the facilities closure accrual, we are required toestimate such factors as future vacancy rates, the time required to subletproperties and sublease rates. These estimates are reviewed quarterly and mayresult in revisions to established facility reserves.

Current liabilities of discontinued operations consistof the following:
|                                      | ** ** | **March 31,** | ** ** | **July 1,** | ** ** |
|--------------------------------------|------------|--------------------|------------|------------------|------------|
| **(in thousands)**              | ** ** | **2007**           | ** ** | **2006**         | ** ** |
| Facility closure  and other costs    |       | $                  | 447        |             | $          | 447 |   |
| Deferred  revenue, gift certificates |       | 839                |       | 840              |       |
|                                 |       |               |       |             |       |
|                                 |       | $                  | 1,286      |             | $          | 1,287 |   |

 

# **4.****       Stock-based Compensation**

Effective July 3, 2005,the Company implemented the fair value recognition provisions of SFAS No. 123revised (“SFAS No. 123R”) and Staff Accounting Bulletin 107 (“SAB 107”) for allshare-based compensation that was not vested as of July 2, 2005.  The Company adopted SFAS No. 123R using amodified prospective application, as permitted under SFAS No. 123R.Accordingly, prior period amounts have not been restated.  Under this application, the Company isrequired to record compensation expense for all awards granted after the dateof adoption and for the unvested portion of previously granted awards thatremain outstanding at the date of adoption. Compensation cost will be recognized over the period that an employee providesservice in exchange for the award.

The application of SFAS No. 123R and SAB 107 duringthe three-month periods ended March 31, 2007 and April 1, 2006 resulted in therecognition of share-based compensation expense of approximately $0.9 millionand $0.4 million, respectively.  For thenine-month period ended March 31, 2007 and April 1, 2006, recognition ofshared-based compensation expense was approximately $2.9 million and $0.6million, respectively. These expenses were divided between cost of sales andoperating expense cost centers based upon the functional responsibilities ofthe individuals holding the respective options.

7

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As of March 31, 2007, there was approximately $2.9million of total unrecognized compensation cost related to non-vested stockoptions/Stock Appreciation Rights (“SARs”) granted under the Company’sincentive plans. This cost is expected to be recognized over a weighted-averageperiod of 1.32 years. As of April 1, 2006, there was approximately $3.6 millionof total unrecognized compensation cost related to nonvested stock optionsgranted under the Company’s incentive plans.

The amount of cash received from the exercise of stockoptions for the nine-month periods ended March 31, 2007 and April 1, 2006 wasapproximately $0.4 million and $7.2 million, respectively.

**StockPlans**

**1990Candela Corporation Employee Stock Purchase Plan**

The 1990 EmployeeStock Purchase Plan (the “Purchase Plan”) provides for the sale of up to 1.5million shares of common stock to eligible employees.  The shares are issued at 85% of the marketprice on the last day of semi-annual periods. Substantially all full-time employees are eligible to participate in thePurchase Plan.  At March 31, 2007 therewere approximately 678 thousand shares available for sale.  Compensation expense for the purchase plan isrecognized over the vesting period.

**1998Candela Corporation Stock Option Plan**

Effective October5, 2005, the Second Amended and Restated 1998 Stock Plan (the “1998 Stock Plan”)was amended to clarify the granting of incentive stock options, non-qualifiedstock options, and SARs.

Stock optionsprovide the holder with the right to purchase common stock.  The exercise price per share of “incentivestock options” within the meaning of Section 422 of the Internal Revenue Codeof 1986, as amended, granted under the 1998 Stock Plan may not be less than thefair market value per share of common stock on the date of grant.  In the case of an incentive stock optiongranted to an employee possessing more than 10% of the total combined votingpower of all classes of stock of the Company, the exercise price per share maynot be less than 110% of the fair market value per share of common stock on thedate of grant.

SARs provide theholder the right to receive an amount, payable in stock, cash or in anycombination of these, as specified by a Committee established by the Board ofDirectors, equal to the excess of the market value of our common shares on thedate of exercise over the grant price at the time of the grant.  The grant price of a SAR may not be less thanthe fair market value per share of common stock on the date of grant, providedthat the grant price of SARs granted in tandem with stock options shall equalthe exercise price of the related stock option.

Options and rights granted under the 1998 Stock Plan become exercisable on the date of grant or in installments, as specified by a Committee established by the Board of Directors, and expire ten years from the date of the grant.  The maximum number of shares for which options and rights may be granted under the 1998 Stock Plan was increased by 2.5 million shares to 7.8 million by affirmative vote at the Company’s Annual Meeting of Shareholders held December 12, 2006. Upon exercise of a SAR, only the net number of shares of common stock issued in connection with such exercise shall be deemed “issued” for this purpose.  The Company may satisfy the awards upon exercise with either newly-issued or treasury shares.

There were approximately 330 thousand stock based SARs granted during the nine-month period ended March 31, 2007. The SARs granted to employees become exercisable ratably over one to four years, while the SARs granted to directors become exercisable over two years.

There were approximately 2.2 million outstanding options/SARs at March 31, 2007 with a weighted-average exercise price of $11.19 per share, an aggregate intrinsic value of approximately $0.5 million, and a weighted-average remaining contractual term of 7.49 years.

There were approximately 1.5 million of exercisable options/SARs at March 31, 2007 with a weighted-average exercise price of $9.88 per share, an aggregate intrinsic value of approximately $2.3 million, and a weighted-average remaining contractual term of 7.0 years.

8

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There were approximately 2.7 million options/SARS available to grant at March 31, 2007

The total intrinsic value of options exercised during the three and nine month periods ended March 31, 2007 was approximately $0.1 million and $0.4 million, respectively.

**5.****      Earnings per Share**

Basic earnings pershare is computed by dividing net income by the weighted average number ofshares of common stock outstanding for the period and, if there are dilutivesecurities, diluted earnings per share is computed by including common stockequivalents outstanding for the period in the denominator. Common stockequivalents include shares issuable upon the exercise of stock options orwarrants, net of shares assumed to have been purchased with the proceeds, usingthe treasury stock method.
|                                                                    | ** ** | **For the three months ended:** | ** ** | **For the nine months ended:** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                         | ** ** | **March 31,**                                  | ** ** | **April 1,**                                  | ** ** | **March 31,** | ** ** | **April 1,** | ** ** |
| **(in thousands, except per share data)** | ** ** | **2007**                                            | ** ** | **2006**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Shares used in  the calculation of Basic earnings per share        |       | 22,937                                              |       | 23,255                                             |       | 23,128 |   | 22,817 |   |
| Effect of  dilutive securities: Stock options/SAR’s           |       | 383                                                 |       | 949                                                |       | 464 |   | 945 |   |
|                                                               |       |                                                |       |                                               |       |   |   |   |   |
| Diluted shares  used in the calculation of earnings per share      |       | 23,320                                              |       | 24,204                                             |       | 23,592 |   | 23,762 |   |
|                                                               |       |                                                |       |                                               |       |   |   |   |   |
| Per share effect  of dilutive securities on net income             |       | $                                                   | —     |                                               | $          | 0.01 |   | $ | — |   | $ | 0.02 |   |
|                                                                    |            |                                                     |            |                                                    |            |  |  |  |  |  |  |  |  |

 

During the threeand nine month periods ended March 31, 2007, options/SARs to purchaseapproximately 1.3 million and 1.0 million shares of common stock, respectively,were excluded from the calculations of diluted earnings per share as theireffect would have been anti-dilutive.

