**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

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**FORM 10-Q**

 

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

** **

**For thequarterly period ended December 29, 2007.**

** **

**Commissionfile number 000-14742**

** **

**CANDELACORPORATION**

(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 filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 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 AcceleratedFiler  o           AcceleratedFiler  x           Non-AcceleratedFiler  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 February 5, 2008** |
|----------------------------------------|------------|-------------------------------------|
| Common Stock, $.01 par value per share |       | 23,160,093                          |

 

 

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**CANDELACORPORATION**

**Index**

 
| ** ** | ** **             | ** **                                                                                                                                                                                                                                | **Page** |
|------------|------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| Part I.    | Financial Information: |                                                                                                                                                                                                                                      |     |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       | Item 1.                | Unaudited Financial Statements                                                                                                                                                                                                            |     |   |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       |                   | Consolidated  Balance Sheets as of December 29, 2007 and June 30, 2007                                                                                                                                                                    |     | 3 |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       |                   | Consolidated  Statements of Income (Loss) and Comprehensive Income (Loss) for the  three-month periods ended December 29, 2007 and December 30, 2006, and for  the six-month periods ended  December  29, 2007 and December 30, 2006 |     | 4 |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       |                   | Condensed  Consolidated Statements of Cash Flows for the six-month periods ended  December 29, 2007 and December 30, 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 - 16 |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       | 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 |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       | Item 4.                | Submission of  Matters to a Vote of Security Holders                                                                                                                                                                                      |     | 24 |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       | Item  5.               | Other  Information                                                                                                                                                                                                                        |     | 24 |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       | Item 6.                | Exhibits                                                                                                                                                                                                                                  |     | 25 |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       | Signatures             |                                                                                                                                                                                                                                      |     | 26 |
|       |                   |                                                                                                                                                                                                                                      |     |   |
|       | Index to Exhibits      |                                                                                                                                                                                                                                      |     | 27 |

 

2

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**Part I.  Financial Information**

 

**Item1 - Financial Statements**

 

**CANDELA CORPORATION**

**Consolidated Balance Sheets**

(inthousands, except per-share data)

(unaudited)

 
| ** **                                                                                                                                        | ** ** | **December 29,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                        | ** ** | **2007**              | ** ** | **2007**          | ** ** |
| **Assets**                                                                                                                                        | ** ** | ** **            | ** ** | ** **        | ** ** |
| Current assets:                                                                                                                                   |       |                  |       |              |       |
| Cash and cash  equivalents                                                                                                                        |       | $                     | 19,787     |              | $          | 27,152 |   |
| Restricted cash                                                                                                                                   |       | 29                    |       | 48                |       |
| Marketable  securities                                                                                                                            |       | 19,952                |       | 11,773            |       |
| Accounts  receivable, net of allowance for doubtful accounts of $2,618 and $1,412 at  December 29 and June 30, respectively             |       | 37,683                |       | 38,455            |       |
| Notes receivable                                                                                                                                  |       | 531                   |       | 1,025             |       |
| Inventories, net                                                                                                                                  |       | 26,672                |       | 21,368            |       |
| Other current  assets                                                                                                                             |       | 11,407                |       | 7,136             |       |
|                                                                                                                                              |       |                  |       |              |       |
| Total current  assets                                                                                                                             |       | 116,061               |       | 106,957           |       |
| Property and  equipment, net                                                                                                                      |       | 4,474                 |       | 3,479             |       |
| Deferred tax  assets                                                                                                                              |       | 6,314                 |       | 6,146             |       |
| Goodwill                                                                                                                                          |       | 10,997                |       | 10,997            |       |
| Acquired  Intangible assets, net                                                                                                                  |       | 7,452                 |       | 8,151             |       |
| Marketable  securities, long-term                                                                                                                 |       | 6,393                 |       | 12,260            |       |
| Other assets                                                                                                                                      |       | 2,178                 |       | 2,240             |       |
| Total assets                                                                                                                                      |       | $                     | 153,869    |              | $          | 150,230 |   |
|                                                                                                                                              |       |                  |       |              |       |
| **Liabilities and Stockholders’ Equity**                                                                                                     |       |                  |       |              |       |
| Current  liabilities:                                                                                                                             |       |                  |       |              |       |
| Accounts payable                                                                                                                                  |       | $                     | 16,548     |              | $          | 6,922 |   |
| Accrued payroll  and related expenses                                                                                                             |       | 4,417                 |       | 5,344             |       |
| Accrued warranty  costs, current                                                                                                                  |       | 4,920                 |       | 5,486             |       |
| Sales tax  payable                                                                                                                                |       | 1,567                 |       | 1,161             |       |
| Royalties  payable                                                                                                                                |       | 667                   |       | 459               |       |
| Other accrued  liabilities                                                                                                                        |       | 6,446                 |       | 9,554             |       |
| Deferred  revenue, current                                                                                                                        |       | 10,829                |       | 10,000            |       |
| Current  liabilities of discontinued operations                                                                                                   |       | 1,228                 |       | 1,257             |       |
|                                                                                                                                              |       |                  |       |              |       |
| Total current  liabilities                                                                                                                        |       | 46,622                |       | 40,183            |       |
| Deferred tax  liability, long-term                                                                                                                |       | 2,332                 |       | 2,659             |       |
| Accrued warranty  costs, long-term                                                                                                                |       | 1,165                 |       | 2,127             |       |
| Deferred  revenue, long-term                                                                                                                      |       | 4,396                 |       | 3,751             |       |
| Total  liabilities                                                                                                                                |       | 54,515                |       | 48,720            |       |
|                                                                                                                                              |       |                  |       |              |       |
| Stockholders’  equity:                                                                                                                       |       |                  |       |              |       |
| Common stock,  $.01 par value, 60,000,000 shares authorized; 26,102,000 and 26,082,000  issued at December 29 and June 30, respectively |       | 261                   |       | 261               |       |
| Treasury stock,  3,450,000 and 3,125,000 common shares at December 29 and June 30,  respectively, at cost                               |       | (24,855               | )          | (22,458           | )          |
| Additional  paid-in capital                                                                                                                       |       | 71,600                |       | 69,466            |       |
| Accumulated  earnings                                                                                                                             |       | 50,297                |       | 54,536            |       |
| Accumulated  other comprehensive income (loss)                                                                                                    |       | 2,051                 |       | (295              | )          |
| Total  stockholders’ equity                                                                                                                  |       | 99,354                |       | 101,510           |       |
| Total  liabilities and stockholders’ equity                                                                                                  |       | $                     | 153,869    |              | $          | 150,230 |   |

 

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

 

3

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**CANDELACORPORATION**

**ConsolidatedStatements of Income (Loss) and Comprehensive Income (Loss)**

**(inthousands, except per-share data)**

** **
| ** **                                                            | ** ** | **For the three-months ended:** | ** ** | **For the six-months ended:** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                            | ** ** | **December 29,**                          | ** ** | **December 30,**                        | ** ** | **December 29,** | ** ** | **December 30,** | ** ** |
| ** **                                                            | ** ** | **2007**                                       | ** ** | **2006**                                     | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                            | ** ** | **(Unaudited)**                                | ** ** | **(Unaudited)**                              | ** ** |
| **Revenue**                                                           | ** ** | ** **                                     | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other  products                                            |       | $                                              | 25,231     |                                         | $          | 29,108 |   | $ | 52,055 |   | $ | 54,997 |   |
| Product-related  service                                              |       | 10,850                                         |       | 8,298                                        |       | 19,499 |   | 15,883 |   |
| Total revenue                                                         |       | 36,081                                         |       | 37,406                                       |       | 71,554 |   | 70,880 |   |
| **Cost of  sales**                                                    |       |                                           |       |                                         |       |   |   |   |   |
| Lasers and other  products                                            |       | 12,076                                         |       | 13,982                                       |       | 24,388 |   | 24,596 |   |
| Product-related  service                                              |       | 7,289                                          |       | 5,647                                        |       | 13,174 |   | 11,081 |   |
| Total cost of  sales                                                  |       | 19,365                                         |       | 19,629                                       |       | 37,562 |   | 35,677 |   |
| **Gross profit**                                                      |       | 16,716                                         |       | 17,777                                       |       | 33,992 |   | 35,203 |   |
| **Operating  expenses:**                                              |       |                                           |       |                                         |       |   |   |   |   |
| Selling, general  and administrative                                  |       | 18,074                                         |       | 12,568                                       |       | 33,102 |   | 23,648 |   |
| Research and  development                                             |       | 3,652                                          |       | 4,586                                        |       | 6,648 |   | 8,186 |   |
| Total operating  expenses                                             |       | 21,726                                         |       | 17,154                                       |       | 39,750 |   | 31,834 |   |
| **(Loss)  income from operations**                                    |       | (5,010                                         | )          | 623                                          |       | (5,758 | ) | 3,369 |   |
| **Other  income (expense):**                                          |       |                                           |       |                                         |       |   |   |   |   |
| Interest income                                                       |       | 500                                            |       | 752                                          |       | 963 |   | 1,515 |   |
| Other (expense)  income, net                                          |       | (2,496                                         | )          | 135                                          |       | (1,755 | ) | 3,641 |   |
| Total other  (expense) income                                         |       | (1,996                                         | )          | 887                                          |       | (792 | ) | 5,156 |   |
| **(Loss)  income before income taxes**                                |       | (7,006                                         | )          | 1,510                                        |       | (6,550 | ) | 8,525 |   |
| **(Benefit  from) provision for income taxes**                        |       | (2,456                                         | )          | 487                                          |       | (2,187 | ) | 3,083 |   |
| **Net  (loss) income**                                                |       | $                                              | (4,550     | )                                            | $          | 1,023 |   | $ | (4,363 | ) | $ | 5,442 |   |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| **Net  (loss) income per share of common stock**                      |       |                                           |       |                                         |       |   |   |   |   |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Basic                                                                 |       | $                                              | (0.20      | )                                            | $          | 0.04 |   | $ | (0.19 | ) | $ | 0.23 |   |
| Diluted                                                               |       | $                                              | (0.20      | )                                            | $          | 0.04 |   | $ | (0.19 | ) | $ | 0.23 |   |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| **Weighted  average shares outstanding:**                             |       |                                           |       |                                         |       |   |   |   |   |
| Basic                                                                 |       | 22,652                                         |       | 22,910                                       |       | 22,778 |   | 23,220 |   |
| Diluted                                                               |       | 22,652                                         |       | 23,403                                       |       | 22,778 |   | 23,725 |   |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| **Net  (loss) income**                                                |       | $                                              | (4,550     | )                                            | $          | 1,023 |   | $ | (4,363 | ) | $ | 5,442 |   |
| **Other  comprehensive (loss) income, net of tax:**                   |       |                                           |       |                                         |       |   |   |   |   |
| Foreign currency  translation adjustment                              |       | 797                                            |       | 318                                          |       | 1,569 |   | 115 |   |
| Unrealized gain  (loss) on available-for-sales securities, net of tax |       | 1,039                                          |       | (408                                         | )          | 777 |   | (332 | ) |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| **Comprehensive  (loss) income**                                      |       | $                                              | (2,714     | )                                            | $          | 933 |   | $ | (2,017 | ) | $ | 5,225 |   |

