**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

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**FORM 10-Q**

 

**Quarterly report pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

 

**For thequarterly period ended April 1, 2006.**

 

**Commissionfile number 000-14742**

 

**CANDELA CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                                 | ** ** | **04-2477008**                        |
|------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction                                                |       | (I.R.S. Employer  Identification No.) |
| of incorporation  or organization)                                           |       |                                  |
|                                                                         |       |                                  |
| **530  Boston Post Road, Wayland, Massachusetts**                            | ** ** | **01778**                             |
| (Address of  principal executive offices)                                    |       | (Zip code)                            |
|                                                                         |       |                                  |
| Registrant’s  telephone number, including area code: **(508) 358-7400** |

 

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

 

Yes  ý     No  o

 

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

 

Yes  ý     No  o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule12b-2 ofthe Exchange Act)

Yes  ý   No  o

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule12b-2 of theExchange Act)

Yes  o   No  ý

 

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

 
| **Class**                               | ** ** | **Outstanding at May 8, 2006** |
|-----------------------------------------|------------|--------------------------------|
| Common Stock, $.01 par  value per share |       | 23,770,178                     |

 

 

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**CANDELACORPORATION**

**Index**

 
| Part I.  | Financial Information: |                                                                                                                                                                                                                       |
|----------|------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |                   |                                                                                                                                                                                                                       |
|     | Item 1.                | Financial Statements                                                                                                                                                                                                       |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     |                   | Consolidated Balance Sheets as of  April 1, 2006 (unaudited) and July 2, 2005                                                                                                                                              |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     |                   | Unaudited Consolidated  Statements of Operations and Comprehensive Income (Loss) for the three-month  periods ended April 1, 2006 and April 2, 2005, and for the nine-month periods  ended April 1, 2006 and April 2, 2005 |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     |                   | Unaudited Consolidated  Statements of Cash Flows for the nine-month periods ended April 1, 2006 and  April 2, 2005                                                                                                         |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     |                   | Notes to Unaudited  Consolidated Financial Statements                                                                                                                                                                      |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     | Item 2.                | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                                                                                                                |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     | Item 3.                | Quantitative and Qualitative  Disclosures about Market Risk                                                                                                                                                                |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     | Item 4.                | Controls and Procedures                                                                                                                                                                                                    |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     |                   |                                                                                                                                                                                                                       |   |
| Part II. | Other Information:     |                                                                                                                                                                                                                       |
|     |                   |                                                                                                                                                                                                                       |   |
|     | Item 1.                | Legal proceedings                                                                                                                                                                                                          |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     | Item 6.                | Exhibits                                                                                                                                                                                                                   |   |
|     |                   |                                                                                                                                                                                                                       |   |
|     | Signatures             |                                                                                                                                                                                                                       |
|     |                   |                                                                                                                                                                                                                       |
|     | Index to Exhibits      |                                                                                                                                                                                                                       |

 

2

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**Part I. Financial Information**

 

**Item 1 - Financial Statements**

 

**CANDELA CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                        | ** ** | **April 1,** | ** ** | **July 2,** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|------------------|------------|
| **(in thousands)**                           | ** ** | **2006**          | ** ** | **2005**         | ** ** |
| ** **                                        | ** ** | **(unaudited)**   | ** ** | ** **       | ** ** |
| **Assets**                                        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Current assets:                                   |       |              |       |             |       |
| Cash and cash  equivalents                        |       | $                 | 35,196     |             | $          | 56,383 |   |
| Restricted cash                                   |       | 167               |       | 199              |       |
| Marketable  securities                            |       | 25,467            |       | —           |       |
| Accounts  receivable, net                         |       | 35,411            |       | 34,866           |       |
| Notes receivable                                  |       | 1,088             |       | 805              |       |
| Inventories, net                                  |       | 15,257            |       | 12,676           |       |
| Other current  assets                             |       | 3,635             |       | 1,821            |       |
| Total current  assets                             |       | 116,221           |       | 106,750          |       |
| Property and  equipment, net                      |       | 3,123             |       | 3,240            |       |
| Deferred tax  assets                              |       | 6,426             |       | 5,743            |       |
| Prepaid licenses                                  |       | 3,521             |       | 878              |       |
| Long-term  investments                            |       | 9,121             |       | —           |       |
| Other assets                                      |       | 347               |       | 205              |       |
| Total assets                                      |       | $                 | 138,759    |             | $          | 116,816 |   |
|                                              |       |              |       |             |       |
| **Liabilities and Stockholders’ Equity**     |       |              |       |             |       |
| Current liabilities:                              |       |              |       |             |       |
| Accounts payable                                  |       | $                 | 13,631     |             | $          | 11,674 |   |
| Accrued payroll  and related expenses             |       | 4,271             |       | 4,830            |       |
| Accrued warranty  costs                           |       | 5,779             |       | 5,291            |       |
| Income taxes  payable                             |       | 1,595             |       | 2,073            |       |
| Sales tax  payable                                |       | 829               |       | 2,206            |       |
| Royalties  payable                                |       | —            |       | 1,661            |       |
| Other accrued  liabilities                        |       | 4,176             |       | 1,298            |       |
| Deferred revenue  (current portion)               |       | 7,044             |       | 6,037            |       |
| Current  liabilities of discontinued operations   |       | 1,301             |       | 1,302            |       |
| Total current  liabilities                        |       | 38,626            |       | 36,372           |       |
| Accrued warranty  costs (long-term portion)       |       | 3,577             |       | 3,355            |       |
| Deferred revenue  (long-term portion)             |       | 1,621             |       | 2,313            |       |
| Long-term  liabilities of discontinued operations |       | 107               |       | 437              |       |
| Total  liabilities                                |       | 43,931            |       | 42,477           |       |
|                                              |       |              |       |             |       |
| Stockholders’  equity:                       |       |              |       |             |       |
| Common stock                                      |       | 258               |       | 248              |       |
| Treasury stock,  at cost                          |       | (12,997           | )          | (12,997          | )          |
| Additional  paid-in capital                       |       | 61,982            |       | 54,027           |       |
| Accumulated  earnings                             |       | 45,877            |       | 33,346           |       |
| Accumulated  other comprehensive income (loss)    |       | (292              | )          | (285             | )          |
| Total  stockholders’ equity                  |       | 94,828            |       | 74,339           |       |
| Total  liabilities and stockholders’ equity  |       | $                 | 138,759    |             | $          | 116,816 |   |

 

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

 

3

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**CANDELA CORPORATION**

**Consolidated Statements of Operations and ComprehensiveIncome (Loss)**

(inthousands, except per share data)

(unaudited)

