**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

----

 

**FORM 10-Q**

 

**Quarterly report pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934**

** **

**For the quarterly period ended October 1,2005.**

 

**Commission file number 000-14742**

 

**CANDELA CORPORATION**

(Exact name of registrant as specified in its charter)

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

 

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

 

----

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes  ý       No  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined by Rule 12b-2 of the Securities Exchange Act of 1934).

Yes  ý       No  o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes o  No ý

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 
| **Class**                              | ** ** | **Outstanding at November 4, 2005** |
|----------------------------------------|------------|------------------------------------------|
| Common Stock, $.01 par value per share |       | 22,680,683                               |

 

 

----

 

**CANDELA CORPORATION**

**Index**

 

 
| Part I.  | Financial Information: |                                                                                                                                                              |
|---------------|------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |                   |                                                                                                                                                              |   |
|          | Item 1.                | Financial Statements                                                                                                                                              |   |
|          |                   |                                                                                                                                                              |   |
|          |                   | Unaudited Consolidated Balance  Sheets as of October 1, 2005 and July 2, 2005                                                                           |   |
|          |                   |                                                                                                                                                              |   |
|          |                   | Unaudited Consolidated  Statements of Operations and Comprehensive Income (Loss) for the three-month  periods ended October 1, 2005 and October 2, 2004 |   |
|          |                   |                                                                                                                                                              |   |
|          |                   | Unaudited Consolidated  Statements of Cash Flows for the three-month periods ended October 1,  2005 and October 2, 2004                                 |   |
|          |                   |                                                                                                                                                              |   |
|          |                   | Notes to Unaudited Consolidated  Financial Statements                                                                                                             |   |
|          |                   |                                                                                                                                                              |   |
|          | Item 2.                | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                                       |   |
|          |                   |                                                                                                                                                              |   |
|          | Item 3.                | Quantitative and Qualitative  Disclosure about Market Risk                                                                                                        |   |
|          |                   |                                                                                                                                                              |   |
|          | Item 4.                | Controls and Procedures                                                                                                                                           |   |
|          |                   |                                                                                                                                                              |   |
| Part II. | Other Information:     |                                                                                                                                                              |
|          |                   |                                                                                                                                                              |
|          | Item 1.                | Legal proceedings                                                                                                                                                 |   |
|          |                   |                                                                                                                                                              |   |
|          | Item 6.                | Exhibits                                                                                                                                                          |   |
|          |                   |                                                                                                                                                              |   |
|          | Signatures             |                                                                                                                                                              |
|          | Index to Exhibits      |                                                                                                                                                              |

 

2

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**Part I.  Financial Information**

 

**Item 1 - Financial Statements**

 

**CANDELA CORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

 
| **(in thousands)**                               | ** ** | **October 1,  2005** | ** **  | **July 2,  2005** | ** ** |
|--------------------------------------------------|------------|---------------------------|-------------|------------------------|------------|
| ** **                                       | ** ** | **(unaudited)**           | ** **  | ** **             | ** ** |
| **Assets:**                                      | ** ** | ** **                | ** **  | ** **             | ** ** |
| ** **                                       | ** ** | ** **                | ** **  | ** **             | ** ** |
| Current assets:                                  |       |                      |        |                   |       |
|                                             |       |                      |        |                   |       |
| Cash and cash  equivalents                       | ** ** | **$**                     | **53,979**  | ** **             | **$**      | **56,383** | ** ** |
| Restricted cash                                  | ** ** | **179**                   | ** **  | **199**                | ** ** |
| Accounts  receivable, net                        | ** ** | **28,656**                | ** **  | **34,866**             | ** ** |
| Notes receivable                                 | ** ** | **1,114**                 | ** **  | **805**                | ** ** |
| Inventories, net                                 | ** ** | **13,890**                | ** **  | **12,676**             | ** ** |
| Other current  assets                            | ** ** | **2,082**                 | ** **  | **1,821**              | ** ** |
| Total current  assets                            | ** ** | **99,900**                | ** **  | **106,750**            | ** ** |
| ** **                                       | ** ** | ** **                | ** **  | ** **             | ** ** |
| Property and equipment, net                      | ** ** | **3,117**                 | ** **  | **3,240**              | ** ** |
| Deferred tax assets                              | ** ** | **5,743**                 | ** **  | **5,743**              | ** ** |
| Prepaid licenses                                 | ** ** | **3,759**                 | ** **  | **878**                | ** ** |
| Other assets                                     | ** ** | **323**                   | ** **  | **205**                | ** ** |
| Total assets                                     | ** ** | **$**                     | **112,842** | ** **             | **$**      | **116,816** | ** ** |
|                                             |       |                      |        |                   |       |
| **Liabilities and Stockholders’ Equity**    |       |                      |        |                   |       |
| Current liabilities:                             |       |                      |        |                   |       |
| Accounts payable                                 | ** ** | **$**                     | **7,795**   | ** **             | **$**      | **11,674** | ** ** |
| Accrued payroll  and related expenses            | ** ** | **3,320**                 | ** **  | **4,830**              | ** ** |
| Accrued warranty  costs                          | ** ** | **5,264**                 | ** **  | **5,291**              | ** ** |
| Income taxes  payable                            | ** ** | **1,603**                 | ** **  | **2,073**              | ** ** |
| Sales tax  payable                               | ** ** | **1,145**                 | ** **  | **2,206**              | ** ** |
| Royalties  payable                               | ** ** | **633**                   | ** **  | **1,661**              | ** ** |
| Other accrued  liabilities                       | ** ** | **2,728**                 | ** **  | **1,298**              | ** ** |
| Deferred Income  (current portion)               | ** ** | **6,017**                 | ** **  | **6,037**              | ** ** |
| Current  liabilities of discontinued operations  | ** ** | **1,302**                 | ** **  | **1,302**              | ** ** |
| Total current  liabilities                       | ** ** | **29,807**                | ** **  | **36,372**             | ** ** |
| Accrued warranty costs (long-term portion)       | ** ** | **3,225**                 | ** **  | **3,355**              | ** ** |
| Deferred Income (long-term portion)              | ** ** | **2,032**                 | ** **  | **2,313**              | ** ** |
| Long-term liabilities of discontinued operations | ** ** | **326**                   | ** **  | **437**                | ** ** |
| Total  liabilities                               | ** ** | **35,390**                | ** **  | **42,477**             | ** ** |
| ** **                                       | ** ** | ** **                | ** **  | ** **             | ** ** |
| Stockholders’ equity:                       | ** ** | ** **                | ** **  | ** **             | ** ** |
| Common stock                                     | ** ** | **248**                   | ** **  | **248**                | ** ** |
| Treasury stock,  at cost                         | ** ** | **(12,997**               | **)**       | **(12,997**            | **)**      |
| Additional  paid-in capital                      | ** ** | **54,139**                | ** **  | **54,027**             | ** ** |
| Accumulated  earnings                            | ** ** | **36,363**                | ** **  | **33,346**             | ** ** |
| Accumulated  other comprehensive income (loss)   | ** ** | **(301**                  | **)**       | **(285**               | **)**      |
| Total  stockholders’ equity                 | ** ** | **77,452**                | ** **  | **74,339**             | ** ** |
| Total liabilities and stockholders’ equity  | ** ** | **$**                     | **112,842** | ** **             | **$**      | **116,816** | ** ** |