*** ***

***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**

(inthousands)

(unaudited)

 
| ** **                                                                                          | ** ** | **For the six-months ended:** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                          | ** ** | **December 29,**                        | ** ** | **December 30,** | ** ** |
| ** **                                                                                          | ** ** | **2007**                                     | ** ** | **2006** | ** ** |
| **Cash  flows from operating activities:**                                                          | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Net (loss)  income                                                                                  |       | $                                            | (4,363     | ) | $ | 5,442 |   |
| Adjustments to  reconcile net income to net cash provided by   (used by) operating activities: |       |                                         |       |   |   |
| Gain on  other-than-temporary impairment of investment (Note 18)                                    |       | 2,546                                        |       | — |   |
| Loss (gain) on  exchange of stock                                                                   |       | —                                       |       | (3,540 | ) |
| Share-based  compensation expense                                                                   |       | 2,056                                        |       | 2,035 |   |
| Depreciation and  amortization                                                                      |       | 1,440                                        |       | 590 |   |
| Provision for  bad debts                                                                            |       | 1,486                                        |       | 600 |   |
| Other non-cash  items                                                                               |       | (41                                          | )          | 48 |   |
| Changes in  operating assets and liabilities                                                        |       |                                         |       |   |   |
| Accounts  receivable                                                                                |       | (435                                         | )          | 1,598 |   |
| Notes receivable                                                                                    |       | 493                                          |       | 824 |   |
| Inventories                                                                                         |       | (5,305                                       | )          | (1,247 | ) |
| Other current  assets                                                                               |       | (2,078                                       | )          | (1,125 | ) |
| Other assets                                                                                        |       | 62                                           |       | 591 |   |
| Accounts payable                                                                                    |       | 9,626                                        |       | (4,688 | ) |
| Accrued payroll  and related expenses                                                               |       | (927                                         | )          | (2,463 | ) |
| Deferred revenue                                                                                    |       | 1,474                                        |       | (257 | ) |
| Accrued warranty  costs                                                                             |       | (1,528                                       | )          | (144 | ) |
| Income taxes  payable                                                                               |       | (1,150                                       | )          | (1,852 | ) |
| Other accrued  liabilities                                                                          |       | (2,523                                       | )          | 825 |   |
| Restricted cash                                                                                     |       | 19                                           |       | 1 |   |
|                                                                                                |       |                                         |       |   |   |
| Net cash  provided by (used by) operating activities                                                |       | 852                                          |       | (2,762 | ) |
|                                                                                                |       |                                         |       |   |   |
| **Cash  flows from investing activities:**                                                          |       |                                         |       |   |   |
| Purchases of  property and equipment                                                                |       | (1,648                                       | )          | (453 | ) |
| Maturities of  held-to-maturity marketable securities                                               |       | 8,168                                        |       | 20,933 |   |
| Cash proceeds  from exchange of stock (Note 18)                                                     |       | —                                       |       | 994 |   |
| Purchases of  held-to-maturity marketable securities                                                |       | (13,920                                      | )          | (9,377 | ) |
| Acquisition of  intangible assets                                                                   |       | (75                                          | )          | (1,380 | ) |
|                                                                                                |       |                                         |       |   |   |
| Net cash (used  by) provided by investing activities                                                |       | (7,475                                       | )          | 10,717 |   |
|                                                                                                |       |                                         |       |   |   |
| **Cash  flows from financing activities:**                                                          |       |                                         |       |   |   |
| Proceeds from  the issuance of common stock                                                         |       | 97                                           |       | 312 |   |
| Purchase of  treasury stock                                                                         |       | (2,400                                       | )          | (8,271 | ) |
|                                                                                                |       |                                         |       |   |   |
| Net cash used by  financing activities                                                              |       | (2,303                                       | )          | (7,959 | ) |
|                                                                                                |       |                                         |       |   |   |
| Effect of  exchange rates on cash and cash equivalents                                              |       | 1,561                                        |       | 274 |   |
|                                                                                                |       |                                         |       |   |   |
| **Net  (decrease) increase in cash and cash equivalents**                                           |       | (7,365                                       | )          | 270 |   |
| ** **                                                                                          |       |                                         |       |   |   |
| **Cash  and cash equivalents at beginning of period**                                               |       | 27,152                                       |       | 40,194 |   |
| ** **                                                                                          |       |                                         |       |   |   |
| **Cash  and cash equivalents at end of period**                                                     |       | $                                            | 19,787     |   | $ | 40,464 |   |

*** ***

***The accompanying notes are an integral partof the unaudited consolidated financial statements****.*

 

5

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**CandelaCorporation**

**Notes toConsolidated Financial Statements (unaudited)**

 

**1.****                   Basis ofPresentation and Consolidation**

 

*Basis ofPresentation*

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesfor interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. The year-end consolidated balance sheetis derived from our audited financial statements, but does not include alldisclosures required by accounting principles generally accepted in the UnitedStates of America. In the opinion of management, the accompanying unauditedconsolidated financial statements contain all adjustments, consisting only ofthose of a normal recurring nature, considered necessary for a fairpresentation of our financial position, results of operations and cash flows atthe dates and for the periods indicated. Actual results may differ from theseestimates.

 

The results for the threeand six-month periods ended December 29, 2007 are not necessarilyindicative of results to be expected for the remainder of the fiscal year. Theinformation contained in the interim financial statements should be read inconjunction with Management’s Discussion and Analysis and the financialstatements and notes thereto included in the Candela Corporation 2007 Form 10-Kfiled with the Securities and Exchange Commission (“SEC”). Certain prior periodamounts have been reclassified to conform to the current period presentation.There was no impact on operating income.

 

*Basisof 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.

 

*SignificantAccounting Policies*

 

On July 1, 2007, weadopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48,(“FIN 48”), *Accounting for Uncertaintyin Income Taxes*, as discussed more fully below. Other than thischange, there have been no significant changes in our significant accountingpolicies during the six months ended December 29, 2007 as compared to thesignificant accounting policies described in our Annual Report on Form 10-Kfor the fiscal year ended June 30, 2007.

 

We adopted the provisionsof FIN 48 effective July 1, 2007. FIN 48 clarifies the accounting forincome taxes, by prescribing a minimum recognition threshold a tax position isrequired to meet before being recognized in the financial statements.FIN 48 also provides guidance on de-recognition, measurement,classification, interest and penalties, accounting in interim periods,disclosure and transition.

 

FIN 48 prescribes atwo-step process to determine the amount of tax benefit to be recognized. Thefirst step is to evaluate the tax position for recognition by determining ifthe weight of available evidence indicates that it is more likely than not thatthe position will be sustained on audit, including resolution of relatedappeals or litigation processes, if any. The second step requires us toestimate and measure the tax benefit as the largest amount that is more than50% likely of being realized upon ultimate settlement. It is inherentlydifficult and subjective to estimate such amounts, as this requires us todetermine the probability of various possible outcomes. We reevaluate theseuncertain tax positions on a quarterly basis. This evaluation is based onfactors including, but not limited to, changes in facts or circumstances,changes in tax law, effectively settled issues under audit, and new auditactivity. Such a change in recognition or measurement would result in therecognition of a tax benefit or an additional charge to the tax provision inthe period.