 
| ** **                                                                                                                    | ** ** | **For the three-months ended:** | ** ** | **For the nine-months ended:** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **April 1,**                              | ** ** | **April 2,**                             | ** ** | **April 1,** | ** ** | **April 2,** | ** ** |
| ** **                                                                                                                    | ** ** | **2006**                                       | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Revenue**                                                                                                                   | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other  products                                                                                                    |       | $                                              | 34,795     |                                          | $          | 28,483 |   | $ | 88,677 |   | $ | 70,365 |   |
| Product-related  service                                                                                                      |       | 7,519                                          |       | 6,199                                         |       | 19,444 |   | 14,912 |   |
| Total revenue                                                                                                                 |       | 42,314                                         |       | 34,682                                        |       | 108,121 |   | 85,277 |   |
| **Cost of  sales**                                                                                                            |       |                                           |       |                                          |       |   |   |   |   |
| Lasers and other  products                                                                                                    |       | 15,688                                         |       | 13,005                                        |       | 39,235 |   | 30,391 |   |
| Product-related  service                                                                                                      |       | 5,228                                          |       | 4,947                                         |       | 13,960 |   | 12,139 |   |
| Litigation  related charges                                                                                                   |       | —                                         |       | 4,829                                         |       | — |   | 4,829 |   |
| Total cost of  sales                                                                                                          |       | 20,916                                         |       | 22,781                                        |       | 53,195 |   | 47,359 |   |
| **Gross  profit**                                                                                                             |       | 21,398                                         |       | 11,901                                        |       | 54,926 |   | 37,918 |   |
| **Operating  expenses:**                                                                                                      |       |                                           |       |                                          |       |   |   |   |   |
| Selling, general  and administrative                                                                                          |       | 11,602                                         |       | 11,281                                        |       | 30,858 |   | 27,938 |   |
| Research and  development                                                                                                     |       | 2,432                                          |       | 1,910                                         |       | 5,873 |   | 4,866 |   |
| Litigation  related charges                                                                                                   |       | —                                         |       | 773                                           |       | — |   | 773 |   |
| Total operating  expenses                                                                                                     |       | 14,034                                         |       | 13,964                                        |       | 36,731 |   | 33,577 |   |
| **Income  (loss) from operations**                                                                                            |       | 7,364                                          |       | (2,063                                        | )          | 18,195 |   | 4,341 |   |
| **Other  income (expense):**                                                                                                  |       |                                           |       |                                          |       |   |   |   |   |
| Interest income                                                                                                               |       | 546                                            |       | 162                                           |       | 1,057 |   | 399 |   |
| Other income  (expense), net                                                                                                  |       | (15                                            | )          | (93                                           | )          | (18 | ) | 25 |   |
| Total other  income                                                                                                           |       | 531                                            |       | 69                                            |       | 1,039 |   | 424 |   |
| **Income  (loss) from continuing operations before income taxes**                                                             |       | 7,895                                          |       | (1,994                                        | )          | 19,234 |   | 4,765 |   |
| **Benefit  from (Provision for) income taxes**                                                                                |       | (2,892                                         | )          | 638                                           |       | (6,703 | ) | (1,525 | ) |
| **Income  (loss) from continuing operations**                                                                                 |       | 5,003                                          |       | (1,356                                        | )          | 12,531 |   | 3,240 |   |
| **Discontinued  operations:**                                                                                                 |       |                                           |       |                                          |       |   |   |   |   |
| Gain on closure  of skin care center including reduction of leasehold obligations of $1,374  less income tax expense of $515. |       | —                                         |       | —                                        |       | — |   | 859 |   |
| **Net  income (loss)**                                                                                                        |       | $                                              | 5,003      |                                          | $          | (1,356 | ) | $ | 12,531 |   | $ | 4,099 |   |
|                                                                                                                          |       |                                           |       |                                          |       |   |   |   |   |
| **Net  income (loss) per share of common stock**                                                                              |       |                                           |       |                                          |       |   |   |   |   |
| **Basic:**                                                                                                                    |       |                                           |       |                                          |       |   |   |   |   |
| Income (loss)  from continuing operations                                                                                     |       | $                                              | 0.22       |                                          | $          | (0.06 | ) | $ | 0.55 |   | $ | 0.14 |   |
| Gain from  discontinued operations                                                                                            |       | —                                         |       | —                                        |       | — |   | 0.04 |   |
| Net income  (loss)                                                                                                            |       | $                                              | 0.22       |                                          | $          | (0.06 | ) | $ | 0.55 |   | $ | 0.18 |   |
| **Diluted:**                                                                                                                  |       |                                           |       |                                          |       |   |   |   |   |
| Income (loss)  from continuing operations                                                                                     |       | $                                              | 0.21       |                                          | $          | (0.06 | ) | $ | 0.53 |   | $ | 0.14 |   |
| Gain from  discontinued operations                                                                                            |       | —                                         |       | —                                        |       | — |   | 0.04 |   |
| Net income  (loss)                                                                                                            |       | $                                              | 0.21       |                                          | $          | (0.06 | ) | $ | 0.53 |   | $ | 0.18 |   |
|                                                                                                                          |       |                                           |       |                                          |       |   |   |   |   |
| **Weighted  average shares outstanding:**                                                                                     |       |                                           |       |                                          |       |   |   |   |   |
| Basic                                                                                                                         |       | 23,255                                         |       | 22,408                                        |       | 22,817 |   | 22,366 |   |
| Diluted                                                                                                                       |       | 24,204                                         |       | 22,408                                        |       | 23,762 |   | 23,062 |   |
|                                                                                                                          |       |                                           |       |                                          |       |   |   |   |   |
| **Other  comprehensive income (loss):**                                                                                       |       |                                           |       |                                          |       |   |   |   |   |
| Net income  (loss)                                                                                                            |       | $                                              | 5,003      |                                          | $          | (1,356 | ) | $ | 12,531 |   | $ | 4,099 |   |
| Foreign currency  translation adjustment                                                                                      |       | $                                              | 367        |                                          | $          | (898 | ) | $ | (7 | ) | $ | 125 |   |
| Total other  comprehensive income (loss)                                                                                      |       | $                                              | 5,370      |                                          | $          | (2,254 | ) | $ | 12,524 |   | $ | 4,224 |   |

 

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

 

4

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**CANDELACORPORATION**

**Consolidated Statements of Cash Flows**

(in thousands)

(unaudited)

 
| ** **                                                                              | ** ** | **For the nine-months ended:** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                              | ** ** | **April 1,**                             | ** ** | **April 2,** | ** ** |
| ** **                                                                              | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| **Cash  flows from operating activities:**                                              | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net income                                                                              |       | $                                             | 12,531     |   | $ | 4,099 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:      |       |                                          |       |   |   |
| Revision of  disposal of discontinued operations                                        |       | —                                        |       | (1,374 | ) |
| Share-based  compensation expense                                                       |       | 642                                           |       | — |   |
| Depreciation and  amortization                                                          |       | 354                                           |       | 556 |   |
| Provision for bad  debts                                                                |       | 700                                           |       | 908 |   |
| Effect of  exchange rate changes on foreign currency denominated assets and liabilities |       | 3                                             |       | (35 | ) |
| Increase  (decrease) in cash from operating assets and liabilites:                      |       |                                          |       |   |   |
| Accounts  receivable                                                                    |       | (1,561                                        | )          | (632 | ) |
| Notes receivable                                                                        |       | (348                                          | )          | (571 | ) |
| Inventories                                                                             |       | (2,473                                        | )          | 976 |   |
| Other current  assets                                                                   |       | (1,922                                        | )          | 1,072 |   |
| Other assets                                                                            |       | (2,777                                        | )          | 373 |   |
| Accounts payable                                                                        |       | 1,542                                         |       | 2,268 |   |
| Accrued payroll  and related expenses                                                   |       | (551                                          | )          | (1,540 | ) |
| Deferred revenue                                                                        |       | 1,062                                         |       | 2,744 |   |
| Accrued warranty  costs                                                                 |       | 7                                             |       | 98 |   |
| Income taxes  payable                                                                   |       | (1,011                                        | )          | 229 |   |
| Other accrued  liabilities                                                              |       | (170                                          | )          | 710 |   |
| Change in  restricted cash                                                              |       | 32                                            |       | 32 |   |
| Net cash  provided by operating activities                                              |       | 6,060                                         |       | 9,913 |   |
|                                                                                    |       |                                          |       |   |   |
| **Cash  flows from investing activities:**                                              |       |                                          |       |   |   |
| Purchases of  property and equipment                                                    |       | (323                                          | )          | (553 | ) |
| Purchases of  investments                                                               |       | (34,588                                       | )          | — |   |
| Net cash used  for investing activities                                                 |       | (34,911                                       | )          | (553 | ) |
|                                                                                    |       |                                          |       |   |   |
| **Cash  flows from financing activities:**                                              |       |                                          |       |   |   |
| Proceeds from  the issuance of common stock                                             |       | 7,321                                         |       | 501 |   |
| Net cash  provided by financing activities                                              |       | 7,321                                         |       | 501 |   |
|                                                                                    |       |                                          |       |   |   |
| Effect of  exchange rates on cash and cash equivalents                                  |       | 343                                           |       | 302 |   |
|                                                                                    |       |                                          |       |   |   |
| **Net  increase (decrease) in cash and cash equivalents**                               |       | (21,187                                       | )          | 10,163 |   |
| **Cash  and cash equivalents at beginning of period**                                   |       | 56,383                                        |       | 37,139 |   |
| **Cash  and cash equivalents at end of period**                                         |       | $                                             | 35,196     |   | $ | 47,302 |   |

