** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

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**FORM 10-Q**

**Quarterly report pursuant to Section 13 or15(d) of the Securities Exchange Act of 1934**

**Forthe quarterly period ended September 30, 2006.**

**Commissionfile number 000-14742**

**CANDELA CORPORATION**

(Exact name of registrantas 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’s telephonenumber, including area code:  (508)358-7400

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

Yes x      No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer  (as defined inRule12b-2 of the Exchange Act)

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

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule12b-2 of the Exchange Act) 

Yes x   No x

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.

| Class                                   | ** ** | **Outstanding at October 30, 2006** |
|-----------------------------------------|------------|-------------------------------------|
| Common Stock,  $.01 par value per share |       | 23,063,104                          |

 

 

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**CANDELACORPORATIONIndex**
|                                 | ** ** | ** **                                                                                                                                      | ** ** | **Page** | ** ** |
|---------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Part  I. Financial Information: |       |                                                                                                                                            |       |
| Item  1.                        |       | Financial  Statements Consolidated Balance Sheets as of September 30, 2006 (unaudited)  and July 1, 2006                                        |       | 3        |       |
|                            |       | Unaudited Consolidated Statements of Income and  Comprehensive Income for the three-month periods ended September 30, 2006 and  October 1, 2005 |       | 4        |       |
|                            |       | Unaudited Consolidated Statements of Cash Flows for  the three-month periods ended September 30, 2006 and October 1, 2005                       |       | 5        |       |
|                            |       | Notes to Unaudited Consolidated Financial Statements                                                                                            |       | 6-13     |       |
| Item 2.                         |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                     |       | 14-18    |       |
| Item 3.                         |       | Quantitative and Qualitative Disclosure about Market  Risk                                                                                      |       | 19       |       |
| Item  4.                        |       | Controls  and Procedures                                                                                                                        |       | 19       |       |
| Part  II. Other Information:    |       |                                                                                                                                            |       |
| Item  1.                        |       | Legal  proceedings                                                                                                                              |       | 20       |       |
| Item 6.                         |       | Exhibits                                                                                                                                        |       | 20       |       |
| Signatures                      |       | 21                                                                                                                                              |       |
| Index to Exhibits               |       | 22                                                                                                                                              |       |

 

2

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**Part I.****   FinancialInformation**

**Item 1—FinancialStatements**

**CANDELA CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

(in thousands, except per share data)
| ** **                                                                                                                             | ** ** | **September 30,  2006 ** | ** ** | **July 1,  2006 ** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                             | ** ** | **(unaudited)**                    | ** ** | ** **                   | ** ** |
| **Assets**                                                                                                                             | ** ** | ** **                         | ** ** | ** **                   | ** ** |
| Current assets:                                                                                                                        |       |                               |       |                         |       |
| Cash and cash equivalents                                                                                                              |       | $                                  | 28,647     |                         | $          | 40,194 |   |
| Restricted cash                                                                                                                        |       | 167                                |       | 166                          |       |
| Marketable  securities                                                                                                                 |       | 24,643                             |       | 27,332                       |       |
| Accounts  receivable, (net of allowance for doubtful accounts of $1,213 at September 30  and $1,831 at July 1)                         |       | 31,758                             |       | 34,273                       |       |
| Notes receivable                                                                                                                       |       | 803                                |       | 1,611                        |       |
| Inventories, net                                                                                                                       |       | 16,742                             |       | 16,666                       |       |
| Other current  assets                                                                                                                  |       | 3,387                              |       | 1,756                        |       |
| Total current  assets                                                                                                                  |       | 106,147                            |       | 121,998                      |       |
| Property and equipment,  net                                                                                                           |       | 3,215                              |       | 3,302                        |       |
| Deferred tax assets                                                                                                                    |       | 8,122                              |       | 8,142                        |       |
| Intangible assets-net                                                                                                                  |       | 4,606                              |       | 3,402                        |       |
| Marketable securities (long-term  portion)                                                                                             |       | 14,519                             |       | 11,953                       |       |
| Other assets                                                                                                                           |       | 380                                |       | 379                          |       |
| Total assets                                                                                                                           |       | $                                  | 136,989    |                         | $          | 149,176 |   |
|                                                                                                                                   |       |                               |       |                         |       |
| **Liabilities  and Stockholders’ Equity**                                                                                         |       |                               |       |                         |       |
| Current liabilities:                                                                                                                   |       |                               |       |                         |       |
| Accounts payable                                                                                                                       |       | $                                  | 7,944      |                         | $          | 15,968 |   |
| Accrued payroll  and related expenses                                                                                                  |       | 3,538                              |       | 5,728                        |       |
| Accrued warranty  costs (current portion)                                                                                              |       | 5,828                              |       | 5,868                        |       |
| Income taxes  payable                                                                                                                  |       | 2,319                              |       | 933                          |       |
| Sales tax  payable                                                                                                                     |       | 561                                |       | 854                          |       |
| Royalties  payable                                                                                                                     |       | 675                                |       | 764                          |       |
| Other accrued  liabilities                                                                                                             |       | 4,145                              |       | 3,672                        |       |
| Deferred revenue  (current portion)                                                                                                    |       | 8,140                              |       | 8,342                        |       |
| Current  liabilities of discontinued operations                                                                                        |       | 1,287                              |       | 1,287                        |       |
| Total current  liabilities                                                                                                             |       | 34,437                             |       | 43,416                       |       |
| Accrued warranty costs  (long-term portion)                                                                                            |       | 3,664                              |       | 3,761                        |       |
| Deferred revenue  (long-term portion)                                                                                                  |       | 1,964                              |       | 1,987                        |       |
| Total  liabilities                                                                                                                     |       | 40,065                             |       | 49,164                       |       |
|                                                                                                                                   |       |                               |       |                         |       |
| Stockholders’ equity:                                                                                                             |       |                               |       |                         |       |
| Common stock,  $.01 par value, 30,000,00 shares authorized; 25,921,000 and 25,914,000 issued  at September 30 and July 1, respectively |       | 259                                |       | 259                          |       |
| Treasury stock,  3,020,000 and 2,250,000 common shares at September 30 and July 1,  respectively, at cost                              |       | (21,265                            | )          | (12,997                      | )          |
| Additional  paid-in capital                                                                                                            |       | 65,122                             |       | 64,234                       |       |
| Accumulated  earnings                                                                                                                  |       | 52,699                             |       | 48,280                       |       |
| Accumulated  other comprehensive income                                                                                                |       | 109                                |       | 236                          |       |
| Total  stockholders’ equity                                                                                                       |       | 96,924                             |       | 100,012                      |       |
| Total liabilities and stockholders’ equity                                                                                        |       | $                                  | 136,989    |                         | $          | 149,176 |   |

 

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

3

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* *

**CANDELA CORPORATION**

**CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVEINCOME**

(in thousands, except per share data)