 

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

 

3

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**CANDELA CORPORATION**

**Consolidated Statements of Operations and Comprehensive Income**

(in thousands, except per share data)

(unaudited)

 
| ** **                                         | ** ** | **For the three months ended:** | ** ** |
|----------------------------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | **October 1,  2005**       | ** ** | **October 2,  2004** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Revenue**                                        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Lasers  and other products**                     | ** ** | **$**                           | **22,225** | ** ** | **$** | **18,343** | ** ** |
| **Product-related  service**                       | ** ** | **5,862**                       | ** ** | **4,048** | ** ** |
| **Total  revenue**                                 | ** ** | **28,087**                      | ** ** | **22,391** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Cost of sales**                                  | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Lasers  and other products**                     | ** ** | **9,485**                       | ** ** | **7,553** | ** ** |
| **Product-related  service**                       | ** ** | **4,050**                       | ** ** | **2,797** | ** ** |
| **Total  cost of sales**                           | ** ** | **13,535**                      | ** ** | **10,350** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Gross profit**                                   | ** ** | **14,552**                      | ** ** | **12,041** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Operating expenses:**                            | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Selling,  general and administrative**           | ** ** | **8,717**                       | ** ** | **6,660** | ** ** |
| **Research  and development**                      | ** ** | **1,642**                       | ** ** | **1,335** | ** ** |
| **Total  operating expenses**                      | ** ** | **10,359**                      | ** ** | **7,995** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Income from operations**                         | ** ** | **4,193**                       | ** ** | **4,046** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Other income:**                                  | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Interest  income**                               | ** ** | **248**                         | ** ** | **96** | ** ** |
| **Other  income ,net**                             | ** ** | **62**                          | ** ** | **43** | ** ** |
| **Total  other income, net**                       | ** ** | **310**                         | ** ** | **139** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Income before income taxes**                     | ** ** | **4,503**                       | ** ** | **4,185** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Provision for income taxes**                     | ** ** | **1,486**                       | ** ** | **1,339** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Net income**                                     | ** ** | **$**                           | **3,017**  | ** ** | **$** | **2,846** | ** ** |
| **Net income per share of common stock:**          | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Basic**                                          | ** ** | **$**                           | **0.13**   | ** ** | **$** | **0.13** | ** ** |
| **Diluted**                                        | ** ** | **$**                           | **0.13**   | ** ** | **$** | **0.12** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Weighted average shares outstanding:**           | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Basic**                                          | ** ** | **22,515**                      | ** ** | **22,326** | ** ** |
| **Diluted**                                        | ** ** | **23,229**                      | ** ** | **23,031** | ** ** |
| ** **                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Net income**                                     | ** ** | **$**                           | **3,017**  | ** ** | **$** | **2,846** | ** ** |
| **Other comprehensive income (loss), net of tax:** | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Foreign  currency translation adjustment**       | ** ** | **(16**                         | **)**      | **(187** | **)** |
| **Total comprehensive income**                     | ** ** | **$**                           | **3,001**  | ** ** | **$** | **2,659** | ** ** |

 

***Theaccompanying notes are an integral part of the unaudited consolidated financialstatements.***

 

4

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**CANDELA CORPORATION**

**Consolidated Statements of Cash Flows**

(in thousands)

(unaudited)

 
| ** **                                                                                   | ** ** | **For the three months ended:** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                   | ** ** | **October 1,**             | ** ** | **October 2,** | ** ** |
| ** **                                                                                   | ** ** | **2005**                        | ** ** | **2004** | ** ** |
| **Cash flows from operating activities:**                                                    | ** ** | ** **                      | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Net  income**                                                                              | ** ** | **$**                           | **3,017**  | ** ** | **$** | **2,846** | ** ** |
| **Adjustments  to reconcile net income to net cash used for operating activities:**          | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Amortization  of share-based compensation expense**                                        | ** ** | **96**                          | ** ** | **—** | ** ** |
| **Depreciation  and amortization**                                                           | ** ** | **129**                         | ** ** | **177** | ** ** |
| **Provision  for bad debts**                                                                 | ** ** | **(216**                        | **)**      | **(137** | **)** |
| **Effect  of exchange rate changes on foreign currency denominated assets and  liabilities** | ** ** | **14**                          | ** ** | **8** | ** ** |
| **Increase  (decrease) in cash from working capital:**                                       | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Accounts  receivable**                                                                     | ** ** | **6,278**                       | ** ** | **2,237** | ** ** |
| **Notes  receivable**                                                                        | ** ** | **(289**                        | **)**      | **591** | ** ** |
| **Inventories**                                                                              | ** ** | **(1,233**                      | **)**      | **(817** | **)** |
| **Other  current assets**                                                                    | ** ** | **(264**                        | **)**      | **(1,019** | **)** |
| **Other  assets**                                                                            | ** ** | **(2,997**                      | **)**      | **43** | ** ** |
| **Accounts  payable**                                                                        | ** ** | **(3,901**                      | **)**      | **(2,571** | **)** |
| **Accrued  payroll and related expenses**                                                    | ** ** | **(1,511**                      | **)**      | **(1,878** | **)** |
| **Deferred  revenue**                                                                        | ** ** | **—**                      | ** ** | **296** | ** ** |
| **Accrued  warranty costs**                                                                  | ** ** | **(31**                         | **)**      | **(482** | **)** |
| **Income  taxes payable**                                                                    | ** ** | **(473**                        | **)**      | **882** | ** ** |
| **Long-term  portion of deferred revenue**                                                   | ** ** | **(411**                        | **)**      | **247** | ** ** |
| **Other  accrued liabilities**                                                               | ** ** | **(640**                        | **)**      | **(814** | **)** |
| **Change  in restricted cash**                                                               | ** ** | **20**                          | ** ** | **(3** | **)** |
| **Net cash used for operating activities**                                                   | ** ** | **(2,412**                      | **)**      | **(394** | **)** |
| ** **                                                                                   | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Cash flows from investing activities:**                                                    | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Purchases  of property and equipment**                                                     | ** ** | **(80**                         | **)**      | **(119** | **)** |
| **Net cash used for investing activities**                                                   | ** ** | **(80**                         | **)**      | **(119** | **)** |
| ** **                                                                                   | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Cash flows from financing activities:**                                                    | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Proceeds  from the issuance of common stock**                                              | ** ** | **15**                          | ** ** | **108** | ** ** |
| **Net cash provided by financing activities**                                                | ** ** | **15**                          | ** ** | **108** | ** ** |
| ** **                                                                                   | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Effect of exchange rates on cash and cash  equivalents**                                   | ** ** | **73**                          | ** ** | **(123** | **)** |
| ** **                                                                                   | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Net decrease in cash and cash equivalents**                                                | ** ** | **(2,404**                      | **)**      | **(528** | **)** |
| **Cash and cash equivalents at beginning of period**                                         | ** ** | **56,383**                      | ** ** | **37,139** | ** ** |
| **Cash and cash equivalents at end of period**                                               | ** ** | **$**                           | **53,979** | ** ** | **$** | **36,611** | ** ** |