 

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

 

5

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

 

The accompanyingunaudited consolidated financial statements and notes do not include all of thedisclosures made in the Annual Report on Form 10-K of Candela Corporation (the “Company”,or “Candela”) for fiscal year 2005, which should be read in conjunction withthese financial statements. The financial information included herein isunaudited, with the exception of the consolidated balance sheet as of July 2,2005, which was derived from the audited consolidated balance sheet dated July 2,2005. However, in the opinion of management, the financial statements includeall necessary adjustments, consisting of normal recurring accruals, for a fairpresentation of the quarterly results and are prepared and presented in amanner consistent with the Company’s Annual Report on Form 10-K. The resultsfor the three and nine-month periods ended April 1, 2006 are not necessarilyindicative of the results to be expected for the full year.

 

**Recent Accounting Pronouncements**:

 

In December 2004, the Financial Accounting StandardsBoard (FASB) issued Statement of Financial Accounting Standards No. 123(Revised 2004) (SFAS No. 123R), “Share-Based Payment”. SFAS No. 123R is arevision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”and supersedes Accounting Principles Board (APB) Opinion No. 25, “Accountingfor Stock Issued to Employees” and its related implementation guidance. TheStatement focuses primarily on accounting for transactions in which an entityobtains employee services through share-based payment transactions. The Companyadopted the standard as of July 3, 2005 (see Note 3).

 

In November 2004, the FASB issued SFAS No. 151, “InventoryCosts”. The Statement amends Accounting Research Bulletin No. 43 to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts and spoilage. The Statement also requires that the allocation of fixedproduction overheads to inventory be based on normal production capacity. TheCompany adopted the standard as of July 3, 2005. The adoption did not have animpact on the Company’s consolidated financial statements.

 

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections.” The Statement replaces APB Opinion No. 20, “AccountingChanges” and SFAS No. 3, “Reporting Accounting Changes in Interim FinancialStatements.” SFAS No. 154 requires companies to apply voluntary changes inaccounting principles retrospectively whenever practicable. The requirementsare effective for the Company beginning in fiscal 2007. Adoption of theStatement is not expected to have a significant impact on the Company’sconsolidated financial statements.

 

6

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**2.****                   DiscontinuedOperations**

 

OnSeptember 27, 2003 management initiated a plan to close its only remaining skincare center. The closure is accounted for as a discontinued operation inaccordance with Statement of Financial Accounting Standards (“SFAS”) 144 “*Accounting for the Impairment or Disposal of Long-Lived Assets*”and SFAS 146 “*Accounting for Costs Associated with Exit orDisposal Activities*”. As a result, in the fiscal quarter endedSeptember 27, 2003, the Company recorded a $2,095 charge for the accrual of$3,000 of future occupancy costs, primarily relating to future lease paymentsfor the Boston facility, and $348 of severance obligations and other relatedcosts of closure, net of anticipated tax benefits of $1,253. Approximately 45positions have been eliminated as a result of this restructuring plan.

 

During the three-monthperiod ended October 2, 2004, the landlord for the Boston facility secured asublease for that property. The Company was not able to determine the futureeconomic benefit of the sublease at that time. The sublessee commenced makingpayments to the landlord during December of 2004. As a result of these andfuture payments scheduled under the sublease, the Company revised the estimatedfuture costs associated with the Boston facility and, in the quarter endedJanuary 1, 2005, reversed approximately $859 of the restructuring reserve. Thisreversal represents the aforementioned anticipated economic benefit due tosublessee payments of $1,703, net of legal and other fees of approximately $329and income taxes of approximately $515, and was recognized in the three-monthperiod ended January 1, 2005.

 

The following tablereflects the restructuring charges incurred in the nine-month period ended April1, 2006:

 
| ** **                    | ** ** | **Leasehold**      | ** ** | ** **   | ** ** | ** ** | ** ** |
|-------------------------------|------------|--------------------|------------|--------------|------------|------------|------------|
| ** **                    | ** ** | **Improvements**   | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **and Fixed** | ** ** | **Facility** | ** ** | ** ** | ** ** |
| **(in thousands)**       | ** ** | **Assets**         | ** ** | **Costs**    | ** ** | **Total**  | ** ** |
| **Balance  at July 2, 2005**  | ** ** | **$**              | **97**     | ** **   | **$**      | **898**    | ** ** | **$** | **995** | ** ** |
| **Amortization**              | ** ** | **50**             | ** ** | **331**      | ** ** | **381**    | ** ** |
| **Balance  at April 1, 2006** | ** ** | **$**              | **47**     | ** **   | **$**      | **550**    | ** ** | **$** | **614** | ** ** |

 

AtApril 1, 2006, the discontinued segment had a net liability of approximately $1,408consisting primarily of the above reserve of $614 and deferred gift certificaterevenue of $794. There have been no subsequent revenues.

 

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

 

EffectiveJuly 3, 2005, the Company implemented the fair value recognition provisions ofSFAS No. 123R and Staff Accounting Bulletin 107 (“SAB 107”) for all share-basedcompensation that was not vested as of July 2, 2005. The Company adopted SFASNo. 123R using a modified prospective application, as permitted under SFAS No.123R. Accordingly, prior period amounts have not been restated. Under thisapplication, the Company is required to record compensation expense for allawards granted after the date of adoption and for the unvested portion ofpreviously granted awards that remain outstanding at the date of adoption.

 

Theapplication of SFAS No. 123R and SAB 107 during the nine-month period endedApril 1, 2006 resulted in the recognition of share-based compensation expenseof $601 attributable to stock options/SARS and $41 attributable to the employeestock purchase plan. This expense was divided between operating expense costcenters based upon the functional responsibilities of the individual holdingthe respective options.

 

7

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The fair valueof each option/SARS award is estimated on the date of grant using theBlack-Scholes-Merton option-pricing model incorporating the assumptions notedin the following table. Expected volatility is determined using both currentand historical implied volatilities of the underlying stock which is obtainedfrom public data sources. The expected term of the options is based onhistorical observations adjusted for the estimated exercise dates ofunexercised options/SARS. Additionally, separate groups of employees that havesimilar historical exercise behavior are considered separately for valuationpurposes. The average risk-free interest rate is based on the U.S. treasurysecurity rate with a term to maturity that approximates the option’s expectedlife as of the grant date.

 
| ** **                                       | ** ** | **For the nine-  months ended  April 1, 2006** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------|------------|
| **Risk-free  interest rate**                     | ** ** | **4.50**                                       | **%**      |
| **Estimated  volatility**                        | ** ** | **73**                                         | **%**      |
| **Expected  life for stock options (yrs)**       | ** ** | **3.44**                                       | ** ** |
| **Expected  life for stock purchase plan (yrs)** | ** ** | **0.5**                                        | ** ** |
| **Expected  dividends**                          | ** ** | **—**                                     | ** ** |

 

Priorto July 3, 2005, the Company followed the provisions of SFAS No. 123, “Accountingfor Stock-Based Compensation”. The provisions of SFAS No. 123 allowed companiesto either expense the estimated fair value of stock options or to continue tofollow the intrinsic value method set forth in Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), butdisclose the pro forma effects on net income (loss) had the fair value ofthe options been expensed. The Company elected to apply APB 25 in accountingfor its stock option incentive plans.