During the threeand nine month periods ended April 1, 2006, options/SARs to purchase 220thousand and 96 thousand shares of common stock, respectively, were excludedfrom the calculations of diluted earnings per share as their effect would havebeen anti-dilutive.

**6.****      Acquisitions**

On March 6, 2007, we acquired Inolase (2002) Ltd. (“Inolase”)a non-public company engaged in the development and manufacture of proprietarydevices for the aesthetic light-based treatment industry as well as thedevelopment of intellectual property related to medical devices and lightsources. The aggregate purchase price was approximately $16.8 million incash, including $0.3 million of acquisition-related transaction costs. NoCandela common stock was issued in the acquisition. This acquisition wasaccounted for as a business combination.

The agreement to purchase Inolase contains certainearn-out provisions and we are currently assessing the likelihood of their attainment.If we conclude that the outcome of these contingencies is determinable beyond areasonable doubt, and that they are directly attributable to the purchase priceitself, such a conclusion would result in an adjustment to goodwill and theestablishment of an additional liability when the purchase-price allocation isfinalized. Our final evaluation may also conclude that these provisions are directlyattributable to the purchase price itself, but that we are unable to presentlycalculate the additional future amounts to be paid. If this is our conclusion,any future earn-out payments would represent increases to goodwill in theperiod(s) in which they are made. The purchase-price allocation is preliminarypending the final determination of the fair value of the assets and liabilitiesacquired. The preliminary purchase-price allocation was recorded in the thirdquarter of 2007 and resulted in approximately $10.5 million of goodwill and$6.3 million of other acquired intangible assets, primarily comprised ofpatents and patent applications, which are being amortized over an estimatedweighted average of 7 years. Values assigned to these acquired intangibleassets are not deductible for tax purposes.

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Based upon thepreliminary purchase price allocation, the total purchase price was allocatedas follows:
|                                             | ** ** | **(in thousands)** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| Goodwill                                    |       | $                       | 10,549     |   |
| Identifiable  intangible assets             |       | 6,300                   |       |
| Inventory                                   |       | 214                     |       |
| Accounts  receivable & other assets     |       | 195                     |       |
| Accounts payable  and accrued expenses      |       | (248                    | )          |
| Other  liabilities                          |       | (201                    | )          |
|                                        |       |                    |       |
| Total preliminary purchase price allocation |       | $                       | 16,809     |   |

 

The excess of thepurchase price of Inolase over the estimated fair values of tangible andintangible assets and liabilities totaling approximately $10.5 million wasallocated to goodwill. We believe that such excess in purchase price foraccounting purposes was warranted by certain factors, including: 1) thepotential to facilitate up-sell and cross-sell opportunities for our productswith that of Inolase; 2) the potential to exploit reduced pain applicationsacross our existing and future products; and 3) the potential to leverageInolase intellectual property into home use applications.

Results of operations forInolase have been included in our accompanying consolidated statement ofoperations beginning March 6, 2007.

**7.****      Marketable Securities**

The Company accounts for marketable securities in accordance with SFAS115*, Accounting for Certain Investments in Debt andEquity Securities*. 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 be classified as one of the following:held-to-maturity, available-for-sale, or trading. The Company classifies itsmarketable debt securities as held-to-maturity as the Company has the intentand ability to hold them to maturity. The Company has classified its equity investments as available-for-salesecurities.  Accordingly, suchinvestments are reported at fair market value, with the resultant unrealizedgains and losses reported as a separate component of shareholders’ equity.  Held-to-maturity debt securities are reportedat amortized cost which approximates fair value.  Current marketable securities include debtinvestments with original maturities that are expected to mature in more thanthree months and up to twelve months and equity investments.   Long-term marketable securities include debtsecurities that have remaining maturities of one to three years and equityinvestments.  Unrealized losses relatedto the held-to-maturity securities are not considered a permanent decline inthe market value of such securities.

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Marketablesecurities consist of the following:
|                                          | ** ** | **March 31, 2007**        | ** ** | **July 1, 2006** | ** ** |
|------------------------------------------|------------|-------------------------------------|------------|----------------------------|------------|
| **(in  thousands)**                      | ** ** | **Net Carrying   Amount** | ** ** | **Fair Value**        | ** ** | **Unrealized  loss** | ** ** | **Net Carrying   Amount** | ** ** | **Fair Value** | ** ** | **Unrealized  loss** | ** ** |
| Short-term  (Held-to-maturity):          |       |                                |       |                       |       |   |   |   |   |   |   |   |   |
| Government-backed securities             |       | $                                   | 9,998      |                       | $          | 9,994 |   | $ | (4 | ) | $ | 17,997 |   | $ | 17,946 |   | $ | (51 | ) |
| Certificates of deposit                  |       | 2,920                               |       | 2,897                      |       | (23 | ) | 2,368 |   | 2,356 |   | (12 | ) |
| Corporate bonds                          |       | —                              |       | —                     |       | — |   | 3,005 |   | 2,996 |   | (9 | ) |
| Commercial paper                         |       | —                              |       | —                     |       | — |   | 3,962 |   | 3,960 |   | (2 | ) |
|                                     |       | 12,918                              |       | 12,891                     |       | (27 | ) | 27,332 |   | 27,258 |   | (74 | ) |
| Short-term  (Available-for-sale):        |       |                                |       |                       |       |   |   |   |   |   |   |   |   |
| Equity investments                       |       | 2,042                               |       | 2,042                      |       | — |   | — |   | — |   | — |   |
| Total marketable  securities, short-term |       | $                                   | 14,960     |                       | $          | 14,933 |   | $ | (27 | ) | $ | 27,332 |   | $ | 27,258 |   | $ | (74 | ) |
|                                     |       |                                |       |                       |       |   |   |   |   |   |   |   |   |
| Long-term  (Held-to-maturity):           |       |                                |       |                       |       |   |   |   |   |   |   |   |   |
| Government-backed securities             |       | $                                   | 10,992     |                       | $          | 11,001 |   | $ | 9 |   | $ | 8,998 |   | $ | 8,917 |   | $ | (81 | ) |
| Certificates of deposit                  |       | 2,668                               |       | 2,647                      |       | (21 | ) | 2,955 |   | 2,903 |   | (52 | ) |
| Total marketable  securities, long-term  |       | $                                   | 13,660     |                       | $          | 13,648 |   | $ | (12 | ) | $ | 11,953 |   | $ | 11,820 |   | $ | (133 | ) |

 

There have been nomaterial realized gains or losses for the three and nine months ended March 31,2007.