 

6

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**2.      RecentAccounting Pronouncements**

 

InFebruary 2007, the FASB issued Statement of Financial Accounting Standards(“SFAS”) No. 159, *The Fair Value Optionfor Financial Assets and Financial Liabilities*, including anamendment of SFAS No. 115. SFAS No. 159 permits companiesto choose to measure certain financial instruments and certain other items atfair value and requires unrealized gains and losses on items for which the fairvalue option has been elected to be reported in earnings. SFAS No. 159is effective for fiscal years beginning after November 15, 2007. We arecurrently in the process of evaluating the impact of SFAS No. 159 onour consolidated financial statements.

 

In September 2006,the FASB issued 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 year2009. 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.

 

**3.      Discontinued Operations**

 

On September 27,2003 management initiated a plan to close its only remaining skin care center.The closure was accounted for as a discontinued operation in accordance withSFAS 144 “*Accounting for the Impairment or Disposal ofLong-Lived Assets*” and SFAS 146 “*Accounting for CostsAssociated with Exit or Disposal Activities*”. In determining theamount of the facilities closure accrual, we are required to estimate such factorsas future vacancy rates, the time required to sublet properties and subleaserates. These estimates are reviewed quarterly and may result in revisions toestablished facility reserves.

 

Current liabilities ofdiscontinued operations consist of the following:

 
| ** **                           | ** ** | **December 29,** | ** ** | **June 30,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|-------------------|------------|
| **(in thousands)**              | ** ** | **2007**              | ** ** | **2007**          | ** ** |
| Facility closure  and other costs    |       | $                     | 389        |              | $          | 418 |   |
| Deferred  revenue, gift certificates |       | 839                   |       | 839               |       |
|                                 |       |                  |       |              |       |
|                                 |       | $                     | 1,228      |              | $          | 1,257 |   |

 

**4.      Stock-basedCompensation**

** **

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 all share-based compensation that was not vested as of July 2,2005.  The Company adopted SFAS No. 123Rusing a modified prospective application, as permitted under SFAS No. 123R.Accordingly, prior period amounts were not 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 is being recognized over the period that an employeeprovides service in exchange for the award.

 

The application of SFAS No. 123Rand SAB 107 during the three-month periods ended December 29, 2007 and December 30,2006 resulted in the recognition of share-based compensation expense ofapproximately $1.2 million for each period, respectively. For the six-monthperiod ended December 29, 2007 and December 30, 2006, recognition ofshared-based compensation expense was approximately $2.1 million and $2.0million, respectively.  These expenseswere divided between cost of sales and operating expense cost centers based uponthe functional responsibilities of the individuals holding the respectiveoptions.

 

As of December 29,2007, there was approximately $4.7 million of total unrecognized compensationcost related to non-vested stock options/Stock Appreciation Rights (“SARs”)granted under the Company’s incentive plans. This cost is expected to berecognized over a weighted-average period of 1.4 years. As of December 30,2006, there was approximately $3.6 million of total unrecognized compensationcost related to non-vested stock options granted under the Company’s incentiveplans.

 

7

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The amount of cashreceived from the exercise of stock options for the six-month periods ended December 29,2007 and December 30, 2006 was approximately $0.1 million and $0.3million, respectively.

 

**StockPlans**

 

### **1990 Candela CorporationEmployee 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 December 29, 2007 there were approximately 661,000shares available for sale. Compensation expense for the purchase plan isrecognized over the vesting period.

 

**1998Candela Corporation Stock Option Plan**

 

Effective October 5,2005, 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 priceper share of “incentive stock options” within the meaning of Section 422of the Internal Revenue Code of 1986, as amended, granted under the 1998 StockPlan may not be less than the fair market value per share of common stock onthe date of grant.  In the case of anincentive stock option granted to an employee possessing more than 10% of thetotal combined voting power of all classes of stock of the Company, theexercise price per share may not be less than 110% of the fair market value pershare of common stock on the date 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. None of the options/SARsoutstanding at December 29, 2007 had cash-settlement features.

 

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 333,000 stock based SARs granted during the six-month period ended December 29, 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 3.1 million outstanding options/SARs at December 29, 2007 with a weighted-average exercise price of $10.96 per share, an aggregate intrinsic value of approximately $0.6 million, and a weighted-average remaining contractual term of 7.06 years.

 

Of the total 3.1 million outstanding options/SARs, there were approximately 1.5 million of exercisable options/SARs at December 29, 2007 with a weighted-average exercise price of $10.08 per share, an aggregate intrinsic value of approximately $0.6 million, and a weighted-average remaining contractual term of 5.85 years.

 

There were approximately 1.7 million options/SARs available for grant at December 29, 2007.

 

8

 

The total intrinsic value of options exercised during the six-month period ended December 29, 2007 was approximately $0.2 million.

 

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

 

Basic earnings orloss per share is computed by dividing net income or loss by the weightedaverage number of shares of common stock outstanding for the period. If thereare dilutive securities, diluted earnings per share is computed by includingcommon stock 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:** | ** ** | **For the six months ended:** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                           | ** ** | **December 29,**                               | ** ** | **December 30,**                             | ** ** | **December 29,** | ** ** | **December 30,** | ** ** |
| **(in thousands, except per share data)**   | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Shares used in  the calculation of Basic (loss) earnings per share   |       | 22,652                                              |       | 22,910                                            |       | 22,778 |   | 23,220 |   |
| Effect of  dilutive securities:                                      |       |                                                |       |                                              |       |   |   |   |   |
| Stock  options/SAR's                                                 |       | —                                              |       | 493                                               |       | — |   | 505 |   |
| Diluted shares  used in the calculation of (loss) earnings per share |       | 22,652                                              |       | 23,403                                            |       | 22,778 |   | 23,725 |   |
| Per share effect  of dilutive securities on net income               |       | $                                                   | —     |                                              | $          | — |   | $ | — |   | $ | — |   |
|                                                                      |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

During the three andsix-month periods ended December 29, 2007, potential common sharesconsisting of all shares issuable upon exercise of stock options/SARs have beenexcluded from the computation of diluted loss per share as their effect wouldhave been anti-dilutive.

 

During the three andsix-month periods ended December 30, 2006, options/SARs to purchaseapproximately 879,000 and 867,000 shares of common stock, respectively, wereexcluded from the calculations of diluted earnings per share as their effectwould have been anti-dilutive.

 

**6.      Acquisitions**

 

On March 6, 2007, weacquired Inolase (2002) Ltd. (“Inolase”) a non-public company engaged in thedevelopment and manufacture of proprietary devices for the aestheticlight-based treatment industry as well as the development of intellectualproperty related to medical devices and light sources. The aggregate purchaseprice was approximately $16.8 million in cash, including $0.3 million ofacquisition-related transaction costs. No Candela common stock was issued in theacquisition. This acquisition was accounted for as a business combination.

 

The purchase-priceallocation is preliminary pending the final determination of the fair value ofthe assets and liabilities acquired. The preliminary purchase-price allocationwas recorded in the third quarter of fiscal 2007 and resulted in approximately$11.0 million of goodwill and $7.4 million of other acquired intangible assets,primarily comprised of patents and patent applications, which are beingamortized over an estimated weighted average of 6 years. Values assigned tothese acquired intangible assets are not deductible for tax purposes.

 

9

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Basedupon the preliminary purchase price allocation, the total purchase price wasallocated as follows:

 
| ** **                                   | ** ** | **(in thousands)** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|
| Goodwill                                     |       | $                       | 10,997     |   |
| Identifiable  intangible assets              |       | 7,433                   |       |
| Inventory                                    |       | 214                     |       |
| Accounts  receivable & other assets |       | 195                     |       |
| Accounts payable  and accrued expenses       |       | (248                    | )          |
| Deferred tax  liability                      |       | (1,581                  | )          |
| Other liabilities                            |       | (201                    | )          |
| Total  preliminary purchase price allocation |       | $                       | 16,809     |   |

 

Theexcess of the purchase price of Inolase over the estimated fair values of itstangible and intangible assets and liabilities which excess was approximately$11.0 million was allocated to goodwill. We believe that such excess inpurchase price for accounting purposes was properly allocated to goodwillbecause of the values implicit in certain factors, including: 1) the potentialfor the Company to facilitate up-sell and cross-sell opportunities for ourproducts with those of Inolase; 2) the potential for the Company to exploitreduced pain applications across our existing and future products; and 3) thepotential for the Company to leverage Inolase intellectual property into homeuse applications.

 

**7.      Marketable Securities**

 

The Company accounts for marketable securities inaccordance with SFAS 115*, Accounting for CertainInvestments in Debt and Equity Securities*. SFAS 115 establishes theaccounting and reporting requirements for all debt securities and forinvestments in equity securities that have readily determinable fairvalues.  All marketable securities mustbe classified as one of the following: held-to-maturity, available-for-sale, ortrading.