 

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

 

Had compensation cost for theCompany’s stock option plans been determined based on the fair value method setforth in SFAS 123 during the prior year, the Company’s net income (loss) andbasic and diluted net income(loss) per common share would have been changed tothe pro forma amounts indicated below:

 

8

----

 
| ** **                                                                                                                                         | ** ** | **For the three-  months ended** | ** ** | **For the nine-  months ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **April 2,**                               | ** ** | **April 2,**                              | ** ** |
| **(in thousands, excepts per share data)**                                                                                | ** ** | **2005**                                        | ** ** | **2005**                                       | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                                      | ** ** | ** **                                     | ** ** |
| **Net  (loss) income , as reported**                                                                                                               | ** ** | **$**                                           | **(1,356** | **)**                                          | **$**      | **4,099** | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                                      | ** ** | ** **                                     | ** ** |
| **Deduct:  total stock-based employee compensation expense, determined under fair value  based method for all awards, net of related tax effects** | ** ** | **(118**                                        | **)**      | **(407**                                       | **)**      |
| ** **                                                                                                                                         | ** ** | ** **                                      | ** ** | ** **                                     | ** ** |
| **Pro  forma net income (loss)**                                                                                                                   | ** ** | **$**                                           | **(1,474** | **)**                                          | **$**      | **3,692** | ** ** |
| **Net  income (loss) per share of common stock**                                                                                                   | ** ** | ** **                                      | ** ** | ** **                                     | ** ** |
| **Basic -  as reported**                                                                                                                           | ** ** | **$**                                           | **(0.06**  | **)**                                          | **$**      | **0.18** | ** ** |
| **Basic -  pro forma**                                                                                                                             | ** ** | **$**                                           | **(0.07**  | **)**                                          | **$**      | **0.17** | ** ** |
| **Diluted  - as reported**                                                                                                                         | ** ** | **$**                                           | **(0.06**  | **)**                                          | **$**      | **0.18** | ** ** |
| **Diluted  - pro forma**                                                                                                                           | ** ** | **$**                                           | **(0.06**  | **)**                                          | **$**      | **0.16** | ** ** |

 

In computing this pro-formaamount, the Company has used the Black-Scholes pricing model using thefollowing assumptions for options granted in fiscal years 2005:

 
| ** **                                       | ** ** | **2005**   | ** ** |
|--------------------------------------------------|------------|------------|------------|
| **Risk-free  interest rate**                     | ** ** | **4.25**   | **%**      |
| **Estimated  volatility**                        | ** ** | **77**     | **%**      |
| **Expected  life for stock options (yrs)**       | ** ** | **2.99**   | ** ** |
| **Expected  life for stock purchase plan (yrs)** | ** ** | **0.5**    | ** ** |
| **Expected  dividends**                          | ** ** | **—** | ** ** |

 

**Stock Plans**

 

### **1990 Candela Corporation Employee StockPurchase Plan**

 

The1990 Employee Stock Purchase Plan (the “Purchase Plan”) provides for the saleof up to 1,500,000 shares of common stock to eligible employees. The shares areissued at 85% of the market price on the last day of semi-annual periods. Substantiallyall full-time employees are eligible to participate in the Purchase Plan. At April1, 2006 there were 707,081 shares available for sale. Compensation expense forthe purchase plan is recognized over the vesting period.

 

9

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**1998 Candela Corporation Stock Option Plan**

 

EffectiveOctober 5, 2005, the 1998 Stock Option Plan (the “Stock Option Plan”) wasamended for granting of incentive stock options, non-qualified stock options,and stock appreciation rights (“SARS”). The stock options provide the holderthe right to purchase common stock at an exercise price not less than the fairmarket value of the stock on the date of grant. SARS provide the holder theright to receive an amount, payable in stock, cash or in any combination ofthese, as specified by a Committee established by the Board of Directors, equalto the excess of the market value of our common shares on the date of exerciseover the base price at the time of the grant. The base price may not be lessthan the market price of our common shares on the date of the grant.

 

Options and rights granted under the 1998 Stock Option Plan become exercisable on the date of grant or in installments, as specified by a Committee established by the Board of Directors, and expire ten years from the date of the grant. The maximum number of shares for which options and rights may be granted under the 1998 Stock Option Plan is 5,300,000. Where payment upon exercise of a SAR is made in shares of the Company’s common stock, only the net number of shares of common stock issued in connection with such exercise shall be deemed “issued” for this purpose. The Company may satisfy the awards upon exercise under both plans with either newly-issued or treasury shares.

 

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

 
| ** **                                             | ** ** | ** **         | ** ** | **Weighted Avg.**  | ** ** | **Aggregate** | ** ** | **Weighted Avg.** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|-------------------------|------------|---------------|------------|------------------------|------------|
| ** **                                             | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** | **Intrinsic** | ** ** | **Contractual**        | ** ** |
| ** **                                             | ** ** | **Shares**         | ** ** | **per Share**      | ** ** | **Value**     | ** ** | **Term**               | ** ** |
|                                                   |       |               |       |                    |       |          |       |                   |       |
| **Balance  outstanding at July 2, 2005**               | ** ** | **2,484,560**      | ** ** | **$**                   | **7.80**   |          |       |                   |       |   |
|                                                   |       |               |       |                    |       |          |       |                   |       |
| **Granted**                                            | ** ** | **520,000**        | ** ** | **$**                   | **15.33**  |          |       |                   |       |   |
| **Exercised**                                          | ** ** | **(970,581**       | **)**      | **$**                   | **6.94**   |          |       |                   |       |   |
| **Forfeited**                                          | ** ** | **(7,568**         | **)**      | **$**                   | **10.30**  |          |       |                   |       |   |
| **Balance  outstanding at April 1, 2006**              | ** ** | **2,026,411**      | ** ** | **$**                   | **9.73**   | ** **    | **$**      | **24,063,225**         | ** ** | **7.96 years** | ** ** |
| ** **                                             | ** ** | ** **         | ** ** | ** **              | ** ** | ** **    | ** ** | ** **             | ** ** |
| **Options/SARS  exercisable at April 1, 2006**         | ** ** | **1,235,161**      | ** ** | **$**                   | **8.35**   | ** **    | **$**      | **16,367,118**         | ** ** | **7.33 years** | ** ** |
|                                                   |       |               |       |                    |       |          |       |                   |       |
| **Options/SARS  available for grant at April 1, 2006** | ** ** | **533,222**        |       |                    |       |          |       |                   |       |

 

There were 520,000 stock based SARS granted during the nine-month period ended April 1, 2006. The SARS granted to employees become exercisable ratably over four years, while the SARS granted to directors become exercisable over two years. The total intrinsic value of options exercised during the nine-month period ended April 1, 2006 was $16 million.

 

Asummary of the non-vested stock options/SARS as of April 1, 2006 and changesduring the fiscal year to date summarized below:

 
| ** **                                   | ** ** | ** **         | ** ** | **Weighted Avg.** | ** ** |
|----------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **Number of** | ** ** | **Grant Date**    | ** ** |
| ** **                                   | ** ** | **Shares**         | ** ** | **Fair Value**    | ** ** |
|                                         |       |               |       |                   |       |
| **Non-vested  options/SARS at July 2, 2005** | ** ** | **332,500**        | ** ** | **$**                  | **3.74**   | ** ** |
| ** **                                   | ** ** | ** **         | ** ** | ** **             | ** ** |
| **Granted**                                  | ** ** | **520,000**        | ** ** | **$**                  | **15.33**  | ** ** |
| **Vested**                                   | ** ** | **(61,250**        | **)**      | **$**                  | **3.35**   | ** ** |
| **Non-vested  balance at April 1, 2006**     | ** ** | **791,250**        | ** ** | **$**                  | **11.96**  | ** ** |

 

10

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Asof April 1, 2006, there was approximately $3,655 of total unrecognizedcompensation cost related to non-vested stock options/SARS granted under theCompany’s incentive plans. This cost is expected to be recognized over aweighted-average period of 1.6 years.