**8.****      Inventories**

Inventoriesconsist of the following:
|                         | ** ** | **March 31,** | ** ** | **July 1,** | ** ** |
|-------------------------|------------|--------------------|------------|------------------|------------|
| **(in thousands)** | ** ** | **2007**           | ** ** | **2006**         | ** ** |
| Raw materials           |       | $                  | 6,807      |             | $          | 5,936 |   |
| Work in process         |       | 1,502              |       | 1,151            |       |
| Finished goods          |       | 11,038             |       | 9,579            |       |
|                    |       |               |       |             |       |
|                    |       | $                  | 19,347     |             | $          | 16,666 |   |

 

**9.****      Property and Equipment**

Property andequipment consists of the following:
|                                           | ** ** | **March 31,** | ** ** | **July 1,** | ** ** |
|-------------------------------------------|------------|--------------------|------------|------------------|------------|
| **(in thousands)**                   | ** ** | **2007**           | ** ** | **2006**         | ** ** |
| Leasehold  improvements                   |       | $                  | 1,002      |             | $          | 920 |   |
| Office furniture                          |       | 701                |       | 603              |       |
| Computers,  software, and other equipment |       | 9,937              |       | 9,236            |       |
|                                      |       |               |       |             |       |
|                                      |       | $                  | 11,640     |             | $          | 10,759 |   |
| Less:  accumulated depreciation           |       | (8,136             | )          | (7,457           | )          |
|                                      |       |               |       |             |       |
| Property and  equipment, net              |       | $                  | 3,504      |             | $          | 3,302 |   |

 

Depreciation expense was approximately $0.2 million and $0.7 millionfor the three and nine month periods ended March 31, 2007, respectively.Depreciation expense was approximately $0.2 million and $0.6 million for thethree and nine month periods ended April 1, 2006, respectively.

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# **10.****   Intangible assets**

Intangible assetswith finite lives (amortized) and indefinite lives consist of the following: 
|                              | ** ** | **March 31, 2007**            | ** ** | **July 1, 2006**    | ** ** |
|------------------------------|------------|-----------------------------------------|------------|-------------------------------|------------|
| **(in thousands)**           | ** ** | **Gross   Carrying   Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Book   Value** | ** ** | **Gross   Carrying   Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Book   Value** | ** ** |
| Patents                      |       | $                                       | 7,679      |                          | $          | (290 | ) | $ | 7,389 |   | $ | — |   | $ | — |   | $ | — |   |
| Prepaid licenses             |       | 4,878                                   |       | (832                          | )          | 4,046 |   | 3,878 |   | (476 | ) | 3,402 |   |
| Goodwill  (indefinite lived) |       | 10,549                                  |       | —                        |       | 10,549 |   | — |   | — |   | — |   |
|                         |       |                                    |       |                          |       |   |   |   |   |   |   |   |   |
|                         |       | $                                       | 23,106     |                          | $          | (1,122 | ) | $ | 21,984 |   | $ | 3,878 |   | $ | (476 | ) | $ | 3,402 |   |

 

# **11.****    Derivative Instruments andHedging Activity**

The Company enters intofinancial instruments to reduce its exposure to fluctuations in foreignexchange rates by creating offsetting positions through the use of foreigncurrency forward contracts.  The Companygenerally recognizes derivative instruments as either assets or liabilities inthe statements of financial position and measures those instruments at fairvalue.  Changes to the fair value ofderivative contracts that do not qualify for hedge accounting are reported inearnings in the period of the change. For derivatives that qualify for hedgeaccounting, changes in the fair value of the derivatives are recorded inshareholders’ equity as a component of other comprehensive income along with anoffsetting adjustment against the basis of the derivative instrument itself.

The Company had four foreigncurrency forward contracts outstanding at March 31, 2007, serving to mitigatethe foreign currency risk of a substantial portion of Euro-denominatedintercompany balances, in the notional amount of approximately 3.7million Euros. The fair value of the foreign currency derivative contractsoutstanding at March 31, 2007 was approximately $4.9 million. Any gains orlosses on the fair value of the effective portion of the derivative contractare largely offset by the losses and gains on the underlying transactions.

# **12.****   Warranty Reserve**

The Company’s products generally carry astandard warranty. The Company maintains a reserve based on anticipatedwarranty claims at the time product revenue is recognized.  Factors that affect the Company’s productwarranty liability include the number of installed units, the anticipated costof warranty repairs and historical and anticipated rates of warranty claims.

# Thefollowing table reflects changes in the Company’s accrued warranty accountduring the three and nine month periods ended March 31, 2007 and April 1, 2006,respectively:

|                                       | ** ** | **For the three months ended:** | ** ** | **For the nine months ended:** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                            | ** ** | **March 31,**                                  | ** ** | **April 1,**                                  | ** ** | **March 31,** | ** ** | **April 1,** | ** ** |
| **(in thousands)**               | ** ** | **2007**                                            | ** ** | **2006**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  balance                    |       | $                                                   | 9,490      |                                               | $          | 8,890 |   | $ | 9,629 |   | $ | 8,646 |   |
| Incremental accruals on current sales |       | 1,240                                               |       | 2,385                                              |       | 4,811 |   | 6,071 |   |
| Amortization of prior-period accruals |       | (2,045                                              | )          | (1,919                                             | )          | (5,755 | ) | (5,361 | ) |
|                                  |       |                                                |       |                                               |       |   |   |   |   |
| Ending balance                        |       | $                                                   | 8,685      |                                               | $          | 9,356 |   | $ | 8,685 |   | $ | 9,356 |   |

 

# **13.****    Deferred Revenue**

# The Company offersextended service contracts that may be purchased for periods from one to fiveyears. The Company 

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# recognizesservice contract revenue ratably over the life of the contract. Actual servicecontract expenses incurred and charged to service costs of sales during aninterim period may be more or less than the amount of amortized service contractrevenue recognized in that period.

# Revenuesare recognized when a signed non-cancelable purchase order exists, the productis shipped, title and risk have passed to the customer, the fee is fixed ordeterminable, and collection is considered probable. Circumstances whichgenerally preclude the immediate recognition of revenue include shipping termsof FOB destination or the existence of a customer acceptance clause in acontract based upon customer inspection of the product. In these instances,revenue is deferred until adequate documentation is obtained to ensure thatthese criteria have been fulfilled.

# Thefollowing table reflects changes in the Company’s deferred revenue accountduring the three and nine month periods ended March 31, 2007 and April 1, 2006,respectively:

|                                            | ** ** | **For the three months ended:** | ** ** | **For the nine months ended:** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                 | ** ** | **March 31,**                                  | ** ** | **April 1,**                                  | ** ** | **March 31,** | ** ** | **April 1,** | ** ** |
| **(in thousands)**                    | ** ** | **2007**                                            | ** ** | **2006**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  balance                         |       | $                                                   | 10,079     |                                               | $          | 9,325 |   | $ | 10,329 |   | $ | 8,350 |   |
| Deferral of new sales                      |       | 4,729                                               |       | 1,339                                              |       | 9,243 |   | 7,850 |   |
| Recognition of previously deferred revenue |       | (2,865                                              | )          | (1,999                                             | )          | (7,629 | ) | (7,535 | ) |
|                                       |       |                                                |       |                                               |       |   |   |   |   |
| Ending balance                             |       | $                                                   | 11,943     |                                               | $          | 8,665 |   | $ | 11,943 |   | $ | 8,665 |   |

 

# **14.****    Common Stock Buyback**

On October 31,2005, the Company’s Board of Directors authorized the purchase by the Companyof up to 10% of the Company’s outstanding shares of its common stock during atwo-year period which expires on October 31, 2007.