 

The Company classifies its marketable debt securitiesas held-to-maturity when the Company has the intent and ability to hold them tomaturity. The Company has classified its equity investments asavailable-for-sale securities. Accordingly, such investments are reported at fair market value, withthe resultant unrealized gains and losses reported as a separate component ofshareholders’ equity. Held-to-maturity debt securities are reported atamortized cost which approximates fair value. Current marketable securitiesinclude debt investments with original maturities that are expected to maturein more than three months and less than or equal to twelve months and equityinvestments. Long-term marketable securities include debt securities that haveremaining maturities of one to three years. Unrealized losses related to theheld-to-maturity securities are not considered a permanent decline in themarket value of such securities.

 

During the three-month period ended December 29,2007, the Company recognized a $2.5 million loss on the other-than-temporaryimpairment in the value of its available-for-sale equity investment inOccuLogix, Inc. (Note 18).

 

10

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Marketablesecurities consist of the following:

 
| ** **                               | ** ** | **December 29, 2007** | ** ** | **June 30, 2007** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|
| **(in thousands)**                       | ** ** | **Net Carrying  Amount**   | ** ** | **Fair Value**         | ** ** | **Unrealized  Gain (Loss)** | ** ** | **Net Carrying  Amount** | ** ** | **Fair Value** | ** ** | **Unrealized   loss** | ** ** |
| ** **                               | ** ** | ** **                      | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Short-term  (Held-to-maturity):          |       |                            |       |                        |       |   |   |   |   |   |   |   |   |
| Government-backed  securities            |       | $                               | 15,486     |                        | $          | 15,515 |   | $ | 29 |   | $ | 6,999 |   | $ | 6,988 |   | $ | (11 | ) |
| Certificates of  deposit                 |       | 4,466                           |       | 4,457                       |       | (9 | ) | 3,476 |   | 3,459 |   | (17 | ) |
|                                     |       |                            |       |                        |       |   |   |   |   |   |   |   |   |
|                                     |       | 19,952                          |       | 19,972                      |       | 20 |   | 10,475 |   | 10,447 |   | (28 | ) |
| Short-term  (Available-for-sale):        |       |                            |       |                        |       |   |   |   |   |   |   |   |   |
| Equity  investments                      |       | —                          |       | —                      |       | — |   | 1,298 |   | 1,298 |   | — |   |
|                                     |       |                            |       |                        |       |   |   |   |   |   |   |   |   |
| Total marketable  securities, short-term |       | $                               | 19,952     |                        | $          | 19,972 |   | $ | 20 |   | $ | 11,773 |   | $ | 11,745 |   | $ | (28 | ) |
|                                     |       |                            |       |                        |       |   |   |   |   |   |   |   |   |
| Long-term  (Held-to-maturity):           |       |                            |       |                        |       |   |   |   |   |   |   |   |   |
| Government-backed  securities            |       | $                               | 5,000      |                        | $          | 5,028 |   | $ | 28 |   | $ | 9,993 |   | $ | 9,974 |   | $ | (19 | ) |
| Certificates of  deposit                 |       | 1,393                           |       | 1,388                       |       | (5 | ) | 2,267 |   | 2,247 |   | (20 | ) |
|                                     |       |                            |       |                        |       |   |   |   |   |   |   |   |   |
| Total marketable  securities, long-term  |       | $                               | 6,393      |                        | $          | 6,416 |   | $ | 23 |   | $ | 12,260 |   | $ | 12,221 |   | $ | (39 | ) |

 

**8.****                   Inventories**

 

Inventoriesconsist of the following:

 
| ** **              | ** ** | **December 29,** | ** ** | **June 30,** | ** ** |
|-------------------------|------------|-----------------------|------------|-------------------|------------|
| **(in thousands)** | ** ** | **2007**              | ** ** | **2007**          | ** ** |
| Raw materials           |       | $                     | 10,014     |              | $          | 8,377 |   |
| Work in process         |       | 1,315                 |       | 2,657             |       |
| Finished goods          |       | 15,343                |       | 10,334            |       |
|                    |       |                  |       |              |       |
|                    |       | $                     | 26,672     |              | $          | 21,368 |   |

 

**9.      Property and Equipment**

 

Property andequipment consists of the following:

 
| ** **                                | ** ** | **December 29,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| **(in thousands)**                   | ** ** | **2007**              | ** ** | **2007**          | ** ** |
| Leasehold  improvements                   |       | $                     | 1,013      |              | $          | 1,014 |   |
| Office furniture                          |       | 675                   |       | 662               |       |
| Computers,  software, and other equipment |       | 11,663                |       | 10,044            |       |
|                                      |       |                  |       |              |       |
|                                      |       | $                     | 13,351     |              | $          | 11,720 |   |
| Less:  accumulated depreciation      |       | (8,877                | )          | (8,241            | )          |
|                                      |       |                  |       |              |       |
| Property and  equipment, net              |       | $                     | 4,474      |              | $          | 3,479 |   |

 

Depreciation expense wasapproximately $0.3 million and $0.6 million for the three and six-month periodsended December 29, 2007, respectively. Depreciation expense wasapproximately $0.2 million and $0.5 million for the three and six-month periodsended December 30, 2006, respectively.

 

11

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** **

**10.    Goodwilland Acquired Intangible Assets**

 

Goodwill is the amount by which the cost of acquired net assets in abusiness acquisition exceeded the fair values of net identifiable assets on thedate of our purchase.

 

Goodwill andacquired intangible assets consist of the following:

 
| **(in thousands)**              | ** ** | **December 29,   2007** | ** ** | **June 30,   2007** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|
| Goodwill                             |       | $                                 | 10,997     |                          | $          | 10,997 |   |
|                                 |       |                              |       |                          |       |
| Intagible assets  with finite lives: |       |                              |       |                          |       |
| Patents                              |       | $                                 | 2,879      |                          | $          | 2,804 |   |
| Developed  technology                |       | 6,009                             |       | 6,009                         |       |
|                                 |       |                              |       |                          |       |
|                                 |       | 8,888                             |       | 8,813                         |       |
| Less:  accumulated amortization      |       | (1,436                            | )          | (662                          | )          |
|                                 |       |                              |       |                          |       |
|                                 |       | $                                 | 7,452      |                          | $          | 8,151 |   |

 

Amortization expense wasapproximately $0.4 million and $0.8 million for the three and six-month periodsended December 29, 2007, respectively. Amortization expense wasapproximately $0.1 million for the three and six-month periods ended December 30,2006, respectively.

 

**11.    Derivative Instruments and Hedging 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 no foreigncurrency forward contracts outstanding at December 29, 2007.

 

**12.    WarrantyReserve**

 

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.

 

The following table reflects changes in the Company’saccrued warranty account during the three and six-month periods ended December 29,2007 and December 30, 2006, respectively:

** **
| ** **                             | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **December 29,**                               | ** ** | **December 30,**                             | ** ** | **December 29,** | ** ** | **December 30,** | ** ** |
| **(in thousands)**                | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  balance                     |       | $                                                   | 6,755      |                                              | $          | 9,492 |   | $ | 7,613 |   | $ | 9,629 |   |
| Incremental  accruals on current sales |       | 1,365                                               |       | 1,891                                             |       | 2,537 |   | 3,582 |   |
| Amortization of  prior-period accruals |       | (2,035                                              | )          | (1,893                                            | )          | (4,065 | ) | (3,721 | ) |
|                                   |       |                                                |       |                                              |       |   |   |   |   |
| Ending balance                         |       | $                                                   | 6,085      |                                              | $          | 9,490 |   | $ | 6,085 |   | $ | 9,490 |   |

 

**13.    DeferredRevenue**

 

The Company offers extended service contracts that maybe purchased for periods from one to five years. The Company recognizes servicecontract revenue ratably over the life of the contract. Actual service contractexpenses incurred and charged to service costs of sales during an interim period

 

12

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may be more or less than the amount of amortizedservice contract revenue recognized in that period.

 

Revenues are recognized when a signed non-cancelablepurchase order exists, the product is shipped, title and risk have passed tothe customer, the fee is fixed or determinable, and collection is consideredprobable. Circumstances which generally preclude the immediate recognition ofrevenue include shipping terms of FOB destination or the existence of acustomer acceptance clause in a contract based upon customer inspection of theproduct. In these instances, revenue is deferred until adequate documentationis obtained to ensure that these criteria have been fulfilled.

 

The following table reflects changes in the Company’sdeferred revenue account during the three and six-month periods ended December 29,2007 and December 30, 2006, respectively:

 
| ** **                                  | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                  | ** ** | **December 29,**                               | ** ** | **December 30,**                             | ** ** | **December 29,** | ** ** | **December 30,** | ** ** |
| **(in thousands)**                     | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  balance                          |       | $                                                   | 14,731     |                                              | $          | 10,104 |   | $ | 13,751 |   | $ | 10,329 |   |
| Deferral of new  sales                      |       | 4,246                                               |       | 3,347                                             |       | 9,435 |   | 5,080 |   |
| Recognition of  previously deferred revenue |       | (3,752                                              | )          | (3,372                                            | )          | (7,961 | ) | (5,330 | ) |
|                                        |       |                                                |       |                                              |       |   |   |   |   |
| Ending balance                              |       | $                                                   | 15,225     |                                              | $          | 10,079 |   | $ | 15,225 |   | $ | 10,079 |   |

 

**14.    Common Stock Buyback**

 

325,000 shares ofcommon stock were purchased for approximately $2.4 million during the six-monthperiod ended December 29, 2007.