 

***Theaccompanying notes are an integral part of the unaudited consolidated financialstatements.***

 

5

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**1.****                   Basisof Presentation**

 

Theaccompanying unaudited consolidated financial statements and notes do not includeall of the disclosures made in the Annual Report on Form 10-K of CandelaCorporation (the “Company”, or “Candela”) for fiscal year 2005, which should beread in conjunction with these financial statements.  The financial information included herein isunaudited, with the exception of the consolidated balance sheet as of July 2,2005, which was derived from the audited consolidated balance sheet dated July 2,2005. However, in the opinion of management, the financial statements includeall necessary adjustments, consisting of normal recurring accruals, for a fairpresentation of the quarterly results and are prepared and presented in amanner consistent with the Company’s Annual Report on Form 10-K. Theresults for the three-month period ended October 1, 2005 are notnecessarily indicative of the results to be expected for the full year.

 

**2.****                   DiscontinuedOperations**

 

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

 

Duringthe three-month period ended October 2, 2004, the landlord for the Bostonfacility secured a sublease for that property. The Company was not able todetermine the future economic benefit of the sublease at that time. Thesublessee commenced making payments to the landlord during December of2004.  As a result of these and futurepayments scheduled under the sublease, the Company revised the estimated futurecosts associated with the Boston facility and, in the quarter ended January 1,2005, reversed approximately $859 of the restructuring reserve. This reversalrepresents the aforementioned anticipated economic benefit due to sublesseepayments of $1,703, net of legal and other fees of approximately $329 andincome taxes of approximately $515, and was recognized in the three-monthperiod ended January 1, 2005.

 

Thefollowing table reflects the combined restructuring charges incurred in thethree-month period ended October 1, 2005:

 
| ** **                          | ** ** | **Leasehold**    | ** ** | ** **   | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------------|------------|--------------|------------|------------|------------|
| ** **                          | ** ** | **Improvements** | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **and Fixed**    | ** ** | **Facility** | ** ** | ** ** | ** ** |
| **(in thousands)**                  | ** ** | **Assets**       | ** ** | **Costs**    | ** ** | **Total**  | ** ** |
| **Balance at July 2, 2005**    | ** ** | **$**            | **97**     | ** **   | **$**      | **898**    | ** ** | **$** | **995** | ** ** |
| ** **                          | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Non-cash amortization**           | ** ** | **25**           | ** ** | **112**      | ** ** | **137**    | ** ** |
| ** **                          | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** |
| **Balance at October 1, 2005** | ** ** | **$**            | **72**     | ** **   | **$**      | **786**    | ** ** | **$** | **858** | ** ** |

 

At October 1, 2005, the discontinued segment had a netliability of approximately $1.6 million consisting primarily of theaforementioned reserve of $0.9 million and deferred gift certificate revenue of$0.8 million partially offset by fixed assets of approximately $0.1 million.

 

6

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**3.****                   Stock-basedCompensation**

 

Prior to July 3, 2005,the Company followed the provisions of Financial Accounting Standards Board (“FASB”)Statement No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”).The provisions of FAS 123 allowed companies to either expense the estimatedfair value of stock options or to continue to follow the intrinsic value methodset forth in Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (“APB 25”), but disclose the pro forma effects onnet income (loss) had the fair value of the options been expensed. Candelaelected to apply APB 25 in accounting for its stock option incentive plans.Effective July 3, 2005, the Company implemented the fair value recognitionprovisions of FASB Statement No. 123R (“FAS 123R”) and Staff AccountingBulletin 107 (“SAB 107”) for all share-based compensation that was not vestedas of July 3, 2005. The Company adopted FAS 123R using a modifiedprospective application, as permitted under FAS 123R. Accordingly, prior periodamounts have not been restated. Under this application, the Company is requiredto record compensation expense for all awards granted after the date ofadoption and for the unvested portion of previously granted awards that remainoutstanding at the date of adoption.

 

In accordance with APB 25and related interpretations, compensation expense for stock options wasrecognized in income based on the excess, if any, of the quoted market price ofthe stock at the grant date of the award or other measurement date over theamount an employee must pay to acquire the stock. Generally, the exercise pricefor stock options granted to employees was equal to the fair market value ofCandela common stock at the date of grant, thereby resulting in no recognitionof compensation expense by Candela prior to July 3, 2005.

 

Hadcompensation cost for Candela’s stock option plans been determined based on thefair value method set forth in FAS 123 during the prior year, Candela’s netincome and basic and diluted net income per common share would havebeen changed to the pro forma amounts indicated below: 

 
| ** **                                                                                                                                         | ** ** | **For the three  months ended:** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **October 2,**              | ** ** |
| **(in thousands, except per share  data)**                                                                                                         | ** ** | **2004**                         | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                       | ** ** |
| **Net income, as reported**                                                                                                                        | ** ** | **$**                            | **2,846**  | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                       | ** ** |
| **Add:  stock-based employee compensation expense included in reported net income,  net of related tax effects**                                   | ** ** | **—**                       | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                       | ** ** |
| **Deduct:  total stock-based employee compensation expense, determined under fair value  based method for all awards, net of related tax effects** | ** ** | **(745**                         | **)**      |
| ** **                                                                                                                                         | ** ** | ** **                       | ** ** |
| **Pro forma net income**                                                                                                                           | ** ** | **$**                            | **2,101**  | ** ** |
| **Net income per share of common stock:**                                                                                                          | ** ** | ** **                       | ** ** |
| **Basic - as reported**                                                                                                                            | ** ** | **$**                            | **0.13**   | ** ** |
| **Basic - pro forma**                                                                                                                              | ** ** | **$**                            | **0.09**   | ** ** |
| **Diluted - as reported**                                                                                                                          | ** ** | **$**                            | **0.12**   | ** ** |
| **Diluted - pro forma**                                                                                                                            | ** ** | **$**                            | **0.09**   | ** ** |