770 thousandshares of common stock were purchased for approximately $8.3 million during thenine-month period ended March 31, 2007.

# **15.****    Commitments and Contingencies**

The Company has an agreementwith the Regents of the University of California (the “Regents”) for exclusivelicense rights to the Dynamic Cooling Device (“DCD”), subject to certainlimited license rights of Cool Touch, Inc. (“Cool Touch”), in the followingfields of use:  procedures that involveskin resurfacing and rejuvenation, vascular skin lesions, and laser hairremoval.  Cool Touch, a subsidiary of NewStar Technology, Inc., obtained a license to the DCD on a co-exclusive basiswith the Company, in certain narrower fields of use.

The Company’s agreement withthe Regents called for an annual license fee of $0.3 million and a royaltyobligation of 3%.  The annual fee of $0.3million was paid to the Regents in a lump sum of $3.0 million and is beingamortized over the remaining life of the patent agreement, which as of March31, 2007 was less than 9 years. The royalty and the amortization of the annuallicense fee payment are reflected in the Company’s consolidated statement ofincome. The unamortized portion of the license fee payment is reflected inintangible assets in the March 31, 2007 and July 1, 2006 balance sheets (Note10).

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# **16.****             Legal Proceedings**

The Company is currently involved in three litigationmatters with Palomar Medical Technologies, Inc. (“Palomar”).

·                  On August 9, 2006, Palomar filed suit againstthe Company in the United States District Court for the District of Massachusetts,asserting willful infringement by the Company of U.S. Patent No.5,735,844.  Palomar seeks compensatoryand treble damages, as well as attorneys’ fees and injunctive relief.  In November 2006, the Company answered thecomplaint by denying Palomar’s allegations and asserting a variety ofaffirmative defenses and counterclaims against Palomar. This response includeda counterclaim by the Company against Palomar seeking a declaratory judgmentthat United States patent No. 5,595,568 (“the ‘568 Patent”) is either invalid,or products manufactured by the Company do not infringe the ‘568 Patent, orboth. In November 2006, Palomar filed an answer denying the Company’scounterclaim. In February 2007, Palomar moved to Amend its Complaint to add TheGeneral Hospital Corporation as a party, to add a claim for infringement of the‘568 patent, and to allege that additional Candela products infringe the ‘568Patent. The Court has not ruled on whether Palomar’s proposed amendments to itsoriginal complaint will be allowed. On February 16, 2007, Candela moved toamend its Answer and Counterclaims to add allegations of inequitable conduct,double-patenting and violation of Mass. Gen. Laws Ch. 93A. The Company’s motionwas granted in March of 2007. Palomar filed a general denial response toCandela’s Amended Answer and Counterclaim on March 29, 2007. The parties arepresently in the midst of pre-trial fact discovery which is expected to takeseveral months.

·                  On August 10, 2006, the Company filed suitagainst Palomar in the United States District Court for the District ofMassachusetts, asserting willful infringement by Palomar of U.S. Patent Nos.6,659,999, 5,312,395, and 6,743,222. The Company seeks compensatory and trebledamages for the patent infringement, as well as attorneys’ fees and aninjunction against Palomar to prevent Palomar’s continuing infringement. TheCompany served its complaint on Palomar in August 2006.  In October 2006, the Company amended theCompany’s suit against Palomar by removing from the suit allegations thatPalomar infringes Patent 6,659,999. In October 2006, Palomar answered theCompany’s amended complaint by denying the Company’s allegations and assertingan affirmative defense of inequitable conduct with respect to the ‘395 patent. Inaddition, Palomar filed a demand for a declaratory judgment seeking a judicialdetermination that Palomar products either do not infringe the ‘395 and ‘222patents or that such patents are invalid. In November 2006, the Company answered the counterclaim by denyingPalomar’s allegations. The parties are in the midst of pre-trial factdiscovery.

·                  In December 2006, the Company filed suitagainst Palomar in the United States District Court for the Eastern District ofTexas, Lufkin Division, asserting that Palomar infringes one or more claims ofUnited States patents Nos: 5,810,801, 6,659,999 and 6,120,497. The Companyseeks compensatory and treble damages for past infringement, as well asattorneys’ fees and an injunction against Palomar from future infringement.  In January 2007, Palomar answered thecomplaint by denying the Company’s allegations and filing a declaratoryjudgment motion seeking a court ruling that it does not infringe such patentsand/or that such patents are invalid. In addition, Palomar filed a motion totransfer the case to the United States District Court for the District ofMassachusetts. In February 2007, the Company added Massachusetts GeneralHospital as a party to its action. The Court denied Palomar’s motion totransfer the case to Massachusetts. The parties are in the midst of pre-trialfact discovery.

Whilethe Company intends to vigorously contest Palomar’s allegations, andto pursue its own claims against Palomar, each lawsuit isinherently uncertain and unpredictable as to its ultimateoutcome.  An adverse outcome in Palomar’s suit against theCompany would materially hurt the Company’s business, financial condition,results of operations and cash flows.  Incontrast, an adverse outcome in either of the two lawsuits which the Companyhas initiated against Palomar would not likely have a material adverse effecton the business or financial condition of the Company.

14

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From time to time, the Company is party to various legal proceedingsincidental to its business.  The Companybelieves that none of the legal proceedings, other than the lawsuit initiatedby Palomar, that are presently pending, if adversely decided against us, willhave a material adverse effect upon the Company’s  financial position, results of operations, orliquidity.

# **17.****             Other Income**

During thenine-month period ended March 31, 2007, the Company recognized a $3.5 milliongain on the exchange of common stock of Solx Inc. for cash and common stock ofOcculogix Inc. (NasdaqGM: OCCX).  Thegain was a result of the acquisition of Solx Inc., a privately-held company, byOcculogix Inc., a publicly traded company. The Company held 19.99% of the outstanding common stock of Solx Inc. onan as-converted basis, prior to the merger. As a result of the acquisition of Solx, Inc., the Company receivedapproximately $1.0 million in cash plus approximately 1.3 million shares ofcommon stock in Occulogix Inc.

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**CANDELACORPORATION**

**Item 2 -Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

**Overview**

We research, develop, manufacture, market and servicelasers used to perform aesthetic and cosmetic procedures. We sell our lasers tophysicians and personal care practitioners. We market our products directly and through a network of distributors toend-users. Our traditional customer base includes plastic and cosmetic surgeonsand dermatologists. More recently, we have expanded our sales to a broadergroup of practitioners consisting of general practitioners and certainspecialists including obstetricians, gynecologists and general and vascularsurgeons.   We derive our revenue fromthe sales of lasers, light-based devices, and other products, as well as theprovision of product-related services.