(unaudited)
| ** **                                          | ** ** | **For the three months ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                          | ** ** | **September 30,**                             | ** ** | **October 1,** | ** ** |
| ** **                                          | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| **Revenue**                                         | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Lasers and other  products                          |       | $                                                  | 25,889     |   | $ | 22,225 |   |
| Product-related  service                            |       | 7,585                                              |       | 5,862 |   |
| Total revenue                                       |       | 33,474                                             |       | 28,087 |   |
| **Cost of sales**                                   |       |                                               |       |   |   |
| Lasers and other  products                          |       | 10,614                                             |       | 9,485 |   |
| Product-related  service                            |       | 5,434                                              |       | 4,050 |   |
| Total cost of  sales                                |       | 16,048                                             |       | 13,535 |   |
| **Gross profit**                                    |       | 17,426                                             |       | 14,552 |   |
| **Operating expenses:**                             |       |                                               |       |   |   |
| Selling, general  and administrative                |       | 11,080                                             |       | 8,717 |   |
| Research and  development                           |       | 3,600                                              |       | 1,642 |   |
| Total operating  expenses                           |       | 14,680                                             |       | 10,359 |   |
| **Income from operations**                          |       | 2,746                                              |       | 4,193 |   |
| **Other income:**                                   |       |                                               |       |   |   |
| Interest income                                     |       | 763                                                |       | 248 |   |
| Other income,  net                                  |       | 3,506                                              |       | 62 |   |
| Total other  income                                 |       | 4,269                                              |       | 310 |   |
| **Income before income taxes**                      |       | 7,015                                              |       | 4,503 |   |
| **Provision for income taxes**                      |       | 2,596                                              |       | 1,486 |   |
| **Net income**                                      |       | $                                                  | 4,419      |   | $ | 3,017 |   |
|                                                |       |                                               |       |   |   |
| **Net income per share of common  stock:**          |       |                                               |       |   |   |
| Basic                                               |       | $                                                  | 0.19       |   | $ | 0.13 |   |
| Diluted                                             |       | $                                                  | 0.18       |   | $ | 0.13 |   |
| ** **                                          |       |                                               |       |   |   |
| **Weighted average shares  outstanding:**           |       |                                               |       |   |   |
| Basic                                               |       | 23,530                                             |       | 22,515 |   |
| Diluted                                             |       | 24,044                                             |       | 23,229 |   |
| ** **                                          |       |                                               |       |   |   |
| **Net income**                                      |       | $                                                  | 4,419      |   | $ | 3,017 |   |
| **Other comprehensive income  (loss), net of tax:** |       |                                               |       |   |   |
| Unrealized gains  on available-for-sell securities  |       | 76                                                 |       | — |   |
| Foreign currency  translation adjustment            |       | (203                                               | )          | (16 | ) |
| **Comprehensive income**                            |       | $                                                  | 4,292      |   | $ | 3,001 |   |

 

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

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**CANDELA CORPORATION**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

(inthousands)

(unaudited)
| ** **                                                                              | ** **   | **For the three months ended** | ** ** |
|-----------------------------------------------------------------------------------------|--------------|----------------------------------------------------|------------|
| ** **                                                                              | ** **   | **September 30,**                             | ** ** | **October 1** | ** ** |
| ** **                                                                              | ** **   | **2006**                                           | ** ** | **2005** | ** ** |
| **Cash flows from operating  activities:**                                              | ** **   | ** **                                         | ** ** | ** ** | ** ** |
| Net income                                                                              |         | $                                                  | 4,419      |   | $ | 3,017 |   |
| Adjustments to  reconcile net income to net cash used by operating activities:          |         |                                               |       |   |   |
| (Gain) on  exchange of stock acquisition                                                |         | (3,540                                             | )          | — |   |
| Share-based  compensation expense                                                       |         | 855                                                |       | 96 |   |
| Depreciation and  amortization                                                          |         | 276                                                |       | 129 |   |
| Provision  (benefit) for bad debts                                                      |         | 300                                                |       | (216 | ) |
| Effect of  exchange rate changes on foreign currency denominated assets and liabilities |         | (1                                                 | )          | 14 |   |
| Increase  (decrease) in cash from working capital:                                      |         |                                               |       |   |   |
| Accounts  receivable                                                                    |         | 2,113                                              |       | 6,278 |   |
| Notes receivable                                                                        |         | 773                                                |       | (289 | ) |
| Inventories                                                                             |         | (157                                               | )          | (1,233 | ) |
| Other current  assets                                                                   |         | (1,640                                             | )          | (264 | ) |
| Other assets                                                                            |         | 116                                                |       | (2,997 | ) |
| Accounts payable                                                                        |         | (7,954                                             | )          | (3,901 | ) |
| Accrued payroll  and related expenses                                                   |         | (2,180                                             | )          | (1,511 | ) |
| Deferred revenue                                                                        |         | (146                                               | )          | (411 | ) |
| Accrued warranty  costs                                                                 |         | (159                                               | )          | (31 | ) |
| Income taxes  payable                                                                   |         | 1,148                                              |       | (473 | ) |
| Other accrued  liabilities                                                              |         | 366                                                |       | (640 | ) |
| Change in  restricted cash                                                              |         | 1                                                  |       | 20 |   |
| Net cash used by  operating activities                                                  |         | (5,409                                             | )          | (2,412 | ) |
| ** **                                                                              |         |                                               |       |   |   |
| **Cash flows from investing  activities:**                                              |         |                                               |       |   |   |
| Purchases of  property and equipment                                                    |         | (133                                               | )          | (80 | ) |
| Maturities of  held-to-maturity marketable securities                                   |         | 7,125                                              |       | — |   |
| Cash proceeds  from exchange of Solx Inc. shares                                        |         | 994                                                |       | — |   |
| Purchases of  held-to-maturity marketable securities                                    |         | (4,381                                             | )          | — |   |
| Acquisition of  intangible assets                                                       |         | (1,380                                             | )          | — |   |
| Net cash provided  (used) for investing activities                                      |         | 2,225                                              |       | (80 | ) |
|                                                                                    |         |                                               |       |   |   |
| **Cash flows from financing  activities:**                                              |         |                                               |       |   |   |
| Proceeds from  the issuance of common stock                                             |         | 33                                                 |       | 15 |   |
| Purchase of  treasury stock                                                             |         | (8,268                                             | )          | — |   |
| Net cash provided  (used) by financing activities                                       |         | (8,235                                             | )          | 15 |   |
|                                                                                    |         |                                               |       |   |   |
| Effect of exchange  rates on cash and cash equivalents                                  |         | (128                                               | )          | 73 |   |
|                                                                                    |         |                                               |       |   |   |
| **Net increase (decrease) in cash  and cash equivalents**                               |         | (11,547                                            | )          | (2,404 | ) |
| **Cash and cash equivalents at  beginning of period**                                   |         | 40,194                                             |       | 56,383 |   |
| **Cash and cash equivalents at  end of period**                                         |         | $                                                  | 28,647     |   | $ | 53,979 |   |
| **Cash paid during the period  for:**                                                   |         |                                               |       |   |   |
| ** **                                                                              |         |                                               |       |   |   |
| Interest                                                                                |         | $                                                  | —     |   | $ | — |   |
| Income taxes                                                                            |         | 886                                                |       | 1,981 |   |
|                                                                                    |         |                                               |       |   |   |
| **Noncash  investing**                                                             | *** *** | *** ***                                       |       |   |   |
| Unrealized gain on  available-for-sale investments                                      | ** **   | $                                                  | 76         |   | $ | — |   |
| Stock acquired from  exchange of Solx                                                   |         | 2,546                                              |       | — |   |