 

Incomputing this pro-forma amount, the Company used the Black-Scholes-Mertonoption-pricing model incorporating the following assumptions for optionsgranted during the first quarter of fiscal year 2005:

 
| ** **                                      | ** ** | **2005**   | ** ** |
|-------------------------------------------------|------------|------------|------------|
| **Risk-free interest rate**                     | ** ** | **4.25**   | **%**      |
| **Estimated volatility**                        | ** ** | **76**     | **%**      |
| **Expected life for stock options (yrs)**       | ** ** | **2.99**   | ** ** |
| **Expected life for stock purchase plan (yrs)** | ** ** | **0.5**    | ** ** |
| **Expected dividends**                          | ** ** | **—** | ** ** |

 

7

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**3.****                   Stock-basedCompensation, continued**

 

The application of FAS 123Rand SAB 107 during the quarter ended October 1, 2005 resulted in therecognition of share-based compensation expense of approximately $96 thousand.This expense was divided between operating expense cost centers based upon thehome department of the individual holding the options.

 

The fair value of each option award is estimated onthe date of grant using the Black-Scholes-Merton option-pricing modelincorporating the assumptions noted in the following table. Expectedvolatilities are based on historical volatility of the Company’s stock priceover the last ten years and other factors. The expected term of the options isbased on historical observations of the Company’s stock over the past tenyears, considering average years to exercise for all options exercised, averageyears to cancellation for all options cancelled and average years remaining foroutstanding options, which was calculated based on the weighted-average vestingperiod plus the weighted-average of the difference between the vesting periodand average years to exercise and cancellation. The risk-free rate for periodswithin the contractual life of the option is based on the U.S. Treasury curvein effect at the time of grant.

 
| ** **                                      | ** ** | **2006**   | ** ** |
|-------------------------------------------------|------------|------------|------------|
| **Risk-free interest rate**                     | ** ** | **4.25**   | **%**      |
| **Estimated volatility**                        | ** ** | **79**     | **%**      |
| **Expected life for stock options (yrs)**       | ** ** | **3.02**   | ** ** |
| **Expected life for stock purchase plan (yrs)** | ** ** | **0.5**    | ** ** |
| **Expected dividends**                          | ** ** | **—** | ** ** |

 

**Stock Plans**

 

### **1990 CandelaCorporation Employee Stock Purchase Plan**

### ** **

The 1990 Employee Stock Purchase Plan (the “PurchasePlan”) provides for the sale of up to 1,500,000 shares of common stock toeligible employees.  The shares areissued at 85% of the market price on the last day of semi-annual periods.  Substantially all full-time employees areeligible to participate in the Purchase Plan. At October 1, 2005 there were 720,227 shares available for sale.

 

**1998 Candela Corporation Stock Option Plan**

 

The 1998 Stock Option Plans (the “Stock Option Plan”)provide for the granting of incentive stock options to employees for thepurchase of common stock at an exercise price not less than the fair marketvalue of the stock on the date of grant. The Stock Option Plan also provides for the granting of non-qualifiedstock options.

 

Options granted under the 1998 Stock Option Planbecome exercisable on the date of grant or in installments, as specified by aCommittee established by the Board of Directors, and expire ten years from thedate of the grant.  The maximum number ofshares for which options may be granted under the 1998 Stock Option Plan wasincreased to 5,300,000 in fiscal 2004.

 

8

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The following is asummary of stock option activity under the Plans:

 
| ** **                                          | ** ** | **Number of  Shares** | ** ** | **Weighted Avg.  Exercise Price  per Share** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Weighted Avg.  Contractual  Term** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|----------------------------------------------|------------|---------------------------------|------------|--------------------------------------|------------|
|                                                |       |                  |       |                                         |       |                            |       |                                 |       |
| Balance outstanding at July 2, 2005            |       | 2,484,560             |       |                                         |       |                            |       |                                 |       |
|                                                |       |                  |       |                                         |       |                            |       |                                 |       |
| Granted                                             |       | —                |       |                                         |       |                            |       |                                 |       |
| Exercised                                           |       | (2,941                | )          |                                         |       |                            |       |                                 |       |
| Forfeited                                           |       | (2,053                | )          |                                         |       |                            |       |                                 |       |
| Balance outstanding at October 1, 2005         |       | 2,480,466             |       | $                                            | 7.48       |                            | $          | 7,336,843                            |       | 7.52 years |   |
|                                                |       |                  |       |                                         |       |                            |       |                                 |       |
| Options exercisable at October 1, 2005         |       | 2,186,716             |       | $                                            | 7.76       |                            | $          | 6,028,981                            |       | 7.49 years |   |
|                                                |       |                  |       |                                         |       |                            |       |                                 |       |
| Options available for grant at October 1, 2005 |       | 1,091,104             |       |                                         |       |                            |       |                                 |       |

 

There were no options granted during the firstquarter of fiscal 2006. The total intrinsic value of options exercised duringthe first quarter of fiscal 2006 was $32 thousand.

 

A summary of the status of our nonvested stockoptions as of October 1, 2005, and changes during the fiscal quarter thenended is summarized below:

 
| ** **                                 | ** ** | ** **    | ** ** | **Weighted Avg.** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|---------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | **Number of** | ** ** | **Grant Date**    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Shares**    | ** ** | **Fair Value**    | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                       |       |          |       |              |       |       |       |       |       |
| Non-vested options at July 2, 2005    |       | 332,500       |       | $                 | 3.74       |       |       |       |       |   |
|                                       |       |          |       |              |       |       |       |       |       |
| Granted                                    |       | —        |       | —            |       |       |       |       |       |
| Vested                                     |       | (38,750       | )          | $                 | 3.80       |       |       |       |       |   |
| Forfeited                                  |       | —        |       | —            |       |       |       |       |       |
| Non-vested balance at October 1, 2005 |       | 293,750       |       | $                 | 3.78       |       |       |       |       |   |

 

As of October 1, 2005, there was approximately$346 thousand of total unrecognized compensation cost related to nonvestedstock options granted under our incentive plans. This cost is expected to berecognized over a weighted-average period of 1.7 years.