**CriticalAccounting Policies**

This discussion and analysis of our financialcondition and results of operations is based upon our consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of these financialstatements requires us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses, and related disclosureof contingent assets and liabilities. We evaluate our estimates and judgmentson an on-going basis, including those related to revenue recognition, allowancefor doubtful accounts, inventories reserves, warranty reserves, contingencies,valuation of long-lived assets, stock based compensation, restructurings andincome taxes. We base our estimates and judgments on historical experience andon various other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying value of assets and liabilities that are not readily apparent fromother sources. Actual results may differ from these estimates and judgmentsunder different assumptions or conditions. A discussion of our criticalaccounting policies and the related estimates and judgments affecting thepreparation of our consolidated financial statements is included in our AnnualReport on Form 10-K for fiscal year 2006.

**Recent AccountingPronouncements**

In September 2006, the Securities and ExchangeCommission issued Staff Accounting Bulletin (“SAB”) No. 108, *Considering the Effects of Prior Year Misstatements when QuantifyingCurrent Year Misstatements*. SAB No. 108 requires analysis ofmisstatements using both an income statement (rollover) approach and a balancesheet (iron curtain) approach in assessing materiality and provides for a one-timecumulative effect transition adjustment. SAB No. 108 is effective for ourfiscal year 2007 annual financial statements. We are currently assessing thepotential impact that the adoption of SAB No. 108 will have on ourfinancial statements; the impact is not expected to be material.

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*, which defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.SFAS No. 157 does not require any new fair value measurements, butprovides guidance on how to measure fair value by providing a fair valuehierarchy used to classify the source of the information. This statement iseffective for our fiscal year 2008. We are currently assessing the potentialimpact that the adoption of SFAS No. 157 will have on our financialstatements; the impact is not expected to be material.

In July 2006, the FASB issued InterpretationNo. 48, *Accounting for Uncertainty in IncomeTaxes-an interpretation of FASB Statement No. 109* (FINNo. 48). FIN No. 48 clarifies the accounting for uncertainty inincome taxes recognized in an enterprise’s financial statements in accordancewith FASB Statement No. 109, *Accounting for IncomeTaxes*.  FIN No. 48prescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN No. 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods anddisclosure relative to uncertain tax positions. FIN No. 48 is effectivefor fiscal years beginning after December 15, 2006, with early adoptionencouraged. We are currently assessing the potential impact that the adoptionof FIN No. 48 will have our consolidated financial statements.

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In February 2006, the FASB issued StatementNo. 155,*Accounting for Certain HybridFinancial Instruments—an amendment of FASB Statements No. 133 and 140*(SFAS No. 155). This standard permits fair value remeasurement for anyhybrid financial instrument that contains an embedded derivative that otherwisewould require bifurcation; clarifies which interest-only strips andprincipal-only strips are not subject to the requirements of SFAS No. 133;requires evaluation of interests in securitized financial assets; clarifiesthat concentrations of credit risk in the form of subordination are notembedded derivatives; and eliminates the prohibition on a qualifyingspecial-purpose entity from holding a derivative financial instrument thatpertains to a beneficial interest other than another derivative financialinstrument. This standard is effective for all financial instruments acquiredor issued for fiscal years beginning after September 15, 2006. We do notbelieve that adoption of SFAS No. 155 will have a material effect on ourfinancial position or results of operations.

**Results ofOperations**

***Revenue***

Revenue source by geographic region is reflected inthe following table:
|                         | ** ** | **For the three months ended:** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|
| ** **              | ** ** | **March 31,**                                  | ** ** | **April 1,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in thousands)** | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **Increase (Decrease)** | ** ** |
| U.S.                    |       | $                                                   | 15,204     |   | 39 | % | $ | 20,157 |   | 48 | % | $ | (4,953 | ) | -25 | % |
| All other  countries    |       | 23,486                                              |       | 61 | % | 22,157 |   | 52 | % | 1,329 |   | 6 | % |
|                    |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total worldwide revenue |       | $                                                   | 38,690     |   | 100 | % | $ | 42,314 |   | 100 | % | $ | (3,624 | ) | -9 | % |

 
|                          | ** ** | **For the nine months ended:** | ** ** |
|--------------------------|------------|----------------------------------------------------|------------|
| ** **               | ** ** | **March 31,**                                 | ** ** | **April 1,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in thousands)**  | ** ** | **2007**                                           | ** ** | **2006** | ** ** | **Increase (Decrease)** | ** ** |
| U.S.                     |       | $                                                  | 47,900     |   | 44 | % | $ | 48,894 |   | 45 | % | $ | (994 | ) | -2 | % |
| All other  countries     |       | 61,670                                             |       | 56 | % | 59,227 |   | 55 | % | 2,443 |   | 4 | % |
|                     |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Total worldwide  revenue |       | $                                                  | 109,570    |   | 100 | % | $ | 108,121 |   | 100 | % | $ | 1,449 |   | 1 | % |

 

Consolidated revenue was $38.7million for thethree-month period ended March 31, 2007 compared to $42.3 million for thethree-month period ended April 1, 2006. The decrease of $3.6 million wascomprised of decreases in the U.S. and Latin America of $5.1 million and $1.4million, respectively, offset by an increase in Europe of $2.9 million. Thedecrease in U.S. revenues was primarily related to a leveling-off in demand forour VBeamTM platform and delays in new productcompletions. The VBeamTM decrease was directly related to theintroduction of the upgraded version in the fiscal quarter ended April 1, 2006which, in turn, created a large initial demand as compared to the quarter endedMarch 31, 2007. The decrease in Latin America was primarily due to theunexpectedly high revenue for the demographics of the region in the previous comparableperiod. The increase in Europe was primarily the result of expanded and moreefficient distribution channels.

Consolidated revenue was $109.6 million for thenine-month period ended March 31, 2007 compared to $108.1 million for thenine-month period ended April 1, 2006. The net increase of $1.4 million wascomprised of decreases in the U.S. and Latin America of $1.0 million and $4.0million, respectively, offset by increases in Europe of $6.0 million and Asiaof $0.4 million. The decrease in Latin America was primarily due to theunexpectedly high revenue for the demographics of the region in the previouscomparable period. The increase in Europe was primarily the result of expandedand more efficient distribution channels.

Foreign revenue accounted for approximately 61% of theconsolidated revenue for the three-month period ended March 31, 2007. Theincrease of 6% to $23.5 million for the three-month period ended March 31, 2007as compared to the three-month period ended April 1, 2006, was comprisedprimarily of an increase in Europe of $2.9 million offset by a decrease inLatin America of $1.4 million.

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Foreign revenue accounted for approximately 56% of theconsolidated revenue for the nine-month period ended March 31, 2007. Theincrease of 1% to $61.7 million for the nine-month period ended March 31, 2007as compared to the nine-month period ended April 1, 2006, was comprisedprimarily of an increase in Europe of $6.0 million offset by a decrease inLatin America of $4.0 million. The increase in Europe was primarily the resultof expanded and more efficient distribution channels. The decrease in LatinAmerica was primarily due to the unexpectedly high revenue for the demographicsof the region in the previous comparable period.