 

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

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**Candela Corporation****Notes to ConsolidatedFinancial Statements (unaudited)**

(amounts are in thousands except per share data)

**1.****                   Basis ofPresentation**

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States for interimfinancial information and with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates for complete financial statements. In the opinion of management, alladjustments (consisting only of adjustments of a normal recurring nature)considered necessary for a fair presentation have been included. Preparingfinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenues and expenses.Actual results may differ from these estimates. The results for the interimperiods are not necessarily indicative of results to be expected for the entireyear. The information contained in the interim financial statements should beread in conjunction with the Company’s audited financial statements as of andfor the year ended July 1, 2006 included in its Form 10-K filed with theSecurities and Exchange Commission (“SEC”).

**RecentAccounting Pronouncements**:

In June 2006,Financial Accounting Standards Board (‘FASB”) issued FASB InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes—an interpretation ofFASB Statement No. 109” (“FIN 48”). FIN 48 requires companies to determinewhether it is more likely than not that a tax position will be sustained uponexamination by the appropriate taxing authorities before any part of the benefitcan be recorded in the financial statements. This interpretation also providesguidance on derecognition, classification, accounting in interim periods, andexpanded disclosure requirements. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. The Company is currently in the processof assessing the impact that FIN 48 will have on its consolidated financialstatements.

**2.    Discontinued Operations**

On September 27, 2003management initiated a plan to close its only remaining skin care center. Theclosure was accounted for as a discontinued operation in accordance withStatement of Financial Accounting Standards (“SFAS”) 144 “*Accountingfor the Impairment or Disposal of Long-Lived Assets*” and SFAS 146 “*Accounting for Costs Associated with Exit or Disposal Activities*”.At September 30, 2006,the discontinued segment had a liability of $1,287 consisting of a reserve forrestructuring charges of $447 and deferred gift certificate revenue of $840.

# **3.    Comprehensive Income**

The Companycomputes comprehensive income in accordance SFAS No.130. SFAS 130 “ReportingComprehensive Income” establishes standards for the reporting and display ofcomprehensive income and its components in the financial statements. Othercomprehensive income (loss), as defined, includes all changes in equity fromnon-owner sources such asunrealized gains and losses on available-for-sale securities, unrealized gainsand losses on foreign currency hedges and foreign currency translation.

# **4.****                 Stock-basedCompensation**

Effective July 3,2005, the Company implemented the fair value recognition provisions of SFAS No.123 revised (“SFAS No. 123R”) and Staff Accounting Bulletin 107 (“SAB 107”) forall share-based compensation that was not vested as of July 2, 2005. TheCompany adopted SFAS No. 123R using a modified prospective application, aspermitted under SFAS No. 123R. Accordingly, prior period amounts have not beenrestated. Under this application, the Company is required to recordcompensation 

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expense for allawards granted after the date of adoption and for the unvested portion ofpreviously granted awards that remain outstanding at the date of adoption. Compensationcost will be recognized over the period that an employee provides service inexchange for the award.

The application of SFAS No. 123R and SAB 107 duringthe three—month period ended September 30, 2006 resulted in the recognition ofshare-based compensation expense of $839 attributable to stock options/stockappreciation rights (“SARs”) and $16 attributable to the employee stockpurchase plan.  Share-based compensationfor the three-month period ended October 1, 2005 of $96 was attributable to theemployee stock option plan. These expenses were divided between operatingexpense cost centers based upon the functional responsibilities of theindividuals holding the respective options.

The fair value ofeach option/SARs award is estimated on the date of grant using theBlack-Scholes-Merton option-pricing model incorporating the assumptions notedin the following table for the three-month periods ended September 30, 2006 andOctober 1, 2005. Expected volatility is determined using both current andhistorical implied volatilities of the underlying stock which is obtained frompublic data sources. The expected term of the options is based on historicalobservations adjusted for the estimated exercise dates of unexercisedoptions/SARs. Additionally, separate groups of employees that have similarhistorical exercise behavior are considered separately for valuation purposes. Theaverage risk-free interest rate is based on the U.S. treasury security ratewith a term to maturity that approximates the option’s expected life as of thegrant date. The forfeiture rate is based on historical experience as well asfuture expectations. Forfeitures are required to be estimated at the time ofgrant and revised, if necessary, in subsequent periods if actual forfeituresdiffer from those estimates.

|                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Risk-free  interest rate                     |       | 4.5      | %          | 4.25     | %          |
| Estimated  volatility                        |       | 73       | %          | 79       | %          |
| Expected life  for stock options (yrs)       |       | 3.56     |       | 3.02     |       |
| Expected life  for stock purchase plan (yrs) |       | 0.50     |       | 0.50     |       |
| Expected dividends                           |       | —   |       | —   |       |

 

As of September30, 2006, there was approximately $3,441 of total unrecognized compensationcost related to non-vested stock options/SARs granted under the Company’sincentive plans. This cost is expected to be recognized over a weighted-averageperiod of 1.32 years. As of October 1, 2005, there was approximately $346of total unrecognized compensation cost related to nonvested stock optionsgranted under the Company’s incentive plans.

The amount of cash received from the exercise of stockoptions for the three-month periods ended September 30, 2006 and October 1,2005, was $33 and $15.

**Stock Plans**

**Candela Corporation 1990 Employee Stock Purchase Plan,as amended**

The 1990 Employee Stock Purchase Plan, as amended (the “Purchase Plan”)provides for the sale of up to 1,500,000 shares of common stock to eligibleemployees. The shares are issued at 85% of the market price on the last day ofsemi-annual periods. Substantially all full-time employees are eligible toparticipate in the Purchase Plan. At September 30, 2006 there were 695,226shares available for sale.

**Candela Corporation Second Amended and Restated 1998 Stock Plan**

Effective October 5, 2005, the Second Amended and Restated 1998 StockPlan (the “1998 Stock Plan”) was amended to clarify the granting of incentivestock options, non-qualified stock options, and stock appreciation rights(“SARs”).