 

Theamount of cash received from the exercise of stock options during the nine-monthperiod ended April 1, 2006, was $7,157 for the stock option and $164 for theemployee stock purchase plan. The actual tax benefit realized for the taxdeductions from option exercise of the share-based payment arrangements totaled$1,373.

 

**4.****                   Earnings PerShare**

 

Basic earnings per shareis computed by dividing net income by the weighted average number of shares ofcommon stock outstanding for the period and, if there are dilutive securities,diluted earnings per share is computed by including common stock equivalentsoutstanding for the period in the denominator.

 

Common stock equivalentsinclude shares issuable upon the exercise of stock options, warrants and SARS,net of shares assumed to have been purchased with the proceeds, using thetreasury stock method.

 
| ** **                                                                                | ** ** | **For the three-months ended:** | ** ** | **For the nine-months ended:** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                | ** ** | **April 1,**                              | ** ** | **April 2,**                             | ** ** | **April 1,** | ** ** | **April 2,** | ** ** |
| **(in thousands, except per share data)**                        | ** ** | **2006**                                       | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic  shares used in the calculation of earnings per share**                           | ** ** | **23,255**                                     | ** ** | **22,408**                                    | ** ** | **22,817** | ** ** | **22,366** | ** ** |
| ** **                                                                                | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Effect  of dilutive securities:**                                                       | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Stock  options/SARS**                                                                   | ** ** | **949**                                        | ** ** | **—**                                    | ** ** | **945** | ** ** | **696** | ** ** |
| ** **                                                                                | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Diluted  shares used in the calculation of earnings per share**                         | ** ** | **24,204**                                     | ** ** | **22,408**                                    | ** ** | **23,762** | ** ** | **23,062** | ** ** |
| ** **                                                                                | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Per  share effect of dilutive securities on income (loss) from continuing  operations** | ** ** | **$**                                          | **.01**    | ** **                                    | **$**      | **.00** | ** ** | **$** | **.02** | ** ** | **$** | **.00** | ** ** |
| ** **                                                                                | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Per  share effect of dilutive securities on net income (loss)**                         | ** ** | **$**                                          | **.01**    | ** **                                    | **$**      | **.00** | ** ** | **$** | **.02** | ** ** | **$** | **.00** | ** ** |

 

During the three- and nine-monthperiod ended April 1, 2006, options/SARS to purchase 220 and 96 shares ofcommon stock, respectively, were excluded from the calculation of dilutedearnings per share as their effect would have been antidilutive.

 

During the three- andnine-month period ended April 2, 2005, options to purchase 1,015 and 360 sharesof common stock, respectively, were excluded from the calculation of dilutedearnings per share as their effect would have been antidilutive.

 

11

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**5.      Cash Equivalent, Marketable Securities andLong-term Investments**

 

Cash equivalents arestated at cost, which approximates market value, and have remaining maturitiesof three months or less at the date of purchase. The Company invests in highquality debt securities. As of April 1, 2006, the Company held marketable debtsecurities of $34,588 of which $25,467 is classified as short-term and $9,121 isclassified as long-term investments. These investments are classified asheld-to-maturity, as the Company has the intent and ability to hold them tomaturity. Held-to-maturity debt securities are reported at amortized cost whichapproximates fair value. Current marketable securities include investments thatare expected to mature in more than three months and up to twelve months. Long-terminvestments have remaining maturities of one to three years. Unrealized gainsand losses related to the marketable securities are not considered a permanentdecline in the market value of such securities. There have been no materialrealized gains or losses as of April 1, 2006.

 

**6.****                   Inventories**

 
| ** **              | ** ** | **April 1,** | ** ** | **July 2,** | ** ** |
|-------------------------|------------|-------------------|------------|------------------|------------|
| **(in thousands)** | ** ** | **2006**          | ** ** | **2005**         | ** ** |
| ** **              | ** ** | ** **        | ** ** | ** **       | ** ** |
| **Raw  materials**      | ** ** | **$**             | **5,232**  | ** **       | **$**      | **3,968** | ** ** |
| **Work in  process**    | ** ** | **721**           | ** ** | **166**          | ** ** |
| **Finished  goods**     | ** ** | **9,304**         | ** ** | **8,542**        | ** ** |
| ** **              | ** ** | **$**             | **15,257** | ** **       | **$**      | **12,676** | ** ** |

 

**7.****                   SegmentInformation**

 

The Company operates inone industry segment: the design, manufacture, sale, and service of medicaldevices and related equipment.

 

**8.****                   Guarantees**

 

The Company’s productsgenerally carry a standard warranty. The Company sets aside a reserve based onanticipated warranty claims at the time product revenue is recognized. Inanticipation of actual warranty claims, the Company amortizes the reserveratably over the life of the warranty thereby offsetting actual warranty claimsincurred. Actual warranty claims incurred and charged to product cost of salesduring an interim period may be more or less than the amount of amortizedwarranty reserve allocated against them. 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 tablereflects changes in the Company’s accrued warranty account during the nine-monthperiod ended April 1, 2006:

 
| **(in thousands)**                         | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|------------|------------|
| **Beginning  balance July 2, 2005**             | ** ** | **$**      | **8,646**  | ** ** |
| **Plus  accruals related to new sales**         | ** ** | **6,071**  | ** ** |
| **Less  amortization of prior period accruals** | ** ** | **5,361**  | ** ** |
| **Ending  balance on April 1, 2006**            | ** ** | **$**      | **9,356**  | ** ** |

 

12

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The Companyalso offers extended service contracts that may be purchased after a standardwarranty has expired. Service contracts may be purchased for periods from oneto five years. The Company recognizes service contract revenue ratably over thelife of the contract. Actual service contract expenses incurred and charged toservice costs of sales during an interim period may be more or less than theamount of amortized service contract revenue recognized in that period.

 

The followingtable reflects changes in the Company’s deferred revenue account during the nine-monthperiod ended April 1, 2006:

 
| **(in thousands)**                          | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| **Beginning  balance July 2, 2005**              | ** ** | **$**      | **8,350**  | ** ** |
| **Plus  deferral of new service contract sales** | ** ** | **7,850**  | ** ** |
| **Less  recognition of deferred revenue**        | ** ** | **7,535**  | ** ** |
| **Ending  balance on April 1, 2006**             | ** ** | **$**      | **8,665**  | ** ** |

 

The Companyhas an agreement (the “Agreement”) with an independent leasing company wherebythe Company will purchase delinquent leases (the “UNL Provision”) relating toCompany products purchased by customers and financed through the leasingcompany. The Company is required to honor the UNL Provision when the leasingcompany’s aggregate losses reach levels specified in the Agreement. The UNLProvision of the Agreement was eliminated for any lease initiated afterDecember 31, 2002. Since the inception of the Agreement, the cumulative amountspaid to the leasing company under the UNL Provision have not been significant.

 

**9.****                  ****Commitments and Contingencies**

 

InAugust 2000, the Company entered into an agreement to amend its licenseagreement with The Regents of the University of California (the “Regents”)whereby in exchange for an exclusivity fee of approximately $1.7 million, whichwas prepaid in full, the Company obtained exclusive license rights to the DCD(subject to certain limited license rights of Cool Touch, Inc. (“Cool Touch”))in the following fields of use: procedures that involve skin resurfacing and rejuvenation, vascular skinlesions, and laser 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,in certain narrower fields of use. Cool Touch is restricted in its ability toassign its license rights to certain existing competitors of the Company. TheCompany is entitled to one-half of all royalty income payable to the Regentsfrom Cool Touch. Under the amended agreement the Company no longer is required by the Regents to negotiatesublicenses to third parties. However, the Company is entitled to one-half ofall royalties due from any other entity that licenses the DCD technology fromthe Regents in other fields of use. The Company recognized royalty expense of$9.2, $2.6, and $3.4 million for fiscal 2005, 2004, and 2003, respectively,based on the license agreement with the Regents. Included in the fiscal 2005expense of $9.2 million is $4.8 million of expense taken in the third quarteras a charge related to the Regents arbitration decision. Of that $4.8 million,$1.3 million related to fiscal 2005, $3.0 million related to fiscal 2004 and $0.5million related to fiscal 2003.