 

**15.    Commitments andContingencies**

 

TheCompany has an agreement with the Regents of the University of California (“Regents”)for exclusive license rights to the Dynamic Cooling Device (“DCD”), subject tocertain limited license rights of Cool Touch, Inc. (“Cool Touch”), in thefollowing fields of use:  procedures thatinvolve skin resurfacing and rejuvenation, vascular skin lesions, and laserhair removal.  Cool Touch, a subsidiaryof New Star Technology, Inc., obtained a license to the DCD on aco-exclusive basis with the Company, in certain narrower fields of use.

 

TheCompany’s agreement with the Regents called for an annual license fee of $0.3million and a minimum annual royalty obligation of $1 million or 3%, whicheveris greater. The multi-year annual fee of $0.3 million was paid to the Regentsin a lump sum of $3.0 million and is being amortized over the remaining life ofthe patent agreement, which as of December 29, 2007 was less than eightyears. The royalty and the amortization of the annual license fee payment arereflected in the Company’s consolidated statement of income. The unamortizedportion of the license fee payment is reflected in other current assets and inother assets at December 29, 2007 and June 30, 2007, respectively.

 

**16.   ****Income Taxes**

 

The Company adopted theprovisions of FIN 48 effective July 1, 2007. FIN 48 addressesthe accounting for and disclosure of uncertainty in income tax positions byprescribing a minimum recognition threshold that a tax position is required tosatisfy before being recognized in the financial statements. FIN 48 alsoprovides guidance on de-recognition, measurement, classification, interest andpenalties, accounting in interim periods, disclosure and transition.

 

The cumulative effect ofadopting FIN 48 was a decrease in tax reserves of approximately$0.1 million, resulting in an offsetting increase to the July 1, 2007Retained Earnings balance.

 

Upon adoption, the grossliability for unrecognized tax benefits at July 1, 2007 was approximately$1.9 million, exclusive of interest and penalties and, if recognized,would favorably affect the Company’s effective tax rate.  In addition, consistent with the provisionsof FIN 48, certain reclassifications were made to the balance sheet,including the reclassification of $0.4 million of income tax liabilities fromcurrent to non-current liabilities because payment of cash is not anticipatedwithin one year of the balance sheet date.

 

13

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The Company’s policy toinclude interest and penalties related to gross unrecognized tax benefitswithin its provision for income taxes did not change upon the adoption ofFIN 48. To the extent accrued interest and penalties do not ultimatelybecome payable, amounts accrued will be reduced in the period that suchdetermination is made and reflected as a reduction of the overall income taxprovision.

 

The Company files income tax returns in the United States (“U.S.”) on afederal basis and in many U.S. state and foreign jurisdictions. The threemost significant tax jurisdictions are the U.S., Spain, and Japan. The associated tax filings remainsubject to examination by applicable tax authorities for a certain length oftime following the tax year to which those filings relate. The 2004 through2007 fiscal tax years remain subject to examination by the IRS forU.S. federal tax purposes, and the 2004through 2007 and the 2003 through 2007 fiscal tax years remain subject to examination by theappropriate governmental agencies for Spanishand Japanese tax purposes,respectively.

 

**17.   ****Legal Proceedings**

 

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

 

·                  On August 9, 2006, Palomar filed suit against theCompany 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 compensatory and treble damages, as well as attorneys’ fees andinjunctive relief.  In November, 2006,the Company answered the complaint by denying Palomar’s allegations andasserting a variety of affirmative defenses and counterclaims against Palomar.This response included a counterclaim by the Company against Palomar seeking adeclaratory judgment that United States patent No. 5,595,568 (“the ‘568Patent”) is either invalid, or products manufactured by the Company do notinfringe the ‘568 Patent, or both. In November, 2006, Palomar filed an answerdenying the Company’s counterclaim. In February, 2007, Palomar moved to amendits Complaint to add The General Hospital Corporation as a party, to add aclaim for infringement by Candela of the ‘568 patent, and to allege thatadditional Candela products infringe the ‘568 Patent. Palomar’s motion to amendits Complaint was granted in August of 2007. In February of 2007,Candela moved to amend its Answer and Counterclaims to add allegations ofinequitable conduct, double-patenting and violation of Mass. Gen. Laws Ch. 93Aby Palomar. The Company’s motion to amend its complaint was granted in March of2007. Palomar filed a general denial response to Candela’s Amended Answer andCounterclaim in March of 2007. In August of 2007, the parties had aMarkman hearing before the U.S. District Court Judge presiding over theabove-described legal proceeding. In a Markman hearing, the Court interpretsthe definition of the disputed claim terms of a patent.  The parties received the Markman ruling on November 8,2007.  The parties continue withpre-trial fact discovery which was scheduled to end on December 31, 2007,but which has been extended until February 15, 2008.

 

·                  On August 10,2006, the Company filed suit against Palomar in the United States DistrictCourt for the District of Massachusetts, asserting willful infringement byPalomar of U.S. Patent Nos. 6,659,999, 5,312,395, and 6,743,222. The Companyseeks compensatory and treble damages for the patent infringement, as well asattorneys’ fees and an injunction against Palomar to prevent Palomar’scontinuing infringement. The Company served its complaint on Palomar in August,2006.  In October, 2006, the Company amendedthe Company’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.In addition, Palomar filed a demand for a declaratory judgment seeking ajudicial determination that Palomar products either do not infringe the ‘395and ‘222 patents or that such patents are invalid.  In November, 2006, the Company answered thecounterclaim by denying Palomar’s allegations. The parties have concludedpre-trial fact discovery.

 

·                  In December, 2006,the Company filed suit against Palomar in the United States District Court forthe Eastern District of Texas, Lufkin Division, asserting that Palomarinfringes one or more claims of United States patents Nos: 5,810,801, 6,659,999and 6,120,497. The 

 

14

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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.  In November of2007, the parties had a Markman hearing before the U.S. District Court’sMagistrate Judge presiding over the above-described legal proceeding.  The parties have yet to receive the Court’swritten opinion.  The parties are in themidst of pre-trial fact discovery, which ends on April 8, 2008.

 

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.

 

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.

 

**18.   ****Other Income**

 

In August 2007the Company recognized a $0.6 million gain on the receipt of additional cashconsideration related to the acquisition of Solx, Inc., a privately heldcompany, by OccuLogix, Inc., a publicly traded company (NasdaqGM: OCCX).Candela Corporation originally held 19.99% of the outstanding common stock ofSolx, Inc., on an as-converted basis, prior to Solx’s acquisition byOccuLogix.

 

During the six-monthperiod ended December 30, 2006, the Company recognized a $3.5 million gainon the above-referenced exchange of common stock of Solx Inc. for cash andcommon stock of OccuLogix, Inc. As a result of this transaction, Candelareceived approximately $1.0 million in cash at the time of closing, future cashconsideration of approximately $2.5 million, and approximately 1.3 millionshares of common stock in OccuLogix, Inc.

 

TheCompany classified the common shares of OccuLogix as available-for-sale securities recorded at fair valuebased upon quoted market prices. The temporary differences between cost andfair value were presented in the consolidated financial statements in accumulated other comprehensive incomewithin stockholders’ equity, net of any related tax effect. At December 29, 2007, in the opinion of management, thevalue of the investment in the common shares of OccuLogix sustained another-than-temporary impairment in value and the Company recognized an associated $2.5 million loss ofwhich approximately $2.4 million was reclassified from accumulated other comprehensiveincome.

 

15

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**CandelaCorporation**

 

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

 

**Overview**

 

We research, develop,manufacture, market, sell, distribute, and service lasers and light-basedproducts used to perform aesthetic and cosmetic procedures. We sell our lasersto physicians and personal care practitioners. We market our products directlyand through a network of distributors to end-users. Our traditional customerbase includes plastic and cosmetic surgeons and dermatologists. More recently,we have expanded our sales to a broader group of practitioners consisting ofgeneral practitioners and certain specialists including obstetricians,gynecologists and general and vascular surgeons. We derive our revenue from thesales of lasers, light-based devices, and other products, as well asproduct-related services.