Revenue source by type is reflected in the followingtable:
|                            | ** ** | **For the three months ended:** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|
| ** **                 | ** ** | **March 31,**                                  | ** ** | **April 1,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in thousands)**    | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **Increase (Decrease)** | ** ** |
| Lasers and other  products |       | $                                                   | 29,017     |   | 75 | % | $ | 34,795 |   | 82 | % | $ | (5,778 | ) | -17 | % |
| Product-related  services  |       | 9,673                                               |       | 25 | % | 7,519 |   | 18 | % | 2,154 |   | 29 | % |
|                       |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total revenue              |       | $                                                   | 38,690     |   | 100 | % | $ | 42,314 |   | 100 | % | $ | (3,624 | ) | -9 | % |

 
|                            | ** ** | **For the nine months ended:** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **March 31,**                                 | ** ** | **April 1,** | ** ** | ** ** | ** ** |
| **(in thousands)**    | ** ** | **2007**                                           | ** ** | **2006** | ** ** | **Increase (Decrease)** | ** ** |
| Lasers and other  products |       | $                                                  | 84,014     |   | 77 | % | $ | 88,677 |   | 82 | % | $ | (4,663 | ) | -5 | % |
| Product-related  services  |       | 25,556                                             |       | 23 | % | 19,444 |   | 18 | % | 6,112 |   | 31 | % |
|                       |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Total revenue              |       | $                                                  | 109,570    |   | 100 | % | $ | 108,121 |   | 100 | % | $ | 1,449 |   | 1 | % |

 

Lasers and other product revenues was $29.0 million ascompared to $34.8 million for the three-month periods ended March 31, 2007 andApril 1, 2006, respectively. The decrease of $5.7 million was comprised of adecrease of approximately $3.7 million in our VBeamTM platform combined with a $2.2 million decreasein our Gentle YAGTM product line. As noted previously, the VBeamTM decrease was directly related to theintroduction of the upgraded version in the fiscal quarter ended April 1, 2006which, in turn, created a large initial demand as compared to the quarter endedMarch 31, 2007. The average selling price of our products remained comparablefor the three-month periods ended March 31, 2007 and April 1, 2006,respectively.

Product-related services increased $2.1 million or 29%and $6.1 million or 31% in the three and nine month periods ended March 31,2007 as compared to the same periods ended April 1, 2006. The increase isprimarily related to the increase in the number of service-related contractssold in addition to an increase in the number of consumables and accessoriessold to support our installed base.

Lasers and other product revenues was $84.0 millioncompared to $88.7 million for the nine-month periods ended March 31, 2007 andApril 1, 2006, respectively. This reduction in product revenue was experiencedacross all product lines.

***Gross Profit.***Grossprofit was approximately $19.7 million or 51.0% for the three-month periodended March 31, 2007 compared to $21.4 million or 50.6% for the three-monthperiod ended April 1, 2006. Gross profit was $54.9 million or 50.1% for thenine-month period ended March 31, 2007 compared to $54.9 million or 50.8% forthe nine-month period ended April 1, 2006. The changes in gross profit for thethree and nine-month periods are principally related to overall sales volumeand product mix.

***Selling, General andAdministrative Expense. ***Selling,general and administrative expenses increased to approximately $13.2 millionfor the three-month period ended March 31, 2007, from approximately $11.6million for the three-month period ended April 1, 2006.  As a percentage of revenue, selling, generaland administrative expenses increased to 34% from 27% of revenues from thecomparative prior year period.  Theincrease was primarily due to legal fees related to the Palomar litigation andto incremental share-based compensation expense, as well as higher salaries dueto increased headcount. For the nine-month period ended March 31, 2007,selling, general and administrative expenses increased to approximately $36.8million from approximately $30.8 million for 

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the nine-month period ended April 1, 2006.  As a percentage of revenue, selling, generaland administrative expenses increased to 33.6% from 28.5% of revenues from thecomparative prior year period.  The increaseis due primarily to legal fees related to the Palomar litigation and toshare-based compensation expense, as well as higher salaries due to increasedheadcount.

***Research and Development Expense.***  Research and development spending increasedto $4.9 million for the three-month period ended March 31, 2007, from $2.4million for the three-month period ended April 1, 2006, due primarily to anincrease in the number of active projects and an increase in employee costs.Spending in this area increased to $13.1 million for the nine-month periodended March 31, 2007, from $5.9 million for the nine-month period ended April1, 2006 due primarily to the aforementioned increase in project spending and anincrease in employee-related costs.

***Other Income/Expense. ***Other income increasedto approximately $0.8 million for the three-months ended March 31, 2007compared to $0.5 million for the three-month period ended April 1, 2006 dueprimarily to an increase in interest income earned on the higher level of cashand cash equivalents, and investments. For the nine-month period ended March31, 2007, other income was approximately $6.0 million compared to other incomeof approximately $1.0 million for the nine-month period ended April 1, 2006.The increase is due primarily to an increase in interest income as a result ofan increase in cash and cash equivalents, investments, and a recognized $3.5million gain which the Company recognized on the exchange of its shares ofcommon stock of Solx Inc. for cash and common stock of Occulogix Inc.

The gain was a result of the acquisition of Solx Inc.,a privately-held company, by Occulogix Inc., a publicly traded company.  We held 19.99% of the outstanding commonstock of Solx Inc. on an as-converted basis, prior to the merger.  As a result of the merger, we receivedapproximately $1.0 million cash plus approximately 1.3 million shares of commonstock in Occulogix Inc., a company publicly traded on the Nasdaq Global Market.

***Income Taxes.***The provision for income taxes results from a combination of activities of theCompany and its domestic and foreign subsidiaries. We recorded effective taxrates of approximately 37% for each of the three-month periods ended March 31,2007 and April 1, 2006, respectively. We recorded effective tax rates ofapproximately 36% and 35% for the nine-month periods ended March 31, 2007 andApril 1, 2006, respectively.  Theincrease was due primarily to the phase out of the extraterritorial incomeexclusion deduction in fiscal year 2007 and a decrease in the valuationallowances for foreign jurisdictions in the same period in the previous year,offset slightly by a retroactive reinstatement of the domestic research &development tax credit.

**Liquidity andCapital Resources**

Our cash and cash equivalents and our investment inshort and long-term marketable securities at March 31, 2007 totaledapproximately $56.5 million compared with approximately $79.5 million at July1, 2006. 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, or that any such required additional capital will beavailable on reasonable terms, if at all, as it becomes required.

Cash used by operating activities amounted toapproximately $4.0 million for the nine-month period ended March 31, 2007 ascompared to cash provided by operating activities of $6.1 million for the sameperiod in the prior year. The increase in cash used by operating activities isprimarily due to the payment of prior year liabilities and a decrease in netincome as compared to the same period in the prior year.