 

The amount of cash receivedfrom the exercise of stock options during the quarter ended October 1,2005 was approximately $15 thousand.

 

9

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** **

**4.****                   EarningsPer Share**

 

Basicearnings per share is computed by dividing net income by the weighted averagenumber of shares of common stock outstanding for the period and, if there aredilutive securities, diluted earnings per share is computed by including commonstock equivalents outstanding for the period in the denominator.

 

Commonstock equivalents 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:** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                        | ** ** | **October 1,**             | ** ** | **October 2,** | ** ** |
| **(in thousands, except per share  data)**                        | ** ** | **2005**                        | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Basic shares used in the calculation of earnings  per share**   | ** ** | **22,515**                      | ** ** | **22,326** | ** ** |
| ** **                                                        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Effect of dilutive securities:**                                | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Stock options**                                                 | ** ** | **714**                         | ** ** | **705** | ** ** |
| ** **                                                        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Diluted shares used in the calculation of  earnings per share** | ** ** | **23,229**                      | ** ** | **23,031** | ** ** |
| ** **                                                        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Per share effect of dilutive securities on net  income**        | ** ** | **$**                           | **0.00**   | ** ** | **$** | **0.01** | ** ** |
|                                                                   |            |                                 |            |  |  |  |  |

 

Duringthe three-month period ended October 1, 2005, options to purchase1,109,426 shares of common stock were excluded from the calculation of dilutedearnings per share because the exercise price of such options was greater thanthe average market price of the common stock for the period.  During the three-month period ended October 2,2004, options to purchase 639,891 shares of common stock were excluded from thecalculation of diluted earnings per share because the exercise price of suchoptions was greater than the average market price of the common stock for theperiod.

 

**5.****                   Inventories**

 
| ** **          | ** ** | **October 1,** | ** ** | **July 2,** | ** ** |
|---------------------|------------|---------------------|------------|------------------|------------|
| **(in thousands)**  | ** ** | **2005**            | ** ** | **2005**         | ** ** |
| ** **          | ** ** | ** **          | ** ** | ** **       | ** ** |
| **Raw materials**   | ** ** | **$**               | **4,654**  | ** **       | **$**      | **3,968** | ** ** |
| **Work in process** | ** ** | **607**             | ** ** | **166**          | ** ** |
| **Finished goods**  | ** ** | **8,629**           | ** ** | **8,542**        | ** ** |
| ** **          | ** ** | **$**               | **13,890** | ** **       | **$**      | **12,676** | ** ** |

 

**6.****                   SegmentInformation**

 

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 Operations forthe appropriate periods.

 

10

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**7.      Guarantees**

 

TheCompany’s products generally carry a standard warranty. The Company sets asidea reserve based on anticipated warranty claims at the time product revenue isrecognized. In anticipation of actual warranty claims, the Company amortizesthe reserve ratably over the life of the warranty thereby offsetting actualwarranty claims incurred. Actual warranty claims incurred and charged toproduct costs of sales during an interim period may be more or less than theamount of amortized warranty reserve allocated against them. Factors thataffect the Company’s product warranty liability include the number of installedunits, the anticipated cost of warranty repairs and historical and anticipatedrates of warranty claims.

 

The following table reflects changes in the Company’saccrued warranty account during the three-month period ended October 1, 2005:

 
| **(in thousands)**                             | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|------------|------------|
| **Beginning balance on July 2, 2005**     | ** ** | **$**      | **8,645**  | ** ** |
| **Plus accruals related to new sales**         | ** ** | **1,529**  | ** ** |
| **Less amortization of prior period accruals** | ** ** | **1,685**  | ** ** |
| **Ending balance on October 1, 2005**     | ** ** | **$**      | **8,489**  | ** ** |

 

The Company also offersextended service contracts that may be purchased after a standard warranty hasexpired. Service contracts may be purchased for periods from one to five years.The Company recognizes service contract revenue ratably over the life of the contract.Actual service contract expenses incurred and charged to service costs of salesduring an interim period may be more or less than the amount of amortizedservice contract revenue recognized in that period.

 

The following tablereflects changes in the Company’s deferred revenue account during thethree-month period ended October 1, 2005:

 
| **(in thousands)**                              | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|------------|------------|
| **Beginning balance on July 2, 2005**      | ** ** | **$**      | **8,350**  | ** ** |
| **Plus deferral of new service contract sales** | ** ** | **1,699**  | ** ** |
| **Less recognition of deferred revenue**        | ** ** | **2,000**  | ** ** |
| **Ending balance on October 1, 2005**      | ** ** | **$**      | **8,049**  | ** ** |

 

The Company has anagreement (the “Agreement”) with an independent leasing company whereby theCompany will purchase delinquent leases (the “UNL Provision”) relating toCompany products purchased by customers and financed through the leasingcompany.  The Company is required tohonor the UNL Provision when the leasing company’s aggregate losses reachlevels specified in the Agreement.  TheUNL Provision of the Agreement was eliminated for any lease initiated after December 31,2002.  Since the inception of theAgreement, the cumulative amounts paid to the leasing company under the UNLProvision have not been significant.

 

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**8.****                  ****Commitments andContingencies**

 

In August 2000, the Company entered into anagreement to amend the license agreement with The Regents of the University ofCalifornia (the “Regents”) whereby in exchange for an exclusivity fee ofapproximately $1.7 million, which was prepaid in full, Candela obtainedexclusive license rights to the DCD (subject to certain limited license rightsof Cool Touch, Inc. (“Cool Touch”)) in the following fields of use:  procedures that involve skin resurfacing andrejuvenation, vascular skin lesions, and laser hair removal.  Cool Touch, a subsidiary of New StarTechnology, Inc. obtained a license to the DCD on a co-exclusive basiswith Candela, in certain narrower fields of use.  Cool Touch is restricted in its ability toassign its license rights to certain existing competitors of Candela.  Candela is entitled to one-half of allroyalty income payable to the Regents from Cool Touch.  Under the amended agreement, Candela nolonger is required by the Regents to negotiate sublicenses to thirdparties.  However, Candela is entitled toone-half of all royalties due from any other entity that licenses the DCDtechnology from the Regents in other fields of use.  The Company recognized royalty expense of$9.2, $2.6, and $3.4 million for fiscal 2005, 2004, and 2003, respectively,based on the license agreement with the Regents. Included in the fiscal 2005expense of $9.2 million is $4.8 of expense for the third quarter charge takenrelated to the Regents arbitration decision. Of that $4.8 million, $1.3 millionrelated to fiscal 2005, $3.0 million related to fiscal 2004 and 0.5 millionrelated to fiscal 2003.