Stock options provide the holder with the right to purchase commonstock. The exercise price per share of “incentive stock options” within themeaning of Section 422 of the Internal Revenue Code of 1986, as amended,granted under the 1998 Stock Plan may not be less than the fair market valueper share of 

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common stock on the date of grant. In the case of an incentive stockoption granted to an employee possessing more than 10% of the total combinedvoting power of all classes of stock of the Company, the exercise price pershare may not be less than 110% of the fair market value per share of commonstock on the date of grant.

SARs provide the holder the right to receive an amount, payable instock, cash or in any combination of these, as specified by a Committeeestablished by the Board of Directors, equal to the excess of the market valueof our common shares on the date of exercise over the grant price at the timeof the grant. The grant price of a SAR may not be less than the fair marketvalue per share of common stock on the date of grant, provided that the grantprice of SARs granted in tandem with stock options shall equal the exerciseprice of the related stock option.

Options and rightsgranted under the 1998 Stock Plan become exercisable on the date of grant or ininstallments, as specified by a Committee established by the Board ofDirectors, and expire ten years from the date of the grant. The maximum numberof shares for which options and rights may be granted under the 1998 Stock Planis 5,300,000. Upon exercise of a SAR, only the net number of shares of commonstock issued in connection with such exercise shall be deemed “issued” for thispurpose. The Company may satisfy the awards upon exercise with eithernewly-issued or treasury shares.

The following is asummary of stock option activity under the Plans:
| ** **                                             | ** ** | ** **         | ** ** | **Weighted**            | ** ** | **Aggregate** | ** ** | **Weighted Avg.** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|-------------------------|------------|---------------|------------|------------------------|------------|
| ** **                                             | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** | **Intrinsic** | ** ** | **Contractual**        | ** ** |
| ** **                                             | ** ** | **Shares**         | ** ** | **per Share**      | ** ** | **Value**     | ** ** | **Term**               | ** ** |
| Balance  outstanding at July 1, 2006                   |       | 1,964,988          |       | $                       | 10.23      |          | $          | 11,250,600             |       | 7.79 |   |
|                                                   |       |               |       |                    |       |          |       |                   |       |
| Granted                                                |       | 150,445            |       | $                       | 15.39      |          |       |                   |       |   |
| Exercised                                              |       | (6,349             | )          | $                       | 5.17       |          |       |                   |       |   |
| Forfeited/cancelled                                    |       | (741               | )          | $                       | 12.22      |          |       |                   |       |   |
| Balance  outstanding at September 30, 2006             |       | 2,108,343          |       | $                       | 10.61      |          | $          | 4,376,389              |       | 7.71 |   |
|                                                   |       |               |       |                    |       |          |       |                   |       |
| Options/SARS  exercisable at September 30, 2006        |       | 1,258,126          |       | $                       | 8.41       |          | $          | 3,591,139              |       | 6.85 |   |
| Options/SARS available  to grant at September 30, 2006 |       | 403,689            |       |                    |       |          |       |                   |       |

 

There were 150,445stock based SARs granted during the three-month period ended September 30,2006. The SARs granted to employees become exercisable ratably over one to fouryears, while the SARs granted to directors become exercisable over two years. Thetotal intrinsic value of options exercised during the three-month period endedSeptember 30, 2006 was $87.

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

Basic earnings pershare is computed by dividing net income by the weighted average number ofshares of common stock outstanding for the period and, if there are dilutivesecurities, diluted earnings per share is computed by including common stock equivalentsoutstanding for the period in the denominator.

Common stockequivalents include shares issuable upon the exercise of stock options,warrants and SARs, net of shares assumed to have been repurchased with theproceeds, using the treasury stock method.

 

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The followingtable provides share information used in the calculation of the Company’s basicand diluted earnings per share:
| **(in thousands, except per share data)** | ** ** | **For the three months ended:** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                         | ** ** | **September 30,**                              | ** ** | **October 1,** | ** ** |
| ** **                                                         | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Shares used in  the calculation of basic earnings per share        |       | 23,530                                              |       | 22,515 | ** ** |
|                                                               |       |                                                |       |   | ** ** |
| Effect of  dilutive securities:                                    | * *   | * *                                            | * *   | * * | *** *** |
| Stock  options/SARs                                                |       | 514                                                 |       | 714 | ** ** |
|                                                               |       |                                                |       |   | ** ** |
| Shares used in  the calculation of diluted earnings per share      |       | 24,044                                              |       | 23,229 | ** ** |
|                                                               |       |                                                |       |   | ** ** |
| Per share effect of dilutive  securities on net income             |       | $                                                   | 0.01       |   | $ | 0.00 | ** ** |
|                                                                    |            |                                                     |            |  |  |  |  |

 

During thethree-month periods ended September 30, 2006, and October 1, 2005, options/SARsto purchase 1,113 and 1,109 shares of common stock, respectively, were excludedfrom the calculation of diluted earnings per share as their effect would havebeen antidilutive.

**6.     Marketable Securities**

The Companyaccounts for marketable securities in accordance with SFAS 115, “Accounting forCertain Investments 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 fair values. Allmarketable securities must be classified as one of the following:held-to-maturity, available-for-sale, or trading. The Company classifies itsmarketable debt securities as held-to-maturity as the Company has the intentand ability to hold them to maturity. The Company has classified its equityinvestments as available-for-sale securities. Accordingly, such investments arereported at fair market value, with the resultant unrealized gains and lossesreported as a separate component of shareholders’ equity. Held-to-maturity debtsecurities are reported at amortized cost which approximates fair value. Currentmarketable securities include debt investments with original maturities thatare expected to mature in more than three months and up to twelve months andequity investments.  Long-term marketablesecurities include debt securities that have remaining maturities of one tothree years and equity investments. Unrealized losses related to theheld-to-maturity securities are not considered a permanent decline in themarket value of such securities.