 

EffectiveJuly 3, 2005, the Company amended certain portions of its agreement with theRegents whereby for the annual license fee of $0.3 million, the Company’sroyalty obligation payable to the Regents, was reduced to 3% from its priorlevel of 6%. The annual fee of $0.3 million was paid to the Regents in a lumpsum of $3.0 million and is being amortized over the remaining life of thepatent agreement, which as of July 3, 2005 was 10 years. This reduced royaltyrate and the amortization of the annual license fee payment is reflected in theCompany’s financial statements as of April 1, 2006. The unamortized portion ofthe license fee payment is reflected in prepaid licenses in the April 1, 2006 balancesheet.

 

13

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On March 31, 2006, theCompany settled the previously disclosed dispute the Company had with DVI, Inc,and DVI affiliates for a one-time payment of $150.

 

From time to time, theCompany is a party to various legal proceedings incidental to its business. TheCompany believes that none of the legal proceedings that are presently pending,if adversely decided against the Company, will have a material adverse effectupon its financial position, results of operations, or liquidity.

 

14

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**CANDELACORPORATION**

 

**Item 2 -****Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

**Overview**

 

We research, develop,manufacture, market and service lasers and light sources used to performaesthetic and cosmetic procedures. We sell our lasers to physicians andpersonal care practitioners. We market our products directly and through anetwork of distributors to end-users. Our traditional customer base includesplastic and cosmetic surgeons and dermatologists. More recently we haveexpanded our sales to a broader group of practitioners consisting of generalpractitioners and certain specialists including obstetricians, gynecologistsand general and vascular surgeons. We derive our revenue from the sales oflasers and light sources and other products, and the provision ofproduct-related services.

 

**CriticalAccounting Policies**

 

****Thisdiscussion and analysis of our financial condition and results of operations isbased upon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. Weevaluate our estimates and judgments on an on-going basis, including thoserelated to revenue recognition, bad debts, inventories, warranty obligations,contingencies, restructurings and income taxes. We base our estimates andjudgments on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances, the results of which form thebasis for making judgments about the carrying value of assets and liabilitiesthat are not readily apparent from other sources. Actual results may differfrom these estimates and judgments under different assumptions or conditions. Adiscussion of our critical accounting policies and the related estimates andjudgments affecting the preparation of our consolidated financial statements isincluded in the Company’s Annual Report on Form 10-K for fiscal year 2005. Exceptfor the Company’s adoption of FAS 123(R) on July 3, 2005, there has been nochanges in the Company’s critical accounting policies as disclosed in theCompany’s Annual Report on Form 10-K for fiscal year 2005.****

 

****With theadoption of FASB 123(R), the Company is required to record the fair value ofstock-based compensation awards as expenses in the consolidated statement ofoperations and comprehensive income (loss). In order to determine the fairvalue of stock options on the date of grant, the Company applies the Black-Scholesoption-pricing model. Inherent in this model are assumptions related toexpected stock-price volatility, option life, risk-free interest rate anddividend yield. While the risk-free interest rate and dividend yield are lesssubjective assumptions, typically based on factual data derived from publicsources, the expected stock-price volatility and option life assumptionsrequire a greater level of judgment which makes them critical accountingestimates.****

 

****TheCompany’s expected stock-price volatility assumption is based on both currentand historical implied volatilities of the underlying stock which is obtainedfrom public data sources. The Company determined the weighted-average optionlife assumption based on the exercise behavior that different employee groupsexhibited historically, adjusted for specific factors that may influence futureexercise patterns. The Company believes the above critical estimates are basedon outcomes that are reasonably likely to occur.****

 

15

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**Results of Operations**

 

***Revenue.***

 

Revenue source bygeographic region is reflected in the following table:

 
| ** **              | ** ** | **For the three months ended:** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands)** | ** ** | **April 1, 2006**                         | ** ** | **April 2, 2005** | ** ** | **Change** | ** ** |
| ** **              | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **US  revenue**         | ** ** | **$**                                               | **20,157** | ** ** | **48%** | ** ** | **$** | **15,073** | ** ** | **43%** | ** ** | **$** | **5,084** | ** ** | **34%** | ** ** |
| **Foreign  revenue**    | ** ** | **22,157**                                          | ** ** | **52%** | ** ** | **19,609** | ** ** | **57%** | ** ** | **2,548** | ** ** | **13%** | ** ** |
| ** **              | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  revenue**      | ** ** | **$**                                               | **42,314** | ** ** | **100%** | ** ** | **$** | **34,682** | ** ** | **100%** | ** ** | **$** | **7,632** | ** ** | **22%** | ** ** |

 
| ** **           | ** ** | **For the nine months ended:** | ** **  |
|----------------------|------------|--------------------------------|-------------|
| ** **           | ** ** | **April 1, 2006**              | ** **  | **April 2, 2005** | ** ** | **Change** | ** ** |
| ** **           | ** ** | ** **                     | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **US  revenue**      | ** ** | **$**                          | **48,894**  | ** ** | **45%** | ** ** | **$** | **37,653** | ** ** | **44%** | ** ** | **$** | **11,241** | ** ** | **30%** | ** ** |
| **Foreign  revenue** | ** ** | **59,227**                     | ** **  | **55%** | ** ** | **47,624** | ** ** | **56%** | ** ** | **11,603** | ** ** | **24%** | ** ** |
| ** **           | ** ** | ** **                     | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  revenue**   | ** ** | **$**                          | **108,121** | ** ** | **100%** | ** ** | **$** | **85,277** | ** ** | **100%** | ** ** | **$** | **22,844** | ** ** | **27%** | ** ** |

 

Consolidated Overview

 

Consolidated revenueincreased $7.6 and $22.8 million, to $42.3 and $108.1 million for the three- andnine-month periods, respectively, ended April 1, 2006, as compared to the threeand nine-month periods ended April 2, 2005. The increase was due primarily to auniform increase in demand for our products and product-related service on aworldwide basis, coupled with our continued expansion into newer markets.

 

Foreign revenue increased 13%or $2.5 million for the three-month period ended April 1, 2006, as compared tothe three-month period ended April 2, 2005, and was spread across all regions.

 

Foreign revenue increased 24%or $11.6 million for the nine-month period ended April 1, 2006, as compared tothe nine-month period ended April 2, 2005. Year-to-date foreign revenueincreased in Europe approximately $1.9 million accounting for 17% while revenuein Latin America increased $8.7 million accounting for approximately for 75% ofthis comparative increase.

 

US revenue increased by $5.1and $11.2 million, respectively, for the three- and nine-month periods endedApril 1, 2006, as compared to the three- and nine-month periods ended April 2,2005. This increase was generally uniform over all US sales territories.