 

Effective July 3,2005, the Company amended certain portions of their agreement with the Regentswhereby for the annual license fee of $0.3 million, the Company’s royalty obligationwill be reduced to 3% from its prior level of 6%. The annual fee of $0.3million is payable by a lump sum of $3.0 million and will be amortized over theremaining life of the patent agreement, which as of July 3, 2005 was 10years. This reduced royalty rate and the amortization of the annual license feepayment is reflected in the Company’s financial statements as of October 1,2005. The unamortized portion of the license fee payment is reflected inprepaid licenses on the October 1, 2005 balance sheet.

 

On August 20, 2005, DVIInc., DVI Financial Services, Inc., and DVI Business Credit CorporationLiquidating Trust (collectively, the “DVI Entities”) filed a complaint againstthe Company in the United States Bankruptcy Court for the District of Delaware.  The DVI Entities filed voluntary petitionsfor relief under Chapter 11 of the United States Bankruptcy Code on August 25,2003 (the “Petition Date”).  Thecomplaint asserts, among other things, that (i) on or within 90 daysbefore the Petition Date, one or more of the DVI Entities transferred propertyto or for the benefit of the Company in an aggregate amount not less than$1,878,921.75, (ii) at the time of the transfers the DVI Entities wereinsolvent, (iii) the transfers enabled the Company to receive more thanthe Company was entitled to under the United States Bankruptcy Code, and (iv) thetransfers constitute an avoidable preference.  The complaint seeks avoidance and recovery ofthe transfers, plus interest and costs of the proceeding.  The complaint also seeks, among other things,to disallow the Company’s claims against the DVI Entities until the Company haspaid the recovery amount to the DVI Entities. As previously disclosed in the Company’s periodic reports, prior to thefiling of the complaint, the Company had received demands for paymentof the recovery amount.  The Companybelieves that it received all transfers from the DVI Entities in theordinary course of business and that the allegations in the complaint arewithout merit.

 

From time to time, the Company is a party to variouslegal proceedings incidental to its business. Except for the bankruptcy preference claims in the DVI matter, theCompany believes that none of the legal proceedings that are presently pending,if adversely decided to the Company, will have a material adverse effect uponits financial position, results of operations, or liquidity.

 

12

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**CANDELA CORPORATION**

 

**Item 2 -****Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

 

**Overview**

 

We research, develop,manufacture, market and service lasers and light-based systems used to performaesthetic and cosmetic procedures. We sell our lasers and light-based systemsto physicians 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 broader groupof practitioners consisting of general practitioners and certain specialistsincluding obstetricians, gynecologists and general and vascular surgeons.  We derive our revenue from the sales oflasers, light-based systems and other products, and the provision of product-relatedservices.

 

**CriticalAccounting Policies**

 

****This discussion and analysis of our financial condition andresults of operations is based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. We evaluate our estimates and judgments onan on-going basis, including those related to revenue recognition, bad debts,inventories, warranty obligations, contingencies, restructurings and incometaxes. We base our estimates and judgments on historical experience and onvarious 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 2005.****

 

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**Resultsof Operations**

 

***Revenue.***

 

Revenue source bygeographic region is reflected in the following table:

 

 
| ** **          | ** ** | **For the three months ended:** | ** ** |
|---------------------|------------|---------------------------------|------------|
| **(in thousands)**  | ** ** | **October 1,  2005**       | ** ** | **October 2,  2004** | ** ** | **Change** | ** ** |
| ** **          | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **US revenue**      | ** ** | **$**                           | **10,268** | ** ** | **37** | **%** | **$** | **9,424** | ** ** | **42** | **%** | **$** | **844** | ** ** | **9** | **%** |
| **Foreign revenue** | ** ** | **17,819**                      | ** ** | **63** | **%** | **12,967** | ** ** | **58** | **%** | **4,852** | ** ** | **37** | **%** |
| ** **          | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total revenue**   | ** ** | **$**                           | **28,087** | ** ** | **100** | **%** | **$** | **22,391** | ** ** | **100** | **%** | **$** | **5,696** | ** ** | **25** | **%** |

 

Consolidated Overview

 

Consolidated revenueincreased $5.7 million, to $28.1 million for the three months ended October 1,2005, from $22.4 million for the three months ended October 2, 2004.  The increase was due primarily to uniformincrease in demand for our products and related service on a worldwide basis,coupled with our expanding reach into new markets.

 

Foreignrevenue accounted for approximately 63% of the consolidated total for thefiscal quarter ended October 1, 2005. The increase of 37% to $17.8 millionfor the three-month period ended October 1, 2005, as compared to thethree-month period ended October 2, 2004, was spread across all regionswith Latin America showing the most strength. Latin America accounted forapproximately $4.04 million or 83% of the comparative increase while the FarEast improved approximately $.64 million for the quarter as compared to thesame period, one year ago. Increases in Europe were more modest as the summer holidaysslowed sales during the first fiscal quarter in that region.

 

US revenue increased a solid9% to $10.3 million for the three-month period ended October 1, 2005, ascompared to the three-month period ended October 2, 2004.

 

Revenue source by type isreflected in the following table:

 
| ** **                     | ** ** | **For the three months ended:** | ** ** |
|--------------------------------|------------|---------------------------------|------------|
| **(in thousands)**             | ** ** | **October 1,  2005**       | ** ** | **October 2,  2004** | ** ** | **Change** | ** ** |
| **Revenue**                    | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers  and other products** | ** ** | **$**                           | **22,225** | ** ** | **79** | **%** | **$** | **18,343** | ** ** | **82** | **%** | **$** | **3,882** | ** ** | **21** | **%** |
| **Product-related  service**   | ** ** | **5,862**                       | ** ** | **21** | **%** | **4,048** | ** ** | **18** | **%** | **1,814** | ** ** | **45** | **%** |
| ** **                     | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total revenue**              | ** ** | **$**                           | **28,087** | ** ** | **100** | **%** | **$** | **22,391** | ** ** | **100** | **%** | **$** | **5,696** | ** ** | **25** | **%** |

 

The increase in revenue from lasers and otherproducts for the three months ended October 1, 2005, compared to thethree-month period ended October 2,2004 resulted primarily from an increase inthe sales volume of our GentleYagTM product line, continued strength of ourGentleLaseTM line, and the introduction during the third quarter of last year ofthe EllipseTMproduct line. The increase in revenuefrom product-related service for the three months ended October 1, 2005compared to the three months ended October 2, 2004 resultedprimarily from an increase in the number of service related contracts sold inaddition to an increase in the number of consumables and accessories sold tosupport our installed base.