9

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Marketablesecurities consist of the following:
|                         | ** ** | **Carrying** | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** |
|-------------------------|------------|--------------|------------|-----------|------------|----------------|------------|
| **(in thousands)** | ** ** | **value**    | ** ** | **value** | ** ** | **losses**     | ** ** |
| Short-term:             |       |         |       |      |       |           |       |
| Held-to-maturity:       |       |         |       |      |       |           |       |
| Corporate bonds         |       | $            | 2,007      |      | $          | 1,999          |       | ($8 | ) |
| Government securities   |       | 17,999       |       | 17,984    |       | (15            | )          |
| Certificates of deposit |       | 2,022        |       | 2,013     |       | (9             | )          |
|                    |       | $            | 22,028     |      | $          | 21,996         |       | (32 | ) |
| Available-for-sale      |       |         |       |      |       |           |       |
| Equity investments      |       | $            | 2,621      |      | $          | 2,621          |       | — |   |

 
| Total marketable securities-short-term |   | $      | 24,649 |   | $      | 24,617 |   | (32  | ) |
|----------------------------------------|--------|--------|--------|--------|--------|--------|--------|------|---|
|                                   |   |   |   |   |   |   |   |
| Long-term:                             |   |   |   |   |   |   |   |
| Held-to-maturity:                      |   |   |   |   |   |   |   |
| Government securities                  |   | $      | 10,995 |   | $      | 10,984 |   | ($11 | ) |
| Certificates of deposit                |   | 3,524  |   | 3,498  |   | (26    | )      |
| Total marketable securities-long term  |   | $      | 14,519 |   | $      | 14,482 |   | (37  | ) |
| Total unrealized  loss                 |   |   |   |   |   | ($69   | )      |

 

**7.     Inventories**

Inventoriesconsist of the following:

|                         | ** **   | **September 30,** | ** **   | **July 1,** | ** **   |
|-------------------------|--------------|------------------------|--------------|------------------|--------------|
| **(in thousands)** | ** **   | **2006**               | ** **   | **2006**         | ** **   |
| *** ***            | *** *** | *** ***           | *** *** | *** ***     | *** *** |
| **Raw  materials**      | ** **   | **$**                  | **6,217**    | ** **       | **$**        | **5,936** | ** ** |
| **Work in  process**    | ** **   | **1,014**              | ** **   | **1,151**        | ** **   |
| **Finished  goods**     | ** **   | **9,511**              | ** **   | **9,579**        | ** **   |
| ** **              | ** **   | **$**                  | **16,742**   | ** **       | **$**        | **16,666** | ** ** |

 

**8.    Property and Equipment**

Propertyand equipment consist of the following:

|                                              | ** ** | **September 30,  2006** | ** ** | **July 1,  2006** | ** ** |
|----------------------------------------------|------------|------------------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **(in thousands)**      | ** ** |
| **Leasehold  improvements**                  | ** ** | **$**                        | **928**    | ** **             | **$**      | **920** | ** ** |
| **Office  furniture**                        | ** ** | **680**                      | ** ** | **603**                | ** ** |
| **Computers,  software and other equipment** | ** ** | **9,282**                    | ** ** | **9,236**              | ** ** |
| ** **                                   | ** ** | **10,890**                   | ** ** | **10,759**             | ** ** |
| **Less  accumulated depreciation**           | ** ** | **7,675**                    | ** ** | **7,457**              | ** ** |
| **Property and equipment, net**              | ** ** | **$**                        | **3,215**  | ** **             | **$**      | **3,302** | ** ** |

 

Depreciationexpense was $219 and $129 for the three-months ended September 30, 2006 andOctober 1, 2005, respectively

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**9.     Intangible assets**

Intangible assets comprise of a prepaid license feeand a patent acquired August 1, 2006, as follows (in thousands):
| ** **      | ** ** | **As of September 30, 2006** | ** ** |
|-----------------|------------|--------------------------------------------------|------------|
| ** **      | ** ** | **Gross  Carrying  Amount**                      | ** ** | **Accumulated  Amortization  Amount** | ** ** | **Net Carrying  Amount** | ** ** |
| Patent          |       | $                                                | 1,379      |   | $ | 57 |   | $ | 1,322 |   |
| Prepaid license |       | 3,878                                            |       | 594 |   | 3,284 |   |
| Total           |       | $                                                | 5,257      |   | $ | 651 |   | $ | 4,606 |   |

 

**10.*  *DerivativeInstruments and Hedging Activity**

The Company enters into financial instruments toreduce its exposure to fluctuations in foreign exchange rates by creatingoffsetting positions through the use of foreign currency forward contracts. TheCompany recognizes all derivative instruments as either assets or liabilitiesin the statements of financial position and measures those instruments at fairvalue. Changes to the fair value of derivative contracts that do not qualifyfor hedge accounting are reported in earnings in the period of the change. Forderivatives that qualify for hedge accounting, changes in the fair value of thederivatives are either recorded in shareholders’ equity as a component of othercomprehensive income and are recognized currently in earnings, along with anoffsetting adjustment against the basis of the item being hedged. Unrealizedgains and losses on derivatives serving as hedged contracts have been recordedin other comprehensive income and did not amount to significant gains or losses.

The Company had four foreign currency forwardcontracts outstanding at September 30, 2006, serving to mitigate the foreigncurrency risk of a substantial portion of Euro and Yen denominated intercompanybalances, in the notional amount of approximately 2,000 Euros and 106,000Yen. The contracts serve as a hedge of a substantial portion of the Euro andYen denominated intercompany balances. The fair value of the foreign currencyderivative contract outstanding at September 30, 2006 was approximately $3,500,resulting in an unrealized loss of $20. Any gains or losses on the fair valueof the effective portion of the derivative contract would be largely offset bythe losses and gains on the underlying transactions.

**11.   Warranty Reserve**

The Company’s products generally carry a standardwarranty. The Company maintains a reserve based on anticipated warranty claimsat the time product revenue is recognized. Factors that affect the Company’sproduct warranty liability include the number of installed units, theanticipated cost of warranty repairs and historical and anticipated rates ofwarranty claims.

The following table reflects changes in the Company’saccrued warranty account during the three-month periods ended September 30,2006:

| (in thousands)                             | ** ** | **2006**  | ** ** |
|-------------------------------------------------|------------|-----------|------------|
| **Beginning  balance**                          | ** ** | **$**     | **9,630**  | ** ** |
| **Plus  accruals related to new sales**         | ** ** | **1,828** | ** ** |
| **Less  amortization of prior period accruals** | ** ** | **1,966** | ** ** |
| **Ending balance**                              | ** ** | **$**     | **9,492**  | ** ** |

 

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** **

**12.   Deferred Revenue**

The Company also offers extended service contractsthat may be purchased for periods from one to five years. The Companyrecognizes service contract revenue ratably over the life of the contract.Actual service contract expenses incurred and charged to service costs of salesduring an interim period may be more or less than the amount of amortizedservice contract revenue recognized in that period.

The following table reflects changes in the Company’sdeferred revenue account during the three-month period ended September 30,2006:

| (in thousands)                          | ** ** | **2006** | ** ** |
|----------------------------------------------|------------|----------|------------|
| Beginning  balance                           |       | $        | 10,329     |   |
| Plus deferral of  new service contract sales |       | 2,316    |       |
| Less recognition  of deferred revenue        |       | 2,541    |       |
| Ending balance                               |       | $        | 10,104     |   |

 

**13.  Common Stock Buyback**

On October 31,2005, the Company’s Board of Directors authorized the purchase by the Companyof up to 10% of the Company’s outstanding shares of its common stock during atwo-year period which expires on October 31, 2007. For the three-month periodended September 30, 2006, 770 shares were purchased for $8,268.