 

**CriticalAccounting Policies**

 

****Thisdiscussion and analysis of our financial condition and results of operations isbased upon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. Weevaluate our estimates and judgments on an on-going basis, including thoserelated to revenue recognition, allowance for doubtful accounts, inventoryreserves, warranty reserves, contingencies, valuation of long-lived assets,stock-based compensation, restructurings and income taxes. We base ourestimates and judgments on historical experience and on various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valueof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates and judgments under differentassumptions or conditions. A discussion of our critical accounting policies andthe related estimates and judgments affecting the preparation of ourconsolidated financial statements is included in our Annual Report on Form 10-Kfor fiscal year 2007.****

 

On July 1, 2007, weadopted Financial Accounting Standards Board, (“FASB”) Interpretation No. 48,(“FIN 48”), *Accounting for Uncertaintyin Income Taxes*, as discussed more fully below. Other than thischange, there have been no significant changes in our significant accountingpolicies during the three months ended December 29, 2007 as compared tothe significant accounting policies described in our Annual Report on Form 10-Kfor the fiscal year ended June 30, 2007.

 

We adopted the provisionsof FIN 48 effective July 1, 2007. FIN 48 clarifies the accounting forincome taxes, by prescribing a minimum recognition threshold a tax position isrequired to meet before being recognized in the financial statements.FIN 48 also provides guidance on de-recognition, measurement, classification,interest and penalties, accounting in interim periods, disclosure andtransition.

 

FIN 48 prescribes atwo-step process to determine the amount of tax benefit to be recognized. Thefirst step is to evaluate the tax position for recognition by determining ifthe weight of available evidence indicates that it is more likely than not thatthe position will be sustained on audit, including resolution of relatedappeals or litigation processes, if any. The second step requires us toestimate and measure the tax benefit as the largest amount that is more than50% likely of being realized upon ultimate settlement. It is inherentlydifficult and subjective to estimate such amounts, as this requires us todetermine the probability of various possible outcomes. We reevaluate theseuncertain tax positions on a quarterly basis. This evaluation is based onfactors including, but not limited to, changes in facts or circumstances,changes in tax law, effectively settled issues under audit, and new audit activity.Such a change in recognition or measurement would result in the recognition ofa tax benefit or an additional charge to the tax provision in the period.

 

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**RecentAccounting Pronouncements**

 

InFebruary 2007, the FASB issued Statement of Financial Accounting Standards(“SFAS”) No. 159, *The Fair Value Optionfor Financial Assets and Financial Liabilities*, including anamendment of SFAS No. 115. SFAS No. 159 permits companiesto choose to measure certain financial instruments and certain other items atfair value and requires unrealized gains and losses on items for which the fairvalue option has been elected to be reported in earnings. SFAS No. 159is effective for fiscal years beginning after November 15, 2007. We arecurrently in the process of evaluating the impact of SFAS No. 159 onour consolidated financial statements.

 

In September 2006,the FASB issued 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 year2009. 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.

 

**Resultsof Operations**

 

***Revenue***

 

Revenue source bygeographic region is reflected in the following table:

 
| ** **               | ** ** | **For the three months ended:** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|
| **(in  thousands)**      | ** ** | **December 29,  2007**                         | ** ** | **December 30,  2006** | ** ** | **Increase  (Decrease)** | ** ** |
| U.S.                     |       | $                                                   | 13,976     |   | 39 | %   | $ | 16,851 |   | 45 | %   | $ | (2,875 | ) | -17 | % |
| All other  countries     |       | 22,105                                              |       | 61 | % | 20,555 |   | 55 | % | 1,550 |   | 8 | % |
|                     |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total worldwide  revenue |       | $                                                   | 36,081     |   | 100 | % | $ | 37,406 |   | 100 | % | $ | (1,325 | ) | -4 | % |

 
| ** **               | ** ** | **For the six months ended:** | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|
| ** **               | ** ** | **December 29,**                             | ** ** | **December 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in thousands)**  | ** ** | **2007**                                          | ** ** | **2006** | ** ** | **Increase (Decrease)** | ** ** |
| U.S.                     |       | $                                                 | 30,706     |   | 43 | %   | $ | 32,696 |   | 46 | %   | $ | (1,990 | ) | -6 | % |
| All other  countries     |       | 40,848                                            |       | 57 | % | 38,184 |   | 54 | % | 2,664 |   | 7 | % |
|                     |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Total worldwide  revenue |       | $                                                 | 71,554     |   | 100 | % | $ | 70,880 |   | 100 | % | $ | 674 |   | 1 | % |
|                          |            |                                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Consolidated revenue was$36.1 million for the three-month period ended December 29, 2007, ascompared to $37.4 million for the same period ended December 30, 2006. Theoverall decrease in quarterly revenue of $1.3 million was comprised of revenuedeclines in the U.S., Latin America, and Japan of approximately $5.8 millionwhich declines were offset by an increase in revenues in Europe andAsia-Pacific of approximately $4.5 million in the most recent quarter. Thedecrease in U.S. and Japanese revenues was primarily related to a leveling-offin demand over all product lines. The decrease in Latin America was primarilydue to the fact that we recognized an unexpectedly high level revenue given thedemographics of the region in the previous comparable period. The increase inEurope was primarily the result of expanded and more efficient distributionchannels.

 

Consolidated revenue was$71.6 million for the six-month period ended December 29, 2007, ascompared to $70.9 million for the same period ended December 30, 2006. Theoverall increase of $0.7 million was comprised of revenue increases in Europeand Asia-Pacific of approximately $8.3 million, offset by revenue declines inthe U.S., Latin America, and Japan of approximately $7.6 million. The decreasein Latin America was primarily due to the unexpectedly high revenue for thedemographics of the region in the previous comparable period. The increase inEurope was primarily the result of expanded and more efficient distributionchannels.

 

Foreign revenue accountedfor approximately 61% of the consolidated revenues for the three-month periodended December 29, 2007. The increase to $22.1 million for the three-monthperiod ended

 

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December 29, 2007,as compared to the same period ended December 30, 2006, was comprised of a$4.3 million increase in Europe and Asia-Pacific, combined with a $2.8 milliondecrease in Japan and Latin America. The increase in Europe was due to thecontinued strong growth in the region across all product lines. The decrease inLatin America was primarily due to the unexpectedly high revenue given thedemographics of the region recognized in the previous comparable period.

 

Foreign revenue accountedfor approximately 57% of the consolidated revenues for the six-month periodended December 29, 2007. The increase to $40.8 million for the six-monthperiod ended December 29, 2007, as compared to the same period ended December 30,2006, was comprised of an $8.2 million increase in Europe and Asia-Pacific,offset by a $5.6 million decrease in Japan and Latin America. The increase inEurope was due to the continued strong growth in the region across all productlines. The decrease in Latin America was primarily due to the unexpectedly highrevenue given the demographics of the region recognized in the previouscomparable period.

 

Revenue source by type isreflected in the following table:

 
| ** **                 | ** ** | **For the three months ended:** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|
| ** **                 | ** ** | **December 29,**                               | ** ** | **December 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in thousands)**    | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **Increase (Decrease)** | ** ** |
| Lasers and other  products |       | $                                                   | 25,231     |   | 70 | %   | $ | 29,107 |   | 78 | %   | $ | (3,876 | ) | -13 | % |
| Product-related  services  |       | 10,850                                              |       | 30 | % | 8,299 |   | 22 | %   | 2,551 |   | 31 | % |
|                       |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total revenue              |       | $                                                   | 36,081     |   | 100 | %   | $ | 37,406 |   | 100 | %   | $ | (1,325 | ) | -4 | % |

 
| ** **                 | ** ** | **For the six months ended:** | ** ** |
|----------------------------|------------|---------------------------------------------------|------------|
| ** **                 | ** ** | **December 29,**                             | ** ** | **December 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in  thousands)**        | ** ** | **2007**                                          | ** ** | **2006** | ** ** | **Increase  (Decrease)** | ** ** |
| Lasers and other  products |       | $                                                 | 52,055     |   | 73 | % | $ | 54,997 |   | 78 | %   | $ | (2,942 | ) | -5 | % |
| Product-related  services  |       | 19,499                                            |       | 27 | % | 15,883 |   | 22 | %   | 3,616 |   | 23 | % |
|                       |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Total revenue              |       | $                                                 | 71,554     |   | 100 | % | $ | 70,880 |   | 100 | %   | $ | 674 |   | 1 | % |

 

The decrease in revenue from lasers and otherproducts for the three and six-month periods ended December 29, 2007,compared to the same periods ended December 30, 2006, resulted primarilyfrom a general reduction in sales in the U.S., Japanese, and Latin-Americanmarkets.

 

Product-related servicesincreased approximately $2.5 million or 31% in the three-month period ended December 29,2007 as compared to the same period ended December 30, 2006. The increaseis primarily 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.

 

Product-related servicesincreased approximately $3.6 million or 23% in the six-month period ended December 29,2007 as compared to the same period ended December 30, 2006. The increaseis primarily 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.

 

***Gross Profit.***Gross profit wasapproximately $16.7 million or 46.3% for the three-month period ended December 29,2007 as compared to $17.8 million or 47.5% for the same period ended December 30,2006. The decrease in gross profit for the three-month period ended December 29,2007 as compared to the same period in the previous fiscal year is due tooverall sales volume, changes in product mix, regional mix, and a greaterproportion of revenues being derived from the sale of product-related servicesin the current period which carry a lower margin than sales of lasers.