 

14

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***Cost of Sales.***Costof sales increased 31% to $13.5 million for the three months ended October 1,2005 as compared to cost of sales of $10.4 million for the three months ended October 2,2004.** As a percentage of revenue, cost of salesincreased 2% on a comparative basis, quarter over quarter.  This resulted primarily from system productmix, coupled with the lower margin service revenue accounting for a largerpercentage of total revenue.

 

***Gross Profit. ***Gross profit was approximately $14.6 million or52% of revenues for the three-month period ended October 1, 2005, comparedto gross profit of approximately $12 million or 54% for the same period oneyear earlier.

 

***Selling,General and Administrative Expense. ***Selling,general and administrative expenses increased 31%, to approximately $8.7million for the three-month period ended October 1, 2005 fromapproximately $6.7 million for the three-month period ended October 2,2004. As a percentage of revenue, selling, general and administrative expensesincreased to 31% from 30% of revenues for the same respective periods. Thisincrease was due primarily to an expansion of marketing programs directed atour core market through workshops and other marketing initiatives ofapproximately $0.8 million, employee related expense of approximately $0.6million driven by hiring and training at all Candela locations, and increasedlegal and audit expense of $0.5 million related primarily to compliance with rule 404of the Sarbanes-Oxley act.

 

***Researchand Development Expense.  ***Researchand development spending increased to $1.6 million for the three-month periodended October 1, 2005 from $1.3 million for the three-month period ended October 2,2004 due primarily to an increase in project related expenses of approximately$0.1 million and employee related expense of approximately $0.2 million.

 

***OtherIncome/Expense. ***Otherincome increased to $0.3 million for the three-month period ended October 1,2005 from $.01 million for the three-month period ended October 2, 2004due primarily to an increase in interest income.

 

***IncomeTaxes.*** The provision for income taxes results from acombination of activities of both the domestic operations and foreignsubsidiaries of the Company.  We recordeda 33% effective tax rate for the three-month period ended October 1,2005.   This compares to the three-monthperiod ended October 2, 2004, in which we recorded a 32% effective taxrate.  The provision for income taxes forthe three months ended October 1, 2005 differs from the U.S. statutoryrate as a result of tax provisions calculated for income generated by foreignsubsidiaries at a rate that differs from the U.S. statutory rate.

 

**Liquidityand Capital Resources**

 

Cashused in operating activities amounted to $2.4 million for the quarter ended October 2,2005 as compared to $0.4 million for the fiscal quarter ending October 2,2004. The increase in cash used by operating activities is due to the paymentof prior year liabilities and the lump sum payment of an annual licensing feepartially offset by the Company’s ongoing efforts to decrease days’ salesoutstanding in accounts receivable. As compared to the same period in the prioryear, days’ sales outstanding in trade accounts receivable was reducedsubstantially to approximately 93 days at October 1, 2005. This trendproduced an additional $4.0 million in available cash during the quarter. Thelump sum payment of the annual licensing fee was the result of the Company amending portions of its agreementwith the Regents of the University of California whereby for an annual license fee of $0.3 million for 10 years, theCompany’s royalty obligation will be reduced. The annual fee of $0.3 millionwas paid by a lump sum of $3.0 million during the quarter ended October 1,2005. Cash used by investing activities and provided by financingactivities remained relatively flat for the first fiscal quarter of 2006 ascompared to the same quarter in the prior year, as the Company continued itsconservative policy towards capital outlays for property, plant and equipmentand had relatively static activity from the issuance of common stock by theCompany, primarily to employees under the existing stock option plan.

 

15

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Off-Balance Sheet Arrangements

 

TheCompany did not have any off-balance sheet arrangements that have or arereasonably likely to have a current or future effect on the Company’s financialcondition, changes in financial condition, revenues or expenses, results ofoperations, liquidity, capital expenditures or capital resources.

 

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

 

 
| ** **                         | ** ** | ** ** | ** ** | **Less than** | ** ** | ** **    | ** ** | ** **    | ** ** | **After**   | ** ** |
|------------------------------------|------------|------------|------------|---------------|------------|---------------|------------|---------------|------------|-------------|------------|
| **(in thousands)**                 | ** ** | **Total**  | ** ** | **1 year**    | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **5 years** | ** ** |
|                               |       |       |       |          |       |          |       |          |       |        |       |
| Royalty commitments                |       | $          | 6,250      |          | $          | 1,250         |       | $             | 2,000      |        | $          | 1,813 |   | $ | 1,187 |   |
| Operating leases                   |       | $          | 2,722      |          | $          | 1,084         |       | $             | 1,374      |        | $          | 228 |   | $ | 36 |   |
| Total contractual cash obligations |       | $          | 8,972      |          | $          | 2,334         |       | $             | 3,374      |        | $          | 2,041 |   | $ | 1,223 |   |

 

Wemaintain a renewable $10,000,000 revolving credit agreement with a major bankwith interest at the bank’s base rate or LIBOR plus 2.25%.  Any borrowings outstanding under the line ofcredit are due on demand or according to a payment schedule established atthe time funds are borrowed.  The line ofcredit is unsecured.  The agreementcontains restrictive covenants limiting the establishment of new liens, and thepurchase of margin stock.  No amountswere outstanding under the line of credit as of October 1, 2005, or October 2,2004.

 

Webelieve that cash balances will be sufficient to meet anticipated cashrequirements.  However, we cannot be surethat we will not require additional capital beyond the amounts currentlyforecasted by us, nor that any such required additional capital will beavailable on reasonable terms, if at all, as it becomes required.

 

#### **Cautionary Statements**

 

This Quarterly Report on Form 10-Qcontains forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Forward-looking statements are not promises or guarantees and aresubject to risks and uncertainties that could cause our actual results todiffer materially from those anticipated. Such statements may relate to, among other things, the future of theindustry, product development, business strategy (including the possibility offuture acquisitions), anticipated operational and capital expenditure levels,continued acceptance and growth of our products, and dependence on significantcustomers and suppliers.  Forward-lookingstatements may also include, without limitation, any statement relating tofuture events, conditions or circumstances or using words such as or similarto:  anticipate; believe; continue;could; estimate; expect; intend; plan; predict; project; may; or will.  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 2, 2005, as well as other risks anduncertainties referenced in this Quarterly Report.  These risks and uncertainties include, butare not limited to, the following:

 

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**Cautionary Statements, continued**

 

•                  Our principal source of liquidity isour current cash and equivalents. Our ability to generate cash from operationsis dependant upon our ability to generate revenue from selling our lasers andother products and providing product-related services. A decrease in demand forour products and related services or increases in operating costs would likelyhave an adverse effect on our liquidity.