Cash used by investing activities amounted toapproximately $0.9 million for the nine-month period ended March 31, 2007 ascompared to approximately $34.9 million for the nine-month period ended April1, 2006. The activity for both nine-month periods reflects the maturity orpurchase of held-to-maturity investments. Cash used by investing activities alsoreflects approximately $15.7 million, net of cash received, for the acquisitionof Inolase during the nine-month period ended March 31, 2007 as compared to thesame period in the prior year (Note 6).

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Cash used by financing activities amounted to approximately$7.9 million for the nine-month period ended March 31, 2007 and primarilyreflects the re-purchase of Company stock by the Company in open markettransactions during the period.

Cash provided by financing activities amounted toapproximately $7.3 million for the nine-month period ended April 1, 2006,and  primarily reflects the proceeds fromthe issuance of common stock by the Company to its employees under existingstock option and stock purchase plan.

**Off-Balance SheetArrangements**

Our only off-balance sheet arrangements consist ofnon-cancelable operating leases entered into in the ordinary course of businessand the license agreement with the Regents. The table below in the next sectiontitled “Contractual Obligations” shows the amounts of our operating leasecommitments and purchase commitments payable by year.

**ContractualObligations**

Outstanding contractual obligations of the Company arereflected in the following table:

| (in thousands)            | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **After  5 years** | ** ** |
|--------------------------------|------------|-----------|------------|---------------------------------|------------|--------------------------------|------------|--------------------------------|------------|-------------------------|------------|
| Royalty  commitments           |       | $         | 5,250      |                            | $          | 1,000                          |       | $                              | 2,000      |                    | $          | 1,500 |   | $ | 750 |   |
| Operating leases               |       | 2,038     |       | 1,217                           |       | 754                            |       | 67                             |       | —                  |       |
|                           |       |      |       |                            |       |                           |       |                           |       |                    |       |
| Total contractual  obligations |       | $         | 7,288      |                            | $          | 2,217                          |       | $                              | 2,754      |                    | $          | 1,567 |   | $ | 750 |   |

 

**CautionaryStatements**

Certain statements contained herein may constitute“forward-looking statements” within the meaning of the Private SecuritiesLitigation Reform Act of 1995 (“Reform Act”). We may also make forward-lookingstatements in other reports filed with the Securities and Exchange Commission,in materials delivered to stockholders and in press releases. In addition, ourrepresentatives may from time to time make oral forward-looking statements.Forward-looking statements provide current expectations of future events basedon certain assumptions and include any statement that does not directly relateto any historical or current fact. Words such as “anticipates,” “believes,”“expects,” “estimates,” “intends,” “plans,” “projects,” and similarexpressions, may identify such forward-looking statements. Such forward-lookingstatements include but are not limited to: that we have the necessaryinfrastructure in place to capitalize on expansion; the affordability of ourproducts will allow for expansion; that we can lower production costs; or thatthe market will expand beyond baby boomers. We assume no obligation to update or revise any forward-lookingstatements whether as a result of new information, future events or otherwise.  The risks and uncertainties that may affectforward-looking statements and/or our business include, among others, thosediscussed in “Cautionary Statements” in our Annual Report filed on Form 10-Kfor the fiscal year ended July 1, 2006, as well as other risks anduncertainties referenced in this Quarterly Report on Form 10-Q, and thefollowing:

·                                          OnAugust 9, 2006, one of our competitors, Palomar Medical Technologies, Inc.(“Palomar”), alleged that the manufacture, use and sale of our products forlaser hair removal willfully infringe certain United States patents. Publicannouncements concerning this litigation that are unfavorable to us may resultin significant declines in our stock price. An adverse ruling or judgment inthis matter is likely to cause our stock price to decline significantly.  Litigation with Palomar is expensive and islikely to be protracted, and our intellectual property position may be weakenedas a result of an adverse ruling or judgment. Whether or not we are successfulin the pending lawsuit, litigation may consume substantial amounts of ourfinancial resources and divert management’s attention away from our corebusiness.  Please see Part II, Item 1(Legal Proceedings) for a further discussion of the Palomar litigation.

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·                                          Claimsby others that our products infringe their patents or other intellectualproperty rights, or that the patents which we own or have licensed rights toare invalid, could prevent us from manufacturing and selling some of ourproducts or require us to incur substantial costs from litigation or developmentof non-infringing technology.

·                                          Ourprincipal source of liquidity is our current cash and equivalents andmarketable investments. Our ability to generate cash from operations isdependant upon our ability to generate revenue from selling our lasers and otherproducts and providing product-related services. A decrease in demand for ourproducts and related services or increases in operating costs would likely havean adverse effect on our liquidity.

·                                          Becausewe typically derive more than half of our revenue from international sales, weare susceptible to currency fluctuations, negative economic changes takingplace in foreign marketplaces, and other risks associated with conductingbusiness overseas.

·                                          Thefailure to obtain alexandrite rods for certain laser systems from our solesupplier would impair our ability to manufacture and sell these laser systems,which has accounted for a substantial portion of our revenue in certain recentperiods.

·                                          Ourfailure to respond to rapid changes in technology and intense competition inthe laser industry could make our lasers obsolete.

·                                          Likeother companies in our industry, we are subject to a regulatory review processand our failure to receive necessary government clearances or approvals couldaffect our ability to sell our products and remain competitive.

·                                          We have modified some of our products without FDA clearance.  The FDA could retroactively decide themodifications were improper andrequire us to cease marketing and/or recall the modified products.

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

·                                          Wecould incur substantial costs as a result of product liability claims.

·                                          Wemay be unable to attract and retain management and other personnel we need tosucceed.

·                                          Ourfailure to manage acquisitions and joint ventures effectively may divertmanagement attention from our core business and cause us to incur debt,liabilities or costs.

We caution readers not to place undue reliance uponany forward-looking statements, which speak only as of the date made.  We expressly disclaim any obligation orundertaking to release publicly any updates or revisions to any such statementsto reflect any change in our expectations or any change in events, conditionsor circumstances on which any such statement is based.

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** **

**Item 3 -Quantitative and Qualitative Disclosures about Market Risk**

We have cashequivalents and marketable securities that consist of money market mutualfunds, certificates of deposit, US government securities, fixed incomecorporate securities and equity investments. The majority of these investmentshave maturities within one to three years. We believe that our exposure tointerest rate risk is minimal due to the term and type of our investments andthose fluctuations in interest rates would not have a material adverse effecton our results of operations.

We have international subsidiaries that transact business in both local and foreign currencies and therefore we are exposed to foreign currency exchange risk resulting from fluctuations in foreign currencies.  This risk could adversely impact our results and financial condition.  From time to time, we may enter into foreign currency exchange contracts to reduce our exposure to foreign currency exchange risk and variability in operating results due to fluctuation in exchange rates underlying the value of current transactions and anticipated transactions denominated in foreign currencies.  These contracts obligate us to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates.  These contracts are denominated in the same currency in which the underlying transactions are denominated and bear a contract value and maturity date that approximate the value and expected settlement date, respectively, of the underlying transactions. Unrealized gains and losses on open contracts at the end of each period, resulting from changes in the fair value of these contracts, are recognized in other comprehensive income in the same period as exchange gains and losses on the underlying foreign denominated receivables. We do not engage in foreign currency speculation.