 

Grossprofit was approximately $34.0 million or 47.5% for the six-month period ended December 29,2007 as compared to $35.2 million or 49.7% for the same period ended December 30,2006. The decrease in gross profit for the six-month period ended December 29,2007 as compared to the same period in the previous fiscal year is due tochanges in product mix, regional mix, and a greater proportion of revenuesbeing derived from the sale of product-related services in the current periodwhich carry a lower margin than sales of lasers.

 

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***Selling, General andAdministrative Expense.***Selling,general and administrative (SG&A) expenses increased to approximately $18.1million for the three-month period ended December 29, 2007 fromapproximately $12.6 million for the three-month period ended December 30,2006. As a percentage of revenue, SG&A expenses increased to 50.1% from33.6% of revenues in the comparative prior year period. The increase was due tolegal fees related to the Palomar litigation, SG&A expenses related torecent expansion offices opened in the U.K. and Australia, the recentlyacquired Israeli subsidiary, and to increased personnel-related expenses.

 

For the six-month period ended December 29,2007,SG&A expenses increased to approximately $33.1 million fromapproximately $23.6 million for the same period ended December 30, 2006.As a percentage of revenue, SG&A expenses increased to 46.3% from 33.4% ofrevenues in the comparative prior year period. Again, the increase was due tolegal fees related to the Palomar litigation, SG&A expenses related torecent expansion offices opened in the U.K. and Australia, the recentlyacquired Israeli subsidiary, and to increased personnel-related expenses.

 

***Researchand Development Expense.*** Research and developmentspending decreased to approximately $3.7 million for the three-month periodended December 29, 2007, from approximately $4.6 million for thecomparative prior-year period. Research and development spending decreased toapproximately $6.6 million for the six-month period ended December 29,2007, from approximately $8.2 million for the comparative prior-year period.The decreases are due primarily to the recently-completed new productintroduction plan. These expenses are expected to increase in future periods,however, as the Company transitions to new projects.

 

***OtherIncome/Expense.***Other expense was approximately $1.9million for the three-months ended December 29, 2007, as compared to otherincome of approximately $0.9 million for the same period ended December 30,2006. The decrease of approximately $2.8 million from the prior-year comparableperiod is due to the recognition of a $2.5 million loss on theother-than-temporary impairment of our holdings of common shares of OccuLogix, Inc.(Note 18), combined with a $0.3 million decrease in interest income earnedduring the second quarter of fiscal 2008.

 

Other expense wasapproximately $0.8 million for the six-months ended December 29, 2007, ascompared to other income of approximately $5.2 million for the same periodended December 30, 2006. The decrease is due to the Company havingrecognized a $3.5 million gain on the initial exchange of common stock of Solx, Inc.for cash and common stock of OccuLogix, Inc. during the six-month periodended December 30, 2006 as compared to the recognition of the above-referencedloss on the same investment during the six-month period ended December 29,2007.

 

The decrease in interestincome earned during the six-month period ended December 29, 2007, ascompared to the same period in the prior fiscal year, is primarily related to adecrease in cash and cash equivalents. During the trailing twelve-month periodended December 29, 2007, the Company used its cash to repurchaseapproximately $3.6 million of its own stock and to acquire Inolase (Note 6) forapproximately $16.8 million.

 

***IncomeTaxes.*** The provision for income taxes results from acombination of activities of the Company and its domestic and foreignsubsidiaries. We recorded effective tax rates of approximately 30% and 37% foreach of the six -month periods ended December 29, 2007 and December 30,2006, respectively. The Company also recorded discrete tax items ofapproximately $0.3 million during the six-month period ended December 29,2007. The discrete items include an expense of $0.1 million resulting from achange in the statutory tax rate in Germany and a benefit of $0.4 millionresulting from the completion of an IRS audit of the 2005 and 2004 income taxreturns. The affect of the change in the German statutory rate on currentearnings is fully reflected in our effective tax rate indicated above.

 

**Liquidityand Capital Resources**

 

Our cash and cashequivalents and our investment in short and long-term marketable securities at December 29,2007 totaled approximately $46.1 million compared with approximately $51.2million at June 30, 2007. A principal component of the decrease was theuse of cash for our stock repurchase program. We continue to have no long-termdebt. We believe that the combination of existing cash and cash equivalents,and marketable securities on hand, along with cash to be generated by futureoperations and amounts available under our line of credit, will be sufficientto meet our ongoing operating and capital expenditure requirements for theforeseeable future. However, we cannot be sure that we will

 

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not require additionalcapital beyond the amounts currently forecasted by us, or that any suchrequired additional capital will be available on reasonable terms, if at all,as it becomes required.

 

Cash provided byoperating activities amounted to approximately $0.9 million for the six-monthperiod ended December 29, 2007 as compared to cash used by operatingactivities of approximately $2.8 million for the same period in the prior year.The increase in cash provided by operating activities is attributable tochanges in operating asset and liability accounts in the normal course ofbusiness and is not attributable to any single or identifiable event.

 

**Off-BalanceSheet Arrangements**

 

Our only off-balancesheet arrangements consist of non-cancelable operating leases entered into inthe ordinary course of business and the license agreement with the Regents. Thetable below in the next section titled “Contractual Obligations” shows theamounts of our operating lease commitments and purchase commitments payable byyear.

 

**ContractualObligations**

 

Outstanding contractualobligations of the Company are reflected in the following table:

 
| **(in thousands)**        | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **After  5 years** | ** ** |
|--------------------------------|------------|-----------|------------|---------------------------------|------------|--------------------------------|------------|--------------------------------|------------|-------------------------|------------|
| Royalty  commitments           |       | $         | 4,250      |                            | $          | 1,000                          |       | $                              | 2,000      |                    | $          | 500 |   | $ | 750 |   |
| Operating leases               |       | 3,489     |       | 1,770                           |       | 1,393                          |       | 326                            |       | —                  |       |
| Total  contractual obligations |       | $         | 7,739      |                            | $          | 2,770                          |       | $                              | 3,393      |                    | $          | 826 |   | $ | 750 |   |

 

#### **Cautionary Statements**

 

Certain statementscontained herein may constitute “forward-looking statements” within the meaningof the Private Securities Litigation Reform Act of 1995 (“Reform Act”). We mayalso make forward-looking statements in other reports filed with the Securitiesand Exchange Commission, in materials delivered to stockholders and in pressreleases. In addition, our representatives may from time to time make oralforward-looking statements. Forward-looking statements provide currentexpectations of future events based on certain assumptions and include anystatement that does not directly relate to any historical or current fact.Words such as “anticipates,” “believes,” “expects,” “estimates,” “intends,” “plans,”“projects,” and similar expressions, may identify such forward-lookingstatements. Such forward-looking statements include but are not limited to:that we have the necessary infrastructure in place to capitalize on expansion;the affordability of our products will allow for expansion; that we can lowerproduction costs; or that the market will expand beyond baby boomers. We assumeno obligation to update or revise any forward-looking statements whether as aresult of new information, future events or otherwise. The risks anduncertainties that may affect forward-looking statements and/or our businessinclude, among others, those discussed in “Cautionary Statements” in our AnnualReport filed on Form 10-K for the fiscal year ended June 30, 2007, aswell as other risks and uncertainties referenced in this Quarterly Report on Form 10-Q,and the following:

 

·                        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 and related litigation between the two partiesthat are unfavorable to us may result in significant declines in our stockprice. An adverse ruling or judgment in this matter is likely to cause ourstock price to decline significantly. Litigation with Palomar is expensive andis likely to be protracted, and our intellectual property position as well asour cash position may be weakened as a result of an adverse ruling or judgment.Whether or not we are successful in the pending lawsuit, litigation may consumesubstantial amounts of our financial resources and divert management’sattention away from our core business. Please see Part II, Item 1 (LegalProceedings) for a further discussion of the Palomar litigation.

 

·                        Claims byothers that our products infringe their patents or other intellectual propertyrights, or that the patents which we own or have licensed rights to areinvalid, could prevent us from manufacturing

 

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and sellingsome of our products or require us to incur substantial costs from litigationor development of 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 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 wetypically derive more than half of our revenue from international sales, we aresusceptible to currency fluctuations, negative economic changes taking place inforeign marketplaces, and other risks associated with conducting businessoverseas.

 

·                        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.

 

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

 

·                        We have modified some of our products withoutFDA clearance. The FDA could retroactively decide the modifications wereimproper and require 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.

 

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

 

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

 

·                        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 toplace undue reliance upon any forward-looking statements, which speak only asof the date made. We expressly disclaim any obligation or undertaking torelease publicly any updates or revisions to any such statements to reflect anychange in our expectations or any change in events, conditions or circumstanceson which any such statement is based.

 

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**Item 3 - Quantitative and Qualitative Disclosuresabout Market Risk**

 

We have cash equivalentsand marketable securities that consist of money market mutual funds,certificates of deposit, US government securities, fixed income corporatesecurities and equity investments. The majority of these investments havematurities within one to three years. We believe that our exposure to interestrate risk is minimal due to the term and type of our investments and thosefluctuations in interest rates would not have a material adverse effect on ourresults of operations.

 

We have international subsidiaries that transact business in 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 no foreign currency forward contractsoutstanding at December 29, 2007.