 

•                  Because we typically derive more thanhalf of our revenue from international sales, we are susceptible to currencyfluctuations, negative economic changes taking place in foreign marketplaces,and other risks associated with conducting business overseas.

 

•                  The failure to obtain alexandriterods for certain laser systems from our sole supplier would impair our abilityto manufacture and sell these laser systems, which has accounted for asubstantial portion of our revenue in certain recent periods.

 

•                  Our failure to respond to rapidchanges in technology and intense competition in the laser industry could makeour lasers obsolete.

 

•                  Like other companies in our industry,we are subject to a regulatory review process and our failure to receivenecessary government clearances or approvals could affect our ability to sellour products and remain competitive.

 

•                  We have modified some of our products without FDAclearance.  The FDA could retroactivelydecide the modifications were improper and require us to cease marketing and/orrecall the modified products.

 

•                  Achieving complete compliance withFDA regulations is difficult, and if we fail to comply, we could be subject toFDA enforcement action.

 

•                  Claims by others that our productsinfringe their patents or other intellectual property rights, or that thepatents which we own or have licensed rights to are invalid, could prevent usfrom manufacturing and selling some of our products or require us to incursubstantial costs from litigation or development of non-infringing technology.

 

•                  We could incur substantial costs as aresult of product liability claims.

 

•                  We may be unable to attract and retainmanagement and other personnel we need to succeed.

 

•                  Our failure to manage acquisitionsand joint ventures effectively may divert management attention from our corebusiness and cause us to incur additional debt, liabilities or costs.

 

Wecaution readers not to place undue reliance upon any forward-lookingstatements, 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 foreign subsidiariesin Japan, Spain, France, Germany, Italy and Portugal.  Approximately 63% of our revenues for thethree months ended October 1, 2005 were from operations outside the UnitedStates.  These subsidiaries transactbusiness in both local and foreigncurrency.  Therefore, we are exposed toforeign currency exchange risks and fluctuations in foreign currencies, whichcould adversely impact our results and financial condition.  However, sales from the United States madedirectly to customers or distributors in foreign countries are invoiced in U.S.dollars and are not exposed to foreign currency risk.

 

From time to time, we mayenter into foreign currency exchange and option contracts to reduce ourexposure to foreign currency risk and variability in operating results due tofluctuation in exchange rates underlying the value of current transactions andanticipated transactions denominated in foreign currencies.  Thesecontracts obligate us to exchange predetermined amounts of specified foreigncurrencies at specified exchange rates on specified dates.  These contracts are denominated in the samecurrency in which the underlying transactions are denominated and carry acontract value and maturity date that approximate the value and expectedsettlement date, respectively, of the underlying transactions. We do notengage in foreign currency speculation.

 

We have cash equivalentsthat primarily consist of certificates of deposit, overnight repurchaseagreements and money market accounts.  Webelieve that any near term changes in interest rates will be immaterial to anypotential losses in future earnings, cash flow and fair values.

 

**Item 4 -Controls and Procedures**

 

Underthe direction of our Chief Executive Officer and Chief Financial Officer, weevaluated our disclosure controls and procedures and internal control overfinancial reporting and concluded that our disclosure controls and procedureswere effective as of October 1, 2005.

 

Duringthe quarter ended October 1, 2005, the Company remediated the materialweakness in internal controls over financial reporting that arose from theexistence of control deficiencies that adversely impacted the Company’s abilityto accurately and timely complete the Company’s year-end close process whichwas reported in Candela’s Annual Report on Form 10-K for the year ended July 2,2005. More specifically, the Company has:

 

Implementedprocedures including additional levels of review for accruals, judgmentalestimates, and demonstration sales, and the creation of additional managementreports used for the analysis of results.

 

Except as discussed above, there were no changes inthe Company’s internal control over financial reporting during the quarterended October 1, 2005, that have materially affected, or are reasonablylikely to materially affect, the Company’s internal controls over financialreporting.

 

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**CANDELACORPORATION**

 

**Part II.  Other Information**

 

**Item 1.  Legal Proceedings.**

 

On August 20, 2005, DVI Inc., DVI FinancialServices, Inc., and DVI Business Credit Corporation Liquidating Trust(collectively, the “DVI Entities”) filed a complaint against the Company in theUnited States Bankruptcy Court for the District of Delaware.  The DVI Entities filed voluntary petitionsfor relief under Chapter 11 of the United States Bankruptcy Code on August 25,2003 (the “Petition Date”).  Thecomplaint asserts, among other things, that (i) on or within 90 daysbefore the Petition Date, one or more of the DVI Entities transferred propertyto or for the benefit of the Company in an aggregate amount not less than$1,878,921.75, (ii) at the time of the transfers the DVI Entities wereinsolvent, (iii) the transfers enabled the Company to receive more thanthe Company was entitled to under the United States Bankruptcy Code, and (iv) thetransfers constitute an avoidable preference.  The complaint seeks avoidance and recovery ofthe transfers, plus interest and costs of the proceeding.  The complaint also seeks, among other things,to disallow the Company’s claims against the DVI Entities until the Company haspaid the recovery amount to the DVI Entities. As previously disclosed in the Company’s periodic reports, prior to thefiling of the complaint, the Company had received demands for paymentof the recovery amount.  The Companybelieves that it received all transfers from the DVI Entities in theordinary course of business and that the allegations in the complaint arewithout merit.  While the Company intendsto vigorously contest the allegations, the litigation process is inherentlyuncertain and unpredictable and there can be no guarantee as to the ultimateoutcome of this pending lawsuit.  An adverse outcome in the litigationcould hurt our business, results of operations, and financial condition.

 

From time to time, theCompany is a party to various legal proceedings incidental to itsbusiness.  Except for the bankruptcypreference claims in the DVI matter, the Company believes that none of thelegal proceedings that are presently pending, if adversely decided to theCompany, will have a material adverse effect upon its financial position,results of operations, or liquidity.

 

**Item 6.   Exhibits**

 
|   | (a)               | Exhibits                                                                                                                                                          |
|--------|-------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |              |                                                                                                                                                              |
|   | 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 Chief 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 Chief 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 the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   | CANDELA  CORPORATION                               |
|--------|----------------------------------------------------|
|   |                                               |
|   |                                               |
| Date:  | November 4,  2005                             |   | /s/ F. Paul  Broyer |   |
|   | F. Paul Broyer                                     |
|   | Senior Vice  President, Finance and Administration |
|   | and Chief  Financial Officer                       |
|        |                                                    |  |  |  |

 

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**Candela Corporation**

 

**INDEX TO EXHIBITS**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                   |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                              |
| 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 Chief 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 Chief 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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