 

16

----

 

Revenue source by type isreflected in the following table:

 

 
| ** **                     | ** ** | **For the three months ended:** | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands)**        | ** ** | **April 1, 2006**                         | ** ** | **April 2, 2005** | ** ** | **Change** | ** ** |
| **Revenue**                    | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers  and other products** | ** ** | **$**                                               | **34,796** | ** ** | **82** | **%** | **$** | **28,483** | ** ** | **82** | **%** | **$** | **6,313** | ** ** | **22** | **%** |
| **Product-related  service**   | ** ** | **7,518**                                           | ** ** | **18** | **%** | **6,199** | ** ** | **18** | **%** | **1,319** | ** ** | **21** | **%** |
| ** **                     | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  revenue**             | ** ** | **$**                                               | **42,314** | ** ** | **100** | **%** | **$** | **34,682** | ** ** | **100** | **%** | **$** | **7,632** | ** ** | **22** | **%** |

 
| ** **                     | ** ** | **For the nine months ended:** | ** **  |
|--------------------------------|------------|----------------------------------------------------|-------------|
| ** **                     | ** ** | **April 1, 2006**                        | ** **  | **April 2, 2005** | ** ** | **Change** | ** ** |
| **Revenue**                    | ** ** | ** **                                         | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers  and other products** | ** ** | **$**                                              | **88,677**  | ** ** | **82** | **%** | **$** | **70,365** | ** ** | **83** | **%** | **$** | **18,312** | ** ** | **26** | **%** |
| **Product-related  service**   | ** ** | **19,444**                                         | ** **  | **18** | **%** | **14,912** | ** ** | **17** | **%** | **4,532** | ** ** | **30** | **%** |
| ** **                     | ** ** | ** **                                         | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  revenue**             | ** ** | **$**                                              | **108,121** | ** ** | **100** | **%** | **$** | **85,277** | ** ** | **100** | **%** | **$** | **22,844** | ** ** | **27** | **%** |

 

Theincrease in revenue from lasers and other products for the three-month periodended April 1, 2006, compared to the three-month period ended April 2, 2005, resultedprimarily from an increase in the sales volume of our GentleYagTM product line,continued strength of our GentleLaseTM line, and the introduction of the VBeamTMplatform.The increase in revenue from product-relatedservice for the three-month period ended April 1, 2006, compared to thethree-month period ended April 2, 2005, resulted primarily from an increase inthe number of service-related contracts sold in addition to an increase in thenumber of consumables and accessories sold to support our installed base.

 

Theincrease in laser and other product revenue for the nine-month period endedApril 1, 2006, compared to the nine-month period ended April 2, 2005, resultedprimarily from an increase in the sales volume of our GentleYagTM product lineand GentleLaseTM, the introduction of the VBeamTM platform. Product-relatedservice increased during the nine-month period ended April 1, 2006, compared tothe comparative April 2, 2005 period, and resulted primarily from an increasein the number of service-related contracts sold in addition to an increase inthe number of consumables and accessories sold to support our installed base.

 

***Litigation Related Charges.***On February 17th 2005, anarbitrator issued an interim decision in the dispute concerning our royaltyobligations under our Amended and Restated License Agreement with The Regentsof the University of California (the “Regents”). In connection with thisinterim decision the Company recognized charges of approximately $5.6 million inthe fiscal quarter ended April 2, 2005. These charges consist of the settlementof prior year royalty claims made by the Regents against the Company ofapproximately $4.8 million and $0.8 million in attorney fees, interest, andprofessional costs as reimbursement of those charges to the Regents as requiredby the aforementioned license agreement. The royalty charges have been reportedseparately under cost of sales. All other charges have been reported separatelywithin operating expenses. OnMay 4th, 2005, the arbitrator issued his final award after review ofpost-arbitration submissions by the parties as to calculation of damages. Thefinal award was consistent with our interim estimation and recognition ofexpense recorded during the third quarter of 2005. There will not be anymaterial additional charges related to this matter in future periods. As aresult of the arbitrator’s ruling, the Company incurred royalty obligations tothe Regents on ongoing sales of the DCD at a royalty rate higher than it hasrecognized on DCD sales over the past few years.

 

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***GrossProfit.***Gross profit increasedto approximately $21.4 million or 50.6% of revenues for the three-month periodended April 1, 2006, compared to gross profit, excluding litigation-relatedcharges, of approximately $16.7 million or 48.2% for the three-month periodended April 2, 2005. Gross profit increased to approximately $54.9 million or 50.8%of revenues for the nine-month period ended April 1, 2006, compared to grossprofit, excluding litigation-related charges, of approximately $42.7 million or50.1% for the nine-month period ended April 2, 2005. These increases in grossprofit result principally from the increase in sales volume.

 

***Selling, General and Administrative Expense***. Selling, general and administrative expenses, increased to approximately $11.6 million for the three-month period ended April 1, 2006, from approximately $11.3 million for the three-month period ended April 2, 2005. As a percentage of revenue, selling, general and administrative expenses decreased to 27.4% from 32.5% of revenues from the three-month period ended April 2, 2005.For the nine-month period ended April 1, 2006, selling, general and administrative expenses increased to approximately $30.9 million from approximately $27.9 million for the nine-month period ended April 2, 2005. The dollar increases for the three-month and nine-month periods ended March 31, 2006 were due primarily to stock-based compensation expenses as a result of the adoption of FASB No. 123R, higher employee compensation consistent with the growth of the Company’s business and other expenses incurred consistent with the Company’s growth. As a percentage of revenue, selling, general and administrative expenses decreased to 28.5% from 32.8%. The percentage decreases for the three-and nine-month was primarily attributable to improved leveraging and productivity that resulted from the higher revenue growth, compared to the expense growth.

 

***Researchand Development Expense.*** Research and development spendingincreased to $2.4 million for the three-month period ended April 1, 2006 from $1.9million for the three-month period ended April 2, 2005 due primarily to anincrease in the number of active projects and an increase in employee costs. Spendingin this area increased to $5.9 million for the nine-month period ended April 1,2006 from $4.9 million for the nine-month period ended April 2, 2005 due primarilyto the aforementioned increase in project spending and an increase in employee-relatedcosts.

 

***OtherIncome/Expense.***Net other income was approximately $0.5million for the three-months ended April 1, 2006, compared to $0.1 million forthe three-months ended April 2, 2005. For the nine-month period ended April 1,2006, other income was approximately $1.0 million compared to other income ofapproximately $0.4 million for the nine-month period ended April 2, 2005. Theseincreases represent interest earned from the increase in our cash and cashequivalents, marketable securities and long-term investments.

 

***IncomeTaxes.*** The provision for income taxes results from acombination of activities of both the domestic and foreign subsidiaries of theCompany. The Company recorded a 37% effective tax rate for the three-monthperiod ended April 2, 2006, which brought the Company’s nine-month effectivetax rate to approximately 35%. This compares to the three-month and nine-month periodended April 2, 2005, in which the Company recorded a 32% effective rate. Theprovision for income taxes differs from the U.S. statutory rate as a result of taxprovisions calculated for income generated by foreign subsidiaries at a rate thatdiffers from the U.S. statutory rate.

 

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**Discontinued Operations**

 

On September 27, 2003, wepermanently closed our only remaining skin care center, which was located inBoston. The closure of the Boston skin care center, together with the earlier closingof our Scottsdale, Arizona spa, and the associated cessation of this line ofbusiness, is accounted for as discontinued operations. As a result of theclosure of the Boston skin care center, in the fiscal quarter ended September27, 2003, we recorded a $2.1 million charge for the accrual of $3.0 million offuture occupancy costs and $0.3 million of severance obligations and otherrelated costs of closure, net of anticipated tax benefits of $1.3 million. Inaddition, both the financial statements for the three months ended October 2,2004 and all prior financial statements have been restated to reflect skin carecenter operations as discontinued. During the three-month period ended October2, 2004, the landlord for the Boston facility secured a sublease for thatproperty. The Company was not able to determine the future economic benefit ofthe sublease at that time. The sublessee commenced making payments to thelandlord during December of 2004. As a result of these and future paymentsscheduled under the sublease, the Company revised the estimated future costsassociated with the Boston facility and, in the quarter ended January 1, 2005,reversed approximately $0.9 million of the restructuring reserve. This reversalrepresents the anticipated economic benefit due to sublessee payments of $1.7million, net of legal and other fees of approximately $0.3 million, and incometaxes of approximately $0.5 million.