**14.    Segment Information**

The Company operates principally in one industry segment: the design,manufacture, sale, and service of medical devices and related equipment. Theresults in this segment have been presented in the Consolidated Statements ofIncome for the appropriate periods. The Company had no single customer thatrepresents a significant portion of revenue or accounts receivable during theperiods presented.

**15.    Commitments and Contingencies**

TheCompany has an agreement with The Regents of the University of California (the”Regents”)for exclusive license rights to the DCD (subject to certain limited licenserights of Cool Touch, Inc. (“Cool Touch”)) in the following fields of use: proceduresthat involve skin resurfacing and rejuvenation, vascular skin lesions, andlaser hair removal. Cool Touch, a subsidiary of New Star Technology, Inc.,obtained a license to the DCD on a co-exclusive basis with the Company, incertain narrower fields of use

TheCompany’s agreement with the Regents called for an annual license fee of $0.3million and a royalty obligation of 3%. The annual fee of $0.3 million was paidto the Regents in a lump sum of $3.0 million and is being amortized over theremaining life of the patent agreement, which as of September 30, 2006 was lessthan 9 years. The royalty rate and the amortization of the annual license feepayment are reflected in the Company’s financial statements as of September 30,2006. The unamortized portion of the license fee payment is reflected inintangible assets on the September 30, 2006 balance sheet. The royalty fee forSeptember 30, 2006 and October 1, 2006 was $784 and $660, respectively.

**16.   Legal Proceedings**

On August 9, 2006, PalomarMedical Technologies, Inc. (“Palomar”) filed suit against the Company in theUnited States District Court for the District of Massachusetts, assertinginfringement by the Company of U.S. Patent No. 5,735,844. On August10, 2006, the Company filed suit against Palomar in the United States DistrictCourt for the District of Massachusetts, asserting infringement byPalomar of U.S. Patent Nos. 6,659,999, 5,312,395, and 6,743,222. Palomarserved its complaint and summons on the Company on August 15, 2006. 

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The Company served itscomplaint and summons on Palomar on August 10, 2006. On October 25,2006, the Company filed a First Amended Complaint, which amended the Company’ssuit against Palomar by removing from the suit Patent 6,659,999. The Companybelieves that it has meritorious defenses against Palomar’s allegationsin its complaint. Both parties seek to recover compensatory andtreble damages, as well as attorneys’ fees and an injunction againstthe other party. While the Company intends to vigorously contest Palomar’s allegations,and to pursue its own claims against Palomar,each lawsuit is inherently uncertain and unpredictable asto its ultimate outcome. An adverse outcome in Palomar’s suitagainst the Company could materially hurt the business, financialcondition, results of operations and cash flows.

Fromtime to time, the Company is party to various legal proceedings incidental toits business. The Company believes that none of the legal proceedings, otherthan Palomar, that are presently pending, if adversely decided against us, willhave a material adverse effect upon its financial position, results ofoperations, or liquidity.

**17.   Other Income**

The Company recognized a$3,540 gain on the exchange of common stock of Solx Inc. for cash and commonstock of Occulogix Inc. The gain was a result of the merger of Solx Inc., aprivately-held company and Occulogix Inc., a publicly traded company. TheCompany held 19.99% of the outstanding common stock of Solx Inc. on anas-converted basis, prior to the merger. As a result of the merger, the Companyreceived $994 in cash and 1,260,308 shares of common stock in Occulogix Inc., acompany publicly traded on the Nasdaq Global Market.

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

**Overview**

We research, develop, manufacture, market, sell andservice lasers and light-based products used to perform aesthetic and cosmeticprocedures.  We sell our lasers andlight-based products principally to medical practitioners.  We market our products directly and through anetwork of distributors to end users. Our traditional customer base includes plastic and cosmetic surgeons anddermatologists.  More recently, we haveexpanded our sales to a broader group of practitioners consisting of generalpractitioners and certain specialists including obstetricians, gynecologists,and general and vascular surgeons.  Wederive our revenue from the sale of lasers, light-based devices, otherproducts, and product-related services.

**CriticalAccounting Policies and Estimates**

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

**Recent AccountingPronouncements**

In June 2006, FASB issued FASB InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes—an interpretation ofFASB Statement No. 109” (“FIN 48”). FIN 48 requires companies to determinewhether it is more likely than not that a tax position will be sustained uponexamination by the appropriate taxing authorities before any part of thebenefit can be recorded in the financial statements. This interpretation alsoprovides guidance on derecognition, classification, accounting in interim periods,and expanded disclosure requirements. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. We are currently in the process ofassessing the impact that FIN 48 will have on our consolidated financialstatements.

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**Resultsof Operations**

***Revenue.***

Revenue source bygeographic region is reflected in the following table:
| **(in thousands)** | ** ** | **For the three months ended:** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|
| ** **              | ** ** | **September 30,  2006**                        | ** ** | **October 1,  2005** | ** ** | **Change** | ** ** |
| ** **              | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **U.S.  revenue**       | ** ** | **$**                                               | **15,845** | ** ** |   | **47** | **%** |   | **$** | **10,268** | ** ** |   | **37** | **%** |   | **$** | **5,577** | ** ** |   | **54** | **%** |   |
| **Foreign  revenue**    | ** ** | **17,629**                                          | ** ** |   | **53** | **%** |   | **17,819** | ** ** |   | **63** | **%** |   | **(190** | **)** |   | **(1)** | **%** |   |
| ** **              | ** ** | ** **                                          | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| **Total  revenue**      | ** ** | **$**                                               | **33,474** | ** ** |   | **100** | **%** |   | **$** | **28,087** | ** ** |   | **100** | **%** |   | **$** | **5,387** | ** ** |   | **19** | **%** |   |

 

Consolidated Overview:

Consolidated revenue increased $5.4 million, to $33.5 million for thethree-months ended September 30, 2006 compared to $28.1 million for thethree-months ended October 1, 2005.  Theincrease was due primarily to the increase in demand for our products andrelated service in the US and Europe, coupled with the success of the newVbeam® models.

Foreign revenue accounted for approximately 53% of the consolidatedtotal for the three-months ended September 30, 2006. Foreign Revenue was $17.6million for the three-months ended September 30, 2006 compared to $17.8 millionfor the three-months ended October 1, 2005. For the three-months ended September 30, 2006 there was a $1.6 millionincrease in Europe, against a $1.4 million decrease in Latin America and a $0.5million decrease in Asia compared to three-months ended October 1, 2005.  The increase in Europe was primarily due tothe continued strong growth in the region across all product lines.  The decrease in Latin America was primarilydue to exceptionally high revenue for the demographics of the region for thethree-month ended period October 1, 2005. We feel revenue for the current quarter is more representative for theregion’s demographics.

U.S. revenue increased 54% to $15.8 million for the three-month periodended September 30, 2006, as compared to the three-month period ended October1, 2005.  Revenue was strong through allregions in the U.S.  A primary cause ofthe increase in the U.S was our agreement with McKesson starting late in ourfirst fiscal quarter of 2006 and continued success of the new Vbeam® modelsintroduced during our third quarter of 2006.