We had four forward exchange contracts outstanding serving as a hedge of our Euro-denominated intercompany receivables at March 31, 2007.  These contracts serve as hedges of a substantial portion of our Euro-denominated intercompany balances. Any gains and losses on the fair value of the derivative contract would be largely offset by losses and gains on the underlying transaction.

# **Item 4 - Controls and Procedures**

***Evaluationof Disclosure Controls and Procedures***

Our Chief Executive Officer and acting Chief Financial Officer (our principal executive officer and principal financial officer, respectively) have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of March 31, 2007, the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and acting Chief Financial Officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective in gathering, analyzing and disclosing information needed to satisfy our disclosure obligations under the Securities Exchange Act of 1934, as amended.

***Changesin Internal Controls over Financial Reporting***

There have been nochanges in the Company’s internal controls over financial reporting thatoccurred during the quarter ended March 31, 2007 that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

 

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**CANDELACORPORATION**

**PartII.  Other Information**

# **Item 1 - Legal Proceedings**

The Company is currently involved in three litigationmatters with Palomar Medical Technologies, Inc. (“Palomar”).

·                  On August 9, 2006, Palomar filed suit againstthe Company in the United States District Court for the District ofMassachusetts, asserting willful infringement by the Company of U.S. Patent No.5,735,844.  Palomar seeks compensatoryand treble damages, as well as attorneys’ fees and injunctive relief.  In November 2006, the Company answered thecomplaint by denying Palomar’s allegations and asserting a variety ofaffirmative defenses and counterclaims against Palomar. This response includeda counterclaim by the Company against Palomar seeking a declaratory judgment thatUnited States patent No. 5,595,568 (“the ‘568 Patent”) is either invalid, orproducts manufactured by the Company do not infringe the ‘568 Patent, or both.In November 2006, Palomar filed an answer denying the Company’s counterclaim.In February 2007, Palomar moved to Amend its Complaint to add The GeneralHospital Corporation as a party, to add a claim for infringement of the ‘568patent, and to allege that additional Candela products infringe the ‘568Patent. The Court has not ruled on whether Palomar’s proposed amendments to itsoriginal complaint will be allowed. On February 16, 2007, Candela moved toamend its Answer and Counterclaims to add allegations of inequitable conduct,double-patenting and violation of Mass. Gen. Laws Ch. 93A. The Company’s motionwas granted in March of 2007. Palomar filed a general denial response toCandela’s Amended Answer and Counterclaim on March 29, 2007. The parties arepresently in the midst of pre-trial fact discovery which is expected to takeseveral months.

·                  On August 10, 2006, the Company filed suitagainst Palomar in the United States District Court for the District ofMassachusetts, asserting willful infringement by Palomar of U.S. Patent Nos.6,659,999, 5,312,395, and 6,743,222. The Company seeks compensatory and trebledamages for the patent infringement, as well as attorneys’ fees and aninjunction against Palomar to prevent Palomar’s continuing infringement. TheCompany served its complaint on Palomar in August 2006.  In October 2006, the Company amended the Company’ssuit against Palomar by removing from the suit allegations that Palomarinfringes Patent 6,659,999. In October 2006, Palomar answered the Company’samended complaint by denying the Company’s allegations and asserting anaffirmative defense of inequitable conduct with respect to the ‘395 patent. Inaddition, Palomar filed a demand for a declaratory judgment seeking a judicialdetermination that Palomar products either do not infringe the ‘395 and ‘222patents or that such patents are invalid. In November 2006, the Company answered the counterclaim by denyingPalomar’s allegations. The parties are in the midst of pre-trial factdiscovery.

·                  In December 2006, the Company filed suitagainst Palomar in the United States District Court for the Eastern District ofTexas, Lufkin Division, asserting that Palomar infringes one or more claims ofUnited States patents Nos: 5,810,801, 6,659,999 and 6,120,497. The Companyseeks compensatory and treble damages for past infringement, as well asattorneys’ fees and an injunction against Palomar from futureinfringement.  In January 2007, Palomaranswered the complaint by denying the Company’s allegations and filing adeclaratory judgment motion seeking a court ruling that it does not infringesuch patents and/or that such patents are invalid. In addition, Palomar filed amotion to transfer the case to the United States District Court for theDistrict of Massachusetts. In February 2007, the Company added MassachusettsGeneral Hospital as a party to its action. The Court denied Palomar’s motion totransfer the case to Massachusetts. The parties are in the midst of pre-trialfact discovery.

Whilethe Company intends to vigorously contest Palomar’s allegations, andto pursue its own claims against Palomar, each lawsuit isinherently uncertain and unpredictable as to its ultimateoutcome.  An adverse outcome in Palomar’s suit against 

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theCompany would materially hurt the Company’s business, financial condition,results of operations and cash flows.  Incontrast, an adverse outcome in either of the two lawsuits which the Companyhas initiated against Palomar would not likely have a material adverse effecton the business or financial condition of the Company.

From time to time, the Company is party to various legal proceedingsincidental to its business.  The Companybelieves that none of the legal proceedings, other than the lawsuit initiatedby Palomar, that are presently pending, if adversely decided against us, willhave a material adverse effect upon the Company’s  financial position, results of operations, orliquidity.

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# **ITEM 6 - Exhibits**

(a)                                  Exhibits
| Exhibit 10.1 | Amended and Restated Employment Agreement dated as  of April 5, 2007, between Candela Corporation and Gerard E. Puorro                                      |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 31.1 | Rule 13a-14(a)/15d-14(a) Certification of the Chief  Executive Officer                                                                                      |
| Exhibit 31.2 | Rule 13a-14(a)/15d-14(a) Certification of the  Principal Financial Officer                                                                                  |
| Exhibit 32.1 | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002     |
| Exhibit 32.2 | Certification of the Principal Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

CANDELACORPORATION
| Date: May 10, 2007 | /s/ Robert E. Quinn |                                 |
|--------------------|---------------------|--------------------------------------|
|               |                | Robert E. Quinn                      |
|               |                | (Treasurer, Corporate Controller and |
|               |                | Principal Financial Officer)         |
|                    |                     |                                      |  |

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**CandelaCorporation**

**INDEX TO EXHIBITS**
| Exhibit No.  | ** ** | **Description**                                                                                                                                             |
|--------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                        |
| Exhibit 10.1 |       | Amended and Restated Employment Agreement dated as  of April 5, 2007, between Candela Corporation and Gerard E. Puorro                                      |
|         |       |                                                                                                                                                        |
| Exhibit 31.1 |       | Rule 13a-14(a)/15d-14(a) Certification of the Chief  Executive Officer                                                                                      |
|         |       |                                                                                                                                                        |
| Exhibit 31.2 |       | Rule 13a-14(a)/15d-14(a) Certification of the  Principal Financial Officer                                                                                  |
|         |       |                                                                                                                                                        |
| Exhibit 32.1 |       | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002     |
|         |       |                                                                                                                                                        |
| Exhibit 32.2 |       | Certification of the Principal Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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