 

The Company believes thatthe remaining accrual is sufficient to cover all future leasehold expenses forthe remainder of the lease term. These expenses could potentially increase ifthe sublessee were not to honor its leasehold obligations.

 

**Liquidity and Capital Resources**

 

Cash provided byoperating activities amounted to $6.1 million for the nine-months ended April 1,2006, in comparison to cash provided by operating activities of $9.9 millionfor the nine-months ended April 2, 2005. This decrease in cash provided byoperating activities is due the increase in inventories in order to maintainour increase in revenue, $4.0 million payment to the Regents, and increased paymentsof estimated taxes. Cash used by investing activities reflected the purchase ofheld-to-maturity investments during the nine-months ended April 1, 2006, comparedto the nine-months ended April 2, 2005. Cash provided by financing activitiesamounted to $7.3 million for the nine-months ended April 1, 2006 in comparisonto cash provided of $.5 million for the nine-months ended April 2, 2005. Theincrease reflects proceeds for the issuance of stock by the corporation,primarily to employees under the existing stock option plan.

 

We believe that ourcurrent cash balances will be sufficient to meet anticipated cash requirementsfor the next twelve months. 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, when such capital becomes required.

 

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**Off-BalanceSheet Arrangements**

 

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

 

Our outstandingcontractual obligations as of April 1, 2006, are reflected in the followingtable:

 
| ** **                          | ** ** | ** ** | ** ** | **Less than** | ** ** | ** **         | ** ** | ** **         | ** ** | **After**        | ** ** |
|-------------------------------------|------------|------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|------------------|------------|
| **(in thousands)**             | ** ** | **Total**  | ** ** | **1 year**    | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **5 years** | ** ** |
|                                |       |       |       |               |       |               |       |               |       |             |       |
| Royalty  commitments                |       | $          | 5,500      |               | $          | 1,000              |       | $                  | 2,000      |             | $          | 1,437 |   | $ | 1,063 |   |
|                                |       |       |       |               |       |               |       |               |       |             |       |
| Operating leases                    |       | $          | 3,069      |               | $          | 1,261              |       | $                  | 1,752      |             | $          | 56 |   | $ | 0 |   |
|                                |       |       |       |               |       |               |       |               |       |             |       |
| Total  contractual cash obligations |       | $          | 8,569      |               | $          | 2,261              |       | $                  | 3,752      |             | $          | 1,493 |   | $ | 1,063 |   |

 

We also maintain a renewable $10,000,000 revolving credit agreementwith a major bank with interest at the bank’s base rate, or LIBOR plus 2.25%. Anyborrowings outstanding under the line of credit are due on demand or accordingto a payment schedule established at the time funds are borrowed. The line ofcredit is unsecured. The agreement contains restrictive covenants limiting theestablishment of new liens, and the purchase of margin stock. No amounts wereoutstanding under the line of credit as of April 1, 2006.

 

**Cautionary Statements**

 

This Quarterly Report onForm 10-Q contains forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Forward-looking statements are notpromises or guarantees and are subject to risks and uncertainties that couldcause our actual results to differ materially from those anticipated. Suchstatements may relate to, among other things, the future of the industry,product development, business strategy (including the possibility of futureacquisitions), anticipated operational and capital expenditure levels,continued acceptance and growth of our products, and dependence on significantcustomers and suppliers. Forward-looking statements may also include, withoutlimitation, any statement relating to future events, conditions orcircumstances or using words such as or similar to:  anticipate; believe; continue; could;estimate; expect; intend; plan; predict; project; may; or will. 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 2, 2005, as well asother risks and uncertainties referenced in this Quarterly Report. These risksand uncertainties include, but are not limited to, the following:

 

•                  Ourprincipal source of liquidity is our cash and cash equivalents and marketablesecurities. Our ability to generate cash from operations is dependant upon ourability to generate revenue from selling our lasers and other products andproviding product-related services. A decrease in demand for our products andrelated services or increases in operating costs would likely have an adverse effecton our liquidity.

 

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

 

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

 

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•                  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 decidethe modifications were improper and require us to cease marketing and/or recallthe 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 toare invalid, could prevent us from manufacturing and selling some of ourproducts or require us to incur substantial costs from litigation ordevelopment of non-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 readers not toplace undue reliance upon any forward-looking statements, which speak only asof the date made. We expressly disclaim any obligation or undertaking torelease publicly any updates or revisions to any such statements to reflect anychange in our expectations or any change in events, conditions or circumstanceson which any such statement is based.

 

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**Item 3 - Quantitative andQualitative Disclosures About Market Risk**

 

We have foreign subsidiariesin Japan, Spain, France, Germany, Italy and Portugal. Approximately 55% of ourrevenues for the nine-months ended April 1, 2006, were from operations outsidethe United States. These subsidiaries transact business in both local and foreign currency. Therefore,we are exposed to foreign currency exchange risks and fluctuations in foreigncurrencies, which could adversely impact our results and financial condition. However,sales from the United States made directly to customers or distributors inforeign countries are invoiced in U.S. dollars and are not exposed to foreigncurrency risk.

 

From time to time, we mayenter into foreign currency exchange and option contracts to reduce ourexposure to foreign currency risk and variability in operating results due tofluctuation in exchange rates underlying the value of current transactions andanticipated transactions denominated in foreign currencies. These contracts obligate us to exchangepredetermined amounts of specified foreign currencies at specified exchangerates on specified dates. These contracts are denominated in the same currencyin which the underlying transactions are denominated and bear a contract valueand maturity date that approximate the value and expected settlement date,respectively, of the underlying transactions. We do not engage in foreigncurrency speculation.

 

We are exposed to avariety of market risks, including changes in interest rate affecting thereturn on its investments. We generally place our marketable securities inhigh-quality debt instruments. We have not experienced any material losses fromour marketable security instruments and therefore believe that our potentialinterest rate exposure is not material.

 

# **Item4 - Controls and Procedures**

 

Underthe direction of our Chief Executive Officer and Chief Financial Officer, weevaluated our disclosure controls and procedures and internal control overfinancial reporting and concluded that our disclosure controls and procedureswere effective as of April 1, 2006.

 

Duringthe nine-month period ended April 1, 2006, the Company remediated the materialweakness in internal controls over financial reporting that arose from theexistence of control deficiencies that adversely impacted the Company’s abilityto accurately and timely complete the Company’s year-end close process which wasreported in Candela’s Annual Report on Form 10-K for the year ended July2, 2005. More specifically, the Company has implemented new proceduresincluding providing for additional levels of senior level review for accruals,certain judgmental estimates, and accounting for sales of demonstration units,and also created additional management reports used for the analysis ofresults.

 

Exceptas discussed above, there were no changes in the Company’s internal controlover financial reporting during the quarter ended April 1, 2006, that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal controls over financial reporting

 

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**CANDELA CORPORATION**

 

**Part II. OtherInformation**

 

# **Item 1 - Legal Proceedings**

 

On March 31, 2006, theCompany settled the previously disclosed dispute the Company had with DVI, Inc,and DVI affiliates for a one-time payment of $150.

 

TheCompany believes that none of the legal proceedings that are presently pending,if adversely decided against the Company, will have a material adverse effectupon its financial position, results of operations, or liquidity.

 

# **ITEM 6 - Exhibits**

 

(a)                                  Exhibits

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

 

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**SIGNATURES**

 

Pursuant to 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:  | May 8, 2006                                         |   | /s/ F. Paul Broyer |   |
|   | F. Paul Broyer                                      |
|   | (Senior Vice President,  Finance and Administration |
|   | and Chief Financial  Officer)                       |
|        |                                                     |  |  |  |  |

 

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**CandelaCorporation**

 

**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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