Revenue source bytype is reflected in the following table:
| **(in thousands)**        | ** ** | **For the three months ended:** | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|
| ** **                     | ** ** | **September 30,  2006**                        | ** ** | **October 1,  2005** | ** ** | **Change** | ** ** |
| **Revenue**                    | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers  and other products** | ** ** | **$**                                               | **25,889** | ** ** |   | **77** | **%** |   | **$** | **22,225** | ** ** |   | **79** | **%** |   | **$** | **3,664** | ** ** |   | **16** | **%** |   |
| **Product-related  service**   | ** ** | **7,585**                                           | ** ** |   | **23** | **%** |   | **5,862** | ** ** |   | **21** | **%** |   | **1,723** | ** ** |   | **29** | **%** |   |
| ** **                     | ** ** | ** **                                          | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| **Total revenue**              | ** ** | **$**                                               | **33,474** | ** ** |   | **100** | **%** |   | **$** | **28,087** | ** ** |   | **100** | **%** |   | **$** | **5,387** | ** ** |   | **19** | **%** |   |

 

The increase inrevenue from lasers and other products for the three-month period endedSeptember 30, 2006, compared to the three-month period ended October 1, 2005 resulted primarilyfrom an increase in the sales volume of our recently introduced Vbeam® models.

The increase inrevenue from product-related service for the three-month period ended September30, 2006 compared to the three-month period ended October 1, 2005 resulted primarilyfrom an increase in the number

15

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of service relatedcontracts sold in addition to an increase in the number of consumables andaccessories sold to support our installed base.

***Costof Sales.***Cost of sales increased 19% to $16 million forthe three-month period ended September 30, 2006 as compared to cost of sales of$13.5 million for the three-monthperiod ended October 1, 2005.** As a percentage of revenue, cost of sales was48% for the three-month period ended September 30, 2006 and October 1, 2005.

***Gross Profit.***Gross profit was approximately $17.4 millionor 52% of revenues for the three-month periods ended September 30, 2006 andOctober 1, 2005 respectively.

***Selling,General and Administrative Expense.***Selling, general andadministrative expenses increased 27%, to approximately $11.1 million for thethree-month period ended September 30, 2006 from approximately $8.7 million forthe three-month period ended October 1, 2005. As a percentage of revenue, selling, general and administrative expensesincreased to 33% from 31% of revenues for the same respective periods. Thisincrease was due primarily to an increase of share-based compensation, legalexpenses associated with the Palomar litigation, and an increase in salesrelated expenses including commissions due to higher revenue and travelexpenses.

***Researchand Development Expense.***Research and developmentspending increased to $3.6 million for the three-month period ended September30, 2006 from $1.6 million for the three-month period ended October 1, 2005 dueprimarily to an increase in spending associated with the new workstations thatwe expect to release in 2007.

***OtherIncome/Expense.***Other income increased to $4.3 millionfor the three-month period ended September 30, 2006 from $0.3 million for thethree-months ended October 1, 2005 due primarily to an increase in interestincome as a result of an increase in cash and cash equivalents and a recognizeda $3.5 million gain on the exchange of common stock of Solx Inc. for cash andcommon stock of Occulogix Inc.  The gainwas a result of the merger of Solx Inc, a privately-held company and OcculogixInc., a publicly traded company.  We held19.99% of the outstanding common stock of Solx Inc. on an as-converted basis,prior to the merger.  As a result of themerger, we received $1 million cash and 1,260,308 shares of common stock inOcculogix Inc., a company publicly traded on the Nasdaq Global Market.

***IncomeTaxes.*** The provision for income taxes results from acombination of activities of both the domestic operations and foreignsubsidiaries of the Company.  We recordeda 37% effective tax rate for the three-month period ended September 30, 2006compared to a 33% effective rate for the three-month period ended October 1,2005.  The increase in the rate is wasdue to the phase out of the extraterritorial income exclusion deduction infiscal year 2007 and a release of the valuation allowances for foreignjurisdictions in the same quarter in the previous year.

**Liquidityand Capital Resources**

Our cash and cash equivalents, and marketable securities at September30, 2006 totaled $67.8 million compared with $79.5 million at July 1, 2006. Wecontinue to have no long-term debt.   Webelieve that the combination of existing cash and cash equivalent, andmarketable 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 not requireadditional capital beyond the amounts currently forecasted by us, or that anysuch required additional capital will be available on reasonable terms, if atall, as it becomes required.

Cash used in operating activities amounted to $5.4 million for thethree-month period ended September 30, 2006 as compared to $2.4 million for thefiscal quarter ending October 1, 2005. The increase in cash used by operatingactivities is due to the payment of prior year liabilities offset by anincrease in net income.

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Cash provided by investing activities amounted to $2.2 million for thethree-month period ended September 30, 2006. This reflects the activity of our investments and cash proceeds from theexchange of Solx Inc. common stock shares offset by a purchase of intangibleassets during the quarter.

Cash used by financing activities amounted to $8.2 million for thethree-month period ended September 30, 2006.   This primarilyreflects the purchasing of treasury stock during the period.

**Off-BalanceSheet Arrangements**

Our only off-balance sheet arrangements consist of non-cancelableoperating leases entered into in the ordinary course of business and thelicense agreement with the Regents. The table below in the next section titled “ContractualObligations” shows the amounts of our operating lease commitments and purchasecommitments payable by year.

**Contractualobligations**

Outstanding contractual obligations of the Company are reflected in thefollowing table:
| **(in thousands)**             | ** ** | ** ** | ** ** | **Less than** | ** ** | ** **         | ** ** | ** **         | ** ** | **After**        | ** ** |
|-------------------------------------|------------|------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|------------------|------------|
| ** **                          | ** ** | **Total**  | ** ** | **1 year**    | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **5 years** | ** ** |
|                                |       |       |       |               |       |               |       |               |       |             |       |
| Royalty  commitments                |       | $          | 5,250      |               | $          | 1,000              |       | $                  | 2,000      |             | $          | 1,250 |   | $ | 1,000 |   |
| Operating leases                    |       | $          | 2,468      |               | $          | 1,215              |       | $                  | 1,149      |             | $          | 104 |   | $ | — |   |
| Total contractual cash  obligations |       | $          | 7,718      |               | $          | 2,215              |       | $                  | 3,149      |             | $          | 1,354 |   | $ | 1,000 |   |

 

**DebtInstruments and Related Covenants**

We maintain a renewable $10,000,000 revolving credit agreement with amajor bank with interest at the bank’s base rate or LIBOR plus 2.25%.  Any borrowings outstanding under the line ofcredit are due on demand or according to a payment schedule established at thetime funds are borrowed.  The line ofcredit is unsecured.  The agreementcontains restrictive covenants limiting the establishment of new liens, and thepurchase of margin stock.  No amountswere outstanding under the line of credit as of September 30, 2006 or October1, 2005.