 

# **Item4 - Controls and Procedures**

 

***Evaluation of Disclosure Controlsand Procedures***

 

Our Chief Executive Officer and Principal 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 December 29, 2007, the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Principal 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.

 

***Changes in Internal Controls overFinancial Reporting***

 

There have been no changes in the Company’s internalcontrols over financial reporting that occurred during the quarter ended December 29,2007 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**CandelaCorporation**

 

**Part II. 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 against theCompany 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 compensatory and treble damages, as well as attorneys’ fees andinjunctive relief. In November, 2006, the Company answered the complaint bydenying Palomar’s allegations and asserting a variety of affirmative defensesand counterclaims against Palomar. This response included a counterclaim by theCompany against Palomar seeking a declaratory judgment that United Statespatent No. 5,595,568 (“the ‘568 Patent”) is either invalid, or productsmanufactured by the Company do not infringe the ‘568 Patent, or both. InNovember, 2006, Palomar filed an answer denying the Company’s counterclaim. InFebruary, 2007, Palomar moved to amend its Complaint to add The GeneralHospital Corporation as a party, to add a claim for infringement by Candela ofthe ‘568 patent, and to allege that additional Candela products infringe the ‘568Patent. Palomar’s motion to amend its Complaint was granted in August of2007. In February of 2007, Candela moved to amend its Answer andCounterclaims to add allegations of inequitable conduct, double-patenting andviolation of Mass. Gen. Laws Ch. 93A by Palomar. The Company’s motion to amendits complaint was granted in March of 2007. Palomar filed a general denialresponse to Candela’s Amended Answer and Counterclaim in March of 2007. InAugust of 2007, the parties had a Markman hearing before the U.S. DistrictCourt Judge presiding over the above-described legal proceeding. In a Markmanhearing, the Court interprets the definition of the disputed claim terms of apatent. The parties received the Markman ruling on November 8, 2007. Theparties continue with pre-trial fact discovery which was scheduled to end on December 31,2007, but which has been extended until February 15, 2008.

 

·                  On August 10,2006, the Company filed suit against Palomar in the United States DistrictCourt for the District of Massachusetts, asserting willful infringement byPalomar of U.S. Patent Nos. 6,659,999, 5,312,395, and 6,743,222. The Companyseeks compensatory and treble damages for the patent infringement, as well asattorneys’ fees and an injunction against Palomar to prevent Palomar’scontinuing infringement. The Company served its complaint on Palomar in August,2006. In October, 2006, the Company amended the Company’s suit against Palomarby removing from the suit allegations that Palomar infringes Patent 6,659,999.In October, 2006, Palomar answered the Company’s amended complaint by denyingthe Company’s allegations and asserting an affirmative defense of inequitableconduct with respect to the ‘395 patent. In addition, Palomar filed a demandfor a declaratory judgment seeking a judicial determination that Palomarproducts either do not infringe the ‘395 and ‘222 patents or that such patentsare invalid. In November, 2006, the Company answered the counterclaim bydenying Palomar’s allegations. The parties have concluded pre-trial factdiscovery.

 

·                  In December, 2006,the Company filed suit against Palomar in the United States District Court forthe Eastern District of Texas, Lufkin Division, asserting that Palomarinfringes one or more claims of United States patents Nos: 5,810,801, 6,659,999and 6,120,497. The Company seeks compensatory and treble damages for pastinfringement, as well as attorneys’ fees and an injunction against Palomar fromfuture infringement. In January, 2007, Palomar answered the complaint bydenying the Company’s allegations and filing a declaratory judgment motionseeking a court ruling that it does not infringe such patents and/or that suchpatents are invalid. In addition, Palomar filed a motion to transfer the caseto the United States District Court for the District of Massachusetts. InFebruary, 2007, the Company added Massachusetts General Hospital as a party toits action. The Court denied Palomar’s motion to transfer the case to Massachusetts.In November of 2007, the parties had a Markman hearing before the U.S.District Court’s Magistrate Judge presiding over the above-described legalproceeding. The parties have yet to receive the Court’s written opinion. Theparties are in the midst of pre-trial fact discovery, which ends on April 8,2008.

 

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 ultimate outcome. An adverse outcome in Palomar’s suit against the Company wouldmaterially hurt the Company’s 

 

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business,financial condition, results of operations and cash flows. In contrast, anadverse outcome in either of the two lawsuits which the Company has initiatedagainst Palomar would not likely have a material adverse effect on the businessor financial condition of the Company.

 

From time to time, the Company is party to variouslegal proceedings incidental to its business. The Company believes that none ofthe legal proceedings, other than the lawsuit initiated by Palomar, that arepresently pending, if adversely decided against us, will have a materialadverse effect upon the Company’s financial position, results of operations, or liquidity.

 

**Item 4 – Submission of Matters to a Vote ofSecurity Holders**

 

On December 11, 2007, the Company held its annualmeeting of shareholders and voted on two proposals.

 

1)              At the Meeting, six (6) directorswere elected to hold office until the Company’s next****annual meeting. The vote was as follows:

 
| ** **            | ** ** | **FOR**    | ** ** | **WITHHOLD** | ** ** |
|-----------------------|------------|------------|------------|--------------|------------|
| George A. Abe         |       | 14,788,566 |       | 3,043,643    |       |
| Ben  Bailey, III |       | 15,127,528 |       | 2,704,681    |       |
| Nancy E. Nager        |       | 14,784,852 |       | 3,047,357    |       |
| Gerard E. Puorro      |       | 15,065,131 |       | 2,767,078    |       |
| Kenneth D.  Roberts   |       | 15,129,712 |       | 2,702,497    |       |
| Douglas W. Scott      |       | 14,783,359 |       | 3,048,850    |       |

 

2)              At the Meeting, thevote on a proposal to ratify the selection of BDO Seidman, LLP to serve as theCompany’s independent registered public accounting firm for the fiscal yearending June 30, 2007, was approved as follows:

 
| **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
|       |       |        |       |        |       |
| 17,269,226 |       | 85,461      |       | 477,522     |       |

 

# **Item 5 - Other Information**

 

On January 25, 2008, theBoard of Directors took final action to ratify the earlier approval of anamendment to the by-laws of the Company. An amendment to Section 1 of ArticleIX, pertaining to authorization for the Company to use un-certificated shares,is included in the Amended and Restated By-laws appended hereto as Exhibit3(ii).

 

24

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# **Item6 - Exhibits**

 

(a)                                  Exhibits

 
| Exhibit 3(ii) | Amended and  Restated By-Laws                                                                                                                                         |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |                                                                                                                                                                  |
| Exhibit 10.14 | Executive  Employment, Non-competition and Non-disclosure Agreement *                                                                                                 |
|               |                                                                                                                                                                  |
| Exhibit 10.15 | Senior Officer  Executive Retention Agreement *                                                                                                                       |
|               |                                                                                                                                                                  |
| Exhibit 10.16 | Amended and  Restated Employment Agreement between Candela Corporation and Gerard E.  Puorro *                                                                        |
|               |                                                                                                                                                                  |
| Exhibit 10.17 | Executive  Retention Agreement with 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 |

 

----

| * | In its Report on  Form 8-K dated November 26, 2007, the Company described the terms  of four agreements being entered into between the Company and certain senior  executive officers named therein. The form of contracts appended as Exhibits  10.14, 10.15, 10.16, and 10.17 contain the text of the agreements described  in such 8-K, and such exhibits should be read in conjunction with such 8-K. |
|---|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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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.

 

 
|   | CANDELA  CORPORATION                                                |
|--------|---------------------------------------------------------------------|
|   |                                                                |
|   |                                                                |
| Date:  | February 7,  2008                                              |   | /s/ Robert E.  Quinn |   |
|   | Robert E. Quinn                                                     |
|   | (Treasurer,  Corporate Controller and  Principal Financial Officer) |
|        |                                                                     |  |  |  |

 

26

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**Candela Corporation**

 

**INDEX TO EXHIBITS**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                       |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                  |
| Exhibit 3(ii)   |       | Amended and  Restated By-Laws                                                                                                                                         |
|                 |       |                                                                                                                                                                  |
| Exhibit 10.14   |       | Executive  Employment, Non-competition and Non-disclosure Agreement *                                                                                                 |
|                 |       |                                                                                                                                                                  |
| Exhibit 10.15   |       | Senior Officer  Executive Retention Agreement *                                                                                                                       |
|                 |       |                                                                                                                                                                  |
| Exhibit 10.16   |       | Amended and  Restated Employment Agreement between Candela Corporation and Gerard E.  Puorro *                                                                        |
|                 |       |                                                                                                                                                                  |
| Exhibit 10.17   |       | Executive  Retention Agreement with 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 |

 

----

| * |   | In its Report on  Form 8-K dated November 26, 2007, the Company described the terms  of four agreements being entered into between the Company and certain senior  executive officers named therein. The form of contracts appended as Exhibits  10.14, 10.15, 10.16, and 10.17 contain the text of the agreements described  in such 8-K, and such exhibits should be read in conjunction with such 8-K. |
|---|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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