**CautionaryStatements**

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 assume no obligation to update or reviseany forward-looking statements whether as a result of new information, futureevents 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 July 1, 2006, as well asother risks and uncertainties referenced in this Quarterly Report.  These risks and uncertainties include, butare not limited to, the following:

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·                                          OnAugust 9, 2006, one of our competitors, Palomar Medical Technologies, Inc. (“Palomar”),alleged that the manufacture, use and sale of our products for laser hairremoval infringe a certain United States patent. Public announcementsconcerning this litigation that are unfavorable to us may result in significantdeclines in our stock price. An adverse ruling or judgment in this matter couldcause our stock price to decline significantly. Litigation with Palomar may be expensive and protracted, and ourintellectual property position may be weakened as a result of an adverse rulingor judgment. Whether or not we are successful in the pending lawsuits,litigation may consume substantial amounts of our financial resources anddivert management’s attention away from our core business.  Please see Part II, Item 1 (LegalProceedings) for a further discussion of the Palomar litigation.

·                                          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.

·                                          Becausewe typically derive more than half of our revenue from international sales, weare susceptible to currency fluctuations, negative economic changes takingplace in foreign marketplaces, and other risks associated with conductingbusiness overseas.  Please see Part I,Item 3 (Quantitative and Qualitative Disclosures about Market Risk) for afurther discussion of risks associated with conducting business overseas.

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

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

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

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

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

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

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

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

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

We caution readersnot to place undue reliance upon any forward-looking statements, which speakonly as of the date made.  We expresslydisclaim any obligation or undertaking to release publicly any updates orrevisions to any such statements to reflect any change in our expectations orany change in events, conditions or circumstances on which any such statementis based.

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

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

We have international subsidiaries that transact business in both localand foreign currencies and therefore we are exposed to foreign currencyexchange risk resulting from fluctuations in foreign currencies.  This risk could adversely impact our resultsand financial condition.  From time totime, we may enter into foreign currency exchange contracts to reduce ourexposure to foreign currency exchange risk and variability in operating resultsdue to fluctuation in exchange rates underlying the value of currenttransactions and anticipated transactions denominated in foreigncurrencies.  These contracts obligate usto exchange predetermined amounts of specified foreign currencies at specifiedexchange rates on specified dates.  Thesecontracts are denominated in the same currency in which the underlyingtransactions are denominated and bear a contract value and maturity date thatapproximate the value and expected settlement date, respectively, of theunderlying transactions. Unrealized gains and losses on open contracts at theend of each period, resulting from changes in the fair value of thesecontracts, are recognized in other comprehensive income in the same period asexchange gains and losses on the underlying foreign denominated receivables. Wedo not engage in foreign currency speculation.

We had four forward exchange contracts outstanding serving as a hedgeof our Euro and Yen denominated intercompany receivables at September 30,2006.  These contracts serve as hedges ofa substantial portion of our Euro and Yen denominated intercompany balances.Any gains and losses on the fair value of the derivative contract would belargely offset by losses and gains on the underlying transaction.

**Item 4 -Controls and Procedures**

***Evaluation of Disclosure Controls and Procedures***

Our Chief Executive Officer and Chief Financial Officer (our principalexecutive officer and principal financial officer, respectively) have evaluatedthe effectiveness of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended)as of September 30, 2006, the end of the period covered by this quarterlyreport on Form 10-Q. Based on this evaluation, our principal executive officerand principal financial officer have concluded that, as of the end of theperiod covered by this report, the Company’s disclosure controls and procedureswere effective in gathering, analyzing and disclosing information needed tosatisfy our disclosure obligations under the Securities Exchange Act of 1934,as amended.

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

There have been no changesin the Company’s internal controls over financial reporting that occurredduring the quarter ended September 30, 2006 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

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**CANDELA CORPORATION**

**Part II.  Other Information**

**Item 1. Legal Proceedings.**

On August 9, 2006, Palomar Medical Technologies, Inc. (“Palomar”) filedsuit against Candela in the United States District Court for the District ofMassachusetts, asserting infringement by Candela of U.S. Patent No.5,735,844.  On August 10, 2006, we filedsuit against Palomar in the United States District Court for the District ofMassachusetts, asserting infringement by Palomar of U.S. Patent Nos.6,659,999, 5,312,395, and 6,743,222. Palomar served its complaint and summons on Candela on August 15,2006.  Candela served its complaint andsummons on Palomar on August 10, 2006.  On October 25, 2006, the Company filed aFirst Amended Complaint, which amended the Company’s suit against Palomar byremoving from the suit Patent 6,659,999. Candela believes that it has meritorious defenses against Palomar’sallegations in its complaint. Both parties seek to recover compensatory and treble damages, as well asattorneys’ fees and an injunction against the other party.  While Candela intends to vigorouslycontest Palomar’s allegations, and to pursue its ownclaims against Palomar, each lawsuit is inherently uncertain andunpredictable as to its ultimate outcome.  An adverseoutcome in Palomar’s suit against us could materially hurt ourbusiness, financial condition, results of operation and cash flows.

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

**Item 1A. Risk Factors**

There have been no materialchanges from the Risk Factors previously disclosed in the Company’s AnnualReport on form 10-K for the fiscal year ended July 1, 2006.

**Item 6.   Exhibits**

(a)                                  Exhibits
| Exhibit 31.1 |   | Rule 13a-14(a)/15d-14(a) Certification of the Chief  Executive Officer                                                                                  |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                    |
| Exhibit 31.2 |   | Rule 13a-14(a)/15d-14(a) Certification of the Chief  Financial Officer                                                                                  |
|         |   |                                                                                                                                                    |
| Exhibit 32.1 |   | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|         |   |                                                                                                                                                    |
| Exhibit 32.2 |   | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

Pursuant to 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: November 1, 2006 |   | /s/ F. Paul Broyer                                |
|                   |   | F. Paul Broyer                                    |
|                   |   | Senior Vice President, Finance and Administration |
|                   |   | and Chief Financial Officer                       |

 

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**Candela Corporation**

**INDEX TOEXHIBITS**
| **Exhibit No.** | ** ** | **Description**                                                                                                                                         |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                    |
| Exhibit 31.1    |       | Rule 13a-14(a)/15d-14(a) Certification of the Chief  Executive Officer                                                                                  |
|            |       |                                                                                                                                                    |
| Exhibit 31.2    |       | Rule 13a-14(a)/15d-14(a) Certification of the Chief  Financial Officer                                                                                  |
|            |       |                                                                                                                                                    |
| Exhibit 32.1    |       | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|            |       |                                                                                                                                                    |
| Exhibit 32.2    |